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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended March 31, 1997 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 Identification No.)
incorporation or organization)
101 ROWLAND WAY, SUITE 110, NOVATO, CALIFORNIA 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
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
The aggregate market value of the voting stock held by non-affiliates of
the registrant on May 31, 1997, based upon the closing price of the Common Stock
on the NASDAQ National Market for such date, was approximately $21,355,481./1/
The number of outstanding shares of the registrant's Common Stock on May
31, 1997 was 7,598,397.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the Proxy Statement to be filed with the Securities and
Exchange Commission on or prior to July 30, 1997 and to be used in connection
with the Annual Meeting of Shareholders expected to be held September 2, 1997
are incorporated by reference in Parts III and IV of this Form 10-K.
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/1/ Excludes 4,181,520 shares held by directors, officers and ten percent or
greater shareholders on May 31, 1997. Exclusion of such shares should not be
construed to indicate that any such person possesses the power, direct or
indirect, to direct or cause the direction of the management or policies of the
registrant or that such person is controlled by or under common control with the
registrant.
1
PART I
FORWARD LOOKING STATEMENTS
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 other factors. In addition, such risks and
uncertainties also include the matters identified under Management's Discussion
and Analysis of Financial Condition and Results of Operations in Item 7 below.
ITEM 1. BUSINESS
Sonic Solutions ("Sonic" or "the Company") designs, develops, manufactures
and markets digital tools for professionals who manipulate media -- sound,
images, moving pictures and text -- in computer based settings. SonicStudio(TM)
is a line of digital audio random access editing and processing systems,
commonly known as Digital Audio Workstations ("DAWs"). SonicStudio systems are
used by a wide range of audio professionals to prepare recorded sound for
release on Digital Audio Compact Discs ("CDs"), for inclusion in film and video
sound tracks, and for broadcast on radio and television. The Company's Sonic
MediaNet product is an FDDI-compliant, high-speed local area network and file
management system that is optimized for management of data intensive file
transfers typically required in digital video, digital audio, computer graphics
and desktop publishing. The Company's DVD Creator product line is a complete
workgroup solution for DVD premastering. It includes MPEG-2 video encoding,
audio preparation and encoding, and the Scenarist-DVD software by Daikin
Industries, Ltd. of Japan ("Daikin") for disc authoring, layout, and formatting.
The Company's Sonic On-Air product line provides broadcast production and
delivery solutions for radio broadcast networks and stations.
Sonic's products generally include application software and specialized
hardware installed on a personal computer. Sonic's products are designed to
improve the productivity and effectiveness of media professionals, enabling them
to process and manipulate more material in a given amount of time and to achieve
results which would have been impossible using traditional linear analog or
digital technology.
INDUSTRY BACKGROUND
AUDIO MARKET; AUDIO MARKET SEGMENTS
The market for Sonic's audio products consists primarily of professional
facilities which prepare sound for commercial release of finished audio and
video products. The Company's products are used both by professionals who
primarily prepare sound, for example in the music recording and radio
broadcasting industries, as well as by professionals who primarily prepare
visual materials which incorporate sound, for example in the film and broadcast
video industries. Sonic's target customers include recording studios, mastering
houses (which balance, equalize and sequence recorded music for final release),
editing facilities (which edit production music, particularly classical and jazz
recordings), radio and television broadcast studios, and film and video post-
production facilities (which create sound tracks for film and video releases).
Sonic also markets to companies and other organizations that produce
professional quality video and audio products for in-house use.
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Sonic divides the professional audio market into three segments: Music
Post-Production/CD Preparation, Sound for Picture and Broadcast. The common
goal of audio professionals in each of these market segments is to produce the
highest quality finished audio product in the shortest period of time for the
lowest total cost. The professionals in each segment must perform somewhat
different tasks, however, and may require different tools. The Music Post-
Production/CD Preparation segment, which includes recording studios, mastering
houses and CD facilities, requires 2-channel, high-quality editing and filtering
to edit, mix, equalize and sequence sound recordings for release on CDs and
other media. The Sound for Picture segment, which includes film studios, video
post-production facilities and television networks and stations, requires multi-
track editing, video machine control, time compression and expansion, networking
and sound storage to modify sound tracks and audio special effects incorporated
in film and video. The Broadcast segment, which includes television and radio
networks, syndicators and independent stations, requires multi-track editing and
time code control to prepare and broadcast program material.
The requirements of these audio market segments are evolving as the
industry incorporates new digital video applications and shifts to production by
work groups. Companies in the Music Post-Production/CD Preparation segment, for
example, are seeking to produce music videos on CD. Participants in the Sound
for Picture segment are preparing for the release of feature films and other
products on CD, and are attempting to network audio and video production systems
for greater efficiency. Broadcast companies are beginning to use networks to
streamline the process of moving sound from production to on-air broadcast.
Sonic's products under development include enhancements of existing products
that address these new requirements and also are oriented to the use of digital
audio in markets outside the Company's traditional market segments, such as
digital video, computer graphics and desktop publishing.
ADOPTION OF PROFESSIONAL DIGITAL AUDIO WORKSTATIONS; VIDEO WORKSTATION MARKET
For the first 100 years of recorded sound, recording devices stored
representations or "maps" of sound waves on various analog media such as wax
cylinders, vinyl records and magnetic tapes. Traditional professional audio
practice had been built around high precision analog recording (usually magnetic
tape) and processing devices which operated in a linear, serial fashion. As
high fidelity analog recording technology developed in the 1950s, 1960s and
1970s, professional systems became larger, more elaborate and more cumbersome.
As a result of developments in the electronics industry, the technology
required for economical real-time recording and playback of digital audio became
generally available in the early 1980s. Digital recording significantly
improves the quality of sound and reduces noise and other forms of degradation
that can occur in analog recordings. A digital recording carefully and rapidly
measures or "samples" the strength of a sound wave at discrete points in time.
From the samples the original sound wave can be reconstructed perfectly within
the relevant range of human hearing. More importantly, the samples, which are
simply numbers, can be randomly accessed, processed, edited, corrected and
otherwise manipulated using digital signal processing software tools running on
general purpose and special purpose computer hardware. Professional recording
engineers became interested in digital recording when the rapid acceptance of
the CD in the music recording industry began to require most recorded music to
be released in digital format. In addition, although other audio formats such
as film sound tracks and radio and television broadcast channels remained
analog, recording engineers wished to gain the greater fidelity and reduced
degradation which digital recording offered and to perform certain kinds of
audio processing that were best performed or could only be performed using
digital technology.
Audio professionals have adopted two digital technologies: digital audio
tape-based systems ("DATs") and digital audio workstations ("DAWs"). DATs
record audio signals as digital information on magnetic tape and are designed to
operate like analog tape recorders. DATs gained early acceptance because they
reduced noise and distortion compared to analog systems, while preserving the
familiarity
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of the linear analog recording process. However, DATs offer little advantage
over analog technology with respect to sound manipulation. In addition, an
inefficient copying process must be used to edit digital audio tape recordings
because the physical "razor blade" editing typically used with analog tape is
generally impractical with digital audio tape.
DAWs allow professional audio engineers to manipulate and process
sound that has been recorded onto computer magnetic disk drives ("hard disks").
Early DAWs gained only limited acceptance because they were based on proprietary
hardware, were usually more costly than tape-based systems, required significant
redesign of studio work flow and operations, and did not permit easy movement of
volumes of sound onto and off of the workstation. However, DAWs offered
significant advantages over analog and DAT technologies through random access to
sound on the hard disks, and editing without altering the original recorded
sound. In addition, certain kinds of operations, such as signal reconstruction,
could be performed effectively only by using DAWs.
Currently available DAWs use digital signal processing and analog-to-
digital converter chip sets which are relatively inexpensive and are available
from a number of semiconductor manufacturers. In addition, the workstations
utilize widely available personal computers, high performance graphics monitors
and economical hard disks. The advantages of DAWs include:
. EFFICIENCY - DAWs enable professionals to perform audio processing and
editing tasks in less time than analog and DAT technologies. These
tasks may be processed concurrently and may be automated.
. COST SAVINGS - A single DAW typically replaces the traditional racks
of individual audio processing devices, each of which is typically
devoted to a single function such as filtering, compression or
reverberation.
. UNIQUE CAPABILITIES - Certain functions such as noise elimination,
declicking, pitch shifting and time compression and expansion are best
performed on DAWs where digital sound can be stored on randomly
accessible hard disks and re-accessed at various stages of analysis
and processing.
Although analog and linear digital technology remain significant
recording and processing formats for audio professionals, the substitution of
DAWs for traditional technologies is continuing due to the performance,
efficiency, cost and functionality benefits of DAWs. In addition, the use of
DAWs is being driven by the shift in the recording industry's standard release
format from analog (LP records and analog cassettes) to digital (CDs, digital
compact cassettes and MiniDiscs) as well as increasing interest in digital
release formats in the video, film and broadcast industries. Sonic believes
that these factors have created a market for the Company's products.
Emerging alongside the market for DAWs is a market for professional
digital video workstations and related tools. The Company believes that the
professional video post-production market is significantly larger than the
professional audio market. As in the case in the professional audio industry,
the substitution of digital video tools for existing analog video tools has
recently commenced and is expected to continue. In addition, as the film and
video industries increasingly utilize digital technology, the opportunities for
leveraging DAWs with digital video systems increase. As networked DAWs become
more widely adopted, teams of special effects, animation, and other media
specialists may be able to combine the traditionally separate processes of video
creation and audio creation, leading to greater efficiency and a reduction in
time to market for finished products.
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BUSINESS STRATEGY: SONICSTUDIO, DVD CREATOR, SONIC MEDIANET
SONICSTUDIO AND STRATEGY
In 1989, the Company introduced the Sonic System(TM), now called
SonicStudio(TM), a family of digital audio workstations for professional audio
users. A wide range of audio professionals now use SonicStudio to prepare
recorded sound for release on CD, for inclusion in film and video sound tracks,
and for broadcast on radio and television. SonicStudio consists of extensive
applications software as well as specialized hardware installed in a personal
computer. Currently, SonicStudio is compatible with most models of Macintosh
personal computers. The Company plans to introduce in fiscal 1998 versions of
SonicStudio compatible with other computer platforms. Because of the uncertain
nature of such development, there can be no assurance that problems or delays
will not be encountered which will delay or prevent such versions of the
SonicStudio from reaching market. In light of the substantial costs associated
with such development, the financial results of the Company would be materially
adversely affected if such introduction were delayed for a significant period of
time.
SonicStudio is designed to improve the productivity and effectiveness
of audio professionals, enabling them to process and manipulate more audio
material in a given amount of time, and to achieve results which would have been
impossible using other audio technologies. Versions of SonicStudio vary in
functionality from 4-channel systems for the editing and assembly of music and
other stereo material, to elaborate systems capable of input and output of 64
independent audio channels, playback of over 80 independent tracks from hard
disk storage, and performing a wide range of signal processing functions. End
user prices of complete Sonic configurations (including host computer and hard
disk storage, neither of which are typically sold by the Company) range from
under $10,000 to over $75,000.
The Company's SonicStudio strategy is to continue to offer products
that enhance professional productivity while meeting the specific needs of each
segment of its target market. The Company believes that SonicStudio and related
peripheral products currently accomplish this strategy for the following
reasons:
. FOCUS ON THE APPLICATION - Each segment of the professional audio
market targeted by Sonic has specialized needs. Sonic's product line
spans a wide range of performance characteristics, hardware and
software options, configurations and price points to address the
specific needs of discriminating professionals in each market segment.
. PROFESSIONAL PERFORMANCE - Sonic's continuing focus has been on
satisfying demanding professional performance requirements. The
Company has accomplished this to date by basing the design of the
SonicStudio on an architecture that utilizes specialized hardware and
software to ensure a fast, professional level of system response, to
avoid processing bottlenecks in handling bulky audio files and to
support the audio quality requirements of professional users. This
architecture also makes SonicStudio easily scaleable to a large number
of inputs and outputs.
. EFFICIENCY FEATURES - Sonic has designed SonicStudio to increase
operator efficiency. Every system allows background loading of sound
to the hard disks while the audio professional works on other material
already loaded on the hard disk. Most SonicStudio systems also allow
the audio professional to off load sound from the hard disks while
processing other material, to queue loading and unloading of audio
material, and to automatically control source and destination external
tape machines or other devices. In addition, the Company's Sonic
MediaNet product enables customers to network their workstations and
accelerate loading and unloading of audio material, thereby increasing
the processing efficiency of professional work groups by allowing them
to share work and resources.
. MODULAR SOFTWARE-BASED SOLUTIONS; UPGRADES - Sonic offers a modular
set of software applications which provide important benefits in terms
of cost effectiveness and the ability to
5
adapt quickly to changing customer needs. Sonic provides its
customers with optional integrated signal processing capabilities,
including digital equalization, filtering, dynamics, processing,
mixing, dithering, time compression, pitch shifting, varispeed and
reverberation. Every SonicStudio sold can be upgraded easily by the
addition of these and other software options. In addition, the
Company has historically offered customers under the Company's
SonicCare(TM) maintenance program relatively low priced hardware
upgrades when hardware versions change. This economical upgrade path
affords customers a degree of assurance that their investment in a
SonicStudio will not be quickly outmoded.
. NETWORKING - The Company's networking system, Sonic MediaNet, allows
users to share digital audio material efficiently among multiple
workers in a facility. SonicStudio is designed to be compatible with
Sonic MediaNet and includes software designed to take advantage of
Sonic MediaNet's high speed transaction protocols and bandwidth
reservation capabilities.
. HIGH LEVELS OF CUSTOMER SUPPORT - To meet the customer support needs
of audio professionals, Sonic employs personnel at its headquarters
and at other locations who deal directly with customers and work
closely with the Company's distributors and dealers to help them
provide customer support. The Company offers the SonicCare(TM)
maintenance program which provides for timely replacement of hardware
components, free access to new versions of SonicStudio software and
unlimited telephone technical support during specified hours.
. COST-EFFECTIVE INDUSTRY-STANDARD HARDWARE COMPONENTS - SonicStudio
utilizes cost-effective personal computers, high performance SCSI
disks and standard digital signal processing chips. This permits
Sonic's customers to benefit from computer industry-driven cost
reductions.
DVD CREATOR AND STRATEGY
During the last quarter of fiscal year 1994, the Company introduced
Sonic Cinema (previously called "Disc Video"), an option to SonicStudio
supporting premastering of Video CDs. Sonic Cinema consisted of third party
software and hardware and Sonic-developed software and hardware which supported
real time encoding of compressed digital video and audio according to the MPEG-1
standard, and encoding and sequencing of the resultant data stream into the
Video CD format.
At its introduction, Sonic Cinema was to be both an extension of the
Company's business in Compact Disc preparation, and a new business opportunity
incorporating elements of video, as well as audio and digital signal processing.
The Company shipped a limited number of Sonic Cinema systems on a Beta
site basis in late March 1994. During fiscal years 1995 and 1996, the Company
shipped a number of additional Sonic Cinema options for use by SonicStudio
customers.
The Company encountered only limited demand for Sonic Cinema. However,
the Company believed that Video CDs were a precursor to longer length, higher
quality video entertainment on a Compact Disc-like medium. In 1996, such a
format was introduced as the DVD/2/ standard, proposed and supported by a
consortium of 10 companies including Toshiba Corporation, Pioneer Electronics
Corporation, Matsushita Electronics Company, Sony Corporation, Time-Warner, and
Philips, N.V., among others. DVD discs are essentially the same physical shape
as conventional CDs but provide for storage of more information than CDs./3/ DVD
is intended to cover a range of applications including data storage (DVD-ROM),
video (DVD-Video), and audio (DVD-Audio), among others./4/
- --------------------
/2/ "DVD" does not stand for anything.
/3/ DVD discs are capable of storing 4.7 Gigabytes of data on a single layer
of a single disc side, compared to approximately 650 megaBytes of data on a
conventional CD-Audio disc. DVD also makes provision for double-sided
discs, and for two layers of storage on each side of a disc, resulting in a
total capacity of 18.2 gigaBytes on a single disc.
6
In March, 1996 the Company publicly announced its intention to produce
a premastering system for DVD-Video discs incorporating the three capabilities
necessary to produce a finished DVD premaster/5/ image: MPEG-2 video
compression, Dolby Digital/6/ Body Text and MPEG-2 audio compression, and
authoring. The system began limited shipment in June, 1996. This system,
called "DVD Creator," has a number of technical elements. For MPEG-2 video
compression, the Company has developed a set of plug-in boards with PCI host
interfaces. These cards are capable of inputting and compressing high
resolution digital video into MPEG at real time rates, and of decoding an MPEG
bit stream into a visible image. For audio compression, the Company has
programmed its USP audio cards to perform both the encoding and decoding of
Dolby Digital and MPEG-2 bitstreams/7/. For authoring, the Company incorporates
into DVD Creator a software package called Scenarist-DVD produced by Daikin
Industries Ltd. ("Daikin"). The Company concluded a distribution agreement with
Daikin covering Scenarist-DVD which gives the Company essentially exclusive
distribution rights outside Japan./8/
As a result of the introduction of the Company's DVD Creator system,
and dwindling demand for the Sonic Cinema product line, the Company discontinued
Sonic Cinema in December, 1996.
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 Digital 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. The DVD Creator
subsystems are networked together via the Company's Sonic MediaNet networking
system. The Company 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 the Company's audio and authoring subsystems with
another company's video encoding system).
During 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
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 (see further discussion of development risk below).
There are a number of
(..continued)
/4/ Version 1.0 standards for the physical DVD disc, the logical DVD disc (DVD-
ROM), and the video DVD disc (DVD-Video) were published in August of 1996.
Draft (Version 0.9) standards for recordable and re-writable DVD discs
(DVD-R and DVD-RAM, respectively) were published in April, 1997. Industry
observers expect that a standard for DVD-Audio will be published in late
1997 or early 1998.
/5/ In Compact Disc manufacturing, a disc "master" refers to a first generation
physical disc from which molds are produced which are used to manufacture
stamped copies. A disc "premaster" refers to the final data stream to
which final error encoding is applied prior to "cutting" the master disc.
Since the error encoding is a purely deterministic process, production of
the premaster marks the point after which no further judgmental or creative
decisions are possible.
/6/ "Dolby Digital" was previously called "AC-3".
/7/ In addition, to support real-time encoding of surround format Dolby
Digital, the Company plans to introduce in calendar 1997 a board which acts
as a co-processor to the USP.
/8/ The Company's exclusive distribution rights under the agreement with Daikin
will terminate under certain conditions, and at a certain point in the
future, after which the Company will have non-exclusive rights to
distribute and re-sell the Scenarist package.
7
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.
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. Further, the agreement
(as amended) provides for termination of Sonic's exclusive distribution rights
within the 1998 fiscal year. Depending on the market situation at that time,
the attractiveness of competitive offerings, the state of Sonic's internal
software development, and a number of other factors, Sonic's competitive
position in the market for DVD-Video premastering tools might be significantly
negatively affected.
While the Company believes that DVD Creator represents a significant
opportunity and it is the Company's current intention to further increase
expenditures for DVD development and marketing in the 1998 fiscal year, there
are a number of risks surrounding this initiative. These risks include but are
not limited to the following:
. DEVELOPMENT RISK -- The Company is new to the development of MPEG
video processing hardware and is utilizing a newly developed chip set
single sourced from IBM. Unanticipated development problems in the
continued production of the IBM chip set, the boards designed by the
Company incorporating the chip set, or the accompanying software could
seriously delay future releases of DVD Creator. In addition, the new
chip set or board could encounter either design or production problems
which would require another version of the chip or the card to be
developed, a process which can consume several months. While the
Company believes that there may be alternatives available to it from
other OEM suppliers, there can be no assurance that such alternatives
would be available on commercially reasonable terms and in the
timeframe needed. Sonic is also delivering as part of DVD Creator,
Dolby Digital and MPEG-2 audio encoding and decoding capabilities by
programming the Company's USP audio signal processing cards and by
designing co-processing hardware. While Sonic has significant
experience in signal processing of high quality digital audio, it has
only limited experience with Dolby Digital and MPEG-2 audio encoding
and decoding. Finally, authoring for DVD-Video is complex, and the
Scenarist-DVD authoring system is a complicated software package.
Daikin, which develops Scenarist, is continuing to develop and enhance
the software package. 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 many
of these problems have been resolved, 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. Delays in completing the Scenarist-DVD package could
result in significant delays in delivering the total DVD Creator
product.
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. MARKET RISK; COMPETITION -- The DVD-Video format has generated
significant interest in the professional marketplace. Sonic
anticipates that a number of companies will provide MPEG-2 video
encoding capabilities, audio encoding capabilities and authoring
systems for the professional user. Sonic is aware of a number of
companies working in some or all of these areas, some of which have
released or announced competitive products, including C-Cube
Microsystems, Digital Vision, Lucent, Minerva, 3DO, Philips,
Matsushita, Toshiba, Pioneer, Dolby Laboratories, and Sony, among
others. A number of these companies have financial or organizational
resources significantly greater than those available to the Company
and/or greater familiarity with certain technologies involved in DVD
premastering solutions. While the Company believes that it can
engineer a solution of acceptable or superior quality at a competitive
point, there can be no assurance that competitive offerings will not
be available in the market, and will not be better received than
Sonic's offering.
. FORMAT RISK; DELAYS -- There have been a number of delays in reaching
agreement on the final specification for DVD-Video, including
disagreements within the DVD 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. The final
specification of the DVD-Video format was published by the DVD
consortium in August, 1996, and an apparently final approach to the
problem of encryption of data was announced in October, 1996.
The DVD-Video format and players were introduced in Japan and other
parts of Asia in late 1996 and in North America and in Europe in early
1997. Many industry observers expect the format to be attractive to
consumers since it combines high-quality digital video, six-channel
surround sound, multiple 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.
Although there has been significant interest in the DVD format among
industry analysts and members of the press, there can be no assurance
that the DVD-Video format will be readily accepted by consumers.
There are a number of consumer entertainment formats that will compete
with DVD-Video in the future including broadcast TV, cable TV, high
definition Digital Tv, VHS cassettes, direct broadcast satellite
systems, and Internet distribution, among others. It is possible that
the DVD format will fail to attain "critical mass" acceptance among
consumers.
The Company expects that its DVD related business line will constitute
an increasing portion of Sonic's overall business in the future. The Company's
DVD strategy will continue to be based on the following elements:
. FOCUS ON PROFESSIONAL APPLICATIONS -- Sonic's DVD product and service
offerings are focused on video and audio professionals whose primary
concern is producing the highest quality DVD discs, in complete
compliance with worldwide standards, with a high level of efficiency.
Sonic plans to continue to evolve DVD-related premastering tools which
are fully compatible with "industry-standard" input formats and
typical professional video and audio equipment sets.
. HIGH PERFORMANCE TOOLS -- Sonic's DVD tools will offer professional
users the highest levels of performance, both in terms of power and
sophistication of processing, and in terms of maximizing facility
efficiency.
. FLEXIBLE CONFIGURATIONS -- Because DVD premastering is relatively new
and the application of DVD technology to the needs of content
publishers is still evolving, the balance of capabilities in typical
DVD premastering settings, and the typical workflow involved in
generating a DVD title are still in flux. Sonic has engineered DVD
Creator as a "workgroup" solution incorporating audio, video and
authoring subsystems integrated on a high speed network to make it
easy for facilities to re-arrange DVD workflow quickly, and to comply
easily with changing demands in the DVD universe. The Company plans
to continue to implement this philosophy in future DVD offerings.
9
. RANGE OF PRODUCT OFFERINGS -- DVD has a number of potential uses,
including applications in corporate and industrial training settings,
as well as in delivery of mass entertainment such as feature films,
videos, and recorded music. Sonic plans to evolve each element of its
DVD premastering tool set-- video, audio and authoring -- to
specifically address the specialized needs of such emerging segments.
SONIC MEDIANET AND STRATEGY
In 1992 the Company introduced SonicNet(TM), a 100 megabit per
second networking system which was designed to connect SonicStudios systems
together. Experience with SonicNet indicated that there might be demand for such
a high performance networking system beyond the population of SonicStudio
customers. Accordingly, in 1993, the Company undertook development to generalize
its networking system. The result was introduced as Sonic MediaNet in the last
quarter of the 1994 fiscal year.
Sonic MediaNet consists of specialized FDDI/CDDI adapter cards which
are installed in the NuBus or PCI Bus expansion slots of Macintosh computers.
Some of the cards include SCSI controllers which permit control over hard disks
and other SCSI-interfaced devices. Sonic MediaNet also includes a set of
specialized software running on the cards. This software includes a real time
operating system, file management system, and a set of standard and optimized
transaction protocols.
The aim of Sonic MediaNet is to provide an intelligent network/storage
subsystem, optimized to the needs of professionals who manipulate high bandwidth
"multimedia" data types such as digital audio, digital video, and high
resolution graphics. Sonic MediaNet includes support for standard networking
protocols, such as TCP/IP and the Apple Filing Protocol In addition to standard
protocols, Sonic MediaNet includes support for optimized movement of multimedia
data types from files, over the network, to calling applications. Included in
this support is provision for bandwidth reservation which permits calling
applications to insure delivery of multimedia data types at real time rates.
Since beginning shipments of Sonic MediaNet, the Company has
encountered demand for the product in applications involving manipulation of
high resolution graphics and images, primarily for pre-press applications, as
well as with DAWs provided by other companies, and with digital video
workstations. The Company has established sales and marketing channels for
Sonic MediaNet which are to some extent separate from sales and marketing
channels for SonicStudio.
EARLY SONIC MEDIANET TECHNOLOGY TRANSITION DIFFICULTIES
In the last quarter of the 1996 fiscal year the Company became aware
of competitive announcements which involved the use of standard high speed
network adapter cards, in particular, those based on 100 megabit per second
Ethernet ("Fast Ethernet"), with specialized software designed to circumvent
bottlenecks inherent in standard Macintosh networking protocols. These products
offered quite significant improvements over standard Macintosh networking at
price points significantly lower than Sonic MediaNet's. The Company believed
that these announcements would significantly reduce demand for Sonic MediaNet in
the prepress industry.
Based on these announcements, the Company began preparing for
transitioning Sonic MediaNet to other, faster networking protocols earlier than
it had previously planned. In connection with its decisions in these areas, the
Company reorganized its Sonic MediaNet sales and marketing group, accepted
certain returns of Sonic MediaNet product from dealers, and established
additional reserves against Sonic MediaNet receivables and inventory (see
discussion below "Products - Sonic MediaNet; Charges Related to Technology
Transition").
10
SONIC MEDIANET FUTURE DEVELOPMENTS
It is the Company's intention to introduce a second generation Sonic
MediaNet product line in fiscal 1998, incorporating newer networking
technologies and increased performance levels. In April 1997, the Company
announced its intention to base the second generation Sonic MediaNet product
line on FibreChannel technology. FibreChannel is a 1 Gigabit per second network
which, practically, can deliver more than 40 Megabytes per second throughput,
allowing uncompressed, professional quality digital video and multiple tracks of
high-resolution audio to be transferred in real time. This technology is
important to customers in the audio and video markets which Sonic serves, and is
finding its way into professional production environments.
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 sell through or returns of dealer
stocks of the first generation product. Such difficulties could have an adverse
affect on results of operations for future periods.
PRODUCTS
SONICSTUDIO
SonicStudio and related products constitute a significant part of the
Company's current product offerings. All SonicStudio systems include a broad
array of integrated applications software and specialized hardware installed on
a personal computer. The Company offers a wide range of options for
SonicStudio, including additional applications software, hardware and
networking products, all of which are integrated with SonicStudio.
The hardware components that support SonicStudio include proprietary
digital signal processing ("DSP") cards designed and manufactured by Sonic,
external interface devices, an Apple Macintosh personal computer and hard disk
storage. The Company commenced shipments of its SSP-3 card, the third
generation in the evolution of the Company's DSP cards, in late 1991. The SSP-3
card is a high performance digital signal processing card that allows the input,
output, storage and retrieval of audio material. Each SSP-3 is capable of input
and output of up to 4 channels of digital audio, and playback of up to 12 tracks
of digital audio from hard disk. The Company produces a number of external
peripheral devices for use with the SSP-3 card to provide necessary conversions
between analog and digital formats and between various digital audio formats,
and to handle synchronization with external video and/or audio equipment.
Multiple SSP-3 cards can be combined together to produce SonicStudio systems
capable of input and output of up to 16 channels of digital audio and 48 tracks
of playback from hard disk.
ULTRASONIC PROCESSOR PRODUCT TRANSITION; TRANSITION DIFFICULTIES
During the third and fourth quarters of the fiscal year ended March
31, 1995, and throughout the fiscal year ended March 31, 1996, the Company
experienced problems in executing a transition to a SonicStudio product line
including a new DSP card, the UltraSonic Processor ("USP"). In November 1994 at
the Audio Engineering Society ("AES") fall convention in San Francisco, the
Company introduced major changes to its SonicStudio product line, including the
introduction of its new UltraSonic Processor ("USP") for higher end SonicStudio
configurations as well as a repositioning of SonicStudio systems based on the
SSP-3 DSP card. The Company incorporates the USP card in SonicStudio
configurations priced at the mid-range and upper-end of the SonicStudio product
line. The USP, like the SSP-3 card, is a high performance signal processing
card that allows the input, output, storage, and retrieval of digital audio.
11
Compared to the SSP-3 card, the USP offers higher 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
the product transition which are discussed more fully in the Company's Form 10-K
for the fiscal year ending March 31, 1996 on file with the Securities and
Exchange Commission.
SONICSTUDIO SOFTWARE
All SonicStudio systems include a library of software tools that
enable a broad range of professional audio processing applications, including:
. RECORDING/LOADING - Professionals may record and load onto the
SonicStudio's hard disks at any resolution from 16 to 24 bits, and at
any of four standard professional sampling rates. The background
loading feature allows professionals to process one segment of program
material while other segments of program material are being prepared
for processing.
. EDITING - Professionals are free to "cut and paste" sound on
SonicStudio's hard disks into any sequence, leaving the originally
recorded sound unchanged. Volume changes and cross fades from one
sound segment to another are all performed in real-time. The operator
has a high degree of control over cross fades with a virtually
unlimited selection of fade durations, fade curves and fade
relationships. Collectively, these editing features offer
professionals highly refined control over the sound during preparation
of music and dialog material.
. SOUND DISPLAY - Professionals can display up to 64 internal tracks
either as waveforms which give a highly detailed, sample-level view of
the sound, as lists of text names and time code data, or as bars
indicating the presence or absence of sound. Fast display algorithms
permit virtually instantaneous modification, redisplay and audition of
edited material.
In addition, all SonicStudio systems include software that provides
audio professionals with the ability to mix and equalize audio material,
synchronize material used and processed on SonicStudio with audio material used
and processed on external devices, and store and replay certain processing
functions such as equalization levels. All SonicStudio systems also facilitate
project management by offering organization and flow control of project elements
as they are brought onto, off of and through the system.
SONICSTUDIO OPTIONS AND PERIPHERALS
SonicStudio is offered with a wide range of options. Most options
involve additional software and in some cases additional hardware. Options
available on the SonicStudio include:
. NONOISE(R) - The NoNOISE software option equips the SonicStudio with a
set of DSP tools for removing hiss, buzz, rumble, clicks, crackles and
other noises typically encountered in recording situations. NoNOISE
software is typically sold with additional SSP cards. Sonic Solutions
received an Emmy(R) award from the National Academy of Television Arts
and Sciences in October, 1996, for development of NoNOISE.
. TIMETWIST - Certain situations require the ability to change the
playing time of a particular sound. For example, it may be necessary
to shorten a radio commercial to fit into a pre-assigned time slot.
In other situations, it may be desirable to change the pitch of a
piece of sound without changing the running time. The TimeTwist
software option permits users to perform these audio functions with a
high degree of fidelity to the original sound and with a wide
operating range.
. MIXING DESK - The Mixing Desk software option adds enhanced
12
equalization and dynamics functions to the SonicStudio. The Mixing
Desk option includes more than fifteen different kinds of filters as
well as advanced dynamics processing.
. ADDITIONAL CHANNELS AND TRACKS - The smallest SonicStudio systems
include a single SSP-3 card capable of input and output of 2 or 4
channels of digital audio. Additional SSP-3 cards plus associated
interface hardware can be added to a SonicStudio system to permit
input and output of additional channels in groups of 4. Since each
SSP-3 card has direct control over external hard disks, additional
cards add to the System's track playback ability. In USP based
SonicStudio systems, each additional card enables input and output of
up to 16 channels, and playback of 24 or more tracks from hard disk.
To date, the largest SonicStudio systems shipped include four USP
cards used for audio input, output and playback. Such SonicStudio
systems are capable of 64 channels of input and output, and playback
of up to 96 independent tracks from the hard disk.
. PQ EDITING/CD MASTERING PACKAGE - This software option is oriented
toward the needs of facilities whose primary activity is preparation
of music for release on CDs. It permits users to edit subcode
information which permits the random accessing of tracks on CDs, and
to input and output CD premasters in a variety of standard formats,
including direct recording onto write-once CDs.
SONICSTUDIO CONFIGURATIONS
The hardware elements of the SonicStudio are combined together with
SonicStudio applications software to create various configurations. A great
number of combinations are possible. Simple SonicStuio configurations
permitting only 4 channels of audio input and output, and a limited range of
processing functionality carry a list price/9/ of $8,000, and when combined with
typical host computer and hard disk storage, represent a total price to the
customer of less than $15,000. A larger SonicStudio system, permitting 24
channels of audio input and output, and supporting a complete range of
processing capabilities, would carry a list price of app roximately $15,000, and
when combined with typical host computer and hard disk storage, would represent
a total customer investment of $25,000.
All of the Company's current products operate on, and a significant
portion of the Company's planned future products will operate on, Macintosh
computers. The Company's results of operations could be materially adversely
affected if the Company or its customers or dealers are unable to obtain
sufficient quantities of Macintosh computers. There can be no assurance that the
Macintosh will be a preferred computer in the professional audio market in the
future. Any future changes to the operating system or architecture of the
Macintosh computer could require the Company to adapt its products to those
changes, and any inability to do so, or delays in doing so, could render the
Company's current and future products obsolete. In this regard, Apple Computer
has introduced new versions of the Macintosh based upon the PowerPC
microprocessor. The Company currently supports the PowerPC in "emulation" mode
and plans to support PowerPC in "native" mode, in the future. The Company
believes that it will be able to make its systems operate on the PowerPC in
"native" mode, but there can be no assurance that this development will be
completed successfully or in a timely manner. Further, Apple Computer has
announced its intention to introduce an advanced operating system for the
Macintosh, based on developments originated by NeXT Computer, recently acquired
by Apple. There can be no assurance that the Company plans to migrate the
Company's products onto such a new operating system or will be able to do so in
a timely fashion.
- --------------------
/9/ Prices are based on U.S. Domestic list prices in effect as of the date of
this report.
13
SONIC MEDIANET; CHARGES RELATED TO TECHNOLOGY TRANSITION
Sonic MediaNet is a high performance, fully distributed networking
system designed specifically to handle digital audio, digital video, high
resolution graphics and other multimedia data types. Sonic MediaNet allows users
to share digital audio and other "multimedia" data types efficiently among
multiple workers in a facility. Sonic MediaNet combines FDDI or CDDI (fiber-
based or copper-based) technology with a special file system running on SCSI
disks attached directly to the network cards. This file system, called the
Digital Media File System (DMFS), addresses the needs of multimedia
applications. In addition to its use in digital audio applications, Sonic
MediaNet has uses in other areas of the computer industry 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. Sonic MediaNet is well-suited to the
problems of data sharing typically encountered by users of time sensitive and
bandwidth intensive applications such as digital video, computer graphics and
desktop publishing. The Company commenced commercial shipments of Sonic MediaNet
in the first calendar quarter of 1994.
The networking market is highly competitive, with purchase decisions
influenced by a variety of factors, including the cost of adoption, overall
performance, standards compliance and interoperability with other platforms and
devices. The networking market is a far more diverse market than the
professional audio market the Company has historically addressed and requires a
different marketing, sales, distribution and customer support strategy. The
Company has limited experience selling, distributing or supporting products such
as Sonic MediaNet, and there can be no assurance that the Company will be able
to establish the necessary distribution channels to sell and support Sonic
MediaNet or that the Company will be successful in marketing and selling Sonic
MediaNet or any of its other new products in new market segments. The Company
expects expenses to increase to support research and development and sales and
marketing efforts related to these new products in fiscal 1998. The Company's
results of operations will be materially adversely affected if these new
products do not achieve market acceptance.
During fiscal year 1996, the Company began preparing for transitioning
Sonic MediaNet to other, faster networking protocols earlier than it had
previously planned, based upon competitive announcements as discussed above in
"Early Sonic MediaNet Technology Transition Difficulties" beginning on page 10.
In connection with its decision, the Company incurred charges related to the
reorganization of its Sonic MediaNet sales and marketing group, accepted certain
returns of Sonic MediaNet product from dealers, and established additional
reserves against Sonic MediaNet receivables and inventory.
DVD CREATOR
The Company announced the DVD Creator product line in March, 1996, and
commenced limited shipments of DVD Creator in the quarter ending June 30, 1996.
DVD Creator includes three separable subsystems capable together of performing
all the tasks necessary for producing a finished DVD Video premaster -- the byte
stream "image" which is replicated on manufactured DVD discs.
The DVD-Video format offers content publishers a wide range of
features and options. Video is presented in the MPEG-1 or MPEG-2 compressed
digital video format. A number of video streams may be presented in parallel so
that, responding to user commands, the player may seamlessly jump from stream to
stream. Audio is available in both compressed digital stereo and "surround"
formats, as well as uncompressed "PCM" digital audio. Up to eight audio streams
may be presented simultaneously (and may also be selected for playback based on
real-time user decisions) -- to support different language dialog tracks, or to
allow stereo and surround versions of the same audio program. Chapter marks may
be specified for random access into the video program. Subpictures (images
overlayed on background video or still images) may be included and can be used
in a number of ways, for example, to create
14
animated "buttons" to facilitate user interaction, or to display language
subtitles. Still pictures may be presented with audio and with subpictures.
Extensive navigation capabilities are available to permit users to select from
various program branches, to return to previous branch points or menus, etc.
DVD Creator incorporates solutions for the major steps involved in
preparing a title for DVD and permits customers to integrate these individual
solutions into a complete DVD workgroup via the Company's MediaNet networking
system.
. DVD STUDIO - The DVD-Video standard specifies MPEG-2 and MPEG-1
compressed digital video as the video formats to be used on DVD-Video
discs. While a number of choices within the standard are possible, the
typically preferred format is variable bit rate MPEG-2 operating at an
average bit rate of approximately 4 Megabits per second./10/ DVD
Creator includes DVD Studio, a system enabling professional users to
compress input professional video into the MPEG-2 format. DVD Studio
consists of plug in circuit cards for the Macintosh incorporating an
MPEG encoding/decoding chipset developed by IBM. Sonic has developed
an extensive suite of applications software for DVD Studio to support
user control of the encoding process, and facilitate the operation of
DVD Studio with standard professional video tape recorders and other
typical peripherals.
. DVD STUDIO AUDIO SYSTEMS - The current audio offering within DVD
Creator bundles a standard USP-based SonicStudio system, running on
the Macintosh, with special software to perform Dolby Digital and
MPEG-2 audio compression and audition. At the current time, real time
compression of stereo Dolby Digital and stereo MPEG-2 audio is
supported; encoding of 5.1 Dolby Digital/11/,/12/ is supported with an
out-of-real time process. It is the Company's intention to support
real time encoding of 5.1 Dolby Digital in the summer of 1997, using
additional plug-in hardware to enable the process. At the present time
there is some confusion in the market regarding the acceptance of
MPEG-2 audio surround formats. Sonic has accordingly advised customers
that it is the Company's intention to support encoding of such formats
within DVD Creator if there is significant demand for them in the
marketplace. Conventional sample rate PCM audio (48 kHz) is supported
within the standard SonicStudio system included in every DVD Creator
Audio System. DVD Creator customers may purchase as an option a
special interface box and software supporting high resolution PCM.
. AUTHORING - DVD Creator's authoring subsystem is currently Scenarist-
DVD, developed by Daikin. In the authoring step individual compressed
video, audio (compressed and/or uncompressed), graphics, still picture
and subpicture elements are assembled, organized, linked with
instructions specifying interactivity (i.e, the response DVD players
will make based on user manipulation of front panel buttons or remote
control buttons), combined and assembled into the final disc image.
Because of the large number of possible elements in a DVD title, and
the wide degree of interaction supported, Scenarist is a complicated
software package. The current version of Scenarist runs on
workstations manufactured by Silicon Graphics. The package offers a
data entry capability where individual DVD elements contained in
individual computer files are logged into a database. A data editor
permits the user to associate individual audio, video, still image and
subpicture elements with each other for synchronous playback. A
scenario editor
- --------------------
/10/ Encoding at this bit rate permits an average feature-length movie (135
minutes) to be encoded on a single layer of a single sided DVD disc.
/11/ The Company is a licensee of Dolby Laboratories both with respect to the
Dolby Digital patents and with respect to the encoding software.
/12/ In this context "5.1" refers to the number of surround channels supported.
In Dolby Digital surround audio 6 speakers are utilized, 5 for the main
program channels -- Left Front, Center Front, Right Front, Left Rear (or
"Left Surround"), and Right Rear (or "Right Surround") -- and 1 for the
sub-woofer optimized for playback of low frequency sound.
15
permits users to script the flow of playback of a DVD title, both
automatic playback and in response to consumer commands. Finally,
Scenarist includes software to perform the elaborate "weaving"
together of elements, a process referred to as "multiplexing," and
then to format the multiplexed data into the micro-UDF file system
required by the DVD standard.
. EMULATION - Because of the complexity of a DVD title, and the absence,
currently, of desktop DVD disc recording systems, users of DVD Creator
require the ability to preview the results of their decision making
before the time consuming and expensive step of cutting a "glass
master" at the replication plant. An optional (software and hardware)
emulation station permits the user to interact with a DVD title stored
as project elements on hard disk prior to final image generation.
DVD Creator is sold both as a complete package and as separable
elements. Customers may purchase a complete DVD Creator system for $175,000, not
including host computers or disk storage (which typically would add $50,000 or
more to the cost of the system). The DVD Studio system is available in a variety
of configurations, with a typical list price of $176,000 for a complete
workgroup of systems. The complete DVD Studio video encoding system carries a
list price of over $90,000. The DVD Studio complete audio system has a list
price of $50,000. Scenarist-DVD carries a list price of $35,000.
Since the market for DVD premastering is still quite new and the
target market is somewhat specialized, the Company offers the current DVD
Creator product line with a limited set of options. The Company anticipates
that in the future it will introduce other versions of the DVD Creator product
line, some with reduced functionality priced more economically to address the
needs of budget conscious customers, and some which will carry higher prices to
reflect additional value added functionality.
CUSTOMERS
The SonicStudio product line has been adopted by many professional
audio facilities around the world, with more than 3,100 SonicStudio systems
shipped to customers, as of March 31, 1997. In addition to sales of SonicStudio
direct to end users or to dealers for resale to end users, Sonic Studio is also
sold on an OEM basis to customers who incorporate SonicStudio into products of
their own. During fiscal year 1997, Sonic's largest such OEM relationship was
with Discreet Logic, which incorporates SonicStudio technology into its
Flame(TM) and Fire(TM) digital video processing and editing systems.
Sonic MediaNet is sold to SonicStudio and DVD Creator customers as
well as to customers who use Sonic MediaNet with other applications, principally
in the pre-press graphic arts industry. As of March 31, 1997, the Company had
shipped approximately 4,000 Sonic MediaNet cards. Of these, approximately 2,900
were shipped for use with applications other than with SonicStudio or DVD
Creator.
DVD Creator is sold to professional audio and video facilities,
production studios, as well as CD/DVD plants and corporate customers. As of
March 31, 1997 Sonic had shipped approximately 64 DVD Creator systems to
customers in various locations around the world (not all customers purchased all
three subsystems of DVD Creator).
The Company is not materially dependent on any one customer and no
customer accounted for more than 10% of the Company's sales revenue during the
fiscal years ended March 31, 1995, 1996 or 1997.
SALES AND DISTRIBUTION
SONICSTUDIO SALES AND DISTRIBUTION
The Company sells its SonicStudio products through a network of
dealers and distributors augmented with sales and technical support which is
provided both to dealers/distributors and to
16
customers by the Company's headquarters and regional sales and support staff.
Generally, dealers and distributors are assigned a territory on an exclusive,
semi-exclusive or non-exclusive basis for part or all of the SonicStudio product
line. Sales leads are generated by the Company's dealers and distributors, by
the Company's regional sales managers, and by the Company's advertising and
other direct marketing activities. The Company works with dealers, distributors
and customers to provide technical and sales support as required to facilitate
the sales process.
The complexities of the SonicStudio and the length of the typical
sales cycle require the Company's dealers and distributors to possess a high
level of technical aptitude, as well as adequate financial resources. Only a
limited number of dealers and distributors possess the required technical
expertise and financial resources, and the Company has experienced difficulties
in identifying and establishing relationships with such dealers and
distributors. The Company's business and financial performance may be
materially adversely affected by any failure of the Company's distributors and
sales force to achieve sales levels consistent with the Company's expectations.
This is particularly true with international dealers and distributors which
possess additional difficulties with fluctuations in exchange rates,
difficulties in managing accounts receivable, tariff regulations, foreign safety
and radio frequency emissions regulations and difficulties in obtaining export
licenses, among other factors. In addition, certain of the Company's dealers
and distributors sell products which may compete directly or indirectly with the
Company's products. There can be no assurance that these dealers and
distributors will not devote greater resources to selling products from other
companies. Failure of the Company's dealers or distributors to successfully
market the Company's products could have a material adverse effect on the
Company's results of operations.
Currently, the Company has 20 dealers in the United States and 38
dealers and distributors outside the United States covering more than 40
countries. The Company employs 6 regional sales managers and 2 field sales
engineers in North America, Europe and the Pacific Rim supported by a
headquarters sales and sales administration staff.
In the 1997 fiscal year the Company opened a sales and support office
in London. In April 1997 the Company opened a sales and support office in
Tokyo.
SONIC MEDIANET SALES AND DISTRIBUTION
The Company sells Sonic MediaNet for use with SonicStudio systems
through its SonicStudio sales and distribution channel described above. Sales
of Sonic MediaNet for applications other than the SonicStudio, principally
graphic arts applications, are made via a network of specialized dealers and a
dedicated sales force. As of March 31, 1997 the Company had 30 Sonic MediaNet
dealers in North America and 18 outside North America. The Company also employs
one full time sales person and one full time customer service representative for
Sonic MediaNet.
DVD CREATOR SALES AND DISTRIBUTION
Since the market for DVD premastering is still quite new, the market
is somewhat specialized and the function of generating DVD premasters is complex
and unfamiliar to many video and audio professionals, the Company has not yet
established an extensive distribution structure for DVD Creator. In the
Americas, all sales are currently made directly to end users without dealer
assistance (except to provide peripheral packages upon customer request). In
Europe, the Company had appointed, by March 31, 1997, 4 dealers covering certain
territories within Europe, although certain sales were still handled directly by
the Company's direct employees. In the Pacific Rim, the Company had appointed 6
dealers for DVD Creator by March 31, 1997, with some significant portion of
sales handled directly by the Company's sales staff.
17
The Company anticipates that in the future it will add additional
dealers for selling DVD Creator systems. Depending on the evolution of the
Company's DVD product line, it may be desirable to establish different dealer
structures for various parts of the Company's DVD business.
CUSTOMER SUPPORT
The Company believes that active customer support is important to
professional users, and has therefore made customer support an important part of
its strategy. The Company offers the SonicCare maintenance program to
SonicStudio and DVD Creator customers. Under this program customers purchase
annual service contracts which provide for ongoing software upgrades, telephone
support, replacement hardware and preferential access to new products and
upgrades. Customers typically add a SonicCare option to their initial system
purchase.
Sonic maintains a staff of product support specialists at the
Company's headquarters and in the field. Unlimited telephone support is
provided during scheduled support hours to all customers under maintenance
contract or initial system warranty. Customer support calls also provide the
Company with another means of understanding customer requirements for future
product enhancements. In addition, the Company also administers a customer
calling program in which customers are contacted by a Sonic customer support
representative to assess their level of satisfaction and to acquaint them with
new product offerings.
RESEARCH AND DEVELOPMENT
The Company's research and development strategy continues to be to
develop high quality digital media product solutions and related tools for its
target markets. The key to this strategy will continue to be the quality and
tenure of the Company's research and development personnel and the Company's
management. The Company's research and development staff consists of twenty-six
hardware and software engineers with technical backgrounds in digital audio
signal processing, digital video image processing, distributed networking, and
computer systems design.
Sonic's research and development program emphasizes development of
additional products or product enhancements to serve existing market segments as
well as extension of existing products to new markets and applications. The
Company's development team exhibits a number of technology capabilities
including the following which the Company believes are particularly important in
light of the Company's strategy:
. DIGITAL SIGNAL PROCESSING - Sonic's engineering team is experienced at
providing DSP solutions which address the quality and performance
requirements of audio and video professionals.
. MEDIA MANIPULATION ARCHITECTURES - The Company's engineers are
experienced in dealing with the requirements of high bandwidth, time
synchronous multimedia data types in computer-based settings. The
Company believes that this has resulted in products which provide cost
effective solutions to multimedia data manipulation for professional
applications.
. CRAFT FAMILIARITY - The Company's engineers are experienced in the
needs and work patterns of audio, film and video professionals. The
Company believes that this has resulted in products which adapt the
power of digital technologies to the work habits of creative
professionals.
The markets for the Company's products are characterized by rapidly
changing technology, evolving industry standards and frequent new product
introductions. The Company's future success will depend in part on its
continued ability to enhance its existing products and to introduce new products
and features to meet changing customer requirements and evolving industry
standards. The Company's research and development efforts are subject to a
number of risks, and there can be no assurance that the
18
Company's research and development efforts will be successful or completed in a
timely manner. In addition, future Company products and enhancements may
contain undetected or unresolved errors which could adversely impact market
acceptance. There can be no assurance that the Company will successfully
complete the development of these enhancements and products or that the
Company's products will achieve market acceptance. Any delay or failure to
complete development of the Company's products and any failure of the Company's
products to achieve market acceptance would have a material adverse effect on
the Company's results of operations.
COMPETITION
The market for professional audio systems is highly competitive.
Digital audio workstations, including systems offered by the Company, currently
account for only a small portion of the overall market for professional audio
equipment. The Company encounters competition from a large number of companies
offering traditional analog production tools, digital tape oriented tools and
workstation-based tools. Sonic generally competes against companies on the
basis of features, cost effectiveness and product quality, customer support, and
marketing and sales efforts. Sonic competes with companies on different bases
depending on the nature of the competitor's products. For example, when selling
against companies offering a traditional analog solution, the Company competes
on the basis of editing capability, industry trends to substitute digital
technologies for analog and potential return on investment through productivity
and quality gains. When selling against companies offering digital tape-based
systems, the Company competes on the basis of speed and ease of editing and
processing, and economic and processing efficiencies afforded by workstations.
When selling against companies offering digital workstation solutions, the
Company competes on the basis of the power and effectiveness of it's software
applications, the cost and availability of expansion through optional upgrades
and the customer's ability to maintain an integrated system and achieve
networking capabilities.
Many of the Company's competitors have greater financial, technical
and marketing resources than Sonic. Traditional professional audio competitors,
such as Japan Victor Corporation (JVC), Otari Corp., Sony Corporation and Studer
AG (a division of Harmon), which have a major share of the analog and digital
tape professional audio market, continue to sell analog and digital-tape based
systems. A number of these competitors have introduced, or may be developing,
digital audio workstations which will compete more directly with Sonic's
products. Divisions of Siemens AG (Siemens Audio) and the Carlton Companies
(SSL), among others, market relatively high end professional disk-based digital
audio systems which compete with the upper end and mid-range of Sonic's product
line. Some independent companies and some divisions of large musical instrument
companies offer hard disk-based digital audio systems which compete with various
parts of Sonic's product line, including Avid Technology, Digidesign (a division
of Avid Technology), Fairlight, Spectral Synthesis (acquired by Euphonix),
Studio Audio and Design, Ltd. (Sadie), Studer Editech (a division of Harmon
International), and TimeLine Vista Inc. (WaveFrame), among others. Alesis
Corporation and Tascam, Inc. have recently introduced low cost multi-track
digital tape systems which compete with the lower end of Sonic's product line.
In addition, other companies manufacture various kinds of single function
digital audio processing devices which compete with the Company's noise
reduction, time compression and reverberation software options, for example,
noise reduction modules from Cambridge Audio Research (CEDAR) and time
compression, pitch shift, and reverberation modules from Lexicon (a division of
Harmon). In the networking area, many companies provide FDDI- and CDDI-
compliant solutions, as well as solutions based on alternate network
technologies such as Asynchronous Transfer Mode (ATM) and "Fast" Ethernet, which
may compete with Sonic MediaNet. Please see discussion "Products - Sonic
MediaNet; Charges Related to Technology Transition" beginning on Page 16.
While the market for DVD premastering systems is still quite new, the
Company has already encountered significant competition from a number of
different kinds of companies. For example, a number of companies specialize in
MPEG video encoding, and many of these have introduced systems
19
compliant with the DVD-Video specification. Among these are C-Cube Microsystems,
Digital Vision, Lucent, Minerva, 3DO, Philips, Matsushita, Toshiba, Pioneer,
Zapex, and Nuko. In addition, the Company believes that other companies, not
currently offering DVD-Video MPEG-2 video compression systems are likely to
enter the market for such systems in the forseeable future. Among these are
Optivision, Optibase, and Sony. In the DVD-Audio area, Dolby Laboratories,
Zapex, Minerva, and other companies already offer, or have announced systems
which perform Dolby Digital and/or MPEG-2 audio compression. Authoring systems
for DVD-Video are available from or have been announced by Philips, Matsushita,
Pioneer, and Hyundai, among others. The Company anticipates that there will be
additional competitors offering solutions in some or all of these areas in the
near future.
Sonic's competitors may be able to develop products comparable or
superior to those offered by the Company, or to adapt more quickly than the
Company to rapidly evolving market requirements and technologies. In addition,
other companies possessing competitive technologies or which are active in the
Company's markets may attempt to develop products that compete with the
Company's products. There can be no assurance that Sonic will be able to
continue to compete effectively in its markets, that competition will not
intensify or that future competition will not have a material adverse effect on
the Company's results of operations.
PROPRIETARY RIGHTS
The Company's future success will depend in large part on its
proprietary technology. The Company relies on a combination of trade secret,
copyright law, and trademark law, contracts and technical measures to establish
and protect its proprietary rights in its products. The Company's products are
generally sold pursuant to purchase and license agreements which contain terms
and conditions restricting unauthorized disclosure of the proprietary software
embodied in its products. The Company has applied in the United States for
patents covering certain of its technology and may apply for additional patents
in the future. There can be no assurance that the patents applied for or any
additional patents applied for by the Company will issue, or that any patents
that may issue will be valid and enforceable. In addition, even if any such
patents were enforceable, the Company anticipates that any attempt to enforce
its patents will be time consuming and costly.
Although the Company relies to a great extent on trade secret
protection for much of its technology, and has obtained confidentiality
agreements from most of its employees, there can be no assurance that third
parties will not independently develop the same or similar technology, obtain
unauthorized access to the Company's proprietary technology or misuse the
technology to which the Company has granted access.
The Company believes that, due to the rapid proliferation of new
technologies in the audio, video and general software industries, intellectual
property protection of the Company's proprietary technology will be less
influential on the Company's ability to compete in its target markets than the
ability of the Company's research and development staff to design products that
continue to address evolving customer requirements, and the ability of the
Company to enter new markets and to service its customers. In addition, the
Company has substantial international sales, and the laws of foreign countries
treat the protection of proprietary rights differently from, and may not protect
the Company's proprietary rights to the same extent as do, laws in the United
States.
The status of United States patent protection in the software industry
is not well defined and will evolve as the United States Patent and Trademark
Office grants additional patents. Patents have been granted recently on
fundamental technologies in the multimedia area and patents may issue which
relate to fundamental technologies incorporated into the Company's products.
Since patent applications in the United States are not publicly disclosed until
the patent issues, applications may have been filed which, if issued as patents,
would relate to the Company's products. In addition, the Company has never
conducted a comprehensive patent search relating to all of the technology used
in its products.
20
Accordingly, there may be issued patents which relate to the Company's products.
There can be no assurance that any infringement claims will not be made or that
they will not be successful. The Company could incur substantial costs in
defending itself and its customers against any such claims, or in prosecuting
infringement claims against third parties. Furthermore, parties making such
claims may be able to obtain injunctive or other equitable relief which could
effectively block the Company's ability to sell its products in the United
States and abroad, as well as substantial damages. Such equitable relief could
materially adversely effect the Company's results of operations. In the event
of a claim of infringement, the Company and its customers may be required to
obtain one or more licenses from third parties. There can be no assurance that
the Company or its customers could obtain necessary licenses from third parties
at a reasonable cost or at all. Failure to obtain any such required license
would have a material adverse effect on the Company's results of operations.
In this regard, the Company has been advised by a patent holder that
Sonic MediaNet infringes patents covering basic token ring technology. The
Company believes that Sonic MediaNet does not infringe such patents, and that if
its does, a license will be available on terms which are reasonable from the
Company's point of view. However, there can be no assurance that such a license
agreement will be available on terms which will not have a material adverse
effect on the Company's results of operations.
The Company has also been advised that its use of the "MediaNet"
trademark infringes the rights of the owner of the trademark "MediaNet"
registered for a product line in an application unrelated to the Company's
business. The Company has negotiated a non-financial settlement regarding the
usage of the MediaNet name with the owner of the registered trademark and the
Company believes that the settlement was concluded on terms which are reasonable
from the Company's point of view.
MANUFACTURING AND SUPPLIERS
Sonic's hardware products are either manufactured under contract by
various electronics manufacturing and assembly houses in the San Francisco Bay
Area or are purchased as completed sub-assemblies from manufacturers. Final
assembly, integration and testing is performed at Sonic's Novato, California
facility. Generally, Sonic's dealers or third parties supply the Macintosh
computer for use with the SonicStudio.
The Company is dependent on sole-source suppliers for certain key
components used in its products, including DSP, AES/EBU audio
receiver/transmitter and FDDI chips, all manufactured by Motorola, Inc., SCSI
controller chips manufactured by NCR Corp., field programmable logic arrays
manufactured by Xilinx, Inc. and Altera, MPEG encoding/decoding chipset
manufactured by IBM, CDDI modules manufactured by Cisco Systems, Inc., and
specialized static RAM manufactured by Integrated Device Technologies ("IDT"),
among others. The Company purchases these sole-source components pursuant to
purchase orders placed from time to time, does not carry significant inventories
of these components and has no guaranteed supply agreements. In December 1994,
the Company experienced shortages in certain key components (IDT Static RAM and
Motorola AES Transceivers) for the USP card, the SSP-3 card, and their
peripherals. The USP card, the SSP-3 card and their peripherals have several
sole-sourced components and the Company cannot guarantee that adequate supplies
of these components will be available in future quarters. The Company
experienced a supply limitation of DSP chips from Motorola, Inc., in the fall of
1993, which the Company was able to remedy by purchasing DSP chips from other
sources at greater cost. Any extended future interruption or limitation in the
supply of any of the components currently obtained from a single source could
have a material adverse effect on the Company's results of operations. Also,
because of the Company's reliance on these sole-source components, the Company
may be subject to increases in component costs which could have an adverse
effect on the Company's results of operations. In the past, the Company has
scheduled introduction of certain products based on the scheduled availability
of components from third parties and has experienced delays in the timely
availability of these components. If such delays occur in the future, the
21
introduction of the Company's proposed new products would be delayed and could
have a material adverse effect on the Company's results of operations.
Early in the 1997 fiscal year the Company began exploring various
"outsourcing" alternatives for further streamlining its manufacturing
operations. In the summer of 1996, the Company began shifting various hardware
products into an outsourcing arrangement with Time Electronics. Under this
arrangement, Time is responsible for purchasing components, assembly into
circuit cards, and testing of hardware products. Time's responsibility is to
produce according to forecast schedules provided by Sonic. During the quarter
ended March 31, 1997, approximately 65% of all product shipped by Sonic during
the quarter were procured through this outsourcing program. It is the Company's
current intention to continue to shift its production into outsourcing until
only new or prototype products are manufactured directly by the Company. Sonic
expects that this point will be reached within the 1998 fiscal year.
While an outsourcing approach presents a number of advantages to
Sonic, there are various risks that are an inherent part of such a program.
Chief among these is that the the Company's production is significantly
dependent on a single source. Financial, operational, or supply problems
encountered by Time could result in Sonic's inability to obtain timely delivery
of finished product. Any such difficulites would adversely effect the Company's
financial results.
BACKLOG
The Company schedules production based on firm customer commitments
and anticipated orders. The Company generally ships its products within one
week of acceptance of a customer purchase order and, accordingly, operates with
only a little or no backlog. All orders are subject to cancellation or delay by
the customer with limited or no penalty. The Company does not believe that the
level of backlog is an indicator of the Company's future performance.
EMPLOYEES
At March 31, 1997, the Company had 90 full-time equivalent employees,
including 34 in marketing, sales and customer support, 33 in software and
hardware engineering, 13 in manufacturing and 10 in administration and finance.
The success of the Company's future operations depends in large part on the
Company's ability to recruit and retain engineers, technicians and other
professionals who are in considerable demand and the process of locating
technical, marketing, sales and management personnel with the combination of
skills and attributes required to execute the Company's strategy is often
lengthy. The Company believes that it will need to hire additional technical
personnel in order to enhance its existing products and to develop new products.
If the Company is unable to hire additional technical personnel, the development
of new products and enhancements would likely be delayed. The loss of the
services of these and other key personnel, particularly Robert J. Doris, Mary C.
Sauer and James A. Moorer, or the inability to attract new personnel, could have
a material adverse effect upon the Company's results of operations and research
and development efforts. None of the Company's employees is represented by a
labor union and the Company has never experienced a work stoppage, slowdown, or
strike. The Company considers its employee relations to be good.
ITEM 2. PROPERTIES
Sonic's principal administrative, sales and marketing, research and
development and support facility is located at 101 Rowland Way in Novato,
California and consists of approximately 30,000 square feet under a lease which
expires in 2001.
22
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the fiscal year ended March 31, 1997, the
Company did not submit any matters to a vote of its security holders.
SUPPLEMENTAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company and their ages as of May 31,
1997 are as follows:
- --------------------------------------------------------------------------------
Name Age Position
---- --- --------
Robert J. Doris 44 President (Chief Executive Officer) and Director
James A. Moorer 51 Senior Vice President of Audio Development and
Director
Mary C. Sauer 44 Senior Vice President of Marketing and Sales and
Director
A. Clay Leighton 40 Vice President of Finance (Chief Financial Officer)
- --------------------------------------------------------------------------------
ROBERT J. DORIS. Mr. Doris founded Sonic Solutions in 1986 and has
served as President and Director of the Company since that time. Prior to 1986
he was President of The Droid Works, a subsidiary of Lucasfilm Ltd., which
produced computer-based video and digital audio systems for the film and
television post-production and music recording industries. Prior to founding
The Droid Works, Mr. Doris was a 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. Mr. Doris is married to Ms. Sauer.
JAMES A. MOORER. Dr. Moorer joined Sonic Solutions in 1987 and has
served as a Vice President and Director of the Company since that time. Dr.
Moorer became Senior Vice President of Audio Development in February 1993. Dr.
Moorer was the principal developer of the NoNOISE and SonicStudio products.
From 1986 to 1987, Dr. Moorer consulted for NeXT, Inc., on DSP software
architecture for audio processing. From 1985 to 1986, he was the Chief Technical
Officer at The Droid Works. From 1980 to 1985, he was the digital audio project
leader at Lucasfilm, Ltd. Dr. Moorer holds a Ph.D. in Computer Science from
Stanford University and S.B. degrees in Applied Mathematics and Electrical
Engineering from MIT. In 1991, he won the Audio Engineering Society Bronze
Award for lifetime achievement.
MARY C. SAUER. Ms. Sauer founded Sonic Solutions in 1986 and has
served as a Vice President and Director of the Company since that time. Ms.
Sauer became Senior Vice President of Marketing and Sales in February 1993.
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 an M.B.A. in Finance and
Marketing from the Wharton School of the University of Pennsylvania and a B.F.A.
from Washington University in St. Louis. Ms. Sauer is married to Mr. Doris.
A. CLAY LEIGHTON. Mr. Leighton joined Sonic Solutions in February
1993 as Vice President of Finance. Prior to joining Sonic, from January 1990 to
July 1992 he was Vice President, Finance and CFO for RESNA Industries Inc., an
environmental services firm, and from August 1988 to December 1989 he was Vice
President, Finance and CFO for Command Data Systems, a software company
specializing in software for the public safety market. Mr. Leighton has also
worked as strategy consultant for the Boston
23
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.
24
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is listed on the Nasdaq National Market.
As of March 31, 1997 there were approximately 106 registered holders of the
Company's common stock. The Company believes, however, that many beneficial
holders of its common stock have registered their shares in nominee or street
name, and that there are substantially more than 106 beneficial owners. The low
price and high price of the Company's common stock during the last eight
quarters, are as follows:
Low Price High Price
--------- ----------
Quarter ended June 30, 1995................. $8.750 $12.125
Quarter ended September 30, 1995............ $9.500 $14.250
Quarter ended December 31, 1995............. $5.500 $10.375
Quarter ended March 31, 1996................ $4.500 $ 7.625
Quarter ended June 30, 1996................. $6.375 $12.250
Quarter ended September 30, 1996............ $5.250 $ 9.750
Quarter ended December 31, 1996............. $5.625 $ 9.125
Quarter ended March 31, 1997................ $5.375 $ 8.250
The Company has not paid any dividends on its Common Stock during the
periods set forth above. It is presently the policy of the Board of Directors
to retain earnings for use in expanding and developing the Company's business.
Accordingly, the Company does not anticipate paying dividends on the Common
Stock in the foreseeable future.
25
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data of the Company
for each of the years in the five year period ended March 31, 1997. The
selected financial data should be read in conjunction with the Financial
Statements and Notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included elsewhere herein. The
financial statements for the periods ended March 31, 1993, 1994, 1995, 1996 and
1997 have been audited by KPMG Peat Marwick LLP, independent certified public
accountants.
Years Ended March 31,
--------------------------------------------
1993 1994 1995 1996 1997
------ ------ ------ ------ ------
(in thousands except share amounts)
STATEMENT OF OPERATIONS DATA:
Net revenue............................. $9,426 15,278 20,154 13,944 15,911
Cost of revenue......................... 3,282 5,576 7,676 7,344 7,432
------ ------ ------ ------ ------
Gross profit............................ 6,144 9,702 12,478 6,600 8,479
Operating expenses:
Marketing and sales.................. 1,799 3,891 5,198 5,873 6,000
Research and development............. 1,279 1,598 2,417 2,961 5,737
General and administrative........... 1,104 1,234 1,627 2,668 1,837
------ ------ ------ ------ ------
Total operating expenses......... 4,182 6,723 9,242 11,502 13,574
------ ------ ------ ------ ------
Operating income (loss)................. 1,962 2,979 3,236 (4,902) (5,095)
Other income (expense).................. (7) 19 298 176 (96)
Pro forma provision for income taxes(1). 745 1,025 - - -
------ ------
Provision (benefit) for income taxes.... - - 1,000 (1,169) -
------ ------ ------
Pro forma net income(1)................. $1,210 1,973 - - -
------ ------
Net income (loss)....................... - - 2,534 (3,557) (5,191)
------ ------ ------
Pro forma net income per share (1)...... $ 0.20 0.31 - - -
------ ------
Net income (loss) per share............. - - 0.33 (0.48) (0.69)
------ ------ ------
Shares used in computing per share
amounts................................ 6,107 6,379 7,726 7,447 7,542
BALANCE SHEET DATA:
Working capital......................... $1,651 12,343 13,529 8,384 6,263
Total assets............................ 4,663 18,644 21,712 16,107 15,889
Shareholders' equity.................... 2,545 13,724 16,332 12,912 8,430
_______________
(1) The Company elected to be treated as an S Corporation for federal
income tax purposes for the period January 1, 1989 through July 31, 1993. As
such, the Company did not pay federal income taxes during that period; the
Company's taxable income was included in the personal tax returns of the
shareholders of the Company. The Statement of Operations Data includes a
pro forma provision for income taxes, computed at the effective corporate rate
on the net income of the Company of 38.1% and 34.2% for the fiscal years ended
March 31, 1993 and 1994, respectively.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW, FORWARD LOOKING STATEMENTS AND CERTAIN FACTORS THAT MAY IMPACT FUTURE
RESULTS
The Company commenced shipments of its Digital Audio Workstation, the
SonicStudio, in the first calendar quarter of 1989. Sales of the SonicStudio
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 Sonic MediaNet accounted for virtually
all of the Company's net revenue during the six fiscal years ended March 31,
1996, and approximately half of the Company's net revenue during the fiscal year
ended March 31, 1997. The Company's future success will depend in part on
sales of the SonicStudio 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. In June, 1996, the Company
began shipments of its DVD Creator system. The Company's future success will
also depend in large part on sales of the DVD Creator system which accounted for
approximately half of the Company's net revenue in the fiscal year ended March
31, 1997.
SonicStudio is an integrated assembly of software, signal processing
cards and other Sonic manufactured hardware, as well as peripheral devices such
as disk drives and CD printers which are purchased as complete or largely
complete devices from other manufacturers. SonicStudio 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 SonicStudio product line including the USP card, as
discussed in "UltraSonic Processor Product Transition; Transition Difficulties"
beginning on Page 11.
In February of 1994, the Company began shipments of Sonic 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 SonicStudio. In the
fiscal year ended March 31, 1997, Sonic MediaNet revenues constituted
approximately 9% of Company revenues. Of total Sonic MediaNet sales during
fiscal 1997, approximately 65% were for use with applications other than
SonicStudio.
Sonic MediaNet allows users to share digital audio and other
"multimedia" data types efficiently among multiple workers in a facility. Sonic
MediaNet consists of specialized network adapter plug in cards installed in the
NuBus or PCI bus of an Apple Macintosh computer. Sonic MediaNet combines FDDI
or CDDI (fiber-based or copper-based) 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, Sonic
MediaNet has uses in other areas of the computer industry 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.
27
In the last quarter of fiscal 1996, the Company became aware of
competitive announcements which would significantly reduce demand for Sonic
MediaNet in the prepress industry. Based on these announcements, the Company
began preparing for transitioning the current Sonic MediaNet product, which
included various charges to the 1996 fiscal year results of operations, as
discussed in "Early Sonic MediaNet Technology Transition Difficulties" beginning
on Page 10.
It is the Company's intention to introduce in fiscal 1998 a second
generation Sonic 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 revenues in future periods.
In the fall of 1995, Apple Computer discontinued sales 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 Sonic MediaNet cards compatible with the PCI bus.
During 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. For the
fiscal year ended March 31, 1997, DVD Creator Systems constituted approximately
46% of the Company's net revenue.
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. See Note 5 to Notes to Financial
Statements.
28
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's
statements of operations as a percentage of net revenue for fiscal years 1995
through 1997:
Years ended March 31,
-----------------------------------------
1995 1996 1997
------------ ------------ -----------
Net revenue 100.0 % 100.0 % 100.0 %
Cost of revenue 38.1 52.7 46.7
------ ----- -----
Gross profit 61.9 47.3 53.3
Operating expenses:
Marketing and sales 25.8 42.1 37.7
Research and development 12.0 21.2 36.1
General and administrative 8.0 19.2 11.5
------ ----- -----
Total operating expenses 45.8 82.5 85.3
------ ----- -----
Operating income (loss) 16.1 (35.2) (32.0)
Other income (expense) 1.5 1.3 (0.6)
Provision (benefit) for income taxes... 5.0 (8.4) -
------ ----- -----
Net income (loss) 12.6% (25.5) % (32.6) %
------ ----- -----
COMPARISON OF FISCAL YEARS ENDED MARCH 31
Net Revenue. Net revenue decreased from $20,154,000 in fiscal 1995 to
-----------
$13,944,000 in fiscal 1996 and increased to $15,911,000 in fiscal 1997,
representing a decrease of 30.8% and an increase of 14.1%, respectively. The
decrease in net revenue in fiscal 1996 is primarily the result of problems
associated with the delivery of reliably working UltraSonic Processor ("USP")
systems and to an unexpectedly early transition in the Sonic MediaNet product
line. In connection with the Sonic MediaNet transition, the Company reorganized
its Sonic MediaNet sales and marketing group, accepted certain returns of Sonic
MediaNet product from dealers, and established additional reserves against Sonic
MediaNet receivables and inventory. In fiscal year 1996, the Company experienced
problems in executing a transition to a SonicStudio product line including a new
DSP card, the USP. See discussion "UltraSonic Processor Product Transition,
Transition Difficulties" beginning on Page 11. The increase in net revenue in
fiscal 1997 is primarily due to sales of DVD Creator systems, which is partially
offset by the decrease in SonicStudio sales due to a general weakness in sales
of professional audio workstations, and a decrease in Sonic MediaNet sales. The
Company began shipping its DVD Creator systems during the quarter ended June
30, 1996.
International sales accounted for 44%, 53% and 45% of net revenue for
the years ended March 31, 1995, 1996 and 1997, respectively. See Note 11 of
Notes to Financial Statements. International sales as a percentage of net
revenue increased in fiscal 1996 primarily due to the increase in sales in the
Pacific Rim. International sales as a percentage of net revenue decreased in
fiscal 1997, primarily due to higher initial sales of DVD Creator in North
America. The Company expects that international sales will continue to
represent a significant percentage of future revenue. International sales
accounted for 60% of net revenue in the quarter ended March 31, 1997.
Cost of Revenue. Cost of revenue, as a percentage of net revenue,
---------------
increased from 38.1% for fiscal 1995 to 52.7% for fiscal 1996 and decreased to
46.7% for fiscal 1997. The increase for fiscal year 1996 is primarily due to
the additional costs related to the USP product transition difficulties. During
the third
29
quarter of fiscal year 1996, the Company specifically identified approximately
$415,000 of additional costs related to the transition. The Company believes
that there were significant additional costs related to the rework, repair, swap
of USP's during the transition and other services performed during the 1996
fiscal year which were not separately identified. See discussion "UltraSonic
Processor Product Transition, Transition Difficulties" beginning on Page 11.
During fiscal year 1996, the Company realized a charge of $350,000 related to
the unexpectedly early technology transition in the Company's Sonic MediaNet
product line. See discussion "Products - Sonic MediaNet; Charges Related to
Technology Transition" beginning on Page 14. The decrease in cost of revenue for
fiscal year 1997 is primarily due to the higher margins attained on DVD Creator
systems as well as the reduction of the additional costs incurred in the prior
year associated with the product transitions. Cost of revenue for the fiscal
year 1997 included a charge of approximately $281,000 for inventory write-down
related to the discontinuance of the Sonic Cinema product line (Sonic Cinema was
a system for Video CD premastering and the predecessor to DVD Creator. See
discussion "Sonic Cinema & DVD Creator").
Marketing and Sales. Marketing and sales expenses increased from
-------------------
$5,198,000 in fiscal 1995 to $5,873,000 in fiscal 1996 to $6,000,000 in fiscal
1997. Marketing and sales represented 25.8%, 42.1% and 37.7% of net revenue for
fiscal 1995, 1996 and 1997, respectively. The Company's marketing and sales
headcount decreased from thirty-two at March 31, 1995 to thirty-one at March 31,
1996 and increased to thirty-four at March 31, 1997. Marketing and sales
expenses increased in fiscal 1996 due to increased participation at major trade
shows and increased sales and marketing activities related to Sonic MediaNet. In
fiscal 1996, marketing and sales, as a percentage of net revenue, increased
significantly due to lower than anticipated revenues. In fiscal 1997, marketing
and sales increased primarily due to the increase in headcount and the enhanced
advertising and marketing related to the DVD Creator system product line.
Included in the marketing and sales expense is dealer and employee commission
expense, which as a percentage of net revenue decreased from 6.0% in fiscal 1996
to 4.2% in fiscal 1997. The decrease in the dealer and employee 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
dealers) to dealer sales (where no commission is payable to dealers).
Research and Development. Research and development expenses increased
------------------------
from $2,417,000 in fiscal 1995 to $2,961,000 in fiscal 1996 to $5,737,000 in
fiscal 1997. Research and development represented 12.0%, 21.2% and 36.1% of net
revenue in fiscal 1995, 1996 and 1997, 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 in dollar amounts each year due to an increase in the number of
software and hardware engineers from twenty-two at March 31, 1995 to twenty-six
at March 31, 1996 to thirty-three at March 31, 1997. In fiscal 1997, research
and development expenses also increased due to the significant increase of
consulting and prototype expenses associated with the development of the DVD
Creator system. Prototype and consulting expenses can fluctuate significantly
from period to period depending upon the status of hardware and software
development projects. In fiscal 1997, research and development, as a percentage
of net revenue, increased significantly due to the investment made in the DVD
Creator system.
General and Administrative. General and administrative expenses
--------------------------
increased from $1,627,000 in fiscal 1995 to $2,668,000 in fiscal 1996 and
decreased to $1,837,000 in fiscal 1997. General and administrative expenses
represented 8.0%, 19.2% and 11.5% of net revenue in fiscal 1995, 1996 and 1997,
respectively. Included in the fiscal year 1996 amount is a charge of $570,000
related to the unexpectedly early technology transition in the Company's Sonic
MediaNet product line. Please see discussion "Products - Sonic MediaNet;
Charges Related to Technology Transition" beginning on Page 14. The Company
anticipates that general and administrative expenses will increase in the future
as the Company's operations expand.
30
Other Income, Net. Other income for fiscal years ended March 31, 1995
-----------------
and 1996 is primarily due to interest income received on investments which were
purchased with cash not immediately needed for operations. Other expense for
fiscal year ended March 31, 1997 is due to the interest expense associated with
the debt financing agreements with entities associated with Hambrecht & Quist,
which is partially offset by the interest income received on investments.
Provision for Income Taxes. The Company has presented a provision
--------------------------
(benefit) for income taxes (for fiscal years 1995 and 1996), computed at the
combined federal and state effective corporate rate in accordance with Statement
of Financial Accounting Standards No. 109. The effective tax rate for fiscal
1995 was 28.3%, and the effective tax benefit rate for fiscal 1996 was 24.7%.
The effective rate for fiscal 1995 was favorably affected primarily as a result
of research and development tax credits and the benefit from the establishment
of the Company's foreign sales corporation. The tax benefit for fiscal 1996
related to the amount the Company expected to recover in a federal income tax
refund. A valuation allowance has been provided for deferred tax assets for
which recovery would depend upon future taxable income. During the fiscal year
ended March 31, 1996, the Company exhausted it's loss carryback capabilities,
therefore, no benefit was recorded during fiscal 1997.
The Company accrues quarterly for income taxes based upon its
projection of its full year tax liability. This may result in adjustments based
on the actual full year results.
Liquidity and Capital Resources. 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. 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.
On March 31, 1997 no borrowings were outstanding.
In December, 1996, the Company also obtained a $5,100,000 financing
facility with entities associated with Hambrecht & Quist. The facility includes
subordinated debt and equipment financing. In 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 of
the assets of the Company subordinate to the Silicon Valley Bank Agreement. In
connection with the financing facility, the Company issued warrants to purchases
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 $549,000 of deferred interest, which
will be amortized to interest expense over the term of the financing facility,
attributable to the value of the warrants.
The Company's operating activities have used cash of $1,456,000,
$2,591,000 and $34,000 in fiscal 1995, 1996 and 1997, respectively. During
fiscal year 1995 cash was used to purchase inventory and to support an increase
in accounts receivables. Inventory increased primarily due to the introduction
of new products including Sonic MediaNet, USP and peripheral devices. Accounts
receivable increased due to difficulties in collecting amounts due for USP based
SonicStudio systems (see discussion "UltraSonic Processor Product Transition;
Transition Difficulties" beginning on Page 11). During fiscal years 1996 and
1997, cash was used primarily to fund the operating loss. During fiscal year
1997 the cash used to fund
31
the operating loss was substantially offset by the improvement in collection of
receivables and the receipt of the income tax refund. The management of the
Company believes that existing cash, cash equivalents and short term
investments, available credit and cash generated from operations will be
sufficient to meet the Company's cash and investment requirements through at
least fiscal 1998.
As of March 31, 1997, the Company had cash, cash equivalents and short
term investments of $4,806,000 and working capital of $6,263,000.
32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Report of Independent Auditors, Financial Statements and Notes to
Financial Statements follow on pages 34 through 49.
33
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Sonic Solutions:
We have audited the financial statements of Sonic Solutions as listed in the
accompanying index in Item 14. In connection with our audits of the financial
statements, we also have audited the financial statement schedule as listed in
the accompanying index in Item 14. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit 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 financial statements referred to above present fairly, in
all material respects, the financial position of Sonic Solutions as of March 31,
1996 and 1997 and the results of its operations and its cash flows for the each
of the years in the three-year period ended March 31, 1997, in conformity with
generally accepted accounting principles. Also in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
KPMG Peat Marwick LLP
San Jose, California
April 29, 1997
34
SONIC SOLUTIONS
BALANCE SHEETS
(in thousands, except share and per share amounts)
March 31,
----------------
ASSETS 1996 1997
------ ------- ------
Current assets:
Cash and cash equivalents............... $1,086 4,806
Short-term investments.................. 2,106 -
Accounts receivable, net of allowance
for returns and doubtful accounts of
$1,690 and $588 at March 31, 1996 and
1997, respectively..................... 4,101 3,105
Inventory............................... 1,881 1,275
Refundable income taxes................. 1,600 450
Prepaid expenses and other current
assets................................. 476 719
Deferred income taxes................... 293 -
------ ------
Total current assets................. 11,543 10,355
Fixed assets, net....................... 2,684 3,154
Purchased and internally developed
software costs, net.................... 1,273 1,954
Other assets............................ 607 426
------ ------
Total assets...................... $16,107 15,889
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable and accrued
liabilities............................ $2,753 2,971
Deferred revenue and deposits........... 442 705
Subordinated debt, current portion...... - 347
Current portion of obligations under
capital leases......................... - 69
------ ------
Total current liabilities............ 3,195 4,092
------ ------
Subordinated debt, net of current portion. - 3,195
Obligations under capital leases, net
of current portion....................... - 172
------ ------
Total liabilities................. 3,195 7,459
------ ------
Commitments and contingencies
Shareholders' Equity:
Common stock, no par value, 30,000,000
shares authorized; 7,493,628
and 7,595,897 shares issued and
outstanding at March 31, 1996 and
1997, respectively....................... 13,133 13,840
Accumulated deficit....................... (219) (5,410)
Unrealized gain (loss) on investments..... (2) -
------ ------
Total shareholders' equity............. 12,912 8,430
------ ------
Total liabilities and shareholders'
equity................................. $16,107 15,889
------ ------
See accompanying Notes to Financial Statements.
35
SONIC SOLUTIONS
STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Years Ended March 31,
-----------------------------
1995 1996 1997
--------- -------- --------
Net revenue............................. $20,154 13,944 15,911
Cost of revenue......................... 7,676 7,344 7,432
------- ------ ------
12,478 6,600 8,479
Gross profit ------- ------ ------
Operating expenses:
Marketing and sales.................. 5,198 5,873 6,000
Research and development............. 2,417 2,961 5,737
General and administrative........... 1,627 2,668 1,837
------- ------ ------
Total operating expenses............. 9,242 11,502 13,574
------- ------ ------
Operating income (loss).............. 3,236 (4,902) (5,095)
Other income (expense), net............. 298 176 (96)
------- ------ ------
Income (loss) before income taxes.... 3,534 (4,726) (5,191)
Provision (benefit) for income taxes.... 1,000 (1,169) -
------- ------ ------
Net income (loss).................... $ 2,534 (3,557) (5,191)
------- ------ ------
Net income (loss) per share.......... $0.33 (0.48) (0.69)
------- ------ ------
Shares used in computing per share
amounts............................. 7,726 7,447 7,542
------- ------ ------
See accompanying Notes to Financial Statements.
36
SONIC SOLUTIONS
STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
Common stock Unrealized Total
---------------- Accumulated Gain (Loss) shareholders'
Shares Amount deficit on Investments equity
------ ------ ------- -------------- ------
Balances at March 31, 1994................... 7,324 $12,920 804 --- 13,724
Exercise of common stock options........... 56 70 --- --- 70
Unrealized gain on investments............. --- --- --- 4 4
Net income................................. --- --- 2,534 --- 2,534
----- ------- ------ ----- ------
Balances at March 31, 1995................... 7,380 12,990 3,338 4 16,332
Exercise of common stock options........... 114 143 --- --- 143
Unrealized loss on investments............. --- --- --- (6) (6)
Net loss................................... --- --- (3,557) --- (3,557)
----- ------- ------ ----- ------
Balances at March 31, 1996................... 7,494 13,133 (219) (2) 12,912
Exercise of common stock options............ 102 158 --- --- 158
Unrealized gain on investments.............. --- --- --- 2 2
Issuance of warrants........................ --- 549 --- --- 549
Net loss.................................... --- --- (5,191) --- (5,191)
----- ------- ------ ----- ------
Balances at March 31, 1997................... 7,596 $13,840 (5,410) --- 8,430
----- ------- ------ ----- ------
See accompanying Notes to Financial Statements.
37
SONIC SOLUTIONS
STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended March 31,
----------------------------
1995 1996 1997
-------- ------- --------
Cash flows from operating activities:
Net income (loss).................................. $ 2,534 (3,557) (5,191)
Adjustments to reconcile net income (loss) to
net cash used in operating activities:
Depreciation and amortization...................... 669 900 1,693
Provision for returns and doubtful accounts, net... 378 880 190
Changes in operating assets and liabilities:
Accounts receivable.............................. (2,411) 1,625 806
Inventory........................................ (1,777) 886 606
Refundable income taxes.......................... - (1,600) 1,150
Prepaid expenses and other current assets........ (501) 107 (243)
Other assets..................................... (388) (96) 181
Accounts payable and accrued liabilities......... 735 (1,717) 218
Deferred revenue and deposits.................... (19) (116) 263
Income taxes payable............................. (364) (37) ----
Deferred income taxes............................ (312) 134 293
------- ------ ------
Net cash used in operating activities.......... (1,456) (2,591) (34)
------- ------ ------
Cash flows from investing activities:
Purchase of fixed assets.............. (1,276) (1,673) (1,462)
Additions to purchased and internally developed
software........................................ (535) (577) (1,112)
Redemption/maturities of short-term investments.. 3,317 5,103 2,108
------- ------ ------
Net cash provided by (used in) investing
activities............... 1,506 2,853 (466)
------- ------ ------
Cash flows from financing activities:
Proceeds from exercise of common stock options... 70 143 158
Proceeds from issuances of subordinated debt..... -- -- 3,542
Borrowings on line of credit..................... 700 3,700 ---
Repayments of line of credit..................... (700) (3,700) ---
Principal payments on capital leases............. -- -- (29)
Proceeds from issuances of warrants.............. -- -- 549
------- ------ ------
Net cash provided by financing activities...... 70 143 4,220
------- ------ ------
Net increase in cash and cash equivalents.......... 120 405 3,720
Cash and cash equivalents, beginning of year....... 561 681 1,086
------- ------ ------
Cash and cash equivalents, end of year............. $ 681 1,086 4,806
------- ------ ------
Supplemental disclosure of cash flow information:
Interest paid during year........................ 3 28 106
------- ------ ------
Income taxes paid during year.................... 1,680 345 ---
------- ------ ------
Noncash financing and investing activities:
Assets acquired through capital lease.......... --- --- 270
------- ------ ------
See accompanying Notes to Financial Statements.
38
SONIC SOLUTIONS
NOTES TO FINANCIAL STATEMENTS
March 31, 1995, 1996 and 1997
(1) SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
(a) Operations
Sonic Solutions ("the Company") designs, develops, manufactures and
markets digital tools for professionals who manipulate media - sound, images,
moving pictures and text - in computer based settings. The Company's principal
product- the SonicStudio- is a line of digital audio random access editing and
processing systems, commonly known as Digital Audio Workstations. SonicStudios
are used by a wide range of audio professionals to prepare recorded sound for
release on Digital Audio Compact Discs, for inclusion in film and video sound
tracks, and for broadcast on radio and television. The Company's Sonic Cinema
product is an optional addition to the SonicStudio for preparing MPEG-1 based
Video Compact Discs. The Company's Sonic MediaNet product is an FDDI-compliant,
high speed local area network and file management system that is optimized for
management of data intensive file transfers typically required in digital video,
digital audio, computer graphics and desktop publishing. The Company's DVD
Creator product line is a complete workgroup solution for DVD premastering. It
includes MPEG-2 video encoding, audio prep and encoding, and Scenarist-DVD
software for disc authoring, layout, and formatting. The Company's products
generally include application software and specialized hardware installed on a
personal computer. The Company's products are designed to improve the
productivity and effectiveness of media professionals, enabling them to process
and manipulate more material in a given amount of time and to achieve results
which would have been impossible using traditional linear analog or digital
technology.
A summary of significant accounting policies applied in the
preparation of the accompanying financial statements of the Company follows:
(b) Use of Estimates and Certain Concentrations
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the period.
Actual results could differ from those estimates.
The Company is dependent on sole-sourced suppliers for certain key
components used in its products. The Company purchases these sole-source
components pursuant to purchase orders placed from time to time, does not carry
significant inventories of these components, and has no guaranteed supply
agreements. Any extended future interruption or limitation in the supply of any
of the components obtained from a single source could have a material adverse
effect on the Company's results of operations.
The Company's products are primarily compatible with Macintosh
personal computers. Although the Company plans to introduce new products
compatible with other computer platforms in the future, the financial results of
the Company could be materially adversely affected should the industry no longer
support the Macintosh platform prior to the new products' release.
39
(c) Revenue Recognition
Revenue is derived from product sales and maintenance contracts.
Revenue from product sales is recognized upon shipment of the products. Revenue
from software maintenance, including maintenance bundled with the product sale,
is recognized on a straight-line basis over the term of the agreement, generally
one year.
Revenue from sales to distributors and dealers may be subject to
agreements allowing limited rights of return and exchange. Accordingly, the
Company provides reserves for estimated future returns and exchanges at the time
of the sale as a reduction of revenue.
In the years ended March 31, 1995, 1996 and 1997, no single customer
accounted for more than 10% of revenue.
Cost of revenue includes hardware product costs, third party hardware
costs, amortization of capitalized software and third party software royalties.
(d) Cash Equivalents
Cash equivalents consist of short-term, highly-liquid investments with
original maturities of ninety days or less. Cash equivalents are generally
invested in money market funds.
(e) Short-term Investments
Short-term investments consist almost exclusively of tax free
municipal bonds. 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.
(f) Inventory
Inventory is valued at the lower of cost, determined on a first-in,
first-out basis, or market. Inventory consists of raw materials, work in
process and original equipment manufacturer's goods.
(g) Fixed Assets
Fixed assets consist of furniture and equipment and are recorded at
cost. Equipment under capital leases is stated at the present value of minimum
lease payments at the inception of the lease. Depreciation of furniture and
equipment is provided using the straight-line method over the estimated useful
lives of the respective assets which are generally three to five years.
Equipment held under capital leases is amortized over the shorter of the lease
term of the estimated useful life of the asset.
(h) Purchased and Internally Developed Software Costs
Subsequent to attaining technological feasibility in accordance with
Statement of Financial Accounting Standards No. 86 "Accounting for the Costs of
Computer Software to be Sold, Leased, or Otherwise Marketed", purchased software
and software product development costs are capitalized and then amortized over a
future period. Amortization of capitalized software costs, for both internally
developed and purchased software products, is computed on a straight-line basis
over the estimated economic life of the product, which is generally three years,
or the ratio of current revenue to the total of current and anticipated future
revenue, whichever is greater. All other research and development expenditures
are charged to research and development expense in the period incurred.
40
(i) 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.
(j) 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 no
common equivalent shares from stock options where losses exist, as the effect
would be anti dilutive.
The Financial Accounting Standards Board recently issued SFAS No. 128,
"Earnings Per Share." SFAS No. 128 requires the presentation of basic earnings
per share (EPS) and, for companies with complex capital structures, diluted EPS.
SFAS No. 128 is effective for annual and interim periods ending after December
15, 1997. The Company expects that for profitable periods basic EPS will be
higher than earnings per share as presented in the accompanying financial
statements and diluted EPS will not differ materially from earnings per share as
presented in the accompanying financial statements. Computations for loss
periods should not change significantly.
(k) Concentrations of Credit Risk
Financial instruments which potentially subject the Company to
concentrations of credit risk are short-term investments and trade receivables.
The Company's investment portfolio consists of municipal bonds and money market
securities of various financial institutions. The Company's investments are
managed by recognized financial institutions that follow the Company's
investment policy. The Company's policy limits the amount of credit exposure in
any one issue and management believes no significant concentration of credit
risk exists with respect to these investments.
The Company manufactures and sells its products to customers who are
primarily audio and video and graphic arts professionals who prepare sound,
video and graphics for use in the music recording, video, film and broadcast and
printing industries or for corporate in-house use and to dealers who support
such customers. Management believes that any risk of credit loss is
significantly reduced due to the diversity of its end users and their dispersion
across many geographic sales areas. The Company maintains an allowance for
doubtful accounts to protect against potential credit losses.
(l) Stock-Based Compensation
The Company has various stock-based compensation plans, as discussed
in Note 8. The Company has accounted for the effect of its stock based
compensation plans under Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees". The Company has elected not to adopt Statement
of Financial Accounting Standards No. 123 "Accounting for Stock-Based
Compensation" and as such has disclosed the pro forma effects on net income
(loss) and net income (loss) per share data as if the Company had elected to use
the fair value approach to account for all its employee stock-based
compensation plans.
(m) Impairment of Long-Lived Assets and Long-Lived Assets to be
Disposed Of
The Company adopted the provisions of SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of," in fiscal 1997. SFAS No. 121 requires
41
that long-lived assets and certain identifiable intangibles be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by comparison of the carrying amount of an asset to
future net cash flows expected to be generated by the asset. If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceed the fair value of the
assets. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell. The adoption of SFAS No. 121 did not
have a material impact on the Company's financial position, results of
operations, or liquidity.
(n) Reclassification
Certain amounts in 1996 and 1997 financial statements have been
reclassified to conform to the 1997 presentation.
(2) SHORT-TERM INVESTMENTS
As of March 31, 1997, the Company had no available-for-sale
securities. The cost and fair value of available-for-sale securities as of
March 31, 1996, by contractual maturity, consisted of (in thousands):
1996
----
Estimated
Cost Fair Value
------ ----------
Due in one year or less........ $ 624 $ 624
Due in greater than one year... 1,484 1,482
------ ------
$2,108 $2,106
====== ======
(3) INVENTORY
The components of inventory consist of (in thousands):
March 31,
---------
1996 1997
------ -----
Raw materials.............................. $1,180 700
Work-in-process............................ 580 500
Original equipment manufacturer's goods.... 121 75
------ -----
$1,881 1,275
------ -----
(4) FIXED ASSETS
Fixed assets consist of (in thousands):
March 31,
---------
1996 1997
------- ------
Equipment, furniture and fixtures....... $ 2,246 3,509
Demonstration equipment................. 1,058 1,375
Parts used in service, not held for sale 958 1,110
------- ------
4,262 5,994
Less accumulated depreciation........... (1,578) (2,840)
------- ------
$ 2,684 3,154
------- ------
Depreciation expense was $479,000, $675,000 and $1,262,000 for the years
ended March 31, 1995, 1996, and 1997, respectively. For fiscal year 1997, fixed
assets held under capital lease totaled $270,000 and accumulated depreciation on
those assets totaled $13,000.
42
(5) PURCHASED AND INTERNALLY DEVELOPED SOFTWARE COSTS
Capitalized software costs consist of (in thousands):
March 31,
---------
1996 1997
---------- -------
Purchased software.............. $ 190 290
Internally developed software... 1,796 2,808
------ ------
1,986 3,098
Accumulated amortization........ (713) (1,144)
------ ------
$1,273 1,954
------ ------
Amortization of capitalized software costs was $190,000, $225,000 and
$431,000 for the years ended March 31, 1995, 1996 and 1997, respectively.
43
(6) ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of (in thousands):
March 31,
---------
1996 1997
------ ------
Accounts payable.................... $1,474 1,697
Commissions payable................. 507 401
Accrued compensation and benefits... 334 445
Accrued expenses.................... 438 428
------ -----
$2,753 2,971
------ -----
(7) 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
(9.25% at March 31, 1997). As of March 31, 1997, 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. Interest on borrowings under these facilities is payable
monthly at a rate of 7.75% and 6.75%, respectively. 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 $549,000 of debt discount, which is being amortized to interest
expense over the term of the financing facility, attributable to the value of
the warrants.
(8) SHAREHOLDERS' EQUITY
Stock Options
Under the Company's September 1989 Stock Option Plan (the Plan), options to
purchase up to an aggregate of 2,090,000 shares of common stock may be granted
to key employees, directors and consultants. Grants of options to the directors
of the Company may not exceed 140,000 shares. The 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. All options to date have been
granted as incentive stock options. Options under the 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.
The Board of Directors and/or the President administer the Plan.
44
During 1995, the Company adopted the 1994 NonEmployee Directors Stock
Option Plan which provides for the grant of stock options to the Company's
nonemployee directors. Under this plan, stock options are granted annually at
the fair market value of the Company's common stock on the date of grant. The
number of options so granted annually is fixed by the plan. Such options
generally vest over four years from the grant date. The total number of shares
to be issued under this plan may not exceed 100,000 shares. During fiscal 1995,
options under this plan were granted to purchase 2,000 shares at a price per
share of $10.25. There were 2,000 options outstanding at March 31, 1997, at a
price of $10.25 per share, of which 1,000 were exercisable.
A summary of the Company's option plans is presented below:
1995 1996 1997
------------------------ ------------------------ ------------------------
Weighted- Weighted- Weighted-
average average average
Options Exercise price Options Exercise price Options Exercise price
------- -------------- ------- -------------- ------- --------------
Outstanding at beginning of year........ 483,000 $1.730 526,191 $3.289 820,398 $4.917
Granted................................. 135,100 8.451 522,500 6.191 310,400 6.306
Exercised............................... (55,799) 1.193 (114,071) 1.257 (102,269) 1.655
Forfeited............................... (36,110) 4.992 (114,222) 6.895 (198,830) 6.190
------- -------- --------
Outstanding at end of year.............. 526,191 $3.289 820,398 $4.917 829,699 $5.534
======= ======== ========
Options exercisable at year end......... 248,090 $1.485 275,675 $2.760 308,723 $4.447
Weighted-average fair value of options
granted during the year............... --- $3.624 $3.730
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company has elected to continue to use the intrinsic value-based method
to account for all of its employee stock-based compensation plans. Under APB
Opinion No. 25, "Accounting for Stock Issued to Employees," the Company has
recorded no compensation costs related to its stock option plans for the years
ended March 31, 1995, 1996 and 1997.
Pursuant to SFAS No. 123, "Accounting for Stock-Based Compensation," the
Company is required to disclose the pro forma effects on net income and net
income per share data as if the Company had elected to use the fair value
approach to account for all its employee stock-based compensation plans. Had
compensation cost for the Company's plans been determined consistent with the
fair value approach enumerated in SFAS No. 123, the Company's net loss and net
loss per share for the years ended March 31, 1996 and 1997 would have been
decreased as indicated below (in thousands, except per share data):
45
March 31,
---------
1996 1997
---- ----
Net loss As Reported $3,557 $5,191
Pro Forma $3,636 $5,603
Net loss per share As Reported $ 0.48 $ 0.69
Pro Forma $ 0.49 $ 0.74
The fair value of options granted was estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1996 and 1997; risk-free interest rate of 5.59%
and 6.31%; expected life of 4 years; 73% expected volatility; and no dividends.
The effect of applying SFAS No. 123 for disclosing compensation costs may
not be representative of the effects on reported net income (loss) for future
years because pro forma net income (loss) reflects compensation costs only for
stock options granted in fiscal 1996 and 1997, and does not consider
compensation costs for stock options granted prior to April 1, 1995.
The following table summarizes information about stock options outstanding
at March 31, 1997:
Options Outstanding Options Exercisable
------------------------------------------------------ -----------------------------------
Number Weighted-average Number
Outstanding Remaining Weighted Average Outstanding Weighted Average
Exercise Prices at March 31, 1997 Contractual Life Exercise Price at March 31, 1997 Exercise Price
- --------------- ----------------- ---------------- -------------- ----------------- --------------
From $0.43 to $1.00 31,167 3.42 $0.775 31,167 $0.775
From $1.14 to $1.71 75,318 5.92 1.482 72,983 1.477
From $2.00 to $2.86 16,553 6.44 2.159 12,614 2.121
From $3.57 to $4.29 20,821 6.58 4.286 17,142 4.286
From $5.50 to $7.50 657,682 8.98 6.190 160,145 6.276
From $8.00 to $11.50 28,158 8.02 9.233 14,672 9.245
------- ---------- ---------- ------- ----------
From $0.43 to $11.50 829,699 8.35 $5.534 308,723 $4.447
======= ========== ========== ======= ==========
46
(9) INCOME TAXES
Income tax expense (benefit) consists of the following for the years
ended March 31:
Current Deferred Total
--------- -------------- -------
(in thousands)
1995:
Federal $ 1,045 (274) 771
State 267 (38) 229
-------- ---- ------
$ 1,312 (312) 1,000
-------- ---- ------
1996:
Federal ($1,304) 83 (1,221)
State 2 50 52
-------- ---- ------
($1,302) 133 (1,169)
-------- ---- ------
1997:
Federal ($293) 293 -
State - - -
-------- ---- ------
($293) 293 -
======== ==== ======
The differences between income taxes computed using the statutory federal
income tax rate and that shown in the statements of operations are summarized as
follows (in thousands):
1996 1997
---- ----
Computed tax at statutory rate............................ $(1,607) $(1,765)
Tax credits utilized...................................... (43) (201)
State taxes, net of federal benefit....................... (198) --
Tax exempt interest income................................ (71) (25)
Current year net operating losses, temporary differences
and credits for which no benefit was recognized......... -- 1,681
Change in beginning of year valuation allowance .......... 746 293
Other..................................................... 4 17
------- -------
$(1,169) $ -
------- -------
47
The components of deferred taxes are as follows at March 31 (in thousands):
1996 1997
------ ------
Deferred tax assets:
Accounts receivable........................................ $ 673 252
Inventories................................................ 544 459
Tax credit carryforwards................................... 222 1,013
Net operating losses (state)............................... 162 1,843
Accrued vacation pay....................................... 36 50
State taxes................................................ -- --
Commissions................................................ 18 29
Warranty and other......................................... 18 22
------ ------
Gross deferred tax assets................................ 1,673 3,668
Valuation allowance...................................... (746) (2,784)
------ ------
Total deferred tax assets, net of valuation allowance.... 927 884
Deferred tax liabilities:
Fixed assets............................................... (198) (172)
Internally developed software.............................. (436) (712)
------ ------
Total deferred tax liability...................... (634) (884)
------ ------
Net deferred taxes................................ $ 293 -
====== ======
The net change in the valuation allowance for the year ended March 31, 1997
was an increase of approximately $2,038,000. Management believes that sufficient
uncertainty exits regarding the future realization of certain deferred tax
assets and that, a valuation allowance is required.
As of March 31, 1997, the Company has cumulative federal and California net
operating losses of approximately $4,600,000 and $3,100,000 which can be used to
offset future income subject to taxes. The federal tax loss carryforwards will
expire in the year 2012. The California tax loss carryforwards will expire
beginning in the year 2001 through 2002.
48
(10) COMMITMENTS AND CONTINGENCIES
(a) Leases
In December, 1996, the Company entered into a leasing agreement to
finance the purchase of up to $1,000,000 in equipment, as discussed in Note 7.
Lease terms under the agreement are for 42 months and are secured by the leased
equipment. The Company also leases certain facilities and equipment under
noncancelable operating leases. Future payments under capital and operating
leases that have initial remaining noncancelable lease terms in excess of one
year are as follows (in thousands):
Year Ending March 31, Capital Operating
Leases Leases
1998..................................................... 84 680
1999..................................................... 79 702
2000..................................................... 74 705
2001..................................................... 36 705
2002..................................................... - 705
Thereafter............................................... - 117
---- -----
Total minimum lease payments............................. 272 3,614
=====
Less amount representing interest........................ (31)
Less current portion of obligations under capital lease.. (69)
----
Long-term obligations under capital lease................ $172
====
Rent expense under operating leases for the years ended March 31, 1995,
1996 and 1997 was approximately $288,000, $447,000 and $610,000, respectively.
(b) Benefit Plan
The Company sponsors a 401(k) savings plan covering most salaried
employees. To date, no contributions have been made to this plan by the
Company.
(c) Other
The Company is from time to time subject to routine claims and
litigation incidental to it's business. The Company believes that the results
of these matters will not have a material adverse effect on the Company's
financial condition.
(11) INDUSTRY AND GEOGRAPHIC INFORMATION
The Company operates in a single industry segment and markets its products
in the United States and in foreign countries through its sales to 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):
Year Ended March 31,
--------------------
1995 1996 1997
---- ---- ----
North America (substantially all United States). $11,264 6,565 8,780
Export:
Europe....................................... 4,233 2,451 2,763
Pacific Rim.................................. 3,981 4,181 3,491
Other international.......................... 676 747 877
------- ------ ------
Total net revenue $20,154 13,944 15,911
------- ------ ------
Foreign based assets were insignificant as of March 31, 1996 and 1997.
49
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item with respect to executive officers is
set forth in Part I of this Report and the information with respect to directors
is incorporated herein by reference to the information set forth under the
caption "Election of Directors" in the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference
to the information set forth under the caption "Executive Compensation" in the
Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by reference
to the information set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by reference
to the information set forth under the caption "Certain Relationships and
Related Transactions" in the Proxy Statement.
50
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)1. FINANCIAL STATEMENTS.
Included in Part II of this report:
Report of Independent Auditors (page 34 of this Report).
Balance Sheets as of March 31, 1996 and March 31, 1997.
Statements of Operations for each of the three years in the period
ended March 31, 1997.
Statements of Shareholders' Equity for each of the three years in
the period ended March 31, 1997.
Statements of Cash Flows for each of the three years in the period
ended March 31, 1997.
Notes to Financial Statements (pages 39 through 49 of this Report).
(a)2. FINANCIAL STATEMENTS SCHEDULES.
Included in Part IV of this report:
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:
3.1 (1) Restated Articles of Incorporation
3.2 (1) Amended and Restated By-Laws
4.1 (1) Specimen Common Stock Certificate
4.2 (1) Investors' Rights Agreement dated August 20, 1993
between the Investors listed on the Schedule of
Investors thereto and the Company
4.3 (1) Right of Last Refusal, Co-Sale and Shareholders'
Option Agreement dated August 20, 1993 between the
Investors listed on the Schedule of Investors
thereto and the Company
10.1 (1) Amended and Restated Stock Option Plan
10.2 (1) Lease Agreement dated December 16, 1991 between
Phoenix Leasing Incorporated and the Company
10.3 (1) Loan Agreement dated November 28, 1993 between
Bank of America and the Company
10.4 (1) Agreement dated September 28, 1993 between JL
Cooper Electronics and the Company
51
10.5 (1) Form of Indemnity Agreement
10.6 Lease Agreement dated January 26, 1995 between
Golden Gate Plaza and the Company
11.1 Statement of computation of earnings per share
24.1 Power of Attorney (see pages 53 and 54)
_______________
(1) Incorporated by reference to exhibits to Registration Statement on Form S-1
(No. 33-72870) effective February 10, 1994.
(b) REPORTS ON FORM 8-K: None.
52
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant, Sonic Solutions, a corporation organized
and existing under the laws of the State of California, 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 25th day of June, 1997.
SONIC SOLUTIONS
By /s/ Robert J. Doris
--------------------
Robert J. Doris
President
POWERS OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Robert J. Doris, Mary C. Sauer, and A.
Clay Leighton, jointly and severally, his attorneys-in-fact, each with the power
of substitution, for him in any and all capacities, to sign any amendments to
this Annual Report on Form 10-K and to file the same, with exhibits thereto and
other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that each of said attorneys-in-
fact, or his or her substitute or substitutes, may do or cause to be done by
virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report on Form 10-K has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Robert J. Doris President and Director June 25, 1997
- ----------------------------- (Principal Executive Officer)
Robert J. Doris
/s/ James A. Moorer Senior Vice President of Audio June 25, 1997
- ----------------------------- Development and Director
James A. Moorer
/s/ Mary C. Sauer Senior Vice President of June 25, 1997
- ----------------------------- Marketing and Sales and Director
Mary C. Sauer
53
/s/ Michael C. Child Director June 25, 1997
- -----------------------------
Michael C. Child
/s/ Robert M. Greber Director June 25, 1997
- -----------------------------
Robert M. Greber
/s/ Peter J. Marguglio Director June 25, 1997
- -----------------------------
Peter J. Marguglio
/s/ A. Clay Leighton Vice President of Finance and June 25, 1997
- ----------------------------- Chief Financial Officer
A. Clay Leighton (Principal Financial Accounting
Officer)
54
SCHEDULE II
SONIC SOLUTIONS
VALUATION AND QUALIFYING ACCOUNTS
Years Ended March 31, 1995, 1996 and 1997
(in thousands)
Balance at Charged to Charged Balance
---------- ---------- -------- ---------
beginning costs and to other at end of
---------- ---------- -------- ---------
of period expenses accounts Deductions period
---------- ---------- -------- ----------- ---------
Year ended March 31, 1995
Allowance for doubtful accounts... $ 273 325 --- (86) 512
Allowance for returns............. 159 --- 150 (11) 298
------ --- --- ------ -----
$ 432 325 150 (97) 810
------ --- --- ------ -----
Year ended March 31, 1996
Allowance for doubtful accounts... $ 512 593 --- --- 1,105
Allowance for returns............. 298 --- 287 --- 585
------ --- --- ------ -----
$ 810 593 287 --- 1,690
------ --- --- ------ -----
Year ended March 31, 1997
Allowance for doubtful accounts... $1,105 90 --- (974) 221
Allowance for returns............. 585 --- 100 (318) 367
------ --- --- ------ -----
$1,690 90 100 (1,292) 588
------ --- --- ------ -----
55
INDEX TO EXHIBITS
3.1 1 Restated Articles of Incorporation
3.2 1 Amended and Restated By-Laws
4.1 1 Specimen Common Stock Certificate
4.2 1 Investors' Rights Agreement dated August 20, 1993
between the Investors listed on the Schedule of
Investors thereto and the Company
4.3 1 Right of Last Refusal, Co-Sale and Shareholders' Option
Agreement dated August 20, 1993 between the Investors
listed on the Schedule of Investors thereto and the
Company
10.1 1 Amended and Restated Stock Option Plan
10.2 1 Lease Agreement dated December 16, 1991 between Phoenix
Leasing Incorporated and the Company
10.3 1 Loan Agreement dated November 28, 1993 between Bank of
America and the Company
10.4 1 Agreement dated September 28, 1993 between JL Cooper
Electronics and the Company
10.5 1 Form of Indemnity Agreement
10.6 Lease Agreement dated January 26, 1995 between Golden
Gate Plaza and the Company
11.1 Statement of computation of earnings per share
24.1 Power of Attorney (see pages 53 and 54)
_______________
1 Incorporated by reference to exhibits to Registration Statement on Form S-1
(No. 33-72870) effective February 10, 1994.
56