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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, 2000 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 incorporation or (I.R.S. Employer
organization) Identification No.)
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, 2000, based upon the closing price of the Common Stock
on the NASDAQ National Market for such date, was approximately $ 40,982,589./1/
The number of outstanding shares of the registrant's Common Stock on May
31, 2000 was 12,114,672.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the Proxy Statement to be filed with the Securities and
Exchange Commission on or prior to July 20, 2000 and to be used in connection
with the Annual Meeting of Shareholders expected to be held on or about
September 5, 2000 are incorporated by reference in Part III of this Form 10-K.
______________________
/1/ Excludes 1,947,812 shares held by directors, officers and ten percent or
greater shareholders on May 31, 2000. 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.
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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
Overview
We develop software and workstations used to edit and process digital audio
and digital video.
We market workstations to professional customers. Our workstation products
are computer based, and usually include both plug-in hardware and application
software installed on a personal computer. Our customers use various kinds of
peripheral devices -- for example, disk drives, streaming tape drives, and audio
and video tape recorders -- along with our products. Although we do not
manufacture or sell the personal computers or peripheral devices used with our
products, we typically refer to the complete configuration of personal computer,
Sonic hardware, Sonic software, and peripherals as a Sonic workstation.
We currently market two workstation product lines: SonicStudio(TM) and DVD
Creator. SonicStudio is a line of professional audio workstations that our
customers use to prepare audio for release on Digital Audio Compact Discs
(CD's), for release with video and film entertainment, and for broadcast on
radio. DVD Creator is a line of DVD-Video/Audio production workstations which
supports the preparation and assembly of video and audio assets for release on
the new DVD-Video disc format and the upcoming DVD-Audio disc format. In
September, 1999, we began shipments of DVD Fusion(TM). DVD Fusion, which is a
part of our DVD Creator product line provides video producers and editors a
comprehensive set of tools for encoding, authoring and proofing DVD-Video titles
derived from projects created on non-linear video editing systems such as those
provided by Avid Technology and Media 100.
In the past year, we have started supplying software products outside of
our traditional professional audio/video market. In September 1999 we began
shipments of DVDit! DVDit! is a DVD-Video authoring software product which
provides simplified DVD authoring capabilities to consumer, "prosumer," and
certain professional users. We currently are offering two versions of DVDit! --
DVDit!-SE ("Standard Edition") and DVDit!-LE ("Limited Edition"). We have also
announced the upcoming availability of DVDit!-PE ("Professional Edition").
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Professional Video and Audio Industry
Customers
Our professional customers are mainly facilities that process and prepare
audio, video and film programming. Most of this programming is for
entertainment, though a significant portion of it is also used for educational
and business communications purposes.
Some of our professional customers are independent organizations that
supply services to audio and video content holders and publishers. Some of our
customers are in-house facilities that are owned by particular content holders
or publishers.
Our customers range in size from relatively small organizations with few
employees to larger facilities with hundreds of employees. Among our customers
are facilities that are independent, privately owned companies, as well as
facilities which are part of much larger public, private, or non-profit
organizations. While we have concluded corporate purchasing agreements with
certain customer organizations that have multiple facilities, decisions even
within such organizations to purchase and deploy our products are usually made
at the facility level.
Most of the time we market our products as Sonic Solutions products, and
not as part of another company's products. From time to time we have concluded
agreements with other companies in which they incorporate some product of ours
into their product line (this is commonly referred to as an "OEM" arrangement).
At the present time there is one such relationship which accounts for a
significant portion of our professional audio revenues. Please see further
discussion about this below under "OEM Customers; Sales Concentration."
The Shift to Digital
The professional audio and video industry has shifted significantly from
analog to digital technology over the past twenty years. Digital technology
encodes sound and video as numbers and stores them as a kind of computer data.
In contrast, analog technology records sound and video by making a physical
representation analogous to the original audio or visual signal. Long-playing
records ("LP") and Digital Audio Compact Discs ("CD-A"), are good examples of
analog (LP's) and digital (CD-A's) media. In an LP the grooves cut into the
vinyl record have a physical shape analogous to the original sound pressure
wave. In a CD-A the original sound pressure wave is encoded into numbers that
are recorded as tiny pits on the surface of an optical disc.
The shift to digital encompasses the tools used to edit, process and
prepare audio and video prior to release, as well as audio and video release
formats -- the form in which the audio or video actually reaches the intended
consumer. Different applications and segments within the professional audio and
video industry have shifted to digital technology at different times. Complete
conversion to digital technology has not yet occurred. We expect that the shift
will continue for the next several years until some point in the first decade of
the 21/st/ century when analog technology will effectively cease being used in
the professional audio and video industries.
There are a number of reasons why digital technology has been attractive to
audio and video professionals:
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. Higher Quality -- Digital technology permits higher quality audio
and video to be recorded and replayed under most circumstances.
Of course, this assumes that the recordings involved are made at
a high resolution.
. Perfect Copying -- Digitally recorded audio and video can be
perfectly reproduced, over an unlimited number of generations.
Every analog recording process involves some amount of signal
loss with each successive generation of copying.
. Speed and Precision of Manipulation -- Digital technologies
permit more rapid and more accurate manipulation of audio and
video signals than is possible in analog technology.
. Special Capabilities -- Digital technology permits certain kinds
of processes that are difficult or practically impossible using
analog techniques. One of our own products, a signal processing
tool called NoNOISE(R), is a good example of this. NoNOISE
permits audio recording engineers to remove various kinds of
noise from already recorded sound with a great degree of
precision and fidelity.
. Declining Costs -- Digital technology is enjoying dramatic cost
reductions, driven by the broad scale adoption and growth of
computer technology in business, in home use, in communications
and on the Internet. In contrast, analog technology for audio and
video recording has reached an effective plateau in terms of
cost.
Of course, digital technologies have presented some drawbacks to adoption
over the past 20 years. A few of these are:
. Enormous Bandwidth -- Representing audio and video in high
resolution consumes a large amount of storage space and computer
processing power. Computers were historically first applied to
text and arithmetic processing applications which require
relatively limited digital storage and processing power. For
example, a 300 page book-length work can easily be represented in
three megaBytes of storage. A single CD-A requires some 600
megaBytes to store a little more than one hour of stereo music.
. Real Time Requirements -- Audio and video are real time data,
meaning that they must be presented to the observer in strict
time sequence --neither too fast nor too slow. For historical
reasons, computer engineers developed much of their technology
using architectures, called asynchronous architectures, which
make it difficult to ensure such strict timing. This meant that
it was difficult for companies like ours to use "off the shelf"
computer technology to develop our products.
. Analog Release Formats -- In many ways release formats have been
the slowest areas to shift to digital. Even today almost all
video programs reaching consumers arrive via analog formats (VCR
cassettes, conventional broadcast television, and conventional
cable television). The Digital Audio Compact Disc, of course, now
accounts for the majority of pre-recorded music sold to consumers
in industrialized countries. But most broadcast radio, as well as
the audio accompanying broadcast video, theatrical feature films,
and pre-recorded video, is still delivered mostly using analog
formats. Slow transition of release formats to digital technology
has tended to retard adoption of digital technology by
professionals for "upstream" processes such as editing.
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Our company was founded to pursue the opportunities presented by this major
transition, and to facilitate the transition by offering professionals
compelling alternatives to traditional analog production tools.
Professional Workstation Lines
We currently offer two professional workstation product lines, oriented
toward somewhat different applications within the professional audio and video
industry. SonicStudio is a line of professional digital audio workstations. DVD
Creator(TM) is a line of DVD-Video/Audio production workstations.
Both our SonicStudio and DVD Creator workstations are designed to run on
versions of the Macintosh personal computer manufactured by Apple Computer.
Current reliance on the Macintosh computer creates risks for our Company.
SonicStudio
A SonicStudio digital audio workstation consists of:
1. one or more of our audio signal processing cards installed on a
Macintosh personal computer;
2. one or more outboard interface boxes (which contain various
styles of professional interface connections used to link the
workstation to other audio devices in the studio); and,
3. extensive applications software.
Applications for SonicStudio
Our customers use their SonicStudio systems to manipulate audio, applying a
number of processes to digital sound to prepare it for final release. Some of
these processes are quite specialized and technical. To give you a sense of the
capabilities of our workstations, here are some of the tasks typically performed
using SonicStudio workstations:
. Editing -- SonicStudio permits very precise and elegant
editing of sound. Editing is the process by which pieces of
sound are combined to create a single resulting sound in
such a way that the existence of the original individual
pieces is imperceptible to the listener. Editing is used
extensively in professional audio work. For example, movie
sound tracks are heavily edited to include sound effects and
replacement dialog (virtually none of the sound effects or
dialog you hear in the theater was actually recorded when
the picture was being shot). Another example: classical
music recordings are in most cases the result of intensive
editing of multiple performances of the same program (our
classical music editing customers tell us that an edit every
six seconds on average is not uncommon).
. EQ -- SonicStudio can be used to equalize ("EQ") the sound,
a process by which certain frequencies are emphasized or de-
emphasized. EQ is similar in concept to manipulating the
bass and treble controls on a consumer audio system, but
with much greater precision and sophistication.
. Mixing -- SonicStudio can be used to mix or combine together
two sound recordings into one. Mixing is often used in
professional audio work because it is more convenient to
record individual elements at different times and under
different conditions. The
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individual elements or tracks are combined or mixed together
to produce the resulting sound used in release.
. Noise Reduction -- We offer NoNOISE(R) as an option to
SonicStudio. NoNOISE is a suite of software tools which
permits users to remove unwanted noise from recordings.
NoNOISE has been used extensively by audio professionals,
particularly to re-issue older recordings on Compact Disc,
and to clean up noisy location sound tracks for film and
broadcast video work. In 1997, our company was honored with
a technical Emmy(R) award for NoNOISE.
Customer Segments for SonicStudio
There are three major segments of SonicStudio customers:
. Mastering -- customers in this segment use our products to
prepare music recordings for release to consumers, primarily
on Digital Audio Compact Discs.
. Broadcast -- customers in this segment use our products to
prepare audio for broadcast on radio.
. Sound-for-Picture -- customers in this segment use our
products to prepare audio tracks used with film or video
programming.
SonicStudio Customers
We have supplied SonicStudio workstations to many professional audio
facilities around the world. As of March 31, 2000, more than 4,000 SonicStudio
systems had been shipped to customers since the product was first introduced in
1990.
SonicStudio Configurations
We offer SonicStudio in a variety of configurations, and with various
hardware and software options. A customer could purchase a SonicStudio system
configured for basic two channel CD premastering for approximately $5,000. A
customer would pay approximately $12,000 for a fully-featured SonicStudio system
configured for multi-track editing and mixing. One of our new SonicStudio HD(TM)
Systems, configured for multi-track high resolution audio editing, and
OneClick(TM) DVD-Audio authoring software would be priced at approximately
$50,000. Please remember that we do not include the cost of the personal
computer or peripheral devices in our illustrative pricing. Remember also that
revenue as we report it on our financial statements is usually based on the net
price we receive from dealers, and is thus lower on average per system than
indicated by these illustrative prices, which are based on end user list prices.
Competition
We encounter competition from a number of companies when selling
SonicStudio. We compete with companies offering:
. traditional analog production tools,
. digital audio recording tools,
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. digital audio processing devices, and
. digital audio workstations.
The key elements of competition include:
. product features,
. cost effectiveness,
. product quality,
. customer support,
. market and sales.
Many of our competitors have greater financial, technical and marketing
resources than we do. Traditional professional audio competitors, such as Japan
Victor Corporation (JVC), Otari Corp., Sony Corporation and Studer AG (a
division of Harmon Industries), sell analog as well as digital systems. A number
of competitors supply digital audio workstations including Digidesign (a
division of Avid Technology), Fairlight, Studio Audio and Design, Ltd. (Sadie),
WaveFrame, Dalet, Augan and others. Our products compete also with various kinds
of single function digital audio processing devices. For example, noise
reduction modules from Cambridge Audio Research compete with the NoNOISE option
for SonicStudio.
New HDSP Platform
In late March 1999, we began shipping the latest generation of our
SonicStudio workstation line -- SonicStudio HD(TM). SonicStudio HD utilizes a
new generation audio signal processing card, the "HDSP" which significantly
increases the processing power of SonicStudio. We released newly developed
application software to support this new workstation. We believe that
SonicStudio HD is important for the future of our audio business, especially in
light of the advent of new, higher resolution DVD based audio formats.
A number of our existing SonicStudio customers purchased upgrades to the
new HDSP platform when we introduced it. We anticipate that HDSP will permit
many of our customers to begin their involvement with new high resolution
formats such as DVD-Audio. We also believe that HDSP will be a very competitive
offering for customers who are shopping for a new digital audio workstation.
Strategy
Our strategy with SonicStudio is to continue to offer products that enhance
professional productivity while meeting the specific needs of each segment of
our target markets. We believe 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 has specialized needs. Our SonicStudio product line spans
a wide range of performance characteristics, hardware and
software options, configurations and price points in order to
address the specific needs of professionals in each market
segment.
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. Professional Performance - We focus on satisfying demanding
professional performance requirements. That is why we implement
an architecture utilizing specialized hardware to ensure a fast,
professional level of system response, and to avoid processing
bottlenecks in handling bulky audio and video files.
. Efficiency Features - We designed SonicStudio to increase
operator efficiency. For example, 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. The re-
design of our applications software to support the new HDSP
involved a year-long effort and a number of customer focus groups
where we carefully analyzed actual customer use patterns to
improve SonicStudio's user interface.
. Modular Software-Based Solutions; Upgrades - We offer a modular
set of software applications including digital equalization,
filtering, dynamics, processing, mixing, dithering, time
compression, pitch shifting, varispeed and reverberation. We
package various features into options which can be added by
customers as they wish and as their business needs dictate. We
have also traditionally offered customers enrolled in our
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.
DVD Creator
DVD-Video
Our DVD Creator(TM) workstations support preparation of DVD-Video discs.
DVD-Video is a relatively new optical disc format, introduced in 1996,
which offers high quality video, surround audio, and interactivity on a Compact
Disc-sized disc. 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 overlaid on background video or still images) may be
included and can be used in a number of ways, for example, to create 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 Functions
DVD-Creator supports the three basic processes required to prepare audio
and video programming in the DVD-Video format. These are:
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. MPEG-2 Video Encoding -- MPEG-2 and MPEG-1 video are the
standards for DVD-Video discs. MPEG is a digital video format
that compresses the original digital video stream to reduce
bandwidth and storage requirements by 90 to 95% but with little
or no loss in perceived quality.
. Audio Preparation and Encoding -- DVD-Video supports uncompressed
("PCM") digital audio as well as MPEG-2 and Dolby Digital
compressed formats.
. Format Authoring -- To support the advanced features of DVD-
Video, particularly menu-drive interactivity and multiple video
and audio streams, the audio, video, graphic and text elements
included in the disc must be organized, linked and then "woven"
together.
Products
DVD Creator includes three principal separable subsystems capable together
of performing all the tasks necessary for producing a finished DVD-Video disc
image, which can then be replicated on manufactured DVD discs. Those are:
. Video Encoding: 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 four Megabits per second. 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. We have 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.
. Audio Encoding: DVD Studio Audio - DVD Creator bundles a standard
SonicStudio system, running on the Macintosh, with special
software to perform Dolby Digital and MPEG-2 audio compression
and audition.
. Format Authoring: DVD Producer - DVD Creator's authoring
subsystem is DVD-Producer. The authoring step takes individual
compressed video, audio, graphics, still picture and subpicture
elements and combines and organizes them along with instructions
specifying interactivity (i.e., the response DVD players will
make based on user manipulation of front panel buttons or remote
control buttons). The output of the authoring step is an "asset
list," containing each of the individual elements, and a "script"
describing how the assets are combined and accessed via user
commands. Because of the large number of potential elements in a
DVD title and the high level of interactivity possible, DVD-
Producer is a complicated software package.
In addition to these main subsystems, DVD Creator includes two other
subsystems:
. Emulation: PrePlay - Because of the complexity of a DVD title,
users of DVD Creator require the ability to preview the results
of their edits before the time consuming and
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expensive step of producing a final version. We offer a
workstation that allows this previewing.
. Formatting and Writing: Format Server and Imager -- We provide a
separate formatting engine as a standalone application called
Format Server. Format Server takes the output of a DVD-Producer
authoring session and combines navigation instructions with audio
and video assets to create a finished disc image. The image can
then be played from computer hard disk, or converted by another
standalone application, called Imager, into a streaming tape
based image (the standard way in which images are transmitted to
the replication plant) or recorded onto a recordable DVD disc.
In September 1999 we introduced a new DVD production system called DVD
Fusion. DVD Fusion is similar to DVD Creator, but somewhat more limited in
capabilities. We intended DVD Fusion to be used in conjunction with professional
video editing systems such as those supplied by Media 100 or Avid.
DVD Creator/Fusion (in the discussion which follows, "DVD Creator" should
be understood to include DVD Fusion as well) is sold in multiple versions for
between $2,999 and $99,999 (again, our prices do not include host computers,
disk storage or other peripheral devices). Customers can purchase upgrade
options for any version to increase the functionality of the system. Typically,
customers will spend between $35,000 and $55,000 for their DVD Creator system.
Please remember also that revenue as we report it on our financial statements is
usually based on the net price we receive from dealers, and is thus lower on
average per system than indicated by these illustrative prices, which are based
on end user list prices
DVD-Audio
Version 1.0 of the DVD-Video specification was published in August of 1996,
and players were introduced into various regions of the world during late 1996,
1997 and 1998. At about the same time the DVD-Video specification was being
finalized, the DVD Forum (the standards-setting industry association for DVD)
formed a working group to develop a DVD-Audio format, intended to be a sister
format to DVD-Video, but to emphasize more audio features.
The DVD-Audio working group spent more than two years developing the new
DVD-Audio specifications in close collaboration with the major record music
companies. The DVD Forum released Version 1.0 of the new DVD-Audio specification
in April 1999. The first commercially released players compatible with the new
format became available in late 1999. We announced support for this new
specification in the fall of 1998, and began delivery of the first software
packages supporting preliminary and limited DVD-Audio authoring early in 1999.
We introduced new releases of DVD-Audio support on a phased release basis during
the balance of 1999 working closely with player manufacturers and early DVD-
Audio content publishers.
Market
We divide the DVD-Creator market into 3 segments:
. "Hollywood" Segment - This segment includes facilities that
prepare film and video material for mass publication on DVD-Video
discs. It includes:
- film and television studios,
- production companies and other content owners, and
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- top flight independent video post production facilities
which provide services to such content holders.
Customers in this segment tend to cluster in major film and video
product centers including Hollywood/Los Angeles, New York City,
Chicago, London, Paris, Tokyo, Taipei, etc. Customers in this
segment demand the very highest quality in terms of processing
output, strict adherence to standards, and are very concerned
with the overall efficiency of production since projects are
often produced on tight schedules. We estimate that there are a
few thousand facilities and organizations in this segment,
worldwide.
. "Corporate" Segment - Customers in this segment prepare DVD-Video
discs for publishing a variety of kinds of information for sales,
training, and other communications purposes. The segment
includes:
- "in-house" departments of corporate, industrial, non-
profit or educational organizations, and
- independent facilities who specialize in assisting such
organizations in preparing such material.
Customers in this segment are typically somewhat more budget
constrained than customers in the "Hollywood" segment. In certain
instances, however, production values and budgets equal or even
exceed those typically encountered in the Hollywood segment. They
tend to be geographically more dispersed. While efficiency of
production is a key requirement of such customers, compatibility
with other, existing recording and post-production equipment is a
major concern of customers in this segment. This segment is only
now beginning to adopt DVD, though given the spread of DVD-ROM in
the personal computer industry, many industry observers predict
rapid growth in the use of DVD in this segment. We estimate that
there are potentially more than 100,000 facilities and
organizations in this segment on a worldwide basis.
. "Multimedia" Segment - This segment includes developers of
multimedia entertainment and educational titles intended for a
mass audience. Many of the organizations in this segment
previously were involved in the production of CD-ROM, CD-I and
computer based interactive entertainment or educational titles.
Customers in this segment tend to use DVD in conjunction with
specialized computer software and accordingly their needs are
more varied than those in the other segments. While relatively
few organizations in this segment have moved to DVD, industry
observers report a high level of interest in the DVD format. We
estimate that there are approximately 15,000 organizations that
might ultimately become involved in DVD-based production in this
segment.
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, 2000
we have shipped more than 1,300 DVD Creator systems (including DVD Fusion
systems) to customers in various locations around the world.
Competition
The DVD-Video format has generated significant interest among professional
system suppliers. A number of companies currently provide MPEG-2 video encoding
capabilities, audio encoding capabilities and
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authoring systems for the professional user. We believe that more companies will
participate in this market in the future.
A number of companies compete with all or part of our DVD Creator offering.
Our competitors include:
Astarte (purchased by Apple) Matsushita
C-Cube Microsystems Minerva Systems
Daikin Industries Mitsubishi
Digital Vision Optibase
Dolby Laboratories Philips
FutureTel Pioneer
Innovacom Sony
Intec Spruce Technologies
Lucent Toshiba
A number of these companies have financial or organizational resources
significantly greater than ours and/or greater familiarity with certain
technologies involved in DVD premastering solutions.
Strategy
We expect that our DVD related business will account for an increasing
portion of our overall business in the future. Our DVD strategy will continue to
be based on the following elements:
. Focus on Professional Applications -- Our 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. We will 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 -- Our 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 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. We have engineered DVD
Creator as a "workgroup" solution incorporating modular audio,
video and authoring subsystems to make it easy for facilities to
re-arrange DVD workflow quickly, and to comply easily with
changing demands in the DVD universe. We plan to continue to
implement this philosophy in future DVD product offerings.
. Range of Product Offerings -- DVD has a number of potential uses,
including applications in corporate and industrial settings, and
in "prosumer" and consumer venues, as well as in delivery of mass
entertainment such as feature films, videos, and recorded music.
We plan to evolve each element of our DVD premastering tool set
-- video, audio and authoring -- to specifically address the
specialized needs of such emerging segments. Please see the
discussion regarding "DVDit!" below.
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DVDit!
In April 1999 we introduced our DVDit! product line. DVDit! is a highly
simplified interactive video authoring tool that can output a DVD image, or can
output the same program in certain other formats. We announced two versions of
DVDit! -- a standard version ("SE") and a more limited version ("LE"). We began
shipping DVDit!-LE in September and DVDit!-SE in December, 1999
In April, 2000 we introduced a new addition to the DVDit! product line --
Sonic DVDit! Professional Edition ("PE"). DVDit!-PE increases DVDit!'s reach
with professional functionality previously found only on authoring systems
costing five to ten times as much. DVDit! PE will carry a suggested retail price
of $999. DVDit! PE includes many features important to professional users such
as multiple audio streams, a video timeline, and Dolby Digital support.
End User Customers
DVDit! is intended to address the needs of a broad range of customers who
wish to author DVD-Video discs. Among DVDit!'s end user customers are:
Consumers -- Individuals who use DVDit! to make DVD-Video discs from home
videos and the like for their personal enjoyment. We believe that this
group of customers demands software that is easy to learn, and is
reasonably priced.
"Prosumers" -- The term "prosumer" describes both video enthusiasts who
make a significant investment of time and money in producing and preparing
amateur videos, and professional and business people who use video in their
work, but for whom video production is not a primary business activity.
Compared to consumers, this customer group tends to be less price
sensitive, and more concerned about a rich feature set, but is unlikely to
have deep knowledge of DVD-Video.
"Professionals" -- This group of customers resembles very closely the
professional customers we described in discussing DVD Creator.
Trends Favoring DVDit!
We introduced DVDit! to take advantage of the following trends:
. Proliferation of MPEG Video -- Due to certain introductions by chip
and software makers, relatively high quality MPEG encoding systems are
becoming widely available during 2000 at prices ranging down to a few
hundred dollars at retail.
. Availability of Accessible DVD Recording -- Until recently, DVD
recorders were high priced and supported less than a full-sized 4.7
Gigabyte disc. In 2000, we anticipate that more reasonably priced DVD
recorders will become available. We believe that DVD recording devices
could eventually be as cheap as current day CD-R and CD-R/W devices
(which currently are available for under $200 and $300, respectively).
Because of the rapid adoption of DVD, we think that consumer level
pricing will be reached within a few years rather than the eight or so
years required for CD recorders to fall from more than $10,000 to
under $500.
. Ubiquitous Digital Video -- Relatively high quality digital video
camera/recorders based on the DV format were introduced in the past
three years aimed at professionals as well as consumers. Prices for
consumer DV cameras will begin moving below $1,000 in 2000. Virtually
every
13
manufacturer of professional and prosumer video editing systems is
intending to release DV compatible systems in 2000 as well.
. Rapid Growth in DVD Playback Units -- By the end of 1998,
approximately eight million DVD-Video playback units (including both
set-top players and DVD-equipped multimedia PCs) had been installed
worldwide, according to industry sources. By the end of 1999, this
installed base had grown to approximately 30 million and by the end of
2000 is forecast to have grown to as many as 60 million units.
Distribution for DVDit!
Because DVDit! is aimed at a broader market than our traditional
professional products, we are building a distribution capability for it. There
are three elements to this effort:
1. We are adding dealers and distributors for DVDit!, some of
which already carry some of our professional products, but
many of which do not. In the near term we are targeting
dealers and distributors specializing in digital video
applications. In the longer term we plan to target dealers
and distributors who participate in the broader personal
computer marketplace.
2. We are entering into "bundling" arrangements with various
other companies in which copies of DVDit! are included or
"bundled" with shipments of those companies' products. These
companies (we refer to them as "OEM Partners") are motivated
to include our software as a value added offering for their
customers. We are motivated to enter into bundling
arrangements because it generates revenue for us as well as
creates a large installed base of customers to whom we can
sell upgraded or enhanced versions of our products. To
facilitate such bundling arrangements we have designed
different versions of DVDit!. Currently we are shipping two
such versions -DVDit! LE ("Limited Edition") and DVDit! SE
("Standard Edition")- and have announced the future
availability of another version - DVDit! PE ("Professional
Edition").
3. We have initiated a web-based retail store for our DVDit!
products. Our web store is intended both to meet retail
demand for our DVDit! products as well as to service upgrade
orders for our products, in particular, the upgrade orders
which derive from our bundle shipments by our OEM partners.
Building distribution for DVDit! will be a time-consuming and expensive
process. Since this is a new kind of product for us, there is significant risk
that our efforts, or at least some of them, will not be successful.
DVDit! OEM Partners
As mentioned above, we have implemented a bundling distribution strategy
for DVDit! By the end of fiscal 2000, we concluded several bundling agreements
with OEM partners to include copies of DVDit! LE and/or SE with their products.
Our current OEM partners include:
. Avid Technologies
. Dazzle
. Margi
14
. Matrox
. Media 100 (including its subsidiaries Terran Interactive and Wired)
. NEC
. Sigma Designs
. Sony
We may also offer DVDit! through conventional computer industry resale
channels.
Competition
We have encountered only limited competition to DVDit! since its
introduction. However, we believe that a number of companies will introduce
products that compete directly or in part with DVDit! We believe that Daikin
Industries and Spruce Technologies, among others, are developing and will
introduce products which compete with all or at least some of the products in
the DVDit! product line. In April 2000 Apple Computer announced that they had
agreed to purchase the DVD authoring technology and business of Astarte GmbH,
who had competed with us in the professional market. Apple could choose to
embody the Astarte technology in products which will compete with DVDit!
DVDit! for the Macintosh
Our current versions of DVD it! run on various versions of the Microsoft
Windows operating system. In April 2000 we announced that we plan to develop
versions of DVDit! to run on the Macintosh operating system. We can not
guarantee that we will be able to successfully complete this development or
that, once completed, there will be a market for the Macintosh versions of
DVDit!.
OEM Customers; Sales Concentration
We generally market our products to end users as Sonic Solutions products.
However, from time to time we have concluded various "OEM" agreements with other
companies (in addition to those listed above for DVDit!), in which those
companies included our products as part of the their product offerings. At the
present time we have one significant OEM relationship with Discreet Logic
("Discreet"), a division of Autodesk, in which we provide audio subsystems for
use with some of their high end video effects and editing workstations. Sales to
Discreet amounted to 11% of our total revenues in the fiscal years ended March
31, 1999, and 2000. Although we consider our relations with Discreet to be good,
we anticipate that at some point in the next two fiscal years, Discreet may
implement changes to its product line replacing or eliminating our subsystems.
During the fiscal year ended March 31, 2000, sales to our Japanese
distributor, Sanshin Electronics Company ("Sanshin"), amounted to 10% of total
revenues. Sanshin is a distributor of all of our products.
Apart from sales to Discreet and Sanshin, no other single customer
accounted for more than 10% of our total revenue during each of the past three
fiscal years.
15
Macintosh Dependence
All of our current professional products operate on Macintosh computers
marketed by Apple Computer. Our business would be particularly at risk if there
was an interruption in the supply of Macintosh computers either because of
operational or financial or other business problems at Apple. Our business would
also be threatened if Apple made changes to the operating system software or
hardware of the Macintosh line that led to compatibility problems with our
hardware or software.
COMPANY OPERATIONS
Marketing, Sales and Distribution
Marketing and Product Management
Our marketing organization plans and manages development of our products
and manages promotion of them in the market. We currently have eight employees
in marketing, all based in our headquarters office in Novato, California,
including product marketing managers, and marketing communications and design
professionals.
Field Sales Force
We sell our professional workstation products through our field sales force
in combination with a network of professional audio/video dealers. We currently
employ 19 people in our field sales organization. Sales personnel are based in
our headquarters office in Novato, California as well as at our offices in
London (covering Europe) and in Tokyo (covering the Pacific Rim). We have other
sales personnel based out of home offices in Chicago, Los Angeles, Atlanta,
Minneapolis, Milwaukee, Boston, Taipei and New York City. Our field sales force
includes sales managers and sales engineers. Most of our field sales personnel
operate under compensation arrangements in which a substantial portion of their
compensation is contingent upon performance relative to revenue targets.
Although all members of our sales organization are familiar with all of our
products, some of our sales personnel focus on DVD Creator, some on DVDit!, and
some on SonicStudio.
Dealers
The vast majority of our workstation sales involve one of our dealers.
Dealers play an important role in our sales and support efforts. They stimulate
demand in their regions, they prospect for and qualify potential new customers,
they give product demonstrations, they close sales, and they assist in post-sale
installation, training and support. Dealers very often sell peripheral equipment
along with our products so that customers can obtain a complete workstation
configuration from one source.
We have dealers in most areas of the world. We generally do not grant
contractual exclusivity to our dealers, though as a matter of practice,
depending on the dealer's territory and competence, we may maintain only one
dealer in a particular region.
Recruiting and maintaining dealers can be a difficult process. Because our
products are sophisticated, our dealers need to be technically proficient and
very familiar with professional audio and video production work. Dealer
organizations sometimes have limited financial resources, and may experience
business
16
reversals for reasons unrelated to our product lines. The attractive dealers in
a region may be carrying competing products.
Our dealers are specialized to some extent by product line. Many
SonicStudio dealers do not carry DVD Creator products, and likewise many DVD
Creator dealers do not carry SonicStudio products. DVDit! dealers often do not
carry our professional product lines. Some dealers carry two or all three of our
product lines. The following table shows our current dealer count by product
line and region of the world:
------------------------------------------------------------------
SonicStudio DVD Creator DVDit! Total*
------------------------------------------------------------------
Americas 20 40 5 62
Europe 15 33 2 41
Pacific Rim 4 7 2 11
------------------------------------------------------------------
*Note: "Total is less than the sum of columns because one dealer
organization sometimes carries more than one of our product lines.
Employees
At March 31, 2000, we employed 92 full-time-equivalent employees, including
the following:
---------------------------------------------------------
#
Employees Function
---------------------------------------------------------
40 Marketing, Sales and Customer Support
32 Software and Hardware Engineering
9 Manufacturing
11 Administration and Finance
---------------------------------------------------------
To a very great degree our success in the future will depend on our ability
to recruit, retain and motivate engineering, technical, sales, marketing and
operations professionals. Recently the U.S. labor market has been quite tight,
and demand for technology professionals has been very strong. To make matters
worse, our company participates in what is perceived to be a "hot" area of the
"high tech" industry. We have found that recruiting high caliber individuals is
difficult and have had to expend considerable efforts in this area.
No labor unions represent any of our employees. We have never experienced a work
stoppage, slowdown or strike. We believe that our employee relations are good
Customer Support
Customer support is important to professional users. This is why we offer
our customers the SonicCare maintenance program. Customers purchase annual
SonicCare service contracts from us that provide for:
. ongoing software upgrades,
17
. telephone support,
. "swap" replacement hardware in case of hardware failure, and
. preferential access to new products and new versions of software.
Customers typically add a SonicCare option to their initial system purchase
and a significant portion of customers renew SonicCare yearly.
To administer SonicCare, we employ a staff of product support specialists
at our Novato headquarters and in our field offices. We provide unlimited
telephone support during scheduled support hours to all customers under
SonicCare. Customer support calls also provide us with an important means of
understanding customer requirements for future product enhancements. We also
undertake regular customer calling programs in which customers are contacted by
a customer support representative to assess their level of satisfaction and to
acquaint them with new product offerings.
Research and Development
Our research and development staff includes a total of 32 hardware and
software engineers and technicians and technical specialists. We tend to hire
research and development personnel with backgrounds in digital audio signal
processing, digital video image processing, distributed networking and computer
systems design. Our development team exhibits a number of technology
capabilities including the following that we believe are particularly important
in light of our strategy and market position:
. Digital Signal Processing - This is the term used to
describe the sophisticated mathematical processing by which
aural and visual signals are processed in computer based
settings. Our engineering team includes individuals
experienced at providing sophisticated digital signal
processing solutions to meet the quality and performance
requirements of audio and video professionals.
. Real Time Architectures - Our engineers are experienced in
dealing with the requirements of high bandwidth, real time
data in computer-based settings. We believe that has helped
us to develop products that provide cost effective solutions
for professional applications.
. Craft Familiarity - Our engineers are experienced in the
needs and work patterns of audio, film and video
professionals. This helps us develop products which can be
adopted more quickly by creative audio and video
professionals.
Backlog
We schedule our production of products based on our projections of customer
demand, and we generally ship products within a few days of acceptance of a
customer purchase order so at any given time we have little or no order backlog.
With few exceptions, customers may cancel or delay orders with little or no
penalty. Thus, even to the extent that we have backlog, we do not think that it
is a reliable indicator of future revenue levels.
18
Manufacturing and Suppliers
How We Manufacture
We have typically contracted with various electronics manufacturing and
assembly houses to manufacture the hardware components of our products. Most of
these contractors are located in the San Francisco Bay Area. Our staff performs
final assembly, integration and testing at our Novato, California headquarters.
Sole-Sourced Components
We utilize a number of components in our products that are available from
only a single source. We purchase these sole-source components from time to
time, that is, we do not carry significant inventories of these components and
we have no guaranteed supply agreements for them. We have experienced shortages
of some sole-sourced components in the past. We are likely to experience similar
shortages at some point in the future. Such shortages can have a significant
negative impact on our business.
Outsourcing
Over the past three years, we have shifted our hardware manufacturing to an
"outsourcing" approach. Under outsourcing we contract with a single partner
organization which takes responsibility for procuring parts, and for
manufacturing them into complete, tested assemblies which are then released to
us according to our instructions. Our current outsourcing arrangement is with
Arrow/Bell. We believe that outsourcing provides us with increased flexibility
to increase or decrease production, and allows us to operate our business with
substantially reduced inventories thereby reducing financing requirements.
During the 2000 fiscal year, we produced approximately 85% of our hardware via
outsourcing. We plan to continue this outsourcing approach.
While we believe that outsourcing is advantageous for Sonic, it makes us
very dependent on a single production source. Financial, operational, or supply
problems encountered by our outsourcing partner or its sub-contractors could
seriously hamper or interrupt our ability to manufacture, sell and ship our
products.
Proprietary Rights
General Approach
We rely on a combination of the following to protect our proprietary rights
in our products:
. patents,
. trade secret,
. copyright law,
. trademark law,
. contracts, and
. technical measures
19
We generally sell our products subject to standard purchase and license
agreements that restrict unauthorized disclosure of our proprietary software and
designs, or copying for purposes other than the use intended when the product is
sold.
Patents
We have applied in the United States for patents covering certain of our
technologies and will probably apply for more in the future. We will probably
also apply for foreign patents. We have been granted U.S. Patent No. 5,812,790:
"Variable encoding rate plan generation" covering certain aspects of MPEG-2
Video encoding technology; and U.S. Patent No. 6,047,356: "Method of dynamically
allocating network node memory's partitions for caching distributed files"
covering a distributed file system, and may be granted additional patents in the
future. Of course, we can't be sure that our current or future patent
applications will be granted. Nor can we be certain that we can successfully
prosecute claims against others based on our patents, or defend our patents
against the claims of others. We believe that becoming involved in patent
litigation can be quite expensive and is highly uncertain in terms of outcome.
The status of patent protection in our industry is not well defined
particularly as it relates to software and signal processing algorithms. In the
past several years there seems to have been a trend on the part of patent
authorities to grant patents in audio and video processing techniques with
increasing liberality. We believe that it is quite possible that some of our
present or future products may infringe issued or yet to be issued patents. It
is almost certain that we will be asked by patent holders to respond to
infringement claims. If such patents were held to be valid, and if they covered
a portion of our technology for which there was no ready substitute, we might
suffer significant market and financial losses.
Our products involve the use of certain technologies in which the overall
patent situation is acknowledged by most industry observers to be very unclear.
For example, patent coverage and license availability for MPEG-2 video encoding
and decoding is currently quite uncertain. While one group of companies has
attempted to create a single licensing entity for this technology (called
"MPEG/LA"), not all relevant patent holding companies have joined this entity.
We plan to continue to monitor this area and to act prudently to avoid needless
litigation and entanglements while continuing to offer our products.
Trade Secrets
We rely to a great extent on the protection the law gives to trade secrets
to protect our proprietary technology. Our policy is to request confidentiality
agreements from all of our employees and key consultants, and we regularly enter
into confidentiality agreements with other companies with whom we discuss any of
our proprietary technology.
Despite trade secret protection, we cannot be sure that third parties will
not independently develop the same or similar technologies. Despite contract and
procedural measures, we believe that it is practically impossible to guard
against unauthorized disclosure or misuse of technology to which we have granted
third parties access. We also have significant international operations. Many
foreign countries, in law or in practice, do not extend the same level of
protection to trade secrets as does U.S. law.
Current Infringement Issues
In the past we have been advised of various infringements of patents and
trademarks. We do not believe that in any such situation currently known to us
we are at risk of material loss or serious interruption of our business. We may
be incorrect in this assessment, of course.
20
Geographic Exposure
We have for many years realized a significant proportion of our revenues
from sales outside the United States. In some fiscal quarters non-U.S. revenue
has constituted as much as 52% of our revenues. In the fiscal year ended March
31, 2000, 47% of our revenues came from sales outside the United States. We
believe that it is quite likely that at some points in the future an even higher
percentage of our sales will be generated outside the United States.
Because of our foreign sales, we are exposed to a number of factors that
would not be relevant if our sales were largely made within the United States.
Currency movements which make the U.S. dollar stronger relative to foreign
currencies can effectively raise the price of our products to foreign customers,
reducing demand for our products. Import restrictions, tariffs, and foreign
product regulations (particularly those dealing with product safety and RF
emissions) may also impede our ability to do business in foreign countries.
Item 2. PROPERTIES
Our 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.
We also have sales offices located in London and Tokyo.
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, 2000, we did
not submit any matters to a vote of our security holders.
21
Supplemental Item. EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers and their ages as of March 31, 2000 are as follows:
NAME AGE POSITION
- ---------------------- --------- -------------------------------------------------------------
Robert J. Doris 47 President (Chief Executive Officer) and Director
Mary C. Sauer 47 Senior Vice President of Business Development and Director
A. Clay Leighton 43 Senior Vice President Worldwide Operations, Finance and Chief
Financial Officer
Christopher A. Kryzan 41 Senior Vice President of Engineering and Marketing
Mr. Doris is married to Ms. Sauer. There are no other family relationships
between any director or executive officer of Sonic Solutions.
ROBERT J. DORIS. Mr. Doris founded Sonic Solutions in 1986 and has served
as President and Director of Sonic Solutions 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.
MARY C. SAUER. Ms. Sauer founded Sonic Solutions in 1986 and has served as
a Vice President and Director of Sonic Solutions 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. In January, 1999, Mr. Leighton was named Senior Vice
President of Worldwide Operations and Finance and Chief Financial Officer. 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
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.
CHRISTOPHER A. KRYZAN. Mr. Kryzan joined Sonic Solutions in March 1996 as
Vice President of Marketing. In January, 1999, Mr. Kryzan was named Senior Vice
President of Marketing and Engineering. Prior to joining Sonic, from May 1994
through February 1996, he was an independent consultant specializing in Internet
business and marketing strategy development. From July 1990 to April 1994, he
was Director of Marketing at SuperMac Technology, a graphics and digital video
technology firm, and General Manager of E-Machines, a subsidiary of SuperMac.
From January 1986 to July 1990, he was Director of Product Marketing at Wyse
Technology, a manufacturer of terminals and personal computers, and National
Sales Manager of
22
Amdek, a subsidiary of Wyse. Mr. Kryzan received a B.S. in Electrical
Engineering from Northwestern University and an M.B.A. from Santa Clara
University.
23
PART II
Item 5. MARKET FOR SONIC SOLUTIONS' COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our common stock is listed on the Nasdaq National Market. As of March 31,
2000 there were approximately 175 registered holders of our common stock. We
believe, however, that many beneficial holders of our common stock have
registered their shares in nominee or street name, and that there are
substantially more than 175 beneficial owners. The low price and high price of
our common stock during the last eight quarters are as follows:
----------------------------------------------------------------------
Low Price High Price
--------- ----------
----------------------------------------------------------------------
Quarter ended June 30, 1998............. $2.125 $ 5.250
Quarter ended September 30, 1998........ $1.250 $ 3.250
Quarter ended December 31, 1998......... $1.500 $ 7.375
Quarter ended March 31, 1999............ $3.563 $ 8.438
Quarter ended June 30, 1999............. $3.875 $ 7.125
Quarter ended September 30, 1999........ $2.000 $ 5.000
Quarter ended December 31, 1999......... $1.688 $ 5.313
Quarter ended March 31, 2000............ $3.875 $12.500
----------------------------------------------------------------------
We have 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 our business. Accordingly, we do
not anticipate paying dividends on the Common Stock in the foreseeable future.
In October 1999, we issued 153,846 shares of Series C Convertible Preferred
Stock and warrants to purchase 120,000 shares of Common Stock at $2.50 per share
to Hambrecht & Quist Guaranty Finance in return for restructuring the debt owed
to Hambrecht & Quist Guaranty Finance. See Management's Discussion and Analysis
of Financial Condition and Results of Operations. Each share of Series C
Convertible Preferred Stock is convertible into 1.625 shares of Common Stock.
These securities were exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933. These securities were sold to one investor which
represented it was sophisticated and accredited.
24
Item 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
the financial statements and related notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" appearing
elsewhere in this Form 10-K. The selected financial data presented below under
the caption "Statement of Operations data" and "Balance Sheet Data" for, and as
of the end of, each of the years in the five-year period ended March 31, 2000
are derived from the financial statements of Sonic Solutions, which financial
statements have been audited by KPMG LLP, independent certified public
accountants. The financial statements as of March 31, 2000 and 1999, and for
each of the years in the three-year period ended March 31, 2000, and the report
thereon, are included elsewhere in this Form 10-K.
Years Ended March 31,
------------------------------------------------
1996 1997 1998 1999 2000
-------- -------- -------- -------- --------
(in thousands except share amounts)
STATEMENT OF OPERATIONS DATA:
Net revenue.................................... $ 13,944 15,911 19,881 21,899 20,827
Cost of revenue................................ 7,344 7,432 10,209 9,547 8,992
-------- -------- -------- -------- --------
Gross profit................................... 6,600 8,479 9,672 12,352 11,835
Operating expenses:
Marketing and sales........................... 5,873 6,000 7,257 7,216 8,938
Research and development...................... 2,961 5,737 6,037 5,137 6,155
General and administrative.................... 2,668 1,837 1,603 1,556 2,284
-------- -------- -------- -------- --------
Total operating expenses....................... 11,502 13,574 14,897 13,909 17,377
-------- -------- -------- -------- --------
Operating loss................................. (4,902) (5,095) (5,225) (1,557) (5,542)
Other income (expense)......................... 176 (96) (651) (302) (249)
Provision (benefit) for income taxes........... (1,169) - - - (97)
-------- -------- -------- -------- --------
Net loss....................................... ($3,557) (5,191) (5,876) (1,859) (5,694)
======== ======== ======== ======== ========
Basic loss per share........................... ($0.48) (0.69) (0.76) (0.21) (0.56)
Weighted average shares used in computing per
share amounts.................................. 7,447 7,542 7,761 8,896 10,460
Diluted loss per share......................... ($0.48) (0.69) (0.76) (0.21) (0.56)
Weighted average shares used in computing per
share amounts.................................. 7,447 7,542 7,761 8,896 10,460
BALANCE SHEET DATA:
Working capital................................ $ 8,384 6,263 1,164 1,167 4,976
Total assets................................... $ 16,107 15,889 12,630 13,765 14,968
Shareholders' equity........................... $ 12,912 8,430 5,418 5,932 8,750
25
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW; CERTAIN FACTORS THAT MAKE FUTURE RESULTS DIFFICULT TO PREDICT; CERTAIN
ITEMS TO REMEMBER WHEN READING OUR FINANCIAL STATEMENTS
Our quarterly operating results vary significantly depending on the timing
of new product introductions and enhancements by ourselves and by our
competitors. Our results also depend on the volume and timing of orders which
are difficult to forecast. Because our customers generally order on an as-needed
basis, and we normally ship products within one week after receipt of an order,
we don't have an order backlog which can assist us in forecasting results. For
all these reasons, our results of operations for any quarter are a poor
indicator of the results to be expected in any future quarter.
A large portion of our quarterly revenue is usually generated in the last
few weeks of the quarter. Since our ongoing operating expenses are relatively
fixed, and we plan our expenditures based primarily on sales forecasts, if
revenue generated in the last few weeks of a quarter do not meet our forecast,
operating results can be very negatively affected.
We capitalize a portion of our software development costs in accordance
with Statement of Financial Accounting Standard No. 86. Such capitalized costs
are amortized to cost of revenue over the estimated economic life of the
product, which is generally three years. See Note 4 of Notes to Financial
Statements.
26
RESULTS OF OPERATIONS
The following table sets forth certain items from Sonic Solutions'
statements of operations as a percentage of net revenue for fiscal years 1998
through 2000:
Years ended March 31,
--------------------------------------------------------
1998 1999 2000
---------------- ---------------- ----------------
Net revenue 100.0% 100.0% 100.0%
Cost of revenue 51.4 43.6 43.2
------ ----- ------
Gross profit 48.6 56.4 56.8
Operating expenses:
Marketing and sales 36.5 33.0 42.8
Research and development 30.4 23.5 29.6
General and administrative 8.0 7.0 11.0
------ ----- ------
Total operating expenses 74.9 63.5 83.4
------ ----- ------
Operating loss (26.3) (7.1) (26.6)
Other expense (3.3) (1.4) (1.2)
Provision (benefit) for income taxes --- --- (0.5)
------ ----- ------
Net loss (29.6)% (8.5)% (27.3)%
====== ===== ======
COMPARISON OF FISCAL YEARS ENDED MARCH 31
Net Revenue. Our net revenue increased from $19,881,000 in fiscal 1998 to
$21,899,000 in fiscal 1999 and decreased to $20,827,000 in fiscal 2000,
representing an increase of 10.2% from fiscal 1998 to fiscal 1999 and a decrease
of 4.9% from fiscal 1999 to fiscal 2000. The increase in fiscal 1999 was
primarily due to increased sales of DVD Creator systems. The decrease in fiscal
2000 was primarily due to the decrease in sales of our audio products which was
partially offset by increases in sales of our DVD systems, including our two
newer products, DVDit! and DVD Fusion.
International sales accounted for 52%, 47% and 47% of our net revenue for
the 1998, 1999, and 2000 fiscal years, respectively. See Note 10 of Notes to
Financial Statements. Our international sales decreased in fiscal 1999 due to
the increased sales of DVD Creator systems in the U.S. markets. Our
international sales remained consistent in fiscal 2000 primarily due to the
continuation of more sales of DVD Creator systems in the U.S. markets.
International sales have historically represented around 50% of our total sales,
and we expect that they will continue to represent a significant percentage of
future revenue.
Cost of Revenue. Our cost of revenue decreased from 51.4% of net revenue in
fiscal 1998 to 43.6% in fiscal 1999 and decreased to 43.2% in fiscal 2000. The
decrease in cost of revenue in fiscal year 1999 and fiscal year 2000 is
primarily due to a shift in sales product mix towards higher margin DVD Creator
system and DVDit! sales. In general we have been selling less hardware as a
percentage of revenue in our professional systems and our new product DVDit!
includes no hardware.
Marketing and Sales. Our marketing and sales expenses decreased from
$7,257,000 in fiscal 1998 to $7,216,000 in fiscal 1999 and increased to
$8,938,000 in fiscal 2000. Marketing and sales represented 36.5%, 33.0% and
42.8% of net revenue for fiscal 1998, 1999 and 2000, respectively. Our marketing
and sales expenses remained relatively consistent in dollar terms from fiscal
1998 to fiscal 1999. Our marketing and sales expenses increased in fiscal 2000
primarily due to increases in salary expenses as a result of the increase in
headcount, and increases in advertising and marketing costs related to our
DVDit! and our DVD product lines. Our marketing and sales headcount increased
from thirty-seven at March 31, 1999 to forty at
27
March 31, 2000. Included in our marketing and sales expenses are dealer and
employee commission expenses, which as a percentage of net revenue decreased
from 5.2% in fiscal 1998 to 4.7% in both fiscal 1999 and fiscal 2000.
Research and Development. Our research and development expenses decreased
from $6,037,000 in fiscal 1998 to $5,137,000 in fiscal 1999 and increased to
$6,155,000 in fiscal 2000. Our research and development expense as a percentage
of net revenue was 30.4% in fiscal 1998, 23.5% in fiscal 1999, and 29.6% in
fiscal 2000. We capitalize a portion of our software development costs in
accordance with statement of Financial Accounting Standard No. 86. (This means
that a portion of the costs we incur for software development are not recorded
as an expense in the period in which they are actually incurred. Instead they
are recorded as an asset on our balance sheet. The amount recorded on our
balance sheet is then amortized over the estimated life of the products in which
the software is included.) Our research and development expenses decreased in
fiscal 1999 due to decreases in consulting and prototype expenses associated
with new product introductions. Research and development expenses increased in
fiscal 2000 primarily due to increased headcount from thirty at March 31, 1999
to thirty-two at March 31, 2000 and due to consulting expenses associated with
introductions of new products, including our DVDit! product. Prototype and
consulting expenses can fluctuate significantly from period to period depending
upon the status of hardware and software development projects and our schedule
of new product introductions.
General and Administrative. Our general and administrative expenses
decreased from $1,603,000 in fiscal 1998 to $1,556,000 in fiscal 1999 and
increased to $2,284,000 in fiscal 2000. These expenses represented 8.0% of net
revenue in fiscal 1998, 7.0% of net revenue in fiscal 1999 and 11.0% of net
revenue in fiscal 2000. Our general and administrative expenses decreased in
fiscal 1999 due to reductions in bad debt and other general expenses. Our
general and administrative expenses increased in fiscal 2000 primarily due to a
charge to bad debt expense of $600,000 which represented an additional reserve
for sales to audio professionals and distributors who are experiencing liquidity
difficulties due to a decline in their business. We anticipate that general and
administrative expenses (exclusive of the bad debt expense) will increase in the
future as costs increase and if our operations expand.
Other Expense, Net. The "Other Expense" item on our statement of operations
includes primarily the net amount of interest or other financing charges we have
incurred due to borrowings, reduced by the interest we earn on cash balances and
short term investments. For our 1998, 1999 and 2000 fiscal years, we incurred
interest and other financing charges related to financing agreements we had with
entities associated with Hambrecht & Quist, as well as borrowings under our bank
credit line.
Provision for Income Taxes. In accordance with Statement of Financial
Accounting Standards No. 109, we made no provision for income taxes for our
1998, 1999 fiscal years. For the 2000 fiscal year a benefit was recorded (during
the quarter ended June 30, 1999) to reflect the refund due us following the
conclusion of an Internal Revenue Service audit. During the 2000 fiscal year we
exhausted our ability to carryback tax losses resulting from operations in the
fiscal year ended March 31, 1996.
Liquidity and Capital Resources. In December, 1996 we entered into a Loan
and Security Agreement with Silicon Valley Bank. This Agreement, which we
sometimes refer to as our "bank credit line", has been modified or renewed at
various times since December 1996. The current bank credit line (renewed in
September, 1999) provides for up to $2,500,000 in available borrowings based
upon our eligible accounts receivable balances. The current bank credit line
will expire on September 28, 2000. This bank credit line provides for a variety
of covenants, including among other things, that we maintain certain financial
ratios. The bank credit line is collateralized by a security interest in
substantially all of our assets. Interest on borrowings under this agreement is
payable monthly at a rate of one and one quarter percent in excess of the prime
rate. On March 31, 2000 there were no borrowings outstanding under this
agreement. In December, 1996, we also obtained a $5,100,000 financing facility
with entities associated with Hambrecht & Quist. This
28
facility included subordinated debt as well as equipment lease financing. We
received $3,000,000 of subordinated debt from Hambrecht & Quist Transition
Capital, LLC and $1,100,000 of subordinated debt from Hambrecht & Quist Guaranty
Finance, LLC, pursuant to the above facility. The remaining $1,000,000 of the
facility was used to fund a master lease line for financing of future capital
asset purchases. The facility with the Hambrecht & Quist entities is secured by
an interest in our fixed assets and substantially all of our other assets but is
subordinate to our bank credit line. In connection with this financing facility,
we issued warrants to purchases 260,200 common shares to entities associated
with Hambrecht & Quist. The Hambrecht & Quist entities were entitled to exercise
the warrants with respect to 130,100 shares at an exercise price of $10.00 at
any time on or before December 24, 2004, and with respect to 130,100 shares at
an exercise price of $7.00 at any time on or after December 24, 1997 and before
December 24, 2004. In December, 1997 all of the $7.00 warrants were exercised on
a "net" basis, and the warrant holder received 40,266 shares of Common Stock. We
recorded $549,000 of deferred interest attributable to the value of the
warrants, which was amortized using the effective interest rate method to
interest expense over the term of the financing facility. The fair value of the
warrants was estimated using the Black-Scholes option pricing model and the
following assumptions: volatility of .75, risk free interest rate of 6.3% and
expected life equal to the contractual terms.
In March, 1998, we renegotiated our financing arrangement with Hambrecht &
Quist Guaranty Finance. The agreement we reached involved the restructuring of
$3,000,000 debt into $1,500,000 of Series C Convertible Preferred Stock (see
note 7 of Notes to Financial Statements) and $1,500,000 of debt. The interest
rate on such restructured debt was 7.25% and was due in October 1999. We filed a
Form S-3 Registration Statement under the Securities Act of 1933 to register the
resale of the 461,538 shares of the Company's Common Stock which underlie the
Series C Convertible Preferred Stock issued to Hambrecht & Quist Guaranty
Finance. In connection with the agreement, the exercise price of 90,000 of the
$10.00 warrants issued with the original arrangement reached in December 1996
was lowered to the fair value of common stock of $3.25. We accounted for this
transaction by revaluing the new warrants, using comparable assumptions as the
original warrant grant, and the resultant value of $90,000 was amortized over
the new loan period. In June, 1998, 90,000 of the $3.25 warrants were exercised
on a "net exercise" basis, and the warrant holder received 29,691 shares of
common stock. During the fiscal years ended March 31, 1999 and March 31, 2000,
167,500 and 292,000 shares of the Preferred Stock were converted into common
stock pursuant to this financing arrangement.
In October, 1999, we renegotiated our financing arrangement with Hambrecht
& Quist Guaranty Finance. The agreement we reached involved the restructuring of
$1,500,000 debt into 153,846 shares of Series C Convertible Preferred Stock and
$1,000,000 of debt. The interest rate on the restructured debt is 7.25% and the
debt and interest are payable in monthly installments through April 30, 2001. In
connection with this agreement, we issued warrants to purchase 120,000 common
shares at an exercise price of $2.50. These warrants expire on April 30, 2006.
We also enhanced the conversion rate of Hambrecht and Quist's existing Series C
Convertible Preferred Stock so that each share of Series C Convertible Preferred
Stock is convertible into 1.625 shares of Common Stock.. The beneficial
conversion feature, warrants and new debt were recorded at their relative fair
values. We recorded $345,000 of deferred financing costs attributable to this
finance restructuring with Hambrecht & Quist Guaranty. This amount is being
amortized using the effective interest rate method to interest expense over the
term of the financing facility (18 months). The fair value of the warrants was
estimated using the Black-Scholes option pricing model and the following
assumptions: volatility of .50, risk free interest rate of 6% and expected life
equal to the contractual terms. We filed a Form S-3 Registration Statement under
the Securities Act of 1933 to register the shares of the common stock which
underlie the Series C Convertible Preferred Stock and the 120,000 shares of our
common stock which underlie the warrants issued to Hambrecht & Quist Guaranty
Finance.
In December, 1997, we secured a $7,000,000 equity-based line of credit.
Under this arrangement, we had the right to draw up to a total of $7,000,000 in
cash in exchange for common stock. Pricing of the common stock issued was based
on the market price of our common stock at the time of a draw subject to a
29
14% discount and a 4% commission payable in common stock. The availability of
the credit line, and the amounts and timing of draws under the line were subject
to a number of conditions. In January, 1998, we filed a Form S-3 Registration
Statement under the Securities Act of 1933 to register the resale of shares
issued under this credit line. During the fiscal year ended March 31, 1998, we
drew $1,450,000 from this credit line for which we issued 618,130 shares of
common stock. During the fiscal year ended March 31, 1999, we drew an additional
$2,358,000 from this credit line for which we issued 903,870 shares of common
stock. This facility is no longer available to us.
On May 20, 1999, we secured a new equity-based line of credit by entering
into a new stock purchase agreement with Kingsbridge. Under this arrangement, we
were able to draw up to $12,000,000 in cash in exchange for common stock.
Pricing of the common stock issued under this arrangement was based on the
market price of our common stock at the time of a draw, discounted by 10% or
12%, depending upon the price of our common stock. The availability of the
credit line, and the amounts and timing of draws under the line were subject to
a number of conditions. On May 27, 1999, we filed a Registration Statement on
Form S-1 to register for resale the shares we may issue to Kingsbridge under
this credit line and on August 12, 1999 the Statement became effective. During
the fiscal year ended March 31, 2000, we drew $7,408,000 from the credit line
for which we issued 1,800,000 shares of common stock. Because of limitations on
the total number of shares that could be issued under this line of credit, this
facility is no longer available to us and was terminated on March 14, 2000.
On May 4, 2000, we secured a new equity-based line of credit by entering
into a new stock purchase agreement with Kingsbridge. Under the new agreement,
we may draw up to $20,000,000 in cash in exchange for common stock. Pricing of
the common stock issued under this agreement is based on the market price of our
common stock at the time of a draw subject to discounts ranging from 8% to 12%.
We will file a Registration Statement on Form S-1 to register for resale the
shares we may issue to Kingsbridge under this credit line. The availability of
the credit line, and the amounts and timing of draws under the lines are subject
to a number of conditions, including the effectiveness of the S-1 Registration
Statement. While we anticipate that the Registration will become effective in
the near future, and that conditions will be such that this line will be
available to us, we cannot be sure of this.
Our operating activities have used cash of $1,412,000 in fiscal year 1998,
$124,000 in fiscal year 1999 and $2,628,000 in fiscal year 2000. During those
fiscal years cash required by operating activities was not as great as our
operating losses due to various factors, including improvements in receivables
collection and inventory turnover, and the receipt of income tax refunds in
certain fiscal years. In addition to our operating losses, we utilized cash
during the 1998, 1999, and 2000 fiscal years to purchase new fixed assets, pay
down debt obligations and to develop and purchase software that was added to
capitalized software.
During fiscal 1998 we augmented cash on hand via borrowings from our bank
credit line described above, as well as draws on the equity credit line
described above. During the 1999 and 2000 fiscal years we augmented cash on hand
primarily by drawing on the equity credit lines described above.
We believe that existing cash, cash equivalents and short term investments,
available credit and cash generated from operations, plus cash available through
the new equity based line of credit with Kingsbridge (when and if it becomes
available-see discussion above) will be sufficient to meet our cash requirements
at least through the end of fiscal year 2001.
As of March 31, 2000, we had cash and cash equivalents of $5,179,000 and
working capital of $4,976,000.
30
Impact of Year 2000 Issue. We have not experienced any major system
failures or disruptions as a result of the Year 2000 issue. In addition, we did
not incur significant incremental costs to become Year 2000 compliant.
31
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Report of Independent Auditors, Financial Statements and Notes to Financial
Statements follow on pages 33 through 51.
32
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Sonic Solutions:
We have audited the accompanying balance sheets of Sonic Solutions as of
March 31, 1999 and 2000, and the related statements of operations, shareholders'
equity and cash flows for each of the years in the three-year period ended March
31, 2000 and the related financial statement schedule. These financial
statements and financial statement schedule are the responsibility of Sonic
Solutions' 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, 1999 and 2000 and the results of its operations and its cash flows for each
of the years in the three-year period ended March 31, 2000, 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.
/s/ KPMG LLP
San Francisco, California
April 28, 2000, except as to note 11 which is as of May 4, 2000
33
FINANCIAL STATEMENTS
SONIC SOLUTIONS
BALANCE SHEETS
(in thousands, except share and per share amounts)
March 31
--------------------------
1999 2000
---------- ----------
Assets
Current assets:
Cash and cash equivalents....................................................... $ 2,414 5,179
Accounts receivable, net of allowance for returns and doubtful accounts
of $599 and $930 at March 31, 1999 and 2000, respectively...................... 5,403 4,635
Inventory....................................................................... 807 945
Prepaid expenses and other current assets....................................... 287 425
-------- -------
Total current assets............................................................ 8,911 11,184
Fixed assets, net.................................................................... 2,313 1,515
Purchased and internally developed software costs, net............................... 2,385 1,876
Other assets......................................................................... 156 393
-------- -------
Total assets.................................................................... $ 13,765 14,968
======== =======
Liabilities And Shareholders' Equity
Current liabilities:
Accounts payable and accrued liabilities........................................ $ 4,359 4,306
Bank note payable............................................................... 500 ---
Deferred revenue and deposits................................................... 1,318 1,224
Subordinated debt, current portion.............................................. 1,419 600
Current portion of obligations under capital leases............................. 148 78
-------- -------
Total current liabilities....................................................... 7,744 6,208
Obligations under capital leases, net of current portion............................. 89 10
-------- -------
Total liabilities............................................................... 7,833 6,218
Commitments and contingencies
Shareholders' Equity
Convertible preferred stock, no par value, 10,000,000 shares authorized:
294,038 and 155,544 shares issued and outstanding at March 31, 1999, and
2000, respectively............................................................. 956 506
Common stock, no par value, 30,000,000 shares authorized; 9,468,123 and
12,050,214 shares issued and outstanding at March 31, 1999 and 2000,
respectively................................................................... 18,121 27,083
Accumulated deficit............................................................. (13,145) (18,839)
-------- -------
Total shareholders' equity...................................................... $ 5,932 8,750
-------- -------
Total liabilities and shareholders' equity...................................... $ 13,765 14,968
======== =======
See accompanying notes to financial statements
34
SONIC SOLUTIONS
STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Years Ended March 31,
-------------------------------------
1998 1999 2000
---------- ---------- ----------
Net revenue................................................................. $19,881 21,899 20,827
Cost of revenue............................................................. 10,209 9,547 8,992
---------- ---------- ----------
Gross profit................................................................ 9,672 12,352 11,835
---------- ---------- ----------
Operating expenses:
Marketing and sales.................................................... 7,257 7,216 8,938
Research and development............................................... 6,037 5,137 6,155
General and administrative............................................. 1,603 1,556 2,284
---------- ---------- ----------
Total operating expenses............................................... 14,897 13,909 17,377
---------- ---------- ----------
Operating loss......................................................... (5,225) (1,557) (5,542)
Other expense, net.......................................................... (651) (302) (249)
---------- ---------- ----------
Loss before income taxes............................................... (5,876) (1,859) (5,791)
Provision (benefit) for income taxes........................................ --- --- (97)
---------- ---------- ----------
Net loss............................................................. (5,876) (1,859) (5,694)
Beneficial conversion feature given to preferred shareholders........ --- --- 110
Dividends paid to preferred shareholders............................. --- 53 49
---------- ---------- ----------
Net loss applicable to common shareholders............................. $(5,876) (1,912) (5,853)
========== ========== ==========
Basic and diluted loss per share applicable to common shareholders..... $ (0.76) (0.21) (0.56)
========== ========== ==========
Weighted average shares used in computing per share amounts............ 7,761 8,896 10,460
========== ========== ==========
See accompanying notes to financial statements
35
SONIC SOLUTIONS
STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
Preferred stock Common stock
------------------- ------------------ Total
Accumulated Shareholders'
Shares Amount Shares Amount deficit Equity
-------- -------- -------- -------- ------------- -------------
Balances at March 31, 1997...................... --- $ --- 7,596 13,840 (5,410) 8,430
Exercise of common stock options............... --- --- 50 84 --- 84
Issuance of preferred stock.................... 462 1,500 --- --- --- 1,500
Equity line of credit issuances, net of
issuance costs of $197....................... --- --- 618 1,253 -- 1,253
Exercise of warrants........................... --- --- 38 --- --- ---
Issuance of warrants........................... --- --- --- 27 --- 27
Net loss....................................... --- --- --- --- (5,876) (5,876)
-------- -------- -------- ------- ------- --------
Balances at March 31, 1998...................... 462 1,500 8,302 15,204 (11,286) 5,418
Exercise of common stock options............... --- --- 64 143 --- 143
Equity line of credit issuances, net of
issuance costs of $75........................ --- --- 904 2,283 -- 2,283
Conversion of preferred stock.................. (168) (544) 168 544 --- ---
Preferred stock dividends...................... --- --- --- (53) --- (53)
Exercise of warrants........................... --- --- 30 --- --- ---
Net loss....................................... --- --- --- --- (1,859) (1,859)
-------- -------- -------- ------- ------- --------
Balances at March 31, 1999...................... 294 956 9,468 18,121 (13,145) 5,932
Exercise of common stock options............... --- --- 298 773 --- 773
Equity line of credit issuances, net of
issuance costs of $363....................... --- --- 1,800 7,053 --- 7,053
Issuance of preferred stock.................... 154 500 --- --- --- 500
Conversion of preferred stock.................. (292) (950) 464 950 --- ---
Preferred stock dividends...................... --- --- --- (49) --- (49)
Return to preferred stock shareholders as a
result of beneficial conversion feature...... --- --- --- (110) --- (110)
Preferred stock beneficial conversion feature.. --- --- --- 110 --- 110
Issuance of warrants........................... --- --- --- 235 --- 235
Exercise of warrants........................... --- --- 20 --- --- ---
Net loss....................................... --- --- --- --- (5,694) (5,694)
-------- -------- -------- ------- ------- --------
Balances at March 31, 2000...................... 156 $ 506 12,050 27,083 (18,839) 8,750
======== ======== ======== ======= ======= ========
See accompanying notes to financial statements
36
SONIC SOLUTIONS
STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended March 31,
--------------------------------------------
1998 1999 2000
---------- ---------- ----------
Cash flows from operating activities:
Net loss $(5,876) (1,859) (5,694)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 2,255 2,621 2,958
Provision for returns and doubtful accounts, net of write-offs 29 (18) 331
Interest expense amortization 482 60 ---
Changes in operating assets and liabilities:
Accounts receivable (122) (2,187) 437
Inventory 641 (173) (138)
Refundable income taxes 450 148 ---
Prepaid expenses and other current assets 254 30 (138)
Other assets (200) (72) (237)
Accounts payable and accrued liabilities 344 1,044 (53)
Deferred revenue and deposits 331 282 (94)
-------- ------- -------
Net cash used in operating activities (1,412) (124) (2,628)
-------- ------- -------
Cash flows from investing activities:
Purchase of fixed assets (787) (913) (850)
Additions to purchased and internally developed software (1,849) (696) (801)
-------- ------- -------
Net cash used in investing activities (2,636) (1,609) (1,651)
-------- ------- -------
Cash flows from financing activities:
Proceeds from exercise of common stock options 84 143 773
Repayments of subordinated debt (55) (568) (84)
Proceeds from equity line financing 1,253 2,283 7,053
Borrowings on line of credit 500 420 422
Repayments of line of credit --- (420) (922)
Principal payments on capital leases (88) (137) (149)
Payment of dividends --- (53) (49)
Issuance of warrants 27 --- ---
-------- ------- -------
Net cash provided by financing activities 1,721 1,668 7,044
-------- ------- -------
Net increase (decrease) in cash and cash equivalents (2,327) (65) 2,765
Cash and cash equivalents, beginning of year 4,806 2,479 2,414
-------- ------- -------
Cash and cash equivalents, end of year $ 2,479 2,414 5,179
======== ======= =======
Supplemental disclosure of cash flow information:
Interest paid during year $ 265 71 109
======== ======= =======
Income taxes paid during year $ 13 9 4
======== ======= =======
Noncash financing and investing activities:
Assets acquired through capital lease $ 221 --- ---
======== ======= =======
Conversion of preferred stock to common stock --- 544 956
======== ======= =======
Conversion of subordinated debt to preferred stock $ 1,500 --- 500
======== ======= =======
Issuance of warrants associated with conversion of
subordinated debt --- --- 235
======== ======= =======
Beneficial conversion feature given to preferred
shareholders --- --- 110
======== ======= =======
See accompanying notes to financial statements
37
SONIC SOLUTIONS
NOTES TO FINANCIAL STATEMENTS
March 31, 1998, 1999 and 2000
(1) SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
(a) Operations
We develop workstations used by professionals to edit and process digital
audio and digital video. Our products are computer based, and usually include
both plug-in hardware and applications software installed on a personal
computer. Our customers use various kinds of peripheral devices -- for example,
disk drives, streaming tape drives, and audio and video tape recorders -- along
with our products. Although we do not manufacture or sell the personal computer
or peripheral devices used with our products, we typically talk about the
complete configuration of personal computer, Sonic hardware, Sonic software, and
peripherals as a Sonic workstation.
We currently market two workstation product lines: SonicStudio(TM) and DVD
Creator(TM). SonicStudio is a line of professional audio workstations that our
customers use to prepare audio for release on digital audio compact discs, for
release with video and film entertainment, and for broadcast on radio. DVD
Creator is a line of DVD-Video/Audio production workstations which supports the
preparation and assembly of video and audio assets for release on the new DVD-
Video disc format and the upcoming DVD-Audio disc format.
During the fiscal year ended March 31, 2000, we introduced and began
shipments of two new products: DVDit!(TM) and DVD Fusion(TM). DVD it! is an
authoring application which provides simplified DVD authoring capabilities to
consumer, "prosumer," and some professional users. DVD Fusion, which is a part
of our DVD Creator product line, provides video producers and editors a
comprehensive set of tools for encoding, authoring and proofing DVD-Video titles
derived from projects created on non-linear video editing systems.
Our products generally include application software and specialized
hardware installed on a personal computer. Our 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.
(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.
We are dependent on sole-source suppliers for certain key components used
in our products. We purchase these sole-source components pursuant to purchase
orders placed from time to time. We do not carry significant inventories of
these components, and have 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 our results of
operations.
38
(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 sold with the product, is recognized
on a straight-line basis over the term of the agreement, generally one year.
We recognize revenue in accordance with Statement of Position (SOP) 97-2,
"Software Revenue Recognition". The statement provides specific industry
guidance and stipulates that revenue recognized from software arrangements is to
be allocated to each element of the arrangement based on the relative fair
values of the elements, based on objective evidence which is specific to the
vendor. Our adoption of SOP 97-2 on April 1, 1998 did not have a material impact
on revenue recognition.
Revenue from sales to distributors and dealers may be subject to agreements
allowing limited rights of return and exchange. Accordingly, we provide reserves
for estimated future returns and exchanges at the time of the sale as a
reduction 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) 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.
(f) 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 or the
estimated useful life of the asset.
(g) Purchased and Internally Developed Software Costs
In accordance with Statement of Financial Accounting Standards (SFAS) 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 when a product's technological feasibility has been established
and then is amortized over a future period. Amortization begins when a product
is available for general release to customers. 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 on a basis using the ratio of
current revenue to the total of current and anticipated
39
future revenue, whichever is greater. All other research and development
expenditures are charged to research and development expense in the period
incurred.
(h) Income Taxes
We account 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.
(i) Basic and diluted loss per share
SFAS No. 128 "Earnings Per Share" requires the presentation of basic net
income per share, and for companies with complex capital structures, diluted net
income per share.
The following table sets forth the computations of shares and net loss per
share, applicable to common shareholders used in the calculation of basic and
diluted net loss per share for the years ended March 31, 1998, 1999 and 2000 (in
thousands, except per share data):
Years Ended March 31,
------------------------------------------
1998 1999 2000
-------- -------- --------
Net loss......................................................... $(5,876) (1,859) (5,694)
Beneficial conversion feature given to preferred shareholders.... -- -- 110
Dividends paid to preferred shareholders......................... -- 53 49
------- ------- -------
Net loss applicable to common shareholders....................... (5,876) (1,912) (5,853)
======= ======= =======
Weighted average number of common shares outstanding............ 7,761 8,896 10,460
======= ======= =======
Basic and diluted net loss per share applicable to common
shareholders.................................................... $ (0.76) (0.21) (0.56)
======= ======= =======
As of March 31, 1998, 1999 and 2000 potentially dilutive shares totaling
2,060,166; 1,834,502; and 1,253,947, respectively, for convertible preferred
stock and options with exercise prices less than the average market price that
could dilute basic earnings per share in the future, were not included in
earnings per share as their effect was anti-dilutive for those periods.
(j) Concentrations of Credit Risk
Financial instruments which potentially subject our company to
concentrations of credit risk are trade receivables. We manufacture and sell our
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. We maintain an
allowance for doubtful accounts to provide against potential credit losses.
40
(k) Stock-Based Compensation
Our company has various stock-based compensation plans, as discussed in
Note 7. We have accounted for the effect of our stock based compensation plans
under Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock
Issued to Employees". We have elected to adopt only the disclosure based
requirements of SFAS No. 123 "Accounting for Stock-Based Compensation" and as
such have disclosed the pro forma effects on net income (loss) and net income
(loss) per share data as if we had elected to use the fair value approach to
account for all our employee stock-based compensation plans.
(l) Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed
Of
We account for long-lived assets, including intangibles, at amortized cost.
As part of our ongoing review of the valuation and amortization of long-lived
assets, we assess the carrying value of such assets if the facts and
circumstances suggest that they may be impaired. As a result, we have determined
that our long-lived assets are not impaired as of March 31, 2000 and 1999.
(m) Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
as amended by SFAS No. 137, "Accounting for Derivative instruments and hedging
activities". We are required to adopt SFAS No. 133 in the first quarter of
fiscal year 2002. We do not anticipate that SFAS No. 133 will have a material
impact on our financial statements.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements", as amended by SAB 101A, which provides guidance on the recognition,
presentation, and disclosure of revenue in financial statements filed with the
SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue
and provides guidance for disclosures related to revenue recognition policies.
We do not expect the adoption of SAB 101 to have a material effect on our
financial position or results of operations.
In March 2000, the Emerging Issues Task Force (EITF) Issue No. 00-2,
"Accounting for Web Site Development Costs", which outlines the accounting
criteria for costs related to the development of web sites. We will be required
to adopt EITF Issue No. 00-2 in fiscal quarters beginning after June 30, 2000.
We are in the process of assessing any impact that the adoption of EITF Issue
No. 00-2 will have on our financial position or results of operations.
In March 2000, the EITF published their consensus on EITF Issue No. 00-3,
"Application of AICPA Statement of Position 97-2, Software Revenue Recognition
to Arrangements that Include the Right to Use Software Stored on Another
Entity's Hardware". EITF Issue No. 00-3 outlines the accounting criteria for
hosting arrangements. We do not expect the adoption of EITF Issue No. 00-3 to
have a material effect on our financial position or results of operations.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, "Accounting For Certain Transactions involving Stock
Compensation". FASB Interpretation No. 44 clarifies the application of APB
Opinion No. 25 for certain issues. The FASB Interpretation No. 44 is effective
July 1, 2000. We are in the process of assessing any impact that the adoption of
FASB Interpretation No. 44 will have on our financial statements.
41
(n) Comprehensive Income
SFAS No. 130 establishes standards for the reporting and disclosure of
comprehensive income and its components which will be presented in association
with our company's financial statements. Comprehensive income is defined as the
change in a business enterprise's equity during a period arising from
transactions, events or circumstances relating to nonowner sources, such as
foreign currency translation adjustments and unrealized gains or losses on
available-for-sale securities. It includes all changes in equity during a period
except those resulting from investments by or distributions to owners. For the
fiscal years ended March 31, 1998, 1999 and 2000, net income and comprehensive
income were equivalent. Accordingly, the adoption of SFAS No. 130 had no impact
on our financial reporting.
(2) INVENTORY
The components of inventory consist of (in thousands):
March 31,
---------------------
1999 2000
------ ------
Finished Goods $ 603 387
Work-in-process 187 75
Raw materials 17 483
----- ----
$ 807 945
===== ====
(3) FIXED ASSETS
Fixed assets consist of (in thousands):
March 31,
----------------------
1999 2000
-------- --------
Equipment, furniture and fixtures $ 4,781 5,382
Demonstration equipment 1,733 1,888
Parts used in service, not held for sale 1,401 1,495
------- ------
7,915 8,765
Less accumulated depreciation (5,602) (7,250)
------- ------
$ 2,313 1,515
======= ======
Depreciation expense was $1,397,000, $1,365,000 and $1,648,000 for the
years ended March 31, 1998, 1999, and 2000, respectively. As of March 31, 2000,
fixed assets held under capital lease totaled $315,000 and accumulated
depreciation on those assets totaled $253,000.
42
(4) PURCHASED AND INTERNALLY DEVELOPED SOFTWARE COSTS
Capitalized software costs consist of (in thousands):
March 31,
----------------------
1999 2000
-------- --------
Purchased software $ 365 409
Internally developed software 5,278 6,035
------- ------
5,643 6,444
Accumulated amortization (3,258) (4,568)
------- ------
$ 2,385 1,876
======= ======
Amortization of capitalized software costs was $859,000, $1,255,000 and
$1,310,000 for the years ended March 31, 1998, 1999 and 2000, respectively.
(5) ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of (in thousands):
March 31,
----------------------
1999 2000
-------- --------
Accounts payable $1,988 1,089
Commissions payable 428 653
Accrued compensation and benefits 555 903
Accrued expenses 1,388 1,661
------ -----
$4,359 4,306
====== =====
(6) CREDIT FACILITIES AND DEBT RESTRUCTURING
In December, 1996, we entered into a Loan and Security Agreement with
Silicon Valley Bank. This Agreement, which we sometimes refer to as our "bank
credit line", has been modified or renewed at various times since December 1996.
The current bank credit line (renewed in September, 1999) provides for up to
$2,500,000 in available borrowings based upon our eligible accounts receivable
balances. The current bank credit line will expire on September 28, 2000. This
bank credit line provides for a variety of covenants, including among other
things, that we maintain certain financial ratios. The bank credit line is
collateralized by a security interest in substantially all of our assets.
Interest on borrowings under this agreement is payable monthly at a rate of one
and one quarter percent in excess of the prime rate. On March 31, 2000, there
were no borrowings outstanding under this agreement.
Since December 1996, we have entered into a couple of different financing
arrangements with Hambrecht & Quist Guaranty Finance, including a $5,100,000
financing facility and a $7,000,000 equity-based line of credit. In March 1998,
$3,000,000 of the $5,100,000 financing facility was restructured into
43
$1,500,000 of debt. The debt had an interest rate of 7.25% and was due in
October 1999. During the year ended march 31, 2000, 292,000 shares of the
convertible preferred stock were converted to common stock.
In October, 1999, we renegotiated our financing arrangement with Hambrecht
& Quist Guaranty Finance. The agreement we reached involved the restructuring of
$1,500,000 debt into 153,846 shares of Series C Convertible Preferred Stock and
$1,000,000 of debt. The interest rate on the restructured debt is 7.25% and the
debt and interest are payable in monthly installments through April 30, 2001. In
connection with this agreement, we issued warrants to purchase 120,000 common
shares at an exercise price of $2.50. These warrants expire on April 30, 2006.
We also enhanced the conversion rate of Hambrecht & Quist's existing Series C
Convertible Preferred Stock so that each share of Series C Convertible Preferred
Stock is convertible into 1.625 shares of Common Stock. The beneficial
conversion feature, warrants and new debt were recorded at their relative fair
values. We recorded $345,000 of deferred financing costs attributable to this
finance restructuring with Hambrecht & Quist Guaranty. This amount is being
amortized using the effective interest rate method to interest expense over the
term of the financing facility (18 months). The value of the warrants was
estimated using the Black-Scholes option pricing model and the following
assumptions: volatility of .50, risk free interest rate of 6% and expected life
equal to the contractual terms. We filed a Form S-3 Registration Statement under
the Securities Act of 1933 to register the shares of the common stock which
underlie the Series C Convertible Preferred Stock and the 120,000 shares of our
common stock which underlie the warrants issued to Hambrecht & Quist Guaranty
Finance.
In December, 1997, we secured a $7,000,000 equity-based line of credit.
Under this arrangement, we had the right to draw up to a total of $7,000,000 in
cash in exchange for common stock. Pricing of the common stock issued was based
on the market price of our common stock at the time of a draw subject to a 14%
discount and a 4% commission payable in common stock. The availability of the
credit line, and the amounts and timing of draws under the line were subject to
a number of conditions. In January, 1998, we filed a Form S-3 Registration
Statement under the Securities Act of 1933 to register the resale of shares
issued under this credit line. Under this equity-based line of credit, we drew a
total of $3,808,000 and issued 1,522,000 shares of our common stock during
fiscal years 1998 and 1999. This facility is no longer available to us.
On May 20, 1999, we secured a new equity-based line of credit by entering
into a new stock purchase agreement with Kingsbridge. Under the new arrangement,
we were able to draw up to $12,000,000 in cash in exchange for common stock;
provided, however, that in any event we can not sell more than a total of
1,800,000 shares to Kingsbridge under this arrangement, unless we obtain
shareholder approval. Pricing of the common stock issued under this arrangement
is based on the market price of our common stock at the time of a draw,
discounted by 10% or 12%, depending upon the price of our common stock. The
availability of the credit line, and the amounts and timing of draws under the
line were subject to a number of conditions. On May 27, 1999, we filed a
Registration Statement on Form S-1 to register for resale the shares we may
issue to Kingsbridge under this credit line and on August 12, 1999 the Statement
became effective. During the fiscal year ended March 31, 2000, we drew
$7,408,000 from the credit line for which we issued 1,800,000 shares of common
stock. Because of limitations on the total number of shares that can be issued
under this line of credit, this facility is no longer available to us and was
terminated on March 14, 2000.
(7) SHAREHOLDERS' EQUITY
Convertible Preferred Stock
In October, 1999, we issued 153,846 shares of Series C Convertible
Preferred Stock to Hambrecht & Quist Guaranty Finance in conjunction with our
renegotiated financing arrangement with them. Also, in
44
conjunction with the new financing arrangement we changed the conversion rate of
all of our outstanding Series C Convertible Preferred Stock so that each share
of Series C Convertible Preferred Stock is convertible into 1.625 shares of
Common Stock.
Stock Options
Under our 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
Sonic Solutions 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.
Our Board of Directors and Chief Executive Officer administer the Plan.
During 1995, we adopted the 1994 NonEmployee Directors Stock Option Plan
which provides for the grant of stock options to Sonic Solutions' nonemployee
directors. Under this plan, stock options are granted annually at the fair
market value of Sonic Solutions' 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. There were 22,000 options
outstanding at March 31, 2000, at prices of $2.6560, $2.5625 and $1.6880 per
share, of which 8,020 were exercisable.
In March 1998, the Board of Directors approved the repricing of options at
an exercise price equal to fair market value on March 3, 1998 of $2.5625 per
share. There were no changes made to the vesting schedules in relation to the
repricing.
In July, 1998, the Board of Directors adopted the Sonic Solutions 1998
Stock Option Plan and the shareholder's approved the 1998 Stock Option Plan in
September, 1998. The 1998 Stock Option Plan covers 1,000,000 shares of Common
Stock, with an annual increase in the number of shares available for issuance
under the Stock Option Plan on the last day of each fiscal year; provided that
the total number of shares issuable under the plan shall not exceed 2,000,000.
45
A summary of Sonic Solutions' option plans is presented below:
1998 1999 2000
---------------------------- ---------------------------- ----------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
----------- ----------- ----------- ----------- ----------- -----------
Outstanding at beginning
of year 829,699 $5.53 1,660,178 2.89 2,026,333 2.80
Granted 1,925,150 3.76 670,250 3.08 782,300 2.73
Exercised (50,062) 1.70 (64,225) 2.22 (298,208) 2.58
Forfeited (1,044,609) 6.66 (239,870) 4.32 (159,386) 4.94
---------- ----- --------- ---- --------- ----
Outstanding at end of year 1,660,178 $2.89 2,026,333 2.80 2,351,039 2.67
========== ========= =========
Options exercisable at
year end 640,809 $2.82 1,179,191 2.65 902,506 2.54
Fair value of options granted
during the year $2.22 2.06 1.93
Had compensation cost for our plans been determined consistent with the
fair value approach enumerated in SFAS No. 123, our net loss and net loss per
share for the years ended March 31, 1998, 1999 and 2000 would have been
increased as indicated below (in thousands, except per share data):
Years Ended
March 31,
----------------------------------
1998 1999 2000
--------- --------- ---------
Net loss As Reported $5,876 1,859 5,694
Pro Forma $6,572 3,640 7,532
Net loss per share As Reported $ 0.76 0.21 0.56
Pro Forma $ 0.85 0.41 0.72
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 1998, 1999 and 2000; risk-free interest rate of
5.97%, 4.65% and 6.04%, respectively; expected life of 4 years; 91%, 91% and
97% expected volatility, respectively; 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 through 2000 and does not consider
compensation costs for stock options granted prior to April 1, 1995.
46
The following table summarizes information about stock options outstanding
at March 31, 2000.
Options Outstanding Options Exercisable
Weighted
Number Average Weighted Number Weighted
Range of Outstanding at Remaining Average Outstanding at Average
Exercise Price March 31, 2000 Contractual Life Exercise Price March 31, 2000 Exercise Price
- ------------------- --------------- ---------------- -------------- --------------- --------------
From $1.43 to $1.75 359,527 7.87 $1.66 164,932 $1.64
From $2.00 to $2.91 1,662,678 8.11 2.56 659,346 2.56
From $3.44 to $3.94 219,084 8.85 3.73 51,304 3.69
From $4.18 to $4.75 27,250 8.89 4.64 10,037 4.63
From $5.25 to $5.75 48,500 8.14 5.52 16,887 5.69
From $6.00 to $6.88 34,000 7.00 6.17 - -
--------- ---- ----- ------- -----
2,351.039 8.14 $2.67 902,506 $2.54
========= ==== ===== ======= =====
(8) INCOME TAXES
The differences between income taxes computed using the statutory federal
income tax rate of 34% and that shown in the statements of operations are
summarized as follows (in thousands):
Years Ended March 31,
-------------------------------------------------------
1998 1999 2000
-------------- -------------- --------------
Computed tax at statutory rate $(1,998) (630) (1,969)
Tax credits utilized 131 105 137
State taxes, net of federal benefit 3 5 4
Tax exempt interest income (36) (19) --
Current year net operating losses, temporary
differences and credits for which no benefit was
recognized 1,880 520 1,804
IRS tax refund -- -- (99)
Other 20 19 26
------- ---- ------
$ -- -- (97)
======= ==== ======
47
The components of deferred taxes are as follows (in thousands):
March 31,
-------------------------------------------------------
1998 1999 2000
-------------- -------------- --------------
Deferred tax assets:
Accounts receivable $ 254 179 585
Inventories 542 123 49
Tax credit carryforwards 1,550 2,086 2,440
Net operating losses 4,103 4,732 6,109
Accrued vacation pay 62 55 101
Commissions 40 1 1
State income taxes 1 52 62
Warranty and other 42 51 37
------- ------ ------
Gross deferred tax assets 6,594 7,279 9,384
------- ------ ------
Valuation allowance (5,343) (6,309) (8,651)
------- ------ ------
Total deferred tax assets, net of valuation allowance 1,251 970 733
Deferred tax liabilities:
Fixed assets (174) (130) (127)
Internally developed software (1,077) (840) (606)
------- ------ ------
Total deferred tax liability (1,251) (970) (733)
------- ------ ------
Net deferred taxes $ - - -
======= ====== ======
The net change in the valuation allowance for the year ended March 31, 1999
and 2000 was an increase of approximately $966,000 and $2,343,000, respectively.
Management believes that sufficient uncertainty exists regarding the future
realization of certain deferred tax assets and, that a valuation allowance is
required.
As of March 31, 2000, we have cumulative federal and California net
operating losses of approximately $16,483,000 and $7,263,000, respectively,
which can be used to offset future income subject to taxes. The federal tax loss
carryforwards will expire beginning in the year 2012 through 2020. The
California tax loss carryforwards will expire beginning in the year 2001 through
2005.
As of March 31, 2000, we have cumulative unused research and development
tax credits of approximately $1,747,000 and $858,000 which can be used to reduce
future federal and California income taxes, respectively. Federal credit
carryforwards expire from 2009 through 2020; California credits will
carryforward indefinitely.
As of March 31, 2000, we have federal minimum tax credit carryforwards of
approximately $135,000 which will carry forward indefinitely until utilized.
(9) COMMITMENTS AND CONTINGENCIES
(a) Leases
In December, 1996, we entered into a leasing agreement to finance the
purchase of up to $1,000,000 in equipment, as discussed in Note 6. Lease terms
under the agreement are for 42 months and are secured by the leased equipment.
We also lease certain facilities and equipment under noncancelable operating
leases.
48
Future payments under capital and operating leases that have initial remaining
noncancelable lease terms in excess of one year are as follows (in thousands):
Years Ended March 31,
----------------------------------------------
Capital Operating
Leases Leases
-------------------- --------------------
2001 $120 705
2002 20 705
2003 - 117
2004 - -
2005 - -
Thereafter - -
---- -----
Total minimum lease payments 140 1,527
=====
Less amount representing interest (52)
Less current portion of obligations under capital lease (78)
----
Long-term obligations under capital lease $ 10
====
Rent expense under operating leases for the years ended March 31, 1998,
1999 and 2000 was approximately $847,000, $954,000 and $953,000, respectively.
(b) Benefit Plan
We sponsor a 401(k) savings plan covering most salaried employees. To date,
no contributions have been made to this plan by the Company.
(c) Other
We from time to time are subject to routine claims and litigation
incidental to our business. We believe that the results of these matters will
not have a material adverse effect on our financial condition.
(10) SIGNIFICANT CUSTOMER INFORMATION AND SEGMENT REPORTING
In 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which was
adopted by us in 1998. SFAS No. 131 requires companies to report financial and
descriptive information about its reportable operating segments, including
segment profit or loss, certain specific revenue and expense items and segment
assets, as well as information about the revenues derived from our products and
services, the countries in which we earn revenue and hold assets, and major
customers. The method for determining what information to report is based on the
way that management organized the operating segments within our company for
making operating decisions and assessing financial performance.
Our chief operating decision maker is considered to be our Chief Executive
Officer ("CEO"). The CEO reviews financial information presented on a
consolidated basis accompanied by desegregated information about revenue by
product line and revenue by geographic region for purposes of making operating
decisions and assessing financial performance. The consolidated financial
information reviewed by the CEO is identical to the information presented in the
accompanying statement of operations. Therefore, we operate in, and measure our
results in a single operating segment. As such, we are required to disclose the
following revenue by product line, revenue by geographic and significant
customer information:
49
Revenues by Product Line:
Years Ended March 31,
-------------------------------------------------------------
1998 1999 2000
---------------- ---------------- ----------------
Revenues
Consumer DVD $ - - 1,805
Pro Audio/Video 19,881 21,899 19,022
------- ------ ------
Total net revenue $19,881 21,899 20,827
======= ====== ======
Our accounting system does not capture meaningful gross margin and
operating income (loss) information by product line, nor is such information
used by the CEO for purposes of making operating decisions. Accordingly, such
information has not been disclosed.
Revenues by Geographic Location:
Years Ended March 31,
-------------------------------------------------------------
1998 1999 2000
---------------- ---------------- ----------------
North America $ 9,612 11,702 11,027
Export:
Europe 4,949 5,707 5,489
Pacific Rim 4,009 4,218 4,034
Other international 1,311 272 277
------- ------ ------
Total net revenue $19,881 21,899 20,827
======= ====== ======
We sell our products to customers categorized geographically by each
customer's country of domicile. We do not have any material investment in long
lived assets located in foreign countries for any of the years presented.
Significant customer information:
Percent of Total Accounts
Years Ended March 31, Receivable March 31,
----------------------------------------------------- ----------------------------
1998 1999 2000 2000
------------ ------------ ---------------- ----------------------------
Customer A 10% 11% 11% 6%
Customer B - - 10% 8%
50
(11) SUBSEQUENT EVENTS
On May 4, 2000, we secured a new equity-based line of credit by entering
into a new Private Equity Line Agreement with Kingsbridge. Under the new
agreement, we may draw up to $20,000,000 in cash in exchange for up to 19.9% of
our common stock. Pricing of the common stock issued under this agreement is
based on the market price of our common stock at the time of a draw subject to
discounts ranging from 8% to 12%. Borrowings from this credit facility are
subject to the completion of a Registration Statement on Form S-1 to register
for resale the shares we may issue to Kingsbridge under this equity-based line
of credit.
51
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
52
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 for the year 2000 Annual
Meeting of Shareholders.
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 for the year 2000 Annual Meeting of Shareholders.
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 for the year 2000
Annual Meeting of Shareholders.
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 for the year 2000 Annual Meeting of
Shareholders.
53
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 33 of this Report).
Balance Sheets as of March 31, 1999 and March 31, 2000.
Statements of Operations for each of the three years in the
period ended March 31, 2000.
Statements of Shareholders' Equity for each of the three years in
the period ended March 31, 2000.
Statements of Cash Flows for each of the three years in the
period ended March 31, 2000.
Notes to Financial Statements (pages 38 through 51 of this
Report).
(a)2. Financial Statements Schedule.
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
10.1 (1) Amended and Restated Stock Option Plan (compensatory
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 (2) Lease Agreement dated January 26, 1995 between Golden
Gate Plaza and the Company
54
10.7 (3) Private Line of Credit Agreement dated December 31,
1997 between Kingsbridge Capital Limited and the
Company
10.8 (4) Private Securities Subscription Agreement dated
March 31, 1998 between Hambrecht & Quist Guaranty
Finance, LLC and the Company
10.9 (5) Stock purchase agreement dated May 20, 1999 between
Sonic Solutions and Kingsbridge Capital Limited
10.10 (5) Registration Rights Agreement dated May 20, 1999
between Sonic Solutions and Kingsbridge Capital
Limited
10.11 (6) Private Securities Subscription Agreement dated
October 15, 1999 between Hambrecht & Quist Guaranty
Finance, LLC and the Company
10.12 (7) 1998 Stock Option Plan (compensatory plan)
10.13 Stock purchase agreement dated May 4, 2000 between
Sonic Solutions and Kingsbridge Capital Limited
10.14 Registration Rights Agreement dated May 4, 2000
between Sonic Solutions and Kingsbridge Capital
Limited
23.1 Consent of KPMG LLP
24.1 Power of Attorney (see page 58)
27 Financial Data Schedule
_______________
(1) Incorporated by reference to exhibits to Registration Statement on Form S-1
(No. 33-72870) effective February 10, 1994.
(2) Incorporated by reference to exhibits to Annual Report on Form 10-K for the
Fiscal Year Ended March 31, 1996 (No. 33-72870).
(3) Incorporated by reference to exhibits to Registration Statement on Form S-3
(No. 333-44347) effective January 30, 1998.
(4) Incorporated by reference to exhibits to Registration Statement on Form S-3
(No. 333-50697) effective April 29, 1998.
(5) Incorporated by reference to exhibits to Registration Statement on Form S-1
filed on May 27, 1999.
(6) Incorporated by reference to exhibits to Registration Statement on Form S-3
filed on March 17, 2000.
(7) Incorporated by reference to Appendix A to the Registrant's Definitive
Proxy Statement filed on July 21, 1998.
(b) Reports on Form 8-K: None.
55
FINANCIAL STATEMENT SCHEDULE
SONIC SOLUTIONS
VALUATION AND QUALIFYING ACCOUNTS
Years Ended March 31, 1998, 1999 and 2000
(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, 1998
Allowance for doubtful accounts............. $221 44 -- (42) 223
Allowance for returns....................... 367 -- 190 (163) 394
---- --- --- ---- ---
$588 44 190 (205) 617
==== === === ==== ===
Year ended March 31, 1999
Allowance for doubtful accounts............. $223 50 -- (133) 140
Allowance for returns....................... 394 -- 85 (20) 459
---- --- --- ---- ---
$617 50 85 (153) 599
==== === === ==== ===
Year ended March 31, 2000
Allowance for doubtful accounts............. $140 650 -- (319) 471
Allowance for returns....................... 459 -- -- -- 459
---- --- --- ---- ---
$599 650 -- (319) 930
==== === === ==== ===
56
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, Sonic Solutions
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form 10-K and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized in Novato, State of California, on the 26th day of June, 1999.
Sonic Solutions
By: /s/ Robert J. Doris
------------------------------------
Robert J. Doris, President
POWER 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.
June 26, 2000 /s/ Robert J. Doris
---------------------------------------------------------
President and Director (Principal Executive Officer)
Robert J. Doris
June 26, 2000 /s/ Mary C. Sauer
---------------------------------------------------------
Senior Vice President of Business Development and
Director Mary C. Sauer
June 26, 2000 /s/ Robert M. Greber
---------------------------------------------------------
Director
Robert M. Greber
June 26, 2000 /s/ Peter J. Marguglio
---------------------------------------------------------
Director
Peter J. Marguglio
June 26, 2000 /s/ A. Clay Leighton
---------------------------------------------------------
Senior Vice President of Worldwide Operations and
Finance and Chief Financial Officer (Principal Financial
Accounting Officer)
A. Clay Leighton
58