<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
(Mark one)
[x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended December 31, 1998 or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ____________ to ___________
Commission File Number: 72870
SONIC SOLUTIONS
(Exact name of registrant as specified in its charter)
California 93-0925818
(State or other jurisdiction of (I.R.S.Employer
incorporation or organization) Identification No.)
101 Rowland Way, Suite 110 Novato, CA 94945
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (415) 893-8000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes x No______
-----
The number of outstanding shares of the registrant's Common Stock on January 31,
1999, was 9,366,326.
================================================================================
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SONIC SOLUTIONS
FORM 10-Q
For the quarterly period ended December 31, 1998
Table of Contents
<TABLE>
<CAPTION>
Page
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Condensed Balance Sheets as of March 31, 1998
and December 31, 1998.....................................3
Condensed Statements of Operations for the
three and nine months ended December 31, 1997 and 1998....4
Condensed Statements of Cash Flows for the
nine months ended December 31, 1997 and 1998..............5
Notes to Condensed Financial Statements...................6
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.............9
PART II. OTHER INFORMATION
ITEM 3. Defaults upon Senior Securities..........................16
ITEM 6. Exhibits and Reports on Form 8-K.........................16
Signatures..........................................................17
</TABLE>
2
<PAGE>
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SONIC SOLUTIONS
CONDENSED BALANCE SHEETS
(in thousands, except share amounts)
<TABLE>
<CAPTION>
1998
--------------------------
ASSETS March 31, December 31,
---------- -------------
(unaudited)
<S> <C> <C>
Current Assets:
Cash and cash equivalents................................................................. $ 2,479 3,081
Accounts receivable, net of allowance for returns and doubtful accounts of $617 and
$567 at March 31, 1998 and December 31, 1998, respectively............................. 3,198 4,442
Inventory................................................................................. 634 962
Prepaid expenses and other current assets................................................. 317 99
Refundable income taxes................................................................... 148 148
-------- --------
Total current assets................................................................. 6,776 8,732
Fixed assets, net............................................................................ 2,766 2,221
Purchased and internally developed software costs, net....................................... 2,944 2,557
Other assets................................................................................. 144 175
-------- --------
Total assets......................................................................... $ 12,630 13,685
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable and accrued liabilities.................................................. $ 3,315 4,093
Bank note payable......................................................................... 500 500
Deferred revenue and deposits............................................................. 1,036 1,270
Subordinated debt, current portion........................................................ 623 369
Current portion of obligations under capital leases....................................... 138 146
-------- --------
Total current liabilities............................................................ 5,612 6,378
-------- --------
Subordinated debt, net of current portion.................................................... 1,364 1,433
Obligations under capital leases, net of current portion..................................... 236 126
-------- --------
Total liabilities.................................................................... 7,212 7,937
-------- --------
Commitments and contingencies
Shareholders' Equity:
Preferred stock, no par value, 10,000,000 shares authorized; 461,538 and 336,538 shares issued
and outstanding at March 31, 1998 and December 31, 1998, respectively..................... 1,500 1,092
Common stock, no par value, 30,000,000 shares authorized; 8,302,230 and 9,366,326
shares issued and outstanding at March 31, 1998 and December 31, 1998, respectively......... 15,204 17,877
Accumulated deficit.......................................................................... (11,286) (13,221)
-------- --------
Total shareholders' equity................................................................. 5,418 5,748
-------- --------
Total liabilities and shareholders' equity................................................. $ 12,630 13,685
======== ========
</TABLE>
See accompanying Notes to Condensed Financial Statements.
3
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SONIC SOLUTIONS
CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts -- unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
-------------------- -------------------
December 31, December 31,
------------ ------------
1997 1998 1997 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenue......................................................... $4,692 5,795 $15,330 15,404
Cost of revenue..................................................... 2,452 2,277 7,123 6,796
------- ------ ------- ------
Gross profit.................................................... 2,240 3,518 8,207 8,608
------- ------ ------- ------
Operating expenses:
Marketing and sales............................................. 1,786 1,837 5,658 5,345
Research and development........................................ 1,319 1,269 4,286 3,798
General and administrative...................................... 378 376 1,124 1,151
------- ------ ------- ------
Total operating expenses........................................ 3,483 3,482 11,068 10,294
------- ------ ------- ------
Operating income (loss)......................................... (1,243) 36 (2,861) (1,686)
Other expense....................................................... (133) (79) (373) (249)
------- ------ ------- ------
Loss before income taxes........................................ (1,376) (43) (3,234) (1,935)
Provision for income taxes.......................................... - - - -
------- ------ ------- ------
Net loss........................................................ ($1,376) (43) ($3,234) (1,935)
======= ====== ======= ======
Basic and diluted loss per share................................ ($0.18) (0.01) ($0.42) (0.23)
======= ====== ======= ======
Weighted average shares used in computing per share amounts.....
7,634 9,127 7,615 8,720
======= ====== ======= ======
</TABLE>
See accompanying Notes to Condensed Financial Statements.
4
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SONIC SOLUTIONS
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands, -- unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
-----------------
December 31,
-----------
1997 1998
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net loss.............................................................................. ($3,234) (1,935)
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization....................................................... 1,888 1,940
Provision for returns and doubtful accounts......................................... - (50)
Changes in operating assets and liabilities:
Accounts receivable.............................................................. 133 (1,194)
Inventory........................................................................ (417) (328)
Prepaid expenses and other current assets........................................ 527 218
Other assets..................................................................... 36 (31)
Accounts payable and accrued liabilities......................................... 440 778
Deferred revenue and deposits.................................................... 187 234
-------- ------
Net cash used in operating activities.......................................... (440) (368)
-------- ------
Cash flows from investing activities:
Purchase of fixed assets.............................................................. (775) (485)
Additions to purchased and internally developed software.............................. (1,856) (523)
-------- ------
Net cash used in investing activities............................................... (2,631) (1,008)
-------- ------
Cash flows from financing activities:
Proceeds from exercise of common stock options........................................ 73 35
Borrowings on line of credit.......................................................... 500 420
Repayments on line of credit.......................................................... - (420)
Proceeds from equity line of financing................................................ - 2,358
Redemption of warrants................................................................ - (83)
Payment of dividends.................................................................. - (45)
Repayments of subordinated debt....................................................... - (185)
Principal payments on capital leases.................................................. (82) (102)
-------- ------
Net cash provided by financing activities........................................... 491 1,978
-------- ------
Net increase (decrease) in cash and cash equivalents.................................... (2,580) 602
Cash and cash equivalents, beginning of period.......................................... 4,806 2,479
-------- ------
Cash and cash equivalents, end of period................................................ $ 2,226 3,081
======== ======
Supplemental disclosure of cash flow information:
Interest paid during period........................................................... $ 200 56
======== ======
Income taxes paid during period....................................................... $ 13 9
======== ======
Noncash financing and investing activities:
Assets acquired through capital lease............................................. $ 161 -
======== ======
Conversion of preferred stock to common stock..................................... $ - 408
======== ======
</TABLE>
See accompanying Notes to Condensed Financial Statements.
5
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Sonic Solutions
Notes to Condensed Financial Statements
(unaudited)
(1) Basis of Presentation
The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. However, in the opinion of management, the condensed
financial statements include all adjustments (consisting of only normal,
recurring adjustments) necessary for their fair presentation. The interim
results are not necessarily indicative of results expected for a full year.
These unaudited condensed financial statements should be read in conjunction
with the financial statements and related notes included in the Company's Form
10-K for the year ended March 31, 1998, filed with the Securities and Exchange
Commission.
(2) Basic and diluted loss per share
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standard (SFAS) No. 128, Earnings Per Share. SFAS No. 128 requires
the presentation of basic net income per share, and for companies with complex
capital structures, diluted net income per share. Excluded from the
computation of diluted loss per share for the quarter ended December 31, 1997
and 1998 are options to acquire 404,151 and 935,775 shares of common stock
because their effects would be anti-dilutive.
The following table sets forth the computations of shares and net loss
used in the calculation of basic and diluted net loss per share for the periods
ended December 31, 1997 and 1998 (in thousands, except per share date):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------- ---------------------------
December 31, December 31,
--------------------------- ---------------------------
1997 1998 1997 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net loss..................................................... ($1,376) (43) ($3,234) (1,935)
Dividends paid to preferred stockholders..................... - 15 - 45
------- ----- ------- ------
Net loss applicable to common stockholders................... ($1,376) (58) ($3,234) (1,980)
======= ===== ======= ======
Weighted average number of common shares outstanding......... 7,634 9,127 7,615 8,720
======= ===== ======= ======
Basic and diluted net loss per common share.................. ($0.18) (0.01) ($0.42) (0.23)
======= ===== ======= ======
</TABLE>
6
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(3) Inventory
The components of inventory, net of obsolescence, consist of (in
thousands):
<TABLE>
<CAPTION>
March 31, December 31,
-------- -----------
1998 1998
----- ----
<S> <C> <C>
Raw materials........................................................... $ 468 846
Work-in-process......................................................... 130 81
Original equipment manufacturers goods.................................. 36 35
----- ----
$ 634 962
===== ====
(4) Industry and Geographic Information
The Company markets its products in the United States and in foreign
countries through its sales personnel, dealers, and distributors. Export sales
account for a significant portion of the Company's net revenues and are
summarized by geographic area as follows (in thousands):
Three Months Ended Nine Months Ended
------------------ -----------------
December 31, December 31,
----------- -----------
1997 1998 1997 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
North America (substantially all United States)........ $2,544 3,276 $7,193 8,062
Export:
Europe............................................. 1,196 1,396 3,699 3,923
Pacific Rim........................................ 951 963 3,379 3,212
Other international................................ 1 160 1,059 207
------ ----- ------- ------
$4,692 5,795 $15,330 15,404
Total net revenue ====== ===== ======= ======
</TABLE>
Foreign based assets were insignificant as of March 31, 1998 and December 31,
1998.
7
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(5) Recently Issued Accounting Pronouncements
SFAS 131 "Disclosures About Segments of an Enterprise and Related
Information", is effective for years beginning after December 15, 1997. This
statement establishes standards for the way companies report information about
operating segments in annual financial statements. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. The Company has not determined what separately reportable business
segments, if any, it may have under SFAS 131.
In June 1998, the Financial Accounting Standards Board issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
establishes standards for derivative instruments and hedging activities. The
Company is required to adopt SFAS 133 in the first quarter of fiscal year 2001.
The Company does not anticipate that SFAS 133 will have a material impact on its
financial statements.
SFAS No. 130 establishes standards for reporting and disclosure of
comprehensive income and its components which will be presented in association
with a 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.
It is expected that the effects of this standard did not have a material effect
on the operations of the Company.
In October 1997, the American Institute of Certified Public Accountants
issued 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, such as software products, upgrades,
enhancements, post contract customer support, installation, or training. Under
SOP 97-2, the determination of fair value is based on objective evidence which
is specific to the vendor. If such evidence of fair value for each element of
the arrangement does not exist, all revenue from the arrangement is generally
deferred until such time that evidence of fair value does exist or until all
elements of the arrangement are delivered. Revenue allocated to software
products, specified upgrades and enhancements is generally recognized upon
delivery of the related products, upgrades and enhancements. Revenue allocated
to post contract customer support is generally recognized ratably over the term
of the support, and revenue allocated to service elements is generally
recognized as the services are performed. SOP 97-2 has been adopted by the
Company effective April 1, 1998 and did not have any material effect
on revenue recognition.
8
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview; Certain Factors that May Impact Future Results
The Company commenced shipments of SonicStudio/1/, a line of
professional digital audio workstations, in the first calendar quarter of 1989.
Sales of the SonicStudio product line including Sonic developed software and
Sonic manufactured hardware, third party developed software and hardware
peripheral devices and associated maintenance fees, together with sales of Sonic
MediaNet accounted for virtually all of the Company's net revenue during the
three fiscal years ended March 31, 1996, approximately 50% of the Company's net
revenue during the fiscal year ended March 31, 1997 and approximately 40% of the
Company's net revenue during the fiscal year ended March 31, 1998. The Company
believes there is little growth in the overall market for professional audio
equipment. Sales of products by Sonic have depended upon the substitution of
digital audio workstations for other existing technologies, and Sonic's ability
to maintain or increase sales will continue to depend in large part on the
continued substitution of digital audio workstations for other technologies. In
June, 1996, the Company began shipments of its DVD Creator system. The Company's
future success will also depend primarily on sales of the DVD Creator system and
related products which accounted for approximately 50% of the Company's net
revenue in the fiscal year ended March 31, 1997, and approximately 60% of the
Company's net revenue in the fiscal year ended March 31, 1998. In June 1998, the
Company began shipments of its DesktopDVD system. Sales of DVD Creator systems,
DesktopDVD systems and related products accounted for slightly more than 60% of
the Company's net revenue in the quarter and nine months ended December 31,
1998.
SonicStudio is an integrated assembly of software and manufactured hardware
including signal processing plug-in cards and interface "boxes". The SonicStudio
hardware and software is installed on a Macintosh personal computer, and used
together with peripheral devices such as disk drives and CD recorders, all of
which are purchased as complete or largely complete devices from other
manufacturers ("OEM hardware"). The Company does not typically provide the
Macintosh computer or other OEM hardware to customers, and instead has de-
emphasized the sale of OEM hardware in recent years. For the fiscal years ended
March 31, 1996, 1997 and 1998, the percentage of net revenue derived from sale
of OEM hardware by the Company has declined from approximately 20% to 2% to 0%
as the Company de-emphasized the sale of OEM hardware.
In February of 1994, the Company began shipments of Sonic MediaNet, a high
performance, fully distributed networking system designed specifically to handle
digital audio, digital video, high resolution graphics and other multimedia data
types for use with applications other than SonicStudio. In the fiscal years
ended March 31, 1996, 1997 and 1998, Sonic MediaNet net revenue constituted
approximately 16%, 9% and 4% of Company net revenue.
DVD Creator is a premastering system for DVD discs incorporating the three
functions necessary to produce a finished DVD premaster image: video encoding,
audio encoding and authoring. DVD Creator is sold both as a single workstation
or as a workgroup with separate subsystems linked together via the Company's
Sonic MediaNet networking system. During June, 1996, the Company began shipping
the first installation phase of the DVD Creator system.
In June, 1998, the Company introduced and began shipments of its DesktopDVD
system which is an "all-in-one" DVD premastering system available at lower
entry price than the DVD Creator System. DesktopDVD is designed to meet the
needs of customers who wish to create DVD-based client presentations,
merchandising and promotions materials, advertising comps, consumer kiosks,
interactive training and multimedia productions. Sonic DesktopDVD is a single
workstation which includes MPEG variable bit-rate and constant bit-rate video
encoding and Dolby Digital stereo audio encoding as well as DVD-Video format
authoring.
/1/ The Company's digital audio workstation product line was called "The Sonic
System" until 1996 when the name was changed to "SonicStudio".
9
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In September, 1998, the Company introduced and began shipments of
preliminary versions of Sonic Lightspeed. When fully relased, Sonic Lightspeed
will be a Fibre Channel networking solution for sharing video and audio files at
high speeds between Macintosh and Windows NT systems. The Company plans to
release other versions of Sonic Lightspeed throughout calendar year 1999. As
with any new high-technology product, there can be no assurance that, despite
testing by the Company, customers will not find errors or "bugs" in the
application software after systems have been installed in the field. These
errors or bugs could cause delays in future shipment of Sonic products or
require design modifications which could adversely affect the Company's
competitive position and results of operations.
The Company's quarterly operating results vary significantly depending on
the timing of new product introductions and enhancements by the Company and its
competitors and on the volume and timing of orders, which are difficult to
forecast. Customers generally order on an as-needed basis, and the Company
normally ships products within one week after receipt of an order. The results
of operations for any quarter are not necessarily indicative of the results to
be expected for any future period A disproportionate percentage of the
Company's quarterly net revenue is typically generated in the last few weeks of
the quarter. A significant portion of the Company's operating expenses is
relatively fixed, and planned expenditures are based primarily on sales
forecasts. As a result, if revenue generated in the last few weeks of a quarter
do not meet with the Company's forecast, operating results may be materially
adversely affected.
The Company capitalizes a portion of its software development costs in
accordance with Statement of Financial Accounting Standard No. 86. Such costs
are amortized to cost of revenue over the estimated economic life of the
product, which is generally three years.
10
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Results of Operations
The following table sets forth certain items from the Company's statements of
operations as a percentage of net revenue for the three and nine months ended
December 31, 1997 and 1998:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------- -----------------
December 31, December 31,
------------ ------------
1997 1998 1997 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenue............................ 100.0% 100.0% 100.0% 100.0%
Cost of revenue........................ 52.3 39.3 46.5 44.1
------ ------ ----- -----
Gross profit........................... 47.7 60.7 53.5 55.9
Operating expenses:
Marketing and sales................. 38.1 31.7 36.9 34.7
Research and development............ 28.1 21.9 28.0 24.7
General and administrative.......... 8.0 6.4 7.3 7.5
Total operating expenses............... 74.2 60.0 72.2 66.9
------ ------ ----- -----
Operating loss......................... (26.5) 0.7 (18.7) (11.0)
Other expense.......................... (2.8) (1.4) (2.4) (1.6)
Provision for income taxes............. - - - -
------ ------ ----- -----
Net loss............................... (29.3)% (0.7)% (21.1)% (12.6)%
====== ====== ===== =====
</TABLE>
Comparison of three and nine months ended December 31
NET REVENUE. Net revenue increased from $4,692,000 for the quarter ended
December 31, 1997 to $5,795,000 for the quarter ended December 31, 1998,
representing an increase of 23.5%. For the nine months ended December 31, 1998,
net revenue increased less than 1% from $15,330,000 to $15,404,000 compared to
the same period in the prior fiscal year. The increase in net revenue for the
quarter ended December 31, 1998 is primarily due to the increase in sales of
Sonic's DVD Creator systems and DesktopDVD systems.
International sales accounted for 45.7% and 43.5% of net revenue for the
quarters ended December 31, 1997 and 1998, respectively. International sales
accounted for 53.1% and 47.7% of net revenue for the nine months ended December
31, 1997, and 1998, respectively. See Note 4 of Notes to Condensed Financial
Statements. International sales as a percentage of net revenue decreased
primarily due to the increase in sales of Sonic's DVD Creator and DesktopDVD
systems in the U.S. markets. The Company expects that international sales will
continue to represent a significant percentage of future revenue.
COST OF REVENUE. Cost of revenue, as a percentage of net revenue, decreased
from 52.3% for the quarter ended December 31, 1997 to 39.3% for the quarter
ended December 31, 1998, primarily due to a shift in sales product mix toward
DVD system sales as well to efficiencies inherent in a higher level of sales.
Cost of revenue, as a percentage of net revenue, decreased from 46.5% for the
nine months ended December 31, 1997 to 44.1% for the nine months ended December
31, 1998. Cost of revenue for the nine months ended December 31, 1998 also
improved primarily due to shift in sales product mix toward DVD system sales.
MARKETING AND SALES. Marketing and sales expenses increased from $1,786,000
for the quarter ended December 31, 1997 to $1,837,000 for the quarter ended
December 31, 1998 and decreased from $5,658,000 for the nine months ended
December 31, 1997 to $5,345,000 for the nine months ended December 31, 1998.
Marketing and sales represented 38.1%, 31.7%, 36.9% and 34.7% of net revenue for
11
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the quarters ended December 31, 1997 and 1998 and the nine months ended December
31, 1997 and 1998, respectively. The Company's marketing and sales headcount
increased from thirty-one at December 31, 1997 to thirty-six at December 31,
1998. Included in the marketing and sales expense is dealer and employee
commission expense, which as a percentage of net revenue increased from 2.3% for
the quarter ended December 31, 1997 to 5.5% for the quarter ended December 31,
1998.
RESEARCH AND DEVELOPMENT. Research and development expenses decreased from
$1,319,000 for the quarter ended December 31, 1997 to $1,269,000 for the quarter
ended December 31, 1998 and decreased from $4,286,000 for the nine months ended
December 31, 1997 to $3,798,000 for the nine months ended December 31, 1998.
Research and development represented 28.1%, 21.9%, 28.0% and 24.7% of net
revenue for the quarter and nine months ended December 31, 1997 and 1998,
respectively. The Company capitalizes a portion of its software development
costs in accordance with Statement of Financial Accounting Standard No. 86.
Research and development expenses decreased for the quarter and nine months
ended December 31, 1998 primarily due to decreases in headcount and consulting
and prototype expenses. Headcount for research and development decreased from
thirty-six at December 31, 1997 to twenty-nine at December 31, 1998. Consulting
and prototype expenses were incurred in association with the development of the
DVD Creator system during the quarter and nine months ended December 31, 1997
and in association with the development of the DesktopDVD system during the nine
months ended December 31, 1998. Consulting and prototype expenses can fluctuate
significantly from period to period depending upon the status of software and
hardware development projects.
GENERAL AND ADMINISTRATIVE. General and administrative expense decreased from
$378,000 for the quarter ended December 31, 1997 to $376,000 for the quarter
ended December 31, 1998 and increased from $1,124,000 for the nine months ended
December 31, 1997 to $1,151,000 for the nine months ended December 31, 1998.
General and administrative expenses represented 8.1%, 6.4%, 7.3% and 7.5% of
net revenue for the quarter ended December 31, 1997 and 1998 and the nine months
ended December 31, 1997 and 1998, respectively. The Company anticipates that
general and administrative expenses will increase in the future as the Company's
operations expand.
OTHER EXPENSE. Other expense for the quarter and nine months ended December
31, 1998 was primarily due to the interest expense associated with the Company's
debt financing agreements with entities associated with Hambrecht & Quist and
with borrowings under the Company's bank line of credit, which was partially
offset by the interest income received on cash balances.
BENEFIT FOR INCOME TAXES. In accordance with Statement of Financial
Accounting Standards No. 109, no provision was made for income taxes for the
third quarter ended December 31, 1997 and 1998, respectively. A valuation
allowance has been provided for deferred tax assets for which recovery would
depend upon future taxable income. During the fiscal year ended March 31, 1996,
the Company exhausted its loss carryback capabilities, therefore, no benefit was
recorded for the third quarter ended December 31, 1997 and 1998.
The Company accrues quarterly for income taxes based upon its projection of
its full year tax liability. This may result in significant adjustments based
on the actual quarterly results.
LIQUIDITY AND CAPITAL RESOURCES. In December, 1996, the Company entered into
a Loan and Security Agreement with Silicon Valley Bank. The current agreement
provides for up to $1,500,000 in available borrowings based upon the Company's
eligible accounts receivable balances, and expires in May, 1999. This Agreement
provides for a variety of covenants, including among other things, that the
Company maintain certain financial ratios and is collateralized by a security
interest in substantially all of the Company's assets. Interest on borrowings
under this agreement is payable monthly at a rate between three-quarters percent
and two and one half percent in excess of the prime rate. On December 31, 1998
$500,000 was outstanding under this agreement. The Company was in compliance
with its debt covenants under this agreement at December 31, 1998.
12
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In December, 1996, the Company also obtained a $5,100,000 financing facility
with entities associated with Hambrecht & Quist. The facility included
subordinated debt and equipment financing. In December, 1996, the Company
received $3,000,000 from Hambrecht & Quist Transition Capital, LLC and
$1,100,000 from Hambrecht & Quist Guaranty Finance, LLC, pursuant to the above
facility. The remaining $1,000,000 was a master lease line for financing of
future capital asset purchases. The facility with the Hambrecht & Quist
entities is secured by an interest in the Company's fixed assets and
substantially all of the assets of the Company subordinate to the Silicon Valley
Bank Agreement. In connection with the financing facility, the Company issued
warrants to purchases 260,200 common shares to entities associated with
Hambrecht & Quist. Under the original agreement, the Hambrecht & Quist entities
could exercise their 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, the Hambrecht & Quist
entities exercised their warrants with respect to 130,100 shares at an exercise
price of $7.00 per share on a "net exercise" basis. Based on the "net exercise"
provisions of the warrant, the Hambrecht & Quist entities received 40,266 shares
of the Company's Common Stock. The Company recorded $549,000 of deferred
interest, which is amortized to interest expense over the term of the financing
facility, attributable to the value of the warrants. The value of the warrants
was estimated using the following assumptions for fiscal 1998 and 1997:
volatility of .75, risk free interest rate of 6.3% and expected life equal to
the contractual terms.
In December, 1997, the Company secured a $7,000,000 equity-based line of
credit. Under this arrangement, the Company has the right to draw up to a total
of $7,000,000 in cash in exchange for the Company's common stock. Pricing of
the common stock issued will be based on the market price of the Company's
common stock at the time of a draw. The timing and amount of individual draws
are at the sole discretion of the Company, subject to a number of conditions.
The line will remain in place for a period of approximately 24 months. The
Company filed a registration statement for the resale of 1,522,000 shares issued
under this arrangement in January, 1998. During the fiscal year ended March 31,
1998, the Company drew down $1,450,000 on this equity-based line of credit and
issued 606,130 shares of common stock. During the quarter ended December 31,
1998, the Company drew down $1,406,340 on this equity-based line of credit and
issued 366,955 shares of common stock. During the nine months ended December 31,
1998, the Company has drawn down $2,456,340 ($2,358,087 net of commissions) on
this equity-based line of credit and issued 903,870 shares of common stock.
Because of certain limitations on the number of shares which can be issued under
the equity-based line of credit, this facility is currently unavailable to the
Company. The Company's management is currently negotiating a new equity-based
line of credit. While management of the Company anticipates the new equity-based
line will become available to the Company in the first or second calendar
quarter of 1999, there can be no assurance that the new equity-based line of
credit will become available to the Company within that time frame or at any
definite point in the future.
In March, 1998, the Company renegotiated its financing arrangement with
Hambrecht & Quist Guaranty Finance. The agreements reached involve the
restructuring of $3,000,000 debt into $1,500,000 of convertible preferred stock
and $1,500,000 of lower interest debt due in October 1999. The Company 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 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 in connection with the original arrangement reached in December
1996 was lowered to $3.25. 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 quarter ended December 31, 1998, 125,000
shares of the Preferred Stock were converted into common stock.
The Company's operating activities have used cash of $440,000 for the nine
months ended December 31, 1997 and used cash of $368,000 for the nine months
ended December 31, 1998. Cash was used primarily for the purchase of inventory
and to support the increase in accounts receivable for the nine months ended
December 31, 1997 and 1998. The management of the Company believes that existing
cash, cash equivalents and short term investments, cash generated from
operations, and cash available from the new equity based line of credit (when
and if it becomes available--see discussion above) will be sufficient to meet
the Company's cash and investment requirements at least through the third
quarter of fiscal 2000.
13
<PAGE>
As of December 31, 1998, the Company had cash and cash equivalents of
$3,081,000 and net working capital of $2,354,000.
IMPACT OF YEAR 2000 ISSUE. The year 2000 issue is the result of computer
programs being written using two digits rather than four to define the
applicable year. Any of the Company's computer programs that have date-
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. This could potentially result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in other similar normal business activities.
The Company is heavily dependent upon the proper functioning of its own
computer or data-dependent systems. This includes, but is not limited to, its
systems in information, business, finance, operations, manufacturing and
customer service. Any failure or malfunctioning on the part of these or other
systems could adversely affect the Company in ways that are not currently known,
discernable, quantifiable or otherwise anticipated by the Company.
The Company has ensured that its internal software and embedded technology
is already Year 2000 compliant, as such this issue is not expected to have a
material effect on the operations of the Company. The Company believes that all
current versions of its product lines are Year 2000 compliant.
To date, the Company has not incurred incremental material costs associated
with its effort to become Year 2000 compliant, as the majority of the costs have
occurred as a result of normal devlopment and upgrade procedures. Furthermore,
the Company believes that future costs associated with its Year 2000 compliance
efforts will not be material.
The Company currently has only limited information on the Year 2000
compliance of its key suppliers and customers. The Company has received
confirmation from a primary supplier that it is Year 2000 compliant. The
Company is in the process of surveying its key suppliers and customers for Year
2000 compliance and anticipates that the surveys should be completed by fiscal
year end. The operations of the Company's key suppliers and customers could be
adversely affected in the event they do not successfully and timely achieve Year
2000 compliance. The Company's business and results of operations could
experience material adverse effects if its key suppliers were to experience Year
2000 issues that caused them to delay the procurement, manufacturing or shipment
of key components to the Company. In addition, the Company's results of
operations could be materially adversely affected if any of the Company's key
customers encounter Year 2000 issues that cause them to delay or cancel
substantial purchase orders or delivery of the Company's product.
There can be no assurance that the Company will be able to develop a plan
to address any unforeseen Year 2000 issues in a timely manner or to upgrade any
or all of its major systems in accordance with such plan. In addition, there
can be no assurance that any such product development or upgrades will
effectively address the Year 2000 issue. If required development or upgrades
are not completed timely or are not successful, the Company may be unable to
conduct its business or manufacture its products, which would have a material
impact on the operations of the Company. Furthermore, there can be no guarantee
that the systems of other companies on which the Company's systems rely will be
timely converted, or that a failure to convert by another company, or a
conversion that is incompatible with the Company's systems, would not have a
material adverse effect on the Company. The Company intends to, but has not yet
established a contingency plan detailing actions that will be taken in the event
that the assessment of the Year 2000 Issue is not successfully completed on a
timely basis.
FORWARD LOOKING STATEMENTS. Certain statements in this Form 10-Q, including
statements contained herein under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations", constitute "forward-
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. Such forward looking statements involve known and
14
<PAGE>
unknown risks, uncertainties and other factors which may cause the actual
results, performance or achievements of the Company to be materially different
from any future results, performance or achievements express or implied by such
forward-looking statements. Such factors include, but are not limited to the
following: general economic and business conditions; charges and costs related
to acquisitions; and the ability of the Company to develop and market products
for the markets in which it operates, to successfully integrate its acquired
products and services, to adjust to changes in technology, customer preferences,
enhanced competition and new competitors in the markets in which it operates.
This Management's discussion and analysis should be read in conjuction with
the Management's discussion and analysis that accompanies the Company's report
on Form 10-K for the fiscal year ended March 31, 1998.
15
<PAGE>
PART II OTHER INFORMATION
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
No disclosure is required or applicable pursuant to Item 102 of Regulation
S-K.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
None.
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant, Sonic Solutions, has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized, in the City of Novato,
State of California, on the 16th day of February, 1999.
SONIC SOLUTIONS
Signature Date
--------- ----
/s/ Robert J. Doris February 16, 1999
- --------------------
Robert J. Doris
President and Director (Principal
Executive Officer)
/s/ A. Clay Leighton February 16, 1999
- --------------------
A. Clay Leighton
Sr. V.P. Worldwide Operations and
Chief Financial Officer
(Principal Financial
Accounting Officer)
17
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