| SONIC SOLUTIONS/CA/ Item 1A Risk Factors RISK FACTORS You should carefully consider the risk factors set forth below as well as those in other documents we file with the Securities and Exchange Commission |
| The risks and uncertainties described below are not the only ones we face |
| Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations |
| The risks identified below could harm our business and cause the value of our shares to decline |
| We cannot, however, estimate the likelihood that our shares may decline in value or the amount by which they may decline |
| We may experience potential fluctuations in our quarterly operating results, face unpredictability of future revenue and incur losses in the future |
| The market for our products is characterized by rapid changes in technology |
| We may not accurately predict customer or business partner behavior and may not recognize or respond to emerging trends, changing preferences or competitive factors, and, therefore, we may fail to make accurate financial forecasts |
| Our quarterly operating results may fluctuate significantly in the future as a result of a variety of factors, many of which are outside our control |
| These factors include: · fluctuations in demand for, and sales of, our products and the PCs and consumer electronics devices with which our products are included; · introduction of new products and services by us and our competitors; · competitive pressures that result in pricing fluctuations; · variations in the timing of orders and shipments of our products; · changes in the mix of products and services sold and the impact on our gross margins; · delays in our receipt of and cancellation of orders forecasted or placed by customers; · our ability to enter into or renew on favorable terms our licensing, distribution and other agreements; · the costs associated with the defense or prosecution of litigation and intellectual property claims; and · general economic conditions specific to the audio and video recording market, as well as related PC and consumer electronics markets |
| Although we were profitable for fiscal years 2004, 2005 and 2006, we were not profitable in the third quarter of fiscal year 2005, and you should not rely on the results for those periods during which we were profitable as an indication of future performance |
| We were not profitable for the third quarter of fiscal year 2005 primarily as a result of expenses in the amount of approximately dlra4cmam188cmam000 incurred in connection with the Roxio CSD acquisition, including the write off of approximately dlra3cmam100cmam000 for in-process research and development |
| Given the general uncertainty of market trends for professional and consumer audio and video products and related technology, we may not remain cash flow positive or generate net income in fiscal year 2007 |
| Moreover, our operating expenses are based on our current expectations of our future revenues and are relatively fixed in the short term |
| We tend to book a significant portion of quarterly revenues in the last month or last weeks of a quarter, and we generally do not know until quite late in a quarter whether we will achieve our sales expectations for the quarter |
| For example, in recent quarters, as much as 65prca of our professional sales have been procured in the last month of the quarter |
| For many of our OEM licenses, we recognize revenues upon receipt of a royalty report from those OEMs |
| OEM royalty reports are sometimes incomplete, or are received on an unpredictable schedule |
| In some cases we determine that we need to perform additional review of reports prior to including the underlying royalties in revenues |
| Therefore, depending on the timing of receipt of royalty reports relative to quarterly cut-offs, our reported revenues may fluctuate and, in some cases, result in negative reported operating results |
| Because most of our quarterly operating expenses and our inventory purchasing are committed well before quarter end, we have little ability to reduce expenses to compensate for reduced sales, and our operating results for that particular quarter may be impacted adversely |
| If we have lower revenues than we expect, we will not be able to quickly reduce our spending in response |
| From time to time, we also may make certain pricing, service or marketing decisions that adversely affect our revenues in a given quarterly or annual period |
| Any shortfall in our 24 _________________________________________________________________ revenues would have a direct impact on our operating results for a particular quarter and these fluctuations could affect the market price of our common stock in a manner unrelated to our long-term operating performance |
| Changes in our product and service offerings could cause us to defer the recognition of revenue, which could harm our operating results and adversely impact our ability to forecast revenue |
| Our products contain advanced features and functionality that may require us to provide increased levels of end-user support |
| As our products and services become more complex, we may also be obligated to provide additional support to our customers, which could require us to defer certain revenues to future periods, harm our short-term operating results and adversely impact our ability to accurately forecast revenue |
| Failure to successfully integrate any business we have acquired or may acquire in the future could negatively impact our results of operations, financial condition and business |
| On December 17, 2004 we acquired the assets of the Roxio CSD for dlra70dtta0 million in cash and 653cmam837 shares of Sonic common stock, valued at dlra8cmam630cmam000, plus an aggregate of approximately dlra2dtta3 million representing certain purchase price adjustments |
| In the acquisition, we acquired Roxio’s CD and DVD recording, authoring, photo and video application products and substantially all of the patents and trademarks of the Roxio CSD, and assumed substantially all the liabilities of the Roxio CSD Two hundred and twelve former employees of the Roxio CSD joined Sonic |
| Integration of the Roxio CSD into Sonic was a lengthy and costly process |
| The integration of any future businesses we may acquire, into our existing business is and will be a complex, time-consuming and expensive process and may disrupt our existing operations if not completed in a timely and efficient manner |
| If our management is unable to minimize the potential disruption to our business during the integration process, the anticipated benefits of an acquisition may not be realized |
| Realizing the benefits of an acquisition will depend in part on the integration of technology, operations and personnel while maintaining adequate focus on our core businesses |
| We may encounter substantial difficulties, costs and delays in integrating various acquisitions, including but not limited to the following: · potential conflicts between business cultures; · diversion of management’s attention from our core business; · adverse changes in business focus perceived by third parties such as customers, business partners and investors; · potential conflicts in distribution, marketing or other important relationships; · an inability to implement uniform standards, controls, procedures and policies; · an inability to integrate our research and development and product development efforts; · the loss or termination of key employees, including costly litigation or settlements resulting from the termination of those employees; · disruptions among employees which may erode employee morale; · undiscovered and unknown problems, defects or other issues related to any acquisition that become known to us only after the acquisition; and · negative reactions from our resellers and customers to an acquisition |
| Our operating expenses may increase significantly over the near term due to the increased headcount, expanded operations and expense or changes related to an acquisition |
| For example, we were not profitable for the third quarter of fiscal year 2005 primarily as a result of expenses of approximately dlra4cmam188cmam000 incurred in connection with the acquisition of the Roxio CSD, including the write off of approximately dlra3cmam100cmam000 for in-process research and development |
| To the extent that our expenses associated with an acquisition increase but our revenues do not, there are unanticipated expenses related to the integration process, or there are significant costs associated with presently unknown liabilities or other problems, our business, operating results and financial condition will be affected adversely |
| Failure to minimize the numerous risks associated with post-acquisition integration activities also may affect adversely the trading price of our common stock |
| 25 _________________________________________________________________ We have grown in recent years, in part due to recent acquisitions such as our Roxio CSD acquisition, and if our executive team is unable to effectively manage our growing company, our operating results and our ability to expand further our operations may suffer |
| Our success depends on our ability to effectively manage the growth of our operations |
| As a result of acquisitions, we have significantly increased our headcount from 110 at March 31, 2002 to 637 at March 31, 2006 |
| In addition, continuing expansion of our business will further increase the scope of our operations both domestically and internationally |
| Furthermore, as a result of our acquisitions and the establishment of foreign subsidiaries and offices, we have expanded our geographical presence domestically and internationally |
| Our management team faces challenges inherent in efficiently managing an increased number of employees over larger geographic distances, including the need to implement appropriate systems, controls, policies, benefits and compliance programs |
| Our inability to manage successfully the geographically more diverse and substantially larger organization, or any significant delay in implementing appropriate systems, controls , policies, benefits and compliance programs for the larger company, could have a material adverse effect on our business and results of operations and, as a result, on the market price of our common stock |
| We depend on a limited number of customers for a significant portion of our revenue, and the loss of one or more of these customers could materially harm our operating results, business and financial condition |
| During the fiscal year 2006 approximately 20prca of our revenue was derived from revenue recognized on licensing agreements from Dell, and approximately 10prca and 12prca of our revenue was derived from revenue recognized on retail agreements from two national and international distributors, Ingram and Navarre, respectively |
| In September 2005, Dell made certain structural changes to its website that, based on initial reports, reduced the rate at which Dell customers have purchased upgraded versions of our software |
| As a result, we have worked cooperatively with Dell to increase our upgrade rates and to compensate us for losses in revenues that we might otherwise experience as a result of internal Dell website changes |
| While we believe that we have successfully negotiated appropriate terms with Dell to address these factors, there can be no assurance that we will be able to fully insulate ourselves from Dell corporate website decisions that could affect adversely sales of our consumer products to Dell customers |
| We anticipate that the relationships with Dell, Ingram and Navarre will continue to account for a significant portion of our revenue in the future |
| Any changes in our relationships with any of these customers, including any actual or alleged breach of the agreements by either party or the early termination of, or any other material change in, any of the agreements could seriously harm our operating results, business, and financial condition |
| Additionally, a decrease or interruption in any of the above-mentioned businesses or their demand for our products or a delay in our development agreements with any one of them could cause a significant decrease in our revenue |
| Also, we may not succeed in attracting new customers, as many of our potential customers have pre-existing relationships with our current or potential competitors |
| To attract new customers, we may be faced with intense price competition, which may affect our gross margins |
| Because we have significant international operations and a significant portion of our revenue derives from sales made to foreign customers located primarily in Europe and Japan, we may be subject to political, economic and other risks that could increase our operating expenses and/or disrupt our business |
| We depend on sales to customers outside the United States, in particular Europe and Japan |
| Revenue derived from these customers accounted for approximately 40prca, 23prca and 23prca of our revenues in fiscal years 2004, 2005 and 2006, respectively |
| As a result of the Roxio CSD acquisition, we currently anticipate that we will generate additional international sales |
| International sales historically have represented approximately 20prca to slightly less than 50prca of our total sales |
| We expect that international sales will continue to account for a significant portion of our net product sales for the foreseeable future |
| As a result, the occurrence of any adverse international political, economic or geographic events could result in significant revenue shortfalls |
| These shortfalls could cause our business, financial condition and results of operations to be harmed |
| Furthermore, although some of our revenue and expenses related to our international operations are transacted in US dollars, we are exposed to currency exchange fluctuations and we expect our exposure to increase in the future as business practices evolve and we transact a greater portion of our business in local currencies |
| We currently do not engage in foreign currency hedging transactions |
| We may in the future choose to limit our exposure by the 26 _________________________________________________________________ purchase of forward foreign exchange contracts or through similar hedging strategies |
| Also, as a result of recent acquisitions, particularly the Roxio CSD acquisition, as well as our general objective to increase our international capabilities, we have a greater international presence than before |
| Our management team faces the challenge of efficiently managing and integrating our international operations |
| Our increased international operations and dependence on foreign customers expose us to additional risks, including, but not limited to: · currency movements in which the US dollar becomes stronger with respect to foreign currencies, thereby reducing relative demand for our products and services outside the United States; · currency movements in which a foreign currency in which we incur expenses becomes stronger in relation to the US dollar, thereby, raising our expenses for the same level of operating activity; · import and export restrictions and duties, including tariffs and other barriers; · foreign regulatory requirements, such as safety or radio frequency emissions regulations; · liquidity problems in various foreign markets; · burdens of complying with a variety of foreign laws; · political and economic instability; · changes in diplomatic and trade relationships; and · natural disasters |
| We may engage in future acquisitions that could dilute our shareholders’ equity and harm our business, results of operations and financial condition |
| As part of our efforts to enhance our existing products and services, introduce new products and services, grow our business, and remain competitive, we have pursued, and we may pursue in the future, acquisitions of companies, products and technologies |
| We are unable to predict whether or when any prospective acquisition will be completed |
| We have limited experience in acquiring and integrating outside businesses |
| The process of integrating an acquired business may produce operating difficulties, may be prolonged due to unforeseen difficulties, may require a disproportionate amount of our resources and expenditures and may require significant attention of our management that otherwise would be available for our ongoing business |
| We cannot assure you that we will be able to successfully identify suitable acquisition candidates, complete acquisitions, integrate acquired businesses into our current operations, or expand into new markets |
| Future a cquisitions may not be well-received by the investment community, which may cause our stock price to fall |
| Further, even if integrated, an acquired business may not achieve anticipated levels of revenues, profitability or productivity or otherwise perform as expected |
| The occurrence of any of these events could harm our business, financial condition or results of operations |
| If we consummate one or more significant future acquisitions in which the consideration consists of stock or other securities, our existing shareholders’ ownership could be diluted significantly |
| If we were to proceed with one or more significant future acquisitions in which the consideration included cash, we could be required to use a substantial portion of our available cash or to seek additional debt or equity financing |
| Future acquisitions by us could result in the following, any of which could seriously harm our results of operations, business, financial condition and/or the price of our stock: · issuance of equity securities that would dilute our current shareholders’ percentages of ownership; · large one-time write-offs; · the incurrence of debt and contingent liabilities; · difficulties in the assimilation and integration of operations, personnel, technologies, products, services, business relationships and information and other systems of the acquired businesses; · contractual and/or intellectual property disputes; 27 _________________________________________________________________ · risks of entering geographic and business markets in which we have no or only limited prior experience; and · potential loss of key employees of acquired businesses |
| Our product prices may decline, which could harm our operating results |
| The market for our software is intensely competitive |
| It is likely that prices for our OEM products will decline due to competitive pricing pressures from other software providers, due to competition in the PC and consumer electronics industries and due to concentration among OEM customers resulting in their having strong negotiating positions relative to us |
| In addition, as a result of the Roxio CSD acquisition, we derive a greater portion of our revenue from retail sales, which also are subject to significant competitive pricing pressures |
| We may experience additional pricing pressures in other parts of our business |
| These trends could make it more difficult for us to increase or maintain our revenue and may cause a decline in our gross and/or operating profits |
| Our reliance on a single supplier for our manufacturing makes us vulnerable to supplier operational problems |
| Our hardware outsourcing manufacturing program commits responsibility for almost all of our professional products manufacturing activities to a single supplier – Arrow Bell Electronics |
| If Arrow Bell Electronics does not achieve the necessary product delivery schedules, yields and hardware product reliability, our customer relationships could suffer, which could ultimately lead to a loss of sales of our products and have a negative effect on our results of operations |
| Moreover, if Arrow Bell Electronics fails to perform as we expect, we cannot guarantee that we would be able to identify and engage a substitute supplier on favorable terms, at a reasonable cost, or in a timely manner, if at all |
| Also, outsourcing our manufacturing processes increases our exposure to potential misappropriation of our intellectual property |
| Manufacturing for our consumer software products is outsourced using Moduslink as our primary supplier |
| Moduslink provides services such as parts procurement, parts warehousing, product assembly and supply chain services |
| These services are provided to Sonic from three primary Moduslink locations |
| Moduslink is a non-exclusive supplier to Sonic |
| The occurrence of any of the above-noted product shortages or quality assurance problems could increase the costs of manufacturing and distributing our products and may adversely impact our operating results |
| We depend on third-party single-source suppliers for components of some of our products and any failure by them to deliver these components could limit our ability to satisfy customer demand |
| We often use components in our products that are available from only a single source |
| We do not carry significant inventories of these components and we have no guaranteed supply agreements for them |
| We are likely to experience similar shortages at some point in the future |
| Such shortages, as well as any pricing fluctuations on these sole-source components, can have a significant negative impact on our business |
| Any interruption in the operations of our vendors of sole source components could affect adversely our ability to meet our scheduled product deliveries to customers |
| If we are unable to obtain a sufficient supply of components from our current sources, we could experience difficulties in obtaining alternative sources or in altering product designs to use alternative components |
| Resulting delays or reductions in product shipments could damage customer relationships and expose us to potential damages that may arise from our inability to supply our customers with products |
| Further, a significant increase in the price of one or more of these components could harm our gross margins and/or operating results |
| Because a large portion of our net revenue is from OEM customers, the potential success of our products is tied to the success of their product sales |
| Much of our consumer revenue is derived from sales through OEM customers for copies of our software bundled with their products |
| Temporary fluctuations in the pricing and availability of the OEM customers’ products could impact negatively sales of our products, which could in turn harm our business, financial condition and results of operations |
| Moreover, increased sales of our consumer products to OEMs depend in large part on consumer acceptance and purchase of DVD players, DVD recorders and other digital media devices marketed by our OEM 28 _________________________________________________________________ customers in PCs, consumer electronics devices, or on a stand-alone basis |
| Consumer acceptance of these digital media devices depends significantly on the price and ease-of use for these devices, among other factors |
| If alternative technology emerges or if the demand for moving, managing and storing digital content is less than expected, the growth of this market may decline, which may affect adversely sales of our consumer products to our OEM customers |
| In addition, some of the materials, components and/or software included in the end products sold by our OEM customers, who also incorporate our products, are obtained from a limited group of suppliers |
| Supply disruptions, shortages, quality issues or termination of any of these sources could have an adverse effect on our business and results of operations due to the delay or discontinuance of orders for our products by our OEM customers until those necessary materials, components or software are available for their own products |
| Moreover, if OEM customers do not ship as many units as forecasted or if there is a general decrease in their unit sales, our net revenue will be impacted adversely and we may be less profitable than forecasted or unprofitable |
| Furthermore, we rely on reports prepared by OEM customers to determine the results of our sales of products through these OEM customers |
| If the OEM customers prepare inaccurate or substandard sales reports, we may be required to take corrective actions, including auditing current and prior reports |
| Such corrective actions may result in a negative impact on our business or our reported results |
| For example, we could conclude that our prior reported net revenue and related results may be less than previously reported |
| Changes in requirements or business models of our OEM customers may affect negatively our financial results |
| OEM customers can be quite demanding with respect to the features they demand in software products they bundle, quality and testing requirements, and economic terms |
| Because there are a relatively small number of significant OEM customers, if they demand reduced prices for our products, we may not be in a position to refuse such demands, which could impact negatively our revenues and results of operations |
| If particular OEMs demand certain products or product features that we are unable to deliver, or if they impose higher quality requirements than we are able to satisfy, we could lose those relationships which likely would damage our revenues and our results of operations |
| Also, if our competitors offer our OEM customers more favorable terms than we do or if our competitors are able to take advantage of their existing relationships with these OEMs, then these OEMs may not include our software with their products |
| These OEM relationships serve an important role in distributing our software to end-users and positioning the market for upgrades to our more fully featured software products |
| Our business will suffer if we are unable to maintain or expand our relationships with OEMs |
| We rely on distributors, resellers and retailers to sell our products, and disruptions to these channels would affect adversely our ability to generate revenues from the sale of our products |
| The portion of our revenue derived from sales of software to end-users via retail channels through our network of national and international distributors and resellers has increased during recent years, in part due to our Roxio CSD acquisition, and we anticipate that this trend will continue |
| There are currently two distributors that account for a significant portion of sales of our consumer software |
| Any decrease in revenue from these distributors or the loss of one of these distributors and our inability to find a satisfactory replacement in a timely manner could affect our operating results adversely |
| Moreover, our failure to maintain favorable arrangements with our distributors and resellers may impact adversely our business |
| For example, our distributors and resellers and the retailers who sell our software to the public also sell products offered by our competitors |
| If our competitors offer our distributors, resellers or retailers more favorable terms, those distributors, resellers or retailers may de-emphasize, fail to recommend or decline to carry our products |
| In the future, we may not be able to retain or attract a sufficient number of qualified distributors, resellers or retailers |
| If our distributors, resellers or retailers attempt to reduce their levels of inventory or if they do not maintain sufficient levels to meet customer demand, our sales could be impacted negatively |
| Further, if we reduce the prices of our products, we may have to compensate our distributors, resellers or retailers for the difference between the higher pric e they paid to buy their inventory and the new lower prices of our products |
| In addition, we are exposed to the risk of product returns from distributors, resellers or retailers through their exercise of contractual return rights |
| If direct sales to customers through our own online channels increase, our distributors, resellers and retailers may suffer decreased sales as a consequence |
| These changes may cause our distributors, resellers or retailers to cease distribution of our products or seek more favorable terms, either of which could seriously harm our business |
| 29 _________________________________________________________________ If we fail to protect our intellectual property rights, such as trade secrets, we may not be able to market our products successfully |
| Unlicensed copying and use of our intellectual property or illegal infringements of our intellectual property rights represent losses of revenue to our company |
| Our products are based in large part on proprietary technology which we have sought to protect with patents, trademarks, copyrights and trade secrets |
| For example, we have many patents and pending applications for additional patents in the United States and in foreign countries |
| We also make significant efforts to acquire trademark protection for the names and brands of our software products, services and unique product features |
| In addition, we make extensive use of trade secrets, which we may not be able to protect adequately |
| Effective patent, trademark, copyright and trade secret protection may not be available in every country in which our products may be manufactured, marketed, distributed, sold or used |
| Moreover, despite our efforts, these measures only provide limited protectio n |
| Third parties may try to copy or reverse engineer portions of our products or otherwise obtain and use our intellectual property without authorization |
| To the extent that we use patents to protect our proprietary rights, we may not be able to obtain needed patents or, if granted, the patents may be held invalid or otherwise indefensible |
| Patent protection throughout the world is generally established on a country-by-country basis |
| We cannot assure you that the protection of our proprietary rights will be adequate or that our competitors will not develop independently similar technology, duplicate our products or design around any of our patents or other intellectual property rights |
| Our business could be harmed seriously if we fail to protect our intellectual property rights and proprietary technology adequately, if there are changes in applicable laws that are adverse to our interests, or if we become involved in legal proceedings relating to our intellectual property rights and proprietary technology or relating to the intellectual property rights of others |
| To the extent we are unable to protect our proprietary rights, competitors also may enter the market offering products substantially similar or identical to ours, with a negative impact on sales of our products |
| Other companies’ intellectual property rights may interfere with our current or future product development and sales |
| We have never conducted a comprehensive patent search relating to our business models or the technology we use in our products or services |
| There may be issued or pending patents owned by third parties that relate to our business models, products or services |
| If so, we could incur substantial costs defending against patent infringement claims or we could even be blocked from engaging in certain business endeavors or selling our products or services |
| Other companies may succeed in obtaining valid patents covering one or more of our business models or key techniques we utilize in our products or services |
| If so, we may be forced to obtain required licenses or implement alternative non-infringing approaches |
| Our products are designed to adhere to industry standards, such as DVD-ROM, DVD-Video, DVD-Audio and MPEG video |
| A number of companies and organizations hold various patents that claim to cover various aspects of DVD, MPEG and other relevant technology |
| We have entered into license agreements with certain companies and organizations relative to some of these technologies |
| For instance, we have entered into license agreements with Dolby’s licensing affiliate covering Dolby Digital Audio, with Meridian Audio Limited covering Meridian Lossless Packing, with MPEG-LA (see below) covering various aspects of MPEG-2 video compression technology, and with Thomson/Fraunhofer covering various aspects of MPEG-2 layer 3 audio compression technology (MP3), among others |
| Such license agreements may not be sufficient to grant us all of the intellectual property rights necessary to market and sell our products |
| We may become involved in costly and time-consuming patent litigation |
| We face risks associated with our patent position, including the potential need to engage in significant legal proceedings to enforce our patents, the possibility that the validity or enforceability of our patents may be denied, the possibility that third parties will be able to compete against us without infringing our patents and the possibility that our products or services may infringe patent rights of third parties |
| Budgetary concerns may cause us not to file, or continue, litigation against known infringers of our patent rights |
| Failure to reliably enforce our patent rights against infringers may make licensing more difficult |
| 30 _________________________________________________________________ Third parties could pursue us claiming that our business models, products or services infringe various patents |
| For example, a group of companies have formed an organization called MPEG LA to enforce the rights of holders of patents covering aspects of MPEG technology |
| Although we have entered into an agreement with MPEG LA, that agreement may not prevent third parties not represented by MPEG LA from asserting that we infringe a patent covering some aspects of MPEG technology |
| has asserted that it owns certain patents that are essential to the MPEG-4 visual standard and that are not covered by the license we have for this standard from MPEG LA In addition, as new standards and technologies evolve and as our relative commercial presence expands, we believe that we may face an increasing number of third party claims relating to patent infringements and potential patent infringements over tim e |
| Additionally, in connection with the Roxio CSD acquisition, we assumed a number of patent infringement claims and suits involving Roxio for which we have potential liability |
| For example, we inherited a lawsuit brought by Optima Technology Corporation against Roxio, Inc |
| alleging infringement of its patent by our products |
| In addition, in April 2002, Roxio and MGI were notified by a number of companies that certain of Roxio and MGI’s software products may infringe patents owned by those companies |
| Furthermore, Electronics for Imaging and Massachusetts Institute of Technology filed an action against 214 companies, including Roxio and MGI, claiming patent infringement |
| These patent infringement matters are discussed in greater detail under the caption “Current Infringement Issues” in Item 1 above |
| Patent infringement litigation can be time consuming and costly, may divert management resources and may result in the invalidation of our intellectual property rights |
| If such litigation resulted in an unfavorable outcome for us, we could be subject to substantial damage claims and/or be required to cease production of infringing products, terminate our use of infringing technology or develop non-infringing technology and obtain a royalty or license agreement to continue using the technology at issue |
| Such royalty or license agreements might not be available to us on acceptable terms, or at all, resulting in serious harm to our business |
| Our use of protected technology may result in liability that threatens our continuing operations |
| We may be liable to some of our customers for damages that they incur in connection with intellectual property claims |
| Although we attempt to limit our exposure to liability arising from infringement of third-party intellectual property rights in our license agreements with customers, we may not succeed |
| If we are required to pay damages to or incur liability on behalf of our customers, our business could be harmed |
| Moreover, even if a particular claim falls outside of our indemnity or warranty obligations to our customers, our customers may be entitled to additional contractual remedies against us, which could harm our business |
| Furthermore, even if we are not liable to our customers, our customers may attempt to pass on to us the cost of any license fees or damages owed to third parties by reducing the amounts they pay for our products |
| These price reductions could harm our business |
| Some of our competitors possess greater technological and financial resources than we do, may produce better or more cost-effective products than ours and may be more effective than we are in marketing and promoting their products |
| There is a substantial risk that competing companies will produce better or more cost-effective products, or will be better equipped than we are to promote products in the marketplace |
| These include Adobe, Apple Computer, ArcSoft, CyberLink, InterVideo, Inc, MedioStream, Nero, Pinnacle (which was acquired by Avid Technology in August 2005) and Ulead (the majority stockholder of which is InterVideo) |
| Some of these companies have greater financial and technological resources than we do |
| Because our products are designed to adhere to industry standards, to the extent that we cannot distinguish our products from those produced by our competitors, our current distributors and customers may choose alternate products or choose to purchase products from multiple vendors |
| We may be unable to compete effectively if we cannot produce products more quickly or at lower cost than our competitors |
| We cannot provide any assurance that the industry standards on which we develop new products will allow us to compete effectively with companies possessing greater financial and technological resources than we have to market, promote and exploit sales opportunities as they arise in the future |
| Accelerated product introductions and short product life cycles require significant expenditures for research and development that could affect adversely 31 _________________________________________________________________ our operating results |
| Further, any new products we develop may not be introduced in a timely manner or in advance of our competitors’ products and may not achieve the broad market acceptance necessary to generate significant revenues |
| We need to develop and introduce new and enhanced products in a timely manner to remain competitive |
| The markets in which we operate are characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions and relatively short product lives |
| The pursuit of necessary technological advances and the development of new products require substantial time and expense |
| To compete successfully in the markets in which we operate, we must develop and sell new or enhanced products that provide increasingly higher levels of performance and reliability |
| For example, our business involves new digital audio and video formats, such as DVD-Video and DVD-Audio, and, more recently, the new recordable DVD formats including DVD-RAM, DVD-R/RW, and DVD+RW Currently, there is extensive activity in our industry targeting the introduction of new, high definition, formats including HD DVD and BD To the extent that competing new formats remain incompatible, consumer adoption may be delayed and we may be required to expend addi tional resources to support multiple formats |
| We expend significant time and effort to develop new products in compliance with these new formats |
| To the extent there is a delay in the implementation or adoption of these formats, our business, financial condition and results of operations could be adversely affected |
| As new industry standards, technologies and formats are introduced, there may be limited sources for the intellectual property rights and background technologies necessary for implementation, and the initial prices that we may negotiate in an effort to bring our products to market may prove to be higher than those ultimately offered to other licensees, putting us at a competitive disadvantage |
| Additionally, if these formats prove to be unsuccessful or are not accepted for any reason, there will be limited demand for our products |
| We cannot assure you that the products we are currently developing or intend to develop will achieve feasibility or that even if we are successful, the developed product will be accepted by the market |
| We may not be able to recover the costs of existing and future product development and our failure to do so may materially and adversely impact our business, financial condition and results of operations |
| Revenue derived from our professional DVD products and services has declined in recent years and may continue to decline |
| We have experienced revenue declines in the professional segment and, absent new format introductions, such as the proposed high definition video optical disc formats, we expect such declines to continue |
| Professional DVD facilities began equipping to prepare DVD titles as early as 1997, and significant expansion of DVD creation capacity occurred during 1998, 1999 and 2000 |
| Although the number of DVD discs replicated will continue to grow in future years, we do not expect that the number of titles published will expand as dramatically, hence we do not expect that DVD production facilities will increase the rate of their capacity expansion |
| Instead, they may decrease the rate of their expansion resulting in a lower level of sales for us |
| We may encounter significant challenges as our business comes to depend more on sales of consumer products |
| We anticipate that our business will continue to evolve to depend more on sales of consumer products to generate additional revenue and grow our business |
| If this trend continues, we will be subject to risks due to changing consumer demands, extensive competition that may result in price erosion, product liability litigation and/or product warranty concerns |
| The general pattern associated with consumer products that we develop is one of higher sales and revenue during the winter holiday season |
| Due to the importance of the winter holiday selling season, we may expect that the corresponding fiscal quarter will contribute a greater proportion of our sales and gross profit for an entire year |
| If, for any reason, our sales or sales of our OEM customers fall below our expectations in that fiscal quarter (for example, if specific events cause consumer confidence to drop or other factors limit consumer spending), our business, financial condition and operating results may be harmed |
| Success in our consumer segment will depend upon our ability to enhance and distinguish our existing products, introduce new competitive products with features that meet changing consumer requirements, and control our inventory levels to minimize impact of sudden price decreases |
| 32 _________________________________________________________________ Moreover, our success will depend on our ability to sell effectively our products in the consumer market |
| Historically, the major portion of sales of our consumer products were through bundling arrangements with our OEM customers |
| However, as we have increased our sales of consumer software, we have increasingly relied on sales of our software through direct (Sonic web store) channels, as well as retail (both physical and web-based) channels |
| We may not have the capital required or the necessary personnel or expertise to develop and enhance these distribution channels |
| If we do spend the capital required to develop and maintain these distribution channels, we cannot guarantee that we will be successful or profitable |
| Moreover, some of these other revenue opportunities are more fragmented than the OEM market and take more time and effort to establish and maintain |
| Also, some of our competitors have well-established ret ail distribution capabilities and existing brands with market acceptance that provide them with a significant competitive advantage |
| If we are not successful in overcoming these challenges our business and results of operations may be harmed |
| We may not be successful in developing additional channels necessary to market and sell our professional products effectively |
| We rely on dealers for the vast majority of sales for our professional products |
| Recruiting and maintaining dealers can pose significant challenges |
| Because our products are sophisticated, our dealers need to be technically proficient and very familiar with our products |
| We may fail to attract the talented dealers necessary to expand our sales and business reversals or turnovers at dealer organizations may have a negative impact on our sales |
| Moreover, the attractive dealers in a targeted region also may carry competing products |
| If our competitors offer our dealers more favorable terms, our dealers may de-emphasize, fail to recommend or decline to carry our products |
| Our revolving credit facility imposes significant operating and financial restrictions, which may prevent us from capitalizing on business opportunities and taking some actions |
| Our revolving credit facility imposes significant operating and financial restrictions on us |
| These restrictions limit our ability to, among other things, incur additional indebtedness, make investments, sell assets, incur certain liens, or merge or consolidate with other businesses |
| In addition, our revolving credit facility requires us to maintain specified financial ratios |
| We cannot assure you that these covenants will not hinder our ability to finance our future operations or capital needs or to pursue available business opportunities |
| A breach of any of these covenants or our inability to maintain the required financial ratios could result in a default under the related indebtedness |
| If a default occurs, the relevant lenders could elect to declare the indebtedness, together with accrued interest and other fees, to be immediately due and payable and proceed against any collateral securing that indebtedness |
| Currently, the borrowings under the credit facility are secured by a lien on substantially all of our assets |
| Further, we may require additional capital in the future to expand our business operations, acquire complementary businesses or replenish cash expended sooner than anticipated |
| Our current revolving credit facility may restrict us from obtaining additional capital or such additional capital may not otherwise be available to us on satisfactory terms, if at all |
| We plan to undertake tax studies that may result in changes to our estimates regarding tax credits accumulated to date |
| During the years prior to fiscal year 2006, we were in a cumulative deficit position and had historically sustained losses |
| As a result, prior to fiscal year 2006, we did not reflect the tax benefits related to certain tax credits including Federal and California research and development credits |
| Beginning with fiscal year 2006, we have begun to recognize the benefits of these tax credits in the course of calculating our tax provision in accordance with US Generally Accepted Accounting Principles (“GAAP”) |
| Accordingly, during fiscal year 2006, we released reserves related to those credits |
| The calculation of these credits requires that significant judgment be applied to expenditures and the evaluation of expenditures relative to guidance in the applicable tax codes |
| In the fourth quarter of fiscal year 2006, we reduced the carry amount of our research and development credits by dlra4cmam439cmam000 as a result of a comprehensive phase I anal ysis, performed with the assistance of third party specialists, of the estimated realizability of the credits |
| We plan to complete phase II of the study prior to the end of fiscal year 2007 the purpose of which is to further support our documentation underlying our research credits |
| We believe, but cannot guarantee that the results of phase II will not result in a significant change in our estimated credits |
| 33 _________________________________________________________________ Our web store makes us vulnerable to third party operational problems and other risks |
| We have initiated a web-based retail store for our consumer products, as well as some of our professional products |
| We may have other similar arrangements in the future |
| We currently make our products available through web-based retail sites in North America, Europe, and Japan |
| These retail sites are operated by third party resellers including Digital River and Sanshin Denki, among others |
| Under these buy/sell arrangements, our reseller partners typically utilize co-branded sites, provide all the infrastructure to handle purchase transactions through their secure web sites, and deliver the product (whether via web download or physical fulfillment) |
| We refer to Digital River, Sanshin and such other organizations as “Outsourcers |
| ” Our web store operations are subject to numerous risks, including unanticipated operating problems, reliance on third-party computer hardware and software providers, system failures and the need to invest in additional computer systems, diversion of sales from other channels, rapid technological change, liability for online content, credit card fraud, and issues relating to the use and protection of customer information |
| We rely on the Outsourcers for smooth operation of our web store |
| Since our web store sales constitute a significant portion of our revenue, any interruption of Digital River’s or any other Outsourcer’s service to us could have a negative effect on our business |
| If Digital River or other Outsourcers were to withdraw from this business, or change its or their terms of service in ways that were unfavorable to us, there might not be a ready alternative outsourcing organization available to us, and we might be unprepared to assume operation of the web store ourselves |
| If any of these events occurs, our results of operations would be harmed |
| Undetected errors or failures found in our products may result in loss of or delay in market acceptance, which could seriously harm our reputation and business |
| Our products may contain undetected software errors or failures when first introduced or as new versions are released |
| Despite testing by us, errors may not be found in new products until after delivery to our customers |
| We may need to modify significantly our products to correct these errors |
| Our reputation and business could be damaged if undetected errors cause our user and customer base to reject our new products |
| Our executive officers and key personnel are critical to our business, and because there is significant competition for personnel in our industry, we may not be able to attract and retain such qualified personnel |
| Our success depends to a significant degree upon the continued contributions of our executive management team, and our technical, marketing, sales, and customer support and product development personnel |
| The loss of key individuals or significant numbers of such personnel could harm significantly our business, financial condition and results of operations |
| We do not have any life insurance or other insurance covering the loss of any of our key employees |
| Because our products are specialized and complex, our success depends upon our ability to attract, train and retain qualified personnel, including qualified technical, marketing and sales personnel |
| However, the competition for personnel is intense and we may have difficulty attracting and retaining such personnel |
| Our stock price has been volatile, is likely to continue to be volatile, and could decline substantially |
| The price of our common stock has been, and is likely to continue to be, highly volatile |
| The price of our common stock could fluctuate significantly for any of the following reasons, among others: · future announcements concerning us or our competitors; · quarterly variations in operating results, including variations due to one-time payments and other non-recurring revenues that may result from certain customer relationships, as well as variations due to the timing of revenue recognition, including deferrals of revenue; · charges, amortization and other financial effects relating to any future acquisitions or divestitures; · introduction of new products or services or changes in product or service pricing policies by us or our competitors, or the entry of new competitors into the digital media software markets; · acquisition or loss of significant customers, distributors or suppliers; · changes in earnings estimates by us or by independent analysts who cover us; · issuances of stock under our current or any future shelf registration statement; 34 _________________________________________________________________ · fluctuations in the US or world economy or general market conditions, as well as those specific to specific to the PC, consumer electronics and related industries; · the delay in delivery to market or acceptance of new DVD or high definition products; · disclosure or remediation of material weaknesses or significant deficiencies in our internal control over financial reporting or our disclosure controls and procedures or of other corporate governance issues; · the costs of litigation and intellectual property claims, including the legal costs incurred to protect our intellectual property rights and settlement of claims based upon our violation or alleged violation of others’ intellectual property rights; and/or · the impact of employee stock-based compensation expenses on our earnings per share |
| In addition, stock markets in general, and the market for technology stocks in particular, have experienced extreme price and volume fluctuations in recent years which frequently have been unrelated to the operating performance of the affected companies |
| These broad market fluctuations may impact adversely the market price of our common stock |
| The market price of our common stock could decline below its current price and may fluctuate significantly in the future |
| These fluctuations may be unrelated to our performance |
| In the past, shareholders of various companies often have instituted securities class action litigation after periods of volatility in the market price of a company’s securities |
| If a shareholder files a securities class action suit against us, we would incur substantial legal fees and our management’s attention and resources would be diverted from operating our business in order to respond to the litigation |
| Failure to comply with internal control attestation requirements could lead to loss of public confidence in our financial statements and negatively impact our stock price |
| As a public reporting company, we are required to comply with the Sarbanes-Oxley Act of 2002, including Section 404, and the related rules and regulations of the SEC, including expanded disclosures and accelerated reporting requirements and more complex accounting rules |
| Compliance with Section 404 and other requirements will continue to increase our costs and require additional management resources |
| In order to satisfy these evolving corporate governance and financial disclosure obligations, we have been taking, and will continue to take, steps to improve our controls and procedures, including disclosure and internal controls, and related corporate governance policies and procedures to address compliance issues and correct any deficiencies that we may discover |
| For example, pursuant to the requirements of Section 404 of Sarbanes-Oxley, we have undertaken a comprehensive and costly evaluation of our internal controls |
| As a result of our evalua tion, performed on the basis of the COSO criteria, management has identified a material weakness in the Company’s interim and annual financial reporting set forth below, and has concluded that, based on the specified criteria, we did not maintain effective internal control over financial reporting as of March 31, 2006: We did not maintain sufficient personnel with an appropriate level of knowledge and experience in the application of generally accepted accounting principles (GAAP), particularly as regards purchase accounting and acquisition integration |
| The Company has not employed personnel qualified to properly account for the complexities of purchase accounting and related post acquisition integration accounting; and the Company has not employed a sufficient number of qualified personnel to follow through on the related increased controls necessary as a result of acquisitions |
| As a result, we did not perform an evaluation of our estimated pre-acquisition accounts receivable allowances for returns and deductions related to the Roxio CSD acquisition |
| This resulted in an adjustment to reduce certain contra accounts receivable balances |
| In addition, for the InterActual acquisition, we did not properly identify the work necessary to analyze and account for certain acquired net operating losses, resulting in an adjustment to goodwill and to deferred tax assets |
| In addition, we did not maintain adequate controls regarding analysis and review of certain accrued liabilities accounts related to our acquired retail channel activities, resulting in certain adjustments to our accruals in amounts that individually were not material |
| Finally, we have not completed fixed asset physical inventories associated with the assets purchased through our historical acquisitions, resulting in a material risk that the assets could have been disposed of, may not be able to be located or are not in active use |
| These adjustments resulting from this material weakness were identified by our independent registered public accountants and were recorded prior to the filing of this Form 10-K for the year ended March 31, 2006 |
| Our efforts to correct the deficiencies in our disclosure and internal controls have required, and will continue to require, the commitment of significant financial and managerial resources |
| In addition, we anticipate the costs 35 _________________________________________________________________ associated with the testing and evaluation of our internal controls will continue to be significant in fiscal year 2007 and may continue to be significant in future fiscal years as these controls are maintained and continually evaluated and tested |
| Furthermore, changes in our operations and the growth of our business following our acquisition of the Roxio CSD have required us to modify and expand our disclosure controls and procedures, internal controls and related corporate governance policies |
| Any future acquisitions and other changes in our operations likely will require us to revise further our disclosure controls and procedures, internal controls and related corporate governance policies |
| In addition, the new and changed laws and regulations are subject to varying interpretations in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies |
| If our efforts to comply with new or changed laws and regulations differ from the conduct intended by regulatory or governing bodies due to ambiguities or varying interpretations of the law, we could be subject to regulatory inqui ries and/or sanctions, our reputation may be harmed and our stock price may be adversely affected |
| Changes in financial accounting standards or practices may cause adverse unexpected financial reporting fluctuations and affect our reported results of operations |
| A change in accounting standards or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective |
| New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future |
| Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business |
| For example, we were required to adopt Statement of Financial Accounting Standards Nodtta 123, revised 2004, “Share-Based Payment” (“SFAS 123(R)”) as of April 1, 2006 |
| The impact of applying SFAS 123(R) for fiscal year ended March 31, 2006 would have adjusted our diluted net income per share from dlra0dtta73 to diluted net loss per share of dlra0dtta76 |
| We expect the adoption of SFAS 123(R) to have a material adverse effect on our results of operations for subseque nt periods |
| We are vulnerable to earthquakes, labor issues and other unexpected events |
| Our corporate headquarters, as well as the majority of our research and development activities, are located in California, an area known for seismic activity |
| An earthquake or other disaster could result in an interruption in our business |
| Our business also may be impacted by labor issues related to our operations and/or those of our suppliers, distributors or customers |
| Such an interruption could harm our operating results |
| We are not likely to have sufficient insurance to compensate adequately for losses that we may sustain as a result of any natural disasters or other unexpected events |