Sonic Solutions F4Q08 (Qtr End 3/31/08) Earnings Call Transcript

Sonic Solutions (SNIC)

F4Q08 Earnings Call

June 10, 2008 4:30 pm ET

Executives

Nils Erdmann - Vice President, Investor Relations

Paul F. Norris - Interim Chief Financial Officer, Executive Vice President, General Counsel

David C. Habiger - President, Chief Executive Officer

Mark Ely - Executive Vice President - Strategy

Analysts

Ralph Schackart - William Blair

Mike Olson - Piper Jaffray

Steven Frankel - Canaccord Adams

Alan Davis - D.A. Davidson & Co.

Analyst for Paul Coster - J.P. Morgan

Mark B. Babka - Eagle Boston

Presentation

Operator

Good day, everyone and welcome to the Sonic Solutions fourth quarter fiscal year 2008 earnings release conference call. As a reminder, today’s conference is being recorded and will last approximately 60 minutes. For your information, the company is aware that the press release has not yet hit the wires. It should be available in a few minutes. And now at this time, I would like to turn the conference over to Mr. Nils Erdmann, Vice President of Investor Relations. Please go ahead, sir.

Nils Erdmann

Good afternoon and thank you for joining Sonic Solutions' earnings conference call for the fourth quarter and fiscal year ended March 31, 2008. With me on today’s call are

Dave Habiger, President and Chief Executive Officer; Paul Norris, Executive Vice President, Interim Chief Financial Officer and General Counsel; and Mark Ely, Executive Vice President and head of Strategy.

Before I hand the call over to Paul, I’ll review our Safe Harbor statement. During the course of this call, we will make forward-looking statements within the meaning of the federal securities laws. All statements other than those of historical fact are statements that could be deemed forward-looking statements, including those regarding growth and financial performance, financial outlook, strategic and operational plans, target markets, strategic priorities, potential benefits of Sonic’s partnerships, Sonic’s ability to strengthen relationships with end users, the opportunities and benefits for Sonic arising from next generation high definition formats and channels and the download and burn business model.

All forward-looking statements are based on current information and expectations and are inherently subject to change. Actual results may differ materially and adversely to those in our forward-looking statements due to various factors.

Now I’d like to turn the call over to Paul Norris.

Paul F. Norris

Thank you. Good afternoon, everyone and thank you for joining us today. I would like to begin today’s call by reviewing our financial results for the 2008 fourth quarter and fiscal year, followed by a discussion of our outlook for the 2009 first quarter and an overview of our outlook for the 2009 fiscal year. I’ll then turn the call over to Dave.

First, let me comment briefly on our regulatory status. I am pleased to report that in addition to completing our stock option review in February, we’ve now filed all of our core -- our past quarterly and annual reports with the SEC and we anticipate filing our fiscal year 2008 annual report within the required timeframe.

Once we hold our consolidated 2006 and 2007 shareholders’ meeting this Thursday, we’ll be back in full compliance with all NASDAQ listing requirements. Because we are now current with our financial reporting, we’ll be able to provide you with more detail regarding our financial condition than we have over the last several quarters.

For purposes of my discussion of our financial results and outlook, please note that unless otherwise indicated, all figures will be reported on a non-GAAP basis, calculated by excluding equity compensation charges, the amortization of acquired intangibles, restructuring charges, and costs associated with our voluntary stock option review. A reconciliation of our GAAP and non-GAAP financials can be found in today’s earnings press release.

For the March quarter, our net revenue was $34.9 million. This was in line with our guidance and analyst average. Our professional products group, PPG, contributed $1.8 million in revenue during the quarter, which was up slightly from the third quarter and in line with our expectations.

Professional systems bookings were up roughly 30% sequentially, a clear indication that Blu-Ray demand is already beginning to improve the performance of our professional unit as we move into our 2009 fiscal year.

Consumer revenue was $33.1 million in the March quarter, down slightly from the December quarter due primarily to seasonality. Our consumer revenue figure was also impacted by the timing of our Toast 9 launch, which occurred in March of this year as compared to our launch of Toast 8 in January last year, which gave us the benefit of the full quarter of sales.

Technology licensing revenue from our ATG group, a component of our consumer revenue, totaled approximately $2.7 million in the March quarter. This exceeded our guidance range of between $2 million and $2.5 million and we expect that licensing revenue will be over $3 million in the June quarter.

In general, we expect ATG sales to increase in the latter part of our 2009 fiscal year as PC and CE manufacturers ramp up use of our software as they implement Blu-Ray technology in their products.

As we pointed out before though, our technology licensing revenue can be very lumpy and can vary significantly from quarter to quarter based upon the timing of contract signings, revenue recognition, and other factors.

Cost of revenue for the fourth quarter, excluding stock-based compensation and the amortization of intangibles, was $7.3 million, or 21% of revenue. This was up slightly less than $500,000 from the December quarter, primarily due to costs associated with the retail launch of Toast 9. The amortization of intangibles was approximately $1.2 million in the March quarter, consistent with the December quarter.

Operating expenses were $24.4 million for the March quarter, down from $24.9 million in the December quarter. These expenses can be split as follows: sales and marketing expenses totaled $8.8 million, a slight decrease from the prior quarter; research and development costs totaled $10.3 million, down $500,000 relative to the third quarter. General and administrative costs totaled $5.2 million, up slightly from the $4.9 million reported in Q3.

On a GAAP basis, in addition to these expenses we also had $1.4 million in costs associated with our voluntary stock option review and $205,000 of share based compensation.

Other income for the quarter, consisting primarily of net interest income, was $321,000. We recorded book taxes at an effective rate of slightly over 40%, resulting in net income of $2.1 million, or $0.08 per fully diluted share.

In the March quarter, we had approximately 26.3 million basic shares outstanding and 27.1 shares outstanding on a fully diluted basis.

For the full 2008 fiscal year, we generated $132.9 million in net revenue, net income of approximately $4.5 million, and fully diluted earnings per share of $0.15. Our gross margin was 79% and our operating margin was 5%.

Turning to our balance sheet, cash, restricted cash, cash equivalents, and short-term investments ended the quarter at $63.5 million, down $1.7 million from the $65.2 million at the end of the prior quarter. The decrease is due primarily to the one-time expenses mentioned earlier, as well as our acquisition of the media business in China.

Our bank debt outstanding at March 31 was $20 million, unchanged from December 31.

Now I’d like to turn to fiscal year 2009, beginning with our first quarter ending June 30th. As a reminder, we provide projections on a non-GAAP basis. Most elements of our business have been operating as expected in the current quarter but we are experiencing a shortfall in the OEM revenues we receive from Dell. In March, Dell transitioned to new bundling programs which we believe will adversely impact our revenue in the first quarter by approximately $3 million. We’ve worked closely with Dell to address the situation and are confident that the problems have now been resolved.

Due to this temporary setback, however, our forecast for the first quarter is for revenues of $29 million or more. This estimate reflects the full extent of the shortfall, meaning that we otherwise would be projecting revenue in line with current consensus.

We estimate that cost of goods sold for the first quarter excluding the amortization of intangibles and stock-based compensation, will be down slightly on a sequential basis. Operating expenses will increase to approximately $27 million, due in large part to additional employees who have joined us through the Simple Star acquisition, as well as some additional expenses related to our Qflix initiative. This will result in a net loss for the quarter of approximately $2.4 million, or $0.09 per share.

For the full 2009 fiscal year, we expect three major drivers to shape our business. First, we expect the launch of the Blu-Ray format to positively impact sales in our PPG and ATG divisions. Second, we are making two significant investments in new businesses, Qflix and online services. We believe Qflix will begin to generate meaningful revenue in the latter part of fiscal 2009 while our web products and services initiative, accelerated by the acquisition of Simple Star, should also produce appreciable revenue towards the end of the fiscal year. And third, we anticipate that our consumer business will grow modestly over the course of the year.

During the remainder of the year, OEM revenues should be stable relative to prior year periods, while our sales team execute an important strategic shift by introducing our web services and Qflix initiative into our major OEM relationships.

In addition, we also expect to add new OEMs, particularly in the areas of mobile communications, cable delivery systems, and other devices.

We anticipate that our profitability will improve throughout the remainder of the 2009 fiscal year. Gross margin should also improve incrementally over this period.

We expect operating expenses to decrease from about $27 million to approximately $25 million, driven in part by increasing efficiency in the traditional parts of our business, counter-balanced by the need to fund our Qflix and web services initiative. By the fourth fiscal quarter, we expect that our operating margin will be approaching 20% and that we will be generating at least [$7 million] of EBITDA per quarter.

Now I’ll turn the call over to Dave who will give you his perspective on our business and an overview of our strategic objectives. Dave.

David C. Habiger

Thanks, Paul. Good afternoon and thank you for joining us today for our fourth quarter and fiscal year 2008 earnings call. I would like to start by recapping some of the events of the fourth quarter fiscal year 2008 and the first few months of our 2009 fiscal year. I will then talk about the upcoming year and the milestones that we are looking to achieve over the next 12 months. Afterwards, we’ll open the call to questions.

Fiscal 2008 was an important year for Sonic. We saw an end to the high definition format war resulting in Hollywood’s swift backing of the Blu-Ray disc format. We helped facilitate the passing and adoption of the [inaudible] amendment to allow for the legal DVD download and burn, paving the way for our Qflix business. We announced numerous agreements with CE and chip manufacturers, such as PLDS, Ritek, and Broadcom for the use of our licensed technology in cars and Blu-Ray devices.

Roxio branded applications, Easy Media Creator, and Toast increased their retail market share over the previous year and led in their categories. Roxio entered into the online services market, is back on track and significantly increased our online capabilities with the acquisition of Photo Show in fiscal 2009.

Our consumer software division also experienced a shift in revenue concentration with our higher margin e-tail sales surpassing brick-and-mortar retail sales of our Roxio branded products. Our Roxio Mobile Media Manager was introduced and bundled on RIM and Motorola smartphones, and we completed our voluntary review of stock option practices, setting the stage for us to regain full NASDAQ compliance.

Each of these achievements was accomplished while maintaining our position as the leading provider of digital media software, strengthening our position with Toast as the top-selling third-party software for Apple computers, and capturing market share among all of our software lines, which occupy nearly 50% of revenues in our retail category.

We expanded our global development sales organization to increase our worldwide position and improve our cost structure. We continued to bolster our workforce in China and Asia-Pacific, which now represents more than 50% of our R&D headcount and 33% of our worldwide employee base. This strategically positions us closer to our OEM partners and gives us the ability to operate around the clock.

Throughout 2008, we repeatedly emphasized that an end to the high definition format war would be a positive catalyst for Sonic, and over the past few months following the resolution of the war and the emergence of BD as the format of choice, our professional products group has begun to experience traction. In March, GDMX, Warner Brothers’ DVD facility, announced that it had selected Sonic’s authoring tools and encoding systems to increase BD production capabilities. The expansion makes GDMX one of the largest high definition production facilities in the world and enables it to address the increase in BD title releases from its major motion picture clients.

We expect our pro business to continue to benefit from the adoption of BD with momentum building throughout the upcoming year.

Our technology licensing division, ATG, experience better than anticipated sales in the fourth quarter and a number of significant announcements in the past few weeks, signaling continued momentum. Just last week, Sun Plus, one of the world’s premier vendors of chips for the DVD player market, licensed Sonic’s Blu-Ray technology to enable interactivity, playback, and navigation in its new system-on-a-chip solution. Both Sun Plus and Broadcom have selected Sonic’s FTK, which should contribute high margin licensing revenue to Sonic as Blu-Ray adoption continues to escalate.

In 2008, our Roxio division maintained its lead as the number one provider of digital media software in the PC industry. We strengthened our relationship with key OEM partners such as Dell and HP, and expanded our OEM offerings with partners including with NEC, Lenovo, and Sony.

For instance, last week we announced that NEC, which has the largest share of Japan’s PC market, has selected our system recovery software, back on track, for its Value Star and LaVie PCs in Japan. This latest agreement expands Sonic’s longstanding relationship with NEC, which has bundled a number of Roxio branded digital media applications in previous releases.

Our Roxio team also continued to penetrate new digital media spaces, like mobile media management and online services. For example, last month we signed an agreement with Motorola to enhance their Z10 handset phones with our mobile media manager software. These mobile OEM relationships represent a huge opportunity for Sonic to capture a significant share of the rapidly growing mobile digital media market. It further signifies the diversification of our OEM portfolio and extends the Roxio brand into another area of our customers’ daily lives.

One of the major initiatives underway at Roxio has been to embrace web services as an important business model. The most interesting part of this trend in our view is sophisticated digital media consumers beginning to use the web to tie together their digital lives. Digital media consumers want their personal content on the PC, on their cell phones, in their car, on their TV, wherever and whenever they want it, seamlessly. Sonic is one of only a handful of companies capable of delivering this experience.

In April, we accelerated Roxio’s web services initiative with the acquisition of Simple Star and its leading personal media web services Photo Show. Photo Show is a comprehensive multimedia story telling platform and online community that enables consumers to quickly and easily turn personal photos and video clips into entertaining shows that can be enjoyed and shared on PCs, TVs, handhelds, or published to popular social networking sites.

Over 12 million copies of the Photo Show desktop software and Flash-based online applications have been installed since the product was first introduced in 2002, and new installations now top 5 million per year.

Photo Show is broadly distributed through a network of major partners, including online photo providers Kodak, Shutterfly, and Snapfish, photo-finishing service providers Ritz Camera as well as cable operators Comcast and Time Warner Cable.

Last year the company launched Photo Show TV, a new service available through Time Warner Cable that enables cable customers to easily create and publicly broadcast their content directly through cable TV. Photo Show TV is being deployed as part of Time Warner’s video-on-demand services.

During the March quarter, Time Warner added two new test markets. The results have been very encouraging, with Photo Show TV becoming the third most popular on-demand service in one of these markets. These rollouts will accelerate throughout fiscal ’09 with two major metropolitan areas launching this summer.

We see an exciting growth opportunity in seamlessly interconnecting desktop applications with online media services and we are not the only ones. Yesterday you may have heard that Apple announced a new web service called mobile needs. This subscription service clearly shows that Apple is heading in the direction of connecting client applications, mobile products, web 2.0 style services. While Mobile Me is targeted at Mac and iPhone users, our services are focused on the broader PC and mobile markets. We intend to bring our installed base of 350 million Roxio Creator customers a set of seamlessly connected client and web applications that dramatically enhance their digital media experience. In addition, Roxio’s web services will enable our OEM partners to foster a greater downstream connection with their customers, further cementing our position in the channel.

Throughout the past few months, Qflix technology has been successfully implemented by various kiosk manufacturers who are working to install download-and-burn kiosks in a number of retail and e-tail businesses. By the end of the fiscal year 2009, Qflix will be operational in a number of different environments and should begin to contribute meaningful revenue.

I would be surprised if by the end of the summer, if you didn’t see a Qflix recorder released by one of our major OEM partners.

In 2009, Sonic’s technology will be found in an increasing number of mobile phones, portable devices, web-enabled services, and Blu-Ray drives and media. Our market dominance at retail, deep OEM relationships, and growing online presence will help us resume our historical growth trajectory.

Looking forward, I am extremely excited by our opportunities in the growing digital media space.

At this point, we will take questions from the group. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first to Ralph Schackart with William Blair.

Ralph Schackart - William Blair

Good afternoon. My first question relates to the pro group. I think you had said it was up, forgive me I get the wrong number here, 30% sequentially on bookings. Is that cash you actually took in hand or is that a service or installs that you will deliver at a future date?

Paul F. Norris

Well that’s -- those are actually the cash that we got from them for a certain [inaudible] of the system sales that we make in the pro group.

Ralph Schackart - William Blair

Okay, and then as you look prospectively, is that sort of an abnormally high order flow, given the resolution of the format or is that something that you would expect, given the sort of ramp in Blu-Ray that should continue through this year and at some point maybe sort of plan out?

Paul F. Norris

Yeah, we’re looking at that basically to continue as part of the ramp that we’ve expected for some time now from Blu-Ray.

Ralph Schackart - William Blair

Okay, great. And then if I turn to ATG, I know it’s just a little bit higher than the range but nonetheless a positive -- what was driving the upside vis-à-vis your original forecast for the quarter?

Paul F. Norris

You know, ATG is hard to say. It tends to be a little bit lumpy. I think it’s getting some benefit too now from the Blu-Ray adoption and we are generally seeing that move in the same upward direction, but there’s not any one thing that you can point to.

Ralph Schackart - William Blair

Okay, and then as we look for next quarter, is it fair to say that the growth in ATG will be driven by, before we get the Qflix and the rollout of Blu-Ray?

Paul F. Norris

I think again we’re looking at kind of some lumpy, [inaudible] deals tend to be in the works for a while, so I think if you are looking at a one quarter time frame, it’s a bit hard to say but those are the general factors that we are looking at and we are expecting that it will be trending upward.

David C. Habiger

I think if you look at the difference year-on-year, the big difference here is Blu-Ray. So if you are looking for the trendline that’s driving that increase in addition to the lumpiness, we obviously have talked about that in the past. That business tends to be lumpy. Blu-Ray certainly is probably one of the main catalysts.

Ralph Schackart - William Blair

Great, Dave, and as long as you are on the line, can you give us a little bit more color on the Dell impact for the next quarter and is this a one-time sort of blip and will it return back after the next quarter?

David C. Habiger

Our [indication] is it’s a one-time blip and we are not anticipating that we are going to see that kind of a dramatic number next quarter or the following quarters. This was really part of a normal refresh cycle at Dell where we transitioned a number of programs and new products, and frankly given some of the ongoing organizational changes at Dell, they had some missteps in launching our programs, products, and initiatives. However, at this point we believe everything is back on track.

Ralph Schackart - William Blair

Okay, great, and one last one, if I could -- and by the way, your release just hit the wires -- on the OpEx, it was higher than we were anticipating next quarter. I think given some of the prior comments that you had given, was that just a one-time integration issue and should OpEx work down to a $25 million run-rate exiting fiscal ’09?

Paul F. Norris

I think that’s right. I mean, we’re looking at the Simple Star acquisition and some of the resources we’ve got on the Qflix initiative, but we are going to see it trending down towards a -- by the end of the year towards a $25 million range.

David C. Habiger

Yeah, we’re still targeting that. I think we are on track on the -- the core business is, we’ve been getting those numbers in line and down, you know, excluding some of the acquisition stuff, so it’s going in the right direction.

Ralph Schackart - William Blair

Great. One last one and I’ll turn it over; I guess I’ll ask the economy question, Dave. In the business, are you seeing an effect for the Roxio, particularly the brick-and-mortar business at this point?

David C. Habiger

You know, not -- look, I don’t think the economy is that -- it certainly would be better if we were in a great economy, but it’s not -- we’re not seeing it really drive our business. Certainly the rise and use of digital media far outweighs the economic pressure that the market may or may not feel relative to recessionary environments, so in general I would say that we are probably impacted a lot less than heavy industry and durable goods. How’s that?

Ralph Schackart - William Blair

Okay. Thanks, Dave.

Operator

We’ll go next to Mike Olson with Piper Jaffray.

Mike Olson - Piper Jaffray

Thanks. Good afternoon. That was a lot of the questions I had but I’ll just dig in a little bit more on the bookings. I guess how does this compare, the ramp so far on the pro side, how does it compare to what we saw in the pro business and where in the early stages of the standard def upgrade cycle?

David C. Habiger

It’s similar -- I would probably qualify it as a little more dramatic and if you pushed me as to why, I’d suggest that with standard def, we had a much more linear growth curve that the business didn’t -- you know, you didn’t have a format war the way you do now, and so I think we are feeling the format war after effects, which is pent-up demand and people that were waiting for it then have decided to get moving and order systems. So it’s slightly more dramatic and that’s a good thing.

Mike Olson - Piper Jaffray

Okay, and then on Qflix, you mentioned OEM partner by the end of this summer. Are you thinking that’s where we see Qflix first or where do we see it first? And then what’s the biggest component for Qflix out of kind of the three buckets of Qflix potential revenue that you’ve talked about? What’s the biggest component for fiscal ’09?

David C. Habiger

Well, let’s see -- I’m happy with our projections. You know, I look over the last year and our comments on Qflix and its always challenging to predict markets in our business and technology shifts, but we’ve I think done a very good job relative to Qflix, so I think you can look back the last year and almost everything we said, we continue to reiterate. The summer to fall is when we suggested you’d start to see real product in the market and we believe you still will see real viable products that consumers can go buy and use in the summer and fall, so none of that’s changed. And the hurdles that we identified over the last year-and-a-half or two years continue to be addressed and we are moving forward.

So yes, you should expect to see some products from OEMs and other offerings and which I think I’m going to punt, Mike, on the which of the three businesses will be most successful, will drive the most revenue, is the three businesses being MOD, you know, the online consumer market and back office or kiosk market. I just am a little uncomfortable trying to predict which one relative to the other is going to do better or worse. We still absolutely believe all those will have -- dramatically change the way media is distributed and we anticipate that we’ll play a pretty important role in it.

Mike Olson - Piper Jaffray

Okay, but it sounds like you are saying maybe that the -- it won’t be the MOD or the kiosk that we see revenue in first. It will more be likely the OEM partnerships. Is that fair to say or no?

David C. Habiger

No, I don’ think I’m saying that. I want to be careful there. I think that we’ve -- I would stick to our current statements. I don’t think we’re pointing to one or the other as being first or more significant relative to revenue. You may see one or any of those three in the market first or be able to use the product or service or buy the products or service before one or the other. That being said, I’m not sure that whichever you use first is indicative of which will drive most of the revenue or the first revenue stream. They are all going to be really launching it very, very close to one another and I don’t want -- I just don’t want people to look and see and try and model out whichever hits the street first. I just don’t think that will be a good methodology.

Mike Olson - Piper Jaffray

Okay, and then just one last one -- can you tell us what the percent of revenue from Dell was in the quarter?

David C. Habiger

Yeah. Paul.

Paul F. Norris

The Dell revenue was 30% for the quarter.

Mike Olson - Piper Jaffray

Okay. Thanks a lot.

Operator

We’ll go next to Steven Frankel with Canaccord Adams.

Steven Frankel - Canaccord Adams

Good afternoon. Dave, could you give us an update on your drive partners for Qflix? How many of the majors have you signed and what should we look forward to between now and the end of the year?

David C. Habiger

We have -- well, I think we’ve given -- we’ve had press releases on some of the majors. You can expect to hear about others as the summer rolls out and what percentage -- I think if you just took the people that we’ve announced, they are the biggest players in the market, so I don’t know what their market share is but I think you’d find it’s significant market share that they make up.

Again, I don’t -- I guess what I’m suggesting is you should expect to see more announcements as people launch product over the course of the summer.

Mark Ely

One thing I can add to that, Steve, is that fundamentally the drive market from a technology standpoint starts with the chip controllers that go into the devices and we’ve got a very good relationship there with [ETEC], who are effectively building out the chipsets for a massive chunk of the drives that are going out, both standard def and Blu-Ray combo drives. And in fact, from a technology roadmap perspective, the core enabling technologies that support Qflix are being adopted by the broadest -- they have a broad range of the OEM drive suppliers.

So as Dave mentioned at this point, we are in the process of essentially signing them up and I think you should expect some more public announcements about those sign-ups when they happen over the next quarter or two.

Steven Frankel - Canaccord Adams

And when should we expect OEM PCs to ship that are Qflix enabled?

David C. Habiger

We haven’t given out timeframes for when you can expect PC OEMs to ship.

Steven Frankel - Canaccord Adams

Okay. Could you size for me what NEC’s PC business is in Japan, kind of what market share do they have?

David C. Habiger

I believe in Japan they have there -- I believe that they have the number one position. I can’t reference the source but I’m -- put that in the 90% category.

Steven Frankel - Canaccord Adams

And what do you do differently with Dell going forward to avoid the June quarter incident? Is it different programs or better coordination? What changes?

David C. Habiger

Well, you know, we are always evaluating and trying to make adjustments so that we can accurately predict and model those businesses. The things that change and the things that I think we are encouraged by is that we continue to go deeper and deeper into Dell and a lot of our OEMs as to how we power the PCs, so we are going to continue to build new offerings and broaden the products and work to make sure they execute on their end of the deal. But nothing specifically I can point to but I would certainly suggest that as the relationships continue to strengthen, we are their apple. The Roxio brand is certainly the digital media software that powers the PC space, so we’ve come -- we continue to remain an important partner and they will work with us to try to make sure these kinds of things don’t happen.

Steven Frankel - Canaccord Adams

Okay, and for Paul, what was cash flow from operations in the quarter?

Paul F. Norris

Let’s see, we were -- let me just check. I’m not sure if I have that handy -- $1.7 million.

Steven Frankel - Canaccord Adams

Thank you.

Operator

We’ll go next to Alan Davis with D.A. Davidson.

Alan Davis - D.A. Davidson & Co.

Just one question here -- I wonder if you can share with us kind of what’s embedded in your expectations in the back-half of the year in terms of Blu-Ray with your PC OEM business, in terms of how -- to what extent will Blu-Ray read-write drives appear on PCs in the back-half of the year for you guys versus just read only? And maybe size the opportunity, read only versus read-write?

David C. Habiger

You know, there’s a lot of numbers out there on that and I think that we would probably point you to some of the different analysts and projections out there. I mean, it’s really -- when we look at the internal numbers and plans from the PC OEMs, they are expecting pretty aggressive switchover, and I expect that they will -- they are working quickly to move to BD and Blu-Ray drives across the board.

But that being said, that’s their internal plans and I think that there’s plenty of people out there who are providing models. That’s probably a better place to look. I’m not sure we’re comfortable giving out our internal projections on that just yet.

Alan Davis - D.A. Davidson & Co.

Okay, I guess then maybe more generally -- how would you characterize what it takes to get you to the 20% operating margin, $7 million in EBITDA that you are projecting for the fourth quarter?

David C. Habiger

Well, I think we need to continue executing on the existing business. We’ve got to see a couple of our new initiatives kick in and certainly to your point on the Blu-Ray drives business, we need to see the adoption rate continue at a nice strong rate and Blu-Ray still plays an important role in all of this.

Alan Davis - D.A. Davidson & Co.

Okay, I guess one last one I’ll throw in here -- internationally, I guess, how much is international expansion a part of the growth plan over the next year or two?

David C. Habiger

I don’t think we can give you an exact dollar amount but it’s certainly -- growing internationally is important. The digital media universe and growth rates outside of the U.S. I think are certainly larger than within the U.S., so our footprint around the globe is bigger than it has been in the past, both from a marketing and engineering perspective. So as we look to and we rely on our third-party hardware manufacturers from cell phones to PCs to cameras, their models show the same kinds of things that we’d expect, which is that more and more people in emerging markets are going to begin consuming and sharing and manipulating digital media. So one way or another, that will flow through to our revenue stream and we expect those markets to grow.

Alan Davis - D.A. Davidson & Co.

Okay, and do you have a sense where you stand right now, international end users versus a year ago, as a percentage of revenues?

David C. Habiger

Well, it always gets a little tricky because when we break out revenues, you’re looking at -- for example, at Dell, revenue shows up as U.S. revenue, although we obviously are aware a lot of Dell PCs are shipped outside of the U.S. So we certainly see from registrations and the data we track that the markets outside of the U.S. are probably -- non-U.S. markets are growing at a faster rate than U.S. markets, but the U.S. market is still certainly the largest.

I don’t think we can -- I’m not sure I can give you an exact non-U.S. average growth rate that I’d be comfortable with, or at least giving out in a public forum.

Alan Davis - D.A. Davidson & Co.

All right, fair enough. Thank you.

Paul F. Norris

I just wanted to jump in with one clarification on the cash flow number I gave out earlier -- that $1.7 million is actually what we used during the quarter and that’s driven primarily by the uMedia acquisition and the one-time stock option costs. And if, on the other hand, if you look at our pro forma EBITDA number for the quarter, that’s $3.9 million.

Operator

And our next question will come from Paul Coster with J.P. Morgan.

Analyst for Paul Coster - J.P. Morgan

This is actually [Sandeep Madore] on behalf of Paul. Just really quickly I guess on Blu-Ray -- so you’re seeing the Blu-Ray ramp accelerating; you’re seeing accelerating revenues from that but how do we reconcile that with the revenue recognition change that you had?

Paul F. Norris

Well, on the pro side, I think you’ve already seen our revenue actually going up that we recognized in the pro group. And we are in general recognizing revenue ratably, so I think that’s why we’re expecting as the impact of Blu-Ray continues to help out that group, you are going to see it gradually going up through the course of the year.

Analyst for Paul Coster - J.P. Morgan

Okay. And then what I guess is -- did you have some sort of a long-term business model in terms of gross margins, operating margins we should think of? And I think you mentioned 20% in operating margins, but anything on gross?

Paul F. Norris

Well, I think on gross margins, we’ve indicated that those should improve through the year and we are continuing by the end of the year to target 80%.

David C. Habiger

That’s generally back to our historical trend, which was 80% gross margins.

Analyst for Paul Coster - J.P. Morgan

Okay. Thank you.

Operator

(Operator Instructions) We’ll go next to Mark Babka with Eagle Boston.

Mark B. Babka - Eagle Boston

I’ve got a couple of questions; so with 20% operating margin and $25 million in operating expenses by the end of the year, that implies a gross -- total revenues $39 million to $40 million by the back-half of the year. Is that correct? And can you kind of walk through the contributors to that? And sort of to help get there, what was the basis of pro revenue? Meaning what was pro revenue last quarter, so I understand what the 30% bookings growth was?

David C. Habiger

First off, we haven’t given exact numbers yet and I’ll let Paul kind of walk you through some of the guidance but I think you’re -- I’ll touch upon some of the growth initiatives that require us -- that need to happen for us to make those numbers. Certainly Blu-Ray needs to continue to be a successful format and so far, all indications are that it will be, in both the consumer business, as well as in the professional business. We need to execute. We can’t -- we need to build good products and deliver professional tools that the market wants to use and likes and so far, we’ve been very encouraged by what we’ve seen and I think our customers are happy and we’re seeing little competition there at the moment.

We’ve got multiple new initiatives that I think we’re going to have to see continue to drive our e-tail business, the mobile phone sales and use of digital media on mobile phones certainly is a trend that needs to continue for people like RIM and Motorola to see value in our software. And again, all indications are that that’s a trend that is going to continue going forward.

And finally, I think as you listen to our prepared remarks, you’ll hear that in general, the PC OEMs, and including Apple, are certainly looking at a cloud based media management world where their PCs and their devices that connect to those PCs are moving digital media around and managing it and we will -- we’ve got to execute on delivering good products that will continue to drive that OEM business and leverage our $350 million Roxio users.

So those are really the key trends. Now, there -- we’d also expect later in the year, and I think we’ve given some indication of that, that we’ll -- you know, we’re confident and hopeful that Qflix will continue to move forward and there will be some revenue stream derived from that as well. But I think that that’s really not something we expect to see the needle moving revenue until, as we said in the past, the later part of the year.

Paul F. Norris

And I second what Dave says and I would add that I think your assumptions there strike me as relatively reasonable. We haven’t really given out a guidance, the sort of sub-component of it, but I think if you are looking at the margins and improving profitability, you can also think about our -- the increasing strength of our e-tail business and just generally, once we start generating some more revenue relative to our costs. You are going to see some improvement in that area.

Mark B. Babka - Eagle Boston

You also said $7 million in EBITDA, is that right?

Paul F. Norris

Yeah, by the -- I think by the fourth quarter of our fiscal year, that’s what we’re looking for.

Mark B. Babka - Eagle Boston

Well, if the numbers work out, $39 million or $40 million in revenue at a 20% operating margin would be $7.5 million, $8 million in operating profit, there should be some addition to that in terms of -- to achieve an EBITDA number. Where’s the discrepancy there?

David C. Habiger

I’m not sure if we’re following. Can you -- the discrepancy on --

Mark B. Babka - Eagle Boston

Well, you’re saying $7 million in EBITDA, right? With a 25% operating margin -- or a 20% operating margin, and $25 million in OpEx. So that would imply somewhere $39 million to $40 million in revenue.

Paul F. Norris

I think that’s -- as I said, I think your --

Mark B. Babka - Eagle Boston

On a quarterly basis.

Paul F. Norris

I think, as I indicated, I don’t know if there’s a discrepancy. I think your --

Mark B. Babka - Eagle Boston

Well, it sounds like you are setting the bar low in terms of EBITDA guidance because that would imply a higher number, if you are going to go for the 20% operating margin.

David C. Habiger

Well again, I think that what you are hearing is since we haven’t given out -- you know, that’s one of the reasons why we don’t have -- we’re not giving out specific guidance for that part of the future, and that any of those numbers that you want to change or manipulate could go up or down accordingly. It just isn’t something that at this stage, we’re going to feel comfortable giving out guidance on.

Mark B. Babka - Eagle Boston

Okay, but you’ve given enough to get pretty close, right?

Paul F. Norris

That’s what we’re targeting for.

David C. Habiger

Yeah, we’re trying to give you enough -- as best as we can understand our business, which clearly is volatile and -- both on the upside and as well as you can see from our guidance next quarter on the downside. We are doing our best to give you metrics you can use and look forward to to help model out nine months from now a technology business that is always changing but fortunately growing.

Mark B. Babka - Eagle Boston

So in terms of the new pro revenue recognition, obviously that’s on an annual -- well, it’s on a ratable basis compared to up-front, as previous. So really to get sort of to the full impact of pro as compared to past cycles, it really is going to take sort of a full year from now, correct?

Paul F. Norris

I think that’s right if you look at today as the first day you’re -- I mean, we’ve been in this revenue recognition mode with pro for some time now but it does take a year for you to get the full impact of a transaction we do today.

Mark B. Babka - Eagle Boston

Yeah, that’s irrelevant until you actually get revenues to ramp, right?

Paul F. Norris

That’s right.

Mark B. Babka - Eagle Boston

Okay. I mean, bookings to ramp. All right. Thank you.

Operator

And at this time, there appear to be no further questions. I would like to turn the conference back over to management for any additional or closing comments.

David C. Habiger

Thank you very much and thanks to the Sonic employees for working hard and helping us build the business. I look forward to speaking with you next quarter.

Operator

And again, that does conclude today’s conference call. Thank you for your participation. You may disconnect at this time.

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