Sonic Solutions Inc. F1Q09 (Qtr End 06/30/08) Earnings Call Transcript

Sonic Solutions Inc. (SNIC)

F1Q09 (Qtr End 06/30/08) Earnings Call Transcript

August 12, 2008 4:30 pm ET

Executives

Nils Erdmann – VP, IR

Dave Habiger – President and CEO

Paul Norris – Interim CFO, EVP and General Counsel

Analyst

Ralph Schackart – William Blair

Alan Davis – D.A. Davidson & Co.

Sandeep Madhavan – JP Morgan

Presentation

Operator

Thank you for standing by and welcome everyone to the Sonic Solutions fiscal year 2009 first quarter earnings conference call. Today’s call is being recorded and will last approximately 60 minutes. Now at this time for opening remarks and introductions, I would like to turn the program over to Nils Erdmann, Vice President of Investor Relations. Mr. Erdmann, you may begin.

Nils Erdmann

Good afternoon and thank you for joining Sonic Solutions earnings conference call for the fiscal 2009 first quarter ended June 30, 2008. With me on today’s call are Dave Habiger, President and Chief Executive Officer and Paul Norris, EVP, acting Chief Financial Officer and General Counsel. Before I hand the call over to Dave, I’ll review our Safe Harbor statement.

During the course of this call, we may 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, 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 high definition Blu-Ray format and the download and burn and online services business models.

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. In addition unless otherwise noted we will present financial information on a non-GAAP basis. These non-GAAP measures should be considered a supplemental to and substitute for or superior to the corresponding measure calculated in accordance with GAAP.

While we believe that the non-GAAP measures provide information that is useful to investors we recommend a careful review of the reconciliation between GAAP and non-GAAP measure provided in today’s press release and to refer to the detailed disclosures related to the purpose of and limitations on non-GAAP disclosures. We ask that you review these cautionary statements and refer to the company’s recent fillings on Form 10-K and 10-Q for a more detailed discussion of the relevant risks and uncertainties.

Sonic Solutions undertakes no obligations to review our update any forward-looking statements. With that, I’d now like to introduce Dave Habiger.

Dave Habiger

Thanks, Nils. Good afternoon everyone and thank you for joining us today. I’d like to start by providing a couple of financial highlights from the quarter, followed by a discussion of the major announcements and key trends we’re noting across our divisions. I’ll then turn the call over to Paul for a discussion of our first quarter financial results as well as our outlook for the fiscal 2009 second quarter and beyond.

For first quarter fiscal ’09, our revenues were over $30 million, which was ahead of expectations and exceeded our guidance of $29 million or more. During the quarter we experienced dramatic year-over-year growth of 120% in our professional products group with sales in Blu-Ray titles up 300% this year already. It’s not surprising that Hollywood is now getting ready to deliver large quantities of new titles for Christmas 2008.

Our Roxio consumer sales showed continued strength and momentum this quarter with strong double-digit year-over-year growth from our retail channel up 30% and our direct eStore channel up 20%. In fact for the six months ended June 30, Roxio products took share from competitors as retailers re-committed to our top selling brands.

On a dollar basis, Roxio products have nearly 50% market share in North America, well over twice that of our nearest competitor and six times that of the third largest. If not for a shortfall in Dell revenue in the first quarter, our consumer segment overall would have shown significant growth and let me remind you, as we’ve discussed previously, we believe we have addressed Dell shortfall and we are moving some of our products with Dell to bundling arrangements that closely mirrors our original highly successful upsell model.

We are well positioned to achieve our two overwriting company goals for the fiscal 2009. Our first goal is to move Sonic to significant profitability and cash generation by the end of the fiscal year. We are convinced that with our product line-up and global organization, Sonic has the capability to be highly profitable. We took important steps this past quarter to reduce the operating expense to be in line with near-term revenues. Over the remainder of this year as we better align cost with revenues, we expect to operate solidly in the black.

Our second and perhaps more important goal is to restore Sonic’s traditional revenue growth rate, measured in double-digit. In this regard, a number of our investments and related industry trends are beginning to positively impact our business. Blu-ray is gaining market attraction as the next generation DVD format. Digital distribution of software is thriving and an increasing number of people are looking for branded, trusted software solutions in our online services to enhance their digital life.

To seize this opportunity, we completed the acquisition of Simple Star creative online photo sharing destination photo show. With Simple Star onboard, we dramatically accelerated our deployment of branded online services and I’m pleased to report that yesterday we launched Roxio online a new web service that enables the creation of personalized multimedia slideshows that can be shared on PCs, DVDs, TVs, handhelds and websites.

Roxio Online is distributed broadly through networks 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. It is clear to us that from Hollywood to Home, digital media is a growing sector and based on first quarter results Sonic is extremely well positioned to leverage its brand and technology to scale revenue and drive business across our division.

At this point I’m going to hand it over to Paul, who will talk about our financial highlights. Paul?

Paul Norris

Thank you, Dave. As Nil mentioned, for purposes of my discussion of our financial results and outlook unless otherwise indicated, the numbers I’m providing are on a non-GAAP basis and exclude equity compensation charges, the amortization of acquired intangible, restructuring charges and costs associated with our voluntary stock option review. A reconciliation on our GAAP and non-GAAP financials can be found in today’s earnings press release.

Our net revenue for the quarter was $30.1 million, breakeven with the first quarter of fiscal year 2008. This was above our guidance of $29 million and more with the increase primarily due to strong licensing sales from our advanced technology group and retail sale. Consumer revenue for the quarter was $27.6 million down slightly from $29 million reported a year-ago due largely to the Dell issues that David has discussed.

This was offset in part by an increase in retail revenue attributable to the highly successful launch of Toast 9 as well as our generally strong retail position. Combined e-tail and brick-and-mortar retail sales were up 23% year-over-year and 7% over the prior quarter, which is seasonally very strong.

Licensing revenue from our advanced technology group, a component of our consumer revenue totaled $3.9 million for the quarter up from $2.7 million in the prior quarter and in excess of our guidance of nearly $3 million. While we’re pleased with this outcome and continue with our positive expectations for ATG as Blu-Ray technology ramps up; as we said before our revenue in this area can vary significantly from quarter-to-quarter.

ATG group generated $2.5 million in revenue during the quarter, up 36% from the last quarter. This continued the upward March that we have anticipated from the Blu-Ray format as it gained traction. Excluding approximately $1.2 million in amortization of acquired intangible, our pro forma gross margin was 78.4%, an improvement from 77.8% in the June quarter year ago and approaching our FY ’09 year end target of 80%.

Pro forma operating expenses totaled $27.2 million for the quarter inline with our guidance. As we’ve noted before, we expect to benefit from an increasing operational efficiency as our fiscal progresses and anticipate that our pro forma operating expenses may dip below $25 million by fiscal year end.

Our first quarter 2009 GAAP operating expenses breakdown as follows; sales and marketing expenses totaled $9.8 million up 14% from $8.6 million reported in the first quarter of 2008. Research and development cost totaled $11.7 million, flat year-over-year.

General and administrative cost totaled $6.7 million up 11% from the $6 million reported in the first quarter of 2008. December’s includes $597,000 in depreciation; $464,000 related to the stock option review project, $521,000 in share based compensation and $1.3 million in restructuring charges related to the headcount reduction we announced at the end of June.

Other expenses for the quarter, consisting primarily of net interest on our outstanding debt were roughly $133,000 with the expense reflecting the interest rate differentials as we transferred funds into safer investment vehicle. At the end of the quarter, we had approximately $26.4 million basic shares outstanding or $27.2 million on a fully diluted basis. On a pro forma basis in assuming a 40% effective tax rate, we had a net loss of $2.3 million or $0.09 per share.

Turning to our balance sheet, cash, restricted cash, cash equivalents and short-term investments ended the quarter at $54.3 million, down from $63.5 million at the end of the prior quarter. The decrease is due primarily to the Simple Star acquisition, cash used in operations and the options review. Our bank debt outstanding at June 30 was $20 million unchanged from March 31.

Turning now to guidance; for our second quarter ending September 30, we forecast revenues of $30 million and more. Seasonally the second quarter is a lower revenue quarter for both us and our OEM partners. In addition while we remain generally bullish about our advanced technology revenue due to some of the lumpiness that we’ve described we expect ATG revenue in September to be roughly $2 million. These factors should be offsetting in part by our launch of the Creator 2009 in September.

We estimate that cost of goods sold for the second quarter excluding the amortization of intangible will be up due to the Creator launch lowering gross margins slightly to 76% to 77%. By contrast, operating expenses should be down sequentially from the first quarter due largely the cost savings recognized from the headcount reduction that we announced in June.

Total non-GAAP OpEx is expected to decrease to around $25.5 million resulting in a net loss for the quarter of approximately $1.3 million or $0.05 per share. For the second half of fiscal 2009, we continue to expect the adoption of the Blu-Ray format to positively impact sales in our PPG and ATG divisions.

Our consumer software business should benefit from new product launches this fall. In addition, the development of our online services offerings should give us the opportunity to leverage our installed base and cross promote and up-sell our premium line of products. We will also look to leverage our online services offering to new and existing OEM partners.

We expect our investments in Qflix to begin generating meaningful revenue in the later part of fiscal 2009. In summary, we believe that we’ll become profitable in the second half of FY ’09 and that by the fourth quarter operating margins should approach 20% and we should be generating at least $7 million in EBITDA assuming favorable condition.

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

Dave Habiger

Thanks, Paul. Strategically, we are focused on digital media as it relates to both Hollywood content production and home content experiences by unique products and technologies book end the digital media value chain. At one end leveraging our deep connections to content community and at the other optimizing our connection to the 100’s of millions of Roxio users both on the desktop and now online.

One great example of this is Blu-Ray. The offering technology we developed for Hollywood is now available in our Roxio consumer products and in the software development kits we licensed to set top player manufactures. As Blu-Ray continues its adoption by consumers, we will see a continued list across all of our businesses.

Another example is Qflix. Three years ago we noticed that while consumers were moving toward digital downloads they still preferred to playback movies in the living room on DVDs. Recognizing this of a scalable business opportunity, we leveraged our Hollywood connections, deep format knowledge and Roxio engineering and distribution expertise to create Qflix.

One of the biggest recent advances this quarter with Qflix was the decision by our partner Amazon to move from beta test of our technology into forward option with its offering of HBO documentaries and specials that can purchased online and burnt on-demand using Qflix.

We expect other HBO and Cinema titles to follow in the coming months with other studios joining to take advantage of the superior economics of managing content digitally and delivering to DVD just in time. This represents a major step floor for Qflix and positions our technology for continued growth and demand for a downloading and burn solution.

Qflix is quickly becoming a reality for at home usage with a major PC manufacture expected to make the first consumer Qflix drives available to consumers as early as next week. Consumers will be able to download their favorite Hollywood hits and burn them to DVD for playback on any standards DVD player. Stay tune for this announcement next week and look for other brand name PC manufacturers to follow.

Our DVD on demand solutions are beginning to gain traction in other areas of the market as well as with our key house partners making straight that bringing in-store devices to market. After a multi year effort here Sonic’s we are excited to finally Qflix drive available to consumers.

On the consumer front our outlook for Roxio remains bullish and as newer versions our flagship software released this summer which is tied to our new Roxio online web services, we are looking forward to introducing millions of Roxio creator users to Roxio online reigniting our consumer business. With Roxio online we are dramatically expanding the influence and reach of our Roxio brands product line. Simultaneously, we are enhancing our revenue mix with the subscription based offering. Lastly and perhaps most importantly we are creating another opportunity to engage and stay connected with our customers while gaining access to a new category of online video consumer.

The benefits of Roxio online also carryover to our OEM business, until now our strategy has been to connect Sonic’s broad OEM distribution to Roxio strong retail brand to drive downstream retail and direct revenue. Going forward we believe that this will fundamentally shift with desktop applications being dramatically enhanced by online digital media services.

Digital media consumers want easy, instantaneous and universal access to their personal content on any connected devices whether it’s a PC, a phone, a cart or a TV, and it is true, it isn’t locked on our OEM partners. By time platform enhancing software with our online web services, Roxio is one of the few companies that can offer a PC manufacturing level of fit and finished that today's has only been seen at Apple.

Roxio’s machine is to deliver that experience and by doing so we believe Roxio products and services will be a must have for all PC OEMs. The remainder of fiscal 2009 has a lot in store for Sonic, but our long-term initiatives starting to bear fruit, Sonic should again start to exhibit a growing revenue line as we approach year end. At the same time, by taking full advantage of our global reach and organization, we should be able to operate with increasing efficiency. Generating profit and cash their wide spreading new opportunities for our company.

Before we sign off, I would like to thank our stakeholders, shareholders, employees, customers and partners for their ongoing commitments to Sonic Solutions, and at this point, we will open the line for questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Our first question this afternoon will come from Ralph Schackart, with William Blair.

Ralph Schackart – William Blair

Hey good afternoon guys.

Dave Habiger

Yes

Ralph Schackart – William Blair

Couple of questions if I could, Dave I’ll start with you, if you don’t mind. In our prepared remarks on Qflix, just want to get a little bit more color. I think you’d mentioned perhaps that there were other studious looking to sort of authorize Qflix service or technologies, will that just be on Amazon, or with of the other channels for the MOD?

Dave Habiger

Hi Rob, there will be other channels for the MOD, you will see a lot of studious next week, obviously in the prepared remarks we’ve referred to one of our larger customers who will be launching their drives next week. So, in that you’ll also see most of the major studios that you can image that you’d expect to see, when you purchase a movie.

Ralph Schackart – William Blair

And then…

Dave Habiger

So, they now are video both MOD and kiosk.

Ralph Schackart – William Blair

And then in terms of the services, will there also be a service announcements or where they just essentially turn on the CSS key through the online services that exist today?

Dave Habiger

The services are handled through, we were obviously handling the key servers, so the end-user will ultimately not see any of that, in all those models you’ll see that the key server and the, think of it as the CSS handshake will flow through Sonic and we’ll handle that part of transaction.

Ralph Schackart – William Blair

Okay, that’s helpful and then in terms of the linearity and the ramps of profitability, how should we think about that from modeling purposes, we’ll Q2 obviously is going to be anther sort of down quarter, will that start to ramp in Q3 and Q4 or will we get a big step function in Q4?

Paul Norris

I think we’re going to see it sort of gradually deepen throughout Q3 and then you’re right, you’re going to see the bigger impact in Q4.

Ralph Schackart – William Blair

Okay, great and then in terms of the pro group, I think you had talked about ATG being down next quarter, but should we continue to see the pro group grow quarter-over-quarter going forward?

Paul Norris

Yes, I think you should see the pro group continue to ramp up in more or less the smooth way over the next few quarters in part again because of the way we recognize revenue with the pro group.

Ralph Schackart – William Blair

Right, and then in terms of the pro group can you sort of talk about high levels of pricing trends there as obviously Blu-Ray starting to rollout in the market?

Paul Norris

Yes, Dave you might, jump in on that one.

Dave Habiger

Sure, yes I think the pricing trend, Ralph mostly I guess there is the consumer pricing trend, which obviously we’d anticipate will start to drop, so we expect obviously that the DVD players at retail will be lower two months from now and lower again two months after that. Regarding our professional tool, we haven't seen any price erosion there given our positions and I think our well there into position in this particular space. So, I will anticipate the near-term any price erosion to our ASPs of that professional tools.

Ralph Schackart – William Blair

Great, one last one and I’ll turn it over. It seems like all of the heavy lifting you guys have done is starting the line up finally congrats on that, just in terms of the risks for Q4 and this steep sort of ramp to profitability, what’s the biggest risk at this point, now that the cycle starting to rollout, Qflix is starting to rollout in you opinion?

Dave Habiger

I think the risks are the consumer behavior around digital media and new technology. We’re always exposed in a market to, the potential people stick with traditional buying patterns, and they don’t buy much digital media online or through new channel, I think that’s ultimately were we are exposed and we’re currently optimistic, because we’ve see key ops becoming more what's more acceptable, we see distribution of contents and digital form in outline being much more accepted, but ultimately those are the drivers right, the drivers going to be Blu-Ray and the consumption of online content and ESE forming the ways that we have historically seen as retail market.

Ralph Schackart – William Blair

Right.

Dave Habiger

There is the risk, there is the same thing that makes us optimistic. We certainly think that may drive our business and may impact us negatively if it doesn’t continue.

Ralph Schackart – William Blair

I just want to clarify one last point Dave in your prepared remarks, you said that there will be potentially a major PC manufacturer within us next week, and potentially more to follow, Qfilx?

Dave Habiger

Correct, we did say in our last call just to clarify, by now you would have seen a major player bringing a product to market, that was Amazon, and so that’s taking place, and why I’m specifically saying is next week, you should be able to purchase as a consumer from a major PC manufacturer, Qflix drives. So, as we’re very close to next lag of Qflix at the consumer level.

Ralph Schackart – William Blair

Great. Thank you.

Dave Habiger

You’re welcome, thanks.

Operator

(Operator instructions) and we go next to Alan Davis, with D.A. Davidson

Alan Davis – D.A. Davidson & Co.

Hi, yes good afternoon just a couple of questions here. First I was wondering if you could just give us some more inside into the new arrangement we Dell, the new bundling arrangements, and how that’s going to give you the same or similar result with the shared revenue arrangement and will it be in place for the entire second quarter?

Dave Habiger

We always had a lot of moving parts and arrangements with our OEM so, with Dell there is multiple new initiatives, existing initiative and I want to make sure that you don’t just kind of think there is one particular model. We certainly, as we said in our prepared remarks believe we’ve addressed the Dell shortfall by moving some of our products with Dell to a bundling arrangement that's closely mere as our original have a successful up sell model.

Alan Davis – D.A. Davidson & Co.

Okay, fair enough and just more of an update on the download-and-burn on the kiosk model. There is story out there that Walgreens pushing out there, they roll out to next year just wanted to get an upside I guess, some more inside to that and just in general on the kiosk?

Dave Habiger

Sure, I missed the first part, what was it there was a rumor…

Alan Davis – D.A. Davidson & Co.

Some stories about Walgreens pushing out their plans, I guess in the wake of title match demise pushing out their plans till next year?

Dave Habiger

As far as the retail kiosk space we have no doubt that Qflix can significantly increase TV sell through at retail, while we can’t comment directly on a plan for our partners. We continue to be engaged with major retail partners like Walgreens and a variety of the kiosk manufacturers that are looking to bring Qflix to market but it should really not our place to talk about their, there plans in a roll out.

Alan Davis – D.A. Davidson & Co.

Okay, I guess, I’ll rephrase in another way. Have your expectations there from the revenue perspective changed in all in terms of timing?

Dave Habiger

No, they have not. The expectations if you look at where we thought us where nine months ago, two year ago and what we have communicated to the market we are both on execution of product deal terms market penetration revenue we are very, very close to plan and certainly haven’t been anything that changes our outlook on the space at moment.

Paul Norris

Yes, I think we’re feeling pretty good about Qflix right now. It’s a complex ecosystem and there are a lot of different partners, and they are doing different things and there maybe some come out a little bit more slowly and some of them may come out a bit more quickly that we had planned originally and we don’t control all of those factors of course but generally speaking it’s tracking very nicely from our perspective.

Alan Davis – D.A. Davidson & Co.

Okay and the lastly here what would your expect your, I guess usage to be on the second quarter?

Paul Norris

Well, I think that you will see our OpEx as we’ve said going down as we started realizing some of the efficiencies that we’ve talked about before and since the very substantial portion of our cash usage in the last quarter was related to the Simple Star acquisition and some of the tail end expenses associated with the stock options review. I think you will see the cash position dial holding a lot more content than it is in the last quarter and again what we’ve talked about is toward the end of fiscal year ’09 as when we expect to actually have impact were something like focused overtime that’s where we’re looking to really be starting to drive the cash in the positive direction.

Alan Davis – D.A. Davidson & Co.

Okay great, thank you.

Paul Norris

Thanks you.

Operator

(Operator instructions) And we have a question from Paul Coster with JP Morgan.

Sandeep Madhavan – JP Morgan

Hi, this is actually Sandeep Madhavan on behalf of Paul. I just had a couple question; first I guess going back to the Qflix, I think some of the articles that we’ve been reading obviously mentioned the Walgreens PhotoShow, but also it seem like Nero had a kind of a competitive product the use CSS, if you could maybe just comment on that, if you’re really seeing any competition on that side?

Dave Habiger

Yes, there is certainly, we’ve always said that we expect in it’s fate people who will want to use some form of CSS outside of Qflix. I would say we’ve seen a lot less than we anticipated, so I’d like to frankly to see more, and the reason being frankly is that we have IP rights in that area. So, we certainly may not get some of the other benefits of Qflix where we are handling key servers, but we certainly expect IP payments in the area that in CSS IP area. So, I think the short answered to it is we haven’t seen a lot, we’ve seen several and I think we’re, its fair to say we are hopeful that there will be more than just Qflix.

Sandeep Madhavan – JP Morgan

And then I guess going back to the Dell revenue. Assuming that you still had the $3 million short fall, that would mean that you get about 7.5 roughly from Dell in the first quarter. Where do you see that for a year, I mean I guess maybe if you could talk briefly about year-over-year change from Dell and maybe even just kind of your PC OEM revenues, which I guess that include Dell and HP?

Dave Habiger

Well, we’ve got a lot of PC OEMs, so if you would like Sony and Lenovo and some of the other smaller PC manufactures, but we never give guidance on any individual OEM, so that’s certainly not something we’d start doing at this stage. As far as I think if you want to look at our overall OEM business, you could probably model that a little more carefully, but I think that you are going to find that given the unforeseen swing both positive and negative in PC OEMs that we’ve just never been comfortable trying that’s to give a specific guidance on anyone customer.

Sandeep Madhavan – JP Morgan

Okay, and then just lastly. I think last quarter you’d mentioned in the Pro Video Group, bookings were up about 30% sequentially and this year record about 36% sequential growth. Is that a decent metric going forward, and if it is could you give us what the change was in bookings?

Dave Habiger

I actually don’t have the bookings numbers handy, and it wasn’t a bad metric especially at the beginning, when we were transitioning to the new revenue recognition model where you would have new bookings recognized over a near period typically. At this point, we are getting to the stage where we’ve had the new revenue recognition model in place long enough so that I think you can see the profile in the landscape of where the pro business is going vis-à-vis adoption of Blu-Ray from the revenue itself.

Sandeep Madhavan – JP Morgan

Okay, thank you.

Dave Habiger

Thanks, Sandeep.

Operator

And at this time, we have no other questions standing by on our question roster. I’d like to turn the program back to our speakers for additional or closing comments.

Dave Habiger

I'd just like to thank everybody very much.

Paul Norris

Thanks, everyone. We'll rejoin next quarter.

Operator

Thank you everyone for your participation on today’s conference and you may disconnect at this time.

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