Edgar Filing: SONIC SOLUTIONS/CA/

Unassociated Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended March 31, 2010

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 72870

SONIC SOLUTIONS

(Exact name of registrant as specified in its charter)

California		93-0925818
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

7250 Redwood Boulevard, Suite 300 Novato, California		94945
(Address of principal executive offices)		(Zip Code)

415-893-8000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Title of each class		Name of each exchange on which registered
Common Stock, no par value		The Nasdaq Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one).

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

The aggregate market value of Common Stock held by non-affiliates of the registrant (based upon the closing sale price on The Nasdaq Global Select Market on September 30, 2009) was approximately $141.0 million. Shares held by each executive officer, director and by each person who owns 10% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of outstanding shares of the registrant’s Common Stock on June 3, 2010 was 30,636,131.

DOCUMENTS INCORPORATED BY REFERENCE: None

SONIC SOLUTIONS

TABLE OF CONTENTS

PART I		Additional Information	3
		Forward Looking Information	3
	Item 1.	Business	3
	Item 1A.	Risk Factors	9
	Item 1B.	Unresolved Staff Comments	18
	Item 2.	Properties	19
	Item 3.	Legal Proceedings	19
	Item 4.	(Removed and Reserved)	19

PART II	Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	20
	Item 6.	Selected Financial Data	22
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
	Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	39
	Item 8.	Financial Statements and Supplementary Data	40
		Report of Independent Registered Public Accounting Firm	41
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	68
	Item 9A.	Controls and Procedures	68
		Management’s Report on Internal Control Over Financial Reporting	68
	Item 9B.	Other Information	69

PART III	Item 10.	Directors, Executive Officers and Corporate Governance	70
	Item 11.	Executive Compensation	73
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	86
	Item 13.	Certain Relationships and Related Transactions and Director Independence	87
	Item 14.	Principal Accountant Fees and Services	88

PART IV	Item 15.	Exhibits and Financial Statement Schedules	89

PART I

Additional Information

References in this Annual Report on Form 10-K (“Annual Report”) to the “Company,” “Sonic,” “it,” or “its” mean Sonic Solutions together with its subsidiaries, except where the context otherwise requires. Quantities or results referred to as “to date” or “as of this date” mean as of or to March 31, 2010, unless otherwise specifically noted. References to “FY” or “fiscal year” refer to the Company’s fiscal year ending on March 31 of the designated year. For example, “FY 2010” and “fiscal year 2010” each refer to the fiscal year ended March 31, 2010. Other references to “years” mean calendar years. This Annual Report includes references to certain Company trademarks and registered trademarks. Products or service names of other companies mentioned in this Annual Report may be trademarks or registered trademarks of their respective owners.

Forward-Looking Statements

This Annual Report includes forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Important factors that could cause such differences include, but are not limited to: the continuing negative impact of current macroeconomic conditions on consumers and associated impact on their ability and inclination to spend on leisure and entertainment-related activities and related software and electronics; the Company’s ability to adapt to rapid changes in technology and consumer preferences, and to cost-effectively develop and introduce new and enhanced products and services; competitive pressures on the Company’s products and services, both from large established competitors with greater technological and financial resources than the Company possesses, and from smaller companies that are able to compete effectively through low-cost Internet sales of their software products and services; changes in operating results, requirements or business models of the Company’s original equipment manufacturer (“OEM”) or other major customers; the Company’s ability to successfully introduce and profitably run its RoxioNow initiative, a business with which it has had limited experience, which is dependent on third parties for premium content selection and delivery services, and which may give rise to legal exposure and other business risks; expenses and issues associated with qualifying and supporting the Company’s products on multiple computer platforms and in developing products and services designed to comply with industry standards; issues impacting third parties who supply the Company with services and operate its web store, as well as retailers, resellers and distributors of its products and services; risks associated with international operations, including risks related to currency fluctuations, as well as to the Company’s extensive software development work in China; changes in product and service offerings that could cause the Company to defer the recognition of revenue, thereby harming operating results; the Company’s ability to maintain sufficient liquidity and continue to fund capital needs; the loss of key management personnel; risks related to the proposed merger with DivX, Inc. (“DivX”), including (i) the parties may not obtain the requisite shareholder or regulatory approvals for the transaction; (ii) the anticipated benefits of the transaction may not be realized; (iii) the parties may not be able to retain key personnel; (iv) the conditions to the closing of the transaction may not be satisfied or waived; and (v) the impact of general economic conditions on the businesses and results of operations of the two companies; risks related to acquisition and integration of acquired businesses, assets, personnel and systems generally; costs associated with litigation, patent prosecution, intellectual property and other claims; changes in effective tax rates; and earthquakes, natural disasters and other unexpected events. Factors that could cause actual results or conditions to differ from those anticipated by forward-looking statements include those more fully described below under Item 1, “Business,” Item 1A, “Risk Factors,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Annual Report. All forward-looking statements included in this Annual Report are based on information available to the Company as of the date of filing of this Annual Report, and the Company assumes no obligation to revise or publicly release any revision to any such forward-looking statement, except as may otherwise be required by law.

Item 1. Business

General

The Company is a leading developer of products and services that enable the creation, management, and enjoyment of digital media content across a wide variety of technology platforms. The Company’s products and services offer innovative technologies to consumers, OEMs, businesses, high-end professional optical disc authoring experts and developers. The Company distributes its products and services through retailers and distributors, personal computer (“PC”) and consumer electronics (“CE”) OEMs, Internet websites including www.roxio.com, and other channels. The Company also licenses core technology and intellectual property to other software companies and technology manufacturers for integration into their own products and services. Sonic software is intended for use with a wide range of PC and CE operating systems, development environments, and proprietary platforms.

Sonic products and services are used to accomplish a wide variety of tasks, including creating and distributing digital audio and video content in a variety of formats; renting, purchasing and enjoying Hollywood movies and other premium content; producing digital media photo and video shows for sharing online and via television, PCs and CE devices; recording and playback of digital content on DVD, Blu-ray Disc (“BD”), other storage media and portable devices; managing digital media on PCs and CE devices; and backing up and preserving digital information, both to local storage devices and on the Internet.

The Company was incorporated in California in 1986 and completed its initial public offering in 1994. Its principal executive headquarters are located at 7250 Redwood Blvd., Suite 300, Novato, California 94945. Its telephone number is (415) 893-8000, and its corporate web address is www.sonic.com.

Proposed Acquisition of DivX

On June 1, 2010, the Company and DivX entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which DivX and the Company will combine their businesses through the merger of DivX with a newly formed, wholly owned subsidiary of the Company (the “DivX Acquisition”). At the effective time of the DivX Acquisition (the “Effective Time”), each share of DivX common stock issued and outstanding immediately prior to the Effective Time will be converted into the right to receive 0.514 shares of the Company’s common stock and $3.75 in cash. The Merger Agreement contains customary representations, warranties and covenants of the Company and DivX including, among others, covenants (1) to use commercially reasonable efforts to conduct their respective businesses in the ordinary course during the interim period between the execution of the Merger Agreement and consummation of the DivX Acquisition, (2) not to engage in specified types of transactions during such period, and (3) not to solicit proposals relating to alternative business combination transactions or, subject to specified exceptions, enter into discussions or provide confidential information in connection with proposals for alternative business combination transactions.

The Company’s and DivX’s obligations to consummate the DivX Acquisition are subject to the satisfaction or waiver of customary conditions, including (1) requisite approvals of their respective shareholders, (2) the absence of any law or order prohibiting the consummation of the DivX Acquisition, (3) the declaration by the U.S. Securities and Exchange Commission (the “SEC”) of the effectiveness of the registration statement relating to the shares of Sonic Solutions common stock to be issued to DivX stockholders pursuant to the Merger Agreement, (4) the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and (5) the absence of any material adverse effect with respect to either party during the interim period between the execution of the Merger Agreement and consummation of the DivX Acquisition. In addition, each party’s obligation to consummate the DivX Acquisition is subject to other specified customary conditions, including (a) the accuracy of the representations and warranties of the other party, subject to an overall material adverse effect qualification, and (b) material compliance by the other party with its covenants.

The Merger Agreement provides each of the Company and DivX with specified termination rights. If the Merger Agreement is terminated under circumstances specified in the Merger Agreement, DivX will be required to pay the Company a termination fee of $8.35 million. See Item 1A, “Risk Factors” for a discussion of the risks associated with our failure to close the DivX Acquisition and factors that impact our ability to successfully integrate DivX’s operations into our existing business.

Operating Segments

The Company differentiates between digital media content that is created by consumers (sometimes referred to herein as “personal” content) and digital content that is professionally created for mass consumption (sometimes referred to herein as “premium” content). Accordingly, the Company organizes its business into two reportable operating segments targeted at these different forms of content: the “Roxio Consumer Products” segment, which offers products and services related to personal content, and the “Premium Content” segment, which offers products and services related to premium content. These segments reflect the Company’s internal organizational structure, as well as the processes by which management makes operating decisions, allocates resources and assesses performance.

Roxio Consumer Products Segment

The Roxio Consumer Products segment creates software and services that enable consumers to easily create, manage, and share personal digital media content on and across a broad range of connected devices. A wide array of leading technology companies and developers rely on Roxio products, services and technologies to bring innovative digital media functionality to PCs and next-generation CE devices and platforms. The Roxio Consumer Products segment offers products and services under a variety of names, including BackonTrack, Backup MyPC, CinePlayer, Crunch, Easy LP to MP3, Easy VHS to DVD, Just!Burn, MyDVD, MyTV To Go, PhotoShow, PhotoSuite, Popcorn, RecordNow, Roxio Burn, Roxio Copy & Convert, Roxio Creator, Toast, VideoWave, WinOnCD, and others. These products are sold in a number of different versions and languages. The Company distributes these products through various channels, including “bundling” arrangements with OEMs, volume licensing programs, its web store, and third party web-based and “bricks and mortar” retail stores. The Company also markets the core technology that powers Roxio products to other companies who wish to build their own PC software products.

Sales and Distribution; Markets

Most Roxio products are sold in a number of different versions and languages. The Company distributes Roxio products through various channels, including “bundling” arrangements with OEMs, volume licensing programs, its web store, and third party web-based and “bricks and mortar” retail stores. The Company also markets the core technology that powers Roxio products to other companies who wish to build their own PC software products.

OEM Bundling

A primary channel for the Company’s Roxio applications software is the inclusion or “bundling” of the Company’s products with compatible products sold by OEMs. The Company believes that most consumers first become exposed to digital media software when they purchase a new PC or a CE device, such as a mobile phone, and begin to use the software that comes bundled with the PC or CE device. Some of these new users later add to their software capabilities via upgrades or add-ons, in many cases through web transactions or purchases at retail locations.

The Company’s OEM customers include Roxio software as a value-added offering for their customers and often pay the Company a royalty on each copy of the software shipped with their products. Typically the royalty paid is only a small fraction of the retail price for the Company’s software. The Company enters into bundling arrangements because they generate revenue for the Company as well as create a large installed base of customers to whom it can sell upgraded, enhanced or different versions of its products and services. Many of the Company’s bundle deals permit it to capture customer registrations or to invite the customer to click-through to the www.roxio.com web site where it can offer additional products for sale directly.

The Company also has non-traditional bundling programs with some of its OEM customers, under which the Company reduces or eliminates the royalty due to it when a copy of its product is shipped by the OEM. In return the OEM actively promotes the purchase of an enhanced version of the bundled product, either at “point of sale” (that is, the point at which end-user customers purchase a PC or other device) or after point of sale. The resulting revenues are split between the Company and the OEM.

The Company usually does not provide end-user support as part of its bundling arrangements, instead relying on OEMs to support the end-user customers. The Company typically does provide “second line” support to OEMs to back up their “first line” support of the Company’s products to their consumer customers.

The Company maintains an engineering and delivery staff that concentrates on OEMs. OEM customers tend to be very sensitive to product quality and stability, and usually are focused on providing their end-user customers with a simple and trouble-free experience. They often demand significant customization of Roxio products to meet their particular requirements. OEMs, particularly those with high volume businesses, require strict adherence to the release schedules of their product lines.

Volume Licensing

The Company licenses Roxio applications software for use by corporate and institutional organizations on populations of in-house computing devices. In many ways, volume licensing resembles the Company’s OEM business: there is a single point of sale for a large number of copies of its software; the price per copy is usually set at a significant discount from retail price; often a single copy of its software is provided that the volume license customer then replicates for internal deployment. Volume license customers also tend to be highly focused on product quality and stability as well as on a simple and trouble-free user experience.

Web Store

The Company makes its products available through web-based retail sites in North America, Europe and Japan. These retail sites are operated by third party resellers. Under these arrangements, the Company’s reseller partners typically maintain Company-branded sites, provide the infrastructure to handle secure purchase transactions, and deliver the product (whether via web download or physical fulfillment). The Company’s web store sales constituted approximately 23%, 22% and 22% of total net revenues for fiscal years 2010, 2009 and 2008, respectively. For additional information see Note 6, “Significant Customer Information, Segment Reporting and Geographic Information,” to the Consolidated Financial Statements included in this Annual Report.

Retail Channel

The Company distributes Roxio products through a large number of traditional physical retail stores as well as catalog and web stores. The Company promotes its products in the retail channel through a variety of techniques, including rebates, advertising in targeted publications, numerous trade show appearances, web promotions, direct mail and e-mail, press and publicity tours and events. The Company’s retail products are often distributed through distributors. These distributors handle inventory, shipment to particular retail locations, and product returns and stock rotation as required by the Company’s retail resellers.

Technology Licensing

The Company also markets the core technology that powers Roxio products to other companies who wish to build their own PC software products. The Company often markets this technology under the AuthorScript and CinePlayer brand names. The Company packages this software with an “application programmer’s interface”; that is, a software interface that enables other companies’ software engineers to access the Company’s processing technology and easily integrate it with their own software applications. The Company’s technology licenses have a variety of structures: (i) software bundling type arrangements in which it receives a royalty on every unit of its software shipped; (ii) annual or one-time license fees; (iii) custom development work for which the Company receives payment, and (iv) broad development relationships through which the license partner receives source-level access and rights to participate with the Company in one or more of its ongoing development programs.

Manufacturing and Suppliers

The Company outsources the manufacture of its Roxio products for physical delivery through retail and web store channels. HP Software Publishing is currently the Company’s primary supplier providing services such as parts procurement, parts warehousing, product assembly and supply chain services. These services are provided to the Company from two primary HP locations: Andover, Massachusetts, servicing North America; and Galway, Ireland, servicing Europe. Production services and supply chain logistics for Asia and the Pacific Rim are serviced by ModusLink, Taipei. HP and ModusLink are non-exclusive suppliers.

The Company selects its suppliers based on their ability to provide high quality, responsive service, competitive costs and the capacity to scale up volumes as necessary to meet Company’s product launches and seasonality requirements. The Company’s supply chain vendors produce the finished goods, generate the required shipping and receiving documents, and provide return goods documentation and reconciliation services.

Competitive Environment

The market for the Company’s Roxio consumer products and services is very competitive. A number of large and small companies produce video editors, photo editors, backup solutions and other products and services that compete with those of the Company’s. The Company’s digital media products, including optical disc playback, authoring and video editing, are in direct competition for strategic relationships with PC and CE OEMs, software companies, online services companies and technical developers. Many of the Company’s competitors have greater technical and financial resources than the Company does. Some of the Company’s products and services provide features and technical capabilities that are generally comparable to higher priced products offered by larger competitors.

Segment Information

The Roxio Consumer Products segment accounted for approximately 86% of net revenue for fiscal year 2010. See Note 6, “Significant Customer Information, Segment Reporting and Geographic Information,” to the Consolidated Financial Statements included in this Annual Report for a summary of the Company’s financial data by business segment, geography and customer concentration.

Premium Content Segment

The Premium Content segment offers a range of products and services related to the creation, distribution and enjoyment of premium content. As part of this segment, the Company also sells, rents and distributes premium entertainment content to consumers over the Internet under RoxioNow branding (in this Annual Report, this service may be referred to as the “RoxioNow Service”). Also within this segment, the Professional Products Group offers software under the Scenarist, CineVision, and DVDit product names as well as under the Sonic and Roxio Professional brands to major motion picture studios, high-end authoring houses and other professional customers. The Company also develops software components that it licenses to CE companies to enable their devices to offer premium content to consumers, and licenses intellectual property, including patents.

RoxioNow Service

The Company has partnered with major retailers such as Best Buy and Blockbuster, offering its RoxioNow Internet delivery platform for the sell-through or rental of premium content. The RoxioNow Service library contains thousands of digital assets, including content from 20th Century Fox, Walt Disney Co., DreamWorks Animation SKG, MGM, Miramax, NBC Universal, Sony, Warner Bros. and Lions Gate Entertainment, which content includes major Hollywood hits, feature-length films, television episodes, short films, and music concerts. This premium content is available for electronic sell-through (“EST” or download to own), rental (video-on-demand or “VOD” ) and DVD burning using Qflix technology.

Professional Products

The Professional Product Group develops, sells, and supports a range of comprehensive authoring solutions that enable commercial content owners such as major Hollywood motion picture studios to create and distribute high-end commercially released digital media titles in DVD, BD and other formats to mass consumer markets worldwide. The Company’s professional products include its Scenarist branded high-end authoring applications, its Scenarist Publisher template-based authoring solutions, CineVision encoding systems, and easy-to-use DVDit and DVDit Pro HD authoring solutions. The Company’s professional software solutions support video and audio encoding, authoring, playback emulation, multiplexing (combining navigation programming with content elements to produce finished disc images), and automated, customizable workflow processing.

Qflix

The Company offers its Qflix intellectual property and technology licensing program for the application of Content Scrambling Systems (“CSS”) to recordable DVD. CSS is the standard protection mechanism used in essentially all DVD players and on the majority of commercial, replicated DVDs. The Qflix program provides branding and certification for CSS recordable drives, CSS recordable media, and related components, and licenses key patents. The Qflix program enables content owners to manufacture and deliver industry-standard copy-protected DVDs directly to consumers on demand replacing the traditional costs associated with DVD manufacturing, distribution and inventory with internet distribution, which can be located in retail establishments, or on a consumer’s PC or set-top box, as well as other manufacturing facilities. Under the Qflix program, retailers and content owners are able to make a broader selection of DVD titles available to consumers without having to manage a large stock of physical inventory, and consumers are able to create their own personal DVDs of premium content at home.

Technology Licensing

The Company licenses its technology to CE device manufacturers, including companies that make the integrated circuits used by equipment manufacturers. The customers and agreements for this business are similar to those for the technology licensing business engaged in by the Company through its Roxio consumer segment.

Patent Program

The Premium Content segment also includes the Company’s patent management and commercialization program. Under the patent program the Company identifies patentable ideas that arise in the course of its internal development operations, assesses and acquires patents as part of its business acquisitions, and assesses and may acquire patents and patent portfolios from other companies, although it has not made an acquisition of separate patents or patent portfolios to date. The Company’s patent program is designed to generate revenues by granting limited licenses to patents directly to other companies or consortia, licensing the use of patents in connection with licenses of its applications software or software technology, including patents in patent pools associated with industry standard formats, and selling or licensing patents to other companies for exploitation. Under appropriate circumstances and in order to protect its intellectual property, the Company may bring legal proceedings against third parties who infringe its patents.

Sales and Distribution; Markets

The Company sells its professional products through a field sales force in combination with a network of specialized professional audio/video dealers. As of March 31, 2010, the Company employed 18 people in its field sales organization for Premium Content professional products. Sales personnel are based in the Company’s headquarters in Novato, CA as well as its offices in Santa Clara, CA, Burbank, CA, London, England and Tokyo, Japan. The Company’s professional products are mainly sold to the high-end film and video post-production facilities that process and prepare audio, video and film content for delivery across a variety of broadcast, broadband and mobile playback platforms. The titles authored by its professional customers consist primarily of major feature film, entertainment, and educational programs as well as business-to-business and business-to-consumer content. The Company’s professional customers range in size from relatively small organizations with few employees to major content creation facilities with thousands of employees.

The Company offers its RoxioNow Service directly through websites and, increasingly, through third party partners who offer the service through their own websites, through PCs and through CE devices. To the extent that the Company offers the RoxioNow Service through PC and CE OEMs, its distribution relationships are similar to, and often overlap with, the OEM relationships that it establishes through the Roxio consumer segment.

Competitive Environment

A number of companies offer products and services that compete with some or all of the Company’s premium product and service offerings. The Company’s RoxioNow Service, in particular, faces a wide range of competition from other companies seeking to position themselves strategically as the digital distribution of Hollywood movies and other premium content grows in scope and importance. Significant competition exists from well-established traditional premium content distribution channels, including retailers that rent, sell or trade DVDs and games, cable and satellite VOD services, and other in-home entertainment. Consumers have a variety of vendor choices and multiple distribution options for premium content consumption, and the Company believes that this competition will increase over the coming years as the proliferation of digital delivery continues. Some of the Company’s competitors have greater financial or organizational resources and/or greater familiarity than the Company does with certain technologies.

Segment Information

The Premium Content segment accounted for approximately 14% of net revenue for fiscal year 2010. See Note 6, “Significant Customer Information, Segment Reporting and Geographic Information,” to the Consolidated Financial Statements included in this Annual Report for a summary of the Company’s financial data by business segment, geography and customer concentration.

General Business Factors

The matters described in this section apply generally to the Company’s business activities, including both of its operating segments.

Intellectual Property

The Company protects its proprietary rights through a variety of means and measures, including patents, trade secrets, copyrights, trademarks, contractual restrictions and technical measures. The Company generally offers its products and services subject to purchase and license agreements that restrict unauthorized disclosure of its proprietary software and designs, or copying for purposes other than the use intended when the product is sold.

The Company owns or licenses many patents and has a number of patent applications pending in the United States and foreign countries. The status of software and business method patent protection has been in flux. On the one hand, there has recently been a trend on the part of patent authorities to grant patents in audio and video processing techniques and, in particular, for software based techniques, with increasing liberality. On the other hand, there has been an increasing tendency on the part of some courts to invalidate patents granted by the patent authorities (for example, in the case of KSR v. Teleflex (April 2007), the U.S. Supreme Court enunciated a new standard of “obviousness” that may call into question many patents granted under the recent, liberal patent regime). Given the general confusion and imprecision in this area, the Company believes that it is possible that some of its present or future products or services might be found to infringe issued or yet to be issued patents, and it is almost certain that the Company will be asked by patent holders to respond to infringement claims. If such patents were held to be valid, and if they covered a portion of the Company’s technology for which there was no ready substitute, the Company might suffer significant market and financial losses.

The Company has endeavored to reduce its risk to some extent by means of contractual provisions. For example, in the case of low revenue-per-copy bundling agreements with OEM customers, the Company typically attempts to limit any indemnity it provides relating to infringement. However, not all of the Company’s OEM customers are willing to agree to the terms that the Company seeks, and, even if they agree, there is no assurance that such limitations will in fact reduce the Company’s exposure to liability.

The Company relies to a great extent on the protection the law gives to trade secrets to protect its proprietary technology. The Company policy is to request confidentiality agreements from all of its employees and key consultants, and it regularly enters into confidentiality agreements with other companies with whom the Company discusses its proprietary technology, financial issues, business opportunities and other confidential matters. Despite trade secret protection, the Company cannot be certain that third parties will not independently develop the same or similar technologies, or whether third parties will improperly disclose or use Company technologies.

Seasonal Trends

The Company’s software product sales have historically followed a seasonal trend, with sales being typically higher in the December and March quarters. Due to adverse global economic conditions, this normal seasonality was not pronounced during fiscal years 2009 and 2010.

Research and Development

The Company’s research and development staff is located principally at its headquarters in Novato and Santa Clara, California, and in Shanghai and Hangzhou, China, as well as San Luis Obispo, California and Wayne, Pennsylvania. The Company typically hires research and development personnel with backgrounds in digital audio signal processing, digital video image processing, distributed networking and computer systems design. For information regarding research and development expenses, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in this Annual Report.

Employees

As of March 31, 2010, the Company had approximately 490 full-time employees. The total included 99 employees engaged in sales and marketing, 290 engaged in research and development and the remaining 101 engaged in general and administration. As of March 31, 2010, the Company had approximately 229 employees in North America, 16 employees in Europe, and 245 employees in Asia. The Company believes that its future success will depend in large part on its ability to attract and retain highly skilled technical, managerial, and sales and marketing personnel. None of the employees are subject to collective bargaining agreements. The Company believes relations with employees are good.

Available Information

The Company’s corporate website is www.sonic.com. The Company makes available free of charge, on or through its website, this Annual Report, quarterly reports on Form 10-Q, and previous annual reports on Form 10-K, current reports on Form 8-K and amendments to those reports, if any, and any other filings filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after electronically filing or furnishing these reports with the SEC. Information contained on any of the Company’s websites is not a part of this Annual Report.

The Company files annual, quarterly and special reports, proxy statements and other information with the SEC. You may inspect and copy these materials at the Public Reference Room maintained by the Commission at Room 100 F Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for more information on the Public Reference Room. The SEC also maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers, such as the Company, that file electronically with the SEC.

Item 1A. Risk Factors

The following are certain risk factors that could affect the Company’s business, financial results and results of operations and its stock price. These risk factors should be considered in connection with evaluating the forward-looking statements contained in this Annual Report because these factors could cause the actual results and conditions to differ materially from those projected in the forward-looking statements. You should carefully consider the following risk factors as well as those in other documents the Company files with the SEC. The risks and uncertainties described below are not the only ones the Company may face. Additional risks and uncertainties not presently known to the Company or that it currently deems immaterial may also impair its business operations.

Adverse global economic conditions may continue to negatively affect the Company’s business, results of operations, and financial condition.

Adverse global economic conditions have had, and may continue to have, a negative impact on consumers and limit their ability and inclination to spend on leisure and entertainment related products and services. If demand for the Company’s products and services further decreases, as a result of economic conditions or otherwise, the Company’s financial condition would be adversely impacted.

The recent financial downturn and continuing financial market volatility may continue to negatively affect the Company’s business, results of operations, and financial condition.

The recent global economic downturn and continuing financial market volatility have resulted in tight credit markets, a low level of liquidity in many financial markets, and extreme volatility in fixed income, credit and equity markets. These factors could lead to a number of follow-on effects on the Company’s business, including insolvency of key suppliers resulting in product delays; inability of customers to obtain credit to finance purchases of the Company’s products and services; increased expense or inability to obtain financing for the Company’s operations or other business plans.

The Company was not profitable in fiscal years 2010, 2009 and 2008, and there can be no assurance that the Company will generate net income in future periods.

The Company experienced net losses for fiscal years 2010, 2009 and 2008, and there can be no assurance that the Company will be cash flow positive or generate net income in fiscal year 2011 or future years.

Rapid changes in technology and consumer preferences may adversely affect the Company’s operating results.

The market for the Company’s products and services is characterized by rapid technological change. The Company may not accurately predict customer or business partner behavior and may not recognize or respond to emerging trends, changing preferences or competitive factors. The Company’s operating results may fluctuate significantly as a result of a variety of factors, many of which are outside its control. These factors include:

fluctuations in demand for, and sales of, the Company’s products and services;

introduction of new products and services by the Company or its competitors;

competitive pressures that result in pricing fluctuations;

variations in the timing of orders for and shipments of the Company products;

changes in the mix of products and services that the Company sells and the resulting impact on its gross margins;

changes in the terms of the Company’s licensing, distribution and other agreements;

costs associated with litigation and intellectual property claims; and

general adverse economic and financial market conditions as noted above in these risks.

The Company’s operating expenses are based on its current expectations of its future revenues and are relatively fixed in the short term. Customer purchasing behavior can be difficult to forecast, and if the Company has lower revenues than expected, it may not be able to quickly reduce its expenses in response. As a consequence, the Company’s operating results for a particular quarter could be adversely impacted.

The Company must develop and introduce new and enhanced products in a timely manner to remain competitive.

To compete successfully in the markets in which the Company operates, it must develop and sell new or enhanced products and services that provide increasingly higher levels of performance and reliability. 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 the Company may negotiate in an effort to bring its products and services to market may prove to be higher than those ultimately offered to other licensees, putting the Company at a competitive disadvantage. Further, if new formats and technologies prove to be unsuccessful or are not accepted for any reason, there may be limited demand for the Company’s products or services. The products and services that the Company is currently developing or intends to develop may not achieve feasibility or be accepted by the market, and if the Company is unable to recover the costs associated with its research and development activities, it may adversely impact the Company’s business, financial condition and results of operations.

The Company relies on distributors, resellers and retailers to sell its products, and disruptions to these channels would affect adversely the Company’s ability to generate revenues from the sale of its products.

The Company sells its retail consumer software to end-users via retail channels through its network of distributors and resellers, and relies on two distributors for a significant portion of sales. Any decrease in revenue from these distributors or the loss of one of these distributors and the Company’s inability to find a satisfactory replacement in a timely manner could negatively impact its operating results.

Moreover, the Company’s failure to maintain favorable arrangements with its distributors and resellers may adversely impact its business. For example, the Company’s distributors and resellers and the retailers who sell the Company’s software to the public also sell products offered by the Company’s competitors. If the Company’s competitors offer its distributors, resellers or retailers more favorable terms, those distributors, resellers or retailers may de-emphasize, fail to recommend or decline to carry the Company products. If Company’s distributors, resellers or retailers attempt to reduce their levels of inventory or if they do not maintain sufficient levels to meet customer demand, the Company’s sales could be impacted negatively. Further, if the Company reduces the prices of its products, the Company may have to compensate its distributors, resellers or retailers for the difference between the higher price they paid to buy their inventory and the new lower prices of the Company’s products. In addition, the Company is 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 the Company’s web-based channels increase, the Company’s distributors, resellers and retailers may suffer decreased sales as a consequence. These changes may cause the Company’s distributors, resellers or retailers to cease distribution of its products or seek more favorable terms, either of which could seriously harm the Company’s business.

Because many of the Company’s products are designed to comply with industry standards, to the extent the Company cannot distinguish its products from those produced by its competitors, its current distributors and customers may choose alternate products or choose to purchase products from multiple vendors. The Company may be unable to compete effectively if it cannot produce products more quickly or at lower cost than its competitors.

The Company cannot provide any assurance that the industry standards for which the Company develops new products will allow it to compete effectively with companies possessing greater financial and technological resources than the Company has to market, promote and exploit sales opportunities as they arise in the future. Products that are designed to comply with standards may be viewed as interchangeable commodities by certain customers. The Company may be unable to compete effectively if it cannot produce products more quickly or at lower cost than its competitors. Further, any new products developed may not be introduced in a timely manner or in advance of the Company’s competitors’ products and may not achieve the broad market acceptance necessary to generate significant revenues.

The Company’s business depends on sales of consumer products and services, which subject it to risks relating to, among other things, changing consumer demands and increased competition.

The Company’s business depends on sales of consumer products and services, subjecting it to risks associated with changing consumer demands and extensive competition. The Company’s ability to succeed in consumer markets depends upon its ability to enhance its existing offerings, introduce new competitive products and services, and minimize the impact of sudden price decreases. The Company sells its consumer products through bundling arrangements with OEM customers, through its web store, and through physical and web-based retail channels. The Company may not have the resources or expertise to continue to develop and exploit these distribution channels effectively. Additionally, some of the Company’s non-OEM revenue opportunities are fragmented and take more time and effort to establish and maintain. Also, some of the Company’s competitors have well established retail distribution capabilities and existing brands with market acceptance that provide them with a significant competitive advantage. If the Company is not successful in overcoming these challenges, its business and results of operations may be adversely impacted.

Because a large portion of the Company’s revenue is from OEM customers, sales of its products are tied to OEM product sales.

A substantial portion of the Company’s revenue is derived from sales through OEM customers who bundle copies of its software with their products. Temporary fluctuations in the pricing and availability of the OEM customers’ products could negatively impact sales of Company products, which could in turn harm its business, financial condition and results of operations. Moreover, sales of Company OEM products depend in large part on consumer acceptance and purchase of DVD players, BD players, DVD recorders, television sets and other digital media devices marketed by the Company’s OEM customers in PCs, CE devices, or on a stand-alone basis. Consumer acceptance of these digital media devices depends significantly on the price and ease of use of these devices, among other factors. If the demand for these devices is impaired, the Company’s OEM sales will suffer a corresponding decline.

The Company sells its products to OEMs pursuant to individual supplements or other attachments to standard terms and conditions the Company has negotiated with each of these customers. These terms and conditions include provisions relating to the delivery of Company products, the customer’s distribution of these products, representations by the Company with respect to the quality of the products and its ownership of the products, its obligations to comply with law, confidentiality obligations, and indemnifications by the Company. The agreements are non-exclusive and do not contain any minimum purchase obligations or similar commitments. The underlying agreements generally renew for one year periods, subject to annual termination by either party or termination for breach and, in certain cases, the ability to terminate without cause with no or short notice. Under each agreement, the customer has the sole discretion to decide whether to purchase any of the Company products. Although the Company has maintained relationships with many of its OEMs for many years, if an OEM agreement with a major customer were terminated and the Company was unable to replace such relationship, its business and results of operations would suffer.

In addition, the Company relies on reports prepared by OEM customers to determine the results of sales of products through these OEM customers. If the OEM customers prepare inaccurate or substandard sales reports, the Company may be required to take corrective actions, including auditing current and prior reports. Such corrective actions may result in a negative impact on its business or reported results.

Changes in requirements or business models of the Company’s OEM customers may affect negatively its financial results.

OEM customers can be 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, the Company may not be in a position to refuse such demands, which would adversely impact revenues and results of operations. If particular OEMs demand products or product features that the Company is unable to deliver, or if they impose higher quality requirements than the Company is able to satisfy, it could lose those relationships, which would adversely impact its revenues and results of operations. Also, if the Company’s competitors offer its OEM customers more favorable terms than the Company does or if its competitors are able to take advantage of their existing relationships with OEMs, then these OEMs may not include the Company’s software with their products. The Company’s business will suffer if it is unable to maintain or expand its relationships with OEMs.

The Company depends on a limited number of customers for a significant portion of its revenue, and the loss of one or more of these customers could materially harm its operating results, business and financial condition.

During the fiscal year ended March 31, 2010, approximately 13% and 11% of the Company’s net revenue were received from various OEM divisions of Dell and Hewlett-Packard, respectively, and approximately 7% and 22% of the Company’s net revenue for fiscal year 2010 were received from the Company’s two largest distributors, Ingram and Navarre, respectively. In addition, during fiscal year 2010, approximately 23% of the Company’s net revenue consisted of online web store revenue received through Digital River. The Company anticipates that the relationships with Dell, Hewlett-Packard, Navarre, Digital River and, to a lesser extent, Ingram, will continue to account for a significant portion of its revenue in the future. Any adverse changes in the Company’s relationships with any of these companies could seriously harm its operating results, business, and financial condition if the Company was unable to replace that relationship.

The Company’s web-based revenue is vulnerable to third party operational problems and other risks.

The Company makes its products and services available through web-based retail sites operated by third party resellers. Under these arrangements, the Company’s reseller partners typically utilize co-branded sites, provide the infrastructure to handle purchase transactions through their secure web sites, and deliver the product (whether via web download or physical fulfillment). The Company’s 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. The Company relies on the third party resellers who operate these web stores for their smooth operation. Any interruption of these web stores could have a negative effect on the Company’s business. If the Company’s web store resellers were to withdraw from this business or change their terms of service in ways that were unfavorable to the Company, there might not be a ready alternative outsourcing organization available to the Company, and it might be unprepared to assume operation of the web stores. If any of these events occurs, the Company’s results of operations would be harmed.

Changes in the Company’s product and service offerings could cause it to defer the recognition of revenue, which could harm its operating results and adversely impact its ability to forecast revenue.

The Company’s products contain advanced features and functionality that may require it to provide increased levels of end user support, and its services require the Company to continue to provide various benefits during the applicable service terms. To the extent that the Company offers a greater degree of customer support and ongoing services, it may be required to defer a greater percentage of revenues into future periods, which could harm short term operating results.

The Company’s reliance on a limited number of suppliers for its manufacturing makes it vulnerable to supplier operational problems.

The Company outsources the manufacturing of its consumer software products to two primary suppliers, who provide services such as parts procurement, parts warehousing, product assembly and supply chain services. Any disruption in the operations of these suppliers, or any product shortages or quality assurance problems could increase the costs of manufacturing and distributing the Company’s products and could adversely impact its operating results. Moreover, although the Company believes there is significant competition in the manufacture of consumer software products, if these suppliers cease to perform or fail to perform as the Company expects, the Company could face potentially significant delays in engaging substitute suppliers and negotiating terms and conditions acceptable to the Company.

The Company’s product prices may continue to decline, which could harm its operating results.

The market for the Company’s software is intensely competitive. It is likely that prices for the Company’s OEM products, particularly in the DVD area, will continue to decline due to competitive pricing pressures from other software providers, competition in the PC and CE industries and continuing concentration among OEM customers. In addition, the Company derives a substantial portion of its revenue from retail sales, which also are subject to significant competitive pricing pressures. The Company may also experience pricing pressures in other parts of its business. These trends could make it more difficult for the Company to increase or maintain its revenue and could adversely affect its operating results.

Revenues derived from the Company’s consumer DVD products have declined in recent years and will likely continue to decline.

The Company has experienced declines in consumer products revenue relating to the DVD format, and absent the introduction and market acceptance of new formats such as BD or new business and service models, including online services, such declines could continue, adversely impacting the Company’s results of operations.

Qualifying and supporting the Company’s products on multiple computer platforms is time consuming and expensive.

The Company devotes significant time and resources to qualify and support its software products on various PC and CE platforms, including Microsoft and Apple operating systems. To the extent that any qualified and supported platform is modified or upgraded, or the Company needs to qualify and support a new platform, it could be required to expend additional engineering time and resources, which could add significantly to its development expenses and adversely affect its operating results.

Failure to complete the DivX Acquisition could have a negative impact on the Company.

On June 1, 2010 the Company entered into the Merger Agreement with DivX pursuant to which DivX will become a wholly owned subsidiary of the Company. The DivX Acquisition is expected to close by September 30, 2010. Closing of the DivX Acquisition is subject to a number of customary closing conditions, and the closing may not occur if any of these conditions is not satisfied or waived. Other risks associated with the DivX Acquisition include:

the parties may not obtain the requisite shareholder or regulatory approvals for the DivX Acquisition;

the operational and financial benefits and synergies that the Company expects from the DivX Acquisition may not be realized;

the parties may not be able to retain key personnel; and

the impact of general economic conditions on the businesses and results of operations of the two companies, as which conditions are further described in these “Risk Factors.”

While as of March 31, 2010, the Company has not incurred substantial expenses in connection with the DivX Acquisition, since that date, the Company has incurred substantial expenses and expects to incur additional significant expenses prior to any closing.

The DivX Merger Agreement does not contain any post-closing indemnification provisions. Therefore, any claims for known or unknown DivX liabilities, whether related to intellectual property ownership, infringement or otherwise, would be the responsibility of the consolidated Company post-DivX Acquisition. Any such claim, with or without merit, could be time consuming to defend, result in costly litigation and divert management’s attention.

Furthermore, if the acquisition is not completed, the Company may be subject to a number of adverse consequences. For example, the market price of the Company’s common stock may decline to the extent that the current market price reflects a market assumption that the DivX Acquisition will be completed and will be successful.

Integrating DivX into the Company’s existing operations will dilute the Company’s existing shareholders’ ownership percentages, involve considerable risks and may not be successful.

The integration of DivX into the Company’s existing operations business may be a complex, time-consuming and expensive process and may disrupt the Company’s existing operations if it is not completed in a timely and efficient manner. If the Company’s management is unable to minimize the potential disruption to its business during the integration process, the Company may not realize the anticipated benefits of the DivX acquisition. Realizing the benefits of the acquisition will depend in part on the integration of technology, operations, and personnel while maintaining adequate focus on the Company’s core businesses. The Company may encounter substantial difficulties, costs and delays in integrating DivX, including the following, any of which could seriously harm its results of operations, business, financial condition and/or the price of its stock:

issuance of equity securities that will dilute the Company’s current shareholders’ percentages of ownership;

conflicts between business cultures;

difficulties and delays in the integration of operations, personnel, technologies, products, services, business relationships and information and other systems of the acquired businesses;

the diversion of management’s attention from normal daily operations of the business;

large one-time write-offs;

the incurrence of debt and contingent liabilities;

contractual and/or intellectual property disputes;

problems, defects or other issues relating to acquired products or technologies that become known to the Company only after the closing of DivX Acquisition;

conflicts in distribution, marketing or other important relationships, or poor acceptance by resellers of the acquired products;

difficulties caused by entering geographic and business markets in which the Company has no or only limited experience;

acquired products and services that may not attract customers;

loss of key employees and disruptions among employees that may erode employee morale;

inability to implement uniform standards, controls, policies and procedures;

failure to achieve anticipated levels of revenue, profitability or productivity; and

poor acceptance of the Company’s revised business model and strategies.

The Company’s operating expenses may increase significantly over the near term due to the increased headcount, expanded operations and changes related to the DivX Acquisition. To the extent that the expenses increase but revenues do not, there are unanticipated expenses related to the integration process, or there are significant costs associated with presently unknown liabilities, the combined Company’s business, operating results and financial condition may be adversely affected. Failure to minimize the numerous risks associated with the post-acquisition integration strategy also may adversely affect the trading price of the Company’s common stock.

The Company’s failure to manage its global operations effectively may adversely affect its business and operating results.

As of March 31, 2010, the Company had seven major locations (defined as a location with more than 15 employees) and employed 268 employees outside the United States. The Company faces challenges inherent in efficiently managing employees over large geographic distances, including the need to implement appropriate systems, controls, policies, benefits and compliance programs. The Company’s inability to successfully manage its global organization could have a material adverse effect on its business and results of operations.

The Company is subject to risks associated with its international operations.

Revenue derived from international customers accounted for approximately 22%, 28% and 18% of the Company’s net revenues in fiscal years 2010, 2009 and 2008, respectively. The Company expects that international sales will continue to account for a significant portion of its net revenues for the foreseeable future. As a result, the occurrence of adverse international political, economic or geographic events could result in significant revenue shortfalls, which could harm the Company’s business, financial condition and results of operations. Areas of risk associated with the Company’s international operations include:

import and export restrictions and duties, including tariffs, quotas, and other barriers;

difficulties in obtaining export licenses for certain technology;

foreign regulatory requirements, such as safety or radio frequency emissions regulations;

liquidity problems in various foreign markets;

uncertainties and liabilities associated with foreign tax laws;

burdens of complying with foreign laws, including consumer and data protection laws;

changes in, or impositions of, foreign legislative or regulatory requirements;

difficulties in coordinating the activities of geographically dispersed and culturally diverse operations;

difficulties in staffing, managing, and operating its international operations;

potential loss of proprietary information due to misappropriation or laws that are less protective of the Company’s intellectual property rights than U.S. law;

political and economic instability in the countries in which the Company operates or sells products;

changes in diplomatic and trade relationships; and

other factors beyond its control including terrorism, war, natural disasters and diseases, particularly in areas in which it has facilities.

Certain political, economic and social considerations relating to China could adversely affect the Company.

In addition to other risks associated with the Company’s global business, it faces risks due to the substantial operations it conducts in China, which could be adversely affected by political, economic and social uncertainties in China. As of March 31, 2010, the Company had 206 employees in China, primarily carrying out research and development activities. China has implemented economic reforms as a way to introduce a stronger market economy, but it is possible that these economic reforms of recent years could be slowed or reversed. In addition, many of the laws and regulations impacting the Company in China are relatively new, the Chinese legal system is still evolving, the interpretation of laws and regulations is not always uniform and enforcement of these laws and regulations involve uncertainties, all of which may limit the remedies available in the event of any claims or disputes with third parties.

The Company faces increasing competition for online sales from smaller software providers.

The Internet enables smaller software providers to distribute products with minimal upfront costs or resources. In the past, a substantial barrier to entry into the packaged software market for small-scale providers was the need to manufacture, package and distribute software through a retail or commercial distribution chain. To the extent consumers increasingly purchase software over the Internet, the Company expects to face increased competition from small software development companies and programmers worldwide. New entrants that have business models focused on Internet distribution may have more favorable cost structures than the companies that employ a multi-channel distribution network, which could give those competitors cost savings, pricing and profitability advantages.

The Company has had limited experience with online premium content services, and cannot assure you when or if its RoxioNow Service will have a positive impact on the Company’s profitability.

During fiscal year 2009, the Company acquired substantially all of the assets of CinemaNow, Inc., an online movie download and streaming business, which the Company now operates as part of its RoxioNow Service. There is no assurance that consumers will widely adopt the Company’s RoxioNow Service offerings or that they will become profitable. The Company has invested, and will continue to invest, significant time and money in building and organizing the premium content business, and its success could be jeopardized by difficulties in implementing and maintaining premium content information technology systems and infrastructure and/or by increased operating expenses and capital expenditures required to in connection with online premium content offerings. Because the Company has limited experience with online premium content offerings, it cannot assure you that it will be successful or profitable.

The Company depends on studios to license its content for its RoxioNow Service.

The Company’s ability to provide its RoxioNow Service depends on studios licensing content for online delivery. The studios have great discretion whether to license their content, and the license periods and the terms and conditions of such licenses vary by studio. If studios change their terms and conditions, are no longer willing or able to provide the Company licenses, or if the Company is otherwise unable to obtain premium content on terms that are acceptable, the ability to provide the RoxioNow Service will be adversely affected, which could harm its business and operating results.

The Company relies on a number of third parties to deliver its RoxioNow Service.

The Company’s RoxioNow Service is embedded in various PC and CE platforms and devices, which are then distributed through multiple retail channels. If the Company is not successful in establishing and maintaining appropriate OEM and distribution relationships, or if it encounters technological, content licensing or other impediments, the Company’s ability to grow its RoxioNow Service could be adversely impacted, which could harm its business and operating results.

If the Company’s customers select titles or formats that are more expensive for the Company to acquire and deliver more frequently, the Company’s expenses may increase.

Certain titles cost the Company more to acquire or result in greater revenue-sharing expenses. If customers select these titles more often on a proportional basis compared to all titles selected, the Company’s costs and margins could be adversely affected. In addition, films released in high-definition formats may be more expensive for the Company to acquire and deliver, and if customers select these formats more frequently on a proportional basis, the Company’s costs and margins could be adversely affected.

The Company could be liable for substantial damages if there is unauthorized duplication of the content it sells.

The Company believes that it is able to license premium content through its RoxioNow Service in part because the service has been designed to reduce the risk of unauthorized duplication and playback of this content. If these security measures fail, studios and other content providers may terminate their agreements with the Company and, in addition, the Company could be liable for substantial damages. Security breaches might also discourage other content providers from entering into agreements with the Company. The Company may be required to expend substantial money and other resources to protect against the threat of security breaches or to alleviate problems caused by security breaches.

The Company’s executive officers and other key personnel are critical to its business, and because there is significant competition for personnel in the Company’s industry, it may not be able to attract and retain qualified personnel.

The Company’s success depends on the continued contributions of its executive management team and its technical, marketing, sales, customer support and product development personnel. The loss of key individuals or significant numbers of such personnel could significantly harm the Company’s business, financial condition and results of operations. The Company does not have any life insurance or other insurance covering the loss of any of its key employees.

Some of the Company’s competitors possess greater technological and financial resources, may produce better or more cost-effective products or services and may be more effective than the Company, in marketing and promoting their products and services.

There is a substantial risk that competing companies will produce better or more cost-effective products or services or will be better equipped than the Company is to promote products or services in the marketplace. A number of companies offer products and services that compete with the Company’s products, either directly or indirectly. Many of these companies have greater financial and technological resources than the Company does.

Errors in Company products and services may result in loss of or delay in market acceptance, which could adversely impact the Company’s reputation and business.

The Company’s products and services may contain undetected errors, especially when first introduced or as new versions are released, and the Company may need to make significant modifications to correct these errors. Failure to achieve acceptance could result in a delay in, or inability to, receive payment, a rejection of products and services, damage to the Company’s reputation, as well as lost revenues, diverted development resources, increased service and warranty costs and related litigation expenses and potential liability to third parties, any of which could harm the Company’s business.

The Company is vulnerable to earthquakes, labor issues and other unexpected events.

The Company’s corporate headquarters, as well as the majority of its research and development activities, are located in California and China, both of which are areas known for seismic activity. An earthquake or other disaster could result in an interruption in the Company business. The Company’s business also may be impacted by labor issues related to its operations and/or those of its suppliers, distributors or customers. Such an interruption could harm its operating results. The Company is not likely to have sufficient insurance to compensate adequately for lost revenues and losses that it may sustain as a result of any natural disasters or other unexpected events.

If the Company fails to protect its intellectual property rights it may not be able to market its products and services successfully.

Unlicensed copying and use of the Company’s intellectual property or illegal infringements of its intellectual property rights represent losses of revenue to the Company. The Company’s products and services are based in large part on proprietary technology, which it has sought to protect with patents, trademarks, copyrights and trade secrets. Effective intellectual property protection may not be available in every country in which the Company’s products and services may be manufactured, marketed, distributed, sold or used. Moreover, despite the Company’s efforts, these measures only provide limited protection. Third parties may try to copy or reverse engineer portions of the Company’s products or services or otherwise obtain and use its intellectual property without authorization. The Company cannot assure you that the protection of its proprietary rights will be adequate or that its competitors will not develop independently similar technology, duplicate the Company’s products or services or design around any of its patents or other intellectual property rights.

The Company may become involved in costly and time-consuming patent litigation.

Third parties could claim that the Company’s products or services infringe their patents, trademarks or other intellectual property rights. As new standards and technologies evolve, the Company believes that it may face an increasing number of third party claims relating to alleged patent infringements. Intellectual property litigation is time consuming and costly, diverts management resources and could result in the invalidation or impairment of the Company’s intellectual property rights. If litigation results in an unfavorable outcome, the Company could be subject to substantial damage claims and/or be required to cease production of infringing products, terminate its use of the infringing technology, develop non-infringing technology and/or obtain a license agreement to continue using the technology at issue. Such license agreements might not be available to the Company on acceptable terms, resulting in serious harm to its business.

The Company may be liable to some of its customers for damages that they incur in connection with intellectual property claims.

Although the Company attempts to limit its exposure to liability arising from infringement of third-party intellectual property rights in the Company’s license agreements with customers, it does not always succeed in obtaining the limitations it seeks. If the Company is required to pay damages to or incur liability on behalf of its customers, its business could be harmed. Moreover, even if a particular claim falls outside of the Company indemnity or warranty obligations, its customers may be entitled to additional contractual remedies against the Company, which could harm its business. Furthermore, even if the Company is not liable to its customers, its customers may stop buying its products or attempt to pass on to the Company the cost of any license fees or damages owed to third parties by reducing the amounts they pay for the Company’s products. Any of these results could harm the Company’s business.

The Company may incur losses associated with currency fluctuations and may not effectively reduce its exposure.

The Company’s operating results are subject to volatility resulting from fluctuations in foreign currency exchange rates, including:

currency movements in which the U.S. dollar becomes stronger with respect to foreign currencies, thereby reducing relative demand for its products and services outside the United States; and

currency movements in which a foreign currency in which the Company has incurred expenses becomes stronger in relation to the U.S. dollar, thereby raising the Company’s expenses for the same level of operating activity.

The Company’s stock price has been volatile, is likely to continue to be volatile, and could decline substantially.

The price of the Company’s common stock is likely to continue to be highly volatile. The price of its common stock could fluctuate significantly for any of the following reasons, among others:

fluctuations in the U.S. or world economy or general market conditions, as well as those specific to specific to the PC, CE and related industries;

future announcements concerning the Company or its competitors;

earnings announcements, quarterly variations in operating results, including variations due to one-time payments and other non-recurring revenues or costs 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 the Company or its competitors, or the entry of new competitors into the markets for digital media software or the digital distribution of premium content;

acquisition or loss of significant customers, distributors or suppliers;

changes in earnings estimates by the Company or by independent analysts who cover it;

delay in delivery to market or acceptance of new products and services;

disclosure of material weaknesses in the Company’s internal control over financial reporting or its disclosure controls and procedures or of other corporate governance issues; and/or

costs of litigation and intellectual property claims.

In addition, stock markets in general, and those 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 the Company’s common stock.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

The Company’s corporate headquarters is located in Novato, California, where it occupies approximately 12,465 square feet under a lease expiring in February 28, 2013. During fiscal 2010, the Company decreased its leased corporate headquarters property by 59% or 18,104 square feet from 30,569 leased in fiscal 2009. The Company and its foreign subsidiaries lease additional space in various locations in the United States and abroad for local sales and product development. The Company believes that the existing facilities are in good condition and adequate to meet its requirements for the foreseeable future. For additional information related to leases, see Part II, Item 8, Note 3, “Commitments and Contingencies,” to the Consolidated Financial Statements included in this Annual Report.

Item 3. Legal Proceedings

Litigation Matters

On October 4, 2007, a putative shareholder class action was filed in the United States District Court for the Northern District of California against the Company and various of its executive officers and directors, premised on allegations concerning the granting of stock options by the Company and the alleged filing of false and misleading financial statements. On March 21, 2008, plaintiffs filed a consolidated amended complaint on behalf of a proposed class of plaintiffs comprised of persons that purchased the Company’s shares between October 23, 2002 and May 17, 2007. On May 27, 2008, plaintiffs filed a “corrected” consolidated amended complaint which alleges various violations of the Securities Exchange Act of 1934 and the rules thereunder. In July 2009, the parties reached an agreement in principle to settle this action, and on October 15, 2009, the parties executed a stipulation of settlement providing for the creation of a settlement fund of $5 million to satisfy claims submitted by class members and to pay any attorneys fees awarded by the Court. As part of the settlement, the Company’s Directors and Officers (“D&O”) liability insurers agreed to fund the settlement amount. On April 8, 2010, this settlement was formally approved and a final judgment and order of dismissal with prejudice was entered. The Company’s D&O liability insurance has covered the legal fees and costs associated with the above legal action, including payment of legal fees of $0.7 million during fiscal 2010.

Indemnification Obligations

In the normal course of business, the Company provides indemnifications of varying scopes, including limited product warranties and indemnification of customers against claims of intellectual property infringement made by third parties arising from the use of its products or services. The Company accrues for known indemnification issues if a loss is probable and can be reasonably estimated. Historically, costs related to these indemnifications have not been significant, but because potential future costs are highly variable, the Company is unable to estimate the maximum potential impact of these indemnifications on its future results of operations. As permitted under California law and in accordance with its Bylaws and certain other commitments and agreements, the Company indemnifies its officers, directors and members of its senior management against certain claims and liabilities, subject to certain limits, while they serve at its request in such capacity. The maximum amount of potential indemnification is unknown and potentially unlimited; however, the Company has D&O liability insurance that enables it to recover a portion of future indemnification claims paid, subject to retentions, conditions and limitations of those policies.

Item 4. (Removed and Reserved)

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The Company’s common stock is currently traded on The Nasdaq Global Select Market under the SNIC ticker symbol. The low price and high prices of its common stock during fiscal 2010 and fiscal 2009 are as follows:

Fiscal Year 2010	Low Price		High Price		Fiscal Year 2009	Low Price		High Price
Quarter ended 6/30/2009	$	1.14	$	3.88	Quarter ended 6/30/2008	$	5.61	$	10.33
Quarter ended 9/30/2009	$	2.57	$	6.60	Quarter ended 9/30/2008	$	3.31	$	6.84
Quarter ended 12/31/2009	$	4.65	$	12.90	Quarter ended 12/31/2008	$	0.61	$	4.67
Quarter ended 3/31/2010	$	7.50	$	12.23	Quarter ended 3/31/2009	$	0.57	$	2.03

As of March 31, 2010, the last reported sale price on the Nasdaq Global Select Market for the Company’s common shares was $9.37 per share.

Record Holders

As of March 31, 2010, there were approximately 107 registered holders of the Company’s common stock. The Company believes, however, that many beneficial holders of its common stock have registered their shares in nominee or street name, and that there are substantially more than 107 beneficial owners.

Dividend Policy

The Company has never declared or paid any cash dividends on its common stock and does not expect to do so in the foreseeable future. It is presently the policy of the board of directors to retain earnings for use in expanding and developing the Company’s business. Accordingly, the Company does not anticipate paying any cash dividends on its common stock in the foreseeable future.

Equity Compensation Plans

Information relating to the securities authorized for issuance under equity compensation plans is set forth below (in thousands except per share data):

Plan Category	Number of securities to be issued upon exercise of outstanding options and RSUs (#)		Weighted-average exercise price of outstanding options ($)		Number of securities remaining available for future issuance under equity compensation plans (#)
Equity compensation plans approved by shareholders		5,435	$	4.96		1,841

2004 Equity Compensation Plan not approved by shareholders (1)(2)		219	$	6.84		-

2005 Foreign Compensation Plan not approved by shareholders (1)(2)		139	$	15.93		-

Total		5,793	$	5.31		1,841

(1)

For information and description of the Company’s stock plans, see Part II, Item 8, Note 4, “Shareholders’ Equity,” to the Consolidated Financial Statements included in this Annual Report.

(2)

During the fourth quarter of fiscal 2010, the Company discontinued the 2004 Equity Compensation Plan and the 2005 Foreign Compensation Plan (non-shareholder approved plans). No additional grants will be made under these discontinued Plans and the termination of these plans will not affect any awards outstanding on the date of termination. For additional information, see Part II, Item 8, Note 4, “Shareholders' Equity - Discontinued Plans,” to the Consolidated Financial Statements included in this Annual Report.

Stock Performance Graph

The following Stock Performance Graph compares the cumulative total shareholder return on the Company’s common stock with the cumulative total return of the Standard and Poor’s 500 Index and the Standard and Poor’s Information Technology Index. The total shareholder return reflects the change in share price during the period, assuming an investment of $100 on March 31, 2005 plus the reinvestment of dividends, if any. No dividends were paid on the Company’s common stock during the period shown. The stock price performance shown below is not necessarily indicative of future stock performance.

Measurement Period (Fiscal Year Covered)	Sonic Solutions		S&P 500 Index		S&P Information Technology
FYE 03/05	$	100.00	$	100.00	$	100.00
FYE 03/06	$	120.33	$	111.73	$	113.53
FYE 03/07	$	93.69	$	124.95	$	117.05
FYE 03/08	$	64.12	$	118.60	$	116.55
FYE 03/09	$	7.97	$	73.43	$	81.51
FYE 03/10	$	62.26	$	109.97	$	128.79

Item 6. Selected Financial Data

The following data should be read in conjunction with the Company’s Consolidated Financial Statements, the notes thereto, and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included elsewhere in this Annual Report. The consolidated statements of operations data for fiscal years 2010, 2009 and 2008, and the selected consolidated balance sheet data as of March 31, 2010 and 2009, are derived from, and are qualified by reference to, the audited consolidated financial statements that are included in this Annual Report. The consolidated statements of operations data for fiscal years 2007 and 2006 and the consolidated balance sheet data as of March 31, 2008, 2007 and 2006 are derived from audited consolidated financial statements that are not included in this Annual Report.

	Years Ended March 31,
Consolidated Statements of Operations Data:	2010			2009			2008			2007			2006
	(In thousands, except share and share data)
Net revenue (1)	$	104,345		$	119,958		$	132,874		$	148,649		$	147,608
Cost of revenue		31,856			32,901			33,151			34,389			34,132
Impairment of intangibles (2)		-			19,579			-			-			-
Gross profit		72,489			67,478			99,723			114,260			113,476

Operating expenses:
Marketing and sales (1)(3)		29,975			35,810			36,186			33,304			35,606
Research and development (3)		24,696			39,250			44,511			44,513			44,157
General and administrative (3)		17,669			24,160			27,310			20,487			22,214
Acquired in-process technology		-			-			-			3,400			-
Abandoned acquisition		-			-			-			1,016			-
Business integration		-			-			-			-			336
Restructuring (4)		513			3,947			3,152			-			-
Impairment of goodwill (2)		-			56,174			-			-			-
Total operating expenses		72,853			159,341			111,159			102,720			102,313
Operating income (loss)		(364	)		(91,863	)		(11,436	)		11,540			11,163
Interest income		75			687			2,768			2,845			1,271
Interest expense		(146	)		(767	)		(1,479	)		(2,024	)		(1,846	)
Other income (expense), net		(319	)		(1,020	)		356			(40	)		(431	)
Income (loss) before income taxes		(754	)		(92,963	)		(9,791	)		12,321			10,157
Provision (benefit) for income taxes		459			25,160			(4,254	)		6,071			(9,177	)
Net income (loss)	$	(1,213	)	$	(118,123	)	$	(5,537	)	$	6,250		$	19,334

Basis and diluted net loss per share:
Net income (loss) per share - basic	$	(0.04	)	$	(4.46	)	$	(0.21	)	$	0.24		$	0.78
Net income (loss) per share - diluted	$	(0.04	)	$	(4.46	)	$	(0.21	)	$	0.23		$	0.74
Shares used in per share calculation - basic		27,792			26,535			26,247			25,982			24,750
Shares used in per share calculation - diluted		27,792			26,535			26,247			27,431			26,234

Balance Sheet Data (at period end)
Working capital	$	39,439		$	1,296		$	36,828		$	35,789		$	41,923
Total assets	$	95,410		$	66,737		$	210,049		$	217,029		$	214,336
Total liabilities (5)	$	32,807		$	40,093		$	65,447		$	66,196		$	76,854
Shareholders' equity	$	62,603		$	26,644		$	144,602		$	150,833		$	137,482

(1)

Warrant share-based expense of $0.7 million and $1.1 million for fiscal 2010 is included in contra-revenue and marketing and sales operating expense, respectively.

(2)

See Note 1, “Business and Summary of Significant Accounting Policies” to the Consolidated Financial Statements included in this Annual Report for additional details regarding impairment of intangibles and goodwill.

(3)

Includes share-based compensation expense as follows:

	Years Ended March 31,
	2010		2009		2008		2007		2006
Marketing and sales	$	840	$	842	$	766	$	1,284	$	3,846
Research and development		294		292		530		740		3,460
General and administrative		1,423		1,057		249		742		2,928
Total share-based compensation expense	$	2,557	$	2,191	$	1,545	$	2,766	$	10,234

(4)

See Note 8, “Restructuring” to the Consolidated Financial Statements included in this Annual Report for additional details regarding the Company’s restructuring plans.

(5)

Prior fiscal years 2009 and 2006 amounts include prior disclosed non-current portion of long term capital lease amounts of $0.2 million and $30.0 million.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with its Consolidated Financial Statements and the related notes included elsewhere in this Annual Report. In addition to historical consolidated financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions as described under the “Forward-Looking Statements” section that appears earlier in this Annual Report. The Company’s actual results could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under Item 1A, “Risk Factors,” and elsewhere in this Annual Report.

Overview of Business

The Company is a leading developer of products and services that enable the creation, management, and enjoyment of digital media content across a wide variety of technology platforms. The Company’s products and services offer innovative technologies to consumers, OEMs, businesses, high-end professional DVD authoring experts and developers. The Company distributes its products and services through retailers and distributors, PC and CE OEMs, Internet websites including www.roxio.com, and other channels. The Company also licenses core technology and intellectual property to other software companies and technology manufacturers for integration into their own products and services. Sonic software is intended for use with Microsoft Windows and Apple Mac operating systems, as well as some Linux environments and proprietary platforms.

Sonic products and services are used to accomplish a wide variety of tasks, including creating and distributing digital audio and video content in a variety of formats; renting, purchasing and enjoying Hollywood movies and other premium content; producing digital media photo and video shows for sharing online and via television, PCs and CE devices; recording and playback of digital content on DVD, BD, other storage media and portable devices; managing digital media on PCs and CE devices; and backing up and preserving digital information, both to local storage devices and on the Internet.

Roxio Consumer Products Segment

Premium Content Segment

Recent Trends & Events

Due to the proliferation of computer technology, broadband Internet connectivity and personal electronic devices of all kinds, digital media content is now everywhere. The Company’s products and services enable people to create, manage, enjoy and distribute premium and personal digital content, allowing them to organize and share their digital lives and memories in new and innovative ways. The Company’s strategy is to utilize its technology, expertise and competitive positioning to deliver exciting products and services to enhance the value of digital media in people’s lives. The Company faces evolving trends in the technology industry that can provide opportunities as well as potential risks, including:

Optical Disc Playback Evolution – Optical disc technologies have enjoyed tremendous growth and extremely widespread consumer adoption, but they tend to evolve, mature and change rapidly. For example, multiple DVD playback units (including set-top players, game consoles and PCs) are present in most households, but DVD sales are now falling as consumers have begun to embrace online alternatives, as well as new formats such as BD. Sales of BD units and players have been growing at a rate comparable to that of standard definition DVD during the equivalent time periods in its life cycle, implying that BD is positioned to grow dramatically over the next several years, but the growth of the BD format has not yet fully compensated for the recent drop in DVD sales. Other technological trends and events can also impact the demand for the Company’s digital media products and services. For example, as new operating systems are introduced (for example, Windows 7 in October 2009), consumers are offered new tools for editing, formatting and burning digital media, and there are opportunities for software vendors such as the Company to provide products that are complementary to the new operating systems.

Growth of Digital Distribution of Premium Content – Content owners, such as Hollywood studios, are increasingly offering sell-through and rental of premium content through digital distribution. Simultaneously, a growing number of consumers are enjoying and taking advantage of the benefits of digital distribution of premium content. As more Internet-enabled electronic devices offer delivery of premium content, the rate of adoption and number of title offerings should continue to increase.

Digital Phone, Portable and Gaming Devices – Consumer usage of mobile phones, gaming consoles and portable CE devices, particularly those with high-end digital media capabilities, continues to increase worldwide. The growing popularity of portable devices leads to greater demand for software products and services, such as those offered by the Company, that provide digital media management and functionality.

Growth of Online Social Networks – Online social networks, such as Facebook and MySpace, increasingly feature personal digital photo, video and audio content, and these networks function as distribution platforms for sharing and enjoying digital media content. The rising popularity of these networks and their platforms creates an increased demand for products and services that can capture, create, edit and manage digital media.

During fiscal 2009, the Company acquired the assets of Simple Star, Inc., a software and online service provider, and the assets of CinemaNow, Inc., an online entertainment provider. The Company has utilized the Simple Star assets to further its initiative to embrace web services as an important part of its consumer business, while the addition of the CinemaNow assets has assisted the Company in expanding its premium content product and service offerings and implementing the RoxioNow Service.

During fiscal 2009, the Company initiated restructuring plans to reorganize operations, optimize its engineering and development efforts, reduce workforce, consolidate divisions into a single reporting segment, unifying its OEM licensing efforts, and eliminate organizational redundancies. For more information see Note 8, “Restructuring,” to the Consolidated Financial Statements included in this Annual Report.

Strategic Objectives

Enable Consumers to Buy and Play Premium Content Anywhere and at Anytime. The Company believes that digital distribution of premium content will grow dramatically over the next few years, and that ultimately industry revenue from the digital distribution of premium content may surpass revenue from the sale and rental of premium content on optical media such as DVD and BD. The Company has put substantial effort into its RoxioNow Service initiatives, as it believes that this area may offer a strong opportunity for counterbalancing the recent decline in DVD sales and the adverse impact of that trend on the Company’s operating results. As the digital content ecosystem continues to expand and evolve, the Company aims to make its products and services available through an increasing range of platforms, devices and partners, with the goal that the Company’s technology will represent a symbol of compatibility and a common point of interaction for consumers who want to enjoy Hollywood movies and other premium digital content anywhere and anytime.

Develop and strengthen Roxio-branded products and services. The Company seeks to build on the brand strength of its Roxio products and services by strengthening its relationships with OEMs and retail partners, while deepening its relationship with consumers by adding new products and services. The Company continues to utilize its knowledge and expertise to develop and introduce products and services relating to new formats such as BD, and believes that these efforts will assist it in offsetting price pressure and declining sales associated with the DVD format. Additionally, the Company plans to continue to enhance its Web-based offerings, add innovative solutions to its consumer product portfolio and extend the reach of the Roxio brand to a new audience of online users.

Outlook

While the continuing global economic downturn and the maturation of the DVD format have adversely impacted the Company’s business and financial results during recent periods, the Company believes that the digital distribution of premium content is poised to enjoy commercial success, and that its RoxioNow Service initiatives provide it with a strategic opportunity to grow its business rapidly in this area. The Company further believes that it is well positioned to capitalize on its strong brand name, consumer market position, and OEM relationships as digital media formats such as BD continue to evolve. The Company made significant strategic and financial progress during fiscal 2010 to bring costs in line with revenues while positioning the Company for revenue growth and margin improvement.

Critical Accounting Policies and Estimates

The Company prepares its Consolidated Financial Statements in conformity with U.S. generally accepted accounting principles (“GAAP”). In preparing its Consolidated Financial Statements, the Company makes estimates, judgments, and assumptions that can significantly affect the amounts reported in its consolidated financial statements. The Company bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances. Actual results could differ from these estimates. The Company regularly evaluates its estimates, judgments, and assumptions and makes changes accordingly. The Company believes the following accounting policies and estimates are the most critical and significant to understanding and evaluating its financial condition and results of operations.

In June 2009, the Financial Accounting Standards Board (“FASB”) approved the FASB Accounting Standards Codification (“ASC”) as the single source of authoritative nongovernmental GAAP. ASC does not change current GAAP, but simplifies user access to all authoritative GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standards documents was superseded and all other accounting literature not included in the ASC is considered non-authoritative. The Company adopted the ASC in June 2009 and discloses the ASC prescribed topic numbering references on a primary basis.

Use of estimates

On an ongoing basis, the Company evaluates estimates used. The following accounting policies require management to make estimates, judgments and assumptions and are critical in fully understanding and evaluating the Company’s reported financial results:

Revenue recognition

Allowances for sales returns and doubtful accounts

Share-based compensation

Valuation of acquired businesses, assets and liabilities

Goodwill, intangible assets and other long-lived assets

Share-based compensation

Accrued liabilities

Contingencies

Income tax and deferred tax asset valuation

Revenue Recognition

The Company derives its revenue primarily from licenses of its software products, software development agreements and maintenance and support. The Company also sells and licenses patents and patented technology. The Company recognizes revenue when the following criteria have been met:

Persuasive evidence of an arrangement exists;

Delivery has occurred or services have been rendered;

The arrangement fees are fixed or determinable; and

Collection is considered probable.

If the Company determines that any of the above criteria has not been met, the Company will defer recognition of the revenue until all the criteria have been met.

The Company generally considers arrangements with payment terms longer than six months from the time of delivery not to be fixed or determinable, and recognizes the related revenue as payments become due from the customer, provided all other revenue recognition criteria have been met. If the Company determines that collection of a fee is not probable, it will defer the fees and recognize revenue upon cash receipt, provided all other revenue recognition criteria have been met.

Generally, the Company records revenue at gross and records costs related to a sale in cost of revenue. In those cases where the Company is not the primary obligor or merchant of record and/or does not bear credit risk, or where it earns a fixed transactional fee, the Company records revenue under the net method. When the Company records revenues at net, revenue is reported at the net amount received and retained by the Company.

Multiple Element Arrangements - In arrangements that include multiple elements (e.g., software, specified upgrades, support services, installation services, and/or training), the Company allocates the total revenue to be earned under the arrangement to the elements based on their relative fair value, as determined by vendor-specific objective evidence of fair value (“VSOE”). VSOE is generally the price charged when that element is sold separately or, in the case of support services, annual renewal rates.

In arrangements where VSOE exists only for the undelivered elements, the Company uses the “residual method” under which it defers the full fair value of the undelivered elements and recognizes the difference between the total arrangement fee and the amount deferred for undelivered items as revenue. If VSOE does not exist for all elements but the only undelivered element is maintenance and support, the Company recognizes revenue from the arrangement ratably over the maintenance and support period. If VSOE does not exist for undelivered elements that are specified products or upgrades, the Company defers revenue until the earlier of the delivery of all elements or the point at which it determines VSOE for these undelivered elements.

Product Sales - Except in the case of consignment arrangements, the Company recognizes revenue from the sale of its packaged software products when title transfers to the distributor or retailer. When the Company sells packaged software products to distributors and retailers on a consignment basis, it recognizes revenue upon sell through to an end customer.

The Company’s distributor arrangements often provide distributors with certain product rotation rights. The Company estimates returns based on its historical return experience and other factors such as channel inventory levels and the introduction of new products. These allowances are recorded as a reduction of revenues and as an offset to accounts receivable to the extent the Company has legal right of offset, otherwise they are recorded in accrued expenses and other current liabilities. If future returns patterns differ from past returns patterns, for example due to reduced demand for the Company’s product, it may be required to increase these allowances in the future and may be required to reduce future revenues.

The Company accounts for cash consideration (such as sales incentives) that it gives to its customers or resellers as a reduction of revenue rather than as an operating expense unless the Company receives a benefit that is separate from the customer’s purchase from the Company and for which it can reasonably estimate the fair value.

Software License Arrangements - Provided all other revenue recognition criteria have been met, the Company recognizes revenue from software licensing arrangements upon delivery, or, in the case of per-unit royalty arrangements, upon sell through to an end user as evidenced by the receipt of a customer royalty report.

Software Development Arrangements - For arrangements that include development or other services that are essential to the functionality of the licensed software, the Company recognizes revenue using the percentage-of-completion method. Under the percentage-of-completion method, management estimates the number of hours needed to complete a particular project, and revenues are recognized as the contract progresses to completion. Changes in estimates are recognized in the period in which they are known.

In certain instances, a development agreement may include additional undelivered elements, such as maintenance and support, or a specified upgrade or other deliverable, and VSOE of fair value may not exist for the undelivered elements, or the Company may not have sufficient experience with either the type of project or the customer involved to be able to make reliable estimates towards completion. If the Company cannot reliably estimate total profitability under the agreement but is reasonably assured that no loss will be realized on the agreement, the Company recognizes revenue using the zero gross margin method. Under the zero gross margin method, revenue recognized under the contract equals costs incurred under the contract and any profit is deferred until development is complete. The Company recognizes the deferred gross profit over the remaining contractual service period (for example, the initial maintenance period).

In addition, the Company receives prepayments of certain usage-based services and offers certain products and services on a subscription basis. Subscription revenue is recognized ratably over the related subscription period. Prepaid revenue is deferred and recognized over the usage period.

Content and Services – Premium content revenue includes RoxioNow Service content sales. When purchased on an individual transaction basis, the Company recognizes revenue from the sale of individual content titles in the period when the content is purchased and delivered. The Company generally recognizes revenue from the sale of content subscriptions pro rata over the term of the subscription period.

Allowance for Sales Returns and Doubtful Accounts

The Company’s distributors and retail arrangements provide for certain product rotation rights and permit certain product returns. The Company estimates reserves for these rights of return based on historical return rates, timing of new product releases, and channel inventory levels.

The Company maintains an allowance for doubtful accounts to reserve for potentially uncollectible accounts based on past collection history and specific risks identified in its portfolio of receivables. If the financial condition of the Company’s distributors or other customers deteriorates, resulting in an impairment of their ability to make payments, or if payments from distributors or other customers are significantly delayed, additional allowances may be required.

Goodwill, Intangible Assets and Long-Lived Assets

Intangible assets are classified into three categories: (1) intangible assets with definite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization; and (3) goodwill. For goodwill and intangible assets with definite lives, tests for impairment must be performed if conditions exist that indicate the carrying value may not be recoverable. For intangible assets with indefinite lives and goodwill, tests for impairment must be performed at least annually or more frequently if events or circumstances indicate that assets might be impaired.

The Company tests for impairment at least annually, in the Company’s fourth fiscal quarter, or more frequently if events and circumstances warrant.

The Company evaluates goodwill and indefinite life intangible assets for impairment by comparing the fair value of each of its reporting units to its carrying value including the goodwill allocated to that reporting unit. A reporting unit is an operating segment or one level below an operating segment. To determine the reporting unit’s fair value, the Company uses the income approach under which it evaluates estimated discounted future cash flows of that unit. The Company bases its cash flow assumptions on historical and forecasted revenue and operating costs.

The Company has reviewed the criteria necessary to evaluate the number of reporting units that exist. Based on its review, the Company has determined it operates in two reporting segments, Roxio Consumer and Premium Content.

A detailed determination of the fair value of a reporting unit may be carried forward from one year to the next if all of the following criteria have been met:

The assets and liabilities that make up the reporting unit have not changed significantly since the most recent fair value determination.

The most recent fair value determination resulted in an amount that exceeded the carrying amount of the reporting unit by a substantial margin.

Based on an analysis of events that have occurred and circumstances that have changed since the most recent fair value determination, the likelihood that a current fair value determination would be less than the current carrying amount of the reporting unit is remote.

Long-lived assets are reviewed for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The Company evaluates long-lived assets, including intangible assets with finite useful lives, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The determination of recoverability of long-lived assets and intangible assets with finite lives is based on an estimate of the undiscounted future cash flows resulting from the use of that asset and its eventual disposition.

Based on a combination of factors occurring during fiscal 2009, including the economic environment, market conditions and decline of the Company’s stock value, the Company determined that indicators for impairment of goodwill and intangible assets existed. Accordingly, during the third quarter of fiscal 2009, the Company performed an impairment analysis and recorded impairment charges of $19.6 million and $56.2 million for its intangible assets and goodwill, respectively, related to its Roxio Consumer reporting segment.

Share-Based Compensation

The Company measures compensation cost for share-based awards at fair value. Share-based compensation cost is measured at the grant date based on the fair value of the award and will be recognized over the requisite service period, which is generally the vesting period. The Company uses the Black-Scholes-Merton (“Black Scholes”) option pricing model to determine the fair value of stock option shares. The determination of the fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include the Company’s expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. The fair value of RSUs is equivalent to the market price of the Company’s common stock on the grant date.

Income Tax and Deferred Tax Asset Valuation

The provision for income taxes is calculated using the liability method of accounting. Under the liability method, deferred tax assets and liabilities are recognized based on the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. In assessing net deferred tax assets, management considers whether it is more likely than not that some or all of the deferred tax assets will not be realized. When the Company does not believe realization of a deferred tax asset is likely, it records a valuation allowance. The valuation allowance is evaluated at the end of each year, considering positive and negative evidence about whether the deferred tax assets will be realized.

The Company is subject to income taxes in the U.S. and certain foreign jurisdictions. Significant judgment is required in evaluating the Company’s uncertain tax positions and determining its provision for income taxes. Accounting for income tax uncertainties requires a two-step approach to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than fifty percent likely of being realized upon settlement.

The Company adjusts these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the impact of reserve provisions as well as related interest and penalties.

Recent Accounting Pronouncements

The following represents a summary of recent authoritative pronouncements that could impact or have impacted the Company’s accounting, reporting, and/or disclosure of financial information.

In September 2009, the Emerging Issues Task Force (“EITF”) issued its final consensus for Accounting Standards Update (“ASU”) 2009-13 (formerly “EITF 08-1”), Revenue Arrangements with Multiple Deliverables, which will supersede the guidance in ASC 605-25 (previous authoritative guidance: EITF 00-21, Revenue Arrangements with Multiple Deliverables). ASU 2009-13 retains the criteria from ASC 605-5 for when delivered items in a multiple-deliverable arrangement should be considered separate units of accounting, but removes the previous separation criterion under ASC 605-25 that objective and reliable evidence of fair value of any undelivered items must exist for the delivered items to be considered a separate unit or separate units of accounting. ASU 2009-13 introduces a selling price hierarchy for multiple deliverable arrangements and allows for management selling price estimates in cases where no vendor specific objective evidence or third party evidence is available. Additionally, this guidance eliminates the residual method of allocation. ASU 2009-13 is effective for fiscal years beginning on or after June 15, 2010. The Company is currently evaluating ASU 2009-13 and the impact, if any, that it may have on its results of operations or financial position.

In September 2009, the EITF issued its final consensus for ASU 2009-14 (formerly “EITF 09-3”), Applicability of SOP 97-2 to Certain Arrangements that Include Software Elements, which amends the prior guidance to exclude tangible products that contain software and non-software components that function together to deliver the products’ “essential functionality” from the guidance on software revenue recognition. The guidance is effective for fiscal years beginning after June 15, 2010; however, early adoption is permitted as of the beginning of an entity’s fiscal year. Entities are required to adopt ASU 2009-13 and ASU 2009-14 concurrently. The Company is in the process of determining the effect of the adoption of ASU 2009-14 and the impact, if any, that it may have on its results of operations or financial position.

In January 2010, the FASB issued ASU 2010-06. The ASU amends ASC 820, Fair Value Measurements and Disclosures, to add new requirements for disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements. It also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. The amendment is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010. The Company does not expect the adoption will have any impact on its results of operations or financial position.

RESULTS OF OPERATIONS

The following table sets forth certain items from the Company’s statements of operations as a percentage of net revenue for the three fiscal years 2008 through 2010 (in percentages):

	Fiscal Years Ended March 31,
	2010			2009			2008
Net revenue		100.0	%		100.0	%		100.0	%
Cost of revenue		30.5	%		27.4	%		24.9	%
Impairment of intangibles		-			16.3	%		-
Gross profit		69.5	%		56.3	%		75.1	%

Operating expenses:
Marketing and sales		28.7	%		29.9	%		27.2	%
Research and development		23.7	%		32.7	%		33.5	%
General and administrative		16.9	%		20.1	%		20.6	%
Restructuring		0.5	%		3.3	%		2.4	%
Impairment of goodwill		-			46.8	%		-
Total operating expenses		69.8	%		132.8	%		83.7	%
Operating loss		(0.3	)%		(76.6	)%		(8.6	)%
Other income (expense)		(0.4	)%		(0.9	)%		1.2	%
Provision (benefit) for income taxes		0.4	%		21.0	%		(3.2	)%
Net loss		(1.1	)%		(98.5	)%		(4.2	)%

Net Revenue

During the fourth quarter of fiscal 2009, the Company reclassified certain revenue segment information in prior period financial tables to conform to the reorganization of the Company’s reportable business segments. For additional information, see Note 6, “Significant Customer Information, Segment Reporting and Geographic Information” to the Consolidated Financial Statements included in this Annual Report. The revenue reclassifications had no effect on the Company’s consolidated balance sheets, consolidated statements of operations, consolidated statements of shareholders’ equity and comprehensive income (loss) and consolidated statements of cash flows for the prior periods presented.

The following table is a comparison of net revenues by segment based on the current reportable business segments (in thousands other than percentages):

	Years Ended March 31,						2010 to 2009						2009 to 2008
Net Revenue	2010		2009		2008		Increase (Decrease)			% Change			Increase (Decrease)			% Change
Roxio Consumer Products	$	90,077	$	104,074	$	122,691	$	(13,997	)		(13	)%	$	(18,617	)		(15	)%
Premium Content		14,268		15,884		10,183		(1,616	)		(10	)%		5,701			56	%
Total net revenue	$	104,345	$	119,958	$	132,874	$	(15,613	)		(13	)%	$	(12,916	)		(10	)%

Fiscal 2010 compared to Fiscal 2009

Net revenue decreased by $15.6 million or 13% to $104.3 million for fiscal 2010, from $120.0 million for fiscal 2009. The fiscal year 2010 decrease in net revenue included a decrease of $14.0 million or 13% in Roxio Consumer Products and a decrease of $1.6 million or 10% in Premium Content net revenue. The Roxio Consumer Products segment experienced a $6.5 million reduction in OEM bundling revenue due to changes in product mixes, per-unit pricing pressure, and lower unit volumes, plus a $2.9 million reduction in technology licensing revenue from PC manufacturers caused by fewer pre-paid license renewals during fiscal year 2010. Also contributing to the decrease within the Roxio Consumer Product segment revenue was a $2.3 million reduction in volume licensing revenue and a $2.3 million reduction in sales through the Company’s web store and retail channels as a result of global economic weakness affecting corporate spending and consumer demand.

The decrease in Premium Content net revenue included a $3.7 million reduction in professional products revenue resulting from a $2.7 million professional development arrangement in Japan during fiscal year 2009 for which there was no corresponding amount during fiscal year 2010, along with the continued global economic weakness affecting consumer demand and corporate spending. Also contributing to the decrease in Premium Content revenue was a $1.3 million reduction in technology licensing revenue from CE manufacturers caused by fewer development contracts and license renewals during fiscal year 2010. The decrease in Premium Content net revenue was partially offset by $3.1 million generated through RoxioNow services and an increase of $0.3 million in content revenue related to the timing of the CinemaNow asset acquisition.

Fiscal 2009 compared to Fiscal 2008

Net revenue decreased by $12.9 million or 10% to $120.0 million for fiscal year 2009, from $132.9 million for fiscal year 2008. The decrease in net revenue included a decrease of $18.6 million or 15% in Roxio Consumer Product revenues offset by an increase of $5.7 million or 56% in Premium Content revenue. The Roxio Consumer Products segment included a $19.6 million reduction in OEM bundling revenue due to changes in product mixes, per-unit pricing pressure, and lower unit volumes. The decrease in Roxio Consumer Products net revenue was partially offset by $1.0 million generated through volume licensing pursuant to a governmental contract.

Premium Content net revenue increased due to a $3.3 million increase in professional products revenue driven by a $2.7 million development contract recorded in fiscal year 2009, for which there was no corresponding amount during fiscal year 2008. Also contributing to the increase in Premium Content revenue was $1.3 million in technology licensing revenue from Qflix and CE manufacturers under development contracts and license renewals during fiscal year 2009. Premium Content revenue also increased due to $0.9 million in content revenue related to the timing of the CinemaNow asset acquisition and $0.2 million generated through RoxioNow services.

Geographical Revenue and Customer Concentration

The following tables set forth a comparison of net revenues geographically (in thousands other than percentages):

	Fiscal Years Ended March 31,						2010 to 2009						2009 to 2008
Net revenue	2010		2009		2008		Increase (Decrease)			%			Increase (Decrease)			%
United States	$	81,403	$	86,818	$	108,604	$	(5,415	)		(6	)%	$	(21,786	)		(20	)%
Export
Canada		877		1,573		1,407		(696	)		(44	)%		166			12	%
France		696		1,422		1,076		(726	)		(51	)%		346			32	%
Germany		2,721		4,429		2,978		(1,708	)		(39	)%		1,451			49	%
United Kingdom		3,138		3,287		3,629		(149	)		(5	)%		(342	)		(9	)%
Europe: Other		2,179		2,910		3,874		(731	)		(25	)%		(964	)		(25	)%
Japan		7,721		14,207		5,948		(6,486	)		(46	)%		8,259			139	%
Singapore		3,212		3,599		3,446		(387	)		(11	)%		153			4	%
Taiwan		869		281		73		588			209	%		208			285	%
Other Pacific Rim		945		887		1,362		58			7	%		(475	)		(35	)%
Other International		584		545		477		39			7	%		68			14	%
Total net revenue	$	104,345	$	119,958	$	132,874	$	(15,613	)		(13	)%	$	(12,916	)		(10	)%

Fiscal 2010 compared to Fiscal 2009

Domestic sales accounted for $81.4 million, or 78%, of the Company’s net revenue in fiscal year 2010, compared to $86.8 million or 72% of net revenue in fiscal year 2009. The decrease in domestic revenue included a reduction in OEM bundling revenue of $4.7 million due to changes in product mixes, per-unit pricing pressure, and lower unit volumes, as well as a $1.6 million reduction in Qflix and technology licensing revenue from CE and PC manufacturers caused by fewer development contracts and license renewals during fiscal year 2010. A $1.4 million reduction in volume licensing revenue, a $1.2 million reduction in sales through the Company’s web store, and a $0.8 reduction in the professional channels as a result of global economic weakness affecting corporate spending and consumer demand also contributed to the decrease in domestic revenue. This decrease was partially offset by $3.1 million generated through RoxioNow services, a $0.8 million increase in the retail channel due to the sales of the Company’s Easy VHS to DVD product, and an increase of $0.3 million in content revenue related to the timing of the CinemaNow asset acquisition.

International sales accounted for $22.9 million, or 22%, of the Company’s net revenue in fiscal year 2010, compared to $33.1 million or 28% of its net revenue in fiscal year 2009. The decrease in international sales partially resulted from a $2.7 million professional development arrangement in Japan during fiscal year 2009 for which there was no corresponding amount during fiscal year 2010, a $2.6 million reduction in technology licensing revenue from PC manufacturers due to one customer changing from a pre-paid to an “as-used” royalty contract, along with the Company’s performance of fewer development contracts during fiscal year 2010. Also contributing to the decrease in international sales was a $1.0 million reduction in web service sales from a German-based web store reseller upon the launch of the Company’s own online services offering.

Fiscal 2009 compared to Fiscal 2008

Domestic sales accounted for $86.8 million, or 72%, of the Company’s net revenue in fiscal year 2009, compared to $108.6 million or 82% of its net revenue in fiscal year 2008. The decrease in domestic revenue included a reduction in OEM bundling revenue of $22.4 million due to changes in product mixes, per-unit pricing pressure, and lower unit volumes, a $2.6 million reduction in sales through the Company’s web store and retail channels as a result of global economic weakness affecting consumer demand, partly offset by sales of products acquired as part of the Simple Star asset acquisition. This decrease was partly offset by $1.4 million generated through volume licensing, $0.9 million in content revenue related to the timing of the CinemaNow asset acquisition, and $0.8 in Qflix and technology licensing revenue from CE and PC manufacturers caused by more development contracts and license renewals.

International sales accounted for $33.1 million, or 28%, of the Company’s net revenue in fiscal year 2009, compared to $24.3 million or 18% of its net revenue in fiscal year 2008. Japan revenue increased primarily due to a returns and allowance charge of $2.0 million posted in the first quarter of fiscal 2008, $2.7 million in fiscal year 2009 revenue from a professional development arrangement for which there was no corresponding amount during fiscal year 2008, along with an increase in technology licensing revenue from CE and PC manufacturers caused by more development contracts and license renewals. German revenue increased due to the use of a new web store reseller upon the acquisition of the Simple Star assets.

Significant Customers

The following table reflects sales to significant customers as a percentage of total net revenue and the related accounts receivable as a percentage of total receivables:

	Percent of Total Net Revenue									Percent of Total Accounts Receivable
	Fiscal Years Ended March 31,									Fiscal Years Ended March 31,
Customer Name	2010			2009			2008			2010			2009
Digital River		23	%		22	%		23	%		15	%		11	%
Navarre		22	%		16	%		13	%		19	%		20	%
Dell		13	%		14	%		26	%		5	%		5	%
Hewlett-Packard		11	%		11	%		13	%		17	%		2	%
Ingram		7	%		6	%		10	%		8	%		8	%

No other customer accounted for more than 10% of the Company’s revenue for fiscal years 2010, 2009 and 2008. The Company sells products to Dell and Hewlett-Packard pursuant to individual supplements, exhibits or other attachments that are appended to the standard terms and conditions the Company has negotiated with each of these customers. These standard terms and conditions include provisions relating to the delivery of the Company’s products, the customer’s distribution of these products, representations by the Company with respect to the quality of the products and the Company’s ownership of the products, obligations by the Company to comply with law, confidentiality obligations, and indemnification by the Company for breach of its representations or obligations. The underlying agreements generally renew for one year periods, subject to annual termination by either party or termination for breach. Under each agreement, the OEM has the sole discretion to decide whether to purchase any of the Company’s products. The agreements are non-exclusive and do not contain any minimum purchase obligations or similar commitments. The loss of Dell, Hewlett-Packard, or any other major customer, would have a material adverse effect on the Company, if it were unable to replace that customer.

Revenue recognized from Digital River was pursuant to a reseller arrangement, and revenue recognized from Navarre was pursuant to distribution arrangement. The Digital River agreement covers the electronic delivery of Company software and the creation and maintenance of the shopping cart process for the Company’s online stores; the Navarre agreement provides for both physical and electronic delivery, and under both consignment and direct sale models. The Company provides products to Digital River and Navarre pursuant to agreements with standard terms and conditions including provisions relating to the delivery of the Company’s products, distribution of these products, representations by the Company with respect to the quality of the products and the Company’s ownership of the products, obligations by the Company to comply with law, confidentiality obligations, and indemnification by the Company for breach of its representations or obligations. The agreements generally renew for one-year periods, subject to annual termination by either party as well as other termination provisions, such as termination for breach. The agreements are non-exclusive and do not contain any minimum purchase obligations or similar commitments.

It is impracticable for the Company to report the net revenues by significant customer per business segment for fiscal years ended March 31, 2010, 2009 and 2008, as some of the these customers may be in both segments.

Cost of Revenue

Cost of revenue consists mainly of third party licensing expenses, employee salaries and benefits for personnel directly involved in the production and support of revenue-generating products and services, packaging and distribution costs, if applicable, and amortization of acquired and internally-developed software and intangible assets. In the case of consumer software distributed in retail channels, cost of revenue also includes the cost of packaging, if any, and certain distribution costs. The following table reflects cost of revenue as a percentage of net revenue (in thousands other than percentages):

	Years Ended March 31,						2010 to 2009						2009 to 2008
	2010		2009		2008		Increase (Decrease)			% Change			Increase (Decrease)			% Change
Roxio Consumer Products	$	23,572	$	27,994	$	29,239	$	(4,422	)		(16	)%	$	(1,245	)		(4	)%
Premium Content		8,284		4,907		3,912		3,377			69	%		995			25	%
Cost of revenue		31,856		32,901		33,151		(1,045	)		(3	)%		(250	)		(1	)%

Fiscal 2010 compared to Fiscal 2009

The Company’s overall cost of revenue as a percentage of net revenue increased to 31% of net revenue for fiscal year 2010 from 27% for fiscal year 2009. Roxio Consumer Products cost of revenue as a percentage of Roxio Consumer Products net revenue decreased to 26% for fiscal year 2010 from 27% for fiscal year 2009. The lower cost of revenue percentages were driven by a 3% decrease in cost of revenue caused by lower purchased technology amortization as a result of the $19.6 million impairment of intangibles recorded in the third quarter of fiscal 2009. This was partly offset by a 2% increase in cost of revenue resulting from higher product costs, which included changes in retail packaging, along with bundling certain promotional items with the Company’s products.

Premium Content cost of revenue as a percentage of Premium Content net revenue increased to 58% for fiscal year 2010 from 31% for fiscal year 2009. The increase was due to $4.4 million additional operational, royalty, and content costs associated with the acquired CinemaNow business. This increase was partially offset by $0.8 million in lower professional costs in royalties, product costs, technical support, and operations due to the Company’s restructuring activities and lower sales. Development costs also decreased $0.3 million due to the Company’s performance of fewer development contracts during fiscal year 2010.

Fiscal 2009 compared to Fiscal 2008

The Company’s overall cost of revenue as a percentage of net revenue increased to 27% of net revenue for fiscal year 2009 from 25% for fiscal year 2008. Roxio Consumer products cost of revenues as a percentage of net revenue increased to 27% for fiscal year 2009 from 24% for fiscal year 2008. The increase in cost of revenue percentages included a 3% increase in costs of revenue resulting from higher product costs and royalties, which was driven by changes in retail packaging, along with bundling certain promotional items with the Company’s products and adding additional features in the software.

Premium Content cost of revenues as a percentage of net revenue decreased to 31% for fiscal year 2009 from 38% for fiscal year 2008. The decrease in cost of revenue percentages were driven by a 6% reduction in technical support costs as a result of the Company’s restructuring activities.

Marketing and Sales

Marketing and sales expenses include salaries, benefits, sales commissions and share-based compensation expense for marketing and sales employees, promotions and incentive programs aimed to generate revenue such as advertising, trade shows, travel related costs, and facility costs related to marketing and sales personnel. The following table reflects the Company’s marketing and sales operating expenses (in thousands other than percentages):

	Years Ended March 31,									2010 to 2009						2009 to 2008
	2010			2009			2008			Increase (Decrease)			%			Increase (Decrease)			%
Marketing and sales	$	29,975		$	35,810		$	36,186		$	(5,835	)		(16	)%	$	(376	)		(1	)%
Percentage of net revenue		29	%		30	%		27	%

Fiscal 2010 compared to Fiscal 2009

Marketing and sales expenses decreased by 16% to $30.0 million for fiscal year 2010, from $35.8 million for fiscal year 2009. As a percentage of net revenue, marketing and sales expenses represented 29% and 30% of net revenue for fiscal years 2010 and 2009, respectively. The decrease in marketing and sales expenses for fiscal 2010 of $5.8 million, as compared to the same period in the prior year, is due to the restructuring activities implemented during fiscal 2009 and the first quarter of fiscal 2010 related to headcount reductions and office closures and downsizing, as well as ongoing cost containment efforts. The decreases experienced during fiscal 2010 compared to the prior year reflect a reduction in personnel related expenses of $3.5 million, a reduction in outside services of $1.0 million, a reduction in travel and entertainment expenses of $0.7 million, and a reduction in advertising and promotional expenses of $1.7 million, which reductions were partially offset by a $1.1 million non-recurring increase in promotional expense as a result of the issuance of a warrant during the fiscal quarter ending December 31, 2009.

On October 29, 2009, the Company issued a warrant to purchase 668,711 shares of its common stock to a third party in connection with the entry of the Company and the third party into a strategic relationship agreement. Under the terms of the warrant, which vested 50% upon execution on of the strategic relationship agreement, 25% upon the first anniversary and 25% upon the second anniversary, the holder is entitled to purchase shares of the Company’s common stock at $4.98 per share (the closing price of the Company’s common stock on the date of the warrant issuance). During the three months ended December 31, 2009, the Company recorded the value representing the initial 50% vesting of the warrant, to equity and a promotional expense within Marketing and Sales operating expense. At the time of signing, no revenue had been earned from the contract. The Company valued this portion of the warrant at $1.1 million using the Black Scholes valuation model at the time of the signing of the agreement. The Black-Scholes valuation assumptions included an expected term of 5 years, volatility of 80.20%, and a risk free rate of 2.44%.

The remaining 50% of the warrant subject to vesting will be remeasured at each reporting period until vested and recognized ratably over the associated vesting period of the warrant with the related expense recorded as contra revenue. At March 31, 2010, the Company valued the unvested portion of the warrant at $1.6 million using the Black Scholes valuation model and recorded $0.7 million against revenue during fiscal year 2010. The Black-Scholes valuation assumptions included an expected term of 4.6 years, volatility of 84.83%, and a risk free rate of 2.31%.

Sales and marketing headcount decreased to 99 at March 31, 2010 from 102 at March 31, 2009. The Company expects to continue to invest in marketing and sales of its products and services to develop market opportunities and promote its offerings while continuing to monitor its needs to reduce operating expenses to align with the Company’s financial condition.

Fiscal 2009 compared to Fiscal 2008

Marketing and sales expenses decreased by 1% to $35.8 million for fiscal year 2009, from $36.2 million for fiscal year 2008. As a percentage of net revenue, marketing and sales expenses represented 30% and 27% of net revenue for fiscal years 2009 and 2008, respectively. The decrease in marketing and sales expenses for fiscal 2009, as compared to fiscal 2008, is due to the restructuring activities implemented during fiscal 2009 related to headcount reductions and office closures and downsizing, as well as ongoing cost containment efforts. The decrease in marketing and sales expenses for the fiscal year ended 2009 of $0.4 million, as compared to fiscal 2008, reflects a reduction in personnel related expenses of $1.2 million and a reduction in travel and entertainment of $0.4 million. These decreases were in part offset by a $1.0 million increase in advertising and promotions along with an increase in outside services of $0.2 million during fiscal 2009 as compared to fiscal 2008. The decrease in personnel related expenses and travel and entertainment in fiscal 2009 resulted from the Company’s cost containment efforts, including the restructuring activities implemented during fiscal 2009. The increase in advertising and promotion, as well as outside services, were attributable to an overall increase of targeted spending on broadcast creative production, OEM brand marketing, market research, and packaging development related to the launch of Toast during fiscal 2009. Sales and marketing headcount decreased to 102 at March 31, 2009 from 127 at March 31, 2008.

Research and Development

Research and development expenses include salaries, benefits, share-based compensation expenses for engineers, contracted development efforts, facility costs related to engineering personnel, and expenses associated with equipment used for development. The following table reflects the Company’s research and development operating expenses (in thousands other than percentages):

	Years Ended March 31,									2010 to 2009						2009 to 2008
	2010			2009			2008			Increase (Decrease)			%			Increase (Decrease)			%
Research and development	$	24,696		$	39,250		$	44,511		$	(14,554	)		(37	)%	$	(5,261	)		(12	)%
Percentage of net revenue		24	%		33	%		34	%

Fiscal 2010 compared to Fiscal 2009

Research and development expenses decreased by 37% to $24.7 million for fiscal year 2010, from $39.3 million for fiscal 2009. As a percentage of net revenue, research and development expenses represented 24% and 33% of net revenue for fiscal years 2010 and 2009, respectively. The decrease for fiscal 2010, as compared to fiscal 2009, was a result of the Company’s cost containment efforts, including the restructuring activities implemented during fiscal 2009 and the first quarter of fiscal 2010. The $14.6 million decrease for the fiscal year ended 2010 compared to fiscal 2009, includes a reduction in personnel related expenses of $11.0 million, a reduction in facility costs of $1.3 million, a reduction in travel and entertainment expenses of $0.8 million, a reduction in outside services of $0.7 million, and a reduction in associated research and development costs of $0.7 million. Research and development headcount decreased to 290 at March 31, 2010 from 314 at March 31, 2009. The Company expects research and development costs to remain consistent as a percentage of net revenue during fiscal 2011.

Fiscal 2009 compared to Fiscal 2008

Research and development expenses decreased by 12% to $39.3 million for fiscal year 2009, from $44.5 million for fiscal year 2008. Research and development expenses represented 33% and 34% of net revenue for fiscal years 2009 and 2008, respectively. The decrease in research and development expense of $5.3 million during fiscal 2009, as compared to fiscal 2008, was due to lower personnel-related costs of $4.4 million, and a reduction in associated research and development costs of $0.9 million. These decreases were a result of the Company’s restructuring activities. Research and development headcount decreased to 314 at March 31, 2009 from 446 at March 31, 2008.

General and Administrative

General and administrative expenses include salaries, benefits, share-based compensation, outside consulting services, travel expenses, legal costs including loss contingency reserves, facility costs for finance, facilities, human resources, legal, information services and executive personnel. The following table reflects the Company’s general and administrative operating expenses (in thousands other than percentages):

	Years Ended March 31,									2010 to 2009						2009 to 2008
	2010			2009			2008			Increase (Decrease)			%			Increase (Decrease)			%
General and administrative	$	17,669		$	24,160		$	27,310		$	(6,491	)		(27	)%	$	(3,150	)		(12	)%
Percentage of net revenue		17	%		20	%		21	%

Fiscal 2010 compared to Fiscal 2009

General and administrative expenses decreased by 27% to $17.7 million for fiscal year 2010, from $24.2 million for fiscal year 2009. As a percentage of net revenue, general and administrative expenses represented 17% and 20% of net revenue for fiscal years 2010 and 2009, respectively. The decrease for fiscal 2010 of $6.5 million, as compared to fiscal 2009, was a result of the following factors: (1) the Company’s cost containment efforts, including the restructuring activities implemented during fiscal 2009 and the first quarter of fiscal 2010, which contributed to a reduction in personnel related expenses of $2.4 million and a decrease of $1.2 million in general and administrative expenses such as travel, office supplies, and depreciation; (2) a reversal of penalties and interest in the amount of $1.4 million as a result of an abatement related to payroll taxes associated with the Company’s voluntary stock option review; (3) the absence of stock option review expenses as compared to $0.5 million in fiscal year 2009; (4) a decrease in loss contingency reserves related to legal settlements of $0.7 million; and (5) a reduction in outside service fees of $0.3 million

General and administrative headcount remained relatively constant between March 31, 2010 and March 31, 2009. Headcount was 101 at March 31, 2010 compared to 102 at March 31, 2009. The Company expects general and administrative expenses will remain consistent as a percentage of net revenue during fiscal 2011.

Fiscal 2009 compared to Fiscal 2008

General and administrative expenses decreased 12% to $24.2 million for fiscal year 2009, from $27.3 million for fiscal year 2008. General and administrative expenses represented 20% and 21% of net revenue for fiscal years 2009 and 2008, respectively. The decrease in general and administrative expense of $3.2 during fiscal 2009, as compared to the prior year, was due to a decrease of stock option review expenses of $7.6 million for fiscal 2009 compared to fiscal 2008. The Company completed its voluntary review of historical stock option grant practices and related accounting by late fiscal 2008. The decrease in stock option review expenses was partially offset by a loss contingency reserve related to a legal settlement in the amount of $1.0 million related to an ordinary course of business claim, an increase in personnel related expenses of $1.1 million due to the hire of certain senior level positions, an increase in share-based compensation expense of $0.8 million, and an increase in rent expense of $1.0 million due to additions of new offices as a result of acquisitions made during fiscal 2009 and the expansion of the Company’s China office. Additionally, there was an increase in penalties of approximately $0.5 million during fiscal 2009 compared to fiscal 2008. In 2008, there was a reversal of penalties as a result of the expiration of the statute of limitations related to payroll taxes associated with the stock option review. There were no expirations in fiscal 2009.

General and administrative headcount decreased to 102 at March 31, 2009 from 110 at March 31, 2008.

Restructuring Expense

Restructuring expenses consist primarily of one-time termination benefits such as severance and other employee related costs, contract termination costs related to facility expenses, and other associated costs.

Restructuring expense decreased 87% to $0.5 million for fiscal 2010, from $3.9 million for fiscal 2009. The decrease in restructuring expenses for fiscal 2010 is due to the Company having completed several restructuring programs that it had implemented during fiscal 2009. At each reporting period, the Company evaluates its accruals for vacated facilities, exit costs and employee separation costs to ensure the accruals are still appropriate. During the first quarter of fiscal 2010, the Company adjusted its accrual by $0.3 million due to changes in its estimates regarding applicable office subleasing markets and made minor adjustments during the second and third quarters of fiscal 2010 to its estimates related to one-time termination benefits, resulting in a non-material decrease in overall restructuring expenses.

Restructuring expense increased 25% to $3.9 million for fiscal year 2009, from $3.2 million for fiscal year 2008. The increase in restructuring expenses for fiscal year 2009 was primarily due to the Company engaging in several restructuring programs during fiscal year 2009. Restructuring expenses incurred for fiscal year 2008 consisted primarily of expenses associated with the closure of the Company’s Richmond Hill Canada office facility in December 2007.

Interest Income, Interest Expense, and Other Expenses, Net

Interest income was approximately $75 thousand, $0.7 million and $2.8 million for fiscal years 2010, 2009 and 2008, respectively. The decline in interest income is related to a decrease in cash and cash equivalents held by the Company prior to the receipt of net cash proceeds from the issuance of common stock on December 16, 2009, as well as lower interest rates.

Interest expense was approximately $0.1 million, $0.8 million and $1.5 million for fiscal years 2010, 2009 and 2008, respectively. Interest expense during fiscal 2010 relates to the finalization of a California sales tax audit while the decrease in fiscal 2009 as compared to fiscal 2008 was due to the repayment of the Company’s Union Bank of California credit facility during fiscal 2009

Other expenses for fiscal years 2010, 2009 and 2008 included foreign currency transaction gains and losses.

Provision for Income Taxes

The provision for income tax represents taxes payable in certain domestic and foreign jurisdictions. Income tax provision was $0.5 million in fiscal 2010. The fiscal year 2010 tax provision is related to taxes on profitable foreign subsidiaries and state franchise taxes. Generally, the Company’s effective tax rate differs from the statutory rates because it has recorded approximately 100% valuation allowance related to its deferred tax assets as the Company does not consider the generation of taxable income to realize their tax benefits to be more likely than not.

The Company recorded an income tax provision in the amount of $25.2 million in fiscal year 2009 and an income tax benefit of $4.3 million in fiscal year 2008. ASC 740-10 defines the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authority. Upon adoption of ASC 740-10, the Company recorded cumulative adjustments to the beginning balances of additional paid-in capital of $0.8 million, accumulated deficit of $0.6 million and goodwill of $0.1 million. At March 31, 2008, the Company had $4.9 million of gross unrecognized tax benefits, $2.0 million of which would affect its effective tax rate if recognized. The Company recognized $0.1 million of interest and penalties related to uncertain tax positions in income tax expense for fiscal 2008.

Impairment of Goodwill and Intangibles

No goodwill or intangible impairments were recorded in fiscal 2010. The Company recorded an impairment of goodwill and intangibles of $56.2 million and $19.6 million in the third quarter of fiscal 2009 related to the Roxio Consumer reporting unit based on a preliminary impairment analysis. The Company finalized the impairment analysis in the fourth quarter of fiscal 2009 and determined there was no further impairment. The carrying value of goodwill is based on fair value estimates on projected financial information which management believes to be reasonable. The valuation methodology used to estimate the fair value of the Company and its reporting units considers the market capitalization of the Company, requires inputs and assumptions that reflect market conditions as well as management judgment.

Acquisitions

The Company did not complete or enter into any acquisitions during fiscal 2010. The following acquisitions occurred during fiscal 2009 and 2008:

uMedia Digital Technology Corporation

During the fourth quarter of fiscal 2008, the Company entered into an Asset Purchase Agreement with uMedia Digital Technology Corporation (“uMedia”), a Chinese software development company, whereby it acquired substantially all of the assets for a purchase price of approximately $0.5 million. In connection with the acquisition, the Company acquired seven employees. uMedia’s expertise lies in developing video and audio compression and decompression technology, which has now been incorporated into the Company’s core audio and video technology.

Simple Star Acquisition

During the first quarter of fiscal 2009, the Company entered into an Asset Purchase Agreement to purchase certain assets from Simple Star, Inc. (“Simple Star”). These assets included PhotoShow, a multimedia storytelling platform and online community that enables consumers to turn photos and video clips into shows that can be viewed and shared on PCs, TVs, and handheld devices, or published to social media sites on the Internet. In connection with the acquisition, the Company acquired 25 employees. The Simple Star purchase price of approximately $6.0 million consisted of $5.0 million in cash due upon closing and $1.0 million plus accrued interest due on the first anniversary of closing. During the first quarter of fiscal 2010, the Company paid the acquisition hold back of $1.0 million.

CinemaNow Acquisition

During the fourth quarter of fiscal 2009, the Company entered into an Asset Purchase Agreement to purchase certain assets and liabilities from CinemaNow, Inc., (“CinemaNow”) a digital video distributor. The CinemaNow assets, which now form part of the RoxioNow Service, facilitate digital distribution of premium video content, including Hollywood movies, TV shows, and music videos, to users across multiple platforms. The CinemaNow purchase price of approximately $3.2 million was comprised of approximately $0.9 million in cash, assumed liabilities not to exceed $1.7 million, $0.2 million in direct costs and $0.5 million for a general holdback payable 180 days after the closing. The Company hired approximately 30 former CinemaNow employees as a result of the acquisition. During the third quarter of fiscal 2010, the Company settled its obligation to pay the $0.5 million acquisition holdback.

Proposed DivX Acquisition

In addition to the completed acquisitions, on June 1, 2010, the Company executed a Merger Agreement with DivX, as described above under Item I, Business – “Proposed Acquisition of DivX.” The Company currently expects to close the DivX Acquisition in September 2010, subject to the conditions described above. The Merger Agreement does not contain a condition that allows the Company not to close if it does not obtain financing, as the Company expects to finance the cash portion of the consideration for the DivX Acquisition from the financial resources of DivX. As of March 31, 2010, the Company had not incurred any significant expenses in connection with the DivX Acquisition. The Company has incurred substantial expenses since such date and expects to incur additional expenses before the expected closing exclusive of any costs relating to integration of DivX operations.

LIQUIDITY AND CAPITAL RESOURCES

Cash and Cash Equivalents (in thousands other than percentages):

	Fiscal Years Ended March 31,				2010 to 2009
	2010		2009		Inc (Dec)		%
Working capital	$	39,439	$	1,296	$	38,143		2943	%
Cash and cash equivalents	$	54,536	$	19,864	$	34,672		175	%

Working capital increased $38.1 million for fiscal 2010, from $1.3 million at the end of fiscal 2009. The increase in working capital in fiscal 2010 was primarily due to an increase in cash balances. Cash and cash equivalents consist of cash and money market funds. Cash and cash equivalents increased by $34.7 million or 175% for fiscal 2010 compared, from $19.9 at the end of fiscal 2009. The increase in working capital includes an increase in net cash proceeds from a public offering. On December 16, 2009, the Company issued 3,450,000 shares of common stock in an underwritten public offering at a per-share public offering price of $9.70. The Company received approximately $31.4 million in net cash proceeds after underwriting discounts, commissions and offering expenses. The following table summarizes cash inflows and/or outflows by category (in thousands other than percentages):

	Fiscal Years Ended March 31,								2010 to 2009					2009 to 2008
	2010			2009			2008		Inc (Dec)		%			Inc (Dec)			%
Net cash provided by (used in) operating activities	$	4,623		$	(15,178	)	$	1,288	$	19,801		(130	)%	$	(16,466	)		(1278	)%
Net cash provided by (used in) investing activities	$	(2,123	)	$	(8,019	)	$	43,168	$	5,896		(74	)%	$	(51,187	)		(119	)%
Net cash provided by (used in) financing activities	$	32,733		$	(19,866	)	$	568	$	52,599		(265	)%	$	(20,434	)		(3598	)%

Net cash provided by operating activities was $4.6 million for fiscal 2010 compared to net cash used in operating activities of $15.2 million for the fiscal year 2009. The significant increase in net cash flows from operating activities during fiscal year 2010 compared to fiscal year 2009 is due to the improvement from a $42.3 million net loss, excluding non-cash impairments of intangible assets of $19.6 million and $56.2 million for goodwill, for fiscal 2009 to a $1.2 million net loss for fiscal 2010. The overall improvement in operating income is largely due to the Company’s efforts to reduce operating expenses to align expenditures with reduced revenues.

Net cash used in operating activities was $15.2 million for fiscal 2009 compared to net cash provided by operating activities of $1.3 million for the fiscal year ended 2008. The $15.2 million increase in net cash used in operating activities was primarily attributable to a decline in net revenues and the payment of restructuring costs as further described above in “Results of Operations.”

Net cash used in investing activities was $2.1 million for fiscal 2010 compared to net cash used in investing activities of $8.0 million for the fiscal year 2009. Net cash used during fiscal 2009 was higher due to the Company’s acquisitions of Simple Star and CinemaNow assets during that period; no comparable acquisitions occurred during fiscal 2010.

Net cash used in investing activities was $8.0 million for fiscal 2009 compared to net cash provided by investing activities of $43.2 million for the fiscal year 2008. The $51.2 million change was primarily attributable to a decline in net redemptions of short-term investments. In fiscal year 2008, the Company redeemed $46.2 million, net, in short-term investments compared to $1.1 million in fiscal year 2009. The acquisitions of Simple Star for $5.0 million and CinemaNow for $2.6 million also contributed to the decline in net cash used in investing activities in fiscal 2009 as compared to fiscal 2008.

Net cash provided by financing activities was $32.7 million for fiscal 2010 compared to net cash used in financing activities of $19.9 million for the fiscal year 2009. The increase is attributable to the Company’s offering and sale of 3,450,000 shares of its common stock during the third quarter of fiscal 2010. The Company recorded net proceeds (after deducting the underwriting discounts, commissions and offering expenses) of $31.4 million. The shares of common stock were offered and sold pursuant to a base prospectus and related prospectus supplement, which have been filed with the SEC.

Net cash used in financing activities was $19.9 million in fiscal year 2009 compared to net cash provided by financing activities of $0.6 million for fiscal year ended 2008. The $20.5 million increase in net cash used by financing activities was primarily attributable to the repayment of the $20 million balance on the Company’s Union Bank of California credit facility paid in full on September 29, 2008.

The Company believes its cash balances and cash flows generated by operations will be sufficient to satisfy its anticipated cash needs for working capital and capital expenditures for at least the next 12 months. The Company expects that its actions to reduce operating expenses will allow it to generate operating cash flows sufficient to sustain operations, and to offset, in whole or in part, the potential impact of a decrease in future revenues. However, the Company may require additional cash to fund acquisitions or investment opportunities. In these instances, the Company may seek to raise such additional funds through public, private equity, debt financing, or from other sources. The Company may not be able to obtain adequate or favorable financing at that time. Any equity financing the Company may obtain may dilute existing ownership interests and any debt financing could contain covenants that impose limitations on the conduct of its business.

Contractual Obligations and Commitments

The following table summarizes the Company’s known contractual obligations to make future payments at March 31, 2010 (in thousands):

			Payments Due by Period
Contractual Obligations	Total		Less Than 1 Year		2 Years		3-5 Years		More Than 5 Years
Operating and capital leases (1)	$	6,466	$	4,159	$	1,868	$	439	$	-
Purchase obligations (2)		1,050		550		500		-		-
Total	$	7,516	$	4,709	$	2,368	$	439	$	-

(1)

Operating and capital leases include the Company’s rent obligations on its leased facilities and copiers.

(2)

For the purposes of this table, purchase obligations for the purchase of goods or services are defined as agreements that are enforceable, non-cancelable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. The expected timing of payment of the obligations discussed above was estimated based on information available as of March 31, 2010. Timing of payments and actual amounts paid may be different depending on the time of receipt of goods or services or changes to agreed-upon amounts for some obligations.

The Company may be required to make significant cash outlays related to its unrecognized tax benefits (“UTBs”). However, due to the uncertainty of the timing of future cash flows associated with its UTBs, the Company is unable to make a reasonably reliable estimate of the period of cash settlement, if any, with the respective taxing authorities. As such, UTBs of $6.0 million at March 31, 2010 have been excluded from the contractual obligations table above. For further information related to UTBs, see Note 5, “Income Taxes,” to the Consolidated Financial Statements included in this Annual Report.

The Company sells its software licenses and services to its customers under software license agreements. Each software license agreement contains the relevant terms of the contractual arrangement with the customer, and generally includes provisions that address indemnification of the customer against losses, expenses, and liabilities from damages that may be awarded against the customer in the event the Company’s software is found to infringe upon a third-party patent, copyright, trademark, or other proprietary right. The Company’s standard software license agreement generally limits the scope of and remedies for such indemnification obligations in a variety of industry-standard respects, including, but not limited to, certain time and geography-based scope limitations, limits on aggregate liability, and a right to replace an infringing product.

The Company believes its internal development processes and other policies and practices limit its exposure related to the indemnification provisions of the software license agreements. To date, the Company has not had to reimburse any of its customers for any losses related to these indemnification provisions and is not aware of any material claims.

Concentration of Credit Risk and Off-Balance Sheet Arrangements

ASC 825-10, Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk, requires disclosure of any significant off-balance-sheet and credit risk concentrations. Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash and cash equivalent and accounts receivable. The Company does not have any credit risk such as foreign exchange contracts, option contracts or other hedging arrangements. The Company maintains its cash, cash equivalents balances with highly rated credit institutions. Although the Company tries to limit the amount of credit exposure with any one financial institution, it does in the normal course of business maintain cash balances in excess of federally insured limits.

The Company does not have any off-balance sheet arrangements, as such term is defined by applicable SEC rules, that have or are reasonably likely to have a current or future effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

The Company’s results of operations are subject to both currency transaction risk and currency translation risk, which risks may be material with respect to certain currencies. The Company incurs currency transaction risk when it enters into either a purchase or sale transaction using a currency other than its functional currency. With respect to currency translation risk, the Company’s financial condition and results of operations are measured and recorded in the relevant domestic currency then translated into U.S. dollars at the balance sheet date for inclusion in its consolidated financial statements.

The Company held cash and cash equivalents denominated in Euros that amounted to approximately €2.2 million (U.S. $2.9 million) at each of March 31, 2010 and March 31, 2009. Due to the weakening of the U.S. dollar in fiscal 2010, the currency rate increase of the Euro from March 31, 2009 to March 31, 2010 was 1.9%. One hundred Euro was equal to approximately $135 at March 31, 2010; $143 at December 31, 2009; $146 at September 30, 2009; $140 at June 30, 2009; and $132 at March 31, 2009. A hypothetical 10% increase or decrease in the U.S. dollar versus the Euro as of March 31, 2010 would have resulted in an approximately $0.3 million change in the Company’s net revenues during fiscal 2010.

The Company held cash and cash equivalents denominated in Great Britain Pounds Sterling (“GBP”) that amounted to approximately £0.6 million (U.S. $1.0 million) at March 31, 2010, compared to approximately £0.7 million (U.S. $0.9 million) at March 31, 2009. Due to the weakening of the U.S. dollar in fiscal 2010, the currency rate increase of the GBP from March 31, 2009 to March 31, 2010 was 6%. One hundred GBP was equal to approximately $151 at March 31, 2010; $159 at December 31, 2009; $159 at September 30, 2009; $1.65 at June 30, 2009; and $142 at March 31, 2009. A hypothetical 10% increase or decrease in the U.S. dollar versus the GBP as of March 31, 2010 would have resulted in an approximately $0.2 million change in the Company’s net revenues during fiscal 2010.

The Company held cash and cash equivalents denominated in Japanese Yen that amounted to approximately ¥168 million (U.S. $1.8 million) at March 31, 2010, compared to approximately ¥176 million (U.S. $1.7 million) at March 31, 2009. Due to the weakening of the U.S. dollar in fiscal 2010, the currency rate increase of the Japanese Yen from March 31, 2009 to March 31, 2010 was 5.2%. One hundred Japanese Yen was equal to approximately $1.08 at March 31, 2010; $1.08 at December 31, 2009; $1.11 at September 30, 2009; $1.05 at June 30, 2009; and $1.03 at March 31, 2009. A hypothetical 10% increase or decrease in the U.S. dollar versus the Japanese Yen as of March 31, 2010 would have resulted in an approximately $0.4 million change in the Company’s net revenues during fiscal 2010.

The Company’s market risk sensitive instruments were all entered into for non-trading purposes. The Company does not engage in any hedging activities and does not use derivatives or equity investments for cash investment purposes.

Item 8. Financial Statements and Supplementary Data

The reports of Independent Registered Public Accounting Firm, Consolidated Financial Statements and Notes to Consolidated Financial Statements follow.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders, Sonic Solutions

We have audited the accompanying consolidated balance sheet of Sonic Solutions and subsidiaries (“the Company”) as of March 31, 2010, and the related consolidated statements of operations, shareholders’ equity and comprehensive loss, and cash flows for the year ended March 31, 2010. We also have audited the Company’s internal control over financial reporting as of March 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Our audit also included the financial statement schedule listed in the Index at Part IV, Item 15. The Company’s management is responsible for these financial statements and schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control Over Financial Reporting, appearing under Item 9A. Our responsibility is to express an opinion on these financial statements and schedule and an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of March 31, 2010, and the results of its operations and its cash flows for the year ended March 31, 2010 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule for the year ended March 31, 2010, when considered in relation to the consolidated financial statements as a whole, presents fairly in all material respects the information set forth therein. Also in our opinion, the Company’s maintained, in all material respects, effective internal control over financial reporting as of March 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by COSO.

/s/ Armanino McKenna, LLP

San Ramon, California

June 4, 2010

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of Sonic Solutions:

We have audited the accompanying consolidated balance sheet of Sonic Solutions and subsidiaries as of March 31, 2009 and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss) and cash flows for each of the two years in the period ended March 31, 2009. In connection with our audits of the financial statements, we have also audited the schedule listed in the accompanying index. These consolidated financial statements and the schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and the schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sonic Solutions and subsidiaries as of March 31, 2009 and the results of their operations and their cash flows for each of the two years in the period ended March 31, 2009, in conformity with accounting principles generally accepted in the United States of America.

Also in our opinion, the related schedule for 2009 and 2008, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects the information set forth therein.

/s/ BDO Seidman, LLP

San Francisco, California

May 29, 2009

CONSOLIDATED FINANCIAL STATEMENTS

SONIC SOLUTIONS