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, 2009





OR




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





For
the transition period from
to





Commission
File Number: 72870











SONIC
SOLUTIONS


(Exact
name of registrant as specified in its charter)


California
                        
                        93-0925818(State
      or other jurisdiction of
                          incorporation
      or organization)
                        
                        (IRS
      Employer
                          Identification
      No.)101
      Rowland Way, Suite 110
                          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 registeredCommon
      Stock, no par value
            
            The
      Nasdaq Stock Market LLC





Securities
registered pursuant to Section 12(g) of the Act





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, 2008) was approximately $126.1 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 May 27, 2009
was 26,615,868.





DOCUMENTS
INCORPORATED BY REFERENCE:  None





SONIC
SOLUTIONS


TABLE
OF CONTENTS





Additional
      Information
                    
                    3Forward
      Looking Information
                    
                    3PART
      I
                    
                    Item
      1.
                    
                    Business
                    
                    3Item
      1A.
                    
                    Risk Factors
                    
                    9Item
      1B.
                    
                    Unresolved Staff Comments
                    
                    18Item
      2.
                    
                    Properties
                    
                    18Item
      3.
                    
                    Legal Proceedings
                    
                    18Item
      4.
                    
                    Submission of Matters to a Vote of Security
      Holders
                    
                    19PART
      II
                    
                    Item
      5.
                    
                    Market for Registrants Common Equity, Related
      Stockholder Matters and Issuer Purchases of Equity
      Securities
                    
                    20Item
      6.
                    
                    Selected Financial Data
                    
                    22Item
      7.
                    
                    Management’s Discussion and Analysis of Financial
      Condition and Results of Operations
                    
                    23Item
      7A.
                    
                    Quantitative and Qualitative Disclosures About
      Market Risk
                    
                    41Item
      8.
                    
                    Financial Statements and Supplementary
      Data
                    
                    42Item
      9.
                    
                    Changes in and Disagreements with Accountants on
      Accounting and Financial Disclosures
                    
                    69Item 9A.
                    
                    Controls and Procedures
                    
                    69Management’s Report on Internal Control over
      Financial Reporting
                    
                    69Report of Independent Registered Public Accounting
      FirmItem 9B.
                    
                    Other Information
                    
                    70PART
      III
                    
                    Item
      10.
                    
                    Directors, Executive Officers and Corporate
      Governance
                    
                    71Item
      11.
                    
                    Executive Compensation
                    
                    74Item
      12.
                    
                    Security Ownership of Certain Beneficial Owners
      and Management and Related Stockholder Matters
                    
                    85Item
      13.
                    
                    Certain Relationships and Related Transaction and
      Director Independence
                    
                    86Item
      14.
                    
                    Principal Accountant Fees and
      Services
                    
                    87PART IV
                    
                    Item 15.
                    
                    Exhibits and Financial Statement
      Schedules
                    
                    88




2




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, 2009, 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 2009” and “fiscal year 2009” each refer to the fiscal year ending
March 31, 2009. 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 include,
but are not limited to, statements regarding:  the market for the
Company’s products;  macroeconomic conditions; consumer spending;
leisure and entertainment related activities and related technologies;
proliferation of Internet-connected devices; the Company’s competitive position;
continued popularity of the DVD format; growing popularity of the Blu-ray Disc
(“BD”) format; market for digital distribution of premium content, impact of
restructuring plans; liquidity and capital needs; gross margins; operating
expenses; significant customers, major distributors and key suppliers; content
licensing; impacts of the Company’s pricing strategies; acquisitions and
integration of related assets, business, personnel and systems; international
operations; litigation or patent prosecution; intellectual property claims; and
changes in effective tax rates.  These forward-looking statements are
subject to risks and uncertainties that could cause actual results and events to
differ.  Factors that could cause actual results or conditions to
differ from those anticipated by these and other forward-looking statements
include those more fully described below under “Item 1.  Business”,
“Item 1A.  Risk Factors”, “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 on the date hereof, 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, original equipment manufacturers
(“OEMs”), enterprises, high-end professional DVD 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 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, 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
101 Rowland Way, Suite 110, Novato, California 94945.  Its telephone
number is (415) 893-8000, and its fax number is (415) 893-8008.




Periodically,
the Company has acquired assets other than in the ordinary course of
business.  For example in its largest acquisition, in December 2004,
the Company acquired substantially all of the assets of the Roxio Consumer
Software business from Roxio, Inc. (which changed its name to Napster, Inc. upon
consummation of the acquisition).  Additionally, during fiscal 2009,
the Company completed two acquisitions qualifying as business combinations:
Simple Star, Inc. and CinemaNow, Inc.  For information regarding
acquisitions, see Note 7, “Acquisitions,” to the Consolidated Financial
Statements included in this Annual Report.




3


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, unify its OEM licensing efforts, and
eliminate organizational redundancies.  For more information seeNote 8,
“Restructuring,” to the Consolidated Financial Statements included in this
Annual Report.




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 now
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 Segment




Products
and Services




The
Company’s Roxio Consumer 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.  Roxio offers products and
services under a variety of names, including BackonTrack, Backup MyPC,
CinePlayer, Crunch, Easy VHS to DVD, Just!Burn, MyDVD, MyTV To Go, PhotoShow,
PhotoSuite, Popcorn, RecordNow, Roxio Copy & Convert, Roxio Creator, Toast,
VideoWave, WinOnCD, and others.




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 same “under the hood”
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.




The
Company has bundling arrangements with a variety of OEMs whose products include
such features as video capture and interface cards, DVD recorders, CD recorders,
PC models that include DVD recorders, PC models that include CD recorders, PC
models positioned as “multimedia” PCs, mobile phones and other
devices.  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 largest such
program is currently with Dell.




4




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.




Roxio
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, elegant, 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 PCs.  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, elegant, and trouble-free user experience.




Web
Store




The
Company currently 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 sites that are branded as the Company’s, provide the
infrastructure to handle secure purchase transactions, and deliver the product
(whether via web download or physical fulfillment).  The Company
believes that its web-based retail channel will represent an increasing
percentage of its overall Roxio software revenues.  Sales through this
channel constituted approximately 22%, 22% and 20% of total net revenues for
fiscal years 2009, 2008 and 2007, respectively.  Digital River was the
primary source through which the Company earned web store revenues
during fiscal 2009, 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 retail partners -
representing both traditional physical retail stores as well as catalog and web
stores, including physical store locations worldwide that sell at least one of
its products.  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.  In North America, the Company’s
major distribution partners are Navarre Corporation and Ingram Micro, Inc.
(“Ingram”).  In Europe, the Company has multiple distribution
partners, including GEM Distribution Ltd., Ingram, Koch Media GmbH, and
Computers Unlimited SAS, that handle the majority of its European distribution
volume.  In Japan, the Company’s distribution partners are Softbank
Commerce Corporation and Marubeni Corporation.




Technology
Licensing




The
Company also markets the same “under the hood” 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 top level
mechanism permitting other companies’ software engineers easily to access the
Company’s processing technology and 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.




5


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 the
Company’s current primary supplier and provides 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.  Finished goods usually are produced and shipped within
a week of receipt of order.  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.  Both large and small companies produce video editors,
photo editors, backup solutions and other products and services that compete
with the Company’s.  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.  The Company’s digital media products, including DVD
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.




Segment
Information




The Roxio
Consumer segment accounted for approximately 87% of net revenue for fiscal year
2009.  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




Products
and Services




The
Company’s Premium Content segment offers a range of products and services
related to the creation, distribution and enjoyment of premium
content.  Within this segment, the Professional Products Group
reporting unit offers software under the Scenarist, CineVision, and DVDit
product names and Sonic and Roxio Professional brands to major motion picture
studios, high-end authoring houses and other professional
customers.  CinemaNow, also part of this segment, sells, rents and
distributes premium entertainment content to consumers over the
Internet.  The Company also develops software components that it
licenses to CE companies to enable their devices to offer premium content to
consumers, licenses intellectual property through its Qflix initiative, and
licenses patents.




Products
and Services




Professional
Products




The
Professional Product Group develops, sells, and provides technical support for 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 various 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 products enable professional customers to prepare DVD, BD
and other digitally formatted titles for a variety of purposes, including
private, one-off, independent and major commercial release packaged media or
digital distribution to mass market consumers worldwide.  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.


6


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.




CinemaNow




CinemaNow
is the Company’s Internet delivery platform for the sell-through or rental of
premium content.  The CinemaNow 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. This premium content is
available for electronic sell-through (download to own), rental or DVD burning
using Qflix technology.  The titles on CinemaNow include blockbuster
Hollywood hits, feature-length films, television episodes, short films, and
music concerts.




Technology
Licensing




In
connection with its CinemaNow service and premium software offerings, 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 the Company’s intellectual property, it may litigate or
bring other 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, 2009, the Company employed 14 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.  Most of the Company’s field sales personnel
operate under compensation arrangements in which a substantial portion of their
compensation is contingent upon performance relative to revenue
targets.  The Company’s professional customers span the “Hollywood to
Home” spectrum.  On the Hollywood end, 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 production facilities utilize the Company’s solutions
to provide authoring services for Digital Video Disc (“DVD”), BD, digital and
other formats.  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 CinemaNow service directly through its www.cinemanow.com
website and, increasingly, through third party partners who offer the service
through their own websites, through computers and through CE
devices.  To the extent that the Company offers the CinemaNow 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.


7


Competitive
Environment




A number
of companies produce or have produced products that compete with some or all of
the Company’s premium product and service offerings.  The Company’s
CinemaNow 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 video on demand (“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 13% of net revenue for
fiscal year 2009.  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 quite possible that some of its present or
future products 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 to its customers against the possibility that their use of its products
will ultimately be held to be infringing.  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 in
the bundling agreements 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 Sonic
technologies.


8


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 2009.




Research
and Development




The
Company’s research and development staff is located principally at its
headquarters in Novato and Santa Clara, California, and in its offices in San
Luis Obispo, California; Wayne, Pennsylvania and; in Shanghai and Hangzhou,
China.  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, 2009, the Company had approximately 518 full-time employees, a
reduction of 24% from its previous level as of March 31, 2008, due primarily to
restructuring activities in fiscal 2009.  The total consists of
102 employees engaged in sales and marketing, 314 engaged in research and
development and the remaining 102 engaged in general and
administration.  As of March 31, 2009, the Company had approximately
246 employees in North America, 28 employees in Europe, and
244 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 on Form 10-K, 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 Securities and Exchange Commission
(“SEC”).  Information contained on the Company’s website is not a part
of this Annual Report.




Item
1A.  Risk Factors





The
following are certain risk factors that could affect the Company’s business,
financial results and results of operations.  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.





Current
adverse global economic conditions has 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 has had and could continue to negatively affect the
Company’s business, results of operations, and financial condition.





The
recent global economic downturn has resulted in a tightening in the credit
markets, a low level of liquidity in many financial markets, and extreme
volatility in fixed income, credit and equity markets. There could be a number
of follow-on effects from the credit crisis on the Company’s business, including
insolvency of key suppliers resulting in product delays; inability of customers
to obtain credit to finance purchases of Company products, and increased expense
or inability to obtain financing for Company operations.


9


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





The
Company experienced net losses of $118.1 million and $5.5 million for fiscal
years 2009 and 2008, respectively.  There can be no assurance that the
Company will be cash flow positive or generate net income in fiscal year 2010 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 changes
in technology.  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, and, therefore, the Company may
fail to make accurate financial forecasts.  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




·
            economic
      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, the Company 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, and this could in
turn negatively affect the market price of its common stock.





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 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 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.  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 adversely.


10


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 its 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’s
products.  If the 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, its sales could be impacted
negatively.  Further, if the Company reduces the prices of its
products, it 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 continue to
increase, its 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
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 on which it
develops new products will allow it to compete effectively with companies
possessing greater financial and technological resources than it 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 the Company’s
customers.  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, extensive
competition, and/or product warranty concerns.  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 harmed.





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





A
substantial portion of the Company’s revenue is derived from sales through OEM
customers who bundle copies of Company’s software with their
products.  Temporary fluctuations in the pricing and availability of
the OEM customers’ products could negatively impact sales of the Company’s
products, which could in turn harm its business, financial condition and results
of operations.  Moreover, sales of the Company’s OEM products depend
in large part on consumer acceptance and purchase of DVD players, BD players,
DVD recorders and other digital media devices marketed by its 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.





In
addition, the Company relies on reports prepared by OEM customers to determine
the results of its 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
the Company’s business or its reported results.





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





OEM
customers can be quite demanding with respect to the features they demand in
software products they bundle, quality and testing requirements, and economic
terms.  Because there are a relatively small number of significant OEM
customers, if they demand reduced prices for Company products, the Company may
not be in a position to refuse such demands, which would damage its revenues and
results of operations.  If particular OEMs demand certain 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, the Company could lose
those relationships, which likely would damage its revenues and its results of
operations.  Also, if the Company’s competitors offer its OEM
customers more favorable terms than it does or if its competitors are able to
take advantage of their existing relationships with these 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.


11


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, 2009, approximately 14% and 11% of the Company’s
net revenue was derived from revenue received from Dell and Hewlett-Packard,
respectively, and approximately 6% and 16% of its net revenue for fiscal 2009
was derived from revenue received from its two largest distributors, Ingram and
Navarre, respectively.  In addition, during fiscal 2009, approximately
22% of the Company’s net revenue was derived from online web store revenue
received through Digital River.  The Company anticipates that the
relationships with Dell, Hewlett-Packard, Ingram, Navarre and Digital River will
continue to account for a significant portion of its revenue in the
future.  Any changes in the Company’s relationships with any of these
companies could seriously harm its operating results, business, and financial
condition.





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





The
Company currently 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 the Company’s 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 end-user support and ongoing services, it may be required to
defer a greater percentage of its revenues into future periods, which could harm
its 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 primarily
to HP Software Publishing.  HP Software Publishing provides services
such as parts procurement, parts warehousing, product assembly and supply chain
services from two primary locations: Andover, Massachusetts,
servicing North America; and Galway, Ireland, servicing
Europe.  Production services and supply chain logistics for Asia and
the Pacific Rim are provided by ModusLink, Taipei.  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, if these suppliers ceased to perform or fail to
perform as the Company expects, the Company could face difficulty in engaging
substitute suppliers in a timely manner or at all or under terms and conditions
acceptable to the Company.





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





The
market for the Company’s software is intensely competitive.  It is
likely that prices for its OEM products, particularly in the DVD area, will
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 now 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
may cause it to incur increasing losses.


12


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





The
Company may engage in future acquisitions that could dilute its existing
shareholders’ ownership and harm its business, results of operations and
financial condition.





As part
of the Company’s efforts to enhance its existing products and services,
introduce new products and services, grow its business and remain competitive,
the Company has pursued, and it may continue to pursue acquisitions of
companies, products and technologies.  The Company cannot assure you
that it will be able to successfully identify suitable acquisition candidates,
complete acquisitions, integrate acquired businesses into its current
operations, or expand into new markets.  In addition, the integration
of a new business into the Company’s existing business is a complex,
time-consuming and expensive process.  If Company’s management is
unable to minimize the potential disruption to its business during the
integration process, the anticipated benefits of an acquisition may not be
realized.  Realizing the benefits of an acquisition depends in part on
integrating technology, operations and personnel while maintaining focus on
existing business.  The Company may encounter substantial
difficulties, costs and delays in integrating various
acquisitions.  As a consequence, acquisitions by the Company could
result in the following, any of which could seriously harm its results of
operations, business, financial condition and/or the price of its
stock:




·
            potential conflicts between
      business cultures, and difficulties and delays in the assimilation and
      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;




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




·
            large one-time
      write-offs;




·
            the incurrence of debt and
      contingent liabilities;




·
            contractual and/or intellectual
      property disputes;




·
            undiscovered and unknown
      problems, defects or other issues related to any acquisition that become
      known to the Company only after the
  acquisition;




·
            potential conflicts in
      distribution, marketing or other important relationships, or poor
      acceptance by the Company’s
resellers;




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




·
            acquired product and services may
      not attract consumers and other end
  users;




·
            potential loss of key employees
      of acquired businesses and disruptions among employees that may erode
      employee morale;




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




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




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





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





As of
March 31, 2009, the Company had four major locations (defined as a location with
more than 15 employees) and employed approximately 272 employees outside the
United States.  The Company’s management team 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 and, as a result, on the market price
of its common stock.


13


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





Revenue
derived from international customers accounted for approximately 28%, 18% and
22% of the Company’s net revenues in fiscal years 2009, 2008 and 2007,
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.





The
Company’s international operations expose it to additional risks, including, but
not limited to:




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




·
            delays resulting from difficulty
      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 a
      variety of foreign laws, including more stringent consumer and data
      protection laws;




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




·
            difficulties in coordinating the
      activities of its 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 may be less protective of
      the Company’s intellectual property rights than U.S.
      law;




·
            political and economic
      instability;




·
            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 its global business, the Company faces
risks due to the substantial operations it conducts in China, which could be
adversely affected by political, economic and social uncertainties in China.
 The economic reforms in China in recent years are regarded by China’s
central government as a way to introduce economic market forces into China.
 However, given the desire of the central government leadership to maintain
stability in China amid rapid social and economic changes, economic market
reforms of recent years could be slowed, or even 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.





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





The
Company has experienced declines in consumer products revenue, and absent the
introduction and market acceptance of new formats such as BD or new business and
service models, the Company expects such declines to
continue.


14


With
the growth in the Internet software sales, the Company expects to face
increasing competition from smaller software providers.





The
increasing popularity of the Internet is enabling 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 has been 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 new CinemaNow service will have a positive
impact on the Company’s profitability.





During
fiscal 2009, the Company acquired substantially all of the assets of CinemaNow,
Inc., an online movie download and streaming business.  There is no
assurance that consumers will widely adopt its online movie service offerings or
that it will become profitable.  The Company has invested, and will
continue to invest, significant time and money in building the premium content
business, and the Company’s 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 CinemaNow
service.





The
Company’s ability to provide its CinemaNow service depends on studios licensing
content for Internet delivery.  The studios have great discretion in
whether to license their content, and the license periods and the terms and
conditions of such licenses vary by studio.  If the 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 CinemaNow service to the
Company’s customers will be adversely affected, which could adversely affect the
Company’s business and operating results.





The
Company relies on a number of third parties to deliver its CinemaNow
service.





The
Company offers its CinemaNow service through various PC and CE platforms and
devices.  If the Company isn’t successful in creating appropriate
distribution relationships with third parties, or if the Company encounters
technological, content licensing or other impediments, the Company’s ability to
grow its CinemaNow service could be adversely impacted, which could adversely
affect the Company’s 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 such as BD may be more expensive for the Company to
acquire and deliver, and if customers select these formats on a proportional
basis more often than the existing standard definition formats, 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
CinemaNow 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 these 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, 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.


15


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, 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.





Undetected
errors found in Company products and services may result in loss of or delay in
market acceptance, which could seriously harm 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
modify significantly its products or services to correct these
errors.  Failure to achieve acceptance could result in a delay in, or
inability to, receive payment.  The Company’s products and services
may not be free from errors or defects after commercial shipments have begun or
services rendered, which could result in the rejection of its products and
damage to its 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 its
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 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 the Company’s operating results.  The Company
is not likely to have sufficient insurance to compensate adequately for 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 patent,
trademark, copyright and trade secret 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.  As new standards and technologies evolve, the Company, it
believes that it may face an increasing number of third party claims relating to
patent infringements and potential patent infringements over
time.  Patent infringement litigation can be time consuming and
costly, may divert management resources and could result in the invalidation of
the Company’s intellectual property rights.  If such litigation
resulted in an unfavorable outcome for the Company, it 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’s use of technology asserted to be infringing could result in liability
that could adversely affect its ability to continue its operations as currently
structured.


16


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 Company license
agreements with customers, the Company 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’s indemnity or warranty obligations to its customers, its customers may
be entitled to additional contractual remedies against the Company, which could
harm its business.  Furthermore, even if the Company was not liable to
its customers, its customers may stop buying Company 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 its products.  Any of these
results could harm its 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 has been and 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 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 digital media software
  markets;




·
            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.


17


The
current volatility and disruption in the capital and credit markets may continue
to exert downward pressure on the Company’s stock price and the Company may
cease to be in compliance with the continued listing standards set forth by
Nasdaq.





The
capital and credit markets have been experiencing extreme volatility and
disruption for more than twelve months.  Stock markets in general and the
Company’s stock prices in particular, have experienced significant price and
volume volatility over the past year.  Although Nasdaq has suspended the
enforcement of rules requiring a minimum $1.00 closing bid price and the rules
requiring a minimum market value of publicly held shares, this suspension is
temporary.  There is no guarantee that the Company will be in compliance
with Nasdaq’s continued listing requirements when this suspension is lifted.
 If the Company’s stock trades below $1.00 per share after the
temporary suspension is lifted, Nasdaq may commence delisting procedures against
the Company.  If the Company were delisted, the market liquidity of its
common stock could be adversely affected and the market price of its common
stock could decrease. A delisting could also adversely affect the Company’s
ability to obtain financing for the continuation of its operations and could
result in a loss of confidence by investors, suppliers and
employees.





Item
1B.  Unresolved Staff Comments





None.




Item
2.  Properties





The
Company’s corporate headquarters is located in Novato, California, where it
occupies approximately 30,569 square feet under a lease expiring in January 31,
2010.  During fiscal 2009, the Company decreased its leased property
by 20% or 7,431 square feet from 38,000 feet that was leased in fiscal
2008.  The Company is in the process of locating and negotiating new
headquarters for fiscal 2010.  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.





Item
3.  Legal Proceedings





Litigation
Matters





Between
March and June 2007, the Company was notified that a total of five shareholder
derivative lawsuits had been filed by persons identifying themselves as
shareholders of the Company and purporting to act on its behalf, naming it as a
nominal defendant and naming some of its current and former officers and
directors as defendants.  Four of these actions were filed in the
United States District Court for the Northern District of California, and one
was filed in the Superior Court of California for the County of
Marin.





In these
actions, the plaintiffs assert claims against the individual defendants for
violations of the Exchange Act, violations of the California Corporations Code,
breach of fiduciary duty and/or aiding and abetting, abuse of control, gross
mismanagement, corporate waste, unjust enrichment, rescission, constructive
fraud, and an accounting and a constructive trust.  The plaintiffs’
claims concern the granting of stock options by the Company and the alleged
filing of false and misleading financial statements.  All of these
claims are asserted derivatively on the Company’s behalf.  The
plaintiffs seek, among other relief, an indeterminate amount of damages from the
individual defendants and a judgment directing the Company to reform its
corporate governance.





The
federal cases were consolidated on August 2, 2007, into one action captioned
Wilder v. Doris, et al.
(C07-1500) (N.D. Cal.). On April 30, 2008, plaintiffs filed a consolidated class
action and shareholder derivative complaint.  On September 19, 2007,
the court in the state action granted the Company’s motion to stay that
proceeding in its entirety until final resolution of the consolidated federal
action.  In February 2009, the parties reached an agreement in
principle to settle these actions.  The Company agreed to adopt
certain remedial measures to improve the Company's stock option granting
processes, in addition to the repayment and repricing of portions of the excess
value received from stock options that certain officers and directors previously
agreed to.  As part of the settlement, the Company’s Directors and
Officers liability insurer agreed to pay the derivative plaintiffs’ counsel
attorneys fees and costs in the amount of $775,000, subject to court
approval.  On May 14, 2009 the Wilder court granted
preliminary approval of the settlement.  The final approval hearing is
scheduled for August 6, 2009.


18


In
addition to the derivative actions, two putative shareholder class actions have
been filed against the Company and various of its executive officers and
directors.  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 on behalf of a proposed class of plaintiffs comprised of persons that
purchased its shares between October 4, 2002 and May 17, 2007.  On
March 21, 2008, plaintiffs filed a consolidated amended complaint against the
Company and various of its executive officers and directors 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.  This
action alleges various violations of the Exchange Act and the rules thereunder,
and is based on substantially similar factual allegations and claims as in the
derivative actions.  On June 27, 2008, defendants filed a motion to
dismiss the consolidated amended complaint.  On September 4, 2008,
this action was reassigned to the judge presiding over the Wilder v. Doris
action.  Upon the reassignment, the court directed defendants to
refile the motion to dismiss.  Defendants refiled their motion to
dismiss on November 25, 2008.    Defendants’ motion was
heard on February 26, 2009.  On April 6, 2009, the judge issued an
order granting in part and denying in part defendants’ motion to dismiss, with
leave to amend.  On May 8, 2009, plaintiffs filed a first amended
class action complaint.  This complaint alleges violations of §§ 10b,
14(a), 20(a), and 20A of the Securities Exchange Act.





On
November 16, 2007, a putative shareholder class action was filed in the Superior
Court of California for the County of Marin, against the Company and various of
its executive officers and directors on behalf of a proposed class of plaintiffs
comprised of persons that purchased the Company’s shares between July 12, 2001
and May 17, 2007.  This action alleges breach of fiduciary duties, and
is based on substantially similar factual allegations and claims as in the other
lawsuits. The court in the state putative shareholder class action sustained the
Company’s demurrers to the complaint with leave to amend.  On April
21, 2008, the plaintiff in that action filed an amended complaint, which asserts
additional claims under the California Corporations Code.  The court
sustained the Company’s demurrers to the amended complaint, without leave to
amend in part and with leave to amend in part.  Plaintiff did not file
an amended complaint.  Accordingly, on July 30, 2008, the court
dismissed the entire case with prejudice and entered judgment in favor of
defendants.  On September 26, 2008, plaintiff filed a notice of appeal
from the court’s order dismissing plaintiff’s complaint with prejudice and
entering final judgment.  The briefing on this appeal is complete, but
the date for oral argument has not been set by the court.





In
addition to the legal proceedings identified above, from time to time the
Company is subject to legal proceedings, claims, investigations and proceedings
in the ordinary course of business, including claims of alleged infringement of
third-party patents and other intellectual property rights, commercial,
employment and other matters.  The Company makes provisions for legal
proceedings as appropriate.  These provisions are reviewed at least
quarterly and adjusted to reflect the impacts of negotiations, settlements,
rulings, advice of legal counsel, and other information and events pertaining to
particular cases.  Litigation is inherently
unpredictable.  However, the Company believes that its has valid
defenses with respect to the legal matters pending against
it.  Nevertheless, it is possible, that the Company’s consolidated
financial position, cash flows or results of operations could be affected by the
resolution of one or more of such matters.





The
Company maintains Directors and Officers (“D&O”) liability insurance, which
has covered, to date, the legal fees and costs associated with the above legal
actions.  During fiscal 2009, the Company’s D&O insurance paid
legal fees and costs totaling $0.8 million.





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.





The
Company, as permitted under California law and in accordance with its Bylaws and
certain other commitments and agreements, 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.  In this regard, the Company has received, or expects to
receive, requests for indemnification by certain current and former officers and
directors in connection with its stock options review and shareholder derivative
and class action litigation described herein.  The maximum amount of
potential indemnification is unknown and potentially unlimited; however, the
Company has D&O liability insurance that enable it to recover a portion of
future indemnification claims paid, subject to retentions, conditions and
limitations of those policies.





Item
4.  Submission of Matters to a Vote of Security Holders





None.


19




PART
II






Item
5.  Market for Registrant’s Common Equity, Related Shareholder 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 2009 and fiscal 2008 are as follows:





Fiscal
      Year 2009
                    
                    Low
      Price
                    
                    
                    High
      PriceQuarter
      ended 6/30/2008
                    
                    $
                    5.61
                    
                    
                    $
                    10.33Quarter
      ended 9/30/2008
                    
                    $
                    3.31
                    
                    
                    $
                    6.84Quarter
      ended 12/31/2008
                    
                    $
                    0.61
                    
                    
                    $
                    4.67Quarter
      ended 3/31/2009
                    
                    $
                    0.57
                    
                    
                    $
                    2.03Fiscal
      Year 2008
                    
                    Low
      Price
                    
                    
                    High
      PriceQuarter
      ended 6/30/2007
                    
                    $
                    11.76
                    
                    
                    $
                    15.16Quarter
      ended 9/30/2007
                    
                    $
                    7.38
                    
                    
                    $
                    13.54Quarter
      ended 12/31/2007
                    
                    $
                    7.72
                    
                    
                    $
                    13.07Quarter
      ended 3/31/2008
                    
                    $
                    7.73
                    
                    
                    $
                    10.94





As of
March 31, 2009, the last reported sale price on the Nasdaq Global Market for the
Company’s common shares was $1.20 per share.





Record
Holders





As of
March 31, 2009, there were approximately 112 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 112 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
regarding the Company’s equity compensation plans and the securities authorized
for issuance thereunder is set forth in Part II, Item 8, Note 4,
“Shareholders’ Equity” to the Consolidated Financial Statements included in this
Annual Report.





Purchases
of Equity Securities by the Issuer and Affiliated Purchasers





On
November 26, 2008, the Company filed a Tender Offer Statement on Schedule TO
with the SEC to repurchase and cancel certain stock options with high exercise
prices and other options that were potentially subject to adverse taxation under
Internal Revenue Code Section 409A.  During the third quarter of fiscal
2009, the Company purchased options to acquire approximately 2.8 million
eligible shares and paid approximately $0.1 million in the fourth quarter of
fiscal 2009.


20


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, 2004 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
                    TechnologyFYE
      03/04
                  
                  $
                  100.00
                  
                  
                  $
                  100.00
                  
                  
                  $
                  100.00FYE
      03/05
                  
                  $
                  78.18
                  
                  
                  $
                  106.69
                  
                  
                  $
                  97.51FYE
      03/06
                  
                  $
                  94.08
                  
                  
                  $
                  119.20
                  
                  
                  $
                  110.70FYE
      03/07
                  
                  $
                  73.25
                  
                  
                  $
                  133.31
                  
                  
                  $
                  114.13FYE
      03/08
                  
                  $
                  50.13
                  
                  
                  $
                  126.54
                  
                  
                  $
                  113.65FYE
      03/09
                  
                  $
                  6.23
                  
                  
                  $
                  78.34
                  
                  
                  $
                  79.48




21




Item
6.  Selected Financial Data







The
selected consolidated statements of operations data presented below for the
three years ended March 31, 2009, and the selected consolidated balance sheet
data as of March 31, 2009, 2008 and 2007, are derived from, and qualified by
reference to, the audited financial statements appearing elsewhere in this
Annual Report (restated as to 2006 and 2005), and should be read in conjunction
with those financial statements.  The consolidated statement of
operations data for the year ended March 31, 2005 and the consolidated balance
sheet data as of March 31, 2006 are derived from restated audited financial
statements not included herein.  The consolidated balance sheet data
as of March 31, 2005 is derived from unaudited financial statements not included
herein.  The 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”, all
included elsewhere herein.





Years
      Ended March 31,Consolidated
      Statements of Operations Data:
                      
                      2009
                      
                      
                      2008
                      
                      
                      2007
                      
                      
                      2006
                      
                      
                      2005(In
      thousands, except share and per share amounts)Net
      revenue
                      
                      $
                      119,958
                      
                      
                      $
                      132,874
                      
                      
                      $
                      148,649
                      
                      
                      $
                      147,608
                      
                      
                      $
                      90,627Cost
      of revenue
                      
                      
                      32,901
                      
                      
                      
                      33,151
                      
                      
                      
                      34,389
                      
                      
                      
                      34,132
                      
                      
                      
                      13,373Impairment
      of intangibles (1)
                      
                      
                      19,579
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Gross
      profit
                      
                      
                      67,478
                      
                      
                      
                      99,723
                      
                      
                      
                      114,260
                      
                      
                      
                      113,476
                      
                      
                      
                      77,254Operating
      expenses:Marketing
      and sales(2)
                      
                      
                      35,810
                      
                      
                      
                      36,186
                      
                      
                      
                      33,304
                      
                      
                      
                      35,606
                      
                      
                      
                      22,547Research
      and development(2)
                      
                      
                      39,250
                      
                      
                      
                      44,511
                      
                      
                      
                      44,513
                      
                      
                      
                      44,157
                      
                      
                      
                      33,299General
      and administrative (2)
                      
                      
                      24,160
                      
                      
                      
                      27,310
                      
                      
                      
                      20,487
                      
                      
                      
                      22,214
                      
                      
                      
                      11,777Acquired
      in-process technology
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      3,400
                      
                      
                      
                      -
                      
                      
                      
                      3,100Abandoned
      acquisition
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      1,016
                      
                      
                      
                      -
                      
                      
                      
                      -Business
      integration
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      336
                      
                      
                      
                      2,190Restructuring
                      
                      
                      3,947
                      
                      
                      
                      3,152
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Impairment
      of goodwill(1)
                      
                      
                      56,174
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Total
      operating expenses
                      
                      
                      159,341
                      
                      
                      
                      111,159
                      
                      
                      
                      102,720
                      
                      
                      
                      102,313
                      
                      
                      
                      72,913Operating
      income (loss)
                      
                      
                      (91,863
                      )
                      
                      
                      (11,436
                      )
                      
                      
                      11,540
                      
                      
                      
                      11,163
                      
                      
                      
                      4,341Interest
      income
                      
                      
                      687
                      
                      
                      
                      2,768
                      
                      
                      
                      2,845
                      
                      
                      
                      1,271
                      
                      
                      
                      998Interest
      expense
                      
                      
                      (767
                      )
                      
                      
                      (1,479
                      )
                      
                      
                      (2,024
                      )
                      
                      
                      (1,846
                      )
                      
                      
                      (214
                      )Other
      income (expense), net
                      
                      
                      (1,020
                      )
                      
                      
                      356
                      
                      
                      
                      (40
                      )
                      
                      
                      (431
                      )
                      
                      
                      (607
                      )Income
      (loss) before income taxes
                      
                      
                      (92,963
                      )
                      
                      
                      (9,791
                      )
                      
                      
                      12,321
                      
                      
                      
                      10,157
                      
                      
                      
                      4,518Provision
      (benefit) for income taxes
                      
                      
                      25,160
                      
                      
                      
                      (4,254
                      )
                      
                      
                      6,071
                      
                      
                      
                      (9,177
                      )
                      
                      
                      1,771Net
      income (loss)
                      
                      $
                      (118,123
                      )
                      
                      $
                      (5,537
                      )
                      
                      $
                      6,250
                      
                      
                      $
                      19,334
                      
                      
                      $
                      2,747Basis
      and diluted net loss per share:Net
      income (loss) per share - basic
                      
                      $
                      (4.46
                      )
                      
                      $
                      (0.21
                      )
                      
                      $
                      0.24
                      
                      
                      $
                      0.78
                      
                      
                      $
                      0.12Net
      income (loss)  per share - diluted
                      
                      $
                      (4.46
                      )
                      
                      $
                      (0.21
                      )
                      
                      $
                      0.23
                      
                      
                      $
                      0.74
                      
                      
                      $
                      0.11Shares
      used in per share calculation - basic
                      
                      
                      26,535
                      
                      
                      
                      26,247
                      
                      
                      
                      25,982
                      
                      
                      
                      24,750
                      
                      
                      
                      23,347Shares
      used in per share calculation - diluted
                      
                      
                      26,535
                      
                      
                      
                      26,247
                      
                      
                      
                      27,431
                      
                      
                      
                      26,234
                      
                      
                      
                      24,952Balance
      Sheet Data (at period end)Working
      capital
                      
                      $
                      1,296
                      
                      
                      $
                      36,828
                      
                      
                      $
                      35,789
                      
                      
                      $
                      41,923
                      
                      
                      $
                      13,112Long
      term obligations (3)
                      
                      $
                      161
                      
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      30,002
                      
                      
                      $
                      30,041Total
      assets
                      
                      $
                      66,737
                      
                      
                      $
                      210,049
                      
                      
                      $
                      217,029
                      
                      
                      $
                      214,336
                      
                      
                      $
                      164,459Shareholders'
      equity
                      
                      $
                      26,644
                      
                      
                      $
                      144,602
                      
                      
                      $
                      150,833
                      
                      
                      $
                      137,482
                      
                      
                      $
                      93,253





(1)
            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.


(2)
            Includes
      share-based compensation expense as
follows:





Years
      Ended March 31,2009
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  2006
                  
                  
                  2005Marketing
      and sales
                  
                  $
                  842
                  
                  
                  $
                  766
                  
                  
                  $
                  1,284
                  
                  
                  $
                  3,846
                  
                  
                  $
                  1,345Research
      and development
                  
                  
                  292
                  
                  
                  
                  530
                  
                  
                  
                  740
                  
                  
                  
                  3,460
                  
                  
                  
                  1,527General
      and administrative
                  
                  
                  1,057
                  
                  
                  
                  249
                  
                  
                  
                  742
                  
                  
                  
                  2,928
                  
                  
                  
                  1,620Total
      stock-based compensation expense
                  
                  $
                  2,191
                  
                  
                  $
                  1,545
                  
                  
                  $
                  2,766
                  
                  
                  $
                  10,234
                  
                  
                  $
                  4,492





(3)
            Consists
      of non-current portion of long term capital
  lease.


22




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




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, original equipment manufacturers
(“OEMs”), enterprises, high-end professional DVD 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 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.




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 now
organizes its business into two reportable operating segments targeted at these
different forms of content:  the “Roxio Consumer” 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 Segment




The
Company’s Roxio Consumer 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.  Roxio offers products and
services under a variety of names, including BackonTrack, Backup MyPC,
CinePlayer, Crunch, Easy VHS to DVD, Just!Burn, MyDVD, MyTV To Go, PhotoShow,
PhotoSuite, Popcorn, RecordNow, Roxio Copy & Convert, Roxio Creator, Toast,
VideoWave, WinOnCD, and others.  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 same
“under the hood” technology that powers Roxio products to other companies who
wish to build their own PC software products.




Premium
Content Segment




The
Company’s Premium Content segment offers a range of products and services
related to the creation, distribution and enjoyment of premium
content.  Within this segment, the Professional Products Group
reporting unit offers software under the Scenarist, CineVision, and DVDit
product names and Sonic and Roxio Professional brands to major motion picture
studios, high-end authoring houses and other professional
customers.  CinemaNow, also part of this segment, sells, rents and
distributes premium entertainment content to consumers over the
Internet.  The Company also develops software components that it
licenses to CE companies to enable their devices to offer premium content to
consumers, licenses intellectual property through its Qflix initiative, and
licenses patents.


23


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.  Sonic’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, capitalizing on evolving trends in
the technology industry, including:




·
            Optical Disc Playback
      Evolution – Optical disc technologies have enjoyed tremendous
      growth and extremely widespread consumer adoption.  For example,
      DVD playback units (including set-top players, game consoles and PCs) have
      been one of the fastest growing consumer technologies in history, and
      multiple DVD players are now present in most
      households.  Similarly, sales of BD units and players grew
      during 2008 at a rate comparable to that of standard definition DVD at the
      equivalent time period in its life cycle, implying that BD is positioned
      to grow dramatically over the next several
  years.




·
            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
  scale.




·
            Digital Phone, Portable and
      Gaming Devices – The consumer adoption rate 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 Sonic, 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
products and online service provider based in San Francisco,
California.  Simple Star is the developer of PhotoShow, a
comprehensive multimedia story telling platform and online community that
enables consumers to quickly and easily turn personal photos and video clips
into entertaining shows that can be enjoyed and shared on PCs, TVs, and handheld
devices, or published to popular social media sites.  PhotoShow is
broadly distributed through a network of major partners, including online photo
providers, photofinishing service providers, cable operators and
others.  One of the major initiatives underway at Roxio has been to
embrace web services as an important part of its consumer business.




During
fiscal 2009, the Company acquired the assets of CinemaNow, Inc., a privately
held online entertainment provider based in Marina Del Rey, California.
CinemaNow is at the forefront of digital video distribution, offering a wide
selection of high-quality Hollywood movies, TV shows and music videos to users
across multiple platforms.  The company has relationships with
numerous content providers, including all major Hollywood studios, and supplies
premium entertainment services to a host of PC and CE device
manufacturers.  The addition of the CinemaNow assets helps expand
Sonic’s products and services across the entire premium entertainment supply
chain, from creation to distribution to consumption.  The Company
plans to increase the number of premium content titles available for rental and
sell-through, increase the number of titles that are enabled for Qflix burning,
and continue to expand the number of CinemaNow relationships it has with PC and
CE OEMs and retail partners.




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, unify its OEM licensing efforts, and
eliminate organizational redundancies.  For more information seeNote 8,
“Restructuring,” to the Consolidated Financial Statements included in this
Annual Report.


24


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.  As the digital
content ecosystem continues to expand and evolve, the Company aims to makes its
products and services available through an increasing range of platforms,
devices and partners, with the goal that Sonic 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 at
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 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.




Improve Operational Efficiencies and
Cash Flow Performance.  Management’s goal for fiscal 2010 is to
achieve operational efficiencies and improve cash flow through revenue growth
and cost management.  In fiscal 2009, the Company engaged in
restructuring activities designed to achieve its efficiency goals, and will
continue to focus on aligning its cost structure and business
initiatives.




Outlook




While the
current global economic downturn has resulted in a decline in overall consumer
and corporate spending, impacting the Company’s business and financial results
in fiscal 2009, the Company believes it is well positioned to capitalize on its
strong brand, consumer market position, OEM relationships and evolving premium
content business models and opportunities.  The Company made
significant strategic and financial progress during fiscal 2009 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.





Use
of estimates





On an
ongoing basis, the Company evaluates estimates used, including those related to
the valuation of goodwill and other intangible assets, valuation of stock
options, valuation of investment instruments, useful lives of intangible assets
and equipment and leasehold improvements, inventory valuation allowances,
revenue recognition, the estimated allowances for sales returns and doubtful
accounts and income tax accruals.  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 product returns and doubtful
accounts


·
            Goodwill,
      intangible assets and other long-lived
assets


·
            Share-based
      compensation


·
            Income
      tax and deferred tax asset
valuation


·
            Valuation
      of acquired businesses, assets and
liabilities


·
            Accrued
      liabilities


·
            Contingencies




25


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 software-related revenue in accordance with American
Institute of Certified Accountants (“AICPA”) Statement of Position (“SOP”) 97-2,
Software Revenue Recognition(“SOP No. 97-2”) as amended by SOP No. 98-9, Software Revenue Recognition With
Respect to Certain Transactions(“SOP No. 98-9”), and Staff Accounting
Bulletin (“SAB”) 104, Revenue
Recognition in Financial Statements (“SAB No. 104”).  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.





The
Company follows Emerging Issues Task Force (“EITF”) 99-19, Reporting Revenue Gross as Principal
versus Net as an Agent(“EITF No. 99-19”).  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 SOP No. 98-9, 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.  In such situations, the Company recognizes
product sales in accordance with SFAS No. 48, Revenue Recognition When Right of
Return Exists(“SFAS No. 48”).  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.





In
accordance with EITF No. 01-09, Accounting for Consideration Given
by a Vendor to a Customer or a Reseller of the Vendor’s Product (“EITF
No. 01-09”), 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.


26


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 in accordance with SOP No. 81-1, Accounting for Performance of
Construction Type and Certain Production Type Contracts (“SOP No. 81-1”),
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.





Allowance
for Product 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.





Impairment of
Goodwill, Intangible Assets and Long-Lived Assets





The
Company accounts for goodwill and other intangible assets in accordance with
SFAS No. 142, Goodwill
and Other Intangible Assets (“SFAS No. 142”).  SFAS
No. 142 classifies intangible assets 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 identifiable intangible assets with
indefinite useful lives 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.





In
accordance with SFAS No.144, Accountingfor the Impairment or Disposal of
Long-LivedAssets(“SFAS No.
144”), 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.





Share-Based
Compensation





In
accordance with SFAS No. 123(R), Share-Based Payment(“SFAS
No. 123(R)”), the Company measures compensation cost for share-based award at
fair value and recognizes compensation over the requisite service period for
awards expected to vest.  Estimating the portion of share-based award that
will ultimately vest requires judgment, and to the extent actual results or
updated estimates differ from the Company’s current estimates, such amounts are
recorded in the period estimates are revised.  The Company considers
several factors when estimating expected forfeitures, including types of awards,
employee class, and historical experience. The Company also considers several
factors when estimating expected volatility and expected life of the
option.


27





Income
Taxes





The
Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes
(“SFAS No. 109”).  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.  Effective April 1, 2007, the Company adopted Financial
Accounting Standards Board (“FASB”) Financial Interpretation Number (“FIN”)
48, Accounting for Income
Tax Uncertainties (“FIN No. 48”), an interpretation of SFAS No. 109,Accounting for Income
Taxes(“SFAS No.
109”).  FIN No. 48 contains a two-step approach to recognize and
measure uncertain tax positions accounted for in accordance with SFAS No.
109.  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
December 2007, the FASB issued SFAS No. 160, Non-controllingInterests in Consolidated Financial
Statements, anAmendmentofAccounting Research
Bulletin(“ARB”)No. 51(“SFAS No.
160”).  SFAS No. 160 establishes accounting and reporting
standards for the non-controlling interest in a subsidiary and for the
deconsolidation of a subsidiary.  SFAS No. 160 is effective for annual
periods beginning after December 15, 2008 and should be applied
prospectively. However, the presentation and disclosure requirements of the
statement shall be applied retrospectively for all periods presented. The
Company will adopt Statement No. 160 in the first quarter of fiscal 2010 and
adoption is not expected to materially impact the Company’s consolidated
financial position or results or operations.





In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations (“SFAS
No. 141(R)”), which replaces SFAS No. 141.  SFAS No. 141(R) establishes
principles and requirements for recognizing and measuring assets acquired,
liabilities assumed and any non-controlling interests in the acquiree in a
business combination.  SFAS No. 141(R) also establishes disclosure
requirements to enable the evaluation of the nature and financial effects of the
business combination. It further requires acquisition-related costs to be
recognized separately from the acquisition and expensed as incurred,
restructuring costs generally to be expensed in periods subsequent to the
acquisition date, and changes in accounting for deferred tax asset valuation
allowances and acquired income tax uncertainties after the measurement period,
which will impact income tax expense. In addition, acquired in-process research
and development is capitalized as an intangible asset with an indefinite useful
life. This statement applies to acquisitions that occur beginning with the
Company’s fiscal year beginning April 1, 2009, and will be adopted on a
prospective basis.  The impact of SFAS No. 141(R) on the Company’s
consolidated financial position, results of operations and cash flows will be
dependent on the number and size of business combinations that the Company
enters into subsequent to the adoption of the standard, as well as the valuation
and allocation of the net assets acquired.


28




In
February 2008, the FASB issued FASB Staff Position (“FSP”) SFAS No. 157-2, Effective Date of FASB Statement No.
157 (“FSP No. 157”), to partially defer SFAS No. 157, Fair Value Measurements
(“SFAS No. 157”).  FSP No. 157-2 defers the effective date of SFAS No. 157
for nonfinancial assets and nonfinancial liabilities, except those that are
recognized and disclosed at fair value in the financial statements on a
recurring basis (at least annually), to fiscal years and interim periods within
those fiscal years, beginning after November 15, 2008.  This portion of the
statement is effective for the Company as of April 1, 2009.  The Company
believes that the adoption of this aspect of SFAS No. 157 will not have a
material impact on the Company’s consolidated financial position, results of
operations and cash flows.





In
April 2008, the FASB issued FSP SFAS No. 142-3, Determination of the Useful Life of
Intangible Assets(“FSP No. 142-3”).  FSP No. 142-3 amends the
factors that should be considered in developing renewal or extension assumptions
used to determine the useful life of a recognized intangible asset under SFAS
No. 142.  The intent of FSP No. 142-3 is to improve the
consistency between the useful life of a recognized intangible asset under SFAS
No. 142 and the period of expected cash flows used to measure the fair
value of the asset under SFAS No. 141(R) and other GAAP
principles.  The provisions of FSP No. 142-3 are effective for the
Company’s fiscal year 2010, and are not expected to have a material effect on
its prospective consolidated financial statements, results of operations or cash
flows.





In
October 2008, the FASB issued FSP No. 157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active(“FSP No.
157-3”). FSP No. 157-3 clarifies the application of SFAS No. 157 in an
inactive market and demonstrates how the fair value of a financial asset is
determined when the market for that financial asset is inactive. FSP No.
157-3 was effective upon issuance, including prior periods for which financial
statements had not been issued. The adoption of this provision did not have
a material impact on the Company’s consolidated financial statements, results of
operations or cash flows.


29





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 2009
through 2007 (in percentages):





Fiscal Years Ended March 31,2009
                        
                        
                        2008
                        
                        
                        2007Net
      revenue
                        
                        
                        100.0
                        %
                        
                        
                        100.0
                        %
                        
                        
                        100.0
                        %Cost
      of revenue
                        
                        
                        27.4
                        %
                        
                        
                        24.9
                        %
                        
                        
                        23.1
                        %Impairment
      of intangibles
                        
                        
                        16.3
                        %
                        
                        
                        -
                        
                        
                        
                        -Gross
      profit
                        
                        
                        56.3
                        %
                        
                        
                        75.1
                        %
                        
                        
                        76.9
                        %Operating
      expenses:Marketing
      and sales
                        
                        
                        29.9
                        %
                        
                        
                        27.2
                        %
                        
                        
                        22.4
                        %Research
      and development
                        
                        
                        32.7
                        %
                        
                        
                        33.5
                        %
                        
                        
                        29.9
                        %General
      and administrative
                        
                        
                        20.1
                        %
                        
                        
                        20.6
                        %
                        
                        
                        13.8
                        %Acquired
      in-process technology
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        2.3
                        %Abandoned
      acquisition
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        0.7
                        %Restructuring
                        
                        
                        3.3
                        %
                        
                        
                        2.4
                        %
                        
                        
                        -Impairment
      of goodwill
                        
                        
                        46.8
                        %
                        
                        
                        -
                        
                        
                        
                        -Total
      operating expenses
                        
                        
                        132.8
                        %
                        
                        
                        83.7
                        %
                        
                        
                        69.1
                        %Operating
      income (loss)
                        
                        
                        (76.6
                        )%
                        
                        
                        (8.6
                        )%
                        
                        
                        7.8
                        %Other
      income (expense)
                        
                        
                        (0.9
                        )%
                        
                        
                        1.2
                        %
                        
                        
                        0.5
                        %Provision
      (benefit) for income taxes
                        
                        
                        21.0
                        %
                        
                        
                        (3.2
                        )%
                        
                        
                        4.1
                        %Net
      income (loss)
                        
                        
                        98.5
                        %
                        
                        
                        (4.2
                        )%
                        
                        
                        4.2
                        %





Comparison
of Fiscal Years Ended March 31, 2009, 2008 and 2007 (in thousands)





Net
Revenues





The
Company has reclassified certain revenue segment information in prior period
financial tables to conform to the reorganization of the Company’s reportable
business segments during the fourth quarter of fiscal 2009. 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 stockholders’ equity and comprehensive
income (loss) and consolidated statements of cash flows for the prior periods
presented.





Net Revenues –
Prior to reclassification





The
following table is a comparison of net revenues by segment based on the revenue
reporting segments prior to the reorganization in the fourth quarter of fiscal
2009 (in thousands other than percentages):





Years Ended March 31,
                          
                          
                          2009 to 2008
                          
                          
                          2008 to 2007Net Revenue
                          
                          2009
                          
                          
                          2008
                          
                          
                          2007
                          
                          
                          Inc (Dec)
                          
                          
                          % Change
                          
                          
                          Inc (Dec)
                          
                          
                          % ChangeRoxio
      Division
                          
                          $
                          98,511
                          
                          
                          $
                          115,920
                          
                          
                          $
                          122,326
                          
                          
                          $
                          (17,409
                          )
                          
                          
                          (15
                          )%
                          
                          $
                          (6,406
                          )
                          
                          
                          (5
                          )%Advanced
      Technology Group
                          
                          
                          12,174
                          
                          
                          
                          10,986
                          
                          
                          
                          18,088
                          
                          
                          
                          1,188
                          
                          
                          
                          11
                          %
                          
                          
                          (7,102
                          )
                          
                          
                          (39
                          )%Total
      Consumer Products
                          
                          
                          110,685
                          
                          
                          
                          126,906
                          
                          
                          
                          140,414
                          
                          
                          
                          (16,221
                          )
                          
                          
                          (13
                          )%
                          
                          
                          (13,508
                          )
                          
                          
                          (10
                          )%Professional
      products
                          
                          
                          9,273
                          
                          
                          
                          5,968
                          
                          
                          
                          8,235
                          
                          
                          
                          3,305
                          
                          
                          
                          55
                          %
                          
                          
                          (2,267
                          )
                          
                          
                          (28
                          )%Total
      net revenue
                          
                          $
                          119,958
                          
                          
                          $
                          132,874
                          
                          
                          $
                          148,649
                          
                          
                          $
                          (12,916
                          )
                          
                          
                          (10
                          )%
                          
                          $
                          (15,775
                          )
                          
                          
                          (11
                          )%





Fiscal
2009 compared to Fiscal 2008 – Prior to reclassification




Net
revenue decreased to $120.0 million for fiscal year 2009 from $132.9 million for
fiscal year 2008.  The Company’s Roxio Division revenue decreased $17.4
million or 15% in fiscal 2009 from $115.9 million in fiscal 2008.  The
decrease was primarily due to the global economic weakness and decreased demand
from the OEM bundling channel.  The Company’s Advanced Technology
Group (“ATG”) net revenue increased by $1.2 million or 11% in fiscal 2009 from
$11.0 million in fiscal 2008 primarily due to selling AuthorScript to medical
device manufacturers, as well as to certain Qflix-related
agreements.   The Company’s Professional Products net revenue
increased by $3.3 million or 55% in fiscal 2009 from $6.0 million in fiscal 2008
primarily due to the continued adoption of the BD format, and revenue from a
development contract.





30




Fiscal
2008 compared to Fiscal 2007 – Prior to reclassification





Net
revenue decreased to $132.9 million for fiscal year 2008 from $148.6 million for
fiscal year 2007.  The decrease in net revenue in fiscal year 2008 was
driven by a decrease of $13.5 million or 10% in Consumer Product revenues and a
decrease of $2.3 million or 28% in professional product revenue.  The
decrease in the Company’s consumer product revenues was primarily due to overall
consumer software market softness and lower licensing revenue from its ATG
products as a result of fewer license sales and renewals.  The
decrease in the Company’s Consumer Product revenues also resulted from a
decrease in sales to top tier retailers due to their closure of stores, a
reduction in revenue due to increased reserves established for slow moving
inventory in Japan and anticipated returns from a former Japanese web store
reseller with which the Company terminated its relationship during fiscal
2008.  Additionally, the Company’s ATG revenue for fiscal year 2007
included a one-time license fee of approximately $1.5 million, a multi-year
license fee of approximately $1.7 million from a Japanese customer, and a $1.0
million patent sale for which there was no corresponding amount during fiscal
year 2008.




The decrease in the Company’s
Professional Products revenue of $2.3 million in fiscal year 2008 was primarily
due to lower sales of standard-definition DVD products and the content
community’s slow adoption of new high-definition disc formats as a result of the
continued competition between HD DVD and BD, which was not resolved until the
later part to the Company’s fourth quarter of fiscal year 2008.





Net
Revenues – As reclassified





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





Years Ended March 31,
                  
                  
                  2009 to 2008
                  
                  
                  2008 to 2007Net Revenue(1)
                  
                  2009
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  Inc (Dec)
                  
                  
                  % Change
                  
                  
                  Inc (Dec)
                  
                  
                  % ChangeRoxio
      Consumer Products
                  
                  $
                  104,074
                  
                  
                  $
                  122,691
                  
                  
                  $
                  131,017
                  
                  
                  $
                  (18,617
                  )
                  
                  
                  (15
                  )%
                  
                  $
                  (8,326
                  )
                  
                  
                  (6
                  )%Premium
      Content
                  
                  
                  15,884
                  
                  
                  
                  10,183
                  
                  
                  
                  17,632
                  
                  
                  
                  5,701
                  
                  
                  
                  56
                  %
                  
                  
                  (7,449
                  )
                  
                  
                  (42
                  )%Total
      net revenue
                  
                  $
                  119,958
                  
                  
                  $
                  132,874
                  
                  
                  $
                  148,649
                  
                  
                  $
                  (12,916
                  )
                  
                  
                  (10
                  )%
                  
                  $
                  (15,775
                  )
                  
                  
                  (11
                  )%





(1)
            During
      the fourth quarter of fiscal 2009, the Company reclassified ATG licensing
      net revenue of $6.7 million to the Roxio Consumer segment, ATG CE
      licensing net revenue of $4.9 million to the Premium Content segment,
      Qflix net revenue of $0.6 million to the Premium Content segment and
      CinemaNow net revenue of $1.1 million was reclassified to the Premium
      Content segment for presentation purposes to reflect the Company's current
      reporting business segments.





Fiscal
2009 compared to Fiscal 2008 – Post reclassification





Net
revenue decreased to $120.0 million for fiscal year 2009 from $132.9 million for
fiscal year 2008.  The decrease in net revenue in fiscal year 2009 was
driven by 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 Company’s Roxio Consumer Product revenues decreased
primarily due to the global economic weakness affecting consumer demand and
decreased demand from the OEM bundling channel during fiscal
2009.  The Company’s Premium Content net revenue increase was
primarily due to the sale of premium content upon the acquisition of CinemaNow,
the continued adoption of the BD format, and revenue from a development
contract.





Fiscal
2008 compared to Fiscal 2007 – Post reclassification





Net
revenue decreased to $132.9 million for fiscal year 2008 from $148.6 million for
fiscal year 2007.  The decrease in net revenue in fiscal year 2008 was
driven by a decrease of $8.3 million or 6% in Roxio Consumer Product revenues
and a decrease of $7.4 million or 42% in Premium Content revenue.  The
decrease in the Company’s Roxio Consumer Product revenues was primarily due to
overall consumer software market softness and lower licensing revenue from its
licensing PC products as a result of fewer license sales and renewals.  The
decrease in the Company’ Consumer Product revenues also resulted from a decrease
in sales to top tier retailers due to their closure of stores, a reduction in
revenue due to increased reserves established for slow moving inventory in Japan
and anticipated returns from a former Japanese web store reseller with which the
Company terminated its relationship during fiscal 2008.


31




The decrease in the Company’s Premium Content revenue of $7.4 million in fiscal
year 2008 was primarily due to lower sales of standard definition DVD products
and the content community’s slow adoption of new high-definition disc formats as
a result of the continued competition between HD DVD and BD, which was not
resolved until the later part to the Company’s fourth quarter of fiscal year
2008. Additionally, the Company’s licensing CE revenue for fiscal year 2007
included a one-time license fee of approximately $1.5 million, a multi-year
license fee of approximately $1.7 million from a Japanese customer, and a $1.0
million patent sale for which there was no corresponding amount during fiscal
year 2008.





Geographical
Revenues and Customer Concentration





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





Fiscal Years Ended March 31,
                              
                              
                              2009 to 2008
                              
                              
                              2008 to 2007Net revenue
                              
                              2009
                              
                              
                              2008
                              
                              
                              2007
                              
                              
                              Inc (Dec)
                              
                              
                              %
                              
                              
                              Inc (Dec)
                              
                              
                              %United
      States
                              
                              $
                              86,818
                              
                              
                              $
                              108,604
                              
                              
                              $
                              116,371
                              
                              
                              $
                              (21,786
                              )
                              
                              
                              (20
                              )%
                              
                              $
                              (7,767
                              )
                              
                              
                              (7
                              )%ExportCanada
                              
                              
                              1,573
                              
                              
                              
                              1,407
                              
                              
                              
                              615
                              
                              
                              
                              166
                              
                              
                              
                              12
                              %
                              
                              
                              792
                              
                              
                              
                              129
                              %France
                              
                              
                              1,422
                              
                              
                              
                              1,076
                              
                              
                              
                              1,275
                              
                              
                              
                              346
                              
                              
                              
                              32
                              %
                              
                              
                              (199
                              )
                              
                              
                              (16
                              )%Germany
                              
                              
                              4,429
                              
                              
                              
                              2,978
                              
                              
                              
                              3,038
                              
                              
                              
                              1,451
                              
                              
                              
                              49
                              %
                              
                              
                              (60
                              )
                              
                              
                              (2
                              )%United
      Kingdon
                              
                              
                              3,287
                              
                              
                              
                              3,629
                              
                              
                              
                              3,821
                              
                              
                              
                              (342
                              )
                              
                              
                              (9
                              )%
                              
                              
                              (192
                              )
                              
                              
                              (5
                              )%Other
      European
                              
                              
                              2,910
                              
                              
                              
                              3,874
                              
                              
                              
                              4,579
                              
                              
                              
                              (964
                              )
                              
                              
                              (25
                              )%
                              
                              
                              (705
                              )
                              
                              
                              (15
                              )%Japan
                              
                              
                              14,207
                              
                              
                              
                              5,948
                              
                              
                              
                              13,282
                              
                              
                              
                              8,259
                              
                              
                              
                              139
                              %
                              
                              
                              (7,334
                              )
                              
                              
                              (55
                              )%Singapore
                              
                              
                              3,599
                              
                              
                              
                              3,446
                              
                              
                              
                              3,682
                              
                              
                              
                              153
                              
                              
                              
                              4
                              %
                              
                              
                              (236
                              )
                              
                              
                              (6
                              )%Taiwan
                              
                              
                              281
                              
                              
                              
                              73
                              
                              
                              
                              175
                              
                              
                              
                              208
                              
                              
                              
                              285
                              %
                              
                              
                              (102
                              )
                              
                              
                              (58
                              )%Other
      pacific rim
                              
                              
                              887
                              
                              
                              
                              1,362
                              
                              
                              
                              1,588
                              
                              
                              
                              (475
                              )
                              
                              
                              (35
                              )%
                              
                              
                              (226
                              )
                              
                              
                              (14
                              )%Other
      international
                              
                              
                              545
                              
                              
                              
                              477
                              
                              
                              
                              223
                              
                              
                              
                              68
                              
                              
                              
                              14
                              %
                              
                              
                              254
                              
                              
                              
                              114
                              %Net
      revenue
                              
                              $
                              119,958
                              
                              
                              $
                              132,874
                              
                              
                              $
                              148,649
                              
                              
                              $
                              (12,916
                              )
                              
                              
                              (10
                              )%
                              
                              $
                              (15,775
                              )
                              
                              
                              (11
                              )%





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 sales was primarily due to
decreased demand from the OEM and direct distribution channels.





International
sales accounted for $33.2 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.  The increase in international sales was primarily due to
increases in Japan and Germany from a dollar perspective, with the increase in
the percentage of net revenue due to a decrease in domestic sales, as noted
above.  Japan revenue increased primarily due to a returns and
allowance charge of $2.0 million posted in the first quarter of fiscal 2008 and
revenue from new development contracts.  Germany increased due to the
use of a new web store reseller upon the acquisition of the Simple Star
assets.





Fiscal
2008 compared to Fiscal 2007





Domestic
sales accounted for $108.6 million or 82% of the Company’s net revenue in fiscal
year 2008 compared to $116.4 million, or 78%, of its net revenue in fiscal year
2007. The decrease in domestic sales was primarily due to overall consumer
software market softness and the decrease in sales to top tier retailers due to
their closure of stores.  Additionally, fiscal year 2007 included a
one-time license fee of approximately $1.5 million and a $1.0 million patent
sale for which there was no corresponding amount during fiscal year
2008.





International
sales accounted for $24.3 million, or 18%, of the Company’s net revenue in
fiscal year 2008 compared to $32.3 million or 22% of its net revenue in fiscal
year 2007.  The decrease in international sales was primarily due to
lower revenue from Japan, as described above.





Significant
Customers





The
following table reflects sales to significant customers as a percentage of total
sales and the related accounts receivable as a percentage of total receivables
(in percentages):


32





Percentage of Total Net Revenue
                  
                  
                  Percentage of Total Accounts
                    ReceivableFiscal Years Ended March 31,
                  
                  
                  Fiscal Years Ended March 31,Customer Name
                  
                  2009
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  2009
                  
                  
                  2008Dell
                  
                  
                  14
                  %
                  
                  
                  26
                  %
                  
                  
                  23
                  %
                  
                  
                  5
                  %
                  
                  
                  11
                  %Digital
      River
                  
                  
                  22
                  %
                  
                  
                  23
                  %
                  
                  
                  20
                  %
                  
                  
                  11
                  %
                  
                  
                  16
                  %Hewlett-Packard
                  
                  
                  11
                  %
                  
                  
                  13
                  %
                  
                  
                  9
                  %
                  
                  
                  2
                  %
                  
                  
                  7
                  %Ingram
                  
                  
                  6
                  %
                  
                  
                  10
                  %
                  
                  
                  9
                  %
                  
                  
                  8
                  %
                  
                  
                  10
                  %Navarre
                  
                  
                  16
                  %
                  
                  
                  13
                  %
                  
                  
                  13
                  %
                  
                  
                  20
                  %
                  
                  
                  11
                  %





No other
customer accounted for more than 10% of the Company’s revenue for fiscal years
2009, 2008 and 2007. Revenue recognized from Dell and Hewlett-Packard was
pursuant to various licensing agreements.  Revenue recognized from
Digital River was pursuant to a reseller agreement.  Revenue
recognized from Ingram and Navarre was pursuant to distributor
agreements.  It is impracticable for the Company to report the net
revenues by significant customer per business segment for fiscal years ended
March 31,2009, 2008 and 2007, as some of the these customers may be in both
segments.





Cost
of Revenue





Cost of
revenue consists mainly of the costs of third party licensing expenses, employee
salaries and benefits for personnel directly involved in the production and
support of revenue-generating products, packaging and distribution costs, if
applicable, and amortization of acquired and internally-developed software and
intangible assets.  In the case of Roxio software distributed in
retail channels, cost of revenue also includes the cost of packaging, if any,
and certain distribution costs.





Cost
of Revenue – Prior to reclassification





The
following table reflects cost of revenue as a percentage of net revenue (in
thousands other than percentages):





Years Ended March 31,
                    
                    
                    2009 to 2008
                    
                    
                    2008 to 20072009
                    
                    
                    2008
                    
                    
                    2007
                    
                    
                    Inc (Dec)
                    
                    
                    % Change
                    
                    
                    Inc (Dec)
                    
                    
                    % ChangeConsumer
      products
                    
                    $
                    30,709
                    
                    
                    $
                    30,513
                    
                    
                    $
                    31,685
                    
                    
                    $
                    196
                    
                    
                    
                    1
                    %
                    
                    $
                    (1,172
                    )
                    
                    
                    (4
                    )%Professional
      products
                    
                    
                    2,192
                    
                    
                    
                    2,638
                    
                    
                    
                    2,804
                    
                    
                    
                    (446
                    )
                    
                    
                    (17
                    )%
                    
                    
                    (166
                    )
                    
                    
                    (6
                    )%Cost
      of Sales
                    
                    
                    32,901
                    
                    
                    
                    33,151
                    
                    
                    
                    34,489
                    
                    
                    
                    (250
                    )
                    
                    
                    (1
                    )%
                    
                    
                    (1,338
                    )
                    
                    
                    (4
                    )%Cost
      of sales as a percentage of Consumer net revenue
                    
                    
                    28
                    %
                    
                    
                    24
                    %
                    
                    
                    23
                    %
                    
                    
                    4
                    %
                    
                    
                    
                    
                    
                    
                    1
                    %Cost
      of sales as a percentage of Professional net revenue
                    
                    
                    24
                    %
                    
                    
                    44
                    %
                    
                    
                    34
                    %
                    
                    
                    (20
                    )%
                    
                    
                    
                    
                    
                    
                    10
                    %





Fiscal
2009 compared to Fiscal 2008 – Prior to reclassification





The
Company’s cost of revenue as a percentage of net revenue increased 2% to 27% of
net revenue for fiscal year 2009 from 25% for fiscal year 2008.  The
increase was primarily due to higher product costs associated with the Roxio
products.





Consumer
Products as a percentage of net revenue increased 4% to 28% for fiscal year 2009
from 24% for fiscal year 2008.  The increase was primarily due to the
following:




·
            Approximately
      56% of the increase was due to higher product costs which had fixed period
      expenses against lower net revenues.  Consumer Product costs
      increased due to changes in retail packaging and the bundling of certain
      promotional items with the Company’s products, in particular, with the
      release of Easy VHS to DVD, and Roxio Creator 2009 Special Edition which
      both included a USB video capture
device.




·
            Approximately
      29% of the increase was due to costs associated with delivering Premium
      Content, through the newly acquired
CinemaNow.





Professional
Products as a percentage of net revenue decreased 20% to 24% for fiscal year
2009 from 44% for fiscal year 2008.  The decrease was primarily due to
the following:


33




·
            Approximately
      46% of the decrease was due to lower technical support costs. Fiscal year
      2008 included hardware support costs and higher employee
      costs.




·
            Approximately
      28% of the decrease was due to lower third party licensing costs as a
      percentage of net revenue resulting from development contract
      revenue.





Fiscal
2008 compared to Fiscal 2007– Prior to reclassification





The
Company’s cost of revenue as a percentage of net revenue increased 2% to 25% of
net revenue for fiscal year 2008 from 23% for fiscal year 2007.  The
increase in cost of revenue as a percentage of net consumer revenue for fiscal
year 2008 was primarily due to higher third party licensing and product
costs.





Consumer
Products as a percentage of net revenue increased 1% to 24% for fiscal year 2008
from 23% for fiscal year 2007.  The increase was primarily due to the
following:




·
            Approximately 59% of the increase
      was due to higher third party licensing costs as a percentage of net
      revenue. Certain third party licensing expenses are fixed and these fixed
      expenses represent a greater percentage of less net revenue.  In
      addition, the Company’s added a greater number of third party
      royalty-bearing features to recent versions of its consumer
      products.




·
            The remaining increase was mainly
      due to higher product costs, primarily for the Consumer Products. This
      increase in product costs was also due to the impact of fixed period
      expenses against lower net revenues. Additionally, Consumer Product costs
      increased due to changes in retail packaging and the bundling of certain
      promotional items with the Company’s products, in particular, with the
      release of Easy Media Creator 10 product in September
      2007.





Professional
Products as a percentage of net revenue increased 10% to 44% for fiscal year
2008 from 34% for fiscal year 2007.  The increase was primarily due to
the following:




·
            Approximately
      94% of the increase was due to higher technical support costs, associated
      with hardware support costs and higher employee
  costs.





Cost
of Revenues – As reclassified





The
following table reflects cost of revenue as a percentage of net revenue (in
thousands other than percentages):





Years Ended March 31,
                    
                    
                    2009 to 2008
                    
                    
                    2008 to 20072009
                    
                    
                    2008
                    
                    
                    2007
                    
                    
                    Inc (Dec)
                    
                    
                    % Change
                    
                    
                    Inc (Dec)
                    
                    
                    % ChangeRoxio
      products
                    
                    $
                    27,994
                    
                    
                    $
                    29,241
                    
                    
                    $
                    29,629
                    
                    
                    $
                    (1,247
                    )
                    
                    
                    (4
                    )%
                    
                    $
                    (388
                    )
                    
                    
                    31
                    %Premium
      content
                    
                    
                    4,907
                    
                    
                    
                    3,912
                    
                    
                    
                    4,760
                    
                    
                    
                    995
                    
                    
                    
                    25
                    %
                    
                    
                    (848
                    )
                    
                    
                    (85
                    )%Cost
      of sales
                    
                    
                    32,901
                    
                    
                    
                    33,153
                    
                    
                    
                    34,389
                    
                    
                    
                    (252
                    )
                    
                    
                    (1
                    )%
                    
                    
                    (1,236
                    )
                    
                    
                    491
                    %Cost
      of sales as a percentage of Roxio net revenue
                    
                    
                    27
                    %
                    
                    
                    24
                    %
                    
                    
                    23
                    %
                    
                    
                    3
                    %
                    
                    
                    
                    
                    
                    
                    1
                    %Cost
      of sales as a percentage of Premium net revenue
                    
                    
                    31
                    %
                    
                    
                    38
                    %
                    
                    
                    27
                    %
                    
                    
                    (7
                    )%
                    
                    
                    
                    
                    
                    
                    11
                    %





Fiscal
2009 compared to Fiscal 2008 – Post reclassification





The
Company’s cost of revenue as a percentage of net revenue increased 2% to 27% of
net revenue for fiscal year 2009 from 25% for fiscal year 2008.  The
increase was primarily due to primarily due the increase was due to higher
product costs associated with the Roxio Consumer products.





Roxio
Consumer products cost of revenues as a percentage of net revenue increased 3%
to 27% for fiscal year 2009 from 24% for fiscal year 2008.  The
increase was primarily due to the following:




·
            Approximately
      75% of the increase was due to higher product costs.  This
      increase in product costs was also due to the impact of fixed period
      expenses against lower net revenues.  Consumer Product costs
      also increased due to changes in retail packaging and the bundling of
      certain promotional items with the Company’s products, in particular, with
      the release of Easy VHS to DVD, and Roxio Creator 2009 Special Edition,
      which both included a USB video capture
device.


34





Premium
Content cost of revenues as a percentage of net revenue decreased 7% to 31% for
fiscal year 2009 from 38% for fiscal year 2008.  The decrease was
primarily due to the following:




·
            Approximately
      74% of the decrease was due to lower technical support costs. In addition,
      fiscal year 2008 included hardware support costs and higher employee
      costs.





Fiscal
2008 compared to Fiscal 2007– Post reclassification





The
Company’s cost of revenue as a percentage of net revenue increased 2% to 25% of
net revenue for fiscal year 2008 from 23% for fiscal year 2007.  The
increase in cost of revenue as a percentage of net revenue for fiscal year 2008
was primarily due to higher third party licensing and product
costs.





Roxio
Consumer products cost of revenues as a percentage of consumer revenue increased
1% to 24% for fiscal year 2008 from 23% for fiscal year 2007.  The
increase was primarily due to the following:




·
            Approximately 64% of the increase
      was due to higher third party licensing costs as a percentage of net
      revenue. Certain of the Company’s third party licensing expenses are fixed
      and these fixed expenses represent a greater percentage of less net
      revenue.  The Company also added more third party
      royalty-bearing features to recent versions of its consumer
      products.





Premium
Content cost of revenues as a percentage of net revenue increased 11% to 38% for
fiscal year 2008 from 27% for fiscal year 2007.  This was primarily
due to the following:




·
            Approximately
      59% of the increase was due to higher technical support costs, associated
      with hardware support costs and higher employee
  costs.




·
            The
      balance was primarily the impact of fixed period costs against lower net
      revenues.




Marketing
and Sales





Marketing
and sales expenses consist primarily of employee salary and benefit expenses,
sales commissions, travel expenses and related facilities costs. Sales and
marketing expenses also include the costs of programs aimed at increasing
revenue, such as advertising, trade shows, public relations and other market
development programs.  The following table reflects the marketing and
sales operating expenses (in thousands other than percentages):





Fiscal Year Ended March 31,
                  
                  
                  2009 to 2008
                  
                  
                  2008 to 20072009
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  Inc (Dec)
                  
                  
                  %
                  
                  
                  Inc (Dec)
                  
                  
                  %Marketing
      and sales
                  
                  $
                  35,810
                  
                  
                  $
                  36,186
                  
                  
                  $
                  33,304
                  
                  
                  $
                  (376
                  )
                  
                  
                  (1
                  )%
                  
                  $
                  2,882
                  
                  
                  
                  9
                  %Percentage
      of net revenue
                  
                  
                  30
                  %
                  
                  
                  27
                  %
                  
                  
                  22
                  %





Fiscal
2009 compared to Fiscal 2008





The
Company’s marketing and sales expenses decreased by 1% to $35.8 million for
fiscal year 2009 from $36.2 million for fiscal year 2008.  Marketing
and sales represented 30% and 27% of net revenue for fiscal years 2009 and 2008,
respectively.  For the years ended March 31, 2007 through 2009,
marketing and sales expense included stock-based compensation expense of $1.3
million, $0.8 million and $0.8 million, respectively. The decrease in
selling, general and administrative expense during fiscal 2009, compared to
fiscal 2008, was primarily due to lower personnel-related costs associated with
the fiscal 2009 restructuring activities.  Sales and marketing
headcount decreased to 102 at March 31, 2009 from 127 at March 31,
2008.





Fiscal
2008 compared to Fiscal 2007





The
Company’s marketing and sales expenses increased 9% to $36.2 million for fiscal
year 2008 from $33.3 million for fiscal year 2007.  Marketing and
sales represented 27% and 22% of net revenue for fiscal years 2008 and 2007,
respectively.  The increase was driven primarily by an increase in
advertising and promotional expense of approximately $1.5 million associated
with overall increase of spending on broadcast creative production, OEM brand
marketing and packaging development related to the launch of Easy Media Creator
10. Personnel-related costs increased approximately $1.2 million due to greater
headcount as a result of growth and reorganization, primarily in the Company’s
consumer products segment.  As a part of the growth and
reorganization, the Company added headcount with higher level position
hires.  Headcount increased to 127 at March 31, 2008 from 118 at March
31, 2007.


35





Research and Development





Research
and development expenses consist primarily of salary and benefit expenses for
software developers, and contracted development efforts, related facilities
costs and expenses associated with test equipment used for
development.  The following table reflects the research and
development operating expenses (in thousands other than
percentages):





Fiscal Year Ended March 31,
                    
                    
                    2009 to 2008
                    
                    
                    2008 to 20072009
                    
                    
                    2008
                    
                    
                    2007
                    
                    
                    Inc (Dec)
                    
                    
                    %
                    
                    
                    Inc (Dec)
                    
                    
                    %Research
      and development
                    
                    $
                    39,250
                    
                    
                    $
                    44,511
                    
                    
                    $
                    44,513
                    
                    
                    $
                    (5,261
                    )
                    
                    
                    (12
                    )%
                    
                    $
                    (2
                    )
                    
                    
                    0
                    %Percentage
      of net revenue
                    
                    
                    33
                    %
                    
                    
                    33
                    %
                    
                    
                    30
                    %





Fiscal
2009 compared to Fiscal 2008





The
Company’s research and development expenses decreased to $39.3 million in 2009
from $44.5 million for fiscal year 2008.  Research and development
expenses represented 33% and 33% of net revenue for fiscal years 2009 and
2008.  For the years ended March 31, 2007 through 2009, research and
development expense included stock-based compensation expense of $0.7 million,
$0.5 million and $0.3 million, respectively. The decrease in research and
development expense during fiscal 2009 was primarily due to lower
personnel-related costs as a result of the continuing impact of prior fiscal
year restructuring activities.  Research and development headcount
decreased to 314 at March 31, 2009 from 446 at March 31, 2008.





Fiscal
2008 compared to Fiscal 2007





The
Company’s research and development expenses remained constant at $44.5 million
for fiscal years 2008 and 2007.  Research and development expenses
represented 33% and 30% of net revenue for fiscal years 2008 and
2007.  Changes in research and development expenses for fiscal year
2008 included a $0.9 million increase in personnel related expenses with
offsetting decreases in computer and software expenses of $0.7 million and
outside services of $0.2 million. Personnel related expenses increased as a
result of headcount increases through the year until December 31, 2007, when
headcount decreased by 84 employees as a result of the closure of the Richmond
Hill, Canada office.  Headcount increased in the Company’s China
locations due to continued expansion of research and development
activities.  At March 31, 2008, the headcount in China was 242
compared to 144 at March 31, 2007.





General
and Administrative





General
and administrative expenses consist primarily of compensation and benefit
expenses, travel expenses and related facilities costs, legal, accounting and
other professional service expenses.  The following table reflects the
general and administrative operating expenses (in thousands other than
percentages):





Fiscal Year Ended March 31,
                  
                  
                  2009 to 2008
                  
                  
                  2008 to 20072009
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  Inc (Dec)
                  
                  
                  %
                  
                  
                  Inc (Dec)
                  
                  
                  %General
      and administrative
                  
                  $
                  24,160
                  
                  
                  $
                  27,310
                  
                  
                  $
                  20,487
                  
                  
                  $
                  (3,150
                  )
                  
                  
                  (12
                  )%
                  
                  $
                  6,823
                  
                  
                  
                  33
                  %Percentage
      of net revenue
                  
                  
                  20
                  %
                  
                  
                  21
                  %
                  
                  
                  14
                  %





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
during fiscal 2009 was primarily due to lower professional fees and other
expenses of $7.6 million for fiscal year 2009 because 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 were partially offset by the following:




·
            Legal
      settlement accruals of $1.0 million related to ordinary course of business
      claim;




·
            an
      increase in share-based expense of $1.1 million,
  and;




·
            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 a
      China location.




36




General
and administrative headcount decreased to 102 at March 31, 2009 from 110 at
March 31, 2008.  For more information seeNote 8,
“Restructuring,” to the Consolidated Financial Statements included in this
Annual Report.




Fiscal
2008 compared to Fiscal 2007





General
and administrative expenses increased 33% to $27.3 million for fiscal year 2008
from $20.5 million for fiscal year 2007.  General and administrative
expenses represented 21% and 14% of net revenue for fiscal years 2008 and 2007,
respectively.  The increase in general and administrative expense for
fiscal year 2008 was primarily due to the following:




·
            Professional services expense
      increased $7.6 million, primarily due to the Company’s costs associated
      with the stock option
review.




·
            Facility expense increased $0.8
      million due to increased building rent and associated common area
      maintenance costs.




·
            Personnel-related expenses
      decreased by $1.0 million, as fiscal year 2007 included an adjustment
      related to a gross up of employee payroll taxes as a result of the stock
      option review.




·
            A decrease in depreciation
      expense of $0.3 million was due to more assets reaching the end of their
      useful lives and lower capital
purchases.




·
            A decrease in share-based
      compensation expense of $0.5 million. Share-based compensation expense was
      $0.2 million and $0.7 million for fiscal years 2008 and 2007,
      respectively.





Overall
headcount was 683 at March 31, 2008, down from 722 at March 31,
2007.  Headcount decreased by 84 associated with the Richmond Hill
Canada office closure.





Acquired
In-Process Technology Expense





The Company did not have any acquired
in-process technology expense in either of fiscal years 2009 or 2008,
respectively.  Acquired-in-process technology expense for fiscal 2007
consisted of an allocation of the purchase price of the SystemOK acquisition for
technology not yet viable at the acquisition date.





Abandoned
Acquisition Expense





The
Company did not have any abandoned acquisition expense in either of fiscal years
2009 or 2008.  Abandoned acquisition expenses for fiscal year 2007
consisted primarily of third party legal, accounting and other professional
service fees in connection with an abandoned potential acquisition.





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.  The following table reflects
the restructuring expenses (in thousands other than percentages):





Fiscal Year Ended March 31,
                  
                  
                  2009 to 2008
                  
                  
                  2008 to 20072009
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  Inc (Dec)
                  
                  
                  %
                  
                  
                  Inc (Dec)
                  
                  
                  %Restructuring
                  
                  $
                  3,947
                  
                  
                  $
                  3,152
                  
                  
                  $
                  -
                  
                  
                  $
                  795
                  
                  
                  
                  25
                  %
                  
                  $
                  3,152
                  
                  
                  
                  100
                  %Percentage
      of net revenue
                  
                  
                  3
                  %
                  
                  
                  2
                  %
                  
                  
                  -





Restructuring
expense increased 25% to $3.9 million for fiscal year 2009 from $3.2 million for
fiscal year 2008.    Restructuring expenses represented 3%
and 2% of net revenue for fiscal years 2009 and 2008,
respectively.  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.  The Company did not have restructuring
expenses in fiscal 2007.


37





Interest
Income, Interest Expense, and Other Expenses, Net





Interest
income includes interest earned on cash and cash equivalent
balances.  Interest income was approximately $0.7 million for 2009 and
$2.8 million for fiscal year 2008.  Interest expense for fiscal years
2009 and 2008 was approximately $0.8 million and $1.5 million,
respectively.  The decrease was primarily related to the Union Bank of
California N.A. (“UBOC”) credit facility being repaid on September 29, 2008
according to its terms. Other expenses for fiscal years 2009 and 2008
included foreign currency transaction gains and losses.





Interest
income was approximately $2.8 million for fiscal year 2007.  Interest
expense for fiscal year 2007 primarily consisted of interest expense of
approximately $2.0 million, relating to the interest due on the UBOC credit
facility.  Other expenses for fiscal year 2007 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 $25.2 million in
fiscal 2009.  The fiscal year 2009 tax provision is related to a
change in valuation allowance and taxes on profitable foreign
subsidiaries. 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 benefit in the amount of $4.3 million in fiscal
year 2008 and an income tax provision of $6.1 million in fiscal year
2007.  FIN No. 48, 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 FIN No. 48, 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





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
products 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 other 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





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.  The uMedia team was
integrated into the ATG division to further enhance 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.  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.


38





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., a
privately held digital video distributor.  The CinemaNow assets
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.





LIQUIDITY
AND CAPITAL RESOURCES





The
following table summarizes the Company’s working capital and cash, cash
equivalents, and investments (in thousands other than percentages):





Fiscal Years Ended March 31,
                        
                        
                        2009 to 20082009
                        
                        
                        2008
                        
                        
                        Inc (Dec)
                        
                        
                        %Working
      capital
                        
                        $
                        1,296
                        
                        
                        $
                        36,828
                        
                        
                        $
                        (35,532
                        )
                        
                        
                        (96
                        )%Cash
      and cash equivalents (1)
                        
                        $
                        19,864
                        
                        
                        $
                        63,459
                        
                        
                        $
                        (43,595
                        )
                        
                        
                        (69
                        )%





(1)
Consists of cash, restricted cash, money market funds and short-term
investments.





Working
capital decreased $35.5 million to $1.3 million at March 31, 2009 from $36.8
million at March 31, 2008.  The decrease in working capital in fiscal
2009 was primarily due to a decrease in cash, cash equivalents and short-term
investment balances caused by the Company’s use of cash for operating activities
and repayment of the UBOC credit facility in fiscal 2009.  Cash and
cash equivalents consist of cash, restricted cash and money market
funds.  Cash and cash equivalents decreased $43.6 million to $19.9
million at March 31, 2009 from $63.5 million at March 31, 2008.





The
following table summarizes cash inflows and/or outflows by category (in
thousands other than percentages):





Fiscal Years Ended March 31,
                    
                    
                    2009 to 2008
                    
                    
                    2008 to 20072009
                    
                    
                    2008
                    
                    
                    2007
                    
                    
                    Inc (Dec)
                    
                    
                    %
                    
                    
                    Inc (Dec)
                    
                    
                    %Net
      cash provided by (used in) operating activities
                    
                    $
                    (15,178
                    )
                    
                    $
                    1,288
                    
                    
                    $
                    18,744
                    
                    
                    $
                    (16,467
                    )
                    
                    
                    (1278
                    )%
                    
                    $
                    (17,456
                    )
                    
                    
                    (93
                    )%Net
      cash provided by (used in) investing activities
                    
                    $
                    (8,019
                    )
                    
                    $
                    43,168
                    
                    
                    $
                    (14,545
                    )
                    
                    $
                    (51,187
                    )
                    
                    
                    (119
                    )%
                    
                    $
                    57,713
                    
                    
                    
                    (397
                    )%Net
      cash provided by (used in) financing activities
                    
                    $
                    (19,866
                    )
                    
                    $
                    568
                    
                    
                    $
                    (5,832
                    )
                    
                    $
                    (20,434
                    )
                    
                    
                    (3598
                    )%
                    
                    $
                    6,400
                    
                    
                    
                    (110
                    )%





The
Company’s cash flow from operations varies significantly from quarter to quarter
and from year to year, depending on its operating results and the timing of
operating cash receipts and payments, specifically trade accounts receivable and
trade accounts payable.





Net cash
used in operating activities was $15.2 million compared to net cash provided by
operating activities of $1.3 million for the fiscal years ended 2009 and 2008,
respectively.  The $16.5 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” above.





The $17.4
million decline in net cash provided from operating activities for fiscal year
2008 compared to fiscal year 2007 was primarily attributable to an $11.8 million
decline in income inclusive of non-cash charges and an increase in deferred
income taxes of $9.4 million during fiscal 2008.  These were partially
offset by an increase in deferred revenue of $3.9 million.  The
Company experienced a net loss of $5.5 million for fiscal year 2008,
attributable to approximately $8.2 million in stock option review
expenses.





Net cash
used in investing activities was $8.0 million compared to net cash provided by
investing activities of $43.2 million for the fiscal years ended 2009 and 2008,
respectively.  This $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 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 $2.1 million also contributed to the decline
in net cash used in investing activities.


39





The Company generated $43.2 million of
cash in investing activities in fiscal year 2008 and used $14.5 million of cash
in investing activities in fiscal year 2007, with the difference primarily
attributable to net redemptions of short-term investments of $46.2 million and
the purchase of fixed assets and third party software of $2.5 million in fiscal
year 2008.  During fiscal year 2007, net purchases of short-term
investments totaled $4.9 million and the Company used $7.3 million for the
purchase of SystemOK, and the purchase of $2.4 million in fixed assets and
third-party software.





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 the fiscal
years 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 UBOC credit facility in full on September 29,
2008.





During
fiscal year 2008, the Company generated $0.6 million of cash in financing
activities from the proceeds from the exercise of stock options.  The
Company used $5.8 million of cash in financing activities during fiscal year
2007 primarily as a result of a $10 million payment on the Company’s UBOC credit
facility, partially offset by $2.7 million from the exercise of stock
options.





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, 2009 (in thousands):





Payments Due by PeriodContractual Obligations
                  
                  Total
                  
                  
                  Less Than 1
                    Year
                  
                  
                  1-3 Years
                  
                  
                  3-5 Years
                  
                  
                  More Than 5
                    YearsOperating
      and capital leases (1)
                  
                  $
                  8,284
                  
                  
                  $
                  4,531
                  
                  
                  $
                  2,884
                  
                  
                  $
                  868
                  
                  
                  $
                  -Acquisition
      holdback (2)
                  
                  
                  1,500
                  
                  
                  
                  1,500
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Purchase
      obligations (3)
                  
                  
                  1,350
                  
                  
                  
                  500
                  
                  
                  
                  850
                  
                  
                  
                  -
                  
                  
                  
                  -Total
                  
                  $
                  11,134
                  
                  
                  $
                  6,531
                  
                  
                  $
                  3,734
                  
                  
                  $
                  868
                  
                  
                  $
                  -





(1)
            Operating
      and capital leases include the Company's rent obligations on its
      properties and copiers.


(2)
            For
      information regarding the acquisition holdbacks see Note 7,
      “Acquisitions,” to the Consolidated Financial Statements included in this
      Annual Report.


(3)
            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, 2009.  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 $5.8 million
at March 31, 2009 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.


40





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.  The Company
evaluates estimated losses for such indemnification provisions under SFAS No. 5,
Accounting for Contingencies(“SFAS No. 5”), as interpreted by FIN No. 45, Guarantor’s Accounting and
Disclosure Requirements for Guarantees Including Indirect Guarantees of
Indebtedness of Others(“FIN 45”).





Concentration
of Credit Risk and Off-Balance Sheet Arrangements





SFAS No.
105,Disclosure of Information
about Financial Instruments with Off-Balance-Sheet Risk and Financial
Instruments with Concentrations of Credit Risk(“SFAS No. 105”),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 marketable securities 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 and marketable securities 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 is exposed to market risks, specifically with respect to foreign
currency exchange rates, interest rate volatility, and concentration of credit
risk especially on short-term investments.  The Company does not
use derivative financial instruments in its investment portfolio and does not
have foreign exchange contracts.





Exchange
Rate Sensitivity





The
Company has global operations and enters into transactions in various foreign
currencies. The value of the Company’s consolidated assets and liabilities
located outside the United States (translated at period end exchange rates) and
income and expenses (translated using average rates prevailing during the
period) are affected by the translation into its reporting currency (the U.S.
Dollar). Such translation adjustments are reported as a separate component
of shareholders’ equity.





Interest
Rate Sensitivity





The
Company is exposed to interest rate risk as a result of its significant cash,
cash equivalents and short-term investment holdings.  The rate of
return that the Company may be able to obtain on investment securities will
depend on market conditions at the time it makes the investments and may differ
from the rates it has secured in the past.





At March
31, 2009, the Company held $19.9 million of cash and cash
equivalents.  The Company’s cash and cash equivalents consist
primarily of cash and money-market funds. At March 31, 2009 and 2008, the
Company had amounts on deposit with financial institutions that were in excess
of the federally insured limit.  The Company has not experienced any
losses on deposits of cash and cash equivalents.  The Company’s money
market funds are currently insured by the U.S. Treasury’s Temporary Guarantee
Program until September 18, 2009.  The primary objective of the
Company’s investment in money market funds is to preserve capital for the
purpose of funding operations and is not for trading or speculative
purposes.





Concentration
of Credit Risk





Financial
instruments that potentially expose the Company to concentration of credit risk
include cash and cash equivalents and accounts receivable.  Cash
and cash equivalents are held with high credit quality financial
institutions.





Accounts
receivable are unsecured and are derived from sales to customers.  See
Note 6, “Significant Customer Information, Segment Reporting and Geographic
Information,” to the Consolidated Financial Statements included in this Annual
Report for significant customer concentration information.


41




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 of Sonic Solutions:





We have
audited Sonic Solutions’ internal control over financial reporting as of March
31, 2009, based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (the COSO criteria).  Sonic Solutions’ management
is responsible 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 Item 9A, Management’s Report
on Internal Control Over Financial Reporting.  Our responsibility is
to express 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
effective internal control over financial reporting was maintained in all
material respects.  Our audit 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 opinion.





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, Sonic Solutions maintained, in all material respects, effective
internal control over financial reporting as of March 31, 2009, based on the
COSO criteria.





We do not
express an opinion or any other form of assurance on management’s statements
referring to any corrective actions taken by the company after the date of
management’s assessment.





We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Sonic
Solutions as of March 31, 2009 and 2008, and the related consolidated statements
of operations, shareholders’ equity and comprehensive income (loss), and cash
flows for each of the three years in the period ended March 31, 2009, and our
report dated May 29, 2009 expressed an unqualified opinion thereon.





/s/ BDO
Seidman, LLP





San
Francisco, California


May  29,
2009


42


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





The Board
of Directors and Shareholders of Sonic Solutions:





We have
audited the accompanying consolidated balance sheets of Sonic Solutions and
subsidiaries as of March 31, 2009 and 2008, and the related consolidated
statements of operations, shareholders’ equity and comprehensive income (loss)
and cash flows for each of the three 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 are
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 2008, and the results of their operations
and their cash flows for each of the three 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, 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.





We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of Sonic Solutions’ internal
control over financial reporting as of March 31, 2009, based on criteria
established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our
report dated May 29, 2008 expressed an unqualified opinion thereon.





/s/ BDO
Seidman, LLP





San
Francisco, California


May 29,
2009


43


CONSOLIDATED
FINANCIAL STATEMENTS


SONIC
SOLUTIONS


CONSOLIDATED
BALANCE SHEETS


(In
thousands, except share and per share data)





March 31,2009
                      
                      
                      2008ASSETSCurrent
      assets:Cash
      and cash equivalents
                      
                      $
                      19,408
                      
                      
                      $
                      61,955Restricted
      cash
                      
                      
                      456
                      
                      
                      
                      454Short-term
      investments
                      
                      
                      -
                      
                      
                      
                      1,050Accounts
      receivable, net of allowances of $2,072 and $3,901 at March 31, 2009 and
      2008, respectively
                      
                      
                      14,874
                      
                      
                      
                      15,773Inventory
                      
                      
                      1,086
                      
                      
                      
                      1,198Prepaid
      expenses and other current assets
                      
                      
                      4,504
                      
                      
                      
                      4,917Deferred
      tax benefits
                      
                      
                      41
                      
                      
                      
                      13,920Total
      current assets
                      
                      
                      40,369
                      
                      
                      
                      99,267Fixed
      assets, net
                      
                      
                      2,851
                      
                      
                      
                      2,959Purchased
      and internally developed software costs, net
                      
                      
                      448
                      
                      
                      
                      704Goodwill
                      
                      
                      4,628
                      
                      
                      
                      55,456Acquired
      intangibles, net
                      
                      
                      16,556
                      
                      
                      
                      35,502Deferred
      tax benefits, net
                      
                      
                      21
                      
                      
                      
                      14,642Other
      assets
                      
                      
                      1,864
                      
                      
                      
                      1,519Total
      assets
                      
                      $
                      66,737
                      
                      
                      $
                      210,049LIABILITIES
      AND SHAREHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable
                      
                      $
                      5,042
                      
                      
                      $
                      6,118Accrued
      expenses and other current liabilities
                      
                      
                      27,026
                      
                      
                      
                      29,467Deferred
      revenue
                      
                      
                      6,875
                      
                      
                      
                      6,854Capital
      lease
                      
                      
                      130
                      
                      
                      
                      -Bank
      note payable
                      
                      
                      -
                      
                      
                      
                      20,000Total
      current liabilities
                      
                      
                      39,073
                      
                      
                      
                      62,439Other
      long term liabilities, net of current portion
                      
                      
                      724
                      
                      
                      
                      2,943Deferred
      revenue, net of current portion
                      
                      
                      135
                      
                      
                      
                      65Capital
      lease, net of current portion
                      
                      
                      161
                      
                      
                      
                      -Total
      liabilities
                      
                      
                      40,093
                      
                      
                      
                      65,447Commitments
      and contingencies (Note 3)Shareholders'
      equity:Convertible
      preferred stock, no par value, 10,000,000 shares authorized; 0 shares
      issued and outstanding at March 31, 2009 and 2008.
                      
                      
                      -
                      
                      
                      
                      -Common
      stock, no par value, 100,000,000 shares authorized; 26,593,647 and
      26,383,277 shares issued and outstanding at March 31, 2009 and
      2008.
                      
                      
                      163,121
                      
                      
                      
                      163,251Accumulated
      deficit
                      
                      
                      (135,076
                      )
                      
                      
                      (16,952
                      )Accumulated
      other comprehensive loss
                      
                      
                      (1,401
                      )
                      
                      
                      (1,697
                      )Total
      shareholders' equity
                      
                      
                      26,644
                      
                      
                      
                      144,602Total
      liabilities and shareholders' equity
                      
                      $
                      66,737
                      
                      
                      $
                      210,049








44





SONIC
SOLUTIONS


CONSOLIDATED
STATEMENT OF OPERATIONS


(In
thousands, except share data)





Years Ended March 31,2009
                                                      
                                                      
                                                      2008
                                                      
                                                      
                                                      2007Net
      revenue
                                                      
                                                      $
                                                      119,958
                                                      
                                                      
                                                      $
                                                      132,874
                                                      
                                                      
                                                      $
                                                      148,649Cost
      of revenue
                                                      
                                                      
                                                      32,901
                                                      
                                                      
                                                      
                                                      33,151
                                                      
                                                      
                                                      
                                                      34,389Impairment
      of intangibles
                                                      
                                                      
                                                      19,579
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -Gross
      profit
                                                      
                                                      
                                                      67,478
                                                      
                                                      
                                                      
                                                      99,723
                                                      
                                                      
                                                      
                                                      114,260Operating
      expenses:Marketing
      and sales
                                                      
                                                      
                                                      35,810
                                                      
                                                      
                                                      
                                                      36,186
                                                      
                                                      
                                                      
                                                      33,304Research
      and development
                                                      
                                                      
                                                      39,250
                                                      
                                                      
                                                      
                                                      44,511
                                                      
                                                      
                                                      
                                                      44,513General
      and administrative
                                                      
                                                      
                                                      24,160
                                                      
                                                      
                                                      
                                                      27,310
                                                      
                                                      
                                                      
                                                      20,487Acquired
      in-process technology
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      3,400Abandoned
      acquisition
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      1,016Restructuring
                                                      
                                                      
                                                      3,947
                                                      
                                                      
                                                      
                                                      3,152
                                                      
                                                      
                                                      
                                                      -Impairment
      of goodwill
                                                      
                                                      
                                                      56,174
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -159,341
                                                      
                                                      
                                                      
                                                      111,159
                                                      
                                                      
                                                      
                                                      102,720Operating
      income (loss)
                                                      
                                                      
                                                      (91,863
                                                      )
                                                      
                                                      
                                                      (11,436
                                                      )
                                                      
                                                      
                                                      11,540Interest
      income
                                                      
                                                      
                                                      687
                                                      
                                                      
                                                      
                                                      2,768
                                                      
                                                      
                                                      
                                                      2,845Interest
      expense
                                                      
                                                      
                                                      (767
                                                      )
                                                      
                                                      
                                                      (1,479
                                                      )
                                                      
                                                      
                                                      (2,024
                                                      )Other
      income (expense)
                                                      
                                                      
                                                      (1,020
                                                      )
                                                      
                                                      
                                                      356
                                                      
                                                      
                                                      
                                                      (40
                                                      )Income
      (loss) before income taxes
                                                      
                                                      
                                                      (92,963
                                                      )
                                                      
                                                      
                                                      (9,791
                                                      )
                                                      
                                                      
                                                      12,321Provision
      (benefit) for income taxes
                                                      
                                                      
                                                      25,160
                                                      
                                                      
                                                      
                                                      (4,254
                                                      )
                                                      
                                                      
                                                      6,071Net
      income (loss)
                                                      
                                                      $
                                                      (118,123
                                                      )
                                                      
                                                      $
                                                      (5,537
                                                      )
                                                      
                                                      $
                                                      6,250Net
      income (loss) per share:Basic
                                                      
                                                      $
                                                      (4.46
                                                      )
                                                      
                                                      $
                                                      (0.21
                                                      )
                                                      
                                                      $
                                                      0.24Diluted
                                                      
                                                      $
                                                      (4.46
                                                      )
                                                      
                                                      $
                                                      (0.21
                                                      )
                                                      
                                                      $
                                                      0.23Shares
      used in computing net income (loss) per share:Basic
                                                      
                                                      
                                                      26,535
                                                      
                                                      
                                                      
                                                      26,247
                                                      
                                                      
                                                      
                                                      25,982Diluted
                                                      
                                                      
                                                      26,535
                                                      
                                                      
                                                      
                                                      26,247
                                                      
                                                      
                                                      
                                                      27,431





See
accompanying Notes to Consolidated Financial Statements.


45


SONIC
SOLUTIONS


CONSOLIDATED
STATEMENT OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)


(In
thousands)





AccumulatedOther
                        
                        
                        TotalCommon Stock
                        
                        
                        Accumulated
                        
                        
                        Comprehensive
                        
                        
                        Shareholders’
                        
                        
                        ComprehensiveShares
                        
                        
                        Amount
                        
                        
                        Deficit
                        
                        
                        Loss
                        
                        
                        Equity
                        
                        
                        Income (Loss)Balances
      at March 31, 2006
                        
                        
                        25,686
                        
                        
                        $
                        155,484
                        
                        
                        $
                        (17,065
                        )
                        
                        $
                        (937
                        )
                        
                        $
                        137,482Exercise
      of common stock options
                        
                        
                        480
                        
                        
                        
                        2,717
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        2,717Shares
      issued for SystemOK acquisition
                        
                        
                        31
                        
                        
                        
                        489
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        489Share-based
      compensation expense
                        
                        
                        -
                        
                        
                        
                        2,765
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        2,765Tax
      benefit from employee stock option plans
                        
                        
                        -
                        
                        
                        
                        1,110
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,110Foreign
      currency translation adjustment
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        20
                        
                        
                        
                        20
                        
                        
                        $
                        20Net
      income
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        6,250
                        
                        
                        
                        -
                        
                        
                        
                        6,250
                        
                        
                        
                        6,250Balances
      at March 31, 2007
                        
                        
                        26,197
                        
                        
                        
                        162,565
                        
                        
                        
                        (10,815
                        )
                        
                        
                        (917
                        )
                        
                        
                        150,833
                        
                        
                        $
                        6,270Cumulative
      effect upon adoption of FIN 48
                        
                        
                        -
                        
                        
                        
                        (788
                        )
                        
                        
                        (600
                        )
                        
                        
                        -
                        
                        
                        
                        (1,388
                        )Exercise
      of common stock options
                        
                        
                        186
                        
                        
                        
                        570
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        570Share-based
      compensation expense
                        
                        
                        -
                        
                        
                        
                        1,557
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,557Tax
      provision from employee stock option plans
                        
                        
                        -
                        
                        
                        
                        (653
                        )
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (653
                        )Foreign
      currency translation adjustment
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (780
                        )
                        
                        
                        (780
                        )
                        
                        $
                        (780
                        )Net
      loss
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (5,537
                        )
                        
                        
                        -
                        
                        
                        
                        (5,537
                        )
                        
                        
                        (5,537
                        )Balances
      at March 31, 2008
                        
                        
                        26,383
                        
                        
                        
                        163,251
                        
                        
                        
                        (16,952
                        )
                        
                        
                        (1,697
                        )
                        
                        
                        144,602
                        
                        
                        
                        (6,317
                        )Exercise
      of common stock options
                        
                        
                        211
                        
                        
                        
                        318
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        318Tax
      provision from employee stock option plans
                        
                        
                        -
                        
                        
                        
                        (2,467
                        )
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (2,467
                        )Tender
      offer payment
                        
                        
                        -
                        
                        
                        
                        (94
                        )
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (94
                        )Share-based
      compensation expense
                        
                        
                        -
                        
                        
                        
                        2,113
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        2,113Foreign
      currency translation adjustment
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (1
                        )
                        
                        
                        296
                        
                        
                        
                        295
                        
                        
                        $
                        295Net
      loss
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (118,123
                        )
                        
                        
                        -
                        
                        
                        
                        (118,123
                        )
                        
                        
                        (118,123
                        )Balances
      at March 31, 2009
                        
                        
                        26,594
                        
                        
                        $
                        163,121
                        
                        
                        $
                        (135,076
                        )
                        
                        $
                        (1,401
                        )
                        
                        $
                        26,644
                        
                        
                        $
                        (117,828
                        )




46


SONIC
SOLUTIONS


CONSOLIDATED
STATEMENT OF CASH FLOWS


(In
thousands)





Years
      Ended March 31,2009
                        
                        
                        2008
                        
                        
                        2007Cash
      flows from operating activities:Net
      income (loss)
                        
                        $
                        (118,123
                        )
                        
                        $
                        (5,537
                        )
                        
                        $
                        6,250Adjustments
      to reconcile net income (loss) to net cash generated by operating
      activities:Depreciation
      and amortization
                        
                        
                        5,883
                        
                        
                        
                        7,693
                        
                        
                        
                        9,418Impairment
      of intangibles
                        
                        
                        19,579Deferred
      income taxes
                        
                        
                        23,774
                        
                        
                        
                        (5,527
                        )
                        
                        
                        3,902Impairment
      of goodwill
                        
                        
                        56,174
                        
                        
                        
                        -
                        
                        
                        
                        -Provision
      for returns and doubtful accounts, net of write-offs
                        
                        
                        (602
                        )
                        
                        
                        2,031
                        
                        
                        
                        (457
                        )Share-based
      compensation
                        
                        
                        2,191
                        
                        
                        
                        1,557
                        
                        
                        
                        2,765Increase
      in restricted cash
                        
                        
                        (2
                        )
                        
                        
                        (454
                        )
                        
                        
                        -Tax
      benefit from employee stock option plans
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,841Excess
      tax benefit from share based compensation
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (1,486
                        )Acquired
      in-process technology
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        3,400Loss
      on disposal of assets
                        
                        
                        9
                        
                        
                        
                        77
                        
                        
                        
                        162Changes
      in operating assets and liabilities, netAccounts
      receivable
                        
                        
                        1,194
                        
                        
                        
                        2,959
                        
                        
                        
                        2,902Inventory
                        
                        
                        (56
                        )
                        
                        
                        (392
                        )
                        
                        
                        (117
                        )Prepaid
      expenses and other current assets
                        
                        
                        874
                        
                        
                        
                        (231
                        )
                        
                        
                        (879
                        )Other
      assets
                        
                        
                        (345
                        )
                        
                        
                        347
                        
                        
                        
                        (534
                        )Accounts
      payable
                        
                        
                        (1,076
                        )
                        
                        
                        192
                        
                        
                        
                        (1,908
                        )Accrued
      expenses and other current liabilities
                        
                        
                        (4,104
                        )
                        
                        
                        (2,764
                        )
                        
                        
                        (3,934
                        )Deferred
      revenue
                        
                        
                        (548
                        )
                        
                        
                        1,337
                        
                        
                        
                        (2,581
                        )Net
      cash provided by (used in) operating activities
                        
                        
                        (15,178
                        )
                        
                        
                        1,288
                        
                        
                        
                        18,744Cash
      flows from investing activities:Purchase
      of fixed assets
                        
                        
                        (1,788
                        )
                        
                        
                        (2,134
                        )
                        
                        
                        (1,276
                        )Additions
      to purchased software
                        
                        
                        (185
                        )
                        
                        
                        (356
                        )
                        
                        
                        (1,110
                        )Acquisition
      of Simple Star, net of cash acquired
                        
                        
                        (5,046
                        )
                        
                        
                        -
                        
                        
                        
                        -Acquisition
      of CinemaNow, net of cash acquired
                        
                        
                        (2,050
                        )
                        
                        
                        -
                        
                        
                        
                        -Acquisition
      of System OK, net of cash acquired
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (7,258
                        )Acquisition
      of uMedia, net of cash acquired
                        
                        
                        -
                        
                        
                        
                        (543
                        )
                        
                        
                        -Purchase
      of short term investment instruments
                        
                        
                        -
                        
                        
                        
                        (19,174
                        )
                        
                        
                        (47,951
                        )Redemption
      of long term investment instruments
                        
                        
                        900
                        
                        
                        
                        -
                        
                        
                        
                        -Redemption
      of short term investment instruments
                        
                        
                        150
                        
                        
                        
                        65,375
                        
                        
                        
                        43,050Net
      cash provided by (used) in investing activities
                        
                        
                        (8,019
                        )
                        
                        
                        43,168
                        
                        
                        
                        (14,545
                        )Cash
      flows from financing activities:Share-based
      compensation
                        
                        
                        (94
                        )
                        
                        
                        -
                        
                        
                        
                        -Proceeds
      from exercise of common stock options
                        
                        
                        318
                        
                        
                        
                        570
                        
                        
                        
                        2,717Excess
      tax benefits from share-based compensation
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,486Payments
      on bank credit facility
                        
                        
                        (20,000
                        )
                        
                        
                        -
                        
                        
                        
                        (10,000
                        )Principal
      payments on capital leases
                        
                        
                        (90
                        )
                        
                        
                        (2
                        )
                        
                        
                        (35
                        )Net
      cash provided by (used in) financing activities
                        
                        
                        (19,866
                        )
                        
                        
                        568
                        
                        
                        
                        (5,832
                        )Effect
      on exchange rate changes on cash and cash equivalents
                        
                        
                        517
                        
                        
                        
                        (159
                        )
                        
                        
                        (8
                        )Net
      increase (decrease) in cash and cash equivalents
                        
                        
                        (42,546
                        )
                        
                        
                        44,865
                        
                        
                        
                        (1,641
                        )Cash
      and cash equivalents at beginning of year
                        
                        
                        61,955
                        
                        
                        
                        17,090
                        
                        
                        
                        18,731Cash
      and cash equivalents at end of year
                        
                        $
                        19,409
                        
                        
                        $
                        61,955
                        
                        
                        $
                        17,090Supplemental
      disclosure of cash flow information:Interest
      paid during year
                        
                        $
                        641
                        
                        
                        $
                        1,398
                        
                        
                        $
                        1,071Income
      taxes paid during year
                        
                        $
                        786
                        
                        
                        $
                        730
                        
                        
                        $
                        2,808Supplemental
      disclosure of non-cash transactionsIssuance
      of common stock for acquistions
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        489Original
      cost of fully depreciated fixed assets written off
                        
                        $
                        -
                        
                        
                        $
                        4,981
                        
                        
                        $
                        142Cumulative
      effect upon adoption of FIN 48
                        
                        $
                        -
                        
                        
                        $
                        788
                        
                        
                        $
                        -





See
accompanying Notes to Consolidated Financial Statements.


47


SONIC
SOLUTIONS





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


Years
ended March 31, 2009, 2008 and 2007





NOTE
1 - BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





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, original equipment manufacturers
(“OEMs”), enterprises, high-end professional DVD 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 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.




Basis
of Presentation





The
Company prepares its financial statements in conformity with U.S. generally
accepted accounting principles (“GAAP”).  The accompanying
consolidated financial statements include the accounts of the Company’s
subsidiaries. All intercompany balances and transactions have been eliminated in
consolidation.





Quantities
or results referred to as “to date” or “as of this date” mean as of or to March
31, 2009, unless otherwise specifically noted.  References to “FY” or
“fiscal year” refer to our fiscal year ending on March 31 of the designated
year. For example, “FY 2009” and “fiscal year 2009” each refer to the fiscal
year ending March 31, 2009. Other references to “years” mean calendar
years.





This
Annual Report on Form 10-K (“Annual Report”) includes references to certain of
the Company’s 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.





Reclassifications





Certain
prior year amounts in the Consolidated Financial Statements and notes thereto
have been reclassified to conform to the current year presentation.





Significant
Accounting Policies





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.





Use
of estimates





On an
ongoing basis, the Company evaluates estimates used, including those related to
the valuation of stock options, valuation of goodwill and other intangible
assets, valuation of investment instruments, useful lives of intangible assets
and equipment and leasehold improvements, inventory valuation allowances,
revenue recognition, the estimated allowances for sales returns and doubtful
accounts and income tax accruals.  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:


48





·
            Revenue
      recognition


·
            Allowances
      for product returns and doubtful
accounts


·
            Goodwill,
      intangible assets and other long-lived
assets


·
            Share-based
      compensation


·
            Income
      tax and deferred tax asset
valuation


·
            Valuation
      of acquired businesses, assets and
liabilities


·
            Accrued
      liabilities


·
            Contingencies





Foreign
Currency Translation





The
functional currency of the Company’s foreign subsidiaries is the local
currency.  Assets and liabilities are translated into U.S. dollars at
the exchange rate on the balance sheet date.  Revenues and expenses
are translated at the average exchange rate prevailing during the
period.  The related gains and losses from translation are recorded in
accumulated other comprehensive income (loss) in the balance
sheet.  Foreign currency transaction gains and losses are included in
“Other income (expense).”





Cash
Equivalents





Cash and
cash equivalents consist of short-term, highly-liquid investments with original
maturities of three months or less and are stated at cost, which approximates
market value.





Short
Term Investments





During
fiscal 2009 and 2008, short term investments included highly-rated (AAA/Aaa)
select auction variable rate securities (“SAVRS”).  Short-term
investments are reported at fair value and are subject to periodic impairment
review with any unrealized gains or losses recorded in other comprehensive
income (loss).  No impairment charges were recorded on any short-term
investments during the years ended March 31, 2009 or 2008.  As of
November 20, 2008, the Company redeemed the remaining SAVRS that it previously
held for $0.9 million, which comprised the full carrying value plus
interest.





Fair
Value of Financial Instruments





In the
first quarter of fiscal 2009, the Company adopted SFAS No. 157, which
defines fair value, establishes a framework for measuring fair value, and
expands disclosures about fair value measurements. Under this standard,
fair value is defined as the price that would be received to sell an asset or
paid to transfer a liability (i.e., the “exit price”) in an orderly transaction
between market participants at the measurement date. The Company reports
certain financial assets and liabilities at their respective carrying amounts as
the carrying amounts approximate fair value due to the short term maturity of
those items.  These include: cash and cash equivalents, cash sweep,
restricted cash, receivables, accounts payables, and accrued
liabilities.





The
Company’s money market funds are considered a Level 1 financial asset where the
fair value is based on unadjusted quoted market prices and the account balance
approximates its fair value due to its short term nature.  The primary
objective of the Company’s investment in money market funds is to preserve
capital for the purpose of funding operations and is not for trading or
speculative purposes.  The following table presents the Company’s
financial assets measured at fair value on a recurring basis at March 31, 2009
(in thousands):


49





FairValueMeasurementsatReportingDateFairValueasof
                                  March31,2009
                                
                                QuotedPricesin
                                  ActiveMarketsfor
                                  IdenticalAssets(Level 1)AssetsMoney market
      accounts (1)
                                
                                $
                                15,737
                                
                                
                                $
                                15,737Total
                                
                                $
                                15,737
                                
                                
                                $
                                15,737(1)Included in "Cash and cash equivalents" in the
      Balance Sheet.





Accounts
Receivable and Allowance for Product Returns and Doubtful Accounts





Accounts
receivable is presented net of allowance for product returns and doubtful
accounts of $2.1 million and $3.9 million at March 31, 2009 and 2008,
respectively. The Company’s distributor 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 deteriorate 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.





Inventory





Inventory
is valued at the lower of cost, determined on a first-in, first-out basis, or
market.  Reserves for excess and obsolete inventory are established
based on an analysis of products on hand and sales trends.  The
Company had finished goods of $1.1 million and $1.2 million at March 31, 2009
and 2008, respectively.  Finished goods inventory included inventory
on consignment of $1.0 million and $0.9 million at March 31, 2009 and 2008,
respectively.





Fixed
Assets, net





Fixed
assets consist primarily of furniture, equipment, and leasehold
improvements.  Fixed assets are stated at cost less accumulated
depreciation and amortization.  The Company depreciates furniture and
equipment using the straight-line method over the estimated useful lives of the
respective assets which are generally three to five years.  Leasehold
improvements are amortized on a straight-line basis over the lesser of their
estimated useful lives or the term of the lease.  Fixed assets consist
of (in thousands):





March 31,2009
                    
                    
                    2008Equipment,
      furniture and fixtures
                    
                    $
                    12,214
                    
                    
                    $
                    10,941Less:
      accumulated depreciation
                    
                    
                    (9,363
                    )
                    
                    
                    (7,982
                    )$
                    2,851
                    
                    
                    $
                    2,959





Impairment
of Goodwill, Intangible Assets and Other Long-Lived Assets





SFAS
No. 142 classifies intangible assets 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 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 has reviewed the provisions of SFAS No. 142 with respect to the
criteria necessary to evaluate the number of reporting units that
exist. Based on its review of SFAS No. 131, the Company has determined it
operates in two reporting segments, Consumer and Professional.  Based
on a combination of factors occurring during fiscal 2009, including the current
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 a preliminary impairment analysis and
recorded estimated impairment charges of $19.6 million and $56.2 million
for its intangible assets and goodwill, respectively, related to its consumer
reporting segment.


50





There are
inherent uncertainties and management judgment required in an analysis of
goodwill impairment. Fair values were determined based upon market
conditions, a blended market and income approach which utilized cash flow
projections, and other factors.  Future adverse changes in these or
other unforeseeable factors could result in an impairment charge that could
materially impact future results of operations and financial position in the
reporting period identified.  The results of the analysis indicated
that there would be $4.6 million remaining carrying value attributable to
goodwill for the Premium segment, $2.1 million attributable to acquired
intangibles for Premium segment and $14.5 million attributable to acquired
intangibles for the Roxio segment as of December 31, 2008. During the
fourth quarter ended March 31, 2009, the Company determined there were no
further impairments to record for fiscal 2009.





Goodwill
and identified intangible asset balances are summarized as follows (in
thousands):





March 31,
                
                
                
                
                
                
                
                
                
                
                
                March 31,2008
                
                
                Additions(1)
                
                
                Adjustments(2)
                
                
                Amortization(3)
                
                
                2009Goodwill
                
                $
                55,456
                
                
                $
                5,305
                
                
                $
                (56,133
                )
                
                $
                -
                
                
                $
                4,628Purchased
      software
                
                
                671
                
                
                
                -
                
                
                
                -
                
                
                
                (224
                )
                
                
                447Internally
      developed software
                
                
                33
                
                
                
                -
                
                
                
                -
                
                
                
                (33
                )
                
                
                -Acquired
      technology
                
                
                3,073
                
                
                
                1,910
                
                
                
                (2,673
                )
                
                
                (2,000
                )
                
                
                310Customer
      lists/contacts
                
                
                6,729
                
                
                
                2,100
                
                
                
                (5,248
                )
                
                
                (1,439
                )
                
                
                2,142Trademark/brand
      name
                
                
                25,700
                
                
                
                70
                
                
                
                (11,658
                )
                
                
                (9
                )
                
                
                14,103$
                91,662
                
                
                $
                9,385
                
                
                $
                (75,712
                )
                
                $
                (3,705
                )
                
                $
                21,630





(1)
            Includes
      amounts capitalized in connection with the Simple Star and CinemaNow
      acquisitions completed in fiscal
2009.


(2)
            Adjustments
      include goodwill impairment of $56.2 million and intangible impairment of
      $19.6 million in fiscal 2009.


(3)
            Amortization
      of intangibles is included in “Cost of Revenue” in the Company’s
      Consolidated Statements of
Operations.


(4)
            A
      portion ($46,000) of the March 31, 2008 ending balance for acquired
      technology and customer lists/contracts was reclassified between the
      intangibles.





March 31,
                
                
                
                
                
                
                
                
                
                
                
                March 31,2007
                
                
                Additions(1)
                
                
                Adjustments(2)
                
                
                Amortization(3)
                
                
                2008Goodwill
                
                $
                55,508
                
                
                $
                413
                
                
                $
                (465
                )
                
                $
                -
                
                
                $
                55,456Purchased
      software
                
                
                3,370
                
                
                
                -
                
                
                
                -
                
                
                
                (2,699
                )
                
                
                671Internally
      developed software
                
                
                9,853
                
                
                
                -
                
                
                
                -
                
                
                
                (9,820
                )
                
                
                33Acquired
      technology
                
                
                5,697
                
                
                
                -
                
                
                
                -
                
                
                
                (2,670
                )
                
                
                3,027Customer
      lists/contacts
                
                
                8,775
                
                
                
                130
                
                
                
                -
                
                
                
                (2,130
                )
                
                
                6,775Trademark/brand
      name
                
                
                25,700
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                25,700$
                108,903
                
                
                $
                543
                
                
                $
                (465
                )
                
                $
                (17,319
                )
                
                $
                91,662





(1)
            Includes
      amounts capitalized in connection with the uMedia acquisition completed in
      February 2008.


(2)
            Adjustments
      include a total decrease to goodwill of $0.4 million related to the
      utilization of Canadian pre-acquisition net operating losses in the third
      and fourth quarters of fiscal 2008, a $0.2 million decrease to goodwill
      related to reserve established in connection with SystemOK and $0.1
      million increase to goodwill related to the adoption of FIN No. 48 in the
      first quarter of fiscal 2008.


(3)
            Amortization
      of intangibles is included in “Cost of Revenue” in the Company’s
      Consolidated Statements of
Operations.





The
acquired intangibles with finite lives are being amortized using accelerated and
straight-line methods over their estimated useful lives.  Amortization
of acquired intangibles was $3.4 million, $4.8 million and $5.4 million for the
years ended March 31, 2009, 2008 and 2007, respectively.  Amortization
of internally developed software costs was $0.1 million, $0.1 million and $0.3
million for the years ended March 31, 2009, 2008 and 2007,
respectively.  The future annual amortization expense is expected to
be as follows (in thousands):


51





AmortizationYear Ending March 31,
                  
                  Expense2010
                  
                  $
                  3812011
                  
                  
                  3922012
                  
                  
                  3252013
                  
                  
                  2102014
                  
                  
                  245Thereafter
                  
                  
                  902$
                  2,455





Other
Comprehensive Income (Loss)





The
Company reports comprehensive income (loss) in accordance with SFAS No. 130,
Reporting Comprehensive
Income (“SFAS No. 130”).  SFAS No. 130 requires companies to
classify items of comprehensive income (loss) by their nature in the
consolidated financial statements and display the accumulated balance of other
comprehensive income (loss) separately from accumulated deficit and additional
paid-in capital in the equity section of the consolidated balance sheets. Other
comprehensive income (loss) items have no impact on the Company’s net income
(loss) as presented in its Consolidated Statements of Operations.  The
Company’s other comprehensive income (loss) is composed primarily of foreign
currency translation adjustments.  See “Statement of Shareholders’
Equity and Comprehensive Income (Loss),” Item 8, “Financial Statements and
Supplementary Data” included in this Annual Report.





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 software-related revenue in accordance with AICPA SOP No.
97-2 as amended by SOP No. 98-9, and SAB No. 104.  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.





The
Company follows EITF No. 99-19.  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 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 SOP No. 98-9, 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.


52





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.  In such situations, the Company recognizes
product sales in accordance with SFAS No. 48.  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.





In
accordance with EITF No. 01-09, 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 in accordance with SOP No. 81-1, 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 CinemaNow content sales.  When purchased on an a-la-carte
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.





Share-Based
Compensation





The
Company accounts for share-based compensation under SFAS No.
123(R).  SFAS No. 123(R) requires the measurement and recognition of
compensation expense for all equity-based payment awards made to the Company’s
employees and directors, including stock options and Restricted Stock Units
(“RSUs”), based on estimated fair values.  On March 29, 2005, the SEC
issued SAB No. 107 which provides supplemental implementation guidance for SFAS
No. 123(R).  The Company applied the provisions of SAB No. 107 in its
adoption of SFAS No. 123(R) on April 1, 2006.





Under the
fair value recognition provisions of this statement, 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 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.


53





If
factors change, share-based compensation for the future periods may differ
significantly from what the Company has recorded in the current period and could
materially affect its operating income, net income and net income per
share.  Additionally, the Black-Scholes-Merton option pricing model
was developed for use in estimating the fair value of traded options that have
no vesting restrictions and are fully transferable, which are characteristics
not present in the Company’s option grants.  Existing assumptions used
and valuation modeling may not provide measures of the fair values of the
Company’s share-based compensation that reflect the actual values realized upon
the exercise, expiration, early termination or forfeiture of those share-based
payments in the future.  Certain share-based payments, such as stock
options, may expire worthless or otherwise result in zero intrinsic value as
compared to the fair values originally estimated on the grant date and reported
in the Company’s financial statements.  Alternatively, value may be
realized from these instruments that are significantly higher than the fair
values originally estimated on the grant date and reported in the Company’s
financial statements.  Currently, there are only very limited
market-based mechanisms or other practical applications to verify the
reliability and accuracy of the estimates stemming from these valuation models,
and there is no means to compare and adjust the estimates to actual
values.





Income
Taxes





The
Company accounts for income taxes in accordance with SFAS No.
109.  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.  Effective April 1, 2007, the Company adopted FIN No.
48, an interpretation of SFAS No. 109.  FIN No. 48 contains a
two-step approach to recognize and measure uncertain tax positions accounted for
in accordance with SFAS No. 109.  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.





Basic
and Diluted Income (Loss) Per Share





In
accordance with SFAS No. 128, Earnings per Share (“SFAS No.
128”), the Company reports Earnings per Share (“EPS”), both basic and diluted,
on the consolidated statements of operations.  Basic EPS is based upon
the weighted average number of common shares outstanding.  Diluted EPS
is computed using the weighted average common shares outstanding plus any
potential common stock, except when their effect is
anti-dilutive.  Potential common stock includes common stock issuable
upon the exercise of stock options and restricted stock units.  The
following table sets forth the computation of basic and diluted income (loss)
per share (in thousands, except per share data):


54





Years Ended March 31,2009
                  
                  
                  2008
                  
                  
                  2007Net
      income (loss) applicable to common shareholders
                  
                  $
                  (118,123
                  )
                  
                  $
                  (5,537
                  )
                  
                  $
                  6,250Net
      income (loss) per share:Basic
                  
                  $
                  (4.46
                  )
                  
                  $
                  (0.21
                  )
                  
                  $
                  0.24Diluted
                  
                  $
                  (4.46
                  )
                  
                  $
                  (0.21
                  )
                  
                  $
                  0.23Shares
      used in computing net income (loss) per share:Basic
                  
                  
                  26,535
                  
                  
                  
                  26,247
                  
                  
                  
                  25,982Diluted
                  
                  
                  26,535
                  
                  
                  
                  26,247
                  
                  
                  
                  27,431





For the
years ended March 31, 2009, 2008 and 2007, outstanding options for 5.6 million,
6.4 million and 6.9 million shares, respectively, were excluded from the
calculation of diluted net income per share, as the inclusion of such shares
would have had an anti-dilutive effect.





Recently
Issued 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
December 2007, the FASB issued SFAS No. 160, Non-controllingInterests in Consolidated Financial
Statements, an amendmentofAccounting Research
Bulletin(“ARB”)No. 51(“SFAS No.
160”).  SFAS No. 160 establishes accounting and reporting
standards for the non-controlling interest in a subsidiary and for the
deconsolidation of a subsidiary. SFAS No. 160 is effective for fiscal
years beginning on or after December 15, 2008.  SFAS No. 160 is
effective for annual periods beginning after December 15, 2008 and should be
applied prospectively. However, the presentation and disclosure
requirements of the statement shall be applied retrospectively for all periods
presented. The Company will adopt Statement No. 160 in the first quarter of
fiscal 2010 and adoption is not expected to materially impact the Company’s
consolidated financial position or results or operations.





In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations (“SFAS
No. 141(R)”), which replaces SFAS No. 141.  SFAS No. 141(R) establishes
principles and requirements for recognizing and measuring assets acquired,
liabilities assumed and any non-controlling interests in the acquiree in a
business combination.  SFAS No. 141(R) also establishes disclosure
requirements to enable the evaluation of the nature and financial effects of the
business combination. It further requires acquisition-related costs to be
recognized separately from the acquisition and expensed as incurred,
restructuring costs to generally be expensed in periods subsequent to the
acquisition date, and changes in accounting for deferred tax asset valuation
allowances and acquired income tax uncertainties after the measurement period,
which will impact income tax expense.  In addition, acquired in-process
research and development is capitalized as an intangible asset with an
indefinite useful life.  This statement applies to acquisitions that occur
beginning with the Company’s fiscal year beginning April 1, 2009, and will
be adopted on a prospective basis. The impact of SFAS No. 141(R) on the
Company’s consolidated financial position, results of operations and cash flows
will be dependent on the number and size of business combinations that the
Company enters into subsequent to the adoption of the standard, as well as the
valuation and allocation of the net assets acquired.




In
February 2008, the FASB issued FASB Staff Position (“FSP”) SFAS No. 157-2, Effective Date of FASB Statement No.
157 (“FSP No. 157”), to partially defer SFAS No. 157 Fair Value Measurements
(“SFAS No. 157”).  FSP No. 157-2 defers the effective date of SFAS No. 157
for nonfinancial assets and nonfinancial liabilities, except those that are
recognized and disclosed at fair value in the financial statements on a
recurring basis (at least annually), to fiscal years and interim periods within
those fiscal years, beginning after November 15, 2008.  This portion of the
statement is effective for the Company as of April 1, 2009.  The Company
believes that the adoption of this aspect of SFAS No. 157 will not have a
material impact on the Company’s consolidated financial position, results of
operations and cash flows.





In
April 2008, the FASB issued FSP SFAS No. 142-3, Determination of the Useful Life of
Intangible Assets(“FSP No. 142-3”).  FSP No. 142-3 amends the
factors that should be considered in developing renewal or extension assumptions
used to determine the useful life of a recognized intangible asset under SFAS
No. 142.  The intent of FSP No. 142-3 is to improve the
consistency between the useful life of a recognized intangible asset under SFAS
No. 142 and the period of expected cash flows used to measure the fair
value of the asset under SFAS No. 141(R) and other GAAP
principles.  The provisions of FSP No. 142-3 are effective for the
Company’s fiscal year 2010, and are currently not expected to have a material
effect on its prospective consolidated financial statements, results of
operations or cash flows.


55





In May
2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles(“SFAS No. 162”).  SFAS No. 162
became effective November 15, 2008.  SFAS No. 162 is intended to
improve financial reporting by identifying a consistent hierarchy for selecting
accounting principles to be used in preparing financial statements that are
presented in conformity with GAAP.  The adoption of the provisions of
SFAS No. 162 is not expected to have a material effect on the Company’s
consolidated financial statements, results of operations or cash
flows.





In
October 2008, the FASB issued FSP No. 157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active(“FSP No.
157-3”). FSP No. 157-3 clarifies the application of SFAS No. 157 in an
inactive market and demonstrates how the fair value of a financial asset is
determined when the market for that financial asset is inactive. FSP No.
157-3 was effective upon issuance, including prior periods for which financial
statements had not been issued. The adoption of this provision did not have
a material impact on the Company’s consolidated financial statements, results of
operations or cash flows.





NOTE
2 - ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES





Accrued
expenses and other current liabilities consist of (in thousands):





March 31,2009
                  
                  
                  2008Commissions
      payable
                  
                  $
                  461
                  
                  
                  $
                  807Accrued
      compensation and benefits
                  
                  
                  3,042
                  
                  
                  
                  4,263Accrued
      professional services
                  
                  
                  1,901
                  
                  
                  
                  4,214Accrued
      marketing costs
                  
                  
                  686
                  
                  
                  
                  1,161Accrued
      sales returns and discounts
                  
                  
                  2,382
                  
                  
                  
                  2,908Accrued
      royalties
                  
                  
                  3,137
                  
                  
                  
                  3,264Accrued
      restructuring costs
                  
                  
                  918
                  
                  
                  
                  591Income
      tax liability
                  
                  
                  2,686
                  
                  
                  
                  657Other
      tax liabilities
                  
                  
                  8,775
                  
                  
                  
                  8,231Other
      accrued expense
                  
                  
                  3,038
                  
                  
                  
                  3,371Total
      accrued expenses and other current liabilities
                  
                  $
                  27,026
                  
                  
                  $
                  29,467





NOTE
3 - COMMITMENTS, CONTINGENCIES AND CREDIT FACILITY





Operating
Leases





The
Company leases certain facilities and equipment under non-cancelable operating
and capital leases.  Operating leases include leased facilities and
capital leases include leased equipment.  Rent expense under operating
and capital leases was approximately $5.0 million, $4.5 million, and $4.7
million for the fiscal years ended March 31, 2009, 2008 and 2007,
respectively.  The facilities leases generally provide that the
Company pay taxes, insurance and maintenance.





Future
payments under various operating and capital leases that have initial remaining
non-cancelable lease terms in excess of one year are as follows (in
thousands):





Years Ending March 31,
                  
                  Lease
                    Obligations2010
                  
                  $
                  4,5312011
                  
                  
                  2,8842012
                  
                  
                  7492013
                  
                  
                  702014
                  
                  
                  50Thereafter
                  
                  
                  -$
                  8,284





Litigation
Matters





Between
March and June 2007, the Company was notified that a total of five shareholder
derivative lawsuits had been filed by persons identifying themselves as
shareholders of the Company and purporting to act on its behalf, naming it as a
nominal defendant and naming some of its current and former officers and
directors as defendants.  Four of these actions were filed in the
United States District Court for the Northern District of California, and one
was filed in the Superior Court of California for the County of
Marin.


56





In these
actions, the plaintiffs assert claims against the individual defendants for
violations of the Exchange Act, violations of the California Corporations Code,
breach of fiduciary duty and/or aiding and abetting, abuse of control, gross
mismanagement, corporate waste, unjust enrichment, rescission, constructive
fraud, and an accounting and a constructive trust.  The plaintiffs’
claims concern the granting of stock options by the Company and the alleged
filing of false and misleading financial statements.  All of these
claims are asserted derivatively on the Company’s behalf.  The
plaintiffs seek, among other relief, an indeterminate amount of damages from the
individual defendants and a judgment directing the Company to reform its
corporate governance.





The
federal cases were consolidated on August 2, 2007, into one action captioned
Wilder v. Doris, et al.
(C07-1500) (N.D. Cal.). On April 30, 2008, plaintiffs filed a consolidated class
action and shareholder derivative complaint.  On September 19, 2007,
the court in the state action granted the Company’s motion to stay that
proceeding in its entirety until final resolution of the consolidated federal
action.  In February 2009, the parties reached an agreement in
principle to settle these actions.  The Company agreed to adopt
certain remedial measures to improve the Company's stock option granting
processes, in addition to the repayment and repricing of portions of the excess
value received from stock options that certain officers and directors previously
agreed to.  As part of the settlement, the Company’s Directors and
Officers liability insurer agreed to pay the derivative plaintiffs’ counsel
attorneys fees and costs in the amount of $775,000, subject to court
approval.  On May 14, 2009 the Wilder court granted
preliminary approval of the settlement.  The final approval hearing is
scheduled for August 6, 2009.





In
addition to the derivative actions, two putative shareholder class actions have
been filed against the Company and various of its executive officers and
directors.  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 on behalf of a proposed class of plaintiffs comprised of persons that
purchased its shares between October 4, 2002 and May 17, 2007.  On
March 21, 2008, plaintiffs filed a consolidated amended complaint against the
Company and various of its executive officers and directors 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.  This
action alleges various violations of the Exchange Act and the rules thereunder,
and is based on substantially similar factual allegations and claims as in the
derivative actions.  On June 27, 2008, defendants filed a motion to
dismiss the consolidated amended complaint.  On September 4, 2008,
this action was reassigned to the judge presiding over the Wilder v. Doris
action.  Upon the reassignment, the court directed defendants to
refile the motion to dismiss.  Defendants refiled their motion to
dismiss on November 25, 2008.    Defendants’ motion was
heard on February 26, 2009.  On April 6, 2009, the judge issued an
order granting in part and denying in part defendants’ motion to dismiss, with
leave to amend.  On May 8, 2009, plaintiffs filed a first amended
class action complaint.  This complaint alleges violations of §§ 10b,
14(a), 20(a), and 20A of the Securities Exchange Act.





On
November 16, 2007, a putative shareholder class action was filed in the Superior
Court of California for the County of Marin, against the Company and various of
its executive officers and directors on behalf of a proposed class of plaintiffs
comprised of persons that purchased the Company’s shares between July 12, 2001
and May 17, 2007.  This action alleges breach of fiduciary duties, and
is based on substantially similar factual allegations and claims as in the other
lawsuits. The court in the state putative shareholder class action sustained the
Company’s demurrers to the complaint with leave to amend.  On April
21, 2008, the plaintiff in that action filed an amended complaint, which asserts
additional claims under the California Corporations Code.  The court
sustained the Company’s demurrers to the amended complaint, without leave to
amend in part and with leave to amend in part.  Plaintiff did not file
an amended complaint.  Accordingly, on July 30, 2008, the court
dismissed the entire case with prejudice and entered judgment in favor of
defendants.  On September 26, 2008, plaintiff filed a notice of appeal
from the court’s order dismissing plaintiff’s complaint with prejudice and
entering final judgment.  The briefing on this appeal is complete, but
the date for oral argument has not been set by the court.





In
addition to the legal proceedings identified above, from time to time the
Company is subject to legal proceedings, claims, investigations and proceedings
in the ordinary course of business, including claims of alleged infringement of
third-party patents and other intellectual property rights, commercial,
employment and other matters.  The Company makes provisions for legal
proceedings as appropriate.  These provisions are reviewed at least
quarterly and adjusted to reflect the impacts of negotiations, settlements,
rulings, advice of legal counsel, and other information and events pertaining to
particular cases.  Litigation is inherently
unpredictable.  However, the Company believes that its has valid
defenses with respect to the legal matters pending against
it.  Nevertheless, it is possible, that the Company’s consolidated
financial position, cash flows or results of operations could be affected by the
resolution of one or more of such matters.


57





The
Company maintains Directors and Officers (“D&O”) liability insurance, which
has covered, to date, the legal fees and costs associated with the above legal
actions.  During fiscal 2009, the Company’s D&O insurance paid
legal fees and costs totaling $0.8 million.





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.





The
Company, as permitted under California law and in accordance with its Bylaws and
certain other commitments and agreements, 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.  In this regard, the Company has received, or expects to
receive, requests for indemnification by certain current and former officers and
directors in connection with its stock options review and shareholder derivative
and class action litigation described herein.  The maximum amount of
potential indemnification is unknown and potentially unlimited; however, the
Company has D&O liability insurance that enable it to recover a portion of
future indemnification claims paid, subject to retentions, conditions and
limitations of those policies.





Credit
Facilities





During
the first quarter of fiscal 2009, the Company entered into an amendment to its
Loan and Security Agreement with the Union Bank of California, N.A. (“UBOC”)
that provided for a three month extension of the maturity date of its revolving
credit facility to September 26, 2008 (the “Fourth Amendment”).  This
amended credit facility (the “Amended Credit Facility”) provided a credit limit
of $20 million, which was secured by a $20 million deposit account which was
funded by the Company in the second quarter of fiscal 2009.  On
September 29, 2008, the Company paid off the credit facility in accordance
with the terms.





Purchase
Commitments





The Company in the normal course of
business enters into various purchase commitments for goods and services. Total
non-cancellable purchase commitments as of March 31, 2009 were approximately
$1.4 million.  The purchase commitments mainly related to contracts
with royalties related to our Roxio Consumer products and
CinemaNow.





Other





The
Company sponsors a 401(k) savings plan that covers most of the Company’s U.S.
employees.  Participants may contribute a portion of their
compensation to the plan subject to IRS limits.  In fiscal years 2009,
2008 and 2007, the Company made $0.9 million, $1.3 million and $0.9 million in
matching contributions to the plan, respectively.  The Company stopped
matching contributions in the third quarter of fiscal 2009 as part of its
ongoing cost cutting measures.





During
fiscal 2009, the Company entered into certain Asset Purchase Agreements that
contained a holdback provision.  The acquisition holdbacks related to
Simple Star, Inc. and CinemaNow, Inc. are approximately $1.5
million.  For additional information see Note 7, “Acquisitions,” to
the Consolidated Financial Statements included in this Annual
Report.




NOTE
4 - SHAREHOLDERS’ EQUITY





Stock
Options





The
Company grants stock options and other share-based awards to employees,
directors under various equity incentive plans:




·
            2000 Stock Option
      Plan


·
            2004
      Stock Incentive Plan


·
            2004
      Equity Compensation Plan


58




·
            2005
      Stock Incentive Plan





In 2000,
the Company adopted the Sonic Solutions 2000 Stock Option Plan (the “2000
Plan”).  The 2000 Plan covers 3.0 million shares of Common Stock with
an annual increase in the number of shares available for issuance under the 2000
Plan on the last day of each fiscal year, provided that the total number of
shares issuable under the plan shall not exceed 3.75 million
shares.  Under this plan, stock options are granted annually at the
fair market value of the Company’s common stock on the date of
grant.  The 2000 Plan provides for issuing both incentive stock
options, which must be granted at fair market value at the date of grant, and
nonqualified stock options, which must be granted at not less than 85% of fair
market value of the stock.  Options under the 2000 Plan generally vest
over four years from the date of grant.  The options generally expire
ten years from the date of grant and are canceled three months after termination
of employment.  The Company’s Board of Directors and Compensation
Committee administer the 2000 Plan.  Upon the completion of the
Company’s voluntary review of stock option grant practices, it was determined
that some grants from this plan were issued at less than fair market value and
have been restated.





In
February 2004, the Company adopted the 2004 Stock Incentive Plan (the “2004
SIP”) and reserved 2.0 million shares of common stock solely for the grant of
“inducement” stock options and other share-based awards.  The 2004 SIP
did not require shareholder approval.  These shares may be issued in
connection with the recruitment of employees in future acquisitions and in the
recruitment of other employees in the future.  The 2004 SIP provides
for issuing nonqualified stock options.  The options generally expire
ten years from the date of grant and are canceled three months after termination
of employment.  The Company’s Board of Directors and Compensation
Committee administer the 2004 SIP. Upon the completion of the Company’s
voluntary review of stock option grant practices, it was determined that some
grants from this plan were issued at less than fair market value and have been
restated.





In June
2004, the Company adopted the Sonic Solutions 2004 Equity Compensation Plan (the
“2004 Plan”) and the shareholders approved the 2004 Plan in September,
2004.  The 2004 Plan originally covered 3,000,000 shares of common
stock, but 750,000 shares are now reserved for issuance under the 2005
Plan.  The 2004 Plan provides for the grant of stock options,
restricted stock, restricted stock units, stock appreciation rights and dividend
equivalent rights (collectively referred to as “awards”).  Stock
options granted under the 2004 Plan may be either incentive stock options under
the provisions of Section 422 of the Code, or nonqualified stock
options.  Incentive stock options may be granted only to
employees.  Awards other than incentive stock options may be granted
to employees, directors and consultants.  Options under the 2004 Plan
generally vest over four years from the date of grant.  The options
generally expire ten years from the date of grant and are canceled three months
after termination of employment.  The Company’s Board of Directors and
Compensation Committee administer the 2004 Plan.  Upon the completion
of the Company’s voluntary review of stock option grant practices, it was
determined that some grants from this plan were issued at less than fair market
value and have been restated.





In March
2005, the Company adopted the 2005 Stock Incentive Plan (Non-U.S. Employees)
(“Non-U.S. Plan”).  The terms and the purposes of the Non-U.S. Plan
and the 2004 Stock Incentive Plan are substantially similar.  The
Board of Directors reserved 750,000 shares of common stock for issuance under
the Non-U.S. Plan which were previously reserved under the 2004 Stock Incentive
Plan.  Options may only be granted to Employees (a) who have not
previously been an Employee or Director of the Company or a Related Entity or
(b) following a bona fide period of non-employment or non-service to the Company
or a Related Entity.  The Non-U.S. Plan provides for issuing
nonqualified stock.  Options under the 2005 Plan generally vest over
four years from the date of grant.  The options generally expire ten
years from the date of grant and are canceled three months after termination of
employment.  The Company’s Board of Directors and Compensation
Committee administer the Non-U.S. Plan.  Upon the completion of the
Company’s voluntary review of stock option grant practices, it was determined
that some grants from this plan were issued at less than fair market value and
have been restated.





On
November 26, 2008 the Company filed a Tender Offer Statement on Schedule TO with
the SEC to repurchase and cancel certain stock options with high exercise prices
and to reprice, repurchase and cancel certain other options that were
potentially subject to adverse taxation under Internal Revenue Code Section
409A.  Eligible employees, officers and directors submitted
notifications of tenders for a total of 2.8 million eligible shares by the
deadline of December 31, 2008.  The total purchase price for the
options was $0.1 million, which was paid in January 2009.





A summary
of the Company’s stock option activity is presented below:


59





Number of
                    Shares
                  
                  
                  Weighted
                    Average
                    Exercise
                    Price
                  
                  
                  Weighted Average
                    Remaining
                    Contractual Life
                    (Years)
                  
                  
                  Aggregate
                    Intrinsic Value
                    (In thousands)Outstanding
      at March 31, 2006
                  
                  
                  7,296,269
                  
                  
                  $
                  13.30
                  
                  
                  
                  6.87
                  
                  
                  $
                  38,026Options
      granted
                  
                  
                  56,600
                  
                  
                  $
                  15.77Options
      exercised
                  
                  
                  (479,537
                  )
                  
                  $
                  5.64Options
      forfeited or expired
                  
                  
                  (254,057
                  )
                  
                  $
                  17.16Outstanding
      at March 31, 2007
                  
                  
                  6,619,275
                  
                  
                  $
                  13.72
                  
                  
                  
                  6.38
                  
                  
                  $
                  17,584Options
      granted
                  
                  
                  -
                  
                  
                  $
                  -Options
      exercised
                  
                  
                  (186,158
                  )
                  
                  $
                  2.56Options
      forfeited or expired
                  
                  
                  (21,233
                  )
                  
                  $
                  15.01Outstanding
      at March 31, 2008
                  
                  
                  6,411,884
                  
                  
                  $
                  14.09
                  
                  
                  
                  5.04
                  
                  
                  $
                  7,917Options
      granted
                  
                  
                  4,055,427
                  
                  
                  $
                  3.02Options
      exercised
                  
                  
                  (100,234
                  )
                  
                  $
                  3.20Tendered
      options
                  
                  
                  (2,805,829
                  )
                  
                  $
                  15.38Options
      forfeited or expired
                  
                  
                  (1,926,191
                  )
                  
                  $
                  15.38Outstanding
      at March 31, 2009
                  
                  
                  5,635,057
                  
                  
                  $
                  5.25
                  
                  
                  
                  7.78
                  
                  
                  $
                  15Vested
      and expected to vest
                  
                  
                  5,073,518
                  
                  
                  $
                  5.58
                  
                  
                  
                  7.58
                  
                  
                  $
                  14Exercisable
      at March 31, 2009
                  
                  
                  2,342,151
                  
                  
                  $
                  8.91
                  
                  
                  
                  5.29
                  
                  
                  $
                  9





Aggregate
intrinsic value represents the difference between the Company’s closing stock
price on the last trading day of the fiscal period, which was $1.20 on March 31,
2009, and the exercise price for the options that were in-the-money at March 31,
2009.  The total intrinsic value of stock options exercised was $0.2
million, $1.2 million and $5.2 million for fiscal years 2009, 2008 and 2007,
respectively.  The weighted average grant date fair value per share of
option granted during each fiscal year’s 2009, 2008 and 2007 was $1.13, $0 and
$10.37, respectively.  Stock options were not granted during fiscal
2008 due to the voluntary stock option review.




The Company records any net charge for tax provision
or benefits from stock option awards or cancelations to additional paid in
capital account, the net charge was $2.5 million for fiscal 2009. See Item 8 -
Statement of Cash Flow to the Consolidated Financial Statements included in this
Annual Report.





Restricted
Stock Units (“RSUs”)





During
fiscal year 2008 no RSUs were granted, and during fiscal year 2009 and 2007 the
Company granted RSUs under the 2004 Equity Compensation Plan.  A
summary of RSU activity is presented below:




Number
                  of Shares
                
                
                Weighted
                  Average
                  Remaining
                  Term
                
                
                Aggregate
                  Intrinsic Value
                  (in thousands)Outstanding
      at March 31, 2006
                
                
                -RSUs
      granted
                
                
                368,000RSUs
      canceled
                
                
                (13,300
                )Outstanding
      at March 31, 2007
                
                
                354,700
                
                
                
                1.88
                
                
                $
                5,001RSUs
      granted
                
                
                -RSUs
      canceled
                
                
                (68,352
                )Outstanding
      at March 31, 2008
                
                
                286,348
                
                
                
                1.38
                
                
                $
                2,763RSUs prior period
      release(1)
                
                
                (171,448
                )RSUs
      granted
                
                
                75,750RSUs
      canceled
                
                
                (46,771
                )Outstanding
      at March 31, 2009
                
                
                143,879
                
                
                
                0.97
                
                
                $
                173Vested
      and expected to vest at March 31, 2009
                
                
                127,958
                
                
                
                0.92
                
                
                $
                154




(1) Includes adjustment for releases for RSUs that vested in previous
quarters but were not released due to the blackout
period.


60


The
weighted average grant date fair value was determined based on the closing
market price of the Company’s common stock on the date of the
award.  The weighted average grant date fair value per share of RSU
granted during fiscal years 2009 and 2007 was $6.89 and $15.07 million,
respectively.  There were no RSUs granted during fiscal
2008.  The grant date fair value of RSU awards is recognized as
compensation cost, on a straight-line basis over the four year vesting
period.  The total unamortized share-based compensation expense
related to unvested RSUs at March 31, 2009 was $1.3 million.  The cost
is expected to be recognized over a remaining weighted average period of 1.81
years.  The aggregate intrinsic value of the outstanding RSUs at March
31, 2009 was $0.2 million, using the closing price of $1.20 per share as of
March 31, 2009.  The total fair value of RSUs vested during fiscal
years 2009, 2008 and 2007 was $0.5 million, $0 million and $5.5 million,
respectively.





The
Company had the following plan activities for the fiscal year ended March 31,
2009 (in thousands except exercise price):





Plan Category
                  
                  Number of Shares
                    to be issued upon
                    exercise of
                    Outstanding
                    Options and RSUs
                  
                  
                  Weighted Average
                    Exercise Price of
                    Outstanding
                    Options
                  
                  
                  Number of shares
                    remaining available for
                    future issuance under
                    equity compensation
                    plansEquity
      compensation plans approved by security holders
                  
                  
                  5,325
                  
                  
                  $
                  5.25
                  
                  
                  
                  3,309Equity
      compensation plans not approved by security holders
                  
                  
                  454
                  
                  
                  $
                  11.23
                  
                  
                  
                  1,452Total
                  
                  
                  5,779
                  
                  
                  $
                  7.78
                  
                  
                  
                  4,761





Share-Based
Compensation





The
Company uses the Black-Scholes-Merton 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
Company estimates the volatility of its common stock by generally using its
historical volatility blended with an implied volatility
rate.  Management determined that a blended volatility was more
reflective of the Company’s market conditions and a better indicator of expected
volatility than using purely historical volatility.  The Company will
continue to monitor relevant factors used to measure expected volatility for
future option grants on a quarterly basis.





The
risk-free interest rates are derived from schedules published by the U.S.
Federal Reserve appropriate for the term of the Company’s stock
options.





The
expected term of employee stock options represents the weighted-average period
that the stock options are expected to remain outstanding.  The
Company derived the expected term assumption based on its historical settlement
experience and expected behavior of unsettled options, while giving
consideration to vesting schedules and options that have life cycles less than
the contractual terms and vesting schedules in accordance with guidance in SFAS
No. 123(R) and SAB No. 107.





The
weighted-average fair value of options granted and the related assumptions used
are as follows (in percentages):





Years Ended March 31,2009
                    
                    
                    2008
                    
                    
                    2007Weighted-average
      fair value of options granted
                    
                    $
                    1.13
                    
                    
                    $
                    -
                    
                    
                    $
                    10.37Risk-free
      interest rate
                    
                    
                    1.9
                    %
                    
                    
                    -
                    
                    
                    
                    5.0
                    %Expected
      volatility
                    
                    
                    50
                    %
                    
                    
                    -
                    
                    
                    
                    75
                    %Expected
      life (in years)
                    
                    
                    3.3
                    
                    
                    
                    -
                    
                    
                    
                    5.0Expected
      dividend
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -





During
fiscal year 2009 and fiscal 2007 the Company granted stock
options.  During fiscal 2008 stock options were not granted due to the
voluntary stock option review.


61





The
following table summarizes share-based compensation expense related to employee
stock options and restricted stock unit grants for the fiscal years ended March
31, 2009, 2008 and 2007 as recorded in accordance with SFAS No. 123(R) (in
thousands):





Years Ended March 31,2009
                    
                    
                    2008
                    
                    
                    2007Marketing  and
      sales
                    
                    $
                    842
                    
                    
                    $
                    766
                    
                    
                    $
                    1,284Research
      and development
                    
                    
                    292
                    
                    
                    
                    530
                    
                    
                    
                    740General
      and administrative
                    
                    
                    1,057
                    
                    
                    
                    249
                    
                    
                    
                    741$
                    2,191
                    
                    
                    $
                    1,545
                    
                    
                    $
                    2,765





The total
unamortized share-based compensation expense related to non-vested stock options
and RSUs including estimated forfeitures was $4.3 million for March 31
2009.  The share-based compensation is expected to be recognized over
a weighted average period of approximately 3.13 years.





The
expense for the year ended March 31, 2008 included a charge of $0.2 million
attributable to the extension of exercise periods for vested options under SFAS
No. 123(R) for employees terminated between November 15, 2006 to March 31, 2008
and a charge of $0.1 million attributable to the extension of exercise periods
for vested options for employees terminated between November 15, 2006 to March
31, 2007.





NOTE
5 - INCOME TAXES





Income
tax expense (benefit) for the year ended March 31, 2009 consists of (in
thousands):





Current
                  
                  
                  Deferred
                  
                  
                  TotalU.S.
      Federal
                  
                  $
                  (103
                  )
                  
                  $
                  17,579
                  
                  
                  $
                  17,476State
      and Local
                  
                  
                  (208
                  )
                  
                  
                  5,886
                  
                  
                  
                  5,678Foreign
                  
                  
                  1,685
                  
                  
                  
                  321
                  
                  
                  
                  2,006$
                  1,374
                  
                  
                  $
                  23,786
                  
                  
                  $
                  25,160





Income
tax expense (benefit) for the year ended March 31, 2008 consists of (in
thousands):





Current
                  
                  
                  Deferred
                  
                  
                  TotalU.S.
      Federal
                  
                  $
                  -
                  
                  
                  $
                  (4,836
                  )
                  
                  $
                  (4,836
                  )State
      and Local
                  
                  
                  23
                  
                  
                  
                  (1,268
                  )
                  
                  
                  (1,245
                  )Foreign
                  
                  
                  1,250
                  
                  
                  
                  577
                  
                  
                  
                  1,827$
                  1,273
                  
                  
                  $
                  (5,527
                  )
                  
                  $
                  (4,254
                  )





Income
tax expense (benefit) for the year ended March 31, 2007 consists of (in
thousands):





Current
                  
                  
                  Deferred
                  
                  
                  TotalU.S.
      Federal
                  
                  $
                  537
                  
                  
                  $
                  4,092
                  
                  
                  $
                  4,629State
      and Local
                  
                  
                  913
                  
                  
                  
                  (487
                  )
                  
                  
                  426Foreign
                  
                  
                  1,056
                  
                  
                  
                  (40
                  )
                  
                  
                  1,016$
                  2,506
                  
                  
                  $
                  3,565
                  
                  
                  $
                  6,071





The
differences between income taxes computed using 35% statutory federal income tax
rate and the Company’s effective tax rate are summarized as follows (in
thousands):


62





Years Ended March 31,2009
                  
                  
                  2008
                  
                  
                  2007Computed
      tax at statutory rate
                  
                  $
                  (32,537
                  )
                  
                  $
                  (3,427
                  )
                  
                  $
                  4,393State
      taxes, net of federal benefit
                  
                  
                  5,678
                  
                  
                  
                  (887
                  )
                  
                  
                  636Extraterritorial
      income exclusion and qualified production income deduction
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (38
                  )Net
      change in valuation allowance
                  
                  
                  47,872
                  
                  
                  
                  -
                  
                  
                  
                  -Goodwill
      impairment
                  
                  
                  3,871
                  
                  
                  
                  -
                  
                  
                  
                  -Research
      and development credits
                  
                  
                  (816
                  )
                  
                  
                  (259
                  )
                  
                  
                  (1,249
                  )SystemOK
      acquired in process technology write-off
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  952Foreign
      rate differential
                  
                  
                  1,228
                  
                  
                  
                  347
                  
                  
                  
                  728Other
      permanent differences
                  
                  
                  (136
                  )
                  
                  
                  (28
                  )
                  
                  
                  649$
                  25,160
                  
                  
                  $
                  (4,254
                  )
                  
                  $
                  6,071





The other
permanent differences consist of provision to return true up adjustments, book
expenses for incentive stock options, and certain meals and entertainment
expenses and penalties.





The
components of deferred taxes are as follows (in thousands):





March 31,2009
                  
                  
                  2008
                  
                  
                  2007Deferred
      tax assets:Accounts
      receivable
                  
                  $
                  83
                  
                  
                  $
                  75
                  
                  
                  $
                  278Inventories
                  
                  
                  215
                  
                  
                  
                  399
                  
                  
                  
                  221Tax
      credit carryforwards
                  
                  
                  15,649
                  
                  
                  
                  13,379
                  
                  
                  
                  13,246Net
      operating losses
                  
                  
                  17,532
                  
                  
                  
                  8,581
                  
                  
                  
                  3,980Accrued
      vacation pay
                  
                  
                  729
                  
                  
                  
                  922
                  
                  
                  
                  917Commissions
      and bonuses
                  
                  
                  24
                  
                  
                  
                  38
                  
                  
                  
                  40Fixed
      assets
                  
                  
                  (349
                  )
                  
                  
                  178
                  
                  
                  
                  284Intangible
      assets
                  
                  
                  23,750
                  
                  
                  
                  -
                  
                  
                  
                  -Research
      and experimental expenses
                  
                  
                  115
                  
                  
                  
                  -
                  
                  
                  
                  -Other
      reserves
                  
                  
                  4,381
                  
                  
                  
                  5,072
                  
                  
                  
                  5,854Stock
      option compensation
                  
                  
                  3,645
                  
                  
                  
                  5,384
                  
                  
                  
                  5,386Gross
      deferred tax assets
                  
                  
                  65,774
                  
                  
                  
                  34,028
                  
                  
                  
                  30,206Valuation
      allowance
                  
                  
                  (65,712
                  )
                  
                  
                  (3,113
                  )
                  
                  
                  (3,084
                  )Total
      deferred tax assets, net of valuation allowance
                  
                  
                  62
                  
                  
                  
                  30,915
                  
                  
                  
                  27,122Deferred
      tax liabilities:Intangible
      assets
                  
                  
                  -
                  
                  
                  
                  (1,822
                  )
                  
                  
                  (1,218
                  )State
      income taxes
                  
                  
                  -
                  
                  
                  
                  (2,818
                  )
                  
                  
                  (2,207
                  )Research
      and experimental expenses
                  
                  
                  -
                  
                  
                  
                  68
                  
                  
                  
                  42Gross
      deferred tax assets
                  
                  
                  -
                  
                  
                  
                  (4,572
                  )
                  
                  
                  (3,383
                  )Total
      deferred tax liability
                  
                  
                  -
                  
                  
                  
                  (4,572
                  )
                  
                  
                  (3,383
                  )Net
      deferred taxes
                  
                  $
                  62
                  
                  
                  $
                  26,343
                  
                  
                  $
                  23,739





At March
31, 2009, the Company had net operating loss carryforwards (“NOLs”) of $41.0
million including $5.6 million related to the Company’s acquisition of
InterActual Technologies, Inc. in 2004.  The loss carryforwards expire
between 2020 and 2029.  To the extent NOLs relate to non-qualified
stock option deductions, the resulting benefits will be credited to
shareholders’ equity when realized.





At March
31, 2009, the Company had cumulative unused federal and California research and
development (“R&D”) tax credits of approximately $5.1 million and $4.9
million, respectively, that can be used to reduce federal and California income
taxes.  The federal R&D credits expire from 2017 through 2029;
California credits carryforward indefinitely.  As of March 31, 2009,
the Company had cumulative accrued foreign tax credits of approximately $5.2
million that expire from 2013 through 2019.  In addition, the Company
had alternative minimum tax credit carryforwards of approximately $0.3 million
available to offset regular income tax over an indefinite period and $0.1
million of California manufacturing investment credits that expire in 2009 and
2010.





In
assessing the 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.  As of March 31, 2008, $3.1 million valuation allowance
consisted of $1.7 million for acquired InterActual net operating loss
carryforwards that may not be utilized primarily due to an annual limitation
under IRC Section 382 and $1.4 million for Canadian deferred tax assets that are
unlikely to be realized.


63





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.  At March 31, 2009, the Company believes it will more likely
than not be unable to realize a significant portion of its deferred tax assets
as a result of recent cumulative losses in fiscal year 2008 and
2009.  As such, a valuation allowance of approximately $65.7 million
has been set up on its deferred tax assets as of March 31, 2009.





The
Company adopted FIN No. 48 on April 1, 2007.  FIN No. 48 clarifies the
accounting for uncertainty in income taxes by prescribing rules for recognition,
measurement and classification in the Company’s financial statements of tax
positions taken in a tax return.  FIN No. 48 also provides guidance on
de-recognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition.  For tax benefits to be
recognized under FIN No. 48, a tax position must be more-likely-than-not to be
sustained upon examination by taxing authorities.  The amount
recognized is measured as the largest amount of benefit that is greater than 50
percent likely of being realized upon ultimate settlement.





At March
31, 2009, the Company had $5.8 million of gross unrecognized tax benefits
(“UTBs”), $1.4 million of which would affect its effective tax rate if
recognized.  The Company does not anticipate a significant increase or
decrease to the total UTBs during fiscal year 2009.   The Company
recognizes interest and penalties related to uncertain tax positions in income
tax expense.





The
Company files its income tax returns in the U.S. federal jurisdiction, various
U.S. states and foreign jurisdictions.  The Company is no longer
subject to U.S. federal and state income tax examination by tax authorities for
years prior to 2003.  Foreign income tax matters for significant
foreign jurisdictions have been concluded for years through 2002.





The
reconciliation of the total gross amounts of UTBs for the fiscal year ended
March 31, 2009 is as follows (in thousands):





Balance
      at April 1, 2007
                    
                    $
                    4,328Additions
      based on tax provisions related to the current year
                    
                    
                    602Reductions
      for tax positions of prior years
                    
                    
                    -Settlements
                    
                    
                    -Balance
      at March 31, 2008
                    
                    
                    4,930Additions
      based on tax provisions related to the current year
                    
                    
                    873Reductions
      for tax positions of prior years
                    
                    
                    -Settlements
                    
                    
                    -Balance
      at March 31, 2009
                    
                    $
                    5,803





Interest
and penalties related to UTBs are classified as a component of the Company’s
provision for income taxes. The Company recognized approximately $85,000 and
$49,000 in interest and penalties through the income tax provision in the
consolidated statements of income as of March 31, 2009 and 2008,
respectively.  There was approximately $0.2 million and $0.1 million
of accrued interest and penalties associated with UTBs as of March 31, 2009 and
2008, respectively.





Pursuant
to Accounting Principles Board Opinion (“APB”) No. 23, Accounting for Income Taxes -
Special Areas (“APB No. 23”), U.S. corporate income taxes were not
provided on a cumulative total of approximately $1.0 million of undistributed
net foreign earnings for all non-U.S. subsidiaries.  The Company
intends to indefinitely reinvest these funds in their respective operations
outside the U.S.





NOTE
6 - SIGNIFICANT CUSTOMER INFORMATION, SEGMENT REPORTING AND GEOGRAPHIC
INFORMATION





SFAS No.
131 requires the Company to report certain information about its operating
segments.  An operating segment is a component of an enterprise for
which separate financial information is available that is evaluated regularly by
the chief operating decision maker in deciding how to allocate resources and in
assessing performance.  The Company’s chief executive officer (“CEO”)
is its chief operating decision maker.


64


During
the fourth quarter of fiscal 2009, the Company reclassified the ATG License and
Consumer product revenue to its Consumer segment and renamed it Roxio Products
segment.  The Company reclassified ATG License CE, Qflix and CinemaNow
to its Professional segment and renamed it Premium Content. The revenue
reclassifications had no effect on the Company’s consolidated balance sheets,
consolidated statements of operations, consolidated statements of stockholders’
equity and comprehensive income (loss) and consolidated statements of cash
flows for the prior periods presented.





Net
Revenues – prior to reclassification





The
following table reflects net revenue by segment based on the revenue reporting
segments prior to the reorganization in the fourth quarter of fiscal 2009 (in
thousands):





Years Ended March 31,Net Revenues
                  
                  2009
                  
                  
                  2008
                  
                  
                  2007Roxio
      Division
                  
                  $
                  98,511
                  
                  
                  $
                  115,920
                  
                  
                  $
                  122,326Advanced
      Technology Group
                  
                  
                  12,174
                  
                  
                  
                  10,986
                  
                  
                  
                  18,088Total
      Consumer Products
                  
                  
                  110,685
                  
                  
                  
                  126,906
                  
                  
                  
                  140,414Professional
      Products
                  
                  
                  9,273
                  
                  
                  
                  5,968
                  
                  
                  
                  8,235Total
      net revenues
                  
                  $
                  119,958
                  
                  
                  $
                  132,874
                  
                  
                  $
                  148,649





Net
Revenues – post reclassification





The
following table reflects net revenue by segment based on the reorganized
reporting segments for fiscal 2009 (in thousands):





Years Ended March 31,Net Revenues
                  
                  2009
                  
                  
                  2008
                  
                  
                  2007Roxio
      Consumer Products (1)
                  
                  $
                  104,074
                  
                  
                  $
                  122,691
                  
                  
                  $
                  131,017Premium
      Content
                  
                  
                  15,884
                  
                  
                  
                  10,183
                  
                  
                  
                  17,632Total
      net revenues
                  
                  $
                  119,958
                  
                  
                  $
                  132,874
                  
                  
                  $
                  148,649





(1)
            In
      conjunction with the segment reclassification mentioned above, the Company
      reclassified ATG licensing net revenue of $6.7 million to the Roxio
      Consumer Products, ATG CE licensing net revenue of $4.9 million to the
      Premium Content segment, Qflix net revenue of $0.6 million to the Premium
      Content and CinemaNow net revenue of $1.1 million was reclassified to the
      Premium content segment for presentation purposes to reflect the Company's
      current reporting business
segments.





Revenues
by Geographic Location (in thousands):




Years Ended March 31,Revenue by region
                  
                  2009
                  
                  
                  2008
                  
                  
                  2007United
      States
                  
                  $
                  86,818
                  
                  
                  $
                  108,604
                  
                  
                  $
                  116,371ExportCanada
                  
                  
                  1,573
                  
                  
                  
                  1,407
                  
                  
                  
                  615France
                  
                  
                  1,422
                  
                  
                  
                  1,076
                  
                  
                  
                  1,275Germany
                  
                  
                  4,429
                  
                  
                  
                  2,978
                  
                  
                  
                  3,038United
      Kingdom
                  
                  
                  3,287
                  
                  
                  
                  3,629
                  
                  
                  
                  3,821Europe:
      Other
                  
                  
                  2,910
                  
                  
                  
                  3,874
                  
                  
                  
                  4,579Japan
                  
                  
                  14,207
                  
                  
                  
                  5,948
                  
                  
                  
                  13,282Singapore
                  
                  
                  3,599
                  
                  
                  
                  3,446
                  
                  
                  
                  3,682Taiwan
                  
                  
                  281
                  
                  
                  
                  73
                  
                  
                  
                  175Other
      Pacific Rim
                  
                  
                  887
                  
                  
                  
                  1,362
                  
                  
                  
                  1,588Other
      International
                  
                  
                  545
                  
                  
                  
                  477
                  
                  
                  
                  223Total
      net revenues
                  
                  $
                  119,958
                  
                  
                  $
                  132,874
                  
                  
                  $
                  148,649





The
Company sells its products to customers categorized geographically by each
customer’s country of domicile.


65





Long-lived
Assets (excluding goodwill and other intangible assets) by country (in
thousands):





March 31,Assets by geography
                        
                        2009
                        
                        
                        2008
                        
                        
                        2007United
      States
                        
                        $
                        1,652
                        
                        
                        $
                        1,922
                        
                        
                        $
                        2,153Japan
                        
                        
                        111
                        
                        
                        
                        154
                        
                        
                        
                        168Canada
                        
                        
                        6
                        
                        
                        
                        7
                        
                        
                        
                        351China
                        
                        
                        1,007
                        
                        
                        
                        810
                        
                        
                        
                        513Other
      International
                        
                        
                        75
                        
                        
                        
                        66
                        
                        
                        
                        56Total
      long-lived assets
                        
                        $
                        2,851
                        
                        
                        $
                        2,959
                        
                        
                        $
                        3,241





Significant
Customer Information:





Percentage of Total Net Revenue
                    
                    
                    Percentage of Total Accounts
                      ReceivableFiscal Years Ended March 31,
                    
                    
                    Fiscal Years Ended March 31,Customer Name
                    
                    2009
                    
                    
                    2008
                    
                    
                    2007
                    
                    
                    2009
                    
                    
                    2008Dell
                    
                    
                    14
                    %
                    
                    
                    26
                    %
                    
                    
                    23
                    %
                    
                    
                    5
                    %
                    
                    
                    11
                    %Digital
      River
                    
                    
                    22
                    %
                    
                    
                    23
                    %
                    
                    
                    20
                    %
                    
                    
                    11
                    %
                    
                    
                    16
                    %Hewlett-Packard
                    
                    
                    11
                    %
                    
                    
                    13
                    %
                    
                    
                    9
                    %
                    
                    
                    2
                    %
                    
                    
                    7
                    %Ingram
                    
                    
                    6
                    %
                    
                    
                    10
                    %
                    
                    
                    9
                    %
                    
                    
                    8
                    %
                    
                    
                    10
                    %Navarre
                    
                    
                    16
                    %
                    
                    
                    13
                    %
                    
                    
                    13
                    %
                    
                    
                    20
                    %
                    
                    
                    11
                    %





Revenue
recognized from Dell and Hewlett-Packard is pursuant to various licensing
agreements; revenue recognized from Ingram and Navarre is pursuant to
distributor agreements; and revenue recognized from Digital River is pursuant to
a reseller agreement.  It is impracticable for the Company to report
the net revenues by significant customer by business segment for fiscal years
ended March 31, 2009, 2008 and 2007 as some of these customers may be in both
segments.





NOTE
7 - ACQUISITIONS





uMedia
Acquisition





During
the fourth quarter of fiscal 2008, the Company entered into an Asset Purchase
Agreement with uMedia, a Chinese software development company whereby it
acquired substantially all the assets of uMedia for a purchase price of
approximately $0.4 million.  In connection with the acquisition the
Company acquired seven employees.  The uMedia team was integrated into
the Company’s ATG Division to further enhance its core audio and video
technology.





The
Company allocated the purchase price to assets purchased based on their relative
fair values with the excess recorded as goodwill.  Based on the
evaluation and review of the assets, the amounts and components of the purchase
price along with the allocation of the purchase price are as follows (in
thousands):





Cash
                    
                    $
                    432Transaction
      costs
                    
                    
                    111Total
      purchase price
                    
                    $
                    543Customer
      relationships
                    
                    $
                    130Goodwill
                    
                    
                    413Net
      assets acquired
                    
                    $
                    543





The
transaction costs of approximately $0.1 million were for professional services,
including legal, tax, audit and advisory services.  Results for uMedia
have been included in the Company’s consolidated results beginning on March 1,
2008.





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.  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, handheld devices, or published to social
media sites on the Internet.  In connection with the acquisition, the
Company acquired twenty five 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.


66





The
following table summarizes the adjusted fair value for the assets acquired (in
thousands):





Cash
                  
                  
                  5,000Holdback
      contingency
                  
                  
                  1,000Transaction
      costs
                  
                  
                  46Total
      purchase price
                  
                  $
                  6,046Unbilled
      accounts receivable
                  
                  $
                  137Fixed
      assets
                  
                  
                  12Prepaid
      assets
                  
                  
                  25Intangible
      assets
                  
                  
                  2,570Goodwill
                  
                  
                  3,660Deferred
      revenue
                  
                  
                  (358
                  )Net
      assets acquired
                  
                  $
                  6,046





CinemaNow
Acquisition





During
the third quarter of fiscal 2009, the Company entered into an Asset Purchase
Agreement to purchase certain assets and liabilities from CinemaNow, Inc., a
privately held digital video distributor.  The CinemaNow assets
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 $0.8 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.  The
following table summarizes the adjusted fair value for the assets acquired (in
thousands):





Cash
                  
                  $
                  850Holdback
      contingency
                  
                  
                  500Assumed
      liabilities
                  
                  
                  1,650Transaction
      costs
                  
                  
                  236Total
      purchase price
                  
                  $
                  3,236Accounts
      receivable
                  
                  $
                  82Prepaid
      expenses and other assets
                  
                  
                  30Fixed
      assets
                  
                  
                  14Other
      assets
                  
                  
                  237Intangibles
                  
                  
                  1,510Goodwill
                  
                  
                  1,645Deferred
      revenue
                  
                  
                  (282
                  )Net
      assets acquired
                  
                  $
                  3,236


67





NOTE
8 - RESTRUCTURING





The
following summarizes the restructuring liability activity (in
thousands):





January 2009
                  
                  
                  October 2008
                  
                  
                  June 2008
                  
                  
                  October 2007Restructuring
                  
                  
                  Restructuring
                  
                  
                  Restructuring
                  
                  
                  RestructuringSeverance &
                    Related
                    Costs
                  
                  
                  Other
                    Charges
                  
                  
                  Severance
                    & Related
                    Costs
                  
                  
                  Other
                    Charges
                  
                  
                  Severance &
                    Related
                    Costs
                  
                  
                  Other
                    Charges
                  
                  
                  Severance &
                    Related
                    Costs
                  
                  
                  Other
                    Charges
                  
                  
                  TotalBalances,
      March 31, 2007
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  1,692
                  
                  
                  $
                  1,233
                  
                  
                  $
                  2,925Payments
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (1,662
                  )
                  
                  
                  (672
                  )
                  
                  
                  (2,334
                  )Impact
      of exchange rate
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Adjustments
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Balances,
      March 31, 2008
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  30
                  
                  
                  
                  561
                  
                  
                  
                  591Restructure
      Accrual
                  
                  
                  764
                  
                  
                  
                  701
                  
                  
                  
                  898
                  
                  
                  
                  127
                  
                  
                  
                  1,327
                  
                  
                  
                  224
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  4,041Payments
                  
                  
                  (587
                  )
                  
                  
                  (52
                  )
                  
                  
                  (883
                  )
                  
                  
                  (70
                  )
                  
                  
                  (1,108
                  )
                  
                  
                  (61
                  )
                  
                  
                  (6
                  )
                  
                  
                  (346
                  )
                  
                  
                  (3,113
                  )Impact
      of exchange rate
                  
                  
                  -
                  
                  
                  
                  1
                  
                  
                  
                  (7
                  )
                  
                  
                  (1
                  )
                  
                  
                  (209
                  )
                  
                  
                  (50
                  )
                  
                  
                  (6
                  )
                  
                  
                  (215
                  )
                  
                  
                  (487
                  )Adjustments
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  12
                  
                  
                  
                  (116
                  )
                  
                  
                  (18
                  )
                  
                  
                  -
                  
                  
                  
                  (122
                  )Balances,
      March 31, 2009
                  
                  $
                  177
                  
                  
                  $
                  650
                  
                  
                  $
                  8
                  
                  
                  $
                  56
                  
                  
                  $
                  22
                  
                  
                  $
                  (3
                  )
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  910





During
the third quarter of fiscal 2008, the Company initiated a restructuring plan to
reorganize its operations, optimize its engineering and development efforts, and
reduce its workforce by closing its office in Richmond Hill,
Canada.  The reorganization was completed and the Richmond Hill office
was closed by December 31, 2007.  The Company incurred severance and
other one-time restructuring charges in connection with this closing, and
eliminated approximately 84 positions.  The Company also accrued
approximately $0.5 million related to the lease for this office, which expired
in December 2008.  During the third quarter of fiscal 2009, the
Company paid out the remaining site closure costs and completed this
restructuring plan.





During
the second quarter of fiscal 2009, the Company initiated a restructuring plan to
reorganize its operations, optimize its engineering and development efforts, and
reduce its workforce by the end of the 2008 calendar year.  Additional
initiatives included establishing certain operations closer in location to the
Company’s global customers and reducing the Company’s overhead costs, resulting
in a restructuring charge of $1.5 million related to severance, the closing of
the Company’s office in Germany and related costs.





During
the third quarter of fiscal 2009, the Company initiated a restructuring plan to
further reorganize and improve its operations, and reduce its workforce by the
end of the 2008 calendar year.  This plan resulted in a restructuring
charge of $1.1 million consisting of $0.9 million related to one-time
termination benefits and other associated costs and approximately $0.1 million
related to building and office consolidations.





On
January 20, 2009, the Company initiated a restructuring of the Company’s
workforce and closure of certain leased facilities.  The workforce
restructuring reduced worldwide headcount by approximately 75 positions and
resulted in a restructuring charge of approximately $1.1 million related to
building and office consolidations and associated charges.





NOTE
9 - QUARTERLY FINANCIAL DATA (Unaudited)





Summarized
quarterly financial information for fiscal years 2009, and 2008 is as follows
(in thousands, except per share amounts):





Three Months EndedMarch 31,
                                          
                                          
                                          December 31,
                                          
                                          
                                          September 30,
                                          
                                          
                                          June 30,
                                          
                                          
                                          March 31,
                                          
                                          
                                          December 31,
                                          
                                          
                                          September 30,
                                          
                                          
                                          June 30,2009
                                          
                                          
                                          2008
                                          
                                          
                                          2008
                                          
                                          
                                          2008
                                          
                                          
                                          2008
                                          
                                          
                                          2007
                                          
                                          
                                          2007
                                          
                                          
                                          2007Net
      revenue
                                          
                                          $
                                          32,244
                                          
                                          
                                          $
                                          26,525
                                          
                                          
                                          $
                                          31,076
                                          
                                          
                                          $
                                          30,114
                                          
                                          
                                          $
                                          34,891
                                          
                                          
                                          $
                                          35,602
                                          
                                          
                                          $
                                          32,270
                                          
                                          
                                          $
                                          30,111Gross
      profit
                                          
                                          
                                          23,622
                                          
                                          
                                          
                                          (278
                                          )
                                          
                                          
                                          21,726
                                          
                                          
                                          
                                          22,408
                                          
                                          
                                          
                                          26,426
                                          
                                          
                                          
                                          27,600
                                          
                                          
                                          
                                          23,514
                                          
                                          
                                          
                                          22,183Operating
      income (loss)
                                          
                                          
                                          (890
                                          )
                                          
                                          
                                          (81,745
                                          )
                                          
                                          
                                          (3,938
                                          )
                                          
                                          
                                          (7,068
                                          )
                                          
                                          
                                          397
                                          
                                          
                                          
                                          (3,436
                                          )
                                          
                                          
                                          (4,246
                                          )
                                          
                                          
                                          (4,151
                                          )Net
      income (loss)
                                          
                                          
                                          328
                                          
                                          
                                          
                                          (111,116
                                          )
                                          
                                          
                                          (3,694
                                          )
                                          
                                          
                                          (3,640
                                          )
                                          
                                          
                                          480
                                          
                                          
                                          
                                          (1,907
                                          )
                                          
                                          
                                          (2,153
                                          )
                                          
                                          
                                          (1,957
                                          )Basic
      income (loss) per share
                                          
                                          $
                                          0.01
                                          
                                          
                                          $
                                          (4.27
                                          )
                                          
                                          $
                                          (0.14
                                          )
                                          
                                          $
                                          (0.14
                                          )
                                          
                                          $
                                          0.02
                                          
                                          
                                          $
                                          (0.07
                                          )
                                          
                                          $
                                          (0.08
                                          )
                                          
                                          $
                                          (0.07
                                          )Basic
      shares used in computing per share amounts
                                          
                                          
                                          26,591
                                          
                                          
                                          
                                          25,997
                                          
                                          
                                          
                                          26,533
                                          
                                          
                                          
                                          26,443
                                          
                                          
                                          
                                          26,317
                                          
                                          
                                          
                                          26,250
                                          
                                          
                                          
                                          26,223
                                          
                                          
                                          
                                          26,197Diluted
      income (loss) per share
                                          
                                          $
                                          0.01
                                          
                                          
                                          $
                                          (4.27
                                          )
                                          
                                          $
                                          (0.14
                                          )
                                          
                                          $
                                          (0.14
                                          )
                                          
                                          $
                                          0.02
                                          
                                          
                                          $
                                          (0.07
                                          )
                                          
                                          $
                                          (0.08
                                          )
                                          
                                          $
                                          (0.07
                                          )Diluted
      shares used in computing per share amounts
                                          
                                          
                                          26,835
                                          
                                          
                                          
                                          25,997
                                          
                                          
                                          
                                          26,533
                                          
                                          
                                          
                                          26,443
                                          
                                          
                                          
                                          27,130
                                          
                                          
                                          
                                          26,250
                                          
                                          
                                          
                                          26,223
                                          
                                          
                                          
                                          26,197


68





NOTE
10 - SUBSEQUENT EVENT





As
described in Item 3, “Legal Proceedings” of this Annual Report, on May 14, 2009,
the court in the Wilder v.
Doris consolidated derivative suit granted preliminary approval of the
parties’ agreement in principle to settle all of the pending derivative actions
brought in connection the Company’s voluntary stock option review, with a final
approval hearing scheduled for August 6, 2009.  The Company agreed to
adopt certain remedial measures to improve the Company’s stock option granting
processes, in addition to the repayment and repricing of portions of the excess
value received from stock options that certain officers and directors previously
agreed to.  As part of the tentative settlement, the Company’s
Directors and Officers liability insurer agreed to pay the derivative
plaintiffs' counsel attorneys fees and costs in the amount of
$775,000.  If the court does not grant final approval of the tentative
settlement, the parties might elect or be required to continue litigating the
consolidated derivative actions.





Item
9.  Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure





None.




Item
9A.  Controls and Procedures




Evaluation
of Disclosure Controls and Procedures





The
Company’s CEO and Acting chief financial officer (“CFO”) (the “Certifying
Officers”) have conducted an evaluation of the Company’s disclosure controls and
procedures as of March 31, 2009, the end of the period covered by this Annual
Report.  As defined under Sections 13a-15(e) and 15d-15(e) of the
Exchange Act, the term “disclosure controls and procedures” means controls and
other procedures of an issuer that are designed to ensure that information
required to be disclosed by the issuer in the reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the SEC’s rules and forms.  Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by an issuer in the
reports that it files or submits under the Exchange Act is accumulated and
communicated to the issuer’s management, including the issuer’s chief executive
officer and chief financial officer, to allow timely decisions regarding
required disclosure.  Based on their evaluation, for the reasons set
forth below, the Certifying Officers have concluded that, as of March 31, 2009,
the Company’s disclosure controls and procedures were effective.





Management’s
Report on Internal Control over Financial Reporting





The
Company’s management, under the supervision of the Certifying Officers, is
responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rule 13a-15(f) under the Exchange
Act.  An internal control system is designed to provide reasonable
assurance regarding the preparation and fair presentation of published financial
statements.  Management has assessed the effectiveness of the
Company’s internal control over financial reporting as of March 31,
2009.  In making its assessment of internal control over financial
reporting, management used the criteria set forth by the Committee of Sponsoring
Organizations (“COSO”) of the Treadway Commission in its report entitled
“Internal Control — Integrated Framework.”





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 GAAP. 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 Company’s transactions and dispositions of the
      assets;





(2)
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with GAAP, and that the
      Company’s receipts and expenditures are being made only in accordance with
      authorizations of its management and Board of Directors;
    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.





Based on
its assessment, management concluded that the Company’s internal control over
financial reporting as of March 31, 2009 was effective.


69





BDO
Seidman, LLP has issued an auditors’ report on the Company’s internal control
over financial reporting.  The auditors’ report appears on page 43 of
this Annual Report.





Changes
in Internal Control over Financial Reporting





Except as
noted above, there were no changes in the Company’s internal control over
financial reporting that have materially affected, or are reasonably likely to
materially affect, its internal control over financial reporting.




Item
9B.  Other Information




None.


70





PART
III




Item
10.  Directors, Executive Officers and Corporate
Governance




The
following sets forth certain information regarding the members of the Company’s
executive officers and Board of Directors as of May 29, 2009:





Name
              
              Age
              
              PositionRobert
      J. Doris
              
              56
              
              Chairman
      of the Board of DirectorsMary
      C. Sauer
              
              56
              
              Director
      & SecretaryRobert
      M. Greber
              
              71
              
              DirectorPeter
      J. Marguglio
              
              62
              
              DirectorR.
      Warren Langley
              
              66
              
              DirectorDavid
      C. Habiger
              
              40
              
              Chief
      Executive Officer and PresidentPaul
      F. Norris
              
              47
              
              Executive
      Vice President, Acting Chief Financial Officer and General
      CounselA.
      Clay Leighton
              
              52
              
              Chief
      Operating OfficerMark
      Ely
              
              39
              
              Executive
      Vice President of Strategy




Mr. Doris
is married to Ms. Sauer. There are no other family relationships between
any director and executive officer of the Company.





Robert J.
Doris.Mr. Doris co-founded
Sonic in 1986 and has served as Chairman of the Board since 1986, as Chief
Executive Officer from 1986 to September 2005, and as President from 1986 to
April 2005.  In September 2005 Mr. Doris became the non-executive Chairman
of the Board, and all services performed by Mr. Doris since that time have been
in his capacity as a Board member.  Prior to 1986, Mr. Doris held the
positions of President of The Droid Works, a subsidiary of Lucasfilm Ltd., Vice
President of Lucasfilm, and General Manager of the Lucasfilm Computer Division.
Mr. Doris received B.A., J.D. and M.B.A. degrees from Harvard
University.





Mary C.
Sauer. Ms.
Sauer co-founded Sonic in 1986 and served as a vice president from 1986 to
September 26, 2005, including as Senior Vice President of Marketing and Sales
from February 1993 to September, 2005, and has served as a director from 1986
until the present.  Since September 2005, all services performed by Ms.
Sauer have been in her capacity as a Board member.  Prior to 1986, Ms.
Sauer was Vice President of Marketing for The Droid Works, and prior to joining
The Droid Works, Ms. Sauer was Director of Marketing for the Lucasfilm Computer
Division.  Ms. Sauer received a B.F.A. from Washington University in St.
Louis and an M.B.A. in Finance and Marketing from the Wharton School of the
University of Pennsylvania.





Robert M.
Greber. Mr.
Greber has served as a director of Sonic since August 1993.  Mr. Greber
served as President and Chief Operating Officer of The Pacific Stock Exchange
from 1990 to 1995. From 1996, until his retirement in 1999, Mr. Greber was
Chairman and Chief Executive Officer of The Pacific Stock Exchange. From 1985 to
1987, Mr. Greber was President and Chief Executive Officer of Diagnostic
Networks, Inc., a network of Magnetic Resonance Imaging Centers which was merged
into NMR America in 1987.  From 1982 to 1985, Mr. Greber was President and
Chief Executive Officer of Lucasfilm Ltd.  Before joining Lucasfilm, Mr.
Greber was associated with the firm of Merrill Lynch where he was Vice President
and Manager of the Los Angeles Institutional Office.  Mr. Greber holds a
B.S. in Finance from Temple University.





Peter J.
Marguglio. Mr. Marguglio has
served as a director of Sonic since 1986.  Mr. Marguglio worked at Eatec
Corporation, a software company, where he was President and a director, from
1990 and until February 19, 2008, when Eatec was sold to Agilysys,
Inc.  Mr. Marguglio retired in April of 2008. Prior to joining Eatec,
Mr. Marguglio was President of Resource Marketing, Inc., an equipment leasing
firm he founded in 1981.  Mr. Marguglio holds a Mechanical Engineering
degree from the University of Washington and an M.B.A. degree from Stanford
University.





R. Warren
Langley. Mr.
Langley has served as a director of Sonic since 2001.  Mr. Langley has been
a consultant and the Managing Principal of the GuruWizard Fund, LLC, a venture
capital firm that emphasizes social investing, since 2000.  Mr. Langley
also has been on the Board of Advisors of Sun Trading LLC, a privately held
partnership, since October 2007.  From 1996 until 1999, Mr. Langley served
as President and Chief Operating Officer of The Pacific Stock Exchange. From
1987 to 1998, he was a Principal and Chief Operating Officer of Hull Trading, a
proprietary derivatives trading firm. Mr. Langley has also worked as Director of
Operations Research and Industrial Engineering at United Airlines and in several
capacities in thesoftware, energy, and
defense consulting industries after serving in the United States Air Force for
15 years.  Mr. Langley holds a B.S. degree in Engineering Science from the
United States Air Force Academy, an S.M. degree in Astronautical Engineering
from Massachusetts Institute of Technology, and a Ph.D. in Operations Research
from Georgia Institute of Technology.


71




David C.
Habiger.Mr. Habiger
joined Sonic in 1993 as a regional manager.  From 1993 until 2000 Mr.
Habiger served in a number of sales and marketing management roles at
Sonic.  Mr. Habiger was Senior Vice President and General Manager from 2002
to 2003 and then General Manager from 2003 to April 2005 of the Roxio Division,
where he played a key role in the development of Sonic’s original equipment
manufacturer and retail markets for consumer software.  In April 2005 Mr.
Habiger was appointed President and Chief Operating Officer (“COO”).  In
September 2005, Mr. Habiger was appointed President and Chief Executive
Officer.  Mr. Habiger received a B.B.A. from St. Norbert College and an
M.B.A. from the University of Chicago.  He is a member of the National
Associations of Corporate Directors and as well as the Center for Corporate
Innovation.  Since September 2007 Mr. Habiger has served as a director for
Akimbo, Inc.





Paul F.
Norris.  Mr.
Norris joined Sonic in 2005 as Senior Vice President and General Counsel.
 In February 2008, Mr. Norris became Sonic’s Executive Vice President,
Acting Chief Financial Officer and General Counsel.  Prior to joining
Sonic, from 2000 to 2005, Mr. Norris was a partner at Steiner Norris PLLC, a law
firm he co-founded in Seattle, Washington. Mr. Norris received a B.A. from Yale
University and a J.D. from Harvard Law School.





A. Clay
Leighton. Mr. Leighton joined
Sonic in 1993 as Vice President of Finance.  In 1999, Mr. Leighton was
named Senior Vice President of Worldwide Operations and Finance and Chief
Financial Officer. In September 2005, Mr. Leighton was named Executive Vice
President and Chief Financial Officer.  In February 2008, Mr. Leighton was
named Executive Vice President and Chief Operating Officer. Prior to
joining Sonic, from 1990 to 1992, he was Vice President, Finance and Chief
Financial Officer for RESNA Industries Inc., an environmental services firm.
 From 1988 to 1989 he was Vice President, Finance and Chief Financial
Officer for Command Data Systems, a software company specializing in software
for the public safety market.  Previously, Mr. Leighton worked as strategy
consultant for the Boston Consulting Group.  Mr. Leighton received a B.A.
from Wesleyan University and an M.B.A. from the Amos Tuck School of Business
Administration at Dartmouth College.





Mark
Ely.  Mr. Ely joined
Sonic in 1992 as a Customer Service Representative.  Over the years, Mr.
Ely was promoted to Product Marketing Manager, Director of Marketing, General
Manager Desktop Products and, in 2004, Senior Vice President of Strategic
Planning.  In September 2005, Mr. Ely was named Executive Vice President of
Strategy.  Mr. Ely received a B.A. from Middlebury College and an M.B.A.
from the UCLA Anderson School of Management.





Section
16(a) Beneficial Ownership Reporting Compliance





Section
16(a) of the Exchange Act requires the Company’s directors and executive
officers, and persons who own more than 10% of its common stock, to file reports
of ownership and reports of changes in ownership of its common stock with the
SEC.  Executive officers, directors and owners of greater than 10% of
its stock are required by SEC regulations to furnish the Company with copies of
all Section 16(a) reports they file.





Based
solely upon a review of the filings in respect of the fiscal year ended March
31, 2009 furnished pursuant to Rule 16a-3(e) promulgated under the Exchange Act
or advice that no filings were required, the Company is not aware of any late
Section 16(a) filings for such fiscal year.





Audit
Committee





The
Company has a separately designated Audit Committee of its Board of Directors
(“Board”) that is comprised of Messrs. Greber, Langley and
Marguglio.  The Company’s Board has determined that Mr. Greber
qualifies as a financial expert according to the SEC’s
regulations.  See “Committees” below for a statement regarding Mr.
Greber’s independence in accordance with applicable regulations and
standards.





Changes
in Procedure for Stockholder Recommendations for Director Nominees





The
nominating committee has no formal policy with respect to consideration of
stockholder recommended director candidates and will consider potential
candidates for director that are brought to the committee’s attention by
stockholders. The Company’s Board believes it is appropriate not to establish a
formal policy in light of the absence of any stockholder recommended director
candidates in the past.  There have been no changes to this
process.




72





Code
of Business Conduct and Ethics





The Company’s Code of Business Conduct
and Ethics covers all employees, officers and directors, including its principal
executive, financial and accounting officers.  A copy of the Company’s
Code of Business Conduct and Ethics can be found on its corporate website,www.sonic.com.Any amendments to the Code of Business
Conduct and Ethics will be posted on the corporate website.





Director
Independence





The
Company’s Board has determined that, without limitation, Messrs. Greber, Langley
and Marguglio, are “independent” as that term is defined in Rule 5605(a)(2) the
Nasdaq Rules.  In making this determination, the Board considered
transactions and relationships between each of these director or his or her
immediate family and the Company and its subsidiaries.  The purpose of
this review was to determine whether any such relationships or transactions were
material and, therefore, inconsistent with a determination that the director is
independent.  As a result of this review, the Board affirmatively
determined, based on its understanding of such transactions and relationships,
that these directors are independent and, therefore, a majority of the members
of the Board are independent pursuant to applicable Nasdaq rules.





Committees





The Board
held a total of seven meetings during the fiscal year ended March 31, 2009, and
each director participated in 100% of the total number of meetings of the Board
and all meetings of committees of the Board, if any, upon which such director
served.  The members of the Audit Committee meet separately on a
regular basis without any non-independent members of the Board or members of
management present.  The chairman of the Audit Committee acts as the
chairman of such meeting of the independent directors.





During
the fiscal year ended March 31, 2009, and currently, the Audit Committee has
consisted solely of independent directors, namely, Messrs. Marguglio, Greber and
Langley, with Mr. Greber serving as chairman.  After considering
transactions and relationships between each member of the Audit Committee or his
immediate family and the Company and its subsidiaries and reviewing the
qualifications of the members of the Audit Committee, the Board has determined
that all current members of the Audit Committee are independent as defined by
the Exchange Act and Nasdaq Rules, and are financially literate.  The
Board also determined that Mr. Greber qualifies as an “audit committee financial
expert,” as defined by the applicable rules of the Exchange Act, due to, among
other things, his experience with The Pacific Stock Exchange in various
capacities, including Chairman, Chief Executive Officer and Chief Operating
Officer, and his position as Chief Executive Officer of Diagnostic Network,
Inc..





The Audit
Committee, pursuant to its charter, is directly responsible for the appointment,
compensation, retention and oversight of the Company’s independent
auditors.  In addition, the Audit Committee is responsible for
approving the audit and non-audit services performed by the independent
auditors; consulting with the independent auditors about the scope of the audit
and reviewing with them the results of their examination and reviewing the
Company’s financial control procedures and personnel.  The Audit
Committee also has established procedures for (a) the receipt, retention and
treatment of complaints received by the Company regarding accounting, internal
accounting controls or auditing matters, and (b) the confidential, anonymous
submission by the Company’s employees of concerns regarding questionable
accounting or auditing matters.  The Audit Committee held 6 meetings
during the fiscal year ended March 31, 2009.





In
September 2005, the Company’s Board appointed a Compensation
Committee.  The Compensation Committee is comprised entirely of
independent directors, namely, Messrs. Marguglio, Greber and Langley, with Mr.
Greber serving as chairman.  Pursuant to its charter, the Compensation
Committee’s functions include assisting the Board in determining the
compensation for its executive officers, including its Chief Executive Officer;
administering and delegating the administration of certain aspects of its stock
option plans, and assisting the Board in other matters as
appropriate.





In
September 2005, the Company’s Board also appointed a Nominating
Committee.  The Nominating Committee is comprised entirely of
independent directors, namely, Messrs. Marguglio, Greber and Langley, with Mr.
Greber serving as chairman.  Pursuant to its charter, the Nominating
Committee’s functions include assisting the Board in monitoring the size and
composition of the Board; considering and making recommendations to the Board
with respect to the nominations or elections of directors; and assisting the
Board in other duties as the Board shall from time to time
prescribe.





Currently,
the same directors serve on the Audit Committee, Compensation Committee and
Nominating Committees, as the size of the Board is relatively small, all
directors serving on these committees have significant experience in operating
companies of approximately the Company’s size, all are financially
sophisticated, and all have evidenced willingness to devote time and attention
to Board and board committee activities.  In the future, depending on
possible changes in the size and composition of the Board, the Board may vary
its current practices relative to board committees.


73




Compensation
Committee Interlocks and Insider Participation





During
fiscal year 2009, no executive officer of the Company served as a board member
or compensation committee member for any other entity, one of whose executive
officers served as a director or Compensation Committee member of the
Company.




Item
11.  Executive Compensation




Compensation
Discussion and Analysis





Overview
of the Company’s Executive Compensation Program





The
Compensation Committee is responsible for, among other things, (a) assisting the
Board in discharging its responsibilities relating to compensation of its
directors and executive officers; and (b) producing an annual report on
executive officer compensation for inclusion in its Proxy Statement, in
accordance with applicable rules and regulations.





Compensation
Objectives and Strategy





The
Company’s core compensation philosophy is to pay its executive officers
competitive levels of compensation that best reflect their individual
responsibilities and contributions to the Company, while providing incentives to
achieve its business and financial objectives.  The Company’s
principal objectives and strategy concerning its executive compensation program
are as follows:




·
            to
      design compensation packages that will attract, retain, and motivate
      highly qualified key employees who can be instrumental to the Company’s
      long-term success;




·
            to
      pay competitively in relation to similar audio and video software and
      hardware companies and to provide appropriate reward opportunities for
      achieving high levels of performance compared to similar organizations in
      the marketplace;




·
            to
      emphasize individual excellence and encourage all employees, not just the
      Company’s executive officers, to take initiative and lead projects that
      enhance the Company’s overall
effectiveness;




·
            to
      emphasize sustained performance by aligning rewards with shareholder
      interests; and




·
            to
      motivate executives and employees to achieve the Company’s annual and
      long-term business goals and encourage behavior toward the fulfillment of
      those objectives.





The
Company does not have a formal executive evaluation and compensation program
with specified performance objectives, targets or ranges.  The
Company’s Board has not historically used any formal benchmarking data or
surveys to establish compensation levels, instead generally relying on publicly
available information regarding compensation levels of similar audio and video
software and hardware companies as well as its own general business knowledge to
design compensation packages that it believes are competitive and provide
appropriate reward opportunities for achieving high levels of performance,
compared to those similar organizations in the marketplace.





In
keeping with the Company’s compensation objectives and strategy, its Board
approved the Company’s entry into Executive Employment Agreements with its
executive officers in January 2007 and in February 2008 (see “Employment
Agreements,” below).  The Company’s Board believes that these
agreements are beneficial in that they provide a certain level of employment
protection to these executives, fostering long term-behavior, emphasizing
sustained performance and the achievement of long-term business goals, and
assisting the Company in retaining its most senior personnel, all without
requiring the Company to increase the total compensation amounts now paid to
those executives.  Each year, the Board, taking into account any input
provided by the Compensation Committees will review and evaluate the
compensation paid to the Company’s executive officers and determine the base
salary, bonus and the equity related grants for each executive
officer.




74




Role
of Executive Officers in Compensation Decisions


In the
ordinary course, the Company’s CEO evaluates the personnel who report directly
to him.  The Board and/or Compensation Committee may consider these
evaluations and any recommendations of the Company’s CEO in determining the base
salaries, adjustments to base salaries, bonuses and equity based awards for each
of its named executive officers, other than the CEO.  The Compensation
Committee and/or the Company’s full Board may exercise its discretion in
modifying any recommended adjustments or awards to executives.





Elements
of Compensation





Compensation
for each executive officer for fiscal year 2009 consisted of a base salary, the
opportunity to receive a bonus in the form of cash, stock and/or grants of
restricted stock units (“RSUs”), options to acquire common stock, and other
benefits (e.g., matching contribution made by the Company under its 401(k)
plan).  The Company provides a competitive salary and benefits package
that it believes is consistent with market practice for its industry and the
size of its company, and allows it to attract and retain executives and
employees.  The Company has not established minimum stock ownership
guidelines for its executive officers or adopted a policy requiring them to
retain their Company stock ownership for any period of time.  In
general, all other employee benefits that the Company’s executive officers
receive, such as matching contributions under its 401(k) plan, are the same
benefits available on a non-discriminatory basis to its other salaried
employees.  During fiscal year 2009, as part of the Company’s cost
cutting measures, the Company suspended matching contributions to the Company’s
401(K) plan.





The
Company chooses to build its compensation program for named executive officers
around these elements because each individual component is useful in achieving
one or more of the objectives of the program and it believes that, together, it
has been and will continue to be effective in achieving the Company’s overall
objectives.





Weighting
of Elements





The
Company does not have an express policy or formulaic method for weighting the
different elements of compensation or for allocating between long-term and
short-term compensation.  The use and weight of each compensation
element is based on a subjective determination by the Company’s Board and/or
Compensation Committee of the importance of each element in meeting its overall
objectives.





Non-cash
compensation includes grants of stock options and/or RSUs.  Stock
options and RSUs provide long-term incentives to increase shareholder value as
well as a retention mechanism for highly-valued named executive
officers.  The Board’s intention is to grant competitive equity
compensation awards.





Base
Salary





The
Company provides its named executive officers and other employees a fixed amount
of cash compensation salary for the executive’s work. Salaries for named
executive officers are established each year by the Board, taking into account
any input provided by the Compensation Committee.  The Compensation
Committee and Board determine the base salaries of the Company’s named executive
officers annually by subjectively evaluating their experience, responsibilities
of their position, and each of the individual’s performance.





The
amount of each executive’s salary is determined based on a number of factors
including:




·
            an
      assessment of individual contribution as judged by the CEO (other than
      with respect to his own salary), as well as the Compensation Committee
      and/or Board;




·
            tenure;




·
            relationship
      with the salaries of other executives at comparable companies;
      and




·
            the
      Company’s overall financial
results.





For
fiscal year 2009, as illustrated in the Company’s Summary Compensation Table
below, base salaries of its  named executive officers represented an
average of approximately 63% of their total compensation (which included base
salary, cash incentive compensation, stock options expense and matching
contributions made to the named executive under the Company’s 401(k)
plan).  The Compensation Committee considers this percentage to be
relatively appropriate, although the percentage may be either higher or lower in
future periods since the Compensation Committee does not target salary at a
particular percentage of total compensation.




75




Bonuses





The
Company provides bonuses, at the discretion of the Compensation Committee and
Board, to compensate its executive officers for their performance over the past
year.  On September 25, 2008, the Compensation Committee recommended
and the Board approved, the 2008 Executive Bonus Plan (the “Plan”).  The
Plan provides for cash bonus payments to Plan participants, including the
Company’s executive officers covered by the disclosure requirements for
executive compensation in Item 402(c) of Regulation S-K (the “Executive
Officers”), in each fiscal quarter, unless otherwise determined by the Board
(the “Performance Period”), based on a performance metric to be designated by
the Board and on the number of bonus sharing units, or points, allocated to
each participant in accordance with the terms of the Plan (the “Bonus
Units”).  The purpose of the Plan is to increase shareholder value and the
success of the Company by (a) aligning the compensation of executive management
to key financial drivers, (b) increasing the competitiveness of executive pay
without increasing fixed costs, making bonus payments contingent upon
organizational success, and (c) creating internal consistency and standard
guidelines among the executive peer group.





For each
Performance Period, the Board, in its sole discretion, shall designate (a) the
performance metric, (b) the aggregate number of participants, which will be the
Executive Officers and the members of the Company’s senior management designated
for participation in the Plan, or a range in the number of participants, to be
included under the Plan, (c) the aggregate number of Bonus Units, or a range of
Bonus Units, to be administered under the Plan, and (d) the specific number of
Bonus Units to be allocated to each of the Executive Officers.  The Board
may, in its sole discretion, make or modify any of these determinations at any
time up to the date the bonus amount under this Plan is paid to participants for
a particular Performance Period.





For each
Performance Period, the Company’s CEO and/or COO shall designate (a) the
specific non-Executive Officer employees who will be participants, and (b) the
specific number of Bonus Units to be allocated to each of the non-Executive
Officer employees, provided that the total number of participants and Bonus
Units will be equal to the aggregate number or range set by the Board.
 Subject to the Board’s discretion, the Chief Executive Officer and Chief
Operating Officer may make or modify any of these determinations at any time up
to the date the bonus amount under this Plan is paid to participants for a
particular Performance Period.





Pursuant
to the Plan, payments of the bonus amounts will be made in cash. At the end of
each Performance Period, the Company’s Chief Financial Officer will calculate
the bonus amount payable to each participant, which is the performance metric
multiplied by the participant’s Bonus Units and divided by the sum of all Bonus
Units held by all participants at the end of such Performance Period.  The
Plan became effective on October 1, 2008 and the First Performance Period ran
from October 1, 2008 through December 31, 2008, with Bonus Units and bonus
amounts associated with that and subsequent Performance Periods to be determined
thereafter. As of March 31, 2009, the Company accrued bonus amount of $0.1
million and had not paid out any cash bonuses under the Plan.





Equity-Based
Incentives





The
Compensation Committee and Board strongly believe that it is important for key
employees who have primary responsibility for the management, growth, and future
success of its company to have significant equity ownership interest in the
Company and to have the potential to gain financially from the Company’s stock
price increases.  The interests of shareholders, executives and
employees should thereby be more closely aligned.  The Compensation
Committee and Board seek to provide such ownership interest to executives and
key employees by grants of RSUs or grants of options to purchase shares of the
Company’s common stock in the future at a price equal to fair market value at
the date of grant.  The Board determines the amounts of long-term
incentive awards after considering cost and dilution impact, market trends
relating to long-term incentive compensation, the individual’s position with the
Company, remaining availability under its stock option plans and other any other
factors it deems relevant.  The Company believes the term and vesting
schedule of its stock options and RSUs provide additional incentive to
management to focus on long-term growth and market performance of its
stock.





Under the
Company’s stock option plans, shares of its common stock may be purchased at the
option grant price.  All grants must be exercised according to the
provisions of the Company’s stock option plans.  All outstanding
options expire on the earlier of ten years after the date of grant or 90 days
after an option holder’s termination of service with the Company.





Change
in Control Provisions





As
further described under “Employment Agreements,” in the event of a change in
control (as defined) the Company’s executive officers are entitled to specified
percentages of their annual base salaries then in effect and the immediate
vesting in all of their outstanding unvested stock options, RSUs, or other
equity compensation.  The change in control provisions in these
agreements are designed to offer protection to these employees to recognize
their many years of commitment to the Company and its continuing
success.


76




Other
Benefits





The
Company provides standard employee benefits to all of its
employees.  Benefits available to executive and non-executive
employees include health insurance, vacation, disability insurance, life
insurance and participation in its 401(k) plan and employee stock option and RSU
programs.  The Company does not offer any supplemental executive
health and welfare or retirement programs, or provide any other supplemental
benefits or perquisites, to its executives.





Impact
of Tax and Accounting on Compensation Decisions





Section
162(m) of the Code limits the deductibility of compensation paid to certain
executive officers in excess of $1 million unless the compensation is
performance based.  When determining amounts of equity grants to
executives and employees under the Company’s equity incentive program, the
Compensation Committee considers the compensation charges associated with the
grants.  Beginning on April 1, 2006, the Company began accounting for
share-based compensation in accordance with the requirements of SFAS No.
123(R).  Under SFAS No. 123(R), grants of stock options result in
compensation expense equal to the fair value of the options, which is calculated
using a Black-Scholes-Merton option pricing model.  The fair value of
restricted stock units is equivalent to the market price of the Company’s common
stock on the grant date.  The expense is recognized over the option
vesting period.





Chief
Executive Officer Compensation





Mr.
Habiger’s compensation as CEO for fiscal year 2009 was established by the Board
in accordance with the guidelines described in this Annual
Report.  For fiscal year 2009, Mr. Habiger’s base salary was $350,000.
Mr. Habiger’s base salary represented approximately 56% of his total
compensation during fiscal year 2009.  For information regarding Mr.
Habiger’s salary see Item 11. “Summary Compensation” table included in this
Annual Report.




Compensation
Committee Report





The
members of the Compensation Committee have reviewed and discussed the
Compensation Discussion and Analysis contained herein with the Company’s
management and, based on the review and discussion, has recommended to its Board
that the Compensation Discussion and Analysis be included in this Annual
Report.





Submitted
by the Compensation Committee


Robert M.
Greber, Chairman


R. Warren
Langley


Peter J.
Marguglio


77


Summary
Compensation





The
following table shows for the fiscal years ended March 31, 2009, 2008 and 2007,
compensation awarded to, paid to, or earned by, the Company’s “principal
executive officer,” “principal financial officer” and other executive officers
(collectively, the “Named Executive Officers”):





*Name and Principal Position
                                      
                                      Year
                                      
                                      Salary
                                        ($) (1)
                                      
                                      
                                      Bonus ($)
                                      
                                      
                                      Stock
                                        Awards ($)
                                      
                                      
                                      Option Awards
                                        ($) (2)
                                      
                                      
                                      Non-Equity
                                        Incentive Plan
                                        Compensation
                                        ($)
                                      
                                      
                                      All Other
                                        Compensation
                                        ($) (3)
                                      
                                      
                                      Total ($)David
      C. Habiger,
                                      
                                      2009
                                      
                                      
                                      354,000
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      270,698
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      5,700
                                      
                                      
                                      
                                      630,398Chief
      Executive Officer
                                      
                                      2008
                                      
                                      
                                      350,000
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      715
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      12,250
                                      
                                      
                                      
                                      362,9652007
                                      
                                      
                                      350,000
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      265,913
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      11,863
                                      
                                      
                                      
                                      627,776Paul
      F. Norris
                                      
                                      2009
                                      
                                      
                                      340,175
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      157,841
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      5,550
                                      
                                      
                                      
                                      503,565Executive
      Vice President,
                                      
                                      2008
                                      
                                      
                                      259,615
                                      
                                      
                                      
                                      50,000
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      50,288
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      7,400
                                      
                                      
                                      
                                      367,303Acting
      Chief Financial Officer and General Counsel
                                      
                                      2007
                                      
                                      
                                      250,096
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      5,784
                                      
                                      
                                      
                                      255,880A. Clay Leighton(4)
                                      
                                      2009
                                      
                                      
                                      258,112
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      163,099
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      6,200
                                      
                                      
                                      
                                      427,411Chief
      Operating Officer
                                      
                                      2008
                                      
                                      
                                      300,000
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      18,000
                                      
                                      
                                      
                                      318,0002007
                                      
                                      
                                      300,000
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      11,800
                                      
                                      
                                      
                                      311,800Mark Ely(5)
                                      
                                      2009
                                      
                                      
                                      386,526
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      166,648
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      8,975
                                      
                                      
                                      
                                      562,149Executive
      Vice President
                                      
                                      2008
                                      
                                      
                                      300,000
                                      
                                      
                                      
                                      50,000
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      143
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      1,000
                                      
                                      
                                      
                                      351,143of
      Strategy
                                      
                                      2007
                                      
                                      
                                      249,670
                                      
                                      
                                      
                                      59,861
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      53,183
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      11,693
                                      
                                      
                                      
                                      374,407




* Other
than the individuals listed above, the Company does not have any other executive
employees who have received more than $100,000 in compensation, including
bonuses and options, during each of the last three fiscal years.




(1)
            In
      addition to salary, the following Named Executive Officers tendered
      options and received cash payments in fiscal 2009 as
    follows:




Name
                        
                        Shares Tendered (#)
                        
                        
                        Tender Offer Price Per
                          Share ($)
                        
                        
                        Cash Received
                          ($)David
      C. Habiger
                        
                        
                        400,000
                        
                        
                        $
                        0.01
                        
                        
                        $
                        4,000Paul
      F. Norris
                        
                        
                        75,000
                        
                        
                        
                        0.02
                        
                        
                        
                        1,500A.
      Clay Leighton
                        
                        
                        100,000
                        
                        
                        
                        0.02
                        
                        
                        
                        2,000200,000
                        
                        
                        
                        0.01
                        
                        
                        
                        2,000Mark
      Ely
                        
                        
                        40,000
                        
                        
                        
                        0.01
                        
                        
                        
                        40080,000
                        
                        
                        
                        0.02
                        
                        
                        
                        1,6004,379
                        
                        
                        
                        0.30
                        
                        
                        
                        1,314




(2)
            Amounts
      shown in this column reflect the Company’s accounting expense for these
      awards and do not reflect whether the recipient has actually realized a
      financial benefit from the awards.  The column reflects the
      dollar amount recognized for financial statement reporting purposes
      (disregarding an estimate of forfeitures related to service-based vesting
      conditions) in accordance with SFAS No. 123(R), and may include amounts
      for awards granted in and prior to 2009, 2008 and 2007,
      respectively.  Please refer to Note 4, “Shareholders’ Equity,”
      to the Consolidated Financial Statements included in this Annual Report
      for the relevant assumptions used to determine the compensation cost of
      the Company’s stock and option
awards.




(3)
            Consists
      of matching contributions made by the Company on behalf of the Named
      Executive Officers to the Company's 401(k)
plan.




(4)
            In
      May 2008, Mr. Leighton’s annual salary was reduced by $45,888 as part of a
      voluntary agreement with the Company in connection with repriced stock
      options due to the Company’s stock option review during fiscal
      2008.  In January 2009, the agreement was satisfied in
      full.


78




(5)
            In
      addition to salary, Mr. Ely received $82,938 in form of
      RSUs.  The grant date fair value of the RSUs was determined by
      using the closing price of the Company’s common stock as of the day of
      release.  Mr. Ely’s grant of RSUs vests 12.5% every six months
      for four years.





Grants
of Plan Based Awards





The
following table sets forth certain information with respect to grants of
plan-based awards in fiscal year 2009 to the Company’s Named Executive Officers,
including cash awards and equity awards. The stock option and RSUs granted
to the Company’s Named Executive Officers in fiscal 2009 were granted under the
1998 and 2000 Stock Option Plans.





Estimated Future Payouts Under Non-
                                    Equity Incentive Plan Awards
      (1)
                                  
                                  
                                  Estimated Future Payouts Under
                                    Equity Incentive Plan AwardsName
                                  
                                  GrantDate
                                  
                                  Threshold
                                    ($)
                                  
                                  
                                  Target
                                    ($)
                                  
                                  
                                  Maximum($)
                                  
                                  
                                  Threshold
                                    ($)
                                  
                                  
                                  Target
                                    ($)
                                  
                                  
                                  Maximum
                                    ($)
                                  
                                  
                                  AllOther
                                    StockAwards:
                                    Numberof
                                    Sharesof
                                    StockorUnits
                                    (#)
                                  
                                  
                                  AllOther
                                    Awards:
                                    Numberof
                                    Securities
                                    Underlying
                                    Options(#)
                                  
                                  
                                  Exercise
                                    orBase
                                    Priceof
                                    Option
                                    Awards
                                    ($/Sh)
                                  
                                  
                                  GrantDate
                                    FairValue
                                    ofStock
                                    andOption
                                    Awards (2)David C. Habiger
      (3)
                                  
                                  6/12/2008
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  375,000
                                  
                                  
                                  
                                  -
                                  
                                  
                                  $
                                  6.89
                                  
                                  
                                  $
                                  975,52512/15/2008
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  300,000
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  1.23
                                  
                                  
                                  
                                  139,350Paul F. Norris (3)
                                  
                                  6/12/2008
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  144,000
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  6.89
                                  
                                  
                                  
                                  374,60212/15/2008
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  150,000
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  1.23
                                  
                                  
                                  
                                  69,675A. Clay Leighton
      (3)
                                  
                                  6/12/2008
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  225,000
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  6.89
                                  
                                  
                                  
                                  585,31512/15/2008
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  200,000
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  1.23
                                  
                                  
                                  
                                  92,900Mark Ely (4)
                                  
                                  6/12/2008
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  50,000
                                  
                                  
                                  
                                  1.20
                                  
                                  
                                  
                                  60,00012/15/2008
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  150,000
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  1.23
                                  
                                  
                                  
                                  69,675




(1)
            On
      September 25, 2008, the Board approved the 2008 Executive Bonus Plan
      (“Plan”).  Pursuant to the Plan, payments for bonus amounts will
      be made in cash and the Company’s Chief Financial Officer will calculate
      the bonus amount payable to each participant at the end of each
      performance period.  As of March 31, 2009 the Company accrued
      bonus amount of $0.1 million and had not paid out any cash bonuses for the
      Named Executive Officers during fiscal
2009.




(2)
            Reflects
      the grant date fair value of each equity award computed in accordance with
      SFAS No. 123(R).  Please refer to Note 4, “Shareholders’
      Equity,” to the Consolidated Financial Statements included in this Annual
      Report for the relevant assumptions used to determine the compensation
      cost of the Company’s stock and option
awards.




(3)
            Grants
      on June 12, 2008 have three year vesting beginning on the date of grant
      date.  Grants on December 15, 2008 vest monthly over four years
      beginning on the date of grant.  All of the options granted are
      subject to change of control vesting per the employment agreement for the
      Named Executive Officers.





(4)
            Mr.
      Ely’s grant of RSUs on June 12, 2008 vests 12.5% every six months for four
      years after the vesting commencement date and December 15, 2008 stock
      option grant vests monthly over four years beginning on the date of
      grant.  The grant date fair value of the RSUs was determined by
      using the closing price of the Company’s common stock as of close on March
      31, 2009.  All options granted are subject to change of control
      vesting per the employment agreement for the Named
      Executive Officers.





Outstanding
Equity Awards at Fiscal Year End





The
following table provides information about unexercised options and RSUs that
have not vested for each of the Company’s Named Executive Officers for the
fiscal year ended March 31, 2009.


79





Option Awards
                                            
                                            
                                            Stock AwardsName
                                            
                                            Number of
                                              Securities
                                              Underlying
                                              Unexercised
                                              Options (#)
                                              Exercisable
                                            
                                            
                                            Number of
                                              Securities
                                              Underlying
                                              Unexercised
                                              Options (#)
                                              Unexercisable
                                            
                                            
                                            Equity Incentive
                                              Plan Awards:
                                              Number of of
                                              Securities
                                              Underlying
                                              Unexercised
                                              Unearned Options
                                              (#)
                                            
                                            
                                            Option
                                              Exercise
                                              Price ($)
                                            
                                            
                                            Option
                                              Expiration
                                              Date
                                            
                                            
                                            Number of
                                              Shares or
                                              Units Not
                                              Vested (#)
                                            
                                            
                                            Maket
                                              Value of
                                              Shares or
                                              Units Not
                                              Vested ($)
                                            
                                            
                                            Equity Incentive
                                              Plan Awards:
                                              Number of
                                              Unearned
                                              Shares, Units or
                                              Other Rights
                                              That Have Not
                                              Vested (#)
                                            
                                            
                                            Equity Incentive
                                              Plan Awards:
                                              Market or Payout
                                              Value of Unearned
                                              Shares, Units or
                                              Other Rights That
                                              Have Not Vested
                                              ($)David
      C. Habiger
                                            
                                            
                                            93,750
                                            
                                            
                                            
                                            281,250
                                            (1)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            6.89
                                            
                                            
                                            6/12/18
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -18,750
                                            
                                            
                                            
                                            281,250
                                            (2)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            1.23
                                            
                                            
                                            12/15/18
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -Paul
      F. Norris
                                            
                                            
                                            36,000
                                            
                                            
                                            
                                            108,000
                                            (1)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            6.89
                                            
                                            
                                            6/12/18
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -9,375
                                            
                                            
                                            
                                            140,625
                                            (2)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            1.23
                                            
                                            
                                            12/15/18
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            --
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            7,000
                                            
                                            
                                            
                                            8,400
                                            (3)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -A.
      Clay Leighton
                                            
                                            
                                            66,392
                                            
                                            
                                            
                                            -
                                            (4)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            1.17
                                            
                                            
                                            10/25/1112,500
                                            
                                            
                                            
                                            187,500
                                            (2)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            1.23
                                            
                                            
                                            12/15/18
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -51,940
                                            
                                            
                                            
                                            -
                                            (4)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            3.97
                                            
                                            
                                            3/11/1356,250
                                            
                                            
                                            
                                            168,750
                                            (1)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            6.89
                                            
                                            
                                            6/12/18
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -36,608
                                            
                                            
                                            
                                            -
                                            (4)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            1.17
                                            
                                            
                                            10/25/1120,000
                                            
                                            
                                            
                                            -
                                            (5)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            1.12
                                            
                                            
                                            7/12/1148,060
                                            
                                            
                                            
                                            -
                                            (4)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            6.33
                                            
                                            
                                            3/11/13Mark
      Ely
                                            
                                            
                                            7,500
                                            
                                            
                                            
                                            -
                                            (2)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            3.97
                                            
                                            
                                            3/11/139,375
                                            
                                            
                                            
                                            140,625
                                            (2)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            1.23
                                            
                                            
                                            12/15/18
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -31,250
                                            
                                            
                                            
                                            37,500
                                            (3)
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -




(1)
            Unvested
      options vest in equal installments monthly for three years beginning on
      the date of grant date and expire in ten years.  All of the
      options granted are subject to change of control vesting per the
      employment agreement for the Named Executive
  Officers.




(2)
            Unvested
      options vest in equal installments monthly for four years beginning on the
      date of grant and expire in ten years.  All of the options
      granted are subject to change of control vesting per the employment
      agreement for the Named Executive
Officers.




(3)
            RSU
      valuation was determined by multiplying the total number of shares by
      $1.20, the closing price of the Company’s common stock on March 31,
      2009.  RSUs vest 12.5% every six months for four years after the
      vesting commencement date.  All of the options granted are
      subject to change of control vesting per the employment agreement for the
      Named Executive Officers.




(4)
            Unvested
      options vest in equal installments monthly for three years beginning on
      the date of grant and expire in ten years.  All of the options
      granted are subject to change of control vesting per the employment
      agreement for the Named Executive
Officers.




(5)
            Unvested
      options vest in equal installments monthly for one year beginning on the
      date of grant.  All of the options granted are subject to change
      of control vesting per the employment agreement for the Named Executive
      Officers.





Options
Exercised





The
following provides information for each of the Company’s Named Executive
Officers, the amounts received upon exercise of options and the vesting of RSUs,
during the fiscal year ended March 31, 2009





Option Awards
                  
                  
                  Stock VestedName
                  
                  Number of Shares
                    Acquired on
                    Exercise (#)
                  
                  
                  Value
                    Realized on
                    Exercise ($)
                  
                  
                  Number of
                    Shares
                    Acquired on
                    Vesting (#)
                  
                  
                  Value
                    Realized on
                    Vesting ($)David
      C. Habiger
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Paul
      F. Norris
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  7,000
                  
                  
                  
                  8,400A.
      Clay Leighton
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Mark
      Ely
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  18,750
                  
                  
                  
                  22,500





80




(1)
            RSU
      valuation was determined by multiplying the total number of shares by
      $1.20, the closing price of the Company’s common stock on March 31,
      2009.





There
were no stock options exercised during the fiscal year ended March 31, 2009 by
the Named Executive Officers in the Summary Compensation Table.





Employment
Agreements





On
January 23, 2007, the Company’s Board approved Executive Employment Agreements
for David C. Habiger, A. Clay Leighton, and Mark Ely.  Effective
February 26, 2008, the Company’s Board approved an Executive Employment
Agreement for Paul F. Norris.  The specific terms of these
arrangements, as well as an estimate of the compensation that would have been
payable had they been triggered as of fiscal year end, are described in detail
in the section entitled “Potential Payments upon Termination or Change in
Control” below.





The
Executive Employment Agreement for Mr. Habiger, the Company’s President and
Chief Executive Officer (the “Habiger Agreement”), provides for a base salary of
$350,000, and the right to participate in any long term or annual incentive
plans maintained by the Company for its executives.  The Habiger
Agreement provides that (i) if Mr. Habiger’s employment is terminated without
Cause or if Mr. Habiger terminates his employment for Good Reason, unless such
termination occurs within 180 days of a Change in Control, the Company will make
a lump sum payment to Mr. Habiger equal to 175% of his annual base salary at the
level in effect immediately prior to his termination; and (ii) in the event of a
Change in Control, all of Mr. Habiger’s outstanding unvested stock options,
RSUs, or other equity compensation will immediately vest in full and the Company
will make a lump sum payment equal to 175% of his annual base salary at the
level in effect at the time of the Change in Control.





The
Executive Employment Agreement for Mr. Norris, the Company’s Executive Vice
President, Acting Chief Financial Officer and General Counsel (the “Norris
Agreement”), provides for a base salary of $300,000, and the right to
participate in any long term or annual incentive plans maintained by the Company
for its executives.  The Norris Agreement provides that (i) if Mr.
Norris’s employment is terminated without Cause or if Mr. Norris terminates his
employment for Good Reason, unless such termination occurs within 180 days of a
Change in Control, the Company will make a lump sum payment to Mr. Norris equal
to 100% of his annual base salary at the level in effect immediately prior to
his termination; and (ii) in the event of a Change in Control, all of Mr.
Norris’s outstanding unvested stock options, restricted stock units and other
equity compensation will immediately vest in full and the Company will make a
lump sum payment to Mr. Norris equal to 100% of his annual base salary at the
level in effect at the time of the Change in Control.





The
Executive Employment Agreement for Mr. Leighton, the Company’s Chief Operating
Officer (the “Leighton Agreement”), provides for a base salary of $300,000, and
the right to participate in any long term or annual incentive plans maintained
by the Company for its executives.  The Leighton Agreement provides
that (i) if Mr. Leighton’s employment is terminated without Cause or if Mr.
Leighton terminates his employment for Good Reason, unless such termination
occurs within 180 days of a Change in Control, the Company will make a lump sum
payment to Mr. Leighton equal to 100% of his annual base salary at the level in
effect immediately prior to his termination; and (ii) in the event of a Change
in Control, all of Mr. Leighton’s outstanding unvested stock options, RSUs, or
other equity compensation will immediately vest in full and the Company will
make a lump sum payment equal to 100% of his annual base salary at the level in
effect at the time of the Change in Control.





The
Executive Employment Agreement for Mr. Ely, the Company’s Executive Vice
President of Strategy (the “Ely Agreement”), provides for a base salary of
$300,000 and the right to participate in any long term or annual incentive plans
maintained by the Company for its executives.  The Ely Agreement
provides that (i) if Mr. Ely’s employment is terminated without Cause or if Mr.
Ely terminates his employment for Good Reason, unless such termination occurs
within 180 days of a Change in Control, the Company will make a lump sum payment
to Mr. Ely equal to 100% of his annual base salary at the level in effect
immediately prior to his termination; and (ii) in the event of a Change in
Control, all of Mr. Ely’s outstanding unvested stock options, RSUs, or other
equity compensation will immediately vest in full and the Company will make a
lump sum payment equal to 100% of his annual base salary at the level in effect
at the time of the Change in Control.





Each of
the Executive Employment Agreements contains the following terms:





For
purposes hereof, “Cause” shall mean (i) Executive’s conviction of any felony
under federal or state law, or any fraud, misappropriation or embezzlement, or
(ii) Executive’s breach of a fiduciary duty owed to Company or commission of a
material violation of Section 4 (relating to confidential
information).


81





Executive
may voluntarily terminate his employment with Company for Good Reason within 30
days of the occurrence of:  (a) a material adverse change in
Executive’s position causing it to be of materially less stature or
responsibility without Executive’s written consent, and such a materially
adverse change shall in all events be deemed to occur if Executive no longer
serves in his position, unless Executive consents in writing to such change; (b)
a reduction, without Executive’s written consent, in his level of compensation
(including base salary and fringe benefits); (c) a relocation of his principal
place of employment by more than 50 miles, or (d) failure to cure a material
breach by Company (or its successor) of this Agreement within thirty (30) days
after written notice from Executive to the Company identifying such
breach.





For
purposes of this Agreement, “Change in Control” shall have the same meaning as
“Corporate Transaction,” as such term is defined in the Company’s 2004 Equity
Compensation Plan.





Potential
Payments upon Termination or Change in Control





The
following table summarizes the Company’s estimated cost of severance payments
had the executive’s employment terminated without cause or if he had terminated
his employment for good reason as of March 31, 2009:





PotentialPaymentsUpon:Involuntary Termination
                      
                      
                      Voluntary TerminationOtherThanForCause
                      
                      
                      forGoodReasonPrior to Change in
                      
                      
                      Change of Control
                      
                      
                      Prior to Change in
                      
                      
                      Change of
                        ControlName
                      
                      TypeofBenefit
                      
                      Control($)
                      
                      
                      ($)
                      
                      
                      Control($)
                      
                      
                      ($)David
      C. Habiger
                      
                      Cash
      Severance Payments
                      
                      
                      613
                      
                      
                      
                      613
                      
                      
                      
                      613
                      
                      
                      
                      613Vesting Acceleration
      (1)
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Total
      Termination Benefits:
                      
                      
                      613
                      
                      
                      
                      613
                      
                      
                      
                      613
                      
                      
                      
                      613Paul
      F. Norris
                      
                      Cash
      Severance Payments
                      
                      
                      300
                      
                      
                      
                      300
                      
                      
                      
                      300
                      
                      
                      
                      300Vesting Acceleration
      (1)
                      
                      
                      -
                      
                      
                      
                      8
                      
                      
                      
                      -
                      
                      
                      
                      8Total
      Termination Benefits:
                      
                      
                      300
                      
                      
                      
                      308
                      
                      
                      
                      300
                      
                      
                      
                      308A.
      Clay Leighton
                      
                      Cash
      Severance Payments
                      
                      
                      300
                      
                      
                      
                      300
                      
                      
                      
                      300
                      
                      
                      
                      300Vesting Acceleration
      (1)
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Total
      Termination Benefits:
                      
                      
                      300
                      
                      
                      
                      300
                      
                      
                      
                      300
                      
                      
                      
                      300Mark
      Ely
                      
                      Cash
      Severance Payments
                      
                      
                      300
                      
                      
                      
                      300
                      
                      
                      
                      300
                      
                      
                      
                      300Vesting Acceleration
      (1)
                      
                      
                      -
                      
                      
                      
                      38
                      
                      
                      
                      -
                      
                      
                      
                      38Total
      Termination Benefits:
                      
                      
                      300
                      
                      
                      
                      338
                      
                      
                      
                      300
                      
                      
                      
                      338




(1)
            Reflects
      the aggregate market value of unvested option grants and or RSUs with
      exercise prices less than or equal to $1.20 (“in-the-money
      options”).  For unvested in-the-money option grants, aggregate
      market value is computed by multiplying (i) the number of shares
      underlying unvested in-the-money options at March 31, 2009, by
      (ii) the difference between $1.20 and the exercise price of such
      in-the-money option.  RSU valuation was determined by
      multiplying the total number of shares by $1.20, the closing price of the
      Company’s common stock on March 31, 2009.  Does not reflect any
      market value for options with exercise prices in excess of
      $1.20.





Director
Compensation





On
January 23, 2007, the Company’s Board approved the Board of Directors
Compensation Policy (the “Policy”). Pursuant to the Policy, the Board shall
review the annual compensation targets, including cash compensation target
percentage, at each annual meeting of the Board for the “independent” Board
members (each, an “Outside Director” and each Outside Director who serves as
chairman of either the Board or a standing committee of the Board (each, a
“Chairman”).  At the June 12, 2008 annual Board meeting, the
Board reviewed the Policy, and after considering survey information regarding
industry practices and other factors, approved amendments to the Policy
providing for an annual compensation target of $120,000 for each Board member
and for each such member serving as chairman of the Board or one of its standing
committees, an annual compensation target equal to 125% of the annual
compensation target for the non-chairman members.  Under the revised
Policy, the annual compensation target for all members is to be paid in equal
parts cash and equity compensation, provided that in the event the annual
organizational meeting of the Board is scheduled later than October 1 in any
year, then, in light of the inability to calculate the next year’s annual equity
compensation target percentage as contemplated under the Policy until such
meeting is held, the Policy provides that effective on October 1 of that year
the equity compensation target percentage shall be shall be reduced to 0% and
the cash compensation target percentage shall be increased to 100%, each until
the occurrence of such annual organizational meeting.


82





In
addition, the Company’s Board and Compensation Committee (excluding Mr. Doris
and Ms. Sauer) considered the current exceptional level of involvement of Mr.
Doris and Ms. Sauer in providing strategic guidance to the Company’s executive
officers and management team as well as the standard level of director
compensation provided pursuant to the Board Compensation Policy and determined
that Mr. Doris shall receive additional cash compensation at the rate of $37,500
per quarter and Ms. Sauer shall receive additional cash compensation at the rate
of $20,000 per quarter, until such time as either Mr. Doris or Ms. Sauer report
that they are no longer providing such extra involvement, or until such time as
the Board directs otherwise.





The
following table sets forth information for the fiscal year ended March 31, 2009
regarding compensation of the Company’s non-employee directors:





Name
                    
                    Fees Earned or Paid in
                      Cash ($)(1)
                    
                    
                    Option
                      Awards ($)(2)
                    
                    
                    Total ($)Robert
      J. Doris (3)
                    
                    
                    114,134
                    (4)
                    
                    
                    97,622
                    (6)
                    
                    
                    211,756Mary
      C. Sauer (3)
                    
                    
                    79,653
                    (5)
                    
                    
                    78,223
                    (7)
                    
                    
                    157,876Robert
      M. Greber
                    
                    
                    70,762
                    
                    
                    
                    21,976
                    (8)
                    
                    
                    92,738Peter
      J. Marguglio
                    
                    
                    67,534
                    
                    
                    
                    17,581
                    (9)
                    
                    
                    85,115R.
      Warren Langley
                    
                    
                    68,022
                    
                    
                    
                    17,581
                    (10)
                    
                    
                    85,603




(1)
            In
      addition to salary, the following Directors tendered options and received
      cash payments in fiscal 2009:




Name
                              
                              Shares Tendered (#)
                              
                              
                              Tender Offer Price Per
                                Share ($)
                              
                              
                              Cash Received
                                ($)Robert
      J. Doris
                              
                              
                              157,790
                              
                              
                              $
                              0.06
                              
                              
                              $
                              9,467332,738
                              
                              
                              
                              0.02
                              
                              
                              
                              6,655Mary
      C. Sauer
                              
                              
                              67,790
                              
                              
                              
                              0.06
                              
                              
                              
                              4,067152,738
                              
                              
                              
                              0.02
                              
                              
                              
                              3,055Robert
      M. Greber
                              
                              
                              25,000
                              
                              
                              
                              0.06
                              
                              
                              
                              1,50052,500
                              
                              
                              
                              0.02
                              
                              
                              
                              1,050Peter
      J. Marguglio
                              
                              
                              24,000
                              
                              
                              
                              0.06
                              
                              
                              
                              1,44042,000
                              
                              
                              
                              0.02
                              
                              
                              
                              840R.
      Warren Langley
                              
                              
                              24,000
                              
                              
                              
                              0.06
                              
                              
                              
                              1,44042,000
                              
                              
                              
                              0.02
                              
                              
                              
                              840




(2)
            Amounts
      shown in this column reflect the Company’s accounting expense for these
      awards and do not reflect whether the recipient has actually realized a
      financial benefit from the awards.  The column reflects the
      dollar amount recognized for financial statement reporting
      purposes disregarding an estimate of forfeitures related to
      service-based vesting conditions in accordance with SFAS No
      123(R),  Please refer to Note 4, “Shareholders’ Equity,” to the
      Consolidated Financial Statements included in this Annual Report for the
      relevant assumptions used to determine the compensation cost of the
      Company’s stock and option awards.




(3)
            In
      lieu of the outside Directors Compensation Policy, Mr. Doris and Ms. Sauer
      received the above amounts in consideration of their providing advisory
      services to the Company’s executives.  Also includes matching
      contributions made by the Company on behalf of Mr. Doris and Ms. Sauer to
      the Company's 401(k) plan.




(4)
            In
      May 2008, Mr. Doris’s compensation was reduced by $45,888 as part of a
      voluntary agreement with the Company in connection with repriced stock
      options due to the Company’s stock option review during fiscal
      2008.  The agreement will be satisfied in full on May 31,
      2009.


83




(5)
            In
      May 2008, Ms. Sauer’s compensation was reduced by $31,324 as part of a
      voluntary agreement with the Company in connection with repriced stock
      options due to the Company’s stock option review during fiscal
      2008.  The agreement will be satisfied in full on May 31,
      2009.




(6)
            As
      of March 31, 2009, Mr. Doris held options to purchase an aggregate of
      755,447 of the Company’s Common Stock and held unvested options of
      65,325.




(7)
            As
      of March 31, 2009, Ms. Sauer held options to purchase an aggregate of
      458,297 of the Company’s Common Stock and held unvested options of
      52,275.




(8)
            As
      of March 31, 2009, Mr. Greber held options to purchase an aggregate of
      163,475 of the Company’s Common Stock, and held unvested options of
      65,325.




(9)
            As
      of March 31, 2009, Mr. Marguglio held options to purchase an aggregate of
      118,825 of the Company’s Common Stock, and held unvested options of
      52,275.




(10)
            As
      of March 31, 2009, Mr. Langley held options to purchase an aggregate of
      112,825 of the Company’s Common Stock, and held unvested options of
      52,275.




84





Item
12.  Security Ownership of Certain Beneficial Owners and Management
and Related Shareholder Matters







The
following table sets forth certain information regarding beneficial ownership of
the common stock as of May 28, 2009 (i) by each person who is known by the
Company to beneficially own more than 5% of the outstanding shares of the
Company’s common stock, (ii) by each of its directors, (iii) by each of its
Named Executive Officers, and (iv) by all directors and executive officers as a
group.




Name
      and Address (1)
              
              Number
      of Shares Beneficially Owned(2)
              
              
              Percentage
      of Shares Beneficially Owned(2)Barclays
      Global Investors, NA (3)
                45
      Freemont Street
                San
      Francisco, CA 94105
              
              
              1,722,855
              
              
              
              6.47
              %Harvest
      Capital Strategies LLC (4)
                600
      Montgomery Street, Suite 1100
                San
      Francisco, CA 94111
              
              
              1,421,568
              
              
              
              5.34
              %Royce
      and Associates (5)
                1414
      Avenue of the Americas
                New
      York, NY 10019
              
              
              1,488,600
              
              
              
              5.59
              %William
      Blair & Company, L.L.C. (6)
                222
      W Adams
                Chicago,
      IL 60606
              
              
              3,414,209
              
              
              
              12.83
              %Waddell
      & Reed Financial, Inc. (7)
                Waddell
      & Reed Financial Services, Inc.
                Waddel
      & Reed, Inc.
                Waddell
      & Reed Investment Management Company
                Ivy
      Investment Company
                6300
      Lamar Avenue
                Overland
      Park, KS 66202
              
              
              2,318,542
              
              
              
              8.71
              %Directors
      and OfficersRobert
      J. Doris (8)
              
              
              2,834,998
              
              
              
              10.65
              %Mary
      C. Sauer (9)
              
              
              2,834,938
              
              
              
              10.65
              %Peter
      Marguglio (10)
              
              
              477,393
              
              
              
              1.79
              %Robert
      M. Greber(11)
              
              
              132,550
              
              
              
              *R.
      Warren Langley(12)
              
              
              92,100
              
              
              
              *David
      C. Habiger (13)
              
              
              188,167
              
              
              
              *A.
      Clay Leighton (14)
              
              
              442,917
              
              
              
              1.66
              %Mark
      Ely (15)
              
              
              95,435
              
              
              
              *Paul
      Norris (16)
              
              
              118,245
              
              
              
              *All
      directors and executive officers as a group (9 persons)
              
              
              7,216,743
              
              
              
              27.11
              %





85




*
              Less
      than 1%.1
              Unless
      otherwise indicated, the address of each person is c/o Sonic Solutions,
      101 Rowland Way, Suite 110, Novato, CA 94945.2
              Table
      is based upon information supplied by directors, officers and principal
      shareholders.  Applicable percentage ownership for each
      shareholder is based on 26,615,868 shares of common stock outstanding as
      of May 27, 2009, together with applicable options for such
      shareholders.  Beneficial ownership is determined in accordance
      with Securities Exchange Commission ("SEC") rules and generally includes
      voting or investment power with respect to securities, subject to
      community property laws where applicable. Shares of common stock subject
      to options are deemed outstanding for the purpose of computing the
      percentage ownership of the person holding such options, but are not
      treated as outstanding for computing the percentage ownership of any other
      person.3
              The
      information is based solely on Schedule 13G filed with the SEC by Barclays
      Global Investors, NA, on December 31, 2008.4
              The
      information is based solely on Schedule 13G filed with the SEC by Harvest
      Capital Strategies, LLC on December 31, 2008.5
              The
      information is based solely on Schedule 13G filed with the SEC by Royce
      and Associates on December 31, 2008.6
              The
      information is based solely on Schedule 13G filed with the SEC by William
      Blair & Company, L.L.C. on December 31, 2008.7
              The
      information is based solely on Schedule 13G filed with the SEC by Waddell
      & Reed, Inc. on December 31, 2008.8
              Includes
      720,531 shares owned by Mr. Doris, 179,066 shares issuable upon exercise
      of options which will be exercisable within 60 days of May 27, 2009,
      1,609,029 owned by the Doris-Sauer Revocable Trust u/a/d 5 Nov 2004,
      217,995 shares owned by Ms. Sauer, and 108,377 shares issuable upon
      exercise of Ms. Sauer's options which will be exercisable within 60 days
      of May 27, 2009.  The revocable trust established by Robert
      Doris and Mary Sauer, husband and wife.  Each of Mr. Doris and
      Ms. Sauer are joint trustees of the Trust and each person has the power to
      vote and dispose of any and all securities held by the
      Trust.  Both Mr. Doris and Ms. Sauer disclaims beneficial
      ownership of the shares and options owned by the other.9
              Includes
      217,995 shares owned by Ms. Sauer, 108,377 shares issuable upon exercise
      of options which will be exercisable within 60 days of May 27, 2009,
      1,609,029 owned by the Doris-Sauer Revocable Trust u/a/d 5 Nov 2004,
      720,531 shares owned by Mr. Doris, and 179,006 shares issuable upon
      exercise of Mr. Doris's options which will be exercisable within 60 days
      of May 27, 2009.  The revocable trust established by Robert
      Doris and Mary Sauer, husband and wife.  Each of Mr. Doris and
      Ms. Sauer are joint trustees of the Trust and each person has the power to
      vote and dispose of any and all securities held by the
      Trust.  Both Ms. Sauer and Mr. Doris disclaims beneficial
      ownership of the shares and options owned by the other.10
              Includes
      193,443 shares owned by Mr. Marguglio, and 136,100 shares issuable upon
      exercise of options which will be exercisable within 60 days of May 27,
      2009.11
              Includes
      10,000 shares owned by Mr. Greber, 12,500 shares owned directly by a trust
      whose sole trustee and beneficary is Mr. Greber's will and 110,050
      issuable upon exercise of options which will be exercisable within 60 days
      of May 27, 2009.12
              Includes
      92,100 shares issuable upon exercise of options which will be exercisable
      within 60 days of May 27, 2009.13
              Includes
      9,000 shares owned by Mr. Habiger and 179,167 shares issuable upon
      exercise of options which will be exercisable within 60 days of May 27,
      2009.14
              Includes
      109,500 shares owned by Mr. Leighton and 333,417 shares issuable upon
      exercise of options which will be exercisable within 60 days of May 27,
      2009.15
              Includes
      41,060 shares owned by Mr. Ely, 25,000 unvested RSUs which will vest every
      six months and 29,375 shares issuable upon exercise of options which will
      be exercisable within 60 days of May 27, 2009.16
              Includes
      39,120 shares owned by Mr. Norris, 5,250 unvested RSUs which will vest
      every six months and 73,875 shares issuable upon exercise of options which
      will be exercisable within 60 days of May 27,
  2009.




Item
13.  Certain Relationships, Related Transactions and Director
Independence







The
Company has agreed to indemnify each of its directors and executive officers to
the fullest extent permitted by California law.  All transactions
between the Company and its officers, directors, principal stockholders and
affiliates have been and will be approved by a majority of its Board, including
a majority of the disinterested, non-employee directors, and have been or will
be on terms no less favorable to the Company than could be obtained from
unaffiliated third parties.





Director
Independence





See Part
III, Item 10, “Directors, Executive Officers and Corporate Governance-Director
Independence” included in this Annual Report.




86





Item
14.  Principal Accounting Fees and Services





BDO
Seidman, LLP performed services for the Company in fiscal years 2009, 2008 and
2007 related to financial statement audit work, quarterly reviews, tax services,
special projects and other ongoing consulting projects. Fees paid or payable to
BDO Seidman, LLP in fiscal years 2009, 2008 and 2007 were as follows (in
thousands):





March 31,2009
                  
                  
                  2008
                  
                  
                  2007Audit
      fees(1)
                  
                  $
                  1,124
                  
                  
                  $
                  1,050
                  
                  
                  $
                  1,524Audit
      related fees(2)
                  
                  
                  130
                  
                  
                  
                  1,963
                  
                  
                  
                  102Total
      fees
                  
                  $
                  1,254
                  
                  
                  $
                  3,013
                  
                  
                  $
                  1,626




(1)
            Audit
      fees are fees related to professional services rendered by BDO Seidman,
      LLP in connection with the audit of the Company’s financial statements and
      its internal controls over financial reporting, the reviews of its interim
      financial statements included in each of its quarterly reports on Form
      10-Q and international statutory
audits.




(2)
            Audit-related
      fees are for assurance and related services, including stock option review
      and review of other SEC filings by BDO Seidman, LLP that are reasonably
      related to the performance of the audit or review of the Company’s
      financial statements.





Pre-Approval
Policy





Under the
Sarbanes-Oxley Act, all audit and non-audit services performed by BDO Seidman,
LLP must be approved in advance by the Company’s Audit Committee to assure that
such services do not impair the auditors’ independence from the
Company.  In accordance with its pre-approval policies and procedures,
the Company’s Audit Committee pre-approved all audit and non-audit services
prior to them being performed by BDO Seidman, LLP during the fiscal year ended
March 31, 2009.


87




PART
IV




Item
15.  Exhibits and Financial Statement Schedules




(a)
              1.Financial
      Statements.




See Item
8 included in this Annual Report.


(a)
              2.Financial
      Statements Schedule.




Schedule
II — Valuation and Qualifying Accounts





All other
schedules are omitted because they are not required, or are not applicable, or
the information is included in the financial statements.





88




(a)           3.
Exhibits:




Exhibit
                
                Note
                
                TitleNo.3.1
                
                (1)
                
                Restated
      Articles of Incorporation3.2
                
                (1)
                
                Amended
      and Restated By-Laws3.3
                
                (7)
                
                Certificate
      of Amendment of Restated Articles of Incorporation4.1
                
                (1)
                
                Specimen
      Common Stock Certificate10.1
                
                (2)
                
                Lease
      Agreement between Golden Gate Plaza and Registrant, dated January 26,
      199510.2
                
                (13)
                
                Amendment
      to Lease Agreement between Golden Gate Plaza and Registrant, dated
      November 20, 200010.3
                
                (12)
                
                Tri-Partite
      Agreement between Roxio, Inc., Registrant and Entrust, Inc., dated
      December 17, 200410.4
                
                (12)
                
                Third
      Amendment to Lease between C&B Ventures-Napa Two LLC and Registrant,
      dated February 4, 200510.5
                
                (4)
                
                Distribution
      Agreement between Registrant and Daikin Industries, Ltd., dated February
      27, 200110.6
                
                (1)
                
                Form
      of Indemnity Agreement10.7
                
                (3)
                
                1998
      Stock Option Plan (compensatory plan)10.8
                
                (9)
                
                Sonic
      Solutions 2004 Equity Compensation Plan10.9
                
                (9)
                
                Sonic
      Solutions 2004 Equity Compensation Plan Notice of Stock Option Award for
      Robert J. Doris and Stock Option Award Agreement10.10
                
                (9)
                
                Sonic
      Solutions 2004 Equity Compensation Plan Notice of Stock Option Award for
      Mary C. Sauer and Stock Option Award Agreement10.11
                
                (9)
                
                Sonic
      Solutions 2004 Equity Compensation Plan Notice of Stock Option Award for
      Robert Greber and Stock Option Award Agreement10.12
                
                (9)
                
                Sonic
      Solutions 2004 Equity Compensation Plan Notice of Stock Option Award for
      Peter Marguglio and Stock Option Award Agreement10.13
                
                (9)
                
                Sonic
      Solutions 2004 Equity Compensation Plan Notice of Stock Option Award for
      Warren R. Langley and Stock Option Award Agreement10.14
                
                (10)
                
                Sonic
      Solutions 2004 Stock Incentive Plan10.15
                
                (14)
                
                Sonic
      Solutions 2005 Stock Incentive Plan (Non-U.S.
Employees)10.16
                
                (15)
                
                Third
      Sublease Amending Agreement between Entrust, Inc. and Sonic Solutions
      dated July 5, 200610.17
                
                (16)
                
                Executive
      Employment Agreement, effective as of January 23, 2007, by and between
      Sonic Solutions and David C. Habiger10.18
                
                (16)
                
                Executive
      Employment Agreement, effective as of January 23, 2007, by and between
      Sonic Solutions and A. Clay Leighton10.19
                
                (16)
                
                Executive
      Employment Agreement, effective as of January 23, 2007, by and between
      Sonic Solutions and Mark Ely10.20
                
                (17)
                
                Amended
      and Restated Executive Employment Agreement, effective as of February 25,
      2008 hereof, by and between Sonic Solutions and Paul F.
    Norris10.21
                
                (18)
                
                Board
      of Directors Compensation Policy, effective as of June 12,
      200821.1
                
                *
                
                List
      of subsidiaries23.1
                
                *
                
                Consent
      of BDO Seidman, LLP, Independent Registered Public Accounting
      Firm31.1
                
                *
                
                Rule
      13a-14(a)/15d-14(a) Certification of Chief Executive
    Officer31.2
                
                *
                
                Rule
      13a-14(a)/15d-14(a) Certification of Chief Financial
    Officer32.1
                
                *
                
                Section
      1350 Certification of Chief Executive Officer32.2
                
                *
                
                Section
      1350 Certification of Chief Financial
Officer




89




*
                    
                    Filed
      herewith.(1)
                    
                    Incorporated
      by reference to exhibits to Registration Statement on Form S-1 effective
      February 10, 1994.(2)
                    
                    Incorporated
      by reference to exhibits to Annual Report on Form 10-K for the fiscal year
      ended March 31, 1996.(3)
                    
                    Incorporated
      by reference to Appendix A to the Registrant’s Definitive Proxy Statement
      filed on July 21, 1998.(4)
                    
                    Incorporated
      by reference to exhibits to Current Report on Form 8-K filed on March 14,
      2001.(5)
                    
                    Incorporated
      by reference to exhibits to Current Report on Form 8-K filed on December
      19, 2001.(6)
                    
                    Incorporated
      by reference to exhibits to Current Report on Form 8-K filed on November
      20, 2002.(7)
                    
                    Incorporated
      by reference to Exhibit 3.5 to Report on Form 10-Q filed on November 12,
      2003.(8)
                    
                    Incorporated
      by reference to Exhibit 99.1 to Current Report on Form 8-K filed on March
      1, 2004.(9)
                    
                    Incorporated
      by reference to exhibits to Current Report on Form 8-K filed on September
      13, 2004.(10)
                    
                    Incorporated
      by reference to Exhibit 10.7 to Quarterly Report on Form 10-Q for the
      quarter ended September 30, 2004.(11)
                    
                    Incorporated
      by reference to Exhibit 2.1 to Current Report on Form 8-K filed December
      23, 2004.(12)
                    
                    Incorporated
      by reference to exhibits to Quarterly Report on Form 10-Q for the quarter
      ended December 31, 2004.(13)
                    
                    Incorporated
      by reference to exhibits to Registration Statement on Form S-1 effective
      May 21, 2001.(14)
                    
                    Incorporated
      by reference to Exhibit 10.21 to Annual Report on Form 10-K for the year
      ended March 31, 2005.(15)
                    
                    Incorporated
      by reference to Exhibit 10.1 to Report on Form 10-Q filed on August 14,
      2006.(16)
                    
                    Incorporated
      by reference to exhibits to Current Report on Form 8-K filed on January
      24, 2007.(17)
                    
                    Incorporated
      by reference to Exhibit 10.1 to Current Report on Form 8-K filed on
      February 25, 2008.(18)
                    
                    Incorporated
      by reference to Exhibit 10.1 to Current Report on Form 8-K filed on June
      16, 2008.
 90




SCHEDULE
II




FINANCIAL
STATEMENT SCHEDULE


SONIC
SOLUTIONS


VALUATION
AND QUALIFYING ACCOUNTS


Years
Ended March 31, 2009, 2008 and 2007


(In
thousands)




Sales
discounts, returns and 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.  At March 31, 2009, 2008 and 2007, $1,874, $3,720 and
$1,862, respectively, were offset against accounts receivable.





Balance at
                      Beginning of
                      Period
                    
                    
                    Charged to
                      Costs and
                      Expenses
                    
                    
                    Charged to
                      Other
                      Accounts
                    
                    
                    Deductions
                    
                    
                    Balance at
                      End of
                      PeriodAllowance
      for doubtful accountsYear
      ended March 31, 2009
                    
                    $
                    181
                    
                    
                    $
                    77
                    
                    
                    $
                    -
                    
                    
                    $
                    (60
                    )
                    
                    $
                    198Year
      ended March 31, 2008
                    
                    
                    664
                    
                    
                    
                    (228
                    )
                    
                    
                    -
                    
                    
                    
                    (255
                    )
                    
                    
                    181Year
      ended March 31, 2007
                    
                    
                    1,243
                    
                    
                    
                    39
                    
                    
                    
                    .
                    
                    
                    
                    (618
                    )
                    
                    
                    664Sales
      discounts, returns and allowancesYear
      ended March 31, 2009
                    
                    
                    6,629
                    
                    
                    
                    -
                    
                    
                    
                    11,169
                    
                    
                    
                    (13,542
                    )
                    
                    
                    4,256Year
      ended March 31, 2008
                    
                    
                    4,114
                    
                    
                    
                    -
                    
                    
                    
                    16,937
                    
                    
                    
                    (14,422
                    )
                    
                    
                    6,629Year
      ended March 31, 2007
                    
                    
                    3,992
                    
                    
                    
                    (49
                    )
                    
                    
                    16,797
                    
                    
                    
                    (16,626
                    )
                    
                    
                    4,114


91




SIGNATURES




In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto,
duly authorized on May 29, 2009.




SONIC
      SOLUTIONSBy:
            /s/
      David C. HabigerDavid
      C. Habiger
              President
      and Chief Executive Officer





Pursuant
to the requirements of the Exchange Act, this report has been signed below by
the following persons on behalf of the Company and in the capacities and on the
dates indicated.





Signature
                                                  
                                                  Title
                                                  
                                                  Date/s/ David
      C. Habiger
                                                  
                                                  President
      and Chief Executive Officer
                                                  
                                                  29-May-09David
      C. Habiger
                                                  
                                                  (Principal
      Executive Officer)/s/ Robert
      J. Doris
                                                  
                                                  Director
                                                  
                                                  29-May-09Robert
      J. Doris/s/
      Robert
      M. Greber
                                                  
                                                  Director
                                                  
                                                  29-May-09Robert
      M. Greber/s/
      Peter
      J. Marguglio
                                                  
                                                  Director
                                                  
                                                  29-May-09Peter
      J. Marguglio/s/
      R.
      Warren Langley
                                                  
                                                  Director
                                                  
                                                  29-May-09R.
      Warren Langley/s/
      Mary
      C. Sauer
                                                  
                                                  Director
      & Secretary
                                                  
                                                  29-May-09Mary
      C. Sauer/s/
      Paul
      F. Norris
                                                  
                                                  Executive
      Vice President, Acting Chief
                                                  
                                                  29-May-09Paul
      F. Norris
                                                  
                                                  Financial
      Officer and General Counsel
                                                    (Principal
      Financial/Accounting Officer)




92