Friday, August 18, 2006

Calls of Note Part 1

- Piper Jaffray notes that within the last several days Dell has changed the layout of its website for customized PC buying. There are various versions of Dell's website that can currently be accessed by those looking to configure a PC: some versions of the site still have the option to upgrade Sonic's software, while other versions no longer offer an upgrade option.

The change to Dell's website could have no impact on Sonic Solution (NASDAQ:SNIC)'s September quarter revenue or as much as a negative 10% impact. The earnings impact for September could range from no impact to a negative $0.05 impact. In the June quarter, Dell accounted for 24% of Sonic's revenue. Sonic's Dell revenue is comprised of per unit royalties and upgrade revenue. Firm estimates upgrade revenue accounts for about half of overall Dell-related revenue. The reason the firm believes the impact to Sonic is less than 12% (i.e. half of the 24% of Dell revenue) is that Dell is now contractually obligated to increase Sonic's per unit royalty if there are changes to the layout of the Dell site that in any way negatively impact Sonic's upgrade revenue.

The key question is the following: Is Dell obligated to make up the entire shortfall in upgrade revenue, or only a portion of the shortfall? At this time, the firm does not know the answer.They believe that if this continues, it will have an ongoing impact on Sonic's number, but given Dell's history in making frequent changes to its website, they are taking a wait-and-see approach to quarters beyond the September quarter. History suggests Dell will compensate Sonic or change the website in a way that is favorable to Sonic, but history would also suggest Sonic will have a small miss in the September quarter.

Last fall Sonic went through a similar situation when Dell moved Sonic's position in the website layout (but still offered upgrades). This resulted in 1% negative impact on Sonic's December quarter revenue.

Maintains Outperform and $25 tgt.

Notablecalls: Nice piece of research guys! Think SNIC will trade down today.

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