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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 000-22023
Macrovision Corporation
(Exact name of registrant as specified in its charter)
DELAWARE 77-0156161
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
2830 De La Cruz Boulevard
Santa Clara, California 95050
(Address of principal executive offices) (Zip code)
(408) 743-8600
(Registrant's telephone number including area code)
Securities registered under Section 12(b) of the Exchange Act: None.
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $0.001 par value.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 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
the 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. |_|
As of March 15, 2002, the aggregate market value of the voting and non-voting
common equity held by non-affiliates of the registrant, based on the closing
price for the registrant's common stock on that day, was approximately
$984,649,387.12.
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
As of March 15, 2002, there were 51,010,376 shares of the Registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain exhibits hereto have been specifically incorporated by reference herein
in Item 13 under Part III hereof. Certain portions of registrant's definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with the registrant's annual meeting of stockholders to be held on
May 23, 2002, are incorporated by reference in Items 10-13 of Part III hereof.
MACROVISION CORPORATION
FORM 10-K
INDEX
PART I
ITEM 1. BUSINESS............................................................ 1
ITEM 2. PROPERTIES.......................................................... 26
ITEM 3. LEGAL PROCEEDINGS................................................... 26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................. 28
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS............ 28
ITEM 6. SELECTED FINANCIAL DATA............................................. 29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS............................................... 30
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.......... 42
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................... 43
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE................................................ 43
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS.................................... 43
ITEM 11. EXECUTIVE COMPENSATION.............................................. 43
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...... 43
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...................... 43
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K..... 43
SIGNATURES................................................................ 46
DISCUSSIONS OF SOME OF THE MATTERS CONTAINED IN THIS ANNUAL REPORT ON FORM
10-K FOR THE MACROVISION CORPORATION ("MACROVISION," "WE" OR "US") MAY
CONSTITUTE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE SECTION 27A OF
THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES AND
EXCHANGE ACT OF 1934, AS AMENDED, AND AS SUCH, MAY INVOLVE RISKS AND
UNCERTAINTIES. SOME OF THESE DISCUSSIONS ARE CONTAINED UNDER THE CAPTIONS "ITEM
1. BUSINESS" AND "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITIONS AND RESULTS OF OPERATIONS." WE HAVE BASED THESE FORWARD-LOOKING
STATEMENTS ON OUR CURRENT EXPECTATIONS AND PROJECTIONS ABOUT FUTURE EVENTS,
WHICH INCLUDE IMPLEMENTING OUR BUSINESS STRATEGY, DEVELOPING AND INTRODUCING NEW
TECHNOLOGIES, OBTAINING AND EXPANDING MARKET ACCEPTANCE OF THE TECHNOLOGIES WE
OFFER, AND COMPETITION IN OUR MARKETS.
IN SOME CASES, YOU CAN IDENTIFY THESE FORWARD-LOOKING STATEMENTS BY
TERMINOLOGY SUCH AS "MAY," "WILL," "SHOULD," "EXPECT," "PLAN," "ANTICIPATE,"
"BELIEVE," "ESTIMATE," "PREDICT," "POTENTIAL," "INTEND," OR "CONTINUE," AND
SIMILAR EXPRESSIONS. THESE STATEMENTS ARE BASED ON THE BELIEFS AND ASSUMPTIONS
OF OUR MANAGEMENT AND ON INFORMATION CURRENTLY AVAILABLE TO OUR MANAGEMENT. OUR
ACTUAL RESULTS, PERFORMANCE AND ACHIEVEMENTS MAY DIFFER MATERIALLY FROM THE
RESULTS, PERFORMANCE AND ACHIEVEMENTS EXPRESSED OR IMPLIED IN SUCH
FORWARD-LOOKING STATEMENTS. FOR A DISCUSSION OF SOME OF THE FACTORS THAT MIGHT
CAUSE SUCH A DIFFERENCE, SEE "ITEM 1. BUSINESS - RISK FACTORS."
PART I
ITEM 1. BUSINESS.
Macrovision Corporation, a Delaware corporation founded in 1983, develops
and licenses rights management and copy protection technologies. Our customers
include major Hollywood studios, independent video producers, enterprise and
consumer software vendors, digital set-top box manufacturers and digital
pay-per-view ("PPV") network operators. We provide content owners with the means
to market, distribute, manage and protect video, software and audio content.
Our business originated in video copy protection. Our technology has been
used to copy protect over 3.4 billion videocassettes worldwide since 1985. In
1997, we expanded the application of our copy protection technology into the DVD
platform. Most Motion Picture Association of America studios use our video copy
protection technology to protect some or all movie releases on videocassette or
DVD. Our customers include Disney, Paramount, Columbia Tristar (Sony), Twentieth
Century Fox, Universal Studios, Warner Brothers and DreamWorks. We believe that
our technology is accepted as the DE FACTO industry standard for video copy
protection.
We also are in the business of consumer software copy protection. We offer
CD-ROM copy protection and rights management technologies to a variety of
software publishers in the PC games, home education, information publishing, and
desktop applications software markets.
As a result of our August 2000 acquisition of GLOBETROTTER Software, Inc.
("GLOBETROTTER"), we added a suite of electronic license delivery ("ELD") and
electronic license management ("ELM") technologies to our product portfolio.
These products encompass the areas of electronic license management, software
asset management and electronic license distribution.
We have built, and continue to add to, a large patent portfolio that helps
differentiate our products and is important to our license driven business
model. We generate recurring revenues from a variety of sources. In our video
copy protection business, we receive unit-based royalties on videocassettes,
DVDs, and set-top boxes. We obtain transaction or use-based royalties for PPV
movies, and license fees from a range of hardware manufacturers, digital
satellite and cable network operators. In our software businesses, we receive
unit-based royalties on CD-ROMs, a combination of time-based licenses and
perpetual licenses for our ELM technology, and recurring fees for maintenance.
To further expand our rights management and copy protection capabilities,
we have continued to foster our strategic relationship with Digimarc Corporation
("Digimarc"), a leading digital watermarking technology company, to develop a
copy protection solution to address next-generation, digital-to-digital copying.
We also continue to work with TTR Technologies, Inc. ("TTR"), a provider of
proprietary digital anti-piracy technologies and products, to develop copy
protection technologies for audio CDs, which represents a new market for us. We
have made strategic investments in iVAST, a developer of MPEG-4 based solutions
for the delivery of streaming media; NTRU Cryptosystems, a developer of security
solutions for developing consumer markets; and Digital Fountain, a developer of
solutions that address the data delivery market; as well as other companies with
complementary technologies or intellectual property. For additional
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information, see the "Strategic Investments" section on page 14. We intend to
continue to evaluate and pursue additional strategic relationships that are
complementary or additive to our existing technologies and served markets.
We own or have rights to various copyrights, trademarks and trade names
used in our business. These include Macrovision(R), GLOBETROTTER(R), FLEXlm(R),
SafeDisc(R), SafeCast(R), Colorstripe(TM), SafeAudio(TM), GTlicensing(TM),
SAMsuite(TM), FLEXbill(TM) and MacroSAFE(TM).
INDUSTRY BACKGROUND
The industry shift towards digital media renders content owners
increasingly vulnerable to unauthorized use of their content. Consumers' ability
to make unauthorized copies of video and audio content has increased due to the
proliferation of inexpensive, easy-to-use devices, such as VCRs, CD-ROM
recorders, audio CD recorders and personal video recorders that allow in-home
copying of videocassettes, DVDs, digital PPV programs, CD-ROMs, and audio CDs.
As technological advances facilitate digital copying at declining prices, motion
picture studios and music labels have become more concerned with protecting
their intellectual property. Independent software vendors ("ISVs") are similarly
concerned about unauthorized or illicit use of their software, be it in the
enterprise environment (where license parameters may be ignored) or at home
(where entertainment software may be copied and redistributed).
Content owners lose billions of dollars every year to casual copying and
piracy. The latest data available from the Motion Picture Association of America
estimates that in 2001 video piracy cost the major studios in excess of $3
billion in lost revenues, and this estimate does not include losses due to
Internet piracy.
As a result, a number of government and legislative initiatives have been
enacted in recent years to encourage technologies that protect the rights of
content owners.
In the United States, Congress enacted the Digital Millennium Copyright
Act in October 1998. This law requires all VCRs to comply with analog copy
protection technologies that are in widespread use, such as those covered in our
patents, beginning in May 2000. Recent effectiveness tests conducted by us in
the U.S. and by an independent third party in Europe in September 2000 and
August 2001 showed that over 95% of the VCRs manufactured in the U.S. and Europe
since 1999 comply and respond to our anticopy process. The Act includes a clause
that outlaws all circumvention devices and technologies that could be used to
defeat any type of copy protection technology. The U.S. law is based on a set of
guidelines for amending basic copyright laws to deal with the protection of
digital media. The guidelines were adopted in 1996 by the World Intellectual
Property Organization, an agency of the United Nations.
The European Union is continuing to discuss a proposed copyright
directive, which we believe includes a provision aimed at controlling hardware
and software circumvention devices and technologies.
In Japan, a revised copyright law that went into effect in October 1999
prohibits the sale, manufacture, and import of circumvention devices. The Japan
Industry Standard requires all digital recording devices to be responsive to
analog copy protection technologies that utilize automatic gain control
techniques, such as those covered by our patents.
VIDEO
VHS COPY PROTECTION. Motion picture studios wish to maximize the economic
value from each feature film or other video program over its copyright life.
Independent studies show that studios and video retailers lose VHS and DVD
revenues when consumers make copies of movies, whether from home video or PPV
releases. The International Recording Media Association has estimated that 50%
of all households in the United States own two or more VCRs. These households
are capable of making unauthorized copies of prerecorded videocassettes. Because
over 90% of all U.S. households own at least one VCR, any of these households
that also owns a DVD player or a digital PPV set top box can make high quality
VHS copies directly from their DVD players or set-top boxes, unless programs are
copy protected. Even with the focus on digital media and growth in DVD, VCR
sales continue to grow as prices fall. With over 600 million VCRs shipped
throughout the world, and with this continued growth in VCR sales, we believe
that VCRs will remain a home copying threat to video content owners for many
years to come.
DVD COPY PROTECTION. DVD hardware and media became commercially available
in the United States in 1997 and, through the end of 2001, approximately 26.7
million DVD players had been shipped by manufacturers in North America,
according to the Consumer Electronics Association. The rapid growth of the DVD
format presents major revenue opportunities for the studios, as well as serious
copy protection concerns. Without effective copy protection, any one of the
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approximately 600 million VCRs throughout the world can, when combined with a
DVD player, make large numbers of videocassette copies of a non-copy protected
DVD. These copies are almost equal in quality to professionally prerecorded
videocassettes. Because of their superior picture quality, lower manufacturing
cost, relative ease of use and smaller size, DVDs are expected to supplant
videocassettes over time as the preferred home video distribution medium. As DVD
becomes the standard in home viewing, we expect the need for reliable copy
protection to remain important. The DVD Entertainment Group and the
International Recording Media Association estimate that 364 million DVD-Video
discs were shipped in the U.S. in 2001. Understanding & Solutions Ltd estimates
that 571 million DVD-Video discs were shipped to retail worldwide in 2001, with
an expected 44% annual increase to 824 million discs in 2002. At the end of
2001, it is estimated that approximately 25% of U.S. households have installed
DVD players.
PPV COPY PROTECTION. Digital PPV enables consumers to purchase and view
movies and other programming in their homes through cable or satellite systems.
Based on data from Paul Kagan & Associates, we believe that revenues at the
studio level from digital PPV, near video on demand ("NVOD"), anddirect
broadcast satellite ("DBS") were approximately $680 million in 2001 in the U.S.
By contrast, studio revenues from their home video business exceeded $13 billion
in 2001 in the U.S. PPV distribution offers motion picture studios higher profit
margins than they receive from home video rentals or sales. Studios have
realized the importance of copy protection in digital PPV networks, and many of
them have required digital PPV system operators to install copy protection
capability in their digital set-top boxes.
In an effort to protect home video revenues, studios typically release a
movie on PPV between one and three months after it is released on videocassette
or DVD. Digital PPV providers have demonstrated that they can substantially
increase the buy rates for PPV by offering subscribers up to 60 PPV channels per
cable/DBS system, and by promoting convenience of frequent start times and
greater variety of movies. In the U.S., the digital PPV system operators have
installed copy protection capability in their digital set top boxes. However,
they have indicated that they will not activate copy protection until the
studios release their movies to the PPV system operators at or closer to the
same time as they release them to home video. This standoff between the system
operators and the studios has had a negative impact on our potential revenues
and net income opportunities, although it is less of an issue in international
markets, where studios have been able to insist that PPV movies be copy
protected.
SOFTWARE
ELECTRONIC LICENSE MANAGEMENT ("ELM"). Software vendors who sell to
enterprise customers are also vulnerable to unauthorized use of their software.
Large organizations, which typically support many end user applications, may
inadvertently allow users to run applications beyond the scope of their license
terms; in other words, users may be obtaining "free" use of the software
vendor's application. As a result, software vendors may not be capturing all the
revenues they are due from their customers. This has led to increased focus on
capturing all software usage revenue that is due from end users, therefore
driving demand for technology solutions that manage and control an application's
usage in the end user environment. Electronic license management is a solution
to this problem. According to International Data Corporation, over 50% of
software revenue will be delivered using electronic licensing by 2003, and
virtually all software revenues will be derived from electronic licensing by
2008.
CONSUMER SOFTWARE. With the proliferation of inexpensive high capacity
PC-based hard disc drives, the increase of Internet connections to the home, and
the availability of higher bandwidth connections, consumers now have the means
to widely distribute software content. Many consumers have the capability to
copy from a CD-ROM, download computer software to their hard drives, copy those
downloaded files onto a CD-recorder device, and distribute the copied software
on CD-ROMs or electronically over the Internet. Recently, CD-recordable drives
have been introduced that are priced below $60 and are expected to become
standard features in personal computers in the near future. In addition, blank
CD-ROM discs can be purchased for less than 20 cents in the U.S. As a result,
computer software and PC-based video game companies are facing an additional
threat of lost revenues due to unauthorized consumer copying of CD-ROM software.
INTERNET. The Internet is increasingly being used as a means to distribute
content, particularly software and music. The proliferation of online content
providers, combined with new and evolving methods of online content delivery,
has created a large market opportunity for rights management and copy protection
solutions. We believe that there is a significant need for rights management
solutions that address these new Internet downloading and streaming business
models.
AUDIO. Major music labels have expressed interest in technology that would
prevent the copying of audio CDs to a PC or CD recordable device. Based on data
from the Record Industry Association of America and the International Federation
of Phonographic Industries, we believe that the music industry is a $40 billion
per year industry compared to the
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$21 billion per year home video industry. We believe that there has not
previously been an effective copy protection technology for audio, because of
the difficulty of developing a copy protection technique that does not interfere
with the playback of the original music. With the emergence of file-sharing
technologies, and the availability of low cost hardware that facilitates copying
of CDs, we believe that music labels are seeking a copy protection solution to
prevent losses due to casual copying and piracy.
MACROVISION SOLUTIONS
We develop and market a broad array of rights management and copy
protection technologies. We offer video copy protection technologies that
address the video content protection needs of motion picture studios and other
content owners, program distributors, and cable and satellite PPV system
operators. We provide ELM and ELD solutions to a range of software vendors,
including application developers, major systems suppliers and embedded software
vendors. We also supply software asset management technologies to enable end
user organizations to manage internal application usage. We offer CD-ROM copy
protection and rights management technologies to a variety of software
publishers in the PC games, home education, information publishing, and desktop
applications software markets. We are actively involved in developing and
acquiring various technologies to meet the needs of emerging delivery systems
such as downloading and streaming of media via the Internet, as well as
technologies to prevent the unauthorized copying of audio CDs.
VIDEO COPY PROTECTION. Our video copy protection technologies allow
consumers to view programming stored on prerecorded videocassettes, DVDs or
transmitted as digital PPV programs via cable or satellite, but deter
unauthorized consumer copying of such programming. Videocassettes are encoded
with our video copy protection signal as they are manufactured. Our licensed
copy protection signal generator equipment is installed in over 228 commercial
duplication facilities in 36 countries around the world. The unique patented
aspects of our copy protection signal are transparent to a TV set, but are
disruptive to the recording circuits of VCRs. The result is that videocassettes
encoded with our anticopy process will play normally on a TV set, but will cause
generally unwatchable copies to be made on the vast majority of VCRs. Our
patented technology takes advantage of the differences in TV signal processing
circuits, VCR playback circuits, and VCR recording circuits without the need for
the installation of any Macrovision components in VCRs.
In the DVD and digital PPV markets, we have implemented a more robust
version of our video copy protection technology. By utilizing another copy
protection component, called Colorstripe, we have made it more difficult for a
casual copier to defeat or circumvent our technology. In these digital video
applications, the copy protection is applied within the consumer device. The
copy protection signal generator is part of an integrated circuit that converts
digital video to analog video for output to a standard TV set or VCR. The copy
protection chips remain dormant until activated by data commands, which are
either embedded in the DVD or are sent along with the PPV movie transmission to
the subscriber's set-top box.
ELECTRONIC LICENSE MANAGEMENT. Our FLEXlm technology allows independent
software vendors to license their products in various ways, and to monitor the
usage and enforce compliance with license terms in an enterprise-wide intranet,
across an extranet or the public Internet, or within an application service
provider ("ASP") extranet environment. Once FLEXlm is integrated into the
software product, the product can be delivered across the Internet, as well as
through more traditional media, such as CD-ROM. The FLEXlm technology consists
of two processes that together perform the function of granting or refusing
license requests based on contents of a license file that describes authorized
license use within an organization.
Our GTlicensing technology is a license creation, distribution, and
tracking tool for software vendors, allowing vendors to ship and track licenses
online without direct human intervention. The system supports multi-tier
software distribution, including the capability for third party distributors to
sell software from participating vendors and allowing end-users to receive their
licenses across the Internet.
Our FLEXbill technology provides usage data to software vendors from their
participating customers. FLEXbill usage data enables pay-per-use billing and can
be used to implement a new set of licensing policies more accurately matched to
each customer's needs. Software vendors use FLEXbill to tailor product offerings
to each customer and to bill for the usage of this portfolio based on an
authenticated usage report.
Our SAMsuite technology is a software asset management solution, designed
for end-user companies that purchase large amounts of software from third
parties. SAMsuite captures and analyzes software usage data to help users
maximize their return on investment, and allocate related costs by project,
department or user, and administers license servers over global networks.
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CONSUMER SOFTWARE COPY PROTECTION AND RIGHTS MANAGEMENT. Our SafeDisc
technology seeks to prevent the copying of CD-ROM computer software by
encrypting the executable files, embedding an authenticating digital signature
and adding multi-layered anti-hacking software. This is a proprietary
software-based copy protection solution that does not require any changes to
standard PC or CD-ROM hardware. Because SafeDisc is designed to operate while
the disc is in the CD-ROM drive, it is ideally suited to PC games and home
education software. The technology is licensed directly to interactive software
publishers, and to mastering and replication facilities that embed our patented
digital signature in a CD-ROM during the manufacturing process. SafeDisc was
introduced in September 1998 and has been licensed to more than 100 replicators
worldwide.
Our SafeCast family of digital rights management products is designed to
provide software publishers with control over the distribution and usage of both
packaged media and Internet delivered software or licenses. It enables software
publishers to establish a variety of license terms, which persistently govern
the use of the software. These license terms can be used to manage every stage
of a software product's life cycle - from pre-release software, through trial
evaluations, and finally commercial distribution resulting in rental, purchase,
or subscriptions.
Our SafeWrap product is a post-development encryption wrapper for
Microsoft Windows software and is based upon technologies we developed for our
SafeDisc product. We refer to it as "tamper-proofing" software because it
protects files from being reverse engineered, disassembled, or modified.
SafeWrap also includes an optional application programming interface ("API"),
which offers additional security to allow individual functions to be encrypted
and decrypted when being executed.
PRODUCTS UNDER DEVELOPMENT
We have three primary new product development programs in progress: audio
CD copy protection (SafeAudio), digital video watermarking and a new secure
digital media distribution platform (MacroSAFE).
SAFEAUDIO. SafeAudio is a family of technologies used for protecting
traditional audio (Red Book) music content, without incurring the playability
and compatability drawbacks of other solutions. We also are currently developing
solutions for compressed (Yellow Book) content that can also be put on optical
media in conjunction with Digital Rights Management ("DRM") technologies. Our
Red Book copy protection is based on technologies from both Macrovision and TTR.
Our Yellow Book copy protection is based upon our SafeDisc technology. Our joint
development/joint marketing arrangement with TTR gives us the exclusive
worldwide rights to market TTR's audio copy protection technology. We shipped
Version 2 and Version 3 of SafeAudio in 2001, and also conducted extensive
testing with major music labels in the U.S. and Europe during that period.
Consumer resistance to audio copy protection has discouraged music labels from
adopting any copy protection solution to date, and, if there is sustained
consumer resistance, may continue to do so in the future.
DIGITAL VIDEO WATERMARKING. As a member of the VWM Companies (Digimarc,
Hitachi, NEC, Philips, Pioneer, Sony and Macrovision), we are jointly developing
a digital video watermarking solution to address the digital-to-digital copy
protection requirements associated with the next generation of DVD recording
devices. Digital watermarks embedded in movies and other video material will
provide basic copyright, record control and playback control information either
to allow or to disallow playback, viewing and copying onto another digital
device. The jointly developed technology is based on patents and related
intellectual property owned by the various VWM Companies. The VWM Companies'
solution can survive numerous transformations, such as from digital to analog
and back to digital, or from one video format to another. The digital watermarks
are designed to be imperceptible to the viewer, but to be read easily by special
purpose detection circuits that may ultimately be deployed in DVD digital
recorders and players. This jointly developed technology is intended to protect
movies and other video content from unauthorized reproduction using digital
recording devices. Macrovision has been selected as the exclusive licensing
administrator for the VWM Companies' digital watermarking solution.
MACROSAFE. During the 4th quarter of 2001 we announced MacroSAFE, a new
secure digital media distribution platform. MacroSAFE is a highly scalable and
flexible, open-standards-based, end-to-end solution for the secure distribution
of digital media. MacroSAFE includes a set of tools that enables rights holders,
distributors and service providers to create and support a range of business
models for the secure distribution of rich media to either a broad or very
targeted audience. It enables rights holders to market digital content in a
trusted environment for either downloads or streamed media.
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THE MACROVISION GROWTH STRATEGY
LEVERAGE KEY CUSTOMER RELATIONSHIPS. We currently maintain strong
relationships with customers in various industry and market segments, including:
o Video content providers such as the major Hollywood studios and
independent movie producers;
o Enterprise and consumer software vendors, serving both
business-to-business and business-to-consumer segments;
o Content distributors such as the leading cable and satellite
television system operators; and
o Consumer electronics manufacturers of DVD players, CD-ROM drives,
and digital set-top boxes.
We intend to build our business by capitalizing on these customer
relationships and delivering our existing and future rights management and copy
protection technologies.
INTRODUCE NEW PRODUCT APPLICATIONS AND TECHNOLOGIES. Simultaneously, we
intend to develop additional rights management solutions to sell to our
extensive customer base, thereby deriving incremental revenues. We have
committed significant resources to expand our technology base, to enhance our
existing products and to introduce additional products. We intend to continue
building our technologies and maintain our technology leadership by investing
significant resources in research and development, and by participating in
industry standard-setting efforts and organizations. We intend to pursue
opportunities for rights management and copy protection solutions in the
following areas:
o Digital video;
o Audio CDs;
o Internet downloaded and streamed audio and video files;
o Internet downloaded software files;
o CD-ROM;
o DVD-ROM;
o Electronic license delivery for enterprise software;
o Software asset management products for enterprise customers; and
o Improved authentication, compression, and encryption technologies.
EXPAND AND PROTECT PATENT POSITION. We believe that our future success
will depend on our ability to continue to introduce proprietary solutions for
rights management and copy protection technologies. We have patented many of
these proprietary solutions, and they underpin our strong competitive position
and financial model. We have acquired key software rights management and copy
protection patents. We use patents to limit the proliferation of devices that
circumvent our video copy protection technologies, and we have initiated legal
action relating to infringement of these patents. We intend to continue to
obtain patents and to protect and defend our patented technologies aggressively,
including developing and obtaining patents covering a number of processes and
devices that unauthorized parties could use to circumvent our video copy
protection technologies.
CONTINUE TO MAKE STRATEGIC INVESTMENTS. We have made strategic equity
investments in public companies like Digimarc and TTR, as well as private
companies such as Command Audio Corporation ("CAC"), Digital Fountain, iVAST,
NTRU Cryptosystems, and Widevine Technologies. In 2001, we invested $17.0
million in private companies. We intend to continue to expand our technology
portfolio by pursuing licensing arrangements, joint ventures, strategic
investments and acquisitions of companies whose technologies or proprietary
rights complement our rights management and copy protection technologies.
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Our minority equity interests totaled $58.1 million and represented 16.9%
of our total assets as of December 31, 2001. There is no active trading market
for securities of our private company investments and our investments in them
are illiquid. We may never have an opportunity to realize a return on our
investment in these private companies, and we may in the future be required to
write off all or part of one or more of these investments. During 2001,
consistent with our policy for evaluating recoverability of these investments,
we concluded that impairment of our investments in AudioSoft, InterActual
Technologies, RioPort and SecureMedia was other than temporary. Accordingly, we
wrote off the book value of these investments during 2001 and took an aggregate
charge to earnings of $6.9 million for the year ended December 31, 2001.
MAINTAIN OUR HIGH-MARGIN REVENUE MODEL. In expanding our customer base and
technology portfolio, we intend to continue to pursue our intellectual
property-based licensing model which includes high margin and recurring
revenues. In assessing minority investments and acquisitions, we seek to
generate incremental revenues and operating income, preserving our profit
margins. Where possible, we look for acquisition transactions that will enlarge
our copy protection capabilities and minority investments that do not have a
detrimental impact on earnings.
TECHNOLOGY LICENSING, SALES AND MARKETING
TECHNOLOGY LICENSING. We license our portfolio of rights management and
copy protection technologies. We believe that content owners and software
vendors utilize our solutions to secure their content or software and to ensure
that they are paid for the use of such content or software by their end user
customers. We receive royalties and recurring revenues as follows:
o Video content owners typically pay us a per unit licensing fee for the
right to use our proprietary technology for videocassette and DVD copy
protection;
o Enterprise software vendors pay us to license our technology using either
time-based subscription or perpetual licenses with annual maintenance
fees;
o Consumer software publishers pay us a per unit licensing fee to use our
technology for CD-ROM copy protection, and transaction based, time-based,
or perpetual licenses for our DRM technology;
o Digital set-top box manufacturers license our video copy protection
technologies for an up-front fee and a per unit royalty;
o Cable and satellite television system operators pay us a one-time license
fee for the right to incorporate our video copy protection technology into
their networks for PPV services. In addition, we are entitled to
transaction-based royalty payments when copy protection for digital PPV
programming is activated by system operators; and
o DVD hardware manufacturers (DVD consumer electronic player manufacturers
and PC DVD ROM suppliers) license our technology for an up-front fee and
annual maintenance/certification fees.
SALES AND MARKETING. We market our rights management and copy protection
technologies directly to content owners and independent software vendors in both
the video and software markets. Our primary sales strategy is to sell at senior
levels, offering worldwide contracts that cover customers' international
operations. We supplement our direct sales efforts with reseller programs and
service partnerships among video duplicator and replicator organizations, and
professional services, value added reseller, and systems integrator
organizations in our enterprise software business. We also utilize a variety of
marketing initiatives, including trade show participation, trade advertisements,
industry education and newsletters.
We develop worldwide product specifications and marketing programs for our
rights management and copy protection technologies in our Silicon Valley and
Woodley, United Kingdom offices, and sell and support our products and
technologies through our U.S. sales force, and through our offices in South
Ruislip, Woodley and Cheshire in the United Kingdom and in Tokyo, Japan, Hong
Kong and Taipei, Taiwan. In addition, we are in the process of establishing a
sales office in Seoul, Korea.
CUSTOMERS
VIDEO COPY PROTECTION
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VIDEO CONTENT. Our copy protection technology has been applied to more
than 3.4 billion videocassettes worldwide since 1985. Since the inception of DVD
in 1997, our copy protection has been applied to over 900 million DVDs,
including more than 500 million DVDs in 2001. Our copy protection technology for
videocassettes and DVDs is used by the following leading major motion picture
studios and home video suppliers:
o Artisan Home Entertainment; o Buena Vista Home Video (Disney);
o Columbia House; o Columbia TriStar Home Video (Sony
Pictures Entertainment)
o DreamWorks; o HBO Home Video;
o Lion's Gate; o Paramount Pictures;
o Twentieth Century Fox; o Universal Studios Home Video
(Vivendi); and
o Warner Brothers Home Video.
There were no customers that accounted for more than 10% of our net
revenues in 2001. One customer accounted for more than 10% of our net revenues
in 2000. No customer accounted for more than 10% of our net revenues in 1999.
The Motion Picture Association of America studios as a group accounted for
33.2%, 24.8% and 23.9% of our net revenues in 2001, 2000 and 1999, respectively.
We also license our video copy protection technology to "Special Interest"
customers that include independent video producers and corporations. Licensed
commercial duplicators act as distributors of our video copy protection
technology to "Special Interest" customers. Revenues from "Special Interest"
customers in the U.S. accounted for approximately 6%, 9% and 11% of our video
copy protection revenues in 2001, 2000, and 1999, respectively.
PPV SYSTEM OPERATORS. We have licensed our digital PPV copy protection
technology for incorporation into the networks of 19 system operators,
including:
o British Sky Broadcasting; o Cable and Wireless
Communications;
o Digital BS (Japan); o DIRECTV;
o DIRECTV Latin America; o EchoStar;
o Korea Digital Broadcast ("KDB"); o NTL;
o Pacific Century Cyberworks ("PCCW"); o Sky Latin America;
o SkyPerfecTV; and o Video Networks Ltd.
These system operators have paid a one-time license fee to us and have
entered into agreements with us pursuant to which we are entitled to
transaction-based royalty payments at such time as copy protection for digital
PPV programming is activated. To this point, only seven international customers
(British Sky Broadcasting, Cable and Wireless Communications, Digital BS
(Japan), NTL, PCCW, SkyPerfecTV, and Video Networks Ltd.) have activated copy
protection in their networks. U.S. systems operators have not yet activated copy
protection, even though the technology is implemented in their network
infrastructure. Other notable system operators that have not signed license
agreements with us, but which are requiring Macrovision-capable set-top boxes in
their networks include: AT&T, Comcast, Cox Enterprises, Deutsche Telecom, Rogers
Cable, Time Warner, UPC and Via Digital.
CONSUMER ELECTRONICS HARDWARE MANUFACTURERS. We believe that our DVD copy
protection technology is currently the only digital-to-analog copy protection
solution that satisfies the principles established by the DVD licensing and
standards group, and has been tested and accepted for compatibility with TV sets
by leading consumer electronics companies. As of December 31, 2001, 212
companies that manufacture DVD players or DVD-ROM drives had signed agreements
with us to incorporate our DVD copy protection technology into their hardware,
including both Sony and Microsoft for their DVD-based game consoles.
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Our PPV copy protection technology is embedded in more than 75 million
digital set-top boxes currently in use worldwide. We have licensed our copy
protection technology for digital PPV to 62 set-top box manufacturers,
including:
o A.B. Pace Micro Technology; o Acer;
o AT&T Network Systems; o Daewoo Electronic Co., Ltd.;
o DiviCom Corporation; o EchoStar Communications;
o Hughes; o Motorola (General Instrument
division);
o Nokia; o Philips;
o Scientific-Atlanta; o Sony; and
o THOMSON multimedia.
We have also authorized 63 semiconductor companies to incorporate our
digital PPV and DVD copy protection technologies into their semiconductor and
reference designs. These companies generally pay a one-time service fee to
verify correct implementation of our video copy protection technology in
digital-to-analog application specific integrated circuits ("ASICS") that are
embedded in digital set-top boxes and DVD hardware. They are authorized to sell
these Macrovision-capable ASICs to Macrovision-licensed DVD hardware
manufacturers and to Macrovision-licensed digital set-top box manufacturers.
We have experienced significant seasonality in our business, and our
business is likely to be affected by seasonality in the future. We have
typically experienced our highest revenues in the fourth quarter of each
calendar year followed by lower revenues and operating income in the first
quarter, and at times in subsequent quarters, of the next year. We believe that
this trend has been principally due to the tendency of our customers to release
their more popular movies on videocassettes and DVDs during the year-end holiday
shopping season. We anticipate that revenues from consumer software copy
protection and DRM technologies will continue to reflect this seasonal trend.
Our revenues generally have tended to be lower in the summer months,
particularly in Europe.
International and export sales together represented 45.2%, 42.3% and 40.2%
of our net revenues in 2001, 2000 and 1999, respectively. We expect that
international and export sales will continue to represent a substantial portion
of our net revenues for the foreseeable future. Our future growth will depend to
a large extent on worldwide deployment of digital PPV/VOD networks, DVDs, and
consumer software, and the use of copy protection in these media.
SOFTWARE
ELECTRONIC LICENSE MANAGEMENT. We believe our electronic license
management software is the industry leader. Worldwide adoption of our ELM
technology will be an important driver of future growth. We provide electronic
license delivery ("ELD") and electronic license management ("ELM") technology to
software companies in a range of market segments, with more than 2,500 ELM
software vendor customers worldwide, including:
o Autodesk; o Cadence;
o Cisco; o Rational Software;
o Sun Microsystems; o Sybase
o Synopsys Inc.; and o Wind River, Inc.
In addition we have licensed software asset management ("SAM")
companion products to over 500 corporate end users, which enable these end users
to deploy, manage, and track the software they have purchased from our software
vendor customers, as well as other third party software vendors. Examples of
such corporate end user customers include:
o BMW; o Eastman Kodak;
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o Ford Motor Company; o IBM;
o Lockheed Martin; o Nokia; and
o Royal Dutch Shell.
CONSUMER SOFTWARE PUBLISHERS. We entered the consumer software market in
1998 with our SafeDisc product, aimed at those applications that require the
CD-ROM to be inserted in the drive to run the application; typically PC games,
and home entertainment applications. In 2001 we extended the SafeDisc market
into professional applications and computer based training. We estimate that
over 60 million discs were copy-protected with SafeDisc in 2001. Our copy
protection technology for consumer software is used by the following leading
software publishers:
o Apple; o Electronic Arts;
o Eidos; o Hasbro;
o Havas; o Interplay;
o Lego; o Mattel;
o Microsoft; o Take 2;
o 3DO; and o Ubisoft.
Our consumer software customers have a wide choice of licensed replicators
that they can use throughout the world. Over 100 replicators have been licensed
and have installed SafeDisc mastering and quality assurance systems from
authorized suppliers of these systems.
To expand our SafeDisc business beyond our direct licensing program with
the major publishers, we have established a reseller program that allows
replicators to be SafeDisc value added resellers for the small publisher market.
We are beginning to see broad market adoption of our SafeCast family of
rights management products. SafeCast enables customers to creatively market,
sell and protect products delivered on CD ROMs, DVDs and via the Internet to
increase their revenues. Such customers include:
o Apple; o Autodesk;
o BBC; o Electronic Arts;
o Havas; and o Microsoft.
Although SafeCast is a more complex sale to software publishers, with a
longer sales cycle than SafeDisc, we believe that over time, as Internet
bandwidth increases, there will be increasing demand for this digital rights
management technology.
SafeWrap is a component-level implementation of multi-layered anti-hacking
elements that are developed for our SafeDisc product. In 2001 we saw early
adopter customers for this product, especially in new media and Internet
services. Such customers include:
o iVAST; and o RioPort, Inc.
In addition to revenue generated from the sale of our SafeWrap product to
iVast and RioPort, Inc., we made minority equity investments in both companies.
For additional information on these related parties, see the "Strategic
Investments" and "Risk Factor" sections on pages 14 and 16, respectively.
SafeAudio toolkit has been released to licensed authorized mastering and
replication facilities that will apply the process on behalf of rights holders
of audio content. SafeAudio provides content owners with an easy-to-implement
copy protection solution for CD audio discs that provides effective protection
against unauthorized disc copying or ripping of
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songs. We have not obtained significant customers for SafeAudio products, as the
major music labels continue to conduct market and lab testing.
TECHNOLOGY
VIDEOCASSETTE COPY PROTECTION. Effective video copy protection systems are
difficult to develop because of the need to address the dual requirements of
playability and effectiveness. High playability means that consumers must be
able to view the original copy-protected content using a VCR and a television
set without the need for any intervening devices, while high effectiveness
requires that the quality of an unauthorized copy must be reduced to such an
extent that it loses its entertainment value. The extent to which the
entertainment value is reduced varies, depending on the VCR model used to make
the copy and the VCR and television combination that plays the unauthorized
copy. To prevent VCRs from making good copies, the copy-protected video must
differ in some manner from the standard video signal because, by design, all
VCRs will make good copies from standard video signals. Television sets are
designed to play standard or near-standard video signals. As a result, there is
a risk that making a video signal non-standard in order to prevent copying will
decrease playability by causing some television sets to generate impaired or
distorted pictures. In the tradeoff between effectiveness and playability,
designers of copy protection systems must favor playability while maintaining
effectiveness.
Our videocassette copy protection technology involves the patented
technique of inserting a series of electronic pulses in and around the vertical
blanking interval of a standard video signal. The vertical blanking interval is
the blank space between the video fields that are refreshed at a rate of 60
fields per second. The copy protection pulses are embedded electronically in the
prerecorded content of the videocassettes in the process of videocassette
manufacture. The electronic pulses are not visible in the television picture.
The pulses are intended to affect the automatic gain control circuit in the
recording system of most VCRs, but not to affect a similar circuit in the
television set. Therefore, when the consumer plays a copy protected prerecorded
videocassette, the picture is clean and crisp, but when the consumer plays an
unauthorized copy of that same videocassette, the picture typically is very
distorted and has substantially reduced entertainment value. Our video copy
protection technology is effective against most casual copying, but generally
does not deter professional pirates who use professional duplication and video
processing equipment. Under the U.S. Digital Millennium Copyright Act of 1998,
all VCRs sold in the U.S. after May 2000 are required by law to respond to our
copy protection technology.
DVD AND DIGITAL PPV COPY PROTECTION. The DVD and digital PPV versions of
our video copy protection technologies employ both the electronic pulses used in
videocassettes and a second patented copy protection process called Colorstripe.
Colorstripe affects the color playback circuit of a VCR causing colored
horizontal stripes to appear in the picture of an unauthorized copy. The
combination of the two processes provides a higher level of effectiveness than
that provided by either process alone. In addition, Colorstripe is more
effective against circumvention by most "black box" circumvention devices that
were sold in the past. Copy protection is implemented in DVD and digital PPV
applications by embedding a copy protection signal generator integrated circuit
within the DVD player or digital set-top box. The integrated circuit is
activated by copy protection control codes, which are embedded into the DVD
media or the PPV transmission. Once the integrated circuit is activated, it adds
the copy protection signal to the analog output of the DVD player or digital
set-top box. As with videocassette copy protection, consumers are able to see a
clear picture on their television sets, but generally cannot make a usable
videocassette copy on a VCR.
ELECTRONIC LICENSING. Software vendors integrate FLEXlm into their
products to monitor or control a customer's compliance with a product's license
terms. When embedding electronic licensing into a product, software vendors
define a customer's license rights in a human readable "license file". The
technology generates electronic license certificates that describe the license
rights of software users. Compliance with those license rights is automatically
monitored. The software vendor may choose to block users from running a product
if doing so violates the license rights, or simply provide notification to the
user or system administrator when license use has exceeded the customer's
license rights. This allows customers to buy and sell software licenses using
much more flexible license terms than traditional one-computer-one-license or
site license approaches. These terms may include floating licenses (where a
specific number of licenses are shared over a network), product suites (where
several product licenses are combined to be licensed as a single product) and
demo licenses (where a prospective customer has full functional use of a
product, but the right to use expires on a specific date).
Independent software vendors integrate flexible electronic licensing
algorithms into their software rather than "hard-coding" license policies into
their products. This avoids the need to change a product's source code and to
support multiple releases when licensing terms change for a product. License
terms are described in a human readable text file as an electronic license
certificate, where marketing, sales, support or order administration staff
define licensing policies, without the need for software engineers to make
changes in software. Software vendors can include information identifying
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customer and other purchasing information as part of the license certificate.
This is done so that if the software and license were diverted to another
company, an audit trail is left, making discovery of improper use of the license
far more likely.
Electronic licensing also records the use of software licensing into a
transaction log called the "Report Log". The information in this log is
authenticated and compressed so software vendors and customers can use this
information as a basis for pay-per-use or other usage-based pricing or
licensing. In addition, customers may use this information to better manage
their software assets and to "bill back" software-related costs to different
departments or projects in the company. The SAMsuite product family contains
this functionality.
CONSUMER SOFTWARE COPY PROTECTION AND RIGHTS MANAGEMENT. Each CD-ROM
published with the SafeDisc technology is premastered with encrypted executable
files and contains authenticating instructions and a unique SafeDisc digital
signature. The digital signature, which cannot be copied by CD recorders or
transferred from a CD-ROM to a hard disc drive, or sent over the Internet, is
added to each original disc during the mastering/replication process. When a
user inserts an original SafeDisc-protected disc in a CD-ROM drive, the
authentication software reads the digital signature, allowing the program to be
decrypted and run normally. The digital signature and authentication process is
transparent to the user. If a consumer or pirate uses a CD-recordable device or
professional mastering equipment to duplicate a CD-ROM and make an unauthorized
copy, SafeDisc is designed to inhibit the transfer of the digital signature to
the copy. If an unauthorized copy is made, decryption will not take place and
the copy will not run.
SafeDisc also contains anti-hacking technology to prevent the compromise
of its security features. The anti-hacking technology is designed not only to
deter consumer copying, but also to thwart hackers. Because of our widespread
penetration in the PC games' market, hackers have targeted and cracked, to
various degrees, several versions of SafeDisc. For us to continue to be
successful in this market, we must continually stay a step ahead of the hacker
community. We develop new product releases approximately three to four times per
year incorporating new anti-hacking features.
Our SafeDisc technology is protected by a patent, and is compliant with
Philips' worldwide Yellow Book CD-ROM standard. We believe that SafeDisc is the
only copy protection technology that has received Philips' certification for
compliance.
SafeCast is an electronic software distribution infrastructure which is
used primarily by developers of applications targeting the consumer and
small-office/home-office markets. SafeCast authenticates the end user's license
by transferring the software publisher's embedded digital rights management
technology from either a CD-ROM disc or from Internet downloaded software to the
user's PC hard drive at the time the application is initially installed.
SafeCast protects the launch of a licensed application by confirming that the
session conforms to the license terms established by the application's
publisher. The publisher establishes license terms that determine how the
application may be used.
SafeWrap is a component-level implementation of multi-layered anti-hacking
elements that is utilized in our SafeDisc product, and can be integrated with
third party software, DRM and portal products. We are currently evaluating other
technologies, both internally and externally developed, that we may choose to
use to enhance SafeWrap in the future.
In the audio CD market, SafeAudio has been jointly developed with TTR
Technologies, Inc. to provide a solution for Red Book CD audio copy protection.
Each of the three current SafeAudio functions (coding, hiding and timing) is
covered by pending patent applications. Our Yellow Book SafeAuthenticate
solution is based upon our SafeDisc product, which is covered by a patent and a
pending patent application (for disc-based rights authentication).
RESEARCH AND DEVELOPMENT
Our internal research and development efforts are focused on developing
enhancements to existing products, new applications for our current technologies
and new patentable technologies related to our various rights management markets
and copy protection products. Our core competencies are in encrypted software,
electronic license management and license delivery software, anti-hacking
software, digital and analog video and audio engineering, copy protection
engineering, watermarking and CD-ROM architecture. We have used our investments
in other companies to supplement our reseach and development expenditures.
In 2001, 2000 and 1999, our expenses for research and development were
$9.3 million, $7.8 million and $6.5 million, respectively.
INTELLECTUAL PROPERTY RIGHTS
12
PATENTS ISSUED & PENDING. We hold 62 U.S. patents and have 65 U.S. patent
applications pending. Of the issued or allowed patents, 36 relate to our copy
protection technologies, 15 relate to video scrambling, 4 relate to audio
scrambling, 5 relate to electronic license management and 2 relate to DRM
technology, namely content usage control, tracking, and e-transactions. Of the
pending patent applications, 4 relate to consumer software copy protection and 5
relate to audio copy protection. The last of our issued U.S. patents expires in
2018. The last of our core group of analog copy protection patents expires in
the year 2008. We have filed numerous applications for additional claims and
improvement patents to extend the current expiration dates. We also have 391
foreign patents issued and 407 foreign patent applications pending in 40
countries. Of the issued foreign patents, 299 relate to our copy protection
technologies, 64 relate to video scrambling, 24 relate to audio scrambling, and
4 relate to electronic license management.
CIRCUMVENTION TECHNOLOGY PATENTS. Included in the patents related to our
copy protection technologies are 14 U.S. and 68 foreign patents covering a
number of processes and devices that unauthorized parties could use to
circumvent our video copy protection technologies. We have historically used
these patents to limit the proliferation of devices intended to circumvent our
video copy protection technologies. We have initiated a number of patent
infringement lawsuits against manufacturers and distributors of such devices.
See "Legal Proceedings."
COMPETITION
VIDEO COPY PROTECTION. We believe that there are currently no significant
video copy protection competitors. Occasionally, companies have developed
hardware based on our technology for sale in limited foreign markets where we
have not sought patent protection. Our video copy protection technologies are
proprietary and have broad international patent coverage. It is possible,
however, that a competitive video copy protection technology could be developed
in the future. For example, one of our customers could attempt to promote
competition by supporting the development of alternative copy protection
technologies or solutions, including solutions that deter professional
duplication.
ELECTRONIC LICENSE MANAGEMENT. Our primary competition in the ELM market
currently comes from independent software vendors who try to develop their own
ELM solutions. Other more traditional competitors include companies offering
digital rights management, electronic licensing, or electronic software
distribution technology, as well as companies that have historically offered
hardware dongle products and are shifting to software-based protection.
Operating system developers or microprocessor suppliers may choose to integrate
rights management solutions into their products. Software resellers could also
begin to develop their own ELM solutions.
CONSUMER SOFTWARE COPY PROTECTION AND DIGITAL RIGHTS MANAGEMENT. We
believe that there are a limited number of competitors in our SafeDisc consumer
software copy protection market, including LaserLock and Sony's DADC optical
disk manufacturing subsidiary. Neither of these companies appear to have made
significant penetration with major publishers in developed countries, and we
believe that we have captured the leading market share of the PC games market.
It is possible that our own customers may develop software copy protection
technologies on their own. It is also possible that personal computer operating
system and microprocessor companies like Microsoft, Red Hat, and Intel, may
develop or license copy protection modules or systems that are internal to the
PC or other consumer electronic devices.
DRM solutions for consumer software, video, and audio have attracted a
number of companies and significant venture capital. Few of them have made any
significant inroads - with the exception of Microsoft and Real Networks in the
audio DRM space. Two high profile DRM companies, Preview Systems and Intertrust
have had major setbacks in the DRM market. Preview sold its main product to
Aladdin Knowlege Systems, and Intertrust has had a series of significant
reductions in force. Our SafeWrap tamper-proofing technology is a new field of
activity in the DRM and IT industry. Customer needs are still being defined and
technologies for satisfying those needs are still being discovered. Many of
these technologies are highly complex and are just emerging. As the market is
still developing, it is still too early to determine the level of competition or
the size of the market.
We believe that there are a limited number of competitors in the audio
copy protection and rights management market, including SunnComm, Sony, and
MidBar. Each of these companies has participated in early market trials with one
or more major record labels. However, the market is still in its infancy and its
evolution remains to be seen. To date, no single vendor has captured a
measurable market share of the worldwide audio CD copy protection market.
We believe that our ability to compete depends on many factors both within
and beyond our control. These include the performance of our technology,
including ease of use, compatibility with installed base of PC and CD-ROM
13
drives and our ability to stay ahead of the efforts of hackers. We also rely on
the effectiveness of our sales and marketing efforts, including our ability to
establish and support a worldwide base of licensed replicators, and to provide
through third party replication equipment vendors the digital signature
technology and associated quality control systems.
OPERATIONS AND TECHNICAL SUPPORT
We have technical support and certification operations to support our DVD
manufacturer licensees, set top box licensees, authorized semiconductor
manufacturers, and our other hardware licensees. We provide technical support
and professional services to our independent software vendor customers during
pre-sale, implementation and maintenance phases of our contracts.
We provide technical support to our videocassette, DVD, digital PPV, ELM
and consumer software customers in various ways:
o We support our licensed duplicators with hardware installation
assistance and quality control. In addition, we support licensed
duplicator sales personnel by providing sales training and sales
incentive programs and literature and by participating in trade
shows;
o We support the efforts of television, VCR and DVD hardware
manufacturers, digital PPV system operators and PPV set-top box
manufacturers to design hardware that properly incorporates our
video copy protection technologies;
o We assist semiconductor manufacturers in incorporating our video
copy protection technologies into a variety of digital video
integrated circuits;
o We regularly test the effectiveness and transparency of our video
copy protection technologies on representative samples of consumer
televisions and VCRs to determine whether modifications or
enhancements may be necessary;
o We assist our software licensees in wrapping their executables with
our SafeDisc and SafeCast modules and in incorporating our
electronic license management software (FLEXlm) and electronic
license delivery software (GTlicensing) into their software
products;
o We provide training and application support for the SafeDisc and
SafeAudio toolkit; and
o We test for SafeDisc and SafeAudio compatibility with PC and CD-ROM
drive combinations.
We have minimal manufacturing operations. Our strategy is to license our
technologies to third parties that manufacture products incorporating our
technologies. Our manufacturing operations are limited to low volume video copy
protection hardware products that require in-house system integration and
quality control efforts.
STRATEGIC INVESTMENTS
We intend to expand our technology base through strategic investments in
companies with complementary technologies or intellectual property. We have made
strategic investments in the following companies:
DIGIMARC CORPORATION (NASDAQ: DMRC). In December 1997, we made our initial
investment in Digimarc. We made two subsequent investments in June 1999 and
October 2000, for a total of $25.3 million. Digimarc completed an initial public
offering in December 1999. As of December 31, 2001, we owned approximately 12.0%
of Digimarc. We have an agreement with Digimarc to jointly develop and market a
digital video watermarking copy protection solution to address the
digital-to-digital copying issues associated with the next generation of
recordable DVD and digital videocassette recording devices.
Digimarc is a leading provider of patented digital watermarking
technologies that allow imperceptible digital code to be embedded in traditional
and digital content, including movies, photographic images and documents such as
financial instruments, passports and event tickets. Digimarc's technologies
enable new communications capabilities related to protecting copyrights,
deterring counterfeiting or piracy and, directly linking physical content with
the Internet. Digimarc is also a member of the VWM Companies.
14
TTR TECHNOLOGIES, INC. (NASDAQ: TTRE). In January 2000, we invested $4.0
million to acquire a minority interest in TTR. In addition, we have entered into
an agreement with TTR to jointly develop and market a copy protection product
designed to inhibit casual copying of music CDs using dual-deck CD recorder
systems and personal computer based CD recordable drives. TTR is a provider of
proprietary digital anti-piracy technologies and products. As of December 31,
2001, we held approximately 10.8% of the outstanding shares of TTR.
COMMAND AUDIO CORPORATION. In October 1995, Command Audio Corporation, or
CAC, was initially incorporated as our wholly-owned subsidiary to commercialize
a new audio-on-demand technology that allows consumers to control the timing and
content of specially formatted radio broadcasts. In August 1996, we divested all
but 19.8% of our ownership in CAC. We assigned to CAC all rights in specified
technology and released our reversion rights in technology that we had
previously assigned to CAC. CAC agreed to pay to us royalties equal to 2.0% of
its gross revenues for 12 years, beginning in 2001. As of December 31, 2001, we
have invested $3.7 million and own approximately 8.0% of the outstanding shares
of this private company.
IVAST. In June 2001, we invested $5.0 million to acquire a 15.7% ownership
interest in iVAST, a developer of MPEG-4 based solutions for the delivery of
streaming multimedia. The iVAST platform encompasses a full range of
functionality including, authoring, streaming, backend integration, playback and
interactivity. The platform is designed to support a wide range of broadband
enabled information appliances.
WIDEVINE TECHNOLOGIES. In August 2001, we invested $3.0 million to acquire
a 13.1% ownership interest in Widevine Technologies, which specializes in
Internet Protocol network security. Widevine Technologies has developed
technology that provides a single solution for secure storage, distribution,
delivery and control of digital data over every stage of an Internet
Protocol-based network.
NTRU CRYPTOSYSTEMS. In August 2001, we invested $1.5 million to acquire a
2.3% ownership interest in NTRU Cryptosystems, a developer of security solutions
for emerging consumer markets, providing security solutions in a variety of
software and hardware formats for all major hardware and software environments.
NTRU Cryptosystems is based on a fundamental mathematical innovation, which
makes efficient public key cryptography practical on a scale necessary for
consumer and embedded applications.
DIGITAL FOUNTAIN. In August 2001, we invested $4.0 million to acquire a
7.0% ownership interest in Digital Fountain, a developer of digital transport
solutions that address the data delivery market. The Digital Fountain solution
uses an advanced mathematical approach to transport data accurately, timely and
securely over the Internet.
AUDIOSOFT, INTERACTUAL TECHNOLOGIES, RIOPORT, INC. and SECURE MEDIA. We
had previously acquired minority equity interests in AudioSoft, Interactual
Technologies, RioPort, Inc. and Secure Media. During 2001, consistent with our
policy for evaluating recoverability of these investments, we concluded that
impairment of our investments in AudioSoft, InterActual Technologies, RioPort
and SecureMedia was other than temporary. Accordingly, we wrote off the book
value of these investments during 2001 and took an aggregate charge to earnings
of $6.9 million for the year ended December 31, 2001.
All of these strategic investments, totaling $58.1 million, represented
16.9% of our total assets as of December 31, 2001. CAC, iVAST, Widevine
Technologies, NTRU Cryptosystems and Digital Fountain are privately held
companies. There is no active trading market for their securities and our
investments in them are illiquid. We may never have an opportunity to realize a
return on our investment in these private companies. We have in the past and may
in the future be required to write off all or part of one or more of these
investments.
EMPLOYEES
As of December 31, 2001, we had 245 employees. Of these employees, 81 are
based outside of the U.S. None of our employees is covered by a collective
bargaining agreement or is represented by a labor union. We have not experienced
any organized work stoppages.
We use a variety of incentive programs to motivate our employees,
including annual performance-based bonuses, stock purchase plans, stock options,
special recognition awards, and a package of other benefit programs including a
401(k) plan, medical/dental benefits, compensating time off for community
service and health club and educational reimbursement.
15
Our engineering teams develop new products and enhance existing offerings,
as well as contribute to our technical due diligence efforts when we make
strategic investments, conclude joint development agreements, or acquire rights
to third party technologies.
Our technical support staff provides customer sales support and conducts
extensive compatibility and effectiveness tests for our various rights
management and copy protection technologies. In addition, this staff runs an
extensive certification lab to confirm that our licensees have implemented our
video copy protection technologies correctly in integrated circuits and DVD or
set-top box hardware.
Our sales and marketing groups include senior executives who manage our
business lines and provide executive level account management to our major
customers. We also have a direct sales staff that works with our content owner
and software vendor customers. Our in-house legal department provides licensing
and patent counsel to our executives.
RISK FACTORS
IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS ANNUAL REPORT ON FORM
10-K, YOU SHOULD CONSIDER CAREFULLY THE FOLLOWING RISKS. IF ANY OF THESE RISKS
OCCURS, OUR BUSINESS, FINANCIAL CONDITION OR OPERATING RESULTS COULD BE
ADVERSELY AFFECTED.
COMPANY RISKS
THE SUCCESS OF OUR BUSINESS DEPENDS ON THE CONTINUED USE BY MAJOR MOVIE
STUDIOS OF OUR VIDEO COPY PROTECTION TECHNOLOGY.
If major motion picture studios were to determine that the benefits of our
technology do not justify the cost of licensing the technology, then demand for
our technology and our revenues would decline. We currently derive a majority of
our net revenues and operating income from fees for the application of our
patented video copy protection technology to prerecorded videocassettes, DVDs
and digital pay per view, or PPV programs. These fees represented 63.0%, 60.9%
and 61.4% of our net revenues during 2001, 2000 and 1999, respectively.
Any future growth in revenues from these fees will depend on the use of
our video copy protection technology on a larger number of videocassettes, DVDs
or digital PPV programs. To increase or maintain our market penetration, we must
continue to persuade content owners that the cost of licensing the technology is
outweighed by the increase in revenues that content owners and retailers gain as
a result of using copy protection, such as revenues from additional sales of the
copy protected material or subsequent revenues from other distribution channels.
The retail prices of DVDs are falling. As retail prices drop, studios face
increased pressure to trim operating expenses, which may include cutting back in
their copy protection usage, as well as negotiated reductions in their usage
fees. Even though we have long-term contracts with large, minimum annual volume
commitments, it is possible for some studios to copy protect a smaller
percentage of their titles and still achieve their minimum volume commitments.
In addition, some studios may reconsider whether they want to continue to copy
protect their older catalog titles.
Any decline in demand for our video copy protection technology, including
a change of video copy protection policy by the major motion picture studios, or
a decline in sales of prerecorded videocassettes and DVDs that are encoded with
our video copy protection technology, or a material decline in our average unit
royalties, would have a material adverse effect on our business. If several of
the motion picture studios withdraw their support for our copy protection
technologies or otherwise determine not to copy protect a significant portion of
prerecorded videocassettes, DVD or digital PPV programs, our business would be
harmed.
OUR OPERATING RESULTS MAY FLUCTUATE, WHICH MAY ADVERSELY AFFECT THE PRICE OF
OUR COMMON STOCK.
Our quarterly and annual revenues, expenses and operating results could
vary significantly in the future and period-to-period comparisons should not be
relied upon as indications of future performance. Due to limited visibility in
predicting software licensing revenues and, particularly, revenues that are
generated from perpetual licenses (under which license fee revenue is recognized
upfront on a one-time basis) we may experience volatility in revenues which may
cause us to not be
16
able to sustain our level of net revenues, or our rate of revenue growth, on a
quarterly or annual basis. Fluctuations in our operating results may cause the
price of our common stock to decline.
Further, we may not be in a position to anticipate a decline in revenues
in any quarter until late in the quarter. This is primarily due to the delay
inherent in reporting from certain licensees and closing of new sales
agreements, resulting in potential volatility in the price of our common stock.
Factors which could cause the price of our common stock to decline include:
o The timing of releases of popular movies on videocassettes, DVDs or
by digital PPV transmission;
o The ability of the Motion Picture Association of America studios to
produce one or more "blockbuster" titles on an annual basis;
o The degree of acceptance of our copy protection technologies by
major motion picture studios and software companies;
o The acceptance of our electronic licensing and DRM software by
software vendors and end-user organizations;
o The timing of releases of computer software CD-ROM multimedia
titles; and
o The extent to which various hacking technologies are viewed to be
successful by our customers.
The technology sector has experienced significant economic downturns,
exacerbated in part by a slowdown in U.S and foreign economies and by the
September 11, 2001 terrorist attacks in the U.S. As a consequence, our future
license fee revenue may experience fluctuations. Further softening in the
technology industry could affect our future results of operations, and may
affect the timing of orders from major customers.
WE EXPERIENCE SEASONALITY IN OUR OPERATING RESULTS, WHICH MAY AFFECT THE PRICE
OF OUR COMMON STOCK.
We have experienced significant seasonality in our business, and our
business is likely to be affected by seasonality in the future. We have
typically experienced our highest revenues in the fourth quarter of each
calendar year followed by lower revenues and operating income in the first
quarter, and at times in subsequent quarters, of the next year. We believe that
this trend has been principally due to the tendency of our customers to release
their more popular movies on videocassettes and DVDs during the year-end holiday
shopping season. We anticipate that revenues from consumer software copy
protection and DRM technologies will reflect this seasonal trend as well. Our
revenues generally have tended to be lower in the summer months, particularly in
Europe.
WE DEPEND ON A SMALL NUMBER OF KEY CUSTOMERS FOR A HIGH PERCENTAGE OF OUR
REVENUES AND THE LOSS OF A SIGNIFICANT CUSTOMER COULD RESULT IN A
SUBSTANTIAL DECLINE IN OUR REVENUES AND PROFITS.
Our customer base and a majority of our net revenues is highly
concentrated among a limited number of customers, primarily due to the fact that
the Motion Picture Association of America studios dominate the motion picture
industry and the loss of any one customer would have a significant adverse
impact on our business. Historically, we have derived the majority of our net
revenues from a relatively small number of customers. The Motion Picture
Association of America studios as a group accounted for 33.2%, 24.8% and 23.9%
of our net revenues in 2001, 2000 and 1999, respectively.
We expect that revenues from the Motion Picture Association of America
studios will continue to account for a substantial portion of our net revenues
for the foreseeable future. We have agreements with major home video companies
for copy protection of a substantial part of their videocassettes and/or DVDs in
the U.S. These agreements expire at various times ranging from 2003 to 2005. The
failure of any one of these customers to renew its contract or to enter into a
new contract with us on terms that are favorable to us would likely result in a
substantial decline in our net revenues and operating income, and our business
would be harmed.
17
WE DEPEND ON SIGNING HIGH-VALUE LICENSE AGREEMENTS DURING THE REPORTING PERIOD
FROM MAJOR SOFTWARE CUSTOMERS FOR OUR ELECTRONIC LICENSE MANAGEMENT PRODUCTS
AND THE INABILITY TO SIGN THESE AGREEMENTS COULD RESULT IN A DECLINE IN OUR
REVENUES AND PROFITS.
Currently, a material portion of our Electronic License Management
revenues are generated from perpetual licenses, under which license fee revenue
is recognized up front on a one-time basis. Failure to close a small number of
high-value perpetual licenses during any period could result in a decline in our
revenues and profits. We currently offer our customers the choice between a
perpetual license and an annual (or time based) license, the latter of which
results in ratable recognition of the license fee over a 12-month period. Annual
licenses provide better visibility into future revenues, and smoothes peaks and
troughs in revenue flows that result from perpetual licenses. If we are not able
to persuade major customers to adopt the annual (or time-based) model, and we
continue to rely on the capture of a number of high-value perpetual licenses in
a given period, we may experience higher volatility in our net revenues and
operating income.
WE ARE DEPENDENT ON INTERNATIONAL SALES FOR A SUBSTANTIAL AMOUNT OF OUR
REVENUE. WE FACE DIVERSE RISKS IN OUR INTERNATIONAL BUSINESS, WHICH COULD
ADVERSELY AFFECT OUR OPERATING RESULTS.
International and export sales together represented 45.2%, 42.3% and 40.2%
of our net revenues in 2001, 2000 and 1999, respectively. We expect that
international and export sales will continue to represent a substantial portion
of our net revenues for the foreseeable future. Our future growth will depend to
a large extent on worldwide deployment of digital PPV networks, DVDs, and
consumer software, and the use of copy protection in these media. Worldwide
adoption of our ELM technology will also be an important driver of future
growth.
To the extent that foreign governments impose restrictions on importation
of programming, technology or components from the U.S., the requirement for copy
protection and rights management solutions in these markets could diminish. In
addition, the laws of some foreign countries may not protect our intellectual
property rights to the same extent as do the laws of the U.S., which increases
the risk of unauthorized use of our technologies and the ready availability or
use of circumvention technologies. Such laws also may not be conducive to
copyright protection of video materials and digital media, which reduces the
need for our copy protection technology.
Due to our reliance on international and export sales, we are subject to
the risks of conducting business internationally, including:
o foreign government regulation;
o changes in diplomatic and trade relationships;
o changes in, or imposition of, regulatory requirements;
o tariffs or taxes and other trade barriers and restrictions;
o difficulty in staffing and managing foreign operations; and
o fluctuations in foreign currency exchange rates.
Our business could be materially adversely affected if foreign markets do
not continue to develop, if we do not receive additional orders to supply our
technologies or products for use in foreign prerecorded video, PPV and other
applications requiring our copy protection solutions or if regulations governing
our international business change. For example, under the U.S. Export
Administration Act of 1979, encryption algorithms such as those used in our
consumer software copy protection technology are classified as munitions and
subject to stringent export controls. Any changes to the statute or the
regulations with respect to export of encryption technologies could require us
to redesign our products or technologies or prevent us from selling our products
and licensing our technologies internationally.
POTENTIAL INTELLECTUAL PROPERTY CLAIMS AND LITIGATION COULD SUBJECT US TO
SIGNIFICANT LIABILITY FOR DAMAGES AND INVALIDATION OF OUR INTELLECTUAL
PROPERTY RIGHTS.
Litigation may be necessary in the future to enforce our patents and other
intellectual property rights, to protect our trade secrets or to determine the
validity and scope of the proprietary rights of others. We are currently subject
to several legal proceedings. See "Legal Proceedings."
Litigation could harm our business and result in:
o substantial settlement or related costs, including indemnification
of customers;
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o diversion of management and technical resources;
o discontinuing the use and sale of infringing products;
o expending significant resources to develop non-infringing
technology; and
o obtaining licenses to infringed technology.
Our success is heavily dependent upon our proprietary technologies. We
rely on a combination of patent, trademark, copyright and trade secret laws,
nondisclosure and other contractual provisions, and technical measures to
protect our intellectual property rights. Our patents, trademarks or copyrights
may be challenged and invalidated or circumvented. Our patents may not be of
sufficient scope or strength or be issued in all countries where our products
can be sold. The last of our core group of analog copy protection patents expire
in the year 2008. In many cases, we have filed applications to expand our patent
claims and for improvement patents to extend the current expiration dates,
however, expiration of some of our patents may harm our business.
Others may develop technologies that are similar or superior to our
technologies, duplicate our technologies or design around our patents. Effective
intellectual property protection may be unavailable or limited in some foreign
countries. Despite efforts to protect our proprietary rights, unauthorized
parties may attempt to copy or otherwise use aspects of processes and devices
that we regard as proprietary. Policing unauthorized use of our proprietary
information is difficult, and the steps we have taken may not prevent
misappropriation of our technologies.
IT MAY BE TIME-CONSUMING AND COSTLY TO ENFORCE OUR PATENTS AGAINST DEVICES AND
HACKING TECHNIQUES THAT ATTEMPT TO CIRCUMVENT OUR COPY PROTECTION
TECHNOLOGY, AND OUR FAILURE TO CONTROL THEM COULD HARM OUR BUSINESS.
We use our patents to limit the proliferation of devices intended to
circumvent our video copy protection technologies. In the past, we have
initiated a number of patent infringement disputes against manufacturers and
distributors of these devices. Any legal action that we may initiate could be
time-consuming to pursue, result in costly litigation, and divert management's
attention from day-to-day operations.
We have one lawsuit of this type pending in Germany to require the
defendant to discontinue the sale of devices that circumvent our video copy
protection technologies, as we believe the device infringes one or more of our
circumvention patents. In the event of an adverse ruling in this litigation or
in any similar litigation, the value of our video protection protection
technology may decline due to the legal availability of such a circumvention
device, or we may have to obtain rights to the offending devices to protect the
value of our technology. The legal availability of circumvention devices could
result in the increased proliferation of devices that defeat our copy protection
technology and a decline in demand for our technologies, which could have a
material adverse effect on our business in Germany.
A limited number of DVD manufacturers may build products that either do
not contain our copy protection technology, or include features that allow
consumers to bypass copy protection. Though we believe this is in contravention
of the U.S. Digital Millennium Copyright Act, as well as the basic DVD CSS
license, proliferation of these products could cause a decline in demand for our
technologies, which could harm our business. Any legal or other enforcement
action that we may initiate could be time consuming to pursue, result in costly
litigation, and divert management's attention from day-to-day activities.
In the electronic license management market, our products include patented
technologies. Any legal action that we may initiate regarding these patents may
be time-consuming to pursue, involve costly litigation, divert management's
attention from operations or may not be successful. See "Legal Proceedings."
In the consumer software copy protection segment, a number of individuals
have developed and posted SafeDisc hacks on the Internet, or CD cloning
software. If we are not able to develop frequent SafeDisc software releases and
new digital signatures, which deter the hackers from developing circumvention or
cloning techniques, our customers could reduce their usage of our technology
because it was compromised. Although the anti-circumvention provisions in the
U.S. Digital Millennium Copyright Act may be applicable to Internet service
providers who support the hacker sites, any legal action that we initiate could
be time-consuming to pursue, result in costly litigation, and divert
management's attention from day-to-day operations.
19
WE ARE EXPOSED TO RISKS ASSOCIATED WITH EXPANDING OUR TECHNOLOGY BASE THROUGH
STRATEGIC ACQUISITIONS AND INVESTMENTS.
We have expanded our technology base in the past through strategic
acquisitions and investments in companies with complementary technologies or
intellectual property and intend to do so in the future. Acquisitions always
hold special challenges in terms of successful integration of technologies,
products and employees. If we were to acquire any of these companies in the
future, we may not be able to incorporate any acquired services, products or
technologies with our existing operations, or integrate personnel from the
acquired businesses, in which case our business could be harmed.
The negotiation, creation and management of the strategic relationships
typically involve a substantial commitment of our management time and resources.
We have in the past and may in the future be required to write off all or part
of one or more of these investments that could harm our business.
Our strategic investments typically involve joint development, joint
marketing, or entry into new business ventures, or new technology licensing. Any
joint development efforts may not result in the successful introduction of any
new products by us or a third party, and any joint marketing efforts may not
result in increased demand for our products. Further, any current or future
strategic acquisitions and investments by us may not allow us to enter and
compete effectively in new markets or enhance our business in any current
markets.
We currently hold minority equity interests in a number of companies,
including Digimarc, TTR, CAC, Digital Fountain, iVAST, NTRU Cryptosystems, and
Widevine Technologies. These investments, totaling $58.1 million, represented
16.9% of our total assets as of December 31, 2001. CAC, Digital Fountain, iVAST,
NTRU Cryptosystems, and Widevine Technologies are privately held companies.
There is no active trading market for the securities of these privately held
companies and our investments in them are illiquid. We may never have an
opportunity to realize a return on our investment in these private companies,
and we may in the future be required to write off all or part of one or more of
these investments.
WE MUST CONTINUE TO PROVIDE SATISFACTORY SUPPORT AND MAINTENANCE SERVICES TO OUR
ELM CUSTOMERS.
Our future success will depend on our ability to provide adequate software
support and maintenance services to our ELM customers. As they release new
applications or modify their software to run on new platforms, it is important
that their businesses not be disrupted as a result of inadequate support from
us. Failure to deliver such services could harm our business.
WE DEPEND ON THIRD PARTIES TO IMPLEMENT AND SUPPORT SAFEDISC AND SAFEAUDIO
SOFTWARE MODULES WITHIN THEIR ENCODING AND QUALITY ASSURANCE EQUIPMENT.
We rely on third party vendors such as DCA, Eclipse, Media Morphics and CD
Associates to develop and incorporate software modules that will:
o apply the SafeDisc digital signature and SafeAudio protection
generator at licensed replication facilities; and
o allow replicators to run specialized quality assurance tests to
confirm the SafeDisc or SafeAudio technology is applied.
Our operations could be disrupted if our relationships with third party
vendors are disrupted or if their products are defective, not available or not
accepted by licensed replicators. This could result in a loss of customer orders
and revenue.
The SafeDisc CD copy protection technology is available to over 100 of the
world's largest mastering and replication facilities worldwide, and is designed
to be fully compatible with standard CD manufacturing processes. Nevertheless,
we rely on such third parties to properly apply the SafeDisc CD copy protection
technology to content on behalf of our customers and to properly perform quality
assurance testing with respect to such content. Any improper application of the
technology or improper quality assurance testing by such third party mastering
and replication facilities may result in content that does not contain our copy
protection technology or may result in other defects in the rights holders
content, and may therefore, result in a loss of revenue or a claim against us by
the content owner.
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WE MUST ESTABLISH AND MAINTAIN LICENSING RELATIONSHIPS WITH COMPANIES OTHER
THAN CONTENT OWNERS OR SOFTWARE PUBLISHERS TO CONTINUE TO EXPAND OUR
BUSINESS, AND FAILURE TO DO SO COULD HARM OUR BUSINESS PROSPECTS.
Our future success will depend upon our ability to establish and maintain
licensing relationships with companies in related business fields, including:
o videocassette duplicators;
o international distributors of videocassettes;
o DVD and CD authoring facilities, mastering houses and replicators;
o DVD and CD authoring tools software companies;
o DVD and CD hardware manufacturers;
o semiconductor and equipment manufacturers;
o operators of digital PPV networks; and
o consumer electronics and digital PPV set-top hardware manufacturers.
Substantially all of our license agreements are non-exclusive, and
therefore our licensees are free to enter into similar agreements with third
parties, including our competitors. Our licensees may develop or pursue
alternative technologies either on their own or in collaboration with others,
including our competitors.
OUR PRODUCTS COULD HAVE UNKNOWN DEFECTS.
We offer and develop a series of complex copy protection and digital
rights management products, which we license to customers. Due to the complexity
of these products offered and developed, the products may contain undetected
defects or errors that may affect the proper use or application of such products
by the customer. Despite our quality assurance testing, defects or errors may
occur in existing or new products, which could result in loss of revenue or
market share, failure to achieve market acceptance, diversion of development
resources, injury to our reputation, increased insurance costs and increased
service, any of which could materially harm our business. The performance of
these products typically involves working with sophisticated software, computing
and communications systems. Our inability to meet customer expectations in a
timely manner could also result in a loss of, or delay in, revenue, loss of
market share, failure to achieve market acceptance, injury to our reputation and
increased costs. In addition, we rely on the customer and third party
replicators to properly use our products to protect the software and
applications to which the process may be applied. Any improper use or
application of the software by the customer or the third party replicators may
render the process useless and result in losses from claims arising out of such
improper use of the products.
Because customers rely on our products for copy protection and digital
rights management of their software and applications, defects or errors in our
products may discourage customers from purchasing our products. These defects or
errors could also result in product liability or warranty claims. Although we
attempt to reduce the risk of losses resulting from these claims through
warranty disclaimers and limitation of liability clauses in our agreements,
these contractual provisions may not be enforceable in every instance.
Furthermore, although we maintain errors and omissions insurance, this insurance
may not adequately cover these claims. If a court refused to enforce the
liability-limiting provisions of our contracts for any reason, or if liabilities
arose that were not contractually limited or adequately covered by insurance,
our business could be materially harmed.
IF USE OF THE INTERNET FOR DELIVERY OF SOFTWARE DOES NOT INCREASE AS WE
ANTICIPATE, OUR BUSINESS WILL SUFFER.
Some of our products, such as SafeCast, focus on using the Internet to
deliver, deploy, and pay for software. The revenues we generate from these
products depend on increased acceptance and use of the Internet as a medium of
commerce, communications and delivery of software. Acceptance and use of the
Internet may not continue to develop at historical rates, and a sufficiently
broad base of business customers may not adopt or continue to use the Internet
to conduct their operations. Demand and market acceptance for recently
introduced services and products over the Internet are subject to a high level
of uncertainty, and there are few proven services and products. Our business
could be seriously harmed if:
21
o The necessary communication and computer network technology
underlying the Internet and other online service does not
effectively support any expansion that may occur;
o New standards and protocols are not developed or adopted in a timely
manner; or
o Concerns about security, reliability, cost, ease of use,
accessibility, quality of service, or other factors results in the
Internet not becoming established as a viable commercial
marketplace, inhibiting the development of electronic commerce and
reducing the need for and desirability of our products and services.
IF WE DO NOT RETAIN OUR KEY EMPLOYEES AND ATTRACT NEW EMPLOYEES, OUR ABILITY TO
EXECUTE OUR BUSINESS STRATEGY WILL BE IMPAIRED.
We compete for employees in California's Silicon Valley, one of the most
challenging employer environments in the U.S. Hiring and retaining key personnel
is highly competitive. Because of the specialized nature of our business, our
future success will depend upon our continuing ability to identify, attract,
train and retain other highly skilled managerial, technical, sales and marketing
personnel, particularly as we enter new markets. In particular, we need to
attract senior software industry executives in anticipation of expanding our
software business through defining new software growth strategies and executing
on these strategies. We have searches underway for a Chief Operating Officer and
Board director in this regard. Additionally, our current stock option plan may
be deemed less effective in retaining employees due to the overall decline in
technology market values and the resultant impact on our stock price. We are
evaluating approaches to ensure effective retention tools are in place. The loss
of key employees or the inability to hire seasoned executives could harm our
business.
CALAMITIES, POWER SHORTAGES OR POWER INTERRUPTIONS AT OUR SILICON VALLEY OFFICE
COULD DISRUPT OUR BUSINESS AND ADVERSELY AFFECT OUR OPERATIONS.
We are in the process of consolidating the operations of our offices in
Sunnyvale, California and San Jose, California to a facility in Santa Clara,
California. These facilities are in areas of seismic activity near active
earthquake faults. Any earthquake, fire or other calamity affecting our
facilities may disrupt our business and substantially affect our operations.
We also rely on the major Northern California public utility, Pacific Gas
& Electric Company ("PG&E"), to supply electric power to our facilities. Due to
problems associated with the deregulation of the power industry in California,
customers of PG&E have been faced with increased electricity prices, power
shortages and, in some cases, rolling black-outs. To date, we have not been
materially adversely affected by such power black-outs. However, more
significant disruptions of our power supply may occur in the future. These
interruptions could delay delivery or development of our technologies or
increase our operating costs, in either case having a material adverse effect on
our operations. We do not presently have a backup power generating facility. The
inability to obtain electricity at cost effective rates would increase our
operating expenses and would decrease our operating income if we were unable to
pass along these costs to our customers in the price of our products.
INDUSTRY RISKS
WE LICENSE TECHNOLOGY FOR DIGITAL PPV COPY PROTECTION, AND IF THIS MARKET DOES
NOT GROW AS ANTICIPATED OR WE ARE UNABLE TO SERVE THIS MARKET EFFECTIVELY,
OUR REVENUES WILL BE ADVERSELY AFFECTED.
While our copy protection capability is embedded in more than 75 million
digital set-top boxes manufactured by the leading digital set-top box
manufacturers, only seven system operators have activated copy protection for
digital PPV programming. Our ability to expand our markets in additional home
entertainment venues such as digital PPV or video on demand ("VOD") will depend
in large part on the support of the major motion picture studios in advocating
the incorporation and activation of copy protection technology in the hardware
and network infrastructure required to distribute such video programming. If the
Motion Picture Association of America studios do not require copy protection
activation for any of their PPV or VOD movies, or if PPV/VOD system operators do
not specify our copy protection in their set top boxes, or if the system
operators do not activate copy protection in other digital PPV networks outside
of Japan, Hong Kong or the United Kingdom, then our business will be harmed.
22
Further, consumers may react negatively to copy protected PPV programming
because they may feel they have an entitlement having in the past routinely
copied for later viewing analog cable and satellite-delivered subscription
television and PPV programs, as well as free broadcast programming. In addition,
when incoming video signals are routed through a VCR before reaching a TV set,
the consumer may see impaired pictures while viewing a copy protected digital
PPV program. If there is consumer dissatisfaction that cannot be managed, or if
there are technical compatibility problems, our business would be harmed.
POTENTIAL REVENUE MAY BE LOST IF THE VWM COMPANIES' DIGITAL VIDEO WATERMARKING
TECHNOLOGY IS NOT SELECTED AS AN INDUSTRY STANDARD OR OTHERWISE ACHIEVE
BROAD MARKET ACCEPTANCE.
In cooperation with Digimarc Corporation, Hitachi Ltd., Koninklijke
Philips N.V., NEC Corporation, Pioneer Corporation and Sony Corporation, we have
developed a digital video watermarking solution to address the
digital-to-digital copying issues associated with the next generation of DVD
recording devices. Our group (the "VWM Companies") has submitted a proposed
solution to the DVD Copy Control Association, or DVD CCA, which has assumed
responsibility for selecting the industry standard. Macrovision has been
selected as the exclusive licensing agent for the VWM Companies' watermarking
solution. Our group is competing with Toshiba Corporation, which has also
submitted a proposal to the DVD CCA.
The VWM Companies' digital watermarking technology may not be selected as
the standard by the DVD CCA. Our proposal was submitted in November 2001 in
response to the second set of Instructions to Bidders issued by the DVD CCA.
However, the DVD CCA issued similar Instructions in 1999, in response to which
the individual VWM Companies bid as two separate groups with competing
technologies: the Millennium group (Digimarc, Philips and Macrovision), and the
Galaxy group (Hitachi, IBM, NEC, Pioneer and Sony). The initial selection
process was delayed due to concerns over potential intellectual property
conflicts. Potential video content owners and hardware manufacturers did not
want to select either the Millennium group or the Galaxy group solution for fear
that they might be subject to patent infringement action by the other group. As
a result the Millennium and Galaxy groups joined forces in 2001 as the VWM
Companies and combined their technologies and patents into a best-of-breed
solution to alleviate this concern and submitted a joint bid in this second
round of testing and evaluation.
While there is no guaranty that the DVD CCA will select a technology in
this testing and evaluation process, if a selection is made, the group whose
digital video watermarking solution is selected will have a significant
advantage in licensing its technology to video content owners worldwide, and in
working with consumer electronics manufacturers, PC platform companies and their
suppliers to implement digital-to-digital copy protection. Even if the DVD CCA
adopts the VWM Companies' solution, other companies may elect to compete in this
market. If the solution being developed by the VWM Companies is not the selected
solution or otherwise is not widely adopted by studios or consumer electronics
manufacturers, our group will be at a competitive disadvantage in marketing our
solution. The solution being developed by our group may not achieve market
acceptance as the market and the standards for digital-to-digital copy
protection evolve. If this happens, our future revenue opportunities will be
negatively impacted.
THE CONTINUED RISKS OF PATENT INFRINGEMENT AND ANTITRUST LAWSUITS MAY REDUCE THE
CHANCES OF THE VWM COMPANIES' DIGITAL VIDEO WATERMARKING TECHNOLOGY FROM
BEING SELECTED AS AN INDUSTRY STANDARD OR OTHERWISE ACHIEVING MARKET
ACCEPTANCE.
We continue to discuss our solution and our implementation plans with the
studios and other industry participants, but risks of patent infringement
lawsuits still remain an issue for the studios and hardware companies. While the
VWM Companies' plan to minimize potential antitrust lawsuits by securing
approval from the Department of Justice with a Business Review Letter, there can
be no assurance that, even if this happens, we will eliminate antitrust risks.
If the VWM Companies are forced to defend against one or more antitrust lawsuits
our business could be significantly impacted.
On October 23 2001, Digimarc filed a patent infringement suit in the
United States District Court, District of Oregon against Verance Corporation
alleging infringement of certain patents owned by Digimarc. Verance's answer and
counter-claim included allegations of patent infringement and antitrust
counterclaims, including allegations that Digimarc conspired with Macrovision to
keep Verance out of the DVD CCA bidding process for selection of a digital
watermarking copy protection technology. Verance's second amended
cross-complaint, filed on or about March 25, 2002, specifically named us as a
party and pled additional allegations of patent infringement and antitrust
violations in connection with our bid to the DVD CCA as one of the VWM
Companies. In the event Verance succeeds on its cross-claims, we may be subject
to significant monetary damages as well as be precluded from licensing the VWM
Companies' jointly developed digital media copy protection technology.
23
WE ENTERED THE MARKET FOR CONSUMER SOFTWARE COPY PROTECTION AND RIGHTS
MANAGEMENT, AND WE DO NOT KNOW IF OUR MOMENTUM WILL CONTINUE IN SELLING OUR
PRODUCTS IN THIS MARKET.
Both the markets for PC hardware and software games publishers have
experienced macroeconomic pressures over the last year. Unit sales of PC's have
slowed; major PC suppliers have announced weaker financial results than
expected. Several PC games software publishers have reported financial
difficulties and experienced management and employee turnover. If economic
conditions in this segment continue to be difficult, demand for our copy
protection and rights management solutions (which is linked to the volume of PC
games and consumer application software titles sold) could decline. This would
result in lower revenues and operating income for this line of business.
A number of competitors and potential competitors are developing CD-ROM
copy protection and DRM solutions. Many of these competitors and potential
competitors have substantially greater name recognition and financial, technical
and marketing resources than we do. If these competitors provide superior or
more cost-effective solutions, our business will be harmed.
WE HAVE RECENTLY ENTERED THE ELM MARKET, AND WE DO NOT KNOW IF WE WILL BE
SUCCESSFUL IN SELLING OUR PRODUCTS IN THIS MARKET.
We acquired GLOBETROTTER Software, Inc. in August 2000. GLOBETROTTER's
major product line is FLEXlm, a software product that is integrated into
independent software vendors' offerings, allowing them to license their software
products electronically, and monitor and enforce compliance with their licensed
use rights. A second product, GTlicensing allows software vendors to create,
ship and track electronic licenses online. Our third product, SAMSuite is an
end-user (enterprise) software asset management product. There is no assurance
of our ability to grow and be successful in this market and if we are
unsuccessful in this market, our business would be harmed.
Major software vendors have experienced deteriorating economic conditions
as corporate customers have reduced capital expenditures. Demand for our FLEXlm
technology is driven, to some degree, by end user demand for software
applications. If economic conditions for software vendors continue to be
difficult, demand for our ELM technology could decline. This would result in
lower revenues and operating income for this line of business.
In some cases, customers make a substantial capital investment when
purchasing our software and commit additional resources to installation and
deployment. Potential customers spend significant time and resources to
determine which software to purchase. Selling our products sometimes requires an
extensive sales effort because the decision to adopt electronic licensing
generally involves several customer executives in various functions and
geographic areas. Due to these factors, our sales cycle is unpredictable, and
the number of sales and amount of revenue generated from such sales varies from
quarter to quarter.
WE ARE ENTERING THE MARKET FOR MUSIC CD COPY PROTECTION AND RIGHTS MANAGEMENT,
AND WE DO NOT KNOW IF WE WILL BE SUCCESSFUL IN SELLING OUR PRODUCTS IN THIS
MARKET.
We entered into a strategic relationship with TTR Technologies, Inc. to
develop and market a copy protection system that will inhibit casual copying of
music CDs using dual-deck CD recorder systems or personal computer systems. A
number of competitors and potential competitors may be developing similar and
related music copy protection solutions. The solution we expect to market may
not achieve or sustain market acceptance, or may not meet, or continue to meet,
the demands of the music industry. It is possible that there could be
significant consumer resistance to audio copy protection, as consumers may feel
that copy protection degrades the sound quality of the original or that they are
entitled to copy audio CDs, because no technology has been used in the past to
prevent copying. It is not clear whether the major music labels will deploy any
copy protection solutions if there is sustained consumer resistance.
If the market for music CD copy protection fails to develop, or develops
more slowly than expected, if our solution does not achieve or sustain market
acceptance or if there is significant and sustained consumer resistance to this
technology, our business would be harmed.
IF WE ARE UNABLE TO COMPETE SUCCESSFULLY AGAINST COMPETITIVE TECHNOLOGIES THAT
MAY BE DEVELOPED IN THE FUTURE OUR BUSINESS WILL BE HARMED.
24
We believe that there are currently no significant videocassette copy
protection competitors other than companies that have occasionally developed
copy protection processor hardware based on our technology for sale in small
foreign markets, where we have not sought patent protection. It is possible,
however, that a competitive copy protection technology could be developed in the
future. For example, our customers could attempt to promote competition by
supporting the development of alternative copy protection technologies or
solutions, including solutions that deter professional duplication. Increased
competition would be likely to result in price reductions and loss of market
share, either of which could harm our business. We believe that our DVD
digital-to-analog copy protection system has no competitors, and because of the
widespread ecosystem that we have developed (semiconductor suppliers and DVD
manufacturer licensees), we believe it would be very difficult for a competitor
to enter this space.
In the video market, there are a variety of supplemental copy protection
and encryption systems that provide partial copy protection for digital links
(the DTLA 5C encryption technology); the 4C pre-recorded media and recordable
media copy protection systems; CSS - the basic content scrambling system for the
DVD format; the Digital Display Working Group's High Definition Copy Protection
("HDCP") encryption for Digital Video Interfaces ("DVI"). These systems are not
directly competitive, but they are sometimes confused with our analog copy
protection and the VWM Companies' watermarking systems, and may create
uncertainty in the minds of customers - thereby reducing or delaying our
licensing opportunities.
Our primary competition in the ELM market currently comes from independent
software vendors who try to develop their own ELM solutions. In the event that
software vendors succeed with their internal developments, or forego the
implementation of such applications, this would adversely affect our business.
Other more traditional competitors include companies offering digital rights
management, electronic licensing, or electronic software distribution
technology, as well as companies that have historically offered hardware dongle
products and are shifting to software-based protection. In addition, operating
system developers or microprocessor suppliers may choose to integrate rights
management solutions into their products. Software resellers could also begin to
develop their own ELM solutions.
There are a limited number of competitors in our SafeDisc consumer
software copy protection market, including LaserLock and Sony's DADC optical
disk manufacturing subsidiary. However, it is possible that our own customers
may develop software copy protection technologies on their own, or that personal
computer operating system and microprocessor companies, may develop or license
copy protection modules or systems that are internal to the PC or other consumer
electronic devices.
DRM solutions for consumer software, video, and audio have attracted a
number of companies and significant venture capital, including Intertrust,
Microsoft and Real Networks. Our SafeWrap tamper-proofing technology is a new
field of activity in the DRM and IT industry. As the market is still developing,
it is still too early to determine the level of competition or the size of the
market. Several of our competitors in the audio copy protection and rights
management market, including SunnComm, Sony, and MidBar, have participated in
early market trials with one or more major record labels. New competitors or
alliances among competitors may emerge and rapidly acquire significant market
share in any of these areas. Our competitors may be able to respond more quickly
to new or emerging technologies and changes in customer requirements than we do,
which could reduce demand for our products or render them obsolete.
INVESTMENT RISKS
THE PRICE OF OUR COMMON STOCK MAY BE VOLATILE.
The market price of our common stock has been, and in the future could be,
significantly affected by factors such as:
o actual or anticipated fluctuations in operating results;
o announcements of technical innovations;
o new products or new contracts;
o competitors or their customers;
o governmental regulatory action;
25
o developments with respect to patents or proprietary rights;
o changes in financial estimates by securities analysts; and
o general market conditions.
In addition, announcements by the Motion Picture Association of America or
its members, satellite television operators, cable television operators or
others regarding motion picture production or distribution, consumer companies'
business combinations, evolving industry standards or other developments could
cause the market price of our common stock to fluctuate substantially.
Further, even with the recent decline in the trading prices of the stocks
of technology companies many of those companies continue to reflect
price/earnings ratios above historical levels. There can be no assurance that
these trading prices and price/earnings ratios will be sustained. In the past,
following periods of volatility in the market price of a company's securities,
some companies have been named in class action suits.
WE UTILIZE PRO FORMA REPORTING IN OUR QUARTERLY EARNINGS PRESS RELEASES.
Since the third quarter of 1999, we have published pro forma results in
our quarterly earnings press releases. In each such earnings release, we have
included a reconciliation of pro forma earnings to earnings compiled in
accordance with Generally Accepted Accounting Principles ("GAAP"). The
reconciling items have adjusted GAAP net income and GAAP earnings per share for
certain non-cash, non-operating or non-recurring items and are described in
detail in each such quarterly earnings press release. We believe that this
presentation may be useful to the investment community in analyzing the results
of operations. We have not included any such pro forma earnings or
reconciliation to GAAP earnings in this annual report. The market price of our
stock may fluctuate based on future pro forma results. Pro forma reporting by
public companies continues to be questioned by the Securities and Exchange
Commission. If we decide to or were required to curtail this pro forma
presentation in our quarterly earnings press releases, the market price of our
stock could be affected.
ITEM 2. PROPERTIES.
We are in the process of consolidating our offices in Sunnyvale,
California and San Jose, California. As of March 4, 2002, our principal
operations have relocated to an 86,785 square foot building in Santa Clara,
California. All U.S. sales, marketing and technical personnel for all product
divisions (video copy protection, electronic license management and consumer
software copy protection and rights management) are now in one location. The
lease for the building expires on January 31, 2012, with the right to renew the
lease for an additional five years. The size of the building, along with our
rights of first negotiation for two adjacent office spaces, should be adequate
for our present and future needs.
We have a leased sales office in Burlington, Massachusetts. We also lease
space for sales, marketing and technical staff in South Ruislip, Woodley and
Cheshire in the United Kingdom and in Tokyo, Japan, Hong Kong and Taipei,
Taiwan.
The process of consolidating our two California offices will result in
increased property rental costs as well as a temporary disruption to the
business.
ITEM 3. LEGAL PROCEEDINGS.
We are involved in legal proceedings related to some of our intellectual
property rights.
Krypton Co., Ltd., a Japanese company, filed an invalidation claim against
one of our copy protection patents in Japan. After a hearing in March 1999, the
Japanese Patent Office recommended that our patent be invalidated. On December
27, 1999, we submitted to the Tokyo High Court a written statement indicating
that the decision of invalidity of our patent should be overturned. In February
2000, a second round of preparatory proceedings was conducted before the Tokyo
High Court, with Oral Arguments in March 2000. In its ruling on March 21, 2000,
the Tokyo High Court revoked the Japanese Patent Office's decision. In
connection with this ruling, the scope of our claims under the patent was
slightly reduced, but this is not expected to have a material adverse effect on
the value of this patent to our business. In short, the patent remains valid and
part of our business. On November 22, 2000, Krypton made an appeal in the Tokyo
26
High Court regarding its earlier decision. We have been involved in several
preparatory proceedings and are seeking that the Tokyo High Court reaffirm its
earlier decision. Even if an adverse ruling ultimately is reached on this
invalidation claim, this would not have a material adverse effect on our
business.
We initiated a patent infringement lawsuit in the District Court of
Dusseldorf in March 1999 against Vitec Audio und Video GmbH, a German company
that manufactures what we believe to be a video copy protection circumvention
device. Vitec filed a reply brief arguing that its product does not infringe our
patents. The case was heard in the District Court of Dusseldorf, Germany. The
District Court of Dusseldorf ruled adversely against us. We appealed the
District Court's ruling in July 2000 to the Court of Appeal in Dusseldorf. A
hearing took place in front of the Court of Appeal in Dusseldorf on August 23,
2001 in which the Court stated that because the appeal involves complex
technical subject matter, the Court will require technical expert witnesses. The
Court solicited us for a list of experts that the Court can call on to serve as
expert witnesses. We submitted a list of experts in the area of analog video
copy protection to the Court on October 5, 2001. The selection of the Court's
expert witnesses is pending. In the event of an adverse ruling, we may incur a
corresponding decline in demand for our video copy protection technology, which
could harm our business in Germany.
In November 1997, GLOBETROTTER filed a patent infringement lawsuit (Case
No. C-98-20419-JF/EAI) in the Federal District Court for the Northern District
of California against Elan Computer Group and its founder, Ken Greer, alleging
infringement of one of its patents and unfair competition and trade practices.
In March 1998, Rainbow Technologies North America, Inc. entered into an
agreement to purchase certain assets of Elan and entered into a litigation
cooperation agreement with Elan regarding the pending GLOBETROTTER litigation.
On or around September 1998, GLOBETROTTER filed a patent infringement suit
against Rainbow Technologies, which was subsequently consolidated with the
action against Elan Computer Group and Ken Greer. Rainbow Technologies and Ken
Greer filed separate counterclaims against GLOBETROTTER and its founder, Matthew
Christiano, alleging antitrust violations, unfair competition, tortious
interference with business relations, and trade libel. Rainbow Technologies and
Ken Greer are seeking compensatory damages, punitive damages, injunctive relief,
and disgorgement of profits. GLOBETROTTER intends to defend the allegations in
the counterclaim vigorously. The patent infringement case was bifurcated from
the counterclaims. In October 1999, Judge Fogel granted the motion for partial
summary judgment for non-infringement of claims 55-59 which was filed by Rainbow
Technologies based on Judge Fogel's claim construction order. On August 31,
2000, we acquired GLOBETROTTER. In January 2001, the Court of Appeals for the
Federal Circuit affirmed the denial of our motion for preliminary injunction by
agreeing with the District Court's claim construction of requiring a user ID as
part of the claimed invention. In February 2001, Rainbow et al. filed a summary
judgment motion to dismiss our patent infringement suit. We filed an opposition
brief and a request for leave to file a reconsideration motion to the dismissal
of claims 55-59 in light of newly discovered evidence. At the hearing on March
19, 2001, Judge Fogel granted our request and agreed to rule on the
reconsideration motion before making a ruling on the summary judgment motion.
The reconsideration motion was argued before the court on July 23, 2001. In a
ruling on September 24, 2001, Judge Fogel denied our reconsideration motion and
granted the partial summary judgment motion by Rainbow et al. The granting of
the partial summary judgment motion by Rainbow et al. means that the patent
infringement case against Rainbow et al. is essentially dismissed. We plan to
appeal. Based on the information available at this time, it is not anticipated
that the adverse ruling of partial summary judgment will have a material adverse
effect on our consolidated financial position, results of operation or cash
flow. We still have unfair competition & trade practices cause of actions
against Rainbow et al. The stay of discovery on the counterclaims has been
lifted and witness depositions have commenced. On January 18, 2002, we filed a
motion to dismiss some of the counterclaims from Rainbow et al. On February 25,
2002, Judge Fogel held a hearing on our motion to dismiss and our motion to
dismiss was granted. The trial for the remaining counterclaims is scheduled for
September 9, 2002. If an adverse ruling is ultimately reached on the remaining
counterclaims, significant monetary damages may be levied against us.
On October 23 2001, Digimarc filed a patent infringement suit in the
United States District Court, District of Oregon against Verance Corporation
alleging infringement of certain patents owned by Digimarc. Verance's answer and
counterclaim included allegations of patent infringement and antitrust
counterclaims, including allegations that Digimarc conspired with Macrovision to
keep Verance out of the DVD CCA bidding process for selection of a digital
watermarking copy protection technology. We are informed and believe that
Verance's second amended cross-complaint was filed on or about March 25, 2002,
and specifically named us as a cross-defendant in connection with our bid to the
DVD CCA as one of the VWM Companies. In the event Verance succeeds on its
cross-claims, we may be subject to significant monetary damages as well as be
precluded from licensing the VWM Companies' jointly developed digital media copy
protection technology.
As of December 31, 2001, it is not possible to estimate the liability, if
any, in connection with these matters. Accordingly, no accruals for these
contingencies have been recorded.
27
From time to time we have been involved in other disputes and legal
actions arising in the ordinary course of business. In management's opinion,
none of these other disputes and legal actions is expected to have a material
impact on our consolidated financial position, results of operation or cash
flow.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
We did not submit any matters to a vote of security holders during the
quarter ended December 31, 2001.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) Our common stock has been traded on the Nasdaq National Market under
the symbol "MVSN" since our initial public offering on March 13, 1997. The
following table sets forth, for the periods indicated, the reported high and low
split adjusted closing prices for our common stock. There have been two 2-for-1
stock splits, one in August 1999 and the other in March 2000. All share and per
share information presented have been retroactively adjusted for the effect of
both such stock splits.
HIGH LOW
---- ---
2000
- ----
First Quarter $ 86.125 $ 30.250
Second Quarter $ 77.000 $ 35.625
Third Quarter $107.000 $ 68.062
Fourth Quarter $ 80.375 $ 39.218
2001
- ----
First Quarter $ 75.810 $ 34.500
Second Quarter $ 68.500 $ 36.750
Third Quarter $ 71.310 $ 28.410
Fourth Quarter $ 39.920 $ 23.720
As of March 15, 2002, there were 102 holders of record of our common
stock, based upon information furnished by EquiServe, the transfer agent for our
securities. We believe, based upon security positions listings, that there are
more than 10,600 beneficial owners of our common stock. As of March 15, 2002,
there were 51,010,376 shares of common stock outstanding.
We have not declared or paid any cash dividends on our common stock since
1994. We do not anticipate paying any cash dividends on our common stock in the
foreseeable future. We intend to retain all earnings for use in our business
operations and in expansion.
28
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected consolidated financial data and
other operating information. On August 31, 2000, we completed our acquisition of
GLOBETROTTER Software, Inc. The transaction has been accounted for using the
"pooling of interests" method. As a result, the consolidated financial
statements for periods prior to the combination have been restated to include
the accounts and results of operations of GLOBETROTTER. The data have been
derived from the combination of Macrovision's and GLOBETROTTER'S audited
financial statements as of and for the years ended December 31, 2001, 2000, 1999
and 1998, Macrovision's audited financial statements as of and for the year
ended December 31, 1997 and GLOBETROTTER's unaudited financial statements as of
and for the year ended December 31, 1997, which, in the opinion of management,
have been prepared on substantially the same basis as the audited consolidated
financial statements, and include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the data. The
financial data and other operating information do not purport to indicate
results of operations as of any future date or for any future period. The
financial data and operating information is derived from our consolidated
financial statements and should be read in conjunction with the consolidated
financial statements, related notes and other financial information included
herein.
Year Ended December 31,
--------------------------------------------
2001 2000 1999 1998 1997
------- ------- ------- ------- --------
(in thousands, except per share data)
Consolidated Statements of Income Data:
Net revenues $98,813 $80,116 $52,076 $36,446 $ 31,063
------- ------- ------- ------- --------
Costs and expenses:
Cost of revenues 5,848 5,425 4,885 2,435 2,693
Research and development 9,285 7,822 6,463 4,072 3,541
Selling and marketing 18,138 15,037 12,713 9,652 8,857
General and administrative 13,245 12,717 7,169 7,437 6,285
Amortization of goodwill and other intangibles
from acquisitions (1) 10,870 4,878 1,600 -- --
Amortization of deferred stock-based compensation(2) 9,591 15,533 -- -- --
In-process research and development (3) -- -- 4,285 -- --
Restructuring expenses 2,214 -- -- -- --
------- ------- ------- ------- --------
Total costs and expenses 69,191 61,412 37,115 23,596 21,376
------- ------- ------- ------- --------
Operating income 29,622 18,704 14,961 12,850 9,687
Impairment losses on investments 6,860 -- -- -- --
Interest and other income (expense), net 10,397 10,714 1,634 1,179 480
------- ------- ------- ------- --------
Income before income taxes 33,159 29,418 16,595 14,029 10,167
Income taxes 13,974 15,825 4,108 4,020 2,447
------- ------- ------- ------- --------
Net income 19,185 13,593 12,487 10,009 7,720
Preferred stock dividends -- -- -- -- (156)
------- ------- ------- ------- --------
Net income available to common stockholders $19,185 $13,593 $12,487 $10,009 $ 7,564
======= ======= ======= ======= ========
Basic earnings per share $ 0.38 $ 0.28 $ 0.28 $ 0.25 $ 0.22
======= ======= ======= ======= ========
Shares used in computing basic earnings per share (1)
50,216 49,135 45,031 40,850 34,739
======= ======= ======= ======= ========
Diluted earnings per share $ 0.37 $ 0.26 $ 0.27 $ 0.23 $ 0.21
======= ======= ======= ======= ========
Shares used in computing diluted earnings per share(1) 51,746 51,386 47,096 43,046 36,675
======= ======= ======= ======= ========
(1) See Note 1 of Notes to Consolidated Financial Statements
(2) The allocation of the amortization of deferred stock-based compensation
relates to the expense categories as set forth in the table below
(3) In connection with the purchase of C-Dilla, Ltd. in June 1999, we
allocated and expensed $4.3 million of the purchase price to in-process
research and development projects.
29
Year Ended December 31,
-------------------------------------
2001 2000 1999 1998 1997
------- ------- ----- ----- -----
AMORTIZATION OF DEFERRED STOCK-BASED
COMPENSATION EXPENSE: (in thousands)
Cost of revenues $ 468 $ 428 $ -- $ -- $ --
Research and development 1,999 3,064 -- -- --
Selling and marketing 5,219 10,645 -- -- --
General and administrative 1,905 1,396 -- -- --
------- ------- ----- ----- -----
$ 9,591 $15,533 $ -- $ -- $ --
======= ======= ===== ===== =====
December 31,
------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
CONSOLIDATED BALANCE SHEET DATA: (in thousands)
Cash, cash equivalents, short and
long term investments $231,048 $217,441 $ 36,162 $ 27,483 $ 13,761
Working capital 144,676 123,895 38,860 29,431 15,969
Total assets 342,869 296,438 132,690 70,530 33,491
Long-term obligations, net of
current portion 33 56 133 367 476
Total stockholders' equity 318,200 275,975 102,273 60,292 25,306
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE FOLLOWING COMMENTARY SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL
STATEMENTS AND RELATED NOTES CONTAINED ELSEWHERE IN THE FORM 10-K. THE
DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. THESE STATEMENTS RELATE TO FUTURE EVENTS OR OUR FUTURE FINANCIAL
PERFORMANCE. IN SOME CASES, YOU CAN IDENTIFY THESE FORWARD-LOOKING STATEMENTS BY
TERMINOLOGY SUCH AS "MAY," "WILL," "SHOULD," "EXPECT," "PLAN," "ANTICIPATE,"
"BELIEVE," "ESTIMATE," "PREDICT," "POTENTIAL," "INTEND," OR "CONTINUE," AND
SIMILAR EXPRESSIONS. THESE STATEMENTS ARE ONLY PREDICTIONS. OUR ACTUAL RESULTS
MAY DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS
AS A RESULT OF A VARIETY OF FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE SET
FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS FORM 10-K.
OVERVIEW
We were founded in 1983 to develop copy protection and video security
solutions for major motion picture studios and independent video producers. Our
initial products were designed to prevent the unauthorized duplication and
distribution of videocassettes. We have expanded our copy protection
technologies to address the unauthorized copying and distribution of DVDs,
digital PPV programs and consumer software. We derive royalty-based licensing
revenue from multiple sources, including video content owners, consumer software
publishers, hardware manufacturers, digital set-top box manufacturers, digital
PPV system operators and commercial replicators/duplicators. In 2000, we entered
the market for Electronic License Management, ("ELM") solutions for software
vendors and software asset management tools for business through the acquisition
of GLOBETROTTER Software Inc.
The following table provides net revenues information by product line
(dollars in thousands):
YEAR ENDED DECEMBER 31,
-------------------------------
2001 2000 1999
------- ------- -------
Video Copy Protection:
DVD $37,610 $20,867 $ 8,629
Videocassette 11,509 12,899 15,877
Pay-Per-View 13,207 15,062 7,477
Consumer Software Copy Protection 10,062 8,372 4,754
Electronic License Management Software 25,643 21,770 14,686
Other 782 1,146 653
------- ------- -------
Total $98,813 $80,116 $52,076
======= ======= =======
30
The following table provides percentage of net revenue information by
product line:
YEAR ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------ ------ ------
Video Copy Protection:
DVD 38.0% 26.0% 16.6%
Videocassette 11.6 16.1 30.5
Pay-Per-View 13.4 18.8 14.4
Consumer Software Copy Protection 10.2 10.5 9.1
Electronic License Management Software 26.0 27.2 28.2
Other 0.8 1.4 1.2
------ ------ ------
Total 100.0% 100.0% 100.0%
====== ====== ======
VIDEO COPY PROTECTION.
Our customers have included the home video divisions of members of the
Motion Picture Association of America, more than 500 videocassette duplication
companies and a number of low volume content owners, such as independent
producers of exercise, sports, educational, documentary and corporate
videocassettes. We typically receive per unit royalties based upon the number of
copy protected videocassettes or DVDs that are produced by Motion Picture
Association of America studios or other content owners. Royalties from Motion
Picture Association of America studios represented a significant portion of such
fees in 2001, 2000 and 1999.
DVD COPY PROTECTION. In 1997, we introduced copy protection for DVDs. Our
customers have included members of the Motion Picture Association of America and
"Special Interest" rights owners. Our customers pay per unit royalties for DVD
copy protection. Additionally, we derive annual license fees from DVD hardware
manufacturers. DVD copy protection revenue represented 38.0%, 26.0% and 16.6% of
our net revenues in 2001, 2000 and 1999, respectively. The increase in DVD copy
protection revenue is due to the increase in numbers of DVDs sold and continued
strong demand for our DVD copy protection solution.
VIDEOCASSETTE COPY PROTECTION. As expected, in 2001 our videocassette copy
protection revenues continued to decline, reflecting the continuing trend for
Hollywood studios to invest proportionally more in copy protecting their DVD
titles compared to VHS releases. Videocassette copy protection revenues
represented 11.6%, 16.1% and 30.5% of our net revenues in 2001, 2000 and 1999,
respectively. We believe videocassette copy protection revenues will continue to
decline as a percentage of our revenues and in absolute terms, as the studios
focus more of their resources on the DVD business line.
PPV COPY PROTECTION. In 1993, we introduced copy protection for digital
PPV to satellite and cable system operators and to the equipment manufacturers
that supply the satellite and cable industries. We derive digital PPV copy
protection revenues from hardware royalties, up-front license fees, and PPV
programming royalties. Digital PPV revenues were 13.4%, 18.8% and 14.4% of our
net revenues in 2001, 2000 and 1999, respectively. Our agreements with digital
PPV system operators entitle us to transaction-based royalty payments when copy
protection for digital PPV programming is activated. To date, such
transaction-based royalty payments have not been significant. The decrease in
our PPV copy protection revenues is due to the overall slowdown in the worldwide
market for digital set top boxes.
CONSUMER SOFTWARE COPY PROTECTION AND RIGHTS MANAGEMENT
In 1998, we made a minority equity investment in C-Dilla, Ltd. (Woodley,
UK) and entered into a Software Marketing License and Development Agreement. In
June 1999, we acquired the remaining shares of C-Dilla for approximately $12.8
million in cash, 218,398 shares of our common stock then valued at $5.1 million
and stock option grants of Macrovision stock then valued at $1.8 million. In
September 1998, in conjunction with C-Dilla, we introduced our CD-ROM consumer
software copy protection technology, called SafeDisc. Customers implementing
SafeDisc include major PC game and educational software publishers. Due to
increased market acceptance of our solution, we expect revenues from Consumer
Software Copy Protection to increase in 2002. We typically receive license fees
based upon the number of copy protected CD-ROMs that are produced by PC game and
educational software publishers. Consumer software copy protection revenues
represented 10.2%, 10.5% and 9.1% of our net revenues in 2001, 2000 and 1999,
respectively.
31
ELECTRONIC LICENSE MANAGEMENT SOFTWARE
In August 2000, we acquired GLOBETROTTER Software, Inc., a leading
supplier of electronic licensing and license management technology to software
vendors and supplier of software asset management products to corporate
customers. We issued 8,944,548 shares of our common stock in exchange for all
the outstanding common stock of GLOBETROTTER. The transaction has been accounted
for using the "pooling of interests" method. As a result, the consolidated
financial statements for periods prior to the combination have been restated to
include the accounts and results of operations of GLOBETROTTER Software, Inc.
GLOBETROTTER generates its revenue from licensing its software and providing
services related to the support and maintenance of this software. Revenues from
this business segment were 26.0%, 27.2% and 28.2% of our net revenues in 2001,
2000 and 1999, respectively. Major software vendors have experienced
deteriorating economic conditions as corporate customers have reduced capital
expenditures. Demand for our technology is driven, to some degree, by end user
demand for software applications. If economic conditions for software vendors
continue to be difficult, demand for our ELM technology could decline.
COSTS AND EXPENSES
Our cost of revenues consists primarily of service fees paid to licensed
duplicators and replicators that produce videocassettes, DVDs and CD-ROMs for
content owners, costs of equipment used to apply our technology and royalties
due C-Dilla based on revenues from copy protection of CD-ROMs prior to our June
1999 acquisition. Also included in cost of revenues are software product
support, patent defense costs and patent amortization. Our research and
development expenses are comprised primarily of employee compensation and
benefits, consulting fees, tooling and supplies and an allocation of facilities
costs. Our selling and marketing expenses are comprised primarily of employee
compensation and benefits, consulting and recruiting fees, travel, advertising
and an allocation of facilities costs. Our general and administrative expenses
are comprised primarily of employee compensation and benefits, consulting and
recruiting fees, travel, professional fees and an allocation of facilities
costs.
We have experienced significant seasonality in our business, and our
financial condition and results of operations are likely to be affected by
seasonality in the future. We have typically experienced our highest revenues in
the fourth quarter of each calendar year followed by lower revenues and
operating income in the first quarter, and at times in subsequent quarters, of
the following year. We believe that this trend has been principally due to the
tendency of certain of our customers to release new video and consumer software
titles during the year-end holiday shopping season, while our operating expenses
are incurred more evenly throughout the year. We anticipate that revenues from
our electronic license management business may also reflect a similar seasonal
trend. In addition, revenues tend to be lower in the summer months, particularly
in Europe.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the U.S.
The preparation of these financial statements requires management to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to revenue recognition, bad debts, investments, intangible assets and
income taxes. Our estimates are based on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances.
Actual results may differ from these estimates under different assumptions or
conditions.
We have identified the accounting policies below as critical to our
business operations and the understanding of our results of operations.
REVENUE RECOGNITION AND COST OF REVENUE
Our revenue recognition policy is detailed in Note 1 of the Notes to the
Audited Consolidated Financial Statements. Management has made significant
judgments related to revenue recognition; specifically, evaluating whether our
fee relating to an arrangement is fixed or determinable and assessing whether
collectibility is probable. These judgments are discussed below.
32
FEE IS FIXED OR DETERMINABLE. In order to recognize revenue, we must make
a judgment as to whether our fee is fixed or determinable. Except in cases where
we grant extended payment terms to a specific customer, we have determined our
fees are fixed or determinable at the inception of our arrangements based on the
following:
o The fee our customers pay for our products is negotiated at the
outset of an arrangement, and is generally based on the specific
volume of products to be delivered.
o Our license fees are not a function of variable-pricing mechanisms
or retail market success of our customers such as the number of
units distributed or copied by the customer, or the expected number
of users of the product delivered.
Our customary payment terms are such that 100% of the arrangement fee is
due within one year or less. These customary payment terms are supported by
historical practice and concessions have not been granted to customers under
this policy. Arrangements with payment terms extending beyond the customary
payment terms are considered not to be fixed or determinable. Revenue from such
arrangements is recognized when amounts become due and payable.
COLLECTIBILITY IS PROBABLE. In order to recognize revenue, we must make a
judgment of the collectibility of our fee. Our judgment of the collectibility is
applied on a customer-by-customer basis pursuant to our credit review policy. We
typically sell to customers for which there is a history of successful
collection. New customers are subjected to a credit review process, which
evaluates the customers' financial positions and ability to pay. New customers
are typically assigned a credit limit based on a formulated review of their
financial position. Such credit limits are only increased after a successful
collection history with the customer has been established. If it is determined
from the outset of an arrangement that collectibility is not probable based upon
our credit review process, revenue is recognized on a cash-collected basis.
VALUATION OF STRATEGIC INVESTMENTS
As of December 31, 2001, the adjusted cost of our strategic investments
totaled $58.1 million. We review our investments in non-public companies and
estimate the amount of any impairment incurred during the current year based on
specific analysis of each investment, considering the activities of and events
occurring at each of the underlying portfolio companies during the period. Our
portfolio companies operate in industries that are rapidly evolving and
extremely competitive. For equity investments in non-public companies for which
there is no market where their value is readily determinable, we review each
investment for indicators of impairment on a regular basis based primarily on
achievement of business plan objectives and current market conditions, among
other factors. The primary business plan objectives we consider include, among
others, those related to financial performance such as liquidity, achievement of
planned financial results or completion of capital raising activities, and those
that are not primarily financial in nature such as the launching of technology
or the hiring of key employees. If it is determined that an impairment has
occurred with respect to an investment in a portfolio company, in the absence of
quantitative valuation metrics, management estimates the impairment and/or the
net realizable value of the portfolio investment based on public- and
private-company market comparable information, valuations completed for
companies similar to our portfolio companies, or latest valuations from most
recent financing rounds. Future adverse changes in market conditions or poor
operating results of underlying investments could result in losses or an
inability to recover the current carrying value of the investments thereby
requiring further impairment charges in the future. Based on these measurements,
$6.9 million in impairment losses were recorded during the year ended December
31, 2001.
VALUATION OF INTANGIBLE ASSETS
Intangible assets, net of accumulated amortization, totaled $25.0 million
as of December 31, 2001. We periodically evaluate our intangible assets for
indications of impairment whenever events or changes in circumstances indicate
that the carrying value may not be recoverable. Intangible assets include
goodwill, purchased technology, workforce, non-compete agreements and customer
base. Factors we consider important which could trigger an impairment review
include significant under-performance relative to expected historical or
projected future operating results, significant changes in the manner of our use
of the acquired assets or the strategy for our overall business or significant
negative industry or economic trends. If this evaluation indicates that the
value of the intangible asset may be impaired, an evaluation of the
recoverability of the net carrying value of the asset over its remaining useful
life is made. If this evaluation indicates that the intangible asset is not
recoverable, based on the estimated undiscounted future cash flows of the entity
or technology acquired over the remaining amortization period, the net carrying
value of the related intangible asset will be reduced to fair value and the
remaining amortization period may be adjusted. Any such impairment charge could
be significant and could have a material adverse effect on our financial
position and results of operations if and when an
33
impairment charge is recorded. If an impairment charge is recognized, the
amortization related to goodwill and other intangible assets would decrease
during the remainder of the fiscal year. No impairment charges for intangible
assets were recorded during the current year based on these measurements.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Management estimates the collectibility of our accounts receivable on an
account-by-account basis. We record an increase in the allowance for doubtful
accounts when the prospect of collecting a specific account receivable becomes
doubtful. In addition, we establish a non-specific reserve for all accounts
receivable aged greater than 90 days, using a specified percentage of the
outstanding balance of all such accounts based on historical bad debt loss
experience. Management specifically analyzes accounts receivable and historical
bad debts experience, customer creditworthiness, current economic trends takes,
international situations (such as currency devaluation), and changes in our
customer payment terms when evaluating the adequacy of the allowance for
doubtful accounts. If the financial condition of our customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. There has been little fluctuation in the
allowance for doubtful accounts other than growth associated with the overall
growth of our revenues.
INCOME TAXES
Our effective tax rate is directly affected by the relative proportions of
domestic and international revenue and income before taxes. We are also subject
to changing tax laws in the multiple jurisdictions in which we operate. As of
December 31, 2001, deferred tax assets net of a $1.4 million valuation
allowance, totaled $5.8 million. Deferred tax assets, related valuation
allowances and deferred tax liabilities are determined separately by tax
jurisdiction. The Company believes sufficient uncertainty exists regarding its
ability to realize its deferred tax assets in certain foreign jurisdictions and,
accordingly, a valuation allowance has been established against the deferred tax
assets in those jurisdictions. We believe that it is more likely than not that
the results of future operations will generate sufficient taxable income to
utilize these deferred tax assets, net of valuation allowance. While we have
considered future taxable income and ongoing prudent and feasible tax planning
strategies in assessing the need for any valuation allowance, in the event we
were to determine that we will be able to realize our deferred tax assets in the
future in excess of the net recorded amount, an adjustment to the deferred tax
asset would increase income in the period such determination was made. Likewise,
should we determine that we would not be able to realize all or part of our net
deferred tax asset in the future, an adjustment to the deferred tax asset would
be charged to income in the period such determination was made.
RESULTS OF OPERATIONS
The following table sets forth selected consolidated statements of income
data expressed as a percentage of net revenues for the periods indicated:
YEAR ENDED DECEMBER 31,
--------------------------
2001 2000 1999
------ ------ ------
Net revenues 100.0% 100.0% 100.0%
------ ------ ------
Costs and expenses:
Cost of revenues 5.9 6.8 9.4
Research and development 9.4 9.8 12.4
Selling and marketing 18.4 18.8 24.4
General and administrative 13.4 15.9 13.8
Amortization of goodwill and other intangibles from acquisitions 11.0 6.0 3.1
Amortization of deferred stock-based compensation 9.7 19.4 --
In-process research and development -- -- 8.2
Restructuring expenses 2.2 -- --
------ ------ ------
Total costs and expenses 70.0 76.7 71.3
------ ------ ------
Operating income 30.0 23.3 28.7
Impairment losses on investments 7.0 -- --
Interest and other income, net 10.5 13.4 3.1
------ ------ ------
Income before income taxes 33.5 36.7 31.8
Income taxes 14.1 19.7 7.8
------ ------ ------
Net income 19.4% 17.0% 24.0%
====== ====== ======
34
COMPARISON OF YEARS ENDED DECEMBER 31, 2001 AND 2000
The following table provides revenue information by specific product
segments for the periods indicated (dollars in thousands):
YEAR ENDED DECEMBER 31,
-----------------------
$ %
2001 2000 CHANGE CHANGE
-------- -------- -------- ------
Video Copy Protection
DVD $ 37,610 $ 20,867 $ 16,743 80.2%
Videocassette 11,509 12,899 (1,390) (10.8)
Pay-Per-View 13,207 15,062 (1,855) (12.3)
Consumer Software Copy Protection 10,062 8,372 1,690 20.2
Electronic License Management Software 25,643 21,770 3,873 17.8
Other 782 1,146 (364) (31.8)
-------- -------- --------
Total Net Revenue $ 98,813 $ 80,116 $ 18,697 23.3%
======== ======== ========
NET REVENUES. Our net revenues for 2001 increased 23.3% from $80.1 million
in 2000 to $98.8 million in 2001. DVD copy protection revenues increased $16.7
million or 80.2% from $20.9 million in 2000 to $37.6 million in 2001, due to the
continued strong growth of the DVD format and our continued high penetration
among Hollywood studio customers. Revenues from videocassette copy protection
decreased $1.4 million or 10.8% from $12.9 million in 2000 to $11.5 million in
2001, reflecting the continuing trend for Hollywood studios to invest more
proportionally in copy protecting their DVD titles compared to VHS releases.
Digital PPV copy protection revenues decreased $1.9 million or 12.3% from $15.1
million in 2000 to $13.2 million in 2001 due to the continued softness in
digital set top box market. Consumer Software Division revenues increased $1.7
million or 20.2% from $8.4 million in 2000 to $10.1 million in 2001 due to the
increased market penetration in our SafeDisc business. Revenues from our
GLOBETROTTER Software Division increased $3.9 million or 17.8% from $21.8
million in 2000 to $25.6 million in 2001 primarily due to increased market
penetration despite the difficult economic environment for enterprise software.
Other revenue decreased $364,000 or 31.8% from $1.1 million in 2000 to $782,000
in 2001, primarily from the decrease in royalties from our pay TV analog
scrambling technology shipments into Brazil by one of our licensees.
COST OF REVENUES. Cost of revenues as a percentage of net revenues
decreased from 6.8% for 2000 to 5.9% for 2001. This decrease was primarily due
to the higher level of revenues in 2001 from royalties and license fees from our
video copy protection business. Cost of revenues increased $423,000 from $5.4
million in 2000 to $5.8 million in 2001 primarily due to higher volumes of
replication associated with higher revenue levels as DVD copy protection
revenues increased from 26% of net revenues in 2000 to 38% in 2001. The increase
was also slightly offset by a decrease in patent related costs. Cost of revenues
includes items such as product costs, duplicator and replicator fees, video copy
protection processor costs, patent amortization, patent defense costs and
royalty expenses related to the purchase of the assets and liabilities of
Productivity through Software plc ("PtS"). We anticipate gross margin may
increase as a result of increases in royalties and license revenues.
RESEARCH AND DEVELOPMENT. Research and development expenses increased by
$1.5 million or 18.7% from $7.8 million in 2000 to $9.3 million in 2001. The
increase is primarily due to research and development activities in our Video
Technology, Consumer Software and GLOBETROTTER Software Divisions. Research and
development expenses decreased as a percentage of net revenues from 9.8% in 2000
to 9.4% in 2001. We expect research and development expenses to increase in
absolute terms over the prior year periods as a result of expected increases in
research and development activity as we develop new technologies across all our
business areas.
SELLING AND MARKETING. Selling and marketing expenses increased by $3.1
million or 20.6% from $15.0 million in 2000 to $18.1 million in 2001. This
increase was primarily due to increased headcount. Selling and marketing
expenses decreased as a percentage of net revenues from 18.8% in 2000 to 18.4%
in 2001. Selling and marketing expenses are
35
expected to increase in absolute terms over the prior year periods as we
continue to expand our efforts in selling and marketing consumer software,
electronic license management software and other digital rights management
products.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
by $528,000 or 4.2% from $12.7 million in 2000 to $13.2 million in 2001,
primarily due to increased headcount. General and administrative expenses
decreased as a percentage of net revenues from 15.9% in 2000 to 13.4% in 2001.
General and administrative expenses are expected to increase in absolute terms
over the prior periods as we continue to expand our administrative support
infrastructure to serve a larger, more diversified business.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES FROM ACQUISITIONS. We
amortize intangibles relating to the acquisition of C-Dilla, in June of 1999, on
a straight-line basis over three to seven years based on expected useful lives
of existing products and technologies, retention of workforce, non-compete
agreements and goodwill. We amortized $3.0 million in each of 2001 and 2000
related to goodwill and other intangibles from the acquisition of C-Dilla.
In October 2000, we acquired certain assets of Manchester (UK) based
Productivity through Software plc ("PtS"). We paid approximately $23.3 million
in cash and related acquisition costs, and assumed liabilities to service
current customer maintenance contracts. We were subject to an additional maximum
payment of $2.8 million contingent upon the business meeting certain
predetermined revenue targets within one year of the acquisition. During the
years ended December 31, 2001 and 2000, we paid $1.2 million and $200,000 of
contingent consideration costs, respectively. The purchase price was allocated
to employee retention, PtS's customer base and other goodwill. We amortize these
intangibles on a straight-line basis over three years. Excluding cumulative
translation adjustments, goodwill and other intangibles associated with the
transaction amounted to $24.7 million as of December 31, 2001. We amortized $7.9
million and $1.9 million in 2001 and 2000, respectively. In accordance with new
accounting guidance, Statement of Financial Accounting Standards No. ("SFAS")
142, "GOODWILL AND OTHER INTANGIBLE ASSETS", goodwill and workforce in place
will not amortize beginning in fiscal year 2002. These assets will be assessed
for impairment at least on an annual basis.
AMORTIZATION OF DEFERRED STOCK-BASED COMPENSATION. In connection with the
acquisition of GLOBETROTTER, approximately 783,742 GLOBETROTTER employee stock
options were exchanged for Macrovision stock options, resulting in a deferred
stock-based compensation charge of approximately $37.9 million. The amortization
of the deferred stock-based compensation for 2001 and 2000 was $9.6 million and
$15.5 million, respectively. The expense associated with this stock-based
compensation will continue to result in substantial non-cash compensation
charges to future earnings.
RESTRUCTURING EXPENSES. During the fourth quarter of 2001, we eliminated
redundant positions relating to legacy businesses and consolidated certain
administrative functions. This reprofiling affected less than 10% of our
employees and resulted in a non-recurring charge of $2.2 million. The charge
consisted of cash severance payments and non-cash compensation expense relating
to the accelerated vesting of certain stock options.
IMPAIRMENT LOSSES ON INVESTMENTS. During 2001, we recorded charges
totaling $6.9 million, relating to other than temporary impairment of certain
strategic investments.
INTEREST AND OTHER INCOME, NET. Interest and other income decreased
$317,000 or 3% from $10.7 million in 2000 to $10.4 million in 2001, primarily
from declining interest rates and lower interest bearing investment balances as
we increased our minority equity investments.
INCOME TAXES. We recorded income taxes of $14.0 million and $15.8 million
for 2001 and 2000, respectively. Income tax expense represents combined federal
and state taxes at effective rates of 42.1% and 53.8% for 2001 and 2000,
respectively. The decrease in the effective tax rate was due to changes in our
international operations resulting in a shift of our taxable income to more
favorable tax jurisdictions and also due to a reduction in the amortization of
deferred stock-based compensation, which is not tax deductible.
36
COMPARISON OF YEARS ENDED DECEMBER 31, 2000 AND 1999
The following table provides revenue information by specific product
segments for the periods indicated (dollars in thousands):
Years ended December 31,
------------------------
$ %
2000 1999 Change Change
-------- -------- -------- ------
Video Copy Protection
DVD $ 20,867 $ 8,629 $ 12,238 141.8
Videocassette 12,899 15,877 (2,978) (18.8)%
Pay-Per-View 15,062 7,477 7,585 101.4
Consumer Software Copy Protection 8,372 4,754 3,618 76.1
Electronic License Management Software 21,770 14,686 7,084 48.2
Other 1,146 653 493 75.5
-------- -------- --------
Total $ 80,116 $ 52,076 $ 28,040 53.8%
======== ======== ========
NET REVENUES. Our net revenues for 2000 increased 53.8% from $52.1 million
in 1999 to $80.1 million in 2000. Revenues from videocassette copy protection
decreased $3.0 million or 18.8% from $15.9 million in 1999 to $12.9 million in
2000, reflecting the continuing trend for Hollywood studios to invest more
proportionally in copy protecting their DVD titles compared to VHS releases. DVD
copy protection revenues increased $12.2 million or 141.8% from $8.6 million in
1999 to $20.9 million in 2000, due to increases in DVD shipments as the market
for both DVD players and DVD titles continued to expand. Digital PPV copy
protection revenues increased $7.6 million or 101.4% from $7.5 million in 1999
to $15.1 million in 2000 due to the continued roll-out of copy protection
enabled digital set-top boxes in the direct broadcast satellite ("DBS") and
cable TV markets, along with the conversion of legacy analog set-top boxes by
certain operators. Consumer Software Copy Protection revenues increased $3.6
million or 76.1% from $4.8 million in 1999 to $8.4 million in 2000 due to the
increased deployment of our solution by several major software publishers and
adoption by new customers. Revenues from our electronic license management
software products increased $7.1 million or 48.2% from $14.7 million in 1999 to
$21.8 million in 2000 primarily due to growth in ELM software acceptance by
independent software vendors ("ISVs"). Other revenue increased $493,000 or 75.5%
from $653,000 in 1999 to $1.1 million in 2000, primarily from royalties on our
pay TV analog scrambling technology shipments into Brazil by one of our
licensees.
COST OF REVENUES. Cost of revenues as a percentage of net revenues
declined from 9.4% for 1999 to 6.8% for 2000. This decrease was primarily due to
the higher level of revenues in 2000 from royalties and license fees, which had
a substantially lower cost. Cost of revenues increased $540,000 from $4.9
million in 1999 to $5.4 million in 2000 primarily due to higher
duplicator/replicator fees associated with a higher volume of duplication,
royalty costs associated with our watermarking license agreement with Digimarc,
and the write-off of our patents related to our legacy video scrambling
products, offset by lower patent defense costs and inventory reserves. Cost of
revenues includes items such as product costs, duplicator/replicator fees, video
copy protection processor costs, patent amortization, patent defense costs and
royalty expense prior to the acquisition of C-Dilla.
RESEARCH AND DEVELOPMENT Research and development expenses increased by
$1.3 million or 21.0% from $6.5 million in 1999 to $7.8 million in 2000. The
increased expenses related to software development activities at C-Dilla that
were included in Macrovision's operations for approximately six months of 1999.
This increase was offset by reimbursement from TTR of expenses relating to the
SafeAudio CD copy protection project and lower expenses for GLOBETROTTER rights
management software products. There were one-time charges in 1999 relating to
licensing fees for technology and bonuses paid to engineering employees at
C-Dilla. Research and development expenses decreased as a percentage of net
revenues from 12.4% in 1999 to 9.7% in 2000.
SELLING AND MARKETING. Selling and marketing expenses increased by $2.3
million or 18.3% from $12.7 million in 1999 to $15.0 million in 2000. This
increase was primarily due to the increased selling and marketing expenses in
our consumer software copy protection and electronic license management
businesses, resulting from increased headcount. Selling and marketing expenses
decreased as a percentage of net revenues from 24.4% in 1999 to 18.8% in 2000.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
by $5.5 million or 77.4% from $7.2 million in 1999 to $12.7 million in 2000
primarily due to a one-time charge related to our acquisition of GLOBETROTTER, a
37
tax consulting project, increased insurance expenses and increased general and
administrative expenses relating to our electronic license management business
and for our consumer software copy protection business. General and
administrative expenses increased as a percentage of net revenues from 13.8% in
1999 to 15.9% in 2000. Without the one-time charge of $2.2 million associated
with the acquisition of GLOBETROTTER, general and administrative expenses would
have increased by $3.3 million, or 47.2% to $10.5 million.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES FROM ACQUISITIONS. We
amortize intangibles relating to the acquisition of C-Dilla, in June of 1999, on
a straight-line basis over three to seven years based on expected useful lives
of existing products and technologies, retention of workforce, non-compete
agreements and goodwill. The Company amortized $3.0 million in 2000 related to
the goodwill and other intangibles.
In October 2000, we acquired certain assets of PtS. We paid approximately
$23.3 million in cash and related acquisition costs, and assumed liabilities to
service current customer maintenance contracts. We were subject to an additional
maximum payment of $2.8 million contingent upon the business meeting certain
predetermined revenue targets within one year of the acquisition. As of December
31, 2000, we paid $200,000 related to such contingent payments. The purchase
price was allocated to employee retention, PtS's customer base and other
goodwill. We will amortize these intangibles on a straight-line basis over three
years. Goodwill and other intangibles associated with the transaction amounted
to $23.5 million as of December 31, 2000. We amortized $1.9 million of goodwill
and other intangibles in 2000.
AMORTIZATION OF DEFERRED STOCK-BASED COMPENSATION. In connection with the
acquisition of GLOBETROTTER, approximately 783,742 GLOBETROTTER employee stock
options were exchanged for Macrovision stock options, resulting in a deferred
stock-based compensation charge of approximately $37.9 million. The amortization
of the deferred stock-based compensation for the year ended December 31, 2000
was $15.5 million. The expense associated with the stock-based compensation
award will continue to result in substantial non-cash compensation charges to
future earnings.
INTEREST AND OTHER INCOME, NET. Interest and other income increased $9.1
million or 556% from $1.6 million in 1999 to $10.7 million in 2000, primarily
from interest income received on the proceeds of our public stock offering in
January 2000.
INCOME TAXES. Income tax expense represents combined federal and state
taxes at effective rates of 53.8% and 24.8% for 2000 and 1999, respectively. As
GLOBETROTTER was an S corporation for federal and state income tax purposes, tax
expense relating to its income is not provided for on the combined statements
for the first eight months of 2000 prior to August 31, 2000 (the acquisition
date) and the period ended December 31, 1999, thus lowering the effective rate.
Deferred stock-based compensation expense, related to in-the-money stock options
issued, is not tax deductible and hence drives a higher effective rate for 2000.
38
QUARTERLY RESULTS OF OPERATIONS
On August 31, 2000, we completed the acquisition of GLOBETROTTER Software,
Inc. The transaction has been accounted for using the "pooling of interests"
method. As a result, the consolidated financial statements for periods prior to
the combination have been restated to include the accounts and results of
operations of GLOBETROTTER. The following table sets forth certain quarterly
unaudited consolidated financial data for the periods indicated, as well as the
percentage of our net revenues represented by such data. The data have been
derived from our unaudited consolidated financial statements and, in the opinion
of management, have been prepared on substantially the same basis as the audited
consolidated financial statements, and include all adjustments, consisting only
of normal recurring adjustments, necessary for a fair presentation of such data.
Such data should be read in conjunction with our audited consolidated financial
statements and notes thereto appearing elsewhere in this Form 10-K. The results
of operations for any quarter are not necessarily indicative of the results to
be expected for any future period.
QUARTER ENDED (IN THOUSANDS)
(UNAUDITED)
-----------------------------------------------------------------------------------------
2001 2000
------------------------------------------- ------------------------------------------
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
-------- -------- -------- -------- -------- -------- -------- --------
Net Revenues $ 22,974 $ 25,764 $ 23,043 $ 27,032 $ 16,171 $ 18,686 $ 20,446 $ 24,813
Costs and Expenses:
Cost of revenues 1,992 1,436 1,043 1,377 1,476 1,036 1,476 1,437
Research and development 2,322 2,528 1,990 2,445 1,570 1,768 2,114 2,370
Selling and marketing 4,040 4,796 4,434 4,868 3,276 3,907 3,418 4,436
General and administrative 3,168 3,719 3,063 3,295 2,451 2,639 4,657 2,970
Amortization of goodwill
and other intangibles 2,683 2,682 2,723 2,782 743 743 743 2,649
from acquisitions
Amortization of deferred
stock-based compensation(1) 3,031 2,210 2,194 2,156 8,732 2,115 2,405 2,281
Restructuring expense -- -- -- 2,214 -- -- -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total costs and expenses 17,236 17,371 15,447 19,137 18,248 12,208 14,813 16,143
Operating income (loss) 5,738 8,393 7,596 7,895 (2,077) 6,478 5,633 8,670
Interest and other income, net 2,696 2,844 2,472 2,385 2,002 2,892 3,127 2,693
Impairment losses on investments (1,160) (2,200) -- (3,500) -- -- -- --
-------- -------- -------- -------- -------- -------- -------- --------
Income (loss) before income
taxes 7,274 9,037 10,068 6,780 (75) 9,370 8,760 11,363
Income Taxes 3,648 3,981 3,665 2,680 2,853 3,648 3,957 5,367
-------- -------- -------- -------- -------- -------- -------- --------
Net Income $ 3,626 $ 5,056 $ 6,403 $ 4,100 $ (2,928) $ 5,722 $ 4,803 $ 5,996
======== ======== ======== ======== ======== ======== ======== ========
Basic EPS $ 0.07 $ 0.10 $ 0.13 $ 0.08 $ (0.06) $ 0.12 $ 0.10 $ 0.12
======== ======== ======== ======== ======== ======== ======== ========
Diluted EPS $ 0.07 $ 0.10 $ 0.12 $ 0.08 $ (0.06) $ 0.11 $ 0.09 $ 0.12
======== ======== ======== ======== ======== ======== ======== ========
(1) The allocation of the amortization of deferred stock-based compensation
relates to the expense categories as set forth below:
Cost of revenues $ 117 $ 117 $ 117 $ 117 $ 86 $ 108 $ 117 $ 117
Research and development 505 505 505 484 1,304 775 505 480
Selling and marketing 1,342 1,292 1,300 1,285 7,078 864 1,401 1,302
General and administrative 1,067 296 272 270 264 368 382 382
-------- -------- -------- -------- -------- -------- -------- --------
$ 3,031 $ 2,210 $ 2,194 $ 2,156 $ 8,732 $ 2,115 $ 2,405 $ 2,281
======== ======== ======== ======== ======== ======== ======== ========
39
QUARTERLY RESULTS OF OPERATIONS AS A % OF REVENUE
(UNAUDITED)
---------------------------------- ---------------------------------
2001 2000
---------------------------------- ---------------------------------
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
----- ----- ----- ----- ----- ----- ----- -----
Net Revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Costs and Expenses:
Cost of revenues 8.6 5.6 4.6 5.1 9.1 5.5 7.2 5.8
Research and development 10.1 9.8 8.6 9.0 9.7 9.5 10.3 9.6
Selling and marketing 17.6 18.6 19.2 18.0 20.3 20.9 16.7 17.8
General and administrative 13.8 14.4 13.3 12.2 15.2 14.1 22.8 12.0
Amortization of goodwill and
other intangibles from 11.7 10.4 11.8 10.3 4.6 4.0 3.6 10.7
acquisitions
Amortization of deferred
stock-based compensation 13.2 8.6 9.5 8.0 54.0 11.3 11.8 9.2
Restructuring expense -- -- -- 8.2 -- -- -- --
----- ----- ----- ----- ----- ----- ----- -----
Total costs and expenses 75.0 67.4 67.0 70.8 112.9 65.3 72.4 65.1
Operating income (loss) 25.0 32.6 33.0 29.2 (12.9) 34.7 27.6 34.9
Interest and other income, net 11.7 11.0 10.7 8.8 12.4 15.4 15.2 10.9
Impairment losses on investments (5.0) (8.5) -- (12.9) -- -- -- --
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) before income
taxes 31.7 35.1 43.7 25.1 (0.5) 50.1 42.8 45.8
Income Taxes 15.9 15.5 15.9 9.9 17.6 19.5 19.3 21.6
----- ----- ----- ----- ----- ----- ----- -----
Net Income 15.8% 19.6% 27.8% 15.2% (18.1)% 30.6% 23.5% 24.2%
===== ===== ===== ===== ===== ===== ===== =====
Our operating results have fluctuated in the past, and are expected to
continue to fluctuate in the future, on an annual and quarterly basis as a
result of a number of factors. Such factors include the timing of release of
popular titles on videocassettes or DVDs or by digital PPV transmission, the
timing of release of popular computer games on CD-ROM, the timing of a small
number of our ELM high-value perpetual licenses during any period, the degree of
acceptance of our copy protection technologies by major motion picture studios
and computer game publishers, the mix of products sold and technologies
licensed, any change in product or license pricing, the seasonality of revenues,
changes in our operating expenses, personnel changes, the development of our
direct and indirect distribution channels, foreign currency exchange rates and
general economic conditions. We may choose to reduce royalties and fees or
increase spending in response to competition or new technologies or elect to
pursue new market opportunities. Because a high percentage of our operating
expenses are fixed, a small variation in the timing of recognition of revenues
can cause significant variations in operating results from period to period.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations primarily from cash generated by
operations, principally our copy protection businesses and our electronic
license management business. Our operating activities provided net cash of $35.0
million, $36.5 million and $18.7 million in 2001, 2000 and 1999, respectively.
Cash provided by operating activities decreased $1.5 million from $36.5 million
in 2000 to $35.0 million in 2001. The decrease is primarily due to the increase
in accounts receivable at December 31, 2001. In addition, the availability of
cash generated by our operations could be affected by other business risks
discussed in the "Risk Factor" section.
Investing activities used net cash of $38.4 million, $165.1 million, and
$12.6 million in 2001, 2000 and 1999, respectively. Cash used in investing
activities decreased $126.7 million from $165.1 in 2000 to $38.4 million in
2001. The decrease is mainly due to higher investing activities in 2000 which
was the result of $146.1 million of proceeds from the sale of common stock,
reduced activity in equity investments and the purchase of PtS assets in 2000.
We made capital expenditures of $3.7 million, $1.7 million and $495,000 in 2001,
2000 and 1999, respectively. The increase in capital expenditures of $2.0
million from $1.7 million in 2000 to $3.7 million in 2001 is primarily due to
the purchase and implementation of a new enterprise resource planning ("ERP")
system. We also paid $2.7 million, $811,000, and $541,000 in 2001, 2000 and
1999, respectively, related to patents and other intangibles during those
periods.
40
Net cash provided by (used in) financing activities was $7.2 million,
$146.3 million and $(6.1) million in 2001, 2000 and 1999, respectively. In 2000,
net cash of $146.1 million was provided from our January public offering and
proceeds from issuance of stock under various stock option plans partially
offset by GLOBETROTTER's dividend distribution to its shareholders prior to its
being acquired by Macrovision.
At December 31, 2001, we had $26.1 million in cash and cash equivalents,
$83.4 million in short-term investments and $121.5 million in long-term
marketable investment securities, which includes the fair market valuation of
our holdings in Digimarc and TTR, which we presently intend to hold for the long
term. We have no material commitments for capital expenditures but anticipate
that capital expenditures for the next 12 months will aggregate approximately
$4.7 million. We also plan to use cash resources to fund the consolidation of
our California facilities. The anticipated increase in capital expenditures is
necessary to support the growth of our new business initiatives. We also have
future minimum lease payments of approximately $32.0 million under operating
leases. We believe that the current available funds and cash flows generated
from operations will be sufficient to meet our working capital and capital
expenditure requirements for the foreseeable future. We may also use cash to
acquire or invest in businesses or to obtain the rights to use certain
technologies.
We expect that revenues from the Motion Picture Association of America
studios will continue to account for a substantial portion of our net revenues
for the foreseeable future. We have agreements with major home video companies
for copy protection of a substantial part of their videocassettes and/or DVDs in
the U.S. These agreements expire at various times ranging from 2003 to 2005. The
failure of any one of these customers to renew its contract or to enter into a
new contract with us on terms that are favorable to us would likely result in a
substantial decline in our net revenues and operating income, and our business
would be harmed.
CONTRACTUAL OBLIGATIONS
The Company leases its facilities and certain equipment pursuant to
noncancelable operating lease agreements. Future minimum lease payments pursuant
to these leases as of December 31, 2001 were as follows (in thousands):
Contractual Obligations Operating
Leases
-------
2002 $ 3,140
2003 2,784
2004 2,829
2005 2,920
2006 3,023
2007 and thereafter 17,334
-------
Total $32,030
=======
Because a significant portion of our cash inflows were generated by
operations during 2001, our ability to generate positive cash flow from
operations may be jeopardized by fluctuations in our operating results. Such
fluctuations can occur as a result of decreases in demand for our copy
protection products, our electric license management products, or due to other
business risks discussed in the "Risk Factor" section.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and other
Intangible Assets".
SFAS No. 141 requires that all business combinations be accounted for
under the purchase method for business combinations initiated after June 30,
2001. Use of the pooling-of-interests method is no longer permitted. We adopted
the provisions of SFAS No. 141 commencing July 1, 2001. We have not effected any
business combinations in 2001 and the adoption of SFAS No. 141 is not expected
to have an impact on our financial position or results of operations.
SFAS No. 142 requires that goodwill resulting from a business combination
will no longer be amortized to earnings, but instead be reviewed for impairment.
We will adopt SFAS No. 142 on January 1, 2002. For goodwill resulting
41
from business combinations prior to July 1, 2001, amortization of goodwill
continued through December 31, 2001. For business combinations occurring on or
after July 1, 2001, the associated goodwill will not be amortized. Upon adoption
of SFAS No. 142, we are required to perform a transitional impairment test for
all recorded goodwill within six months and if necessary, determine the amount
of an impairment loss by the end of the second quarter of fiscal year 2002. The
adoption of SFAS No. 142 will reduce the amount of amortization of goodwill and
intangible assets by approximately $2.0 million per quarter, including the
impact of all acquisitions through December 31, 2001. In addition, approximately
$742,000 of intangible assets previously allocated to workforce in place will be
subsumed into goodwill as of January 1, 2002. On adoption, management will
evaluate the effect, if any, of the required impairment testing on our recorded
goodwill, which had a net book value of $25.0 million at December 31, 2001.
In August 2001 the FASB issued SFAS No. 143. "Accounting for Asset
Retirement Obligations", and in October issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 143 requires that the
fair value of an asset retirement obligation be recorded as a liability in the
period in which it incurs the obligation. SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets and
supercedes SFAS No. 121 and the accounting and reporting provisions of APB
Opinion No. 30 as it relates to the disposal of a segment of a business. SFAS
No. 143 is effective for fiscal years beginning after June 15, 2002 and SFAS No.
144 is effective for fiscal years beginning after December 15, 2001. We will
adopt SFAS No. 144 effective January 1, 2002, and SFAS No. 143 will be adopted
effective January 1, 2003. The effect of adopting these Statements is not
expected to have material effect on our consolidated financial position or
results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are exposed to financial market risks, including changes in interest
rates, foreign exchange rates and security investments. Changes in these factors
may cause fluctuations in our earnings and cash flows. We evaluate and manage
the exposure to these market risks as follows:
FIXED INCOME INVESTMENTS. We have an investment portfolio of fixed income
securities, including those classified as cash equivalents, short-term
investments and long-term marketable investments securities of $185.0 million as
of December 31, 2001. These securities are subject to interest rate
fluctuations. An increase in interest rates could adversely affect the market
value of our fixed income securities.
We do not use derivative financial instruments in our investment portfolio
to manage interest rate risk. We limit our exposure to interest rate and credit
risk, however, by establishing and strictly monitoring clear policies and
guidelines for our fixed income portfolios. The primary objective of these
policies is to preserve principal while at the same time maximizing yields,
without significantly increasing risk. A hypothetical 50 basis point increase in
interest rates would result in an approximate $890,000 decrease (approximately
0.4%) in the fair value of our available-for-sale securities as of December 31,
2001. Yield risk is also reduced by keeping the weighted average maturity of our
portfolio at 12 months so that the portfolio's yield regenerates itself as
portions of the portfolio mature.
FOREIGN EXCHANGE RATES. Due to our reliance on international and export
sales, we are subject to the risks of fluctuations in currency exchange rates.
Because a substantial majority of our international and export revenues are
typically denominated in U.S. dollars, fluctuations in currency exchange rates
could cause our products to become relatively more expensive to customers in a
particular country, leading to a reduction in sales or profitability in that
country. Our subsidiaries in the U.K. and Japan operate in their local currency,
which mitigates a portion of the exposure related to the respective currency
royalties collected.
STRATEGIC INVESTMENTS. We currently hold minority equity interests in CAC,
Digimarc, Digital Fountain, InterActual, iVAST, NTRU Cryptosystems, RioPort,
Inc., SecureMedia, Widevine Technologies and TTR. These investments, totaling
$58.1 million, represented 16.9% of our total assets as of December 31, 2001.
CAC, Digital Fountain, InterActual, iVAST, NTRU Cryptosystems, RioPort, Inc. and
Widevine Technologies are privately held companies. There is no active trading
market for their securities and our investments in them are illiquid. We may
never have an opportunity to realize a return on our investment in these private
companies, and we may in the future be required to write off all or part of one
or more of these investments. During 2001, we wrote off $6.9 million of
strategic investments resulting from impairment that was other than temporary.
42
ITEM 8. FINANCIAL STATEMENTS AND SUPPLELEMENTARY DATA.
The information required by this item is submitted in a separate section
of this report beginning on F-1 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS.
The information required by this item is incorporated by reference from
the information under the caption "Election of Directors," with respect to
Directors, and under the caption "Management," with respect to Executive
Officers, contained in our definitive Proxy Statement, which will be filed with
the Securities and Exchange Commission in connection with the solicitation of
proxies for our 2002 Annual Meeting of Stockholders (the "Proxy Statement") to
be held on May 23, 2002.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated by reference to the
information under the caption "Executive Compensation" to be contained in the
Proxy Statement for the 2002 Annual Meeting of Stockholders to be held on May
23, 2002.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is incorporated by reference to the
information under the caption "Security Ownership of Certain Beneficial Owners
and Management" to be contained in the Proxy Statement for the 2002 Annual
Meeting of Stockholders to be held on May 23, 2002.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated by reference to the
information under the caption "Certain Relationships and Related Transactions"
to be contained in the Proxy Statement for the 2002 Annual Meeting of
Stockholders to be held on May 23, 2002.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(A) 1. FINANCIAL STATEMENTS
The following statements are filed as part of this report:
o Report of Independent Auditors (See F-2)
o Consolidated Balance Sheets at December 31, 2001 and 2000 (See
F-3)
o Consolidated Statements of Income for the Years Ended December
31, 2001, 2000 and 1999 (see F-4)
o Consolidated Statement of Stockholders' Equity and
Comprehensive Income (Loss) for the Years Ended December 31,
2001, 2000 and 1999 (see F-5)
43
o Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999 (See F6)
o Notes to Consolidated Financial Statements (See F-7)
2. FINANCIAL STATEMENT SCHEDULES
The Schedule of Valuation and Qualifying Accounts is contained in footnote
2 to the Consolidated Financial Statements.
3. EXHIBITS
2.01 Agreement and Plan of Merger with GLOBETROTTER Software, Inc, GSI
Acquisition Corp., Matthew Christiano and Sallie J. Calhoun dated June
19, 2000. (1)
2.02 Agreement For Sale of Shares relating to C-Dilla Limited dated as of
June 18, 1999 by and among Macrovision and the shareholders of C-Dilla
Limited. (2/*)
2.03 Business Sale Agreement among Productivity through Software PLC,
C-Dilla Limited, Mr. John Rowlinson and Macrovision Corporation dated
October 4, 2000. Pursuant to Item 601(b)(2) of Regulation of S-K,
certain schedules have been omitted but will be furnished
supplementally to the Commission upon request. (3/*)
3.01 Amended and Restated Certificate of Incorporation of Macrovision
Corporation. (4)
3.02 Certificate of Amendment to the Amended and Restated Certificate of
Incorporation of Macrovision Corporation. (3)
3.03 Amended and Restated Bylaws of Macrovision Corporation, amended as of
October 27, 2000. (3)
10.01 Stock Option Plan and related documents of Macrovision Corporation. (5)
10.02 Macrovision Corporation's 1996 Equity Incentive Plan and related
documents. (5)
10.03 Macrovision Corporation's 1996 Directors Stock Option Plan. (5)
10.04 Macrovision Corporation's 1996 Employee Stock Purchase Plan and related
documents. (5)
10.05 Macrovision Corporation's Executive Incentive Plan. (5)
10.06 Macrovision Corporation's 2000 Equity Incentive Plan. (6)
10.07 Offer Letter to Ian R. Halifax dated October 8, 1999. (3)
10.08 Form of Indemnification Agreement to be entered into by Macrovision
Corporation with each of its directors and executive officers. (5)
10.09 Recapitalization and Stock Purchase Agreement dated as of July 31,
1996, between Macrovision Corporation and Command Audio Corporation.
(5)
10.10 Restricted Stock Acquisition Agreement dated as of July 31, 1996,
between Macrovision Corporation and Command Audio Corporation, and
First Amendment dated as of November 29, 1996. (5)
10.11 Technology Transfer and Royalty Agreement dated as of July 31, 1996,
between Macrovision Corporation and Command Audio Corporation, and
First Amendment dated as of November 29, 1996. (5)
10.12 Letter dated December 6, 1996 from Macrovision Corporation to Command
Audio Corporation. (5)
10.20 Lease Agreement dated April 21, 1995, by and between Macrovision
Corporation and Caribbean Geneva Investors. (5)
10.21 Standard Sublease dated September 21, 1995, by and between Macrovision
Corporation and Deutsch Technology Research, together with Lease
Agreement dated May 26, 1992, by and between Macrovision Corporation
and Crossroads Investment Group. (5)
10.24 Second Amendment to Restricted Stock Acquisition Agreement dated as of
January 29, 1997 by and between Macrovision Corporation and Command
Audio Corporation. (5)
10.25 Letter dated February 10, 1997 from Macrovision Corporation to Command
Audio Corporation. (5)
10.26 Promissory Note dated January 7, 1997 executed by Command Audio
Corporation. (5)
10.27 Letter Agreement dated November 24, 1999 between Macrovision
Corporation and TTR Technologies, Inc. (7/*)
44
10.28 Subscription Agreement between Macrovision Corporation and C-Dilla
Limited dated February 17, 1998. (8/*)
10.29 Software Marketing License and Development Agreement between
Macrovision Corporation and C-Dilla Limited dated February 19, 1998.
(9/*)
10.30 Digimarc Corporation Series C Preferred Stock Purchase Agreement by and
among Digimarc Corporation and the Several Purchasers Named in Schedule
I. (10)
10.31 Key Employee Agreement dated August 31, 2000 for Matthew Christiano.
(3)
10.32 Key Employee Agreement dated August 31, 2000 for Sallie Calhoun. (3)
10.33 Standard Office Lease dated February 1, 2000 by and between
GLOBETROTTER Software, Inc. and the Christiano Family Trust and
Amendment No. 1 to the Lease. (3)
10.34 Executive Severance and Arbitration Agreement dated April 30, 2001
between Macrovision Corporation and William Krepick. (11)
10.35 Executive Severance and Arbitration Agreement dated April 30, 2001
between Macrovision Corporation and Brian Dunn. (11)
10.36 Executive Severance and Arbitration Agreement dated April 30, 2001
between Macrovision Corporation and Carol Flaherty. (11)
10.37 Executive Severance and Arbitration Agreement dated April 27, 2001
between Macrovision Corporation and Mark Belinsky. (11)
10.38 Employment Protection Agreement dated April 27, 2001 between
Macrovision Corporation and Mark Belinsky. (11)
10.39 Lease Between WB Airport Technology, L.L.C. ("Landlord") and
Macrovision Corporation ("Tenant"). (11)
21.01 List of subsidiaries.
23.01 Consent of KPMG LLP, Independent Auditors.
- ----------
1 Incorporated by reference to Annex B to our 2000 Definitive Proxy
Statement filed on July 28, 2000 pursuant to Schedule 14A. Pursuant to
Item 601(b)(2) of Regulation of S-K, certain schedules have been omitted
but will be furnished supplementally to the Commission upon request.
2 Incorporated by reference to Exhibit 2.01 of our Form 8-K dated as of June
18, 1999. Pursuant to Item 601(b)(2) of Regulation of S-K, certain
schedules have been omitted but will be furnished supplementally to the
Commission upon request.
3 Incorporated by reference to the exhibit of the same number to our Form
10-K filed on April 2, 2001.
4 Incorporated by reference to Exhibit 3.02 of our Registration Statement on
Form SB-2 (Registration No. 333-19373), which was declared effective on
March 12, 1997.
5 Incorporated by reference to the exhibit of the same number in our
Registration Statement on Form SB-2 (Registration No. 333-19373), which
was declared effective on March 12, 1997.
6 Incorporated by reference to Annex D to our 2000 Definitive Proxy
Statement filed on July 28, 2000 pursuant to Schedule 14A.
7 Incorporated by reference to Exhibit 10.01 to our Registration Statement
on Form S-3 (Registration No. 333-93477) declared effective on
January 24, 2000.
8 Incorporated by reference to Exhibit 10.01 to our Form 10-QSB/A filed on
June 23, 1998.
9 Incorporated by reference to Exhibit 10.02 to our Form 10-QSB filed on May
15, 1998.
10 Incorporated by reference to Exhibit 1 to our Schedule 13-D filed on June
23, 2000.
11 Incorporated by reference to the exhibit of the same number to our Form
10-Q filed on November 13, 2001.
* Confidential treatment has been granted with respect to certain portions
of this Exhibit. These portions have been omitted from this filing and
have been filed separately with the Securities and Exchange Commission.
(B) REPORTS ON FORM 8-K:
We filed two Form 8-Ks during the fourth quarter of 2001, relating to: (a)
net revenue and pro forma earnings results for the third quarter, and the
announcement that William A. Krepick, Macrovision's Chief Operating Officer, has
been elected to act as Chief Executive Officer, replacing John O. Ryan (filed
October 29, 2001); and (b) mid-quarter earnings estimates for the fourth quarter
of 2001 and initial guidance for calendar year 2002 (filed December 12, 2001).
45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant caused this report to be signed on its
behalf by the undersigned thereunto duly authorized on this 29th day of March,
2002.
MACROVISION CORPORATION
By: /s/ William Krepick
-------------------------------------
William A. Krepick
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant, and in the capacities and on the date indicated.
NAME TITLE DATE
- ---- ----- ----
PRINCIPAL FINANCIAL OFFICER AND
PRINCIPAL ACCOUNTING OFFICER:
/s/ Ian R. Halifax Vice President, Finance and Administration March 29, 2002
- ----------------------------------- and Chief Financial Officer
Ian R. Halifax
ADDITIONAL DIRECTORS:
/s/ John O. Ryan Chairman of the Board of Directors March 29, 2002
- -----------------------------------
John O. Ryan
/s/ William A. Krepick Director March 29, 2002
- -----------------------------------
William A. Krepick
/s/ Matthew Christiano Director March 29, 2002
- -----------------------------------
Matthew Christiano
/s/ Donna S. Birks Director March 29, 2002
- -----------------------------------
Donna S. Birks
/s/ William N. Stirlen Director March 29, 2002
- -----------------------------------
William N. Stirlen
/s/ Thomas Wertheimer Director March 29, 2002
- -----------------------------------
Thomas Wertheimer
46
MACROVISION CORPORATION
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Report of KPMG LLP, Independent Auditors F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Income F-4
Consolidated Statements of Stockholders' Equity and
Comprehensive Income (Loss) F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7
F-1
REPORT OF KPMG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Macrovision Corporation and Subsidiaries:
We have audited the accompanying consolidated balance sheets of
Macrovision Corporation and subsidiaries (the Company) as of December 31, 2001
and 2000, and the related consolidated statements of income, stockholders'
equity and comprehensive income (loss), and cash flows for each of the years in
the three-year period ended December 31, 2001. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit 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 Macrovision
Corporation and subsidiaries as of December 31, 2001 and 2000, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2001 in conformity with accounting principles
generally accepted in the United States of America.
/s/ KPMG LLP
Mountain View, California
February 20, 2002
F-2
MACROVISION CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
DECEMBER 31,
----------------------
2001 2000
--------- ---------
Current assets:
Cash and cash equivalents $ 26,112 $ 22,409
Short-term investments 83,456 85,500
Accounts receivable, net of allowance for doubtful accounts of
$1,747 and $1,145 as of December 31, 2001 and 2000, respectively 28,033 15,903
Inventories 342 180
Income taxes receivable 12,675 3,952
Deferred tax assets 5,287 5,971
Prepaid expenses and other current assets 6,124 6,230
--------- ---------
Total current assets 162,029 140,145
Property and equipment, net 4,337 2,040
Patents, net of accumulated amortization of $2,273 and $1,840 as of
December 31, 2001 and 2000, respectively 4,594 2,341
Long-term marketable investment securities 121,480 109,532
Goodwill and other intangibles from acquisitions, net of accumulated
amortization of $17,399 and $6,515 as of December 31, 2001 and
2000, respectively 24,951 35,252
Deferred tax assets 7,828 --
Other assets 17,650 7,128
--------- ---------
$ 342,869 $ 296,438
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,955 $ 2,436
Accrued expenses 4,843 5,422
Deferred revenue 9,555 8,392
--------- ---------
Total current liabilities 17,353 16,250
Notes payable 33 56
Deferred tax liabilities 7,283 4,157
--------- ---------
24,669 20,463
Commitments and contingencies (Notes 7 and 9)
Stockholders' equity:
Preferred stock, $.001 par value, 5,000,000 shares authorized; -- --
none issued
Common stock, $.001 par value, 250,000,000 shares authorized;
50,818,986 and 49,818,101 shares issued and outstanding as of
December 31, 2001 and 2000, respectively 51 50
Additional paid-in capital 280,529 266,741
Stockholder notes receivable -- (297)
Deferred stock-based compensation (10,526) (22,405)
Accumulated other comprehensive income 7,917 10,842
Retained earnings 40,229 21,044
--------- ---------
Total stockholders' equity 318,200 275,975
--------- ---------
$ 342,869 $ 296,438
========= =========
See accompanying notes to consolidated financial statements.
F-3
MACROVISION CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------
Net revenues $98,813 $80,116 $52,076
------- ------- -------
Costs and expenses:
Cost of revenues 5,848 5,425 4,885
Research and development 9,285 7,822 6,463
Selling and marketing 18,138 15,037 12,713
General and administrative 13,245 12,717 7,169
Amortization of goodwill and other intangibles from
acquisitions 10,870 4,878 1,600
Amortization of deferred stock-based compensation* 9,591 15,533 --
In-process research and development -- -- 4,285
Restructuring expenses 2,214 -- --
------- ------- -------
Total costs and expenses 69,191 61,412 37,115
------- ------- -------
Operating income 29,622 18,704 14,961
Impairment losses on investments 6,860 -- --
Interest and other income (expense), net 10,397 10,714 1,634
------- ------- -------
Income before income taxes 33,159 29,418 16,595
Income taxes 13,974 15,825 4,108
------- ------- -------
Net income $19,185 $13,593 $12,487
======= ======= =======
Basic net earnings per share $ 0.38 $ 0.28 $ 0.28
======= ======= =======
Shares used in computing basic net earnings per share 50,216 49,135 45,031
======= ======= =======
Diluted net earnings per share $ 0.37 $ 0.26 $ 0.27
======= ======= =======
Shares used in computing diluted net earnings per share 51,746 51,386 47,096
======= ======= =======
* The allocation of the amortization of deferred stock-based compensation
relates to the expense categories as set forth below:
YEAR ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
------- ------- -----
Cost of revenues $ 468 $ 428 $ --
Research and development 1,999 3,064 --
Selling and marketing 5,219 10,645 --
General and administrative 1,905 1,396 --
------- ------- -----
$ 9,591 $15,533 $ --
======= ======= =====
See accompanying notes to consolidated financial statements.
F-4
MACROVISION CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)
(In thousands, except share data)
Additional Stockholder Deferred
Common stock paid-in notes stock-based
Shares Amount capital receivable compensation
-----------------------------------------------------------------
Balances as of December 31, 1998 44,045,538 $ 44 $ 52,791 $ (78) $ --
Comprehensive income (loss):
Net income
Translation adjustment
Unrealized gain in investments, net
Total comprehensive income
Issuance of common stock upon exercise of options 1,087,122 1 1,297 -- --
Issuance of common stock under employee stock purchase plan 94,784 -- 331 -- --
Issuance of common stock for payment of director fees under
the stock option plan 2,000 -- 25 -- --
Issuance of common stock in acquisition of C-Dilla Ltd. 436,796 11 5,0722 -- --
Issuance of options in acquisition of C-Dilla Ltd. -- -- 1,829 -- --
Distribution to shareholders -- -- -- -- --
Payment on stockholder note receivable -- -- -- 78 --
Tax benefit associated with stock plans -- -- 2,407 -- --
---------- -------- --------- ----- --------
Balances as of December 31, 1999 45,666,240 46 63,752 -- --
---------- -------- --------- ----- --------
Comprehensive income (loss):
Net income
Translation adjustment
Unrealized loss in investments, net
Total comprehensive loss
Issuance of common stock upon exercise of options 1,203,768 1 4,633 (297) --
Issuance of common stock under employee stock purchase plan 73,943 -- 728 -- --
Issuance of common stock in secondary public offering, net
issuance costs of $565 2,874,000 3 146,101 -- --
Directors fees paid in stock 150 -- 15 -- --
Distribution to shareholders -- -- -- -- --
Deferred stock-based compensation related to GLOBEtrotter -- -- 37,938 -- (37,938)
Other deferred stock-based compensation -- -- 225 -- (225)
Amortization of deferred stock-based compensation related to
GLOBEtrotter -- -- -- -- 15,533
Amortization of other deferred stock-based compensation -- -- -- -- 225
Tax benefit associated with stock plans -- -- 13,349 -- --
---------- -------- --------- ----- --------
Balances as of December 31, 2000 49,818,101 50 266,741 (297) (22,405)
---------- -------- --------- ----- --------
Comprehensive income (loss):
Net income
Translation adjustment
Unrealized loss in investments, net
Total comprehensive income
Issuance of common stock upon exercise of options 943,882 1 5,813 -- --
Repayment of stockholder note -- -- -- 297 --
Issuance of common stock under employee stock purchase plan 57,003 -- 1,158 -- --
Reversal of unamortized deferred stock-based compensation
related to GLOBEtrotter stock option forfeitures -- -- (1,361) -- 1,361
Compensation expense related to accelerated vesting of
severed employee stock options -- -- 837 -- 927
Amortization of deferred stock-based compensation related to
GLOBEtrotter -- -- -- -- 9,591
Tax benefit associated with stock plans -- -- 7,341 -- --
---------- -------- --------- ----- --------
Balances as of December 31, 2001 50,818,986 $ 51 $ 280,529 $ -- $(10,526)
========== ======== ========= ===== ========
Accumulated
other
comprehensive Total
income Retained stockholders'
(loss) earnings equity
----------------------------------------
Balances as of December 31, 1998 $ (81) $ 7,617 $ 60,293
Comprehensive income (loss):
Net income 12,487 12,487
Translation adjustment 132 132
Unrealized gain in investments, net 25,115 25,115
---------
Total comprehensive income 37,734
---------
Issuance of common stock upon exercise of options -- -- 1,298
Issuance of common stock under employee stock purchase plan -- -- 331
Issuance of common stock for payment of director fees under
the stock option plan -- -- 25
Issuance of common stock in acquisition of C-Dilla Ltd. -- -- 5,073
Issuance of options in acquisition of C-Dilla Ltd. -- -- 1,829
Distribution to shareholders -- (6,795) (6,795)
Payment on stockholder note receivable -- -- 78
Tax benefit associated with stock plans -- -- 2,407
-------- -------- ---------
Balances as of December 31, 1999 25,166 13,309 102,273
-------- -------- ---------
Comprehensive income (loss):
Net income 13,593 13,593
Translation adjustment 513 513
Unrealized loss in investments, net (14,837) (14,837)
---------
Total comprehensive loss (731)
---------
Issuance of common stock upon exercise of options -- -- 4,337
Issuance of common stock under employee stock purchase plan -- -- 728
Issuance of common stock in secondary public offering, net
issuance costs of $565 -- -- 146,104
Directors fees paid in stock -- -- 15
Distribution to shareholders -- (5,858) (5,858)
Deferred stock-based compensation related to GLOBEtrotter -- -- --
Other deferred stock-based compensation -- -- --
Amortization of deferred stock-based compensation related to
GLOBEtrotter -- -- 15,533
Amortization of other deferred stock-based compensation -- -- 225
Tax benefit associated with stock plans -- -- 13,349
-------- -------- ---------
Balances as of December 31, 2000 $ 10,842 21,044 275,975
-------- -------- ---------
Comprehensive income (loss):
Net income 19,185 19,185
Translation adjustment (740) (740)
Unrealized loss in investments, net (2,185) (2,185)
---------
Total comprehensive income 16,260
---------
Issuance of common stock upon exercise of options -- -- 5,814
Repayment of stockholder note -- -- 297
Issuance of common stock under employee stock purchase plan -- -- 1,158
Reversal of unamortized deferred stock-based compensation
related to GLOBEtrotter stock option forfeitures -- -- --
Compensation expense related to accelerated vesting of
severed employee stock options -- -- 1,764
Amortization of deferred stock-based compensation related to
GLOBEtrotter -- -- 9,591
Tax benefit associated with stock plans -- -- 7,341
-------- -------- ---------
Balances as of December 31, 2001 $ 7,917 $ 40,229 $ 318,200
======== ======== =========
See accompanying notes to consolidated financial statements.
F-5
MACROVISION CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
Year ended December 31,
--------------------------------
2001 2000 1999
--------- --------- --------
Cash flows from operating activities:
Net income $ 19,185 $ 13,593 $ 12,487
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization 1,806 1,708 1,189
Amortization of goodwill 10,870 4,878 1,600
Amortization of deferred stock-based compensation 9,591 15,758 --
Impairment losses on investments 6,860 -- --
Restructuring expenses 2,214 -- --
Tax benefit from stock options 7,341 13,349 2,407
Loss on disposal of fixed assets -- 722 15
In-process research and development -- -- 4,286
Changes in operating assets and liabilities:
Accounts receivable (12,221) (2,974) (6,088)
Deferred revenue 1,190 (1,425) 1,917
Other assets (8,905) (7,068) 554
Other liabilities (2,933) (2,084) 372
--------- --------- --------
Net cash provided by operating activities 34,998 36,457 18,739
--------- --------- --------
Cash flows from investing activities:
Purchases of long-term marketable investment securities (116,583) (115,592) (11,578)
Purchases of short-term investments (184,015) (152,231) (39,513)
Sales or maturities of long-term marketable investments 100,496 59,347 24,218
Sales or maturities of short-term investments 186,221 97,898 30,838
Purchases of property and equipment, net of acquisitions (3,686) (1,740) (495)
Payments for patents (2,684) (811) (541)
Minority equity investments in companies (17,000) (28,410) (3,601)
Acquisition of assets of PtS (1,163) (23,536) --
Acquisition of C-Dilla Ltd., net of cash acquired -- -- (11,960)
Other, net -- -- 62
--------- --------- --------
Net cash used in investing activities (38,414) (165,075) (12,570)
--------- --------- --------
Cash flows from financing activities:
Repayment (loan) to related party -- 555 (555)
Proceeds from issuance of common stock upon exercise of options 5,814 4,634 1,298
Proceeds from issuance of common stock under employee stock purchase plan 1,158 728 331
Repayment (loan) of stockholder note receivable 297 (297) 78
Proceeds from sale of common stock, net of issuance costs -- 146,104 (69)
Cash distribution to stockholders -- (5,858) (6,795)
Other, net (21) 451 (354)
--------- --------- --------
Net cash provided by (used in) financing activities 7,248 146,317 (6,066)
--------- --------- --------
Effect of exchange rate changes on cash (129) -- --
Net increase in cash and cash equivalents 3,703 17,699 103
Cash and cash equivalents at beginning of year 22,409 4,710 4,607
--------- --------- --------
Cash and cash equivalents at end of year $ 26,112 $ 22,409 $ 4,710
========= ========= ========
Cash paid during the year:
Interest $ 1 $ 5 $ 10
========= ========= ========
Income taxes $ 19,806 $ 10,273 $ 3,475
========= ========= ========
See accompanying notes to consolidated financial statements.
F-6
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
Macrovision Corporation develops and markets copy protection, rights
management and electronic license management technologies for the home video,
consumer interactive software, enterprise software and music markets.
Macrovision Corporation is a Delaware corporation founded in 1983.
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
Macrovision Corporation and its wholly owned subsidiaries after elimination of
intercompany accounts and transactions.
Certain prior year amounts have been reclassified to conform to the
current year presentation.
ACQUISITIONS
On August 31, 2000, the Company completed its acquisition of privately held
GLOBEtrotter Software, Inc. ("GLOBETROTTER") of San Jose, California. The
Company acquired all the outstanding shares of GLOBETROTTER for 8,944,548 shares
of Macrovision common stock and assumed all vested and unvested GLOBEtrotter
stock options in exchange for options to purchase 821,852 shares of Macrovision
common stock. The transaction was accounted for using the "pooling of interests"
method. As a result, the consolidated financial statements for periods prior to
the combination were restated to include the accounts and results of operations
of GLOBEtrotter Software, Inc.
On October 5, 2000, the Company acquired certain assets of Manchester (UK)
based Productivity through Software plc ("PtS"). The Company paid approximately
$23.3 million in cash and related acquisition costs, and assumed liabilities to
service current customer maintenance contracts. The Company was subject to an
additional maximum payment of $2.8 million contingent upon the business meeting
certain predetermined revenue targets within one year of the acquisition. The
Company paid $1.2 million and $200,000 of contingent consideration costs during
the years ended December 31, 2001 and 2000, respectively. The purchase price was
allocated to employee retention, PtS's customer base and goodwill. The Company
amortizes these intangibles on a straight-line basis over three years. Excluding
cumulative translation adjustments, goodwill and other intangibles associated
with the transaction amounted to $24.7 million as of December 31, 2001. The
Company amortized $7.9 million and $1.9 million of goodwill and other
intangibles in 2001 and 2000, respectively. In accordance with new accounting
guidance, Statement of Financial Accounting Standards No. ("SFAS") 142,
"Goodwill and Other Intangible Assets", goodwill and workforce in place will not
amortize beginning in fiscal year 2002. These assets will be assessed for
impairment at least on an annual basis.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported results of operations during the reporting period. On an
ongoing basis, we evaluate our estimates, including those related to revenue
recognition, allowance for doubtful accounts, investments, intangible assets and
income taxes. Actual results could differ from those estimates under different
assumptions or conditions.
CASH, CASH EQUIVALENTS, AND INVESTMENTS
The Company considers all highly liquid investments with maturities from
date of purchase of three months or less to be cash equivalents. Cash and cash
equivalents consist of cash on deposit with banks and money market funds. All
other liquid investments with maturities over three months and less than 12
months are classified as short-term investments. Short-term investments consist
of government bonds, government agency securities and corporate securities. All
marketable securities with maturities over one year or which the Company's
intent is to retain for the long-term are classified as long-term marketable
investment securities.
F-7
The Company accounts for its publicly traded investments in accordance
with Statement of Financial Accounting Standard (SFAS) No. 115, "ACCOUNTING FOR
CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES." Management determines the
appropriate classification of investment securities at the time of purchase and
re-evaluates such designation as of each balance sheet date. The Company enters
into certain equity investments for the promotion of business and strategic
objectives, and typically does not attempt to reduce or eliminate the inherent
market risks associated with these investments. As of December 31, 2001 and
2000, all investment securities were designated as "available-for-sale."
Available-for-sale securities are carried at fair value based on quoted market
prices, with unrealized gains and losses, reported in comprehensive income
(loss), as a separate component of stockholders' equity.
Realized gains and losses and declines in value judged to be
other-than-temporary for available-for-sale securities will be reported in other
income or expense as incurred. The cost of securities sold is based on the
specific identification method. Interest and dividends on securities classified
as available-for-sale are also included in other income.
The following is a summary of available-for-sale securities (in
thousands):
December 31,
------------------
2001 2000
-------- --------
Cash equivalents - money market funds $ 20,976 $ 20,238
-------- --------
Investments:
Corporate bonds 124,357 142,787
United States government bonds and agency securities 39,708 5,957
Equity investments 40,871 46,288
-------- --------
204,936 195,032
-------- --------
$225,912 $215,270
======== ========
As of December 31, 2001 and 2000, government and corporate bond securities
and equity investments totaling $121.5 million and $109.5 million respectively,
were classified as long-term marketable investment securities.
As of December 31, 2001 and 2000, the difference between the fair value
and the amortized cost of available-for-sale securities was an unrealized gain
of $13,906,000 and $17,595,000, respectively. As of December 31, 2001 and 2000,
the unrealized gain, net of taxes, was $8,240,000 and $10,425,000, respectively.
These unrealized gains, net of deferred income taxes, related to short-term and
long-term government bonds and investment securities, have been recorded as a
component of comprehensive income (loss). As of December 31, 2001 and 2000, the
weighted average portfolio duration and contractual maturity for the bond
securities was approximately thirteen months and eleven months, respectively.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, net of accumulated depreciation
and amortization. Depreciation and amortization is computed using the
straight-line method over the estimated useful lives of the respective assets,
generally three to five years. Leasehold improvements and assets recorded under
capital leases are amortized on a straight-line basis over the shorter of the
assets' useful lives or lease terms.
PATENTS
Patent application costs of $1.8 million and $1.4 million as of December
31, 2001 and 2000, respectively, are included in patents and other intangibles
and, upon the granting of the related patent, are amortized using the
straight-line method over the shorter of the estimated useful life of the patent
or 10 years.
SOFTWARE OBTAINED FOR INTERNAL USE
The Company accounts for software obtained for internal use in accordance
with Statements of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," which requires that certain
costs relating to
F-8
the purchase of internal use software should be capitalized, including costs of
software configuration and enhancements. Approximately $1.1 million was
capitalized during the year ended December 31, 2001. This has been classified on
the consolidated balance sheet as a component of property and equipment.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company's long-lived assets consist primarily of goodwill and other
intangibles from acquisitions, property and equipment and long-term investments.
The Company review's long-lived assets for impairment whenever events or changes
in circumstances indicate that the carrying amount of such an asset may not be
recoverable. Such events or circumstances include, but are not limited to, a
significant decrease in the fair value of the underlying business, a significant
decrease in the benefits realized from the acquired business, or a significant
change in the operations of the acquired business.
Recoverability of long-lived assets is measured by comparison of the
carrying amount to future undiscounted net cash flows the assets are expected to
generate. If assets are considered to be impaired, the impairment is measured by
the amount by which the carrying amount of the assets exceeds the fair value of
the assets, as derived by discounted future net cash flows. No impairment
charges for long-lived assets were recorded during the current year based on
these measurements. Assets to be disposed of are reported at the lower of the
carrying amount or fair value less costs to sell. The Company uses similar
methods to analyze the recoverability of goodwill and its other long-lived
assets.
OTHER ASSETS
The Company has made strategic minority investments in companies and
accounts for such investments under the cost method.
F-9
REVENUE RECOGNITION
The Company's revenue mainly consists of royalty fees on copy protected
products on a per unit basis, licenses of the Company's copy protection
technology and software products, maintenance, consulting and training.
Revenue from the replication of videocassettes and digital versatile discs
("DVDs") is recognized when realized or realizable and earned. In certain
limited instances, studio customers report biannually, which results in
modification of the general policy to recognize revenue on an as reported basis
until such time that the Company has established significant experience with
such customers to reasonably estimate current period volume for purposes of
making an accurate revenue accrual. Advanced license fees attributable to
minimum copy quantities or shared revenues are deferred until earned. In the
case of agreements with minimum guaranteed payments with no specified volume,
revenue is recognized on a straight-line basis over the life of the agreement.
Retroactive credits on certain agreements that contain pricing adjustments or
return provisions are accrued based upon anticipated respective unit volumes.
Nonrefundable technology licensing revenue, which applies principally to DVD and
PC subassembly manufacturers, digital PPV, cable and satellite system operators,
and set-top decoder manufacturers, is recognized upon establishment of
persuasive evidence of an arrangement, performance of all significant
obligations and determination that collection of a fixed and determinable
license fee is considered probable. In fiscal 1999, the Company began
recognizing royalty revenue associated with PPV set top boxes when reported,
rather than estimating volumes. This change did not have a material effect on
the financial statements in the year of implementation. Revenue from the sale of
encoders, decoders, and systems incorporating the Company's video copy
protection and scrambling technologies is recognized upon shipment provided that
the Company has no significant additional performance obligations.
During the current year, a studio customer for which revenue was
historically recognized on an as reported basis has demonstrated sufficient
volumes of reporting history and regularity of payments to enable the Company to
reliably estimate and recognize such revenues on an as earned basis. As a result
of this change, the Company recognized an additional $3.5 million of revenue in
the year ended December 31, 2001.
The Company recognizes revenue on its software products in accordance with
SOP 97-2, Software Revenue Recognition, as amended by SOP 98-4 and 98-9. The
Company also adopted Staff Accounting Bulletin ("SAB") 101, Revenue Recognition
in Financial Statements in the fourth quarter of 2000. The adoption of SAB101
did not have a significant impact on the Company's consolidated financial
statements. The Company recognizes revenue when all of the following criteria
are met: persuasive evidence of an arrangement exists; delivery of the product
has occurred; no significant obligations by the Company remain; the fee is fixed
and determinable; and collectibility is probable.
In order to recognize revenue, the Company must make a judgment as to
whether the arrangement fee is fixed or determinable. Except in cases where the
Company grants extended payment terms to a specific customer, the Company has
determined its fees are fixed or determinable at the inception of its
arrangements based on the following:
o The fee customers pay for products is negotiated at the outset of an
arrangement, and is generally based on the specific volume of
products to be delivered.
o License fees are not a function of variable-pricing mechanisms such
as the number of units distributed or copied by the customer, or the
expected number of users of the product delivered.
Customary payment terms are such that 100% of the arrangement fee is due
within one year or less. These customary payment terms are supported by
historical practice and concessions have not been granted to customers under
this policy. Arrangements with payment terms extending beyond the customary
payment terms are considered not to be fixed or determinable. Revenue from such
arrangements is recognized when such amounts become due and payable.
In order to recognize revenue, the Company must make a judgment of the
collectibility of the arrangement fee. Judgment of the collectibility is applied
on a customer-by-customer basis pursuant to the Company's credit review policy.
The Company typically sells to customers for which there is a history of
successful collection. New customers are subjected to a credit review process,
which evaluates the customers' financial positions and ability to pay. New
customers are typically assigned a credit limit based on a formulated review of
their financial position. Such credit limits are only increased after a
successful collection history with the customer has been established. If it is
determined from the outset of an arrangement that collectibility is not probable
based upon the Company's credit review process, revenue is recognized on a
cash-collected basis.
For license agreements in which customer acceptance is a condition to
earning the license fees, revenue is not recognized until acceptance occurs. For
arrangements containing multiple elements, such as software license fees,
consulting services and maintenance, or multiple products and where
vendor-specific objective evidence of fair value ("VSOE") exists for all
undelivered elements, the Company accounts for the delivered elements in
accordance with the "residual method." Under the residual method, the fair value
of
F-10
the undelivered elements is deferred and the remaining portion of the
arrangement fee is recognized as revenue. For arrangements containing multiple
elements where VSOE does not exist, all revenue is deferred until such time that
VSOE is evidenced or all elements of the arrangement have been delivered, or if
the only undelivered element is maintenance, revenue is recognized pro rata over
the maintenance contract period. Service revenues include fees for consulting,
training and other services which are recognized as revenue as the services are
performed. Maintenance revenues are deferred and recognized ratably over the
maintenance contract period.
COST OF REVENUES
The Company has agreements with certain licensed duplicators, DVD and CD
replicators, DVD authoring facilities and CD mastering facilities utilized by
customers of the Company's video copy protection and software copy protection
technologies. The Company has agreed to pay these licensees a specified fixed
service fee or on a per unit basis utilizing the Company's copy protection
technologies to help offset the cost of operating the Company's copy protection
equipment and reporting requirements of their contracts. Such amounts are
charged to cost of revenues when incurred. Cost of revenues also includes items
such as product costs, videocassette copy protection processor costs, royalty
expense and software product support.
Cost of revenues included outside legal costs of $836,000, $970,000 and
$1,453,000 in 2001, 2000 and 1999, respectively, associated with litigation to
enforce the Company's patents. Amortization of patents is also included in cost
of revenues.
INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax carry forwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. The measurement of deferred tax assets is reduced, if necessary,
by a valuation allowance for any tax benefits of which future realization is
uncertain.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
The functional currency for the Company's foreign subsidiaries is the
applicable local currency. The translation of foreign currency denominated
financial statements into United States dollars is performed for balance sheet
accounts using current exchange rates in effect at the balance sheet date and
for revenues and expense accounts using an average exchange rate for the
respective periods. Adjustments resulting from such translation are included in
comprehensive income. Gains or losses resulting from foreign currency
transactions included in the consolidated statements of income were not material
in any of the periods presented.
BUSINESS AND CONCENTRATION OF CREDIT RISK AND FAIR VALUE OF FINANCIAL
INSTRUMENTS
The Company licenses its video copy protection, CD-ROM copy protection and
electronic license management software to customers in the home videocassette,
DVD, cable and satellite pay-per-view, corporate communication markets,
multimedia software markets and business software markets primarily in the
United States, Europe, Japan, and the Far East. In 2001, 33.2% of the Company's
business is attributed to the licensing of its video copy protection technology
through Motion Picture Association of America ("MPAA") movie studios.
Accordingly, the ability of the Company to grow its video copy protection
operations has been dependent on MPAA movie studios' continued success in the
production and distribution of movies utilizing the Company's technology. The
Company also licenses its digital PPV video copy protection technologies to
satellite and cable television operators and to the equipment manufacturers that
supply the satellite and cable television industries. The Company licenses its
CD-ROM copy protection to publishers of software in the multimedia and
educational software and rights management application markets. With the
acquisition of GLOBEtrotter Software, Inc. the Company began business in the
electronic license management ("ELM") software segment. The Company licenses ELM
solutions to independent software vendors ("ISVs") and software asset management
("SAM") solutions to end user companies. The Company also provides support,
maintenance and consulting services. In addition, 45.2%, 42.3% and 40.2% of the
Company's sales in 2001, 2000 and 1999, respectively, are from export or foreign
operations.
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash, cash equivalents,
marketable securities, trade accounts receivable and long-term investments. The
Company places its cash and cash equivalents and marketable securities in
deposits and money market funds with various high credit quality institutions.
The carrying value of the Company's financial instruments approximates fair
market value due to the relatively short maturities of those instruments, or the
ending price of shares as represented on a national exchange for the Company's
investments in Digimarc and TTR.
F-11
The Company performs ongoing credit evaluations of its customers. No one
customer accounted for more than 10% of net revenue for the year ended December
31, 2001. One customer accounted for more than 10% of net revenue for the year
ended December 31, 2000. No one customer accounted for more than 10% of net
revenue for the year ended December 31, 1999. At December 31, 2001, receivables
from one customer were approximately 11% of accounts receivable. At December 31,
2000, receivables from one customer were approximately 11% of accounts
receivable.
EARNINGS PER SHARE
Basic EPS is computed using the weighted average number of common shares
outstanding during the period. Diluted EPS is computed using the weighted
average number of common and dilutive common equivalent shares outstanding
during the period except for periods of operating loss for which no common share
equivalents are included because their effect would be anti-dilutive. Dilutive
common equivalent shares consist of common stock issuable upon exercise of stock
options using the treasury stock method.
(In thousands) December 31,
----------------------
2001 2000 1999
------ ------ ------
Basic EPS - weighted average number of common shares outstanding 50,216 49,135 45,031
Effect of dilutive common equivalent shares - stock options outstanding 1,530 2,251 2,065
------ ------ ------
Diluted EPS - weighted average number of common shares and common share
equivalents outstanding 51,746 51,386 47,096
====== ====== ======
In 2001, 2000 and 1999, the weighted average number of stock options that
were not included in the diluted earnings per share calculation because the
exercise price was greater than the average market price, were approximately
1,441,000, 171,000, and 82,000, respectively.
ADVERTISING EXPENSE
The cost of advertising is expensed as incurred. Such costs are included
in selling and marketing expense and totaled $785,000, $1.3 million and $1.6
million for the years ended December 31, 2001, 2000 and 1999, respectively.
RESEARCH AND DEVELOPMENT
Expenditures for research and development are expensed as incurred.
STOCK BASED COMPENSATION
The Company accounts for employee stock-based compensation arrangements in
accordance with the provisions of (i) Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees," (ii) Financial
Accounting Standards Board Interpretation No. 44 ("FIN 44"), "Accounting for
Certain Transactions Involving Stock Compensation - an Interpretation of APB
Opinion No. 25," and complies with the disclosure provisions of (iii) Statement
of Financial Accounting Standard No. 123 ("SFAS No. 123"), "Accounting for
Stock-Based Compensation." The Company accounts for equity instruments issued to
non-employees in accordance with the provisions of SFAS No. 123 and Emerging
Issues Task Force ("EITF") No. 96-18, "Accounting for Equity Instruments That
Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services."
DERIVATIVES
In June 2000, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 138, Accounting for Derivative Instruments and Hedging Activities, an
amendment of SFAS No. 133. SFAS No. 133, as amended by SFAS No. 138, establishes
accounting and reporting standards for derivative instruments and hedging
activities and requires the Company to recognize all derivatives as either
assets or liabilities on the balance sheet and measure them at fair value. Gains
and losses resulting from changes in fair value would be accounted for based on
the intended use of the derivative and whether it is designated and qualifies
for hedge accounting. The Company adopted SFAS No. 138 concurrently with SFAS
No. 133 in the first quarter of fiscal 2001. The Company has not engaged in any
transactions involving derivative instruments or hedging activities in 2001.
RECENT ACCOUNTING PRONOUNCEMENTS
F-12
In June 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and other
Intangible Assets".
SFAS No. 141 requires that all business combinations be accounted for
under the purchase method for business combinations initiated after June 30,
2001. Use of the pooling-of-interests method is no longer permitted. The Company
adopted the provisions of SFAS No. 141 commencing July 1, 2001. The Company has
not effected any business combinations in 2001 and the adoption of SFAS No. 141
is not expected to have an impact on its financial position or results of
operations.
SFAS No. 142 requires that goodwill resulting from a business combination
will no longer be amortized to earnings, but instead be reviewed for impairment.
The Company will adopt SFAS No. 142 on January 1, 2002. For goodwill resulting
from business combinations prior to July 1, 2001, amortization of goodwill
continued through December 31, 2001. For business combinations occurring on or
after July 1, 2001, the associated goodwill will not be amortized. Upon adoption
of SFAS No. 142, the Companyis required to perform a transitional impairment
test for all recorded goodwill within six months and if necessary, determine the
amount of an impairment loss by the end of the second quarter of fiscal year
2002. The adoption of SFAS No. 142 will reduce the amount of amortization of
goodwill and intangible assets by approximately $2.0 million per quarter,
including the impact of all acquisitions through December 31, 2001. In addition,
approximately $742,000 of intangible assets previously allocated to workforce in
place will be subsumed into goodwill as of January 1, 2002. On adoption,
management will evaluate the effect, if any, of the required impairment testing
on the Company's recorded goodwill, which had a net book value of $25.0 million
at December 31, 2001.
In August 2001 the FASB issued SFAS No. 143. "Accounting for Asset
Retirement Obligations", and in October issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 143 requires that the
fair value of an asset retirement obligation be recorded as a liability in the
period in which it incurs the obligation. SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets and
supercedes SFAS No. 121 and the accounting and reporting provisions of APB
Opinion No. 30 as it relates to the disposal of a segment of a business. SFAS
No. 143 is effective for fiscal years beginning after June 15, 2002 and SFAS No.
144 is effective for fiscal years beginning after December 15, 2001. The Company
will adopt SFAS No. 144 effective January 1, 2002, and SFAS No. 143 will be
adopted effective January 1, 2003. The effect of adopting these Statements is
not expected to have material effect on Macrovision's consolidated financial
position or results of operations.
(2) FINANCIAL STATEMENT DETAILS
INVENTORIES
Inventories consisted of the following (in thousands):
December 31,
---------------------
2001 2000
---- ----
Raw materials $ 33 $ 82
Work in progress -- 16
Finished goods 309 82
---- ----
$342 $180
==== ====
Property and Equipment, Net
Property and equipment consisted of the following (in thousands):
December 31,
------------------
2001 2000
------- ------
Machinery and equipment $ 7,265 $4,300
Leasehold improvements 1,281 1,516
Furniture and fixtures 1,601 1,094
------- ------
10,147 6,910
Less accumulated depreciation and amortization 5,810 4,870
------- ------
$ 4,337 $2,040
======= ======
F-13
OTHER ASSETS
The Company intends to hold its investments in non-marketable securities
for the long-term and monitors the recoverability of these investments based on
management's estimates of the net realizable value based on the achievements of
milestones in business plans and third-party financings. In 2001, the Company
invested an aggregate of $17.0 million in RioPort, Inc., iVast, Inc., Widevine
Technologies, Inc., NTRU Cryptosystems, Inc. and Digital Fountain, Inc. During
2001, consistent with our policy for evaluating recoverability of these
investments, we concluded that impairment of our investments in AudioSoft,
InterActual Technologies, RioPort and SecureMedia was other than temporary.
Accordingly, we wrote off the book value of these investments during 2001 and
took an aggregate charge to earnings of $6.9 million for the year ended December
31, 2001. The carrying amounts of such investments, net of impairment charges,
which are accounted for on the cost basis, are as follows (in thousands):
December 31,
-----------------------
2001 2000
------- ------
Minority equity investments $17,188 $7,048
Deposits and other assets 462 80
------- ------
$17,650 $7,128
======= ======
Accrued Expenses
Accrued expenses consisted of the following (in thousands):
December 31,
------------------
2001 2000
------ ------
Accrued compensation $2,704 $3,868
Restructuring reserve 196 --
Accrued professional fees 716 595
Income taxes payable and other accrued taxes 666 291
Other accrued liabilities 561 668
------ ------
$4,843 $5,422
====== ======
Interest and Other Income (Expense), Net
Interest and other income (expense), net, consisted of the following (in
thousands):
Year ended December 31,
-----------------------------------------
2001 2000 1999
-------- -------- -------
Interest income $ 10,590 $ 10,913 $ 1,530
Interest expense (1) (5) (10)
Other (192) (194) 114
-------- -------- -------
$ 10,397 $ 10,714 $ 1,634
======== ======== =======
Valuation and Qualifying Accounts (in thousands):
Balance at Charged to
Beginning of Costs and Balance at
Period Expenses Deductions End of Period
------------ --------- ---------- -------------
Allowance for doubtful accounts:
2001 $1,145 995 393 $1,747
2000 $1,059 274 188 $1,145
1999 $ 912 353 206 $1,059
Supplemental Cash Flow Information
F-14
Supplemental cash flow information related to non-cash investing and
financing activities is as follows (in thousands):
Year ended December 31,
--------------------------
2001 2000 1999
---- ---- ------
Stock issued for C-Dilla Ltd -- -- $5,073
==== ==== ======
Issuance of options in acquisition of C-Dilla Ltd -- -- $1,829
==== ==== ======
(3) RESTRUCTURING EXPENSE
During the fourth quarter of 2001, the Company announced a restructuring
program and eliminated redundant positions relating to legacy businesses and
consolidated certain administrative functions. All terminated employees were
notified of their severance and related benefits at the time the program was
announced. This program resulted in the elimination of 26 redundant positions on
a worldwide basis and related to less than 10% of the Company's employees. The
restructuring charge totaled $2.2 million and consisted principally of severance
payments and non-cash compensation expense relating to accelerated vesting of
certain stock options. Expenses relating to the charge are summarized as follows
(in thousands):
Compensation
expense relating
to accelerated
vesting of certain
Severance stock options Other Total
--------- ------------------ ----- -------
Total charge in 2001 $ 317 $ 1,764 $ 133 $ 2,214
Cash paid (235) -- (19) (254)
Non cash charge -- (1,764) -- (1,764)
----- ------- ----- -------
Balance at December 31, 2001 $ 82 $ -- $ 114 $ 196
===== ======= ===== =======
(4) TRANSACTIONS WITH RELATED PARTIES
In December 1997, the Company made its initial investment in Digimarc
(Nasdaq, symbol DMRC), a world leader in digital watermark technology and
applications. The Company made two subsequent investments in June 1999 and
October 2000. Digimarc completed an initial public offering in December 1999,
and the Company owned approximately 12.0% of the outstanding shares of Digimarc
as of December 31, 2001. The Company has an agreement with Digimarc to jointly
develop a digital video watermarking copy protection solution to address
digital-to-digital copying associated with next-generation recordable DVD and
digital videocassette recording devices. In addition, the Company has an
exclusive marketing agreement with Digimarc through December 31, 2002, with
minimum royalty payments of $2 million. As of December 31, 2001, the Company has
paid a total of $2.0 million under this agreement.
In January 2000, the Company invested $4.0 million to acquire a minority
interest in TTR Technologies, Inc. ("TTR"), a public company (Nasdaq, symbol
TTRE). In addition, the Company has entered into an agreement with TTR to
jointly develop and market a copy protection product designed to inhibit casual
copying of music CDs using dual-deck CD recorder systems and personal computer
based CD recordable drives. TTR is a provider of proprietary digital anti-piracy
technologies and products. Pursuant to the agreement, TTR reimbursed the Company
$1,000,000 of engineering and marketing expenses in 2000. As of December 31,
2001, the Company holds approximately 10.8% of the outstanding shares of TTR.
During the year ended December 31, 2001, the Company recorded $1.8 million
of revenue from iVAST and $900,000 from RioPort from the sale of software,
maintenance and royalties. The Company invested $5.0 million and $3.5 million in
iVast, Inc. and RioPort, Inc., respectively, in 2001.
The Company leased certain of its premises in San Jose, California from a
related party. Rent paid to such related party amounted to $635,000, $538,000,
and $249,000 for the years ended December 31, 2001, 2000 and 1999, respectively.
(5) STOCKHOLDERS' EQUITY
F-15
SERIES A CONVERTIBLE PREFERRED STOCK
The Company's Certificate of Incorporation provides for the issuance of up
to 5,000,000 shares of $0.001 par value preferred stock.
COMMON STOCK
On January 26, 2000, the Company consummated an offering (the "offering")
of 3,820,000 shares of its Common Stock, of which 2,874,000 shares were issued
and sold by the Company and 946,000 shares were sold by shareholders of the
Company. All shares were sold for $53.44 per share. The net proceeds to the
Company from the offering, after deducting the underwriting discount and other
expenses of the offering, were approximately $146.0 million. The Company did not
receive any proceeds from the sale of shares sold by the selling stockholders.
On February 1, 2000, the Company issued 109,290 shares of common stock,
pursuant to a stock option agreement exercise, to an officer of the Company in
exchange for a full recourse promissory note in the principal amount of
$297,000. Interest accrues at the rate of 6.03% per annum. Principal and accrued
interest, are due and payable on the earlier of five years from February 1,
2000, the sale or transfer by the officer of any or all shares purchased with
this note or the termination of the officer's service other than for death or
disability. The note was repaid in full during the year ended December 31, 2001.
STOCK OPTION AND PURCHASE PLANS
In December 1996, the Company adopted the 1996 Equity Incentive Plan (the
"Equity Incentive Plan"), which serves as the successor to the Company's 1988
Stock Option Plan (the "1988 Plan"). Options granted under the 1988 Plan before
its termination continue to remain outstanding in accordance with their terms,
but no further options may be granted under the 1988 Plan. Nonstatutory stock
options and incentive stock options granted under the 1988 Plan were exercisable
at prices not less than 85% and 100%, respectively, of the fair value of the
Company's common stock on the date of grant, as determined by the Company's
Board of Directors. The options were generally exercisable over a 3-year vesting
period and expire 7 to 10 years from date of grant.
Pursuant to the Equity Incentive Plan, the Company's Board of Directors
has reserved 5,088,888 shares of common stock for issuance. In May 1998, an
additional 1,600,000 shares were reserved by approval of the Board of Directors
and stockholders. The Equity Incentive Plan provides for the grant of stock
options, stock appreciation rights, and restricted stock awards by the Company
to employees, officers, directors, consultants, independent contractors, and
advisers of the Company. The Equity Incentive Plan permits the grant of either
incentive or nonqualified stock options at the then current market price.
Options granted under the Equity Incentive Plan will have a maximum term of ten
years and generally vest over three years at the rate of 1/6, 1/3 and 1/2,
respectively.
In December 1996, the Company's Board of Directors adopted the 1996
Employee Stock Purchase Plan (the "Purchase Plan") and reserved 560,000 shares
of common stock for issuance thereunder. The Purchase Plan was effective upon
the Company's initial public offering in March 1997. The Purchase Plan permits
eligible employees to purchase common stock, through payroll deductions of
between 1% and 20% of the employee's compensation, at a price equal to 85% of
the lower of the fair market value of the common stock on the first day of the
offering period or on the last day of the purchase period. The Company's
stockholders approved the Purchase Plan in February 1997. In 2001, 2000 and
1999, the Company issued 57,003, 73,943 and 94,784 shares, respectively,
pursuant to the Purchase Plan.
In August 2000, the Company adopted the 2000 Equity Incentive Plan which
serves as the successor to the Company's 1996 Equity Incentive Plan. The total
number of shares of Macrovision common stock for which options and other stock
awards may be granted under the 2000 Equity Incentive Plan is 4,500,000, and the
maximum number of stock options that the Company may grant to any individual in
any calendar year is 500,000, in each case subject to adjustment as described
below.
The shares available for issuance under the 2000 Equity Incentive Plan may
be authorized but unissued shares of common stock or shares of common stock that
the Company reacquires. If any options expire or are forfeited or canceled, the
shares are added back to the total number of shares available for issuance under
the 2000 Equity Incentive Plan.
In December 1996, the Company's Board of Directors adopted the 1996
Directors Stock Option Plan (the "Directors Plan") and reserved 240,000 shares
of common stock for issuance thereunder. In June 2000, the Board of Directors
increased the number of shares of common stock reserved for issuance under the
Directors Plan by 126,000 shares. The Company's stockholders approved the
Directors Plan in February 1997 and approved the share increase in August 2000.
The Directors Plan provides each eligible director an initial grant of a
nonqualified option to purchase 40,000 shares (increased from 20,000 shares
prior to 1999) of common stock on the date the eligible director first becomes a
director, with each initial option granted after 1999 vesting in monthly
increments over a three-year period. The
F-16
Directors Plan provides for additional annual grants of nonqualified options to
each eligible director to purchase 15,000 shares of common stock on each
anniversary of the date such person became a director, with monthly vesting over
one year. Prior to 2001, the annual grants under the Directors Plan were for
10,000 shares vesting over one year (in 2000), for 30,000 shares vesting over
three years (in 1999), and for 12,000 shares vesting over four years (prior to
1999).
During 2001, 2000 and 1999, the Company granted options to purchase
75,000, 30,000 and 90,000 shares, respectively, of common stock to outside
directors under the Directors Plan.
The Company uses the intrinsic value-based method to account for all of
its employee stock-based compensation plans. Accordingly, compensation cost has
been recognized in the accompanying consolidated financial statements for its
plans when the exercise price of each option was less than the fair value of the
underlying common stock as of the grant date for each stock option. With respect
to the options assumed in connection with the acquisition of GLOBEtrotter, the
Company recorded deferred stock-based compensation of approximately $37.9
million, for the difference between the exercise price and the fair value of the
stock underlying the options. This amount is being amortized over the vesting
period of the individual options, generally four years. Amortization expenses
recognized in 2001 relating to the GLOBEtrotter totaled $9.6 million.
If compensation cost for the Company's stock-based compensation plans had
been determined in a manner consistent with the fair value approach described in
SFAS No. 123, the Company's net income and net income per share as reported
would have been reduced to the pro forma amounts indicated below (in thousands,
except per share data):
Year ended December 31,
-------------------------------
2001 2000 1999
-------- -------- --------
Net income (loss) As reported $ 19,185 $ 13,593 $ 12,487
Adjusted pro forma (24,054) (15,763) 7,656
Basic net income (loss) per share As reported .38 .28 .28
Adjusted pro forma (.48) (.28) .17
Diluted net income (loss) per share As reported .37 .26 .27
Adjusted pro forma (.46) (.28) .16
Options vest over several years and new options are generally granted each
year. Because of these factors, the pro forma effect shown above may not be
representative of the pro forma effect of SFAS No. 123 in future years.
The fair value of each option is estimated on the date of grant using the
Black-Scholes method with the following weighted average assumptions for the
Option Plans and the ESPP Plan:
Year ended December 31,
--------------------------------------
2001 2000 1999
---------- ---------- ----------
Option Plans:
Dividends None None None
Expected term 3.81 years 3.73 years 4.32 years
Risk free interest rate 6.66% 6.18% 5.62%
Volatility rate 100.4% 85.7% 71.7%
ESPP Plan:
Dividends None None None
Expected term 1.25 years 1.25 years 1.25 years
Risk free interest rate 5.79% 5.97% 5.92%
Volatility rate 77.1% 67.4% 65.7%
Activity under the Company's option plans is as follows:
F-17
Number of shares Weighted-average
exercise price
---------------- ----------------
Outstanding as of December 31, 1998 2,826,520 2.14
Granted 1,933,040 12.32
Canceled (242,540) 5.56
Exercised (1,089,122) 1.22
----------
Outstanding as of December 31, 1999 3,427,898 7.92
Granted 1,786,788 39.09
Canceled (184,678) 18.35
Exercised (1,203,918) 3.86
----------
Outstanding as of December 31, 2000 3,826,090 23.27
Granted 2,091,505 45.59
Canceled (298,413) 47.18
Exercised (944,777) 6.20
----------
Outstanding as of December 31, 2001 4,674,405 43.71
==========
December 31,
-----------------------------
2001 2000 1999
--------- ------- -------
Options exercisable at end of year 1,117,695 648,634 859,106
Weighted average fair value of options granted during the period $ 32.18 $ 47.75 $ 7.72
F-18
The following table summarizes information about fixed stock options
outstanding as of December 31, 2001:
Outstanding Exercisable
----------------------------------------------- ------------------------------
Weighted average Weighted
Number remaining Weighted average Number average
Range of exercise prices of shares contractual life exercise price exercisable exercise price
- -----------------------------------------------------------------------------------------------------------
$ 0.675 - $ 3.750 632,332 6.77 $ 2.69 398,072 $ 2.67
$ 5.000 - $ 8.785 514,122 7.15 $ 8.31 251,472 $ 7.92
$ 9.625 - $ 23.315 770,696 7.51 $14.56 257,754 $14.81
$ 23.720 - $ 44.250 891,897 9.78 $29.89 27,187 $40.15
$ 45.250 - $ 65.000 931,984 9.02 $50.57 80,223 $52.88
$ 65.313 - $ 102.313 933,374 8.90 $78.80 102,987 $89.66
--------- ---------
4,674,405 8.38 $35.20 1,117,695 $19.18
========= =========
(6) Income Taxes
Income tax expense for the years ended December 31, 2001, 2000 and 1999
consisted of the following (in thousands):
December 31,
-------------------------------
2001 2000 1999
-------- -------- -------
Current:
Federal $ 6,183 $ 4,931 $ 3,136
State 1,200 592 1,074
Foreign 1,763 1,339 535
-------- -------- -------
Total current 9,146 6,862 4,745
-------- -------- -------
Deferred:
Federal (1,936) (3,793) (2,447)
State (577) (593) (597)
-------- -------- -------
Total deferred tax expense (2,513) (4,386) (3,044)
-------- -------- -------
Charges in lieu of income taxes associated with the
exercise of stock options
7,341 13,349 2,407
-------- -------- -------
Total tax expense $ 13,974 $ 15,825 $ 4,108
======== ======== =======
Income tax expense for the years ended December 31, 2001, 2000, and 1999,
differed from the amounts computed by applying the U.S. federal income tax rate
of 35% to pretax income as a result of the following (in thousands):
Year ended December 31,
-------------------------------
2001 2000 1999
-------- -------- -------
Federal tax statutory rate $ 11,606 $ 10,296 $ 5,654
State taxes 976 1,399 718
Income tax credits (258) (374) (287)
Foreign tax differential (1,312) (129) 80
Exempt interest (306) (376) (482)
Nondeductible expenses related to acquisition of GLOBEtrotter -- 1,480 (1,837)
GLOBEtrotter pre-merger loss -- 2,649 --
Change in valuation allowance 1,440 -- --
Others 1,828 880 262
-------- -------- -------
Total tax expense $ 13,974 $ 15,825 $ 4,108
======== ======== =======
F-19
The tax effects of the temporary differences that give rise to significant
portions of the deferred tax assets and liabilities are presented below (in
thousands):
December 31,
------------------------
2001 2000
-------- -------
Deferred tax assets:
Accruals, reserves and others $ 1,878 $ 688
Allowance for doubtful accounts 666 427
Plant and equipment 720 623
Deferred revenue 1,304 3,415
Intangible assets 5,719 2,911
Impairment losses on investments 2,724 --
Net operating losses 1,544 1,564
-------- -------
Gross deferred tax assets 14,555 9,628
Valuation allowance (1,440) --
-------- -------
Total deferred tax assets 13,115 9,628
Deferred tax liabilities:
Patents (1,617) (644)
Unrealized gains (5,666) (7,170)
-------- -------
Total deferred tax liabilities (7,283) (7,814)
-------- -------
Net deferred tax assets $ 5,832 $ 1,814
======== =======
The net change in the total valuation allowance for the year ended
December 31, 2001 was an increase of approximately $1.4 million. Net deferred
tax assets as of December 31, 2001 include a deferred tax liability of
approximately $5.7 million of net unrealized capital gains, which primarily
relates to the Company's investment in Digimarc.
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible.
Based on projections of future taxable income over the periods in which
the deferred tax assets are deductible and the history of the Company's
profitability, management believes that it is more likely than not that the
Company will realize the benefits of these deductible differences, net of
valuation allowances as of December 31, 2001.
Deferred tax liabilities have not been recognized for undistributed
earnings of foreign subsidiaries because it is management's intention to
reinvest such undistributed earnings outside the U.S. indefinitely.
Undistributed earnings of foreign subsidiaries for which deferred taxes have not
been provided aggregate approximately $10.4 million at December 31, 2001. The
amount of income tax liability that would have resulted if such earnings had
been repatriated is estimated to be approximately $3.2 million.
F-20
(7) COMMITMENTS
LEASES
The Company leases its facilities and certain equipment pursuant to
noncancelable operating lease agreements. Future minimum lease payments pursuant
to these leases as of December 31, 2001 were as follows (in thousands):
Operating
Leases
---------
2002 $ 3,140
2003 2,784
2004 2,829
2005 2,920
2006 3,023
2007 and thereafter 17,334
-------
Total $32,030
=======
Rent expense was $1,488,000, $1,278,000, and $850,000 for the years ended
December 31, 2001, 2000 and 1999, respectively.
EMPLOYEE BENEFIT PLANS
The Company has a 401(k) plan that allows eligible employees to contribute
up to 20% of their compensation, which contribution was limited to $10,500 in
2001. Employee contributions and earnings thereon vest immediately. The Company
is not required to contribute to the 401(k) plan, but has made voluntary
contributions. The Company made matching contributions to the 401(k) plan equal
to 20% of each participating employee's contribution, up to a maximum annual
matching contribution of $2,100, $2,100 and $2,000 in 2001, 2000, and 1999,
respectively. Matching contributions aggregated $204,000, $80,000 and $65,000
for the year ended December 31, 2001, 2000 and 1999, respectively, and are fully
vested after three years of service.
GLOBEtrotter Software, Inc. had a 401(k) plan that allowed eligible
employees to contribute up to 15% of their compensation, which was terminated
effective August 31, 2000. All eligible GLOBEtrotter Software, Inc. employees'
contributions were merged into the abovementioned Macrovision Corporation 401(k)
plan after August 31, 2000. Employee contributions and earnings thereon vest
immediately. The Company was not required to contribute to the 401(k) plan and
highly compensated employees were not eligible for the Company's contribution.
The Company made no contributions for the year ended December 31, 2000 and made
contributions of $210,000 for the year ended December 31, 1999.
GLOBEtrotter Software, Inc. had a pension plan that allowed eligible
employees to share in contributions to the plan made solely by the Company on
behalf of the employees. This plan was terminated effective August 31, 2000.
There was no provision for employee contributions to this plan. The Company was
required to contribute 10% of each eligible employee's compensation to the plan.
The Company made no contributions for the year ended December 31, 2000 and made
contributions of $431,000 for the year ended December 31, 1999.
(8) SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in three industry segments as follows: video copy
protection, consumer software copy protection and electronic license management
("ELM") software. These are the operating segments that are regularly evaluated
by the chief operating decision maker in deciding how to allocate resources and
in assessing performance. In the video copy protection segment, the Company
licenses its video technologies for videocassette, DVD and digital pay-per-view
applications. In the consumer software copy protection segment, the Company
licenses copy protection technology and digital rights management technology
primarily in the PC multimedia software market. In the electronic license
management software segment, the Company licenses ELM solutions for enterprise
applications to independent software vendors ("ISVs"), and software asset
management tools for end user customers.
The Company identifies segments based principally upon the type of
products sold. The accounting policies of these reportable segments are the same
as those described for the consolidated entity. The Company evaluates the
performance of its segments based on revenue and segment income. In addition, as
the Company's assets are primarily located in its corporate office in the United
States, and not allocated to any specific segment, the Company does not produce
reports for or measure the performance of its segments based on any asset-based
metrics. Therefore, segment information is presented only for revenue and
income.
F-21
The following segment reporting information of the Company is provided (in
thousands):
Revenue by Significant Product Group:
Year ended December 31,
-------------------------------
2001 2000 1999
------- ------- -------
Video Copy Protection:
DVD $37,610 $20,867 $ 8,629
Videocassette 11,509 12,899 15,877
Pay-Per-View 13,207 15,062 7,477
------- ------- -------
Total 62,326 48,828 31,983
Consumer Software Copy Protection 10,062 8,372 4,754
Electronic License Management Software 25,643 21,770 14,686
Other 782 1,146 653
------- ------- -------
Total $98,813 $80,116 $52,076
======= ======= =======
Operating Income:
Year ended December 31,
----------------------------
2001 2000 1999
------- ------- --------
Video Copy Protection $55,055 $40,973 $ 25,026
Consumer Software Copy Protection 5,572 3,417 1,157
Electronic License Management Software 13,753 14,828 10,380
Other 447 436 (778)
------- ------- --------
Segment income 74,827 59,654 35,785
Research and development 9,285 7,822 5,615
General and administrative 13,245 10,555 9,324
Amortization of goodwill and other intangibles from acquisitions 10,870 4,878 1,600
Amortization of deferred stock-based compensation 9,591 15,533 --
Acquisition costs related to GLOBEtrotter Software Inc. -- 2,162 --
In-process research and development -- -- 4,285
Restructuring expenses 2,214 -- --
------- ------- --------
Operating income $29,622 $18,704 $ 14,961
======= ======= ========
Information on Revenue by Geographic Areas:
Year ended December 31,
-------------------------------------
2001 2000 1999
------- ------- -------
United States $54,169 $46,245 $31,120
International 44,645 33,871 20,956
------- ------- -------
Total Revenue $98,813 $80,116 $52,076
======= ======= =======
Geographic area information is based upon country of destination for
products shipped and country of contract holder for royalties and license fees.
(9) Contingencies
The Company is involved in legal proceedings related to some of its
intellectual property rights.
Krypton Co., Ltd., a Japanese company, filed an invalidation claim against
one of the Company's copy protection patents in Japan. After a hearing in March
1999, the Japanese Patent Office recommended that the Company's patent be
invalidated. On December 27, 1999, the Company submitted to the Tokyo High Court
a written statement indicating that the decision of invalidity of
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the Company's patent should be overturned. In February 2000, a second round of
preparatory proceedings was conducted before the Tokyo High Court, with Oral
Arguments in March 2000. In its ruling on March 21, 2000, the Tokyo High Court
revoked the Japanese Patent Office's decision. In connection with this ruling,
the scope of the Company's claims under the patent was slightly reduced, but
this is not expected to have a material adverse effect on the value of this
patent to the Company's business. In short, the patent remains valid and part of
the Company's business. On November 22, 2000, Krypton made an appeal in the
Tokyo High Court regarding its earlier decision. The Company has been involved
in several preparatory proceedings and is seeking that the Tokyo High Court
reaffirm its earlier decision. Even if an adverse ruling ultimately is reached
on this invalidation claim, this would not have a material adverse effect on the
Company's business.
The Company initiated a patent infringement lawsuit in the District Court
of Dusseldorf in March 1999 against Vitec Audio und Video GmbH, a German company
that manufactures what the Company believes to be a video copy protection
circumvention device. Vitec filed a reply brief arguing that its product does
not infringe patents held by the Company. The case was heard in the District
Court of Dusseldorf, Germany. The District Court of Dusseldorf ruled adversely
against the Company. The Company appealed the District Court's ruling in July
2000 to the Court of Appeal in Dusseldorf. A hearing took place in front of the
Court of Appeal in Dusseldorf on August 23, 2001 in which the Court stated that
because the appeal involves complex technical subject matter, the Court will
require technical expert witnesses. The Court solicited the Company for a list
of experts that the Court can call on to serve as expert witnesses. The Company
submitted a list of experts in the area of analog video copy protection to the
Court on October 5, 2001. The selection of the Court's expert witnesses is
pending. In the event of an adverse ruling, the Company may incur a
corresponding decline in demand for the Company's video copy protection
technology, which could harm the Company's business in Germany.
In November 1997, GLOBEtrotter filed a patent infringement lawsuit (Case
No. C-98-20419-JF/EAI) in the Federal District Court for the Northern District
of California against Elan Computer Group and its founder, Ken Greer, alleging
infringement of one of its patents and unfair competition and trade practices.
In March 1998, Rainbow Technologies North America, Inc. entered into an
agreement to purchase certain assets of Elan and entered into a litigation
cooperation agreement with Elan regarding the pending GLOBEtrotter litigation.
On or around September 1998, GLOBEtrotter filed a patent infringement suit
against Rainbow Technologies, which was subsequently consolidated with the
action against Elan Computer Group and Ken Greer. Rainbow Technologies and Ken
Greer filed separate counterclaims against GLOBEtrotter and its founder, Matthew
Christiano, alleging antitrust violations, unfair competition, tortious
interference with business relations, and trade libel. Rainbow Technologies and
Ken Greer are seeking compensatory damages, punitive damages, injunctive relief,
and disgorgement of profits. GLOBEtrotter intends to defend the allegations in
the counterclaim vigorously. The patent infringement case was bifurcated from
the counterclaims. In October 1999, Judge Fogel granted the motion for partial
summary judgment for non-infringement of claims 55-59 which was filed by Rainbow
Technologies based on Judge Fogel's claim construction order. On August 31,
2000, the Company acquired GLOBEtrotter. In January 2001, the Court of Appeals
for the Federal Circuit affirmed the denial of the Company's motion for
preliminary injunction by agreeing with the District Court's claim construction
of requiring a user ID as part of the claimed invention. In February 2001,
Rainbow et al. filed a summary judgment motion to dismiss the Company's patent
infringement suit. The Company filed an opposition brief and a request for leave
to file a reconsideration motion to the dismissal of claims 55-59 in light of
newly discovered evidence. At the hearing on March 19, 2001, Judge Fogel granted
the Company's request and agreed to rule on the reconsideration motion before
making a ruling on the summary judgment motion. The reconsideration motion was
argued before the court on July 23, 2001. In a ruling on September 24, 2001,
Judge Fogel denied the Company's reconsideration motion and granted the partial
summary judgment motion for Rainbow et al. The granting of the partial summary
judgment motion by Rainbow et al. means that the patent infringement case
against Rainbow et al. is essentially dismissed. The Company plans to appeal.
Based on the information available at this time, it is not anticipated that the
adverse ruling of partial summary judgment will have a material adverse effect
on the Company's consolidated financial position, results of operations or cash
flow. The Company still has unfair competition & trade practices cause of
actions against Rainbow et al. The stay of discovery on the counterclaims has
been lifted and witness depositions have commenced. On January 18, 2002, the
Company filed a motion to dismiss some of the counterclaims from Rainbow et al.
On February 25, 2002, Judge Fogel held a hearing on the Company's motion to
dismiss and the Company's motion to dismiss was granted. The trial for the
remaining counterclaims is scheduled for September 9, 2002. If an adverse ruling
is ultimately reached on the remaining counterclaims, significant monetary
damages may be levied against the Company.
On October 23 2001, Digimarc filed a patent infringement suit in the
United States District Court, District of Oregon against Verance Corporation
alleging infringement of certain patents owned by Digimarc. Verance's answer and
counter-claim included allegations of patent infringement and antitrust
counterclaims, including allegations that Digimarc conspired with the Company to
keep Verance out of the DVD CCA bidding process for selection of a digital
watermarking copy protection technology. The Company was informed and believes
that Verance's second amended cross-complaint was filed on or about March 25,
2002, and specifically named the Company as a cross-defendant in connection with
our bid to the DVD CCA as one of the VWM Companies. In the event Verance
succeeds on its cross-claims, the Company may be subject to significant monetary
damages as well as be precluded from licensing the VWM Companies' jointly
developed digital media copy protection technology.
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As of December 31, 2001, it is not possible to estimate the liability, if
any, in connection with these matters. Accordingly, no accruals for these
contingencies have been recorded.
From time to time the Company has been involved in other disputes and
legal actions arising in the ordinary course of business. In management's
opinion, none of these other disputes and legal actions is expected to have a
material impact on the Company's consolidated financial position, results of
operation or cash flow.
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