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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, 2002
[ ] 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 mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of 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. [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No
--- ---
As of March 25, 2003, 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
$662,748,654.75.
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 25, 2003, there were 48,553,015 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 27, 2003, 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.................................................................................... 30
ITEM 3. LEGAL PROCEEDINGS............................................................................. 30
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........................................... 32
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...................................... 32
ITEM 6. SELECTED FINANCIAL DATA....................................................................... 33
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS......... 34
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.................................... 49
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................................................... 49
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES......... 49
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS.............................................................. 50
ITEM 11. EXECUTIVE COMPENSATION........................................................................ 50
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................................ 50
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................................ 50
ITEM 14. CONTROLS AND PROCEDURES....................................................................... 50
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K............................... 51
SIGNATURES........................................................................................... 54
DISCUSSIONS OF SOME OF THE MATTERS CONTAINED IN THIS ANNUAL REPORT ON FORM
10-K FOR 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
CONDITION 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, music labels, 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 3.6 billion videocassettes worldwide since 1985. Since
1997, we have expanded the application of our copy protection technology into
the DVD and digital set-top box ("STB") and personal video recorder ("PVR")
platforms. Most Motion Picture Association of America ("MPAA") 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 analog video copy protection.
We are also in the business of consumer software copy protection. We offer
CD-ROM copy protection and digital rights management ("DRM") technologies to a
variety of software publishers in the PC games, education, information
publishing, and desktop applications software markets.
Our Enterprise Software Division provides electronic license management
software to software and systems vendors and their enterprise customers. We
believe Macrovision is the clear leader in this field, with approximately 1,000
customers under maintenance. The Enterprise Software Division was previously
named the Globetrotter Software Division, formed after our August 2000
acquisition of Globetrotter Software, Inc.
We have recently expanded our business into copy protection,
authentication, and rights management technologies for music CDs. In November
2002, we acquired the assets of Midbar Tech (1998) Ltd. and entered into an
agreement to acquire certain assets from TTR Technologies, Inc. in order to
extend our product portfolio and build our customer base. We expect this
transaction to close in the second quarter of 2003, subject to certain
conditions being met.
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 by licensing the
use of our patented technologies. In our video copy protection business,we
receive unit-based royalties for copy-protected videocassettes, DVDs, set-top
boxes and personal video recorders. We obtain transaction or use-based royalties
from digital satellite/cable network operators for copy protected PPV movies,
and up-front and annual license fees from DVD and set-top box hardware
manufacturers, and digital satellite/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 DRM and electronic license
management ("ELM") technologies, and recurring fees for maintenance. In our
music business we receive unit-based royalties for copy-protected music CDs.
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To further expand our business, we have made strategic investments in
companies that have complementary technologies or intellectual property. Our
largest investment is in Digimarc Corporation ("Digimarc"), a leading digital
watermarking technology company. Over the past 2 years we have partnered with
Digimarc and 5 other companies in the Video Watermarking group to develop what
we intend to be an industry standard copy protection solution to address
next-generation, digital-to-digital copying. For additional information, see the
"Strategic Investments" section on page 16. We intend to continue to evaluate
and pursue additional strategic relationships and acquisitions that are
complementary or extensible 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), MacroSAFE(TM), SafeWrite(TM), SafeAuthenticate(TM),
SafeDVD(TM), SafeScan(TM), and Cactus Data Shield(TM) ("CDS").
A copy of this annual report on Form 10-K, as well as our quarterly reports
on Form 10-Q, current reports on Form 8-K and all amendments to these reports
are available, free of charge, through our Internet website at
www.macrovision.com under the heading "Investors" as soon as reasonably
practicable after we file such material electronically or otherwise furnish it
to the Securities and Exchange Commission. The reference to our Internet website
does not constitute incorporation by reference of the information contained on
or hyperlinked from our Internet website and should not be considered part of
this document.
INDUSTRY BACKGROUND
The industry shift towards digital media renders content and copyright
owners increasingly vulnerable to unauthorized use of their content. Consumers'
ability to make unauthorized copies of video, audio and software content has
increased due to the proliferation of inexpensive, easy-to-use devices, such as
VCRs, CD and DVD recorders, audio CD recorders and personal video recorders that
allow in-home copying of videocassettes, DVDs, digital PPV/VOD programs,
CD-ROMs, desktop software, and audio CDs. As technological advances facilitate
digital copying at declining prices, motion picture studios, music labels and
software publishers have become more concerned with protecting their
intellectual property. Independent software vendors ("ISVs") and systems vendors
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 PC software may be copied and redistributed).
Content owners lose billions of dollars every year to casual copying and
professional or bootleg piracy. The latest data available from the Motion
Picture Association of America estimates that the U.S. motion picture industry
loses in excess of $3 billion annually due to packaged media piracy. In
addition, the International Intellectual Property Alliance ("IIPA") estimated
that copyright piracy around the world inflicts $20-$22 billion in annual losses
to the U.S. copyright industries. We believe that a substantial portion of these
losses arise from casual consumer copying or unauthorized use of software. This
is the focus for our technology.
As a result, a number of government and legislative initiatives have been
enacted in recent years to encourage technologies that protect the rights of the
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. Based on recent tests of new DVD
recorder devices, we believe that manufacturers have designed them so they will
not record analog input that is Macrovision-protected. Hence, our technology
also prevents copying on this platform. 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 has proposed a similar EU-wide copyright directive,
which we believe includes a provision aimed at controlling hardware and software
circumvention devices and technologies. Individual countries' legislatures are
currently discussing these new copyright initiatives.
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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.
We have four divisions, which are: the Video Technology Division, the
Enterprise Software Division, the Consumer Software Division and the Music
Technology Division. These four divisions are described in more detail below.
VIDEO TECHNOLOGY DIVISION
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 or
Video-On-Demand ("VOD") releases. Kagan World Media estimated that over 59% of
all households in the United States now 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 ("STB") 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 andgrowth in
DVD, VCR sales remain strong as prices fall and as DVD/VCR combination units
become more popular. We believe there are over 700 million VCRs in use
throughout the world, and with continued shipments of VCR devices to the market,
VCRs will remain a home copying threat to video content owners for many years to
come.
DVD-TO-VHS COPY PROTECTION. DVD hardware and media became commercially
available in the United States in 1997 and, through the end of 2002,
approximately 56.5 million DVD playback devices have been sold to consumers in
the U.S., according to the DVD Entertainment Group ("DEG") and Consumer
Electronics Association ("CEA"). 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 approximately 170
million VCRs in use in the U.S. (or 600 million VCRs throughout the world) can,
when combined with a DVD playback device, make videocassette copies of a
non-copy protected DVD. These copies are almost equal in quality to
professionally prerecorded videocassettes.
RECORDABLE DVD COPY PROTECTION. 2002 represented the year in which DVDs
supplanted the VHS as the preferred home video distribution medium. Adams Media
Research reported that consumers spent more than $12 billion last year to own
movies, with DVD outselling VHS two to one. Understanding & Solutions Ltd.
estimates that approximately 1.1 billion DVD-Video discs were shipped to retail
worldwide in 2002, representing an 85% growth over 571 million DVD-Video discs
worldwide in 2001. They project a 28.5% annual increase to 1.3 billion discs in
2003. According to DEG and CEA, there are currently more than 95 million DVD
playback devices in American homes, including stand-alone players, DVD-ROM
drives and DVD-capable videogame consoles, with more than 10 million homes with
two or more DVD-capable devices. All of these devices have analog video outputs
that connect to TV sets.
Virtually 100% of DVD playback devices sold and in use since the DVD format
introduction to the market in 1997 in North America, Western Europe and Japan
are designed to output Macrovision copy-protected analog video if the device
plays a Macrovision copy-protected original DVD disc. These are the major
regions in which the respective countries comply with the 1996 World
Intellectual Property Organization ("WIPO") Copyright Treaty and the WIPO
Performances and Phonograms Treaty. All DVD recording devices that we have
tested to-date do not make a digital DVD copy from the analog video output of a
compliant DVD playback device when playing a copy-protected DVD disc. Since
almost all the installed DVD playback devices only have an analog output, this
means that Macrovision's copy protection technology inhibits both VHS and DVD
copying.
VOD AND PPV COPY PROTECTION. Digital PPV/VOD services enable consumers to
purchase and view movies and other programming in their homes through cable or
satellite systems. Studios have realized the importance of copy protection in
digital PPV/VOD networks, and many of them have required digital PPV/VOD system
operators to install copy protection capability in their digital set-top boxes.
Macrovision's technology enables consumers to view PPV/VOD programs but
inhibits unauthorized copying or significantly distorts unauthorized copies of
the program when copies are attempted by both DVD and VHS recording devices. To
date, Macrovision's copy protection technology has been embedded in over 100
million digital STBs worldwide, representing nearly 90% of total digital STBs
deployed. Our technology is dormant until it is activated by
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system operators for specific PPV or VOD movies. For the past 3 years, our video
copy protection technology has been activated by PPV system operators in the UK
and Japan only,even though there are approximately 40 million digital
cable/satellite PPV subscribers with access to PPV/VOD in the U.S.
VOD is an emerging service, with approximately 8 million U.S. households
currently enabled to view VOD, and an estimated 30 million expected to be VOD
ready by 2005. Macrovision is in the process of negotiating agreements with
several major MPAA studios for activating copy protection for VOD services in
the U.S.
ENTERPRISE SOFTWARE DIVISION
Software vendors who sell to enterprise customers are 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 or the term of their licenses; in other words, users may be
obtaining "free" use of the software vendor's application. In a weak economic
climate, it may be crucial for independent software vendors ("ISVs") to ensure
they are compensated for all software usage. They may also choose to restructure
their offerings to better match the evolving licensing and pricing needs of
their customers. Electronic License Management ("ELM") is a solution to this
problem, and although many ISVs use their own, internally developed license
management software, we believe that ISVs are increasingly recognizing that this
is not their core competency and will opt to purchase a third-party solution,
such as our FLEXlm technology. In September 2002, the International Data
Corporation forecast that while $90 billion of software uses electronic license
management today, this number is expected to grow at a 20% compounded annual
growth rate to reach $186 billion by 2006. We believe that we are positioned to
benefit from this market growth due to our current market leadership, installed
base of customers and broad product set.
CONSUMER SOFTWARE DIVISION
With the proliferation of inexpensive high capacity CD-ROM burners, and the
increase of high bandwidth Internet connections to the home and small office,
individual consumers now have the means to easily copy and distribute
unauthorized desktop software copies on a broad scale. In fact, unauthorized
downloads of application and entertainment software frequently meet or exceed
the volume of downloads of music from Internet file sharing services. As a
result, application software and interactive entertainment (games) software
companies are facing unprecedented loss of revenues due to unauthorized consumer
copying of CD-ROM software and unauthorized file sharing over the Internet.
The rapid expansion of high bandwidth Internet connections for consumers
and small businesses may result in the adoption of new licensing (subscription,
rental, etc.) and distribution models for software. We believe this has created
a large market opportunity for our digital rights management and copy protection
solutions.
MUSIC TECHNOLOGY DIVISION
The music industry is at a digital crossroads. Music industry unit (CD)
sales have been falling approximately 10% year-over-year for the past two years,
according to the International Federation of Phonographic Industries ("IFPI").
The continued decline was attributed to the high penetration of personal
computer-based CD-burners, proliferation of peer-to-peer file sharing services
and the lack of commercially viable copy protection and DRM technologies.
Approximately 40% of recordings sold worldwide are reportedly illegal copies,
resulting in an estimated $4.3 billion of lost industry sales in 2001 alone,
according to IFPI's "Music Piracy Report 2002 and 2001." In addition,
peer-to-peer file sharing of ripped music continues unabated in the
"post-Napster" era. IFPI estimated that, in 2001, approximately 99% of music
files available on the Internet were unauthorized. In May 2002, IFPI estimated
there were approximately 3 million users and 500 million files available for
copying at any one time on all of the peer-to-peer services worldwide. There are
approximately 200,000 Web and FTP sites hosting or linking to some 100 million
unauthorized recorded music files.
Consequently, the music industry is pursuing multiple initiatives to
reverse the year over year sales declines, including CD copy protection and
digital rights management technologies. In December 2002, after purchasing the
assets of Midbar Tech (1998) Ltd., we formed the Music Technology Division and
hired many key Midbar managers and employees in order to better address the
needs of the music industry.
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Since early 2000, music labels have expressed interest in technology that
would prevent the copying of audio CDs to a PC or CD recordable device. Initial
deployment has occurred in Europe and Japan. During 2002, Macrovision estimates
that of the approximately 65 million copy protected CDs produced worldwide in
2002, approximately 60% were distributed in the Asia Pacific region (principally
Japan), 35% in Western Europe, and 5% in North America, South America, and the
rest of the world combined.
In January 2003, Microsoft officially announced its "second session" DRM
system for the music industry, called "Windows Media(R) Data Session Toolkit."
We are working with two of the five major music labels and with Microsoft to
integrate Windows Media Data Session Toolkit capabilities into our latest Cactus
Data Shield product, CDS-300(TM). This will enable music files to be transferred
in a secure manner from a CDS-300 protected CD to a Windows personal computer
for subsequent export to portable devices and utltimately to enable burning a
copy-protected second generation CDs. Our proprietary disc-based local
authentication process (derived from our SafeDisc(R) technology) ensures that
consumers can only transfer these second session music files to their personal
computer if they are in possession of an original CD.
MACROVISION SOLUTIONS
We develop and market a broad array of proprietary 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 amd VOD system
operators. We provide ELM and electronic license delivery ("ELD") solutions to a
range of software vendors, including application developers, computer systems
suppliers and embedded software vendors. We also supply software asset
management technologies to enable end-user organizations to manage third-party
application software 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 also offer technologies to prevent the unauthorized copying of music
CDs.
VIDEO TECHNOLOGY DIVISION
Our video copy protection technologies allow consumers to view programming
stored on prerecorded videocassettes, DVDs or transmitted as digital PPV or VOD
programs via cable or satellite, but deter unauthorized consumer copying of such
programming on both VCRs and recordable DVD devices. Videocassettes are encoded
with our video copy protection signal as they are manufactured. Our licensed
copy protection signal generator equipment is installed in 237 commercial
duplication facilities in 36 countries around the world. The unique patented
aspects of our copy protection signal are transparent to an analog TV set, but
are disruptive to the recording circuits of VCRs and act to turn off the
recording operation of recordable DVD devices. The result is that videocassettes
and DVDs that are encoded with our anticopy process will play normally on an
analog TV set, but will cause generally unwatchable copies to be made on the
vast majority of VCRs, and will shut down the analog-to-digital recording
circuits of DVD recording devices. 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 or DVD recording devices. However, both the DVD and VCR
recording devices do need to be manufactured in accordance with the guidelines
of the Digital Millennium Copyright Act with respect to responding to
Macrovision copy protected analog inputs.
In the DVD and digital PPV markets, we have implemented an enhanced version
of our video copy protection technology. By utilizing another copy protection
component, called Colorstripe(TM), 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, VCR, or DVD
recording device. The copy protection circuits remain dormant until activated by
data commands, which are either embedded in the DVD disc or are sent along with
the PPV movie transmission to the subscriber's set-top box or personal video
recorder. Macrovision's technology is licensed to 271 DVD manufacturers, 343 DVD
authoring houses, 98 replication facilities, 68 digital set-top box
manufacturers and 58 semiconductor component suppliers worldwide.
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ENTERPRISE SOFTWARE DIVISION
Macrovision provides a complete electronic license management solution,
ranging from core software toolkits that software vendors incorporate into their
products to enable flexible licensing, to license fulfillment servers, to
end-user monitoring applications, and to worldwide professional services teams
that help companies follow best practices and integrate the preceding offerings
into various back office systems.
Our FLEXlm(R) licensing system enables software vendors to offer multiple
licensing models, 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") 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.
Our GTlicensing(TM) application is an electronic license creation,
distribution, and tracking tool for software vendors, allowing vendors to ship
and track electronic 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 electronic licenses across the Internet.
Our FLEXbill(TM) technology provides usage data to software vendors from
their participating customers. FLEXbill usage data enables pay-per-use billing
and can be used to automatically implement a new set of licensing policies
(e.g., metered usage) more accurately matched to each customer's needs. Software
vendors use FLEXbill to tailor product offerings to each customer and to invoice
for the usage of this portfolio based on an authenticated usage report.
Our SAMsuite(TM) offering 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.
CONSUMER SOFTWARE DIVISION
Our SafeDisc(R) technology is designed to prevent the copying of CD-ROM
computer software by encrypting 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 education software. The technology is licensed directly to 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, has been licensed to approximately 120 replicators
worldwide, and is estimated to have been used on more than 150 million CD ROMs.
Our SafeCast(R) 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(TM) product is a post-development encryption wrapper for
Microsoft Windows' compatible 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.
MUSIC TECHNOLOGY DIVISION
We are actively involved in developing and marketing 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
6
copying of music CDs. Our current products (CDS-100(TM), CDS-200(TM), and
CDS-300(TM)) provide music labels with the following capabilities:
o First session (Redbook) copy protection, which inhibits the ability to
copy music to a PC for subsequent redistribution on Internet based
file sharing services;
o Encrypted second session (Yellowbook) music files that can play on the
PC, as long as the CD is in the PC CD-ROM drive; and
o DRM technology that enables the second session music files to be
copied to a personal computer hard disk and be managed/played via
Windows Media Player but inhibits subsequent transfer to portable
devices, CD-Rs, and the Internet.
In November 2002, we completed the acquisition of the assets of Midbar
Tech (1998) Ltd. of Israel, and, as a result, acquired what we believe to be the
market leading proprietary CD copy protection and controlled burning
technologies. The CDS-100 and CDS-200 solutions have been used on over 65
million music CDs through 2002. The CDS-300 product is the first integrated
product developed by the combined Midbar and Macrovision engineering staff.
Combining the Midbar patents, Macrovision patents and patents resulting
from our pending acquisition of the intellectual property and other assets of
TTR Technologies, Inc., we believe that we are well positioned to develop and
market unique solutions that meet the needs of the consumer, the artist, the
publisher and the music label. We expect the acquisition of these assets from
TTR to close in the second quarter of 2003, subject to certain closing
conditions being met.
THE MACROVISION GROWTH STRATEGY
LEVERAGE KEY CUSTOMER RELATIONSHIPS. We currently maintain strong
relationships with customers in various industry and market segments, including:
o Video and music content providers such as the major Hollywood studios
and independent movie producers and major record labels;
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 and DVD drives,
PVRs, and digital set-top boxes.
We intend to build our business by capitalizing on these customer
relationships and targeting them for delivery of 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. We have committed significant resources to expand our
technology base, to enhance our existing products, to introduce additional
products and to participate in industry standard-setting efforts and
organizations. We intend to pursue opportunities for rights management, copy
protection and enabling solutions in the following areas:
o Digital video;
o Music CDs;
o Internet downloaded and streamed audio and video files;
o Internet downloaded software files;
o Peer-to-peer file sharing;
o CD-ROM, CD-Rs;
o DVD-ROM, DVD-Rs;
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o Electronic license management and 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 that can be supplemented by
enabling features that will incent consumers and users to pay for video, audio
and software products, rather than trying to get them for free in an
unauthorized fashion. 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 DRM and copy protection
technologies.
CONTINUE TO MAKE STRATEGIC ACQUISITIONS. We intend to continue to expand
our technology portfolio by pursuing licensing arrangements, joint ventures and
strategic acquisitions of companies whose technologies or proprietary rights
complement our rights management and copy protection technologies.
We have made four acquisitions since 1999. We acquired C-Dilla, Ltd. of
the UK in June 1999 in order to enter the application software copy protection
and DRM business; in August 2000, we acquired Globetrotter Software, Inc., which
provided our enterprise electronic license management and software asset
management business; in October 2000, we acquired Productivity through Software
plc ("PtS") of the UK, which was a distributor of our enterprise software
solutions; and, in November 2002, we acquired the assets of Midbar Tech (1998)
Ltd., which provided us with significant intellectual property and key personnel
skilled in music copy protection and controlled disc burning applications. We
have also entered into a definitive agreement to acquire certain assets of TTR
Technologies, Inc., further enhancing our intellectual property relating to
music copy protection.
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 their end-user customers pay them for the use of such content or software.
We receive royalties and recurring revenues as follows:
o Video and music content owners typically pay us a per-unit licensing fee
for the right to use our proprietary copy protection technologies for DVDs,
videocassettes, and music CDs;
o Enterprise software vendors and enterprise end-user customers pay us a fee
to license our technology using either time-based licenses 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 time-based or perpetual licenses
for our DRM technology;
o Digital set-top box and digital PVR 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 or VOD services. In addition, we are entitled to
transaction-based royalty payments when copy protection for digital PPV or
VOD 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 license fee.
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. We also license our software asset management
solutions directly to end-user enterprise customers. Our primary sales strategy
is to sell at senior levels,
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offering worldwide contracts that cover customers' international operations. We
supplement our direct sales efforts with reseller programs and service
partnerships among VHS, DVD, and CD duplicator, replicator and authoring
organizations, and internal 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.
Our primary locations for product development, business strategy, and
operations are in our Santa Clara (California) and Woodley (United Kingdom)
offices. We have sales and support operations through our U.S.sales force, and
through our offices in South Ruislip, Woodley and Cheshire in the United
Kingdom; Frankfurt, Germany; Tokyo, Japan; Seoul, Korea; Hong Kong; Taipei,
Taiwan; and Tel Aviv, Israel.
CUSTOMERS
VIDEO TECHNOLOGY DIVISION
VIDEO CONTENT. Our copy protection technology has been applied to more
than 3.6 billion videocassettes worldwide since 1985. Since the inception of DVD
in 1997, our copy protection has been applied to over 1.5 billion DVDs. 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 New Line Cinema
o Buena Vista Home Video (Disney) o Paramount Pictures
o Columbia TriStar Home Entertainment o Twentieth Century Fox Home
(Sony Pictures) Entertainment
o DreamWorks SKG o Universal Studios Home Video
o HBO Home Video (Vivendi)
o Lion's Gate/Trimark Pictures o Warner Brothers Home Video
One customer accounted for more than 10% of Macrovision's net revenues
in 2002. There was no customer 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. The Motion Picture Association of America ("MPAA") studios as a group
accounted for 42.2%, 33.2% and 24.8% of Macrovision's total net revenues in
2002, 2001 and 2000, 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.
PPV/VOD SYSTEM OPERATORS. There are over 20 system operators who have
licensed or specified Macrovision's digital PPV copy protection technology for
incorporation into their networks, including:
o British Sky Broadcasting Group o Optus (Australia)
o BS Conditional Access Systems Co., o Premier (Germany)
Ltd. (Digital BS Broadcast) (Japan)
o DirecTV (North America) o SkyPerfecTV! (Japan)
o DirecTV Latin America o Telewest Communications (UK)
o Korea Digital Broadcast ("KDB") o UPC (Holland)
o NTL o Video Networks Ltd. (UK)
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 or VOD programming is activated. However, only 9 international system
operators have activated Macrovision's copy protection in their networks:
British Sky Broadcasting (UK), Digital BS (Japan), Kingston Communications (UK),
Korea Digital Broadcast (Korea), NTL (UK), SkyPerfecTV! (Japan), Telewest (UK),
Premiere (Germany) and Video Networks Ltd. (UK). 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 usage license agreements with us, but which are requiring
Macrovision-capable set-top boxes in their networks include: AT&T, Comcast, Cox
from a variety of sourcesEnterprises, Deutsche
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Telecom, Rogers Cable, Time Warner, UPC and Via Digital. We are in discussions
with a number of major studios to activate VOD copy protection in the U.S.
CONSUMER ELECTRONICS HARDWARE MANUFACTURERS. We believe that our DVD
copy protection technology is currently the only viable digital-to-analog and
analog-to-digital 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, 2002, 271 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 PlayStation(R)2 and Xbox(TM).
Our PPV/VOD copy protection technology is embedded in more than 100
million digital set-top boxes currently in use worldwide, which we believe
represents approximately 90% of all digital set-top boxes. We have licensed our
copy protection technology for digital PPV/VOD to 68 set-top box and 9 PVR
manufacturers, including:
o Acer o Pace Micro Technology
o AT&T Network Systems o Philips Electronics
o Daewoo Electronic Co., Ltd. o Pioneer Electronics
o EchoStar Communications o Scientific-Atlanta
o Hughes Electronics o Sony
o Motorola Broadband o THOMSON Multimedia
We have also authorized 58 semiconductor companies to incorporate our
digital PPV/VOD 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 and personal video
recorder (sometimes referred to as "digital video recorder") manufacturers.
ENTERPRISE SOFTWARE DIVISION
We believe that FLEXlm, our electronic license management ("ELM")
software, is the industry leader. Worldwide adoption of our ELM technology will
be an important driver of future growth. We have licensed our ELM and electronic
license delivery ("ELD") technologies to more than 2,500 independent software
vendor companies in a range of market segments, including:
o Autodesk o Sun Microsystems
o Cadence Design Systems o Sybase
o Cisco Systems o Synopsys
o Rational Software o Wind River Systems
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 ABB o IBM
o BMW o Lockheed Martin
o Eastman Kodak o Nokia
o Ford Motor Company o Royal Dutch/Shell Group
CONSUMER SOFTWARE DIVISION
We entered the consumer software copy protection 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
entertainment applications. In 2001, we extended the SafeDisc market into
professional applications and computer based
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training and, in 2002, we extended SafeDisc into the Apple Macintosh
environment. We estimate that approximately 150 million CD-ROMs have now been
shipped using SafeDisc.
Our copy protection technology for consumer software is used by leading
software publishers, including the following:
o Activision o Hyperion Solutions
o Apple o MathWorks
o CDV Software Entertainment o Mattel
o Eidos o Microsoft
o Electronic Arts o Take 2 Interactive
o Hasbro (Infogrames) o 3DO
o Havas (Viveni Universal Interactive) o Ubisoft Entertainment
Our consumer software customers have a wide choice of licensed
replicators that they can use throughout the world. Approximately 120
replicators have been licensed and have installed SafeDisc mastering and quality
assurance systems from authorized suppliers of these systems.
In 2002, we experienced continued broad market adoption of our SafeCast
family of digital rights management products. SafeCast enables publishers to
flexibly market, license and protect software products delivered on CD ROMs,
DVDs and via the Internet to increase their revenues. Such customers include:
o Autodesk o Intuit
o BBC o MathSoft
o Electronic Arts 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.
MUSIC TECHNOLOGY DIVISION
CDS-100 and CDS-200 have been utilized on music CDs by all five major
music labels (i.e., Universal, Warner, Sony, BMG, and EMI) in Europe and/or
Japan, and by Avex, Pony Canyon and others in Japan. As of December 2002, our
CDS technology has been applied to over 65 million music CDs worldwide.
The CDS processor, which our customers use to apply our copy protection
technologies to their CDs, has been installed in 42 manufacturing plants
worldwide, including plants in North America, Europe and Japan.
TECHNOLOGY
VIDEO TECHNOLOGY DIVISION
Macrovision's technology was originally designed to prevent unauthorized
copying of VHS, DVD and PPV/VOD programming to VCRs without impacting the
original playback. An added feature of Macrovision's DVD copy protection
technology is that it helps to prevent DVD-to-DVD copying, as well as DVD-to-VHS
copying. The majority of the recently introduced PVRs, DVD/VCR combo units, DVD
recorders ("DVDRs") and PVR/DVDR combo units comply with the U.S. Digital
Millennium Copyright Act and, as a result, they recognize Macrovision's
proprietary analog copy protection process and disable digital recording on
recordable DVD discs.
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 or DVD and a TV set or projection TV 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. In the tradeoff between effectiveness and playability,
designers of copy protection systems must favor playability while maintaining
effectiveness.
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VIDEOCASSETTE COPY PROTECTION. 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/VOD COPY PROTECTION. The DVD and digital PPV/VOD
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, and DVD recorders do not make DVD
copies when they sense Macrovision on the input signal.
ENTERPRISE SOFTWARE DIVISION
Software vendors integrate FLEXlm into their products to monitor or
control a customer's compliance with a product's license terms. When selling
their product, software vendors who use FLEXlm 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. Marketing,
sales, support or order administration staff define licensing policies in the
human readable text file, without the need for software engineers to make
changes in software. Software vendors can include information identifying the
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.
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CONSUMER SOFTWARE DIVISION
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 prevents copying by CD
recorders or transfer from a CD-ROM to a hard disc drive, is added to each
original disc during the mastering/replication process. SafeDisc is a
"unilateral" copy protection solution, which means that all of the copy
protection technology resides on the CD-ROM and nothing has to be added to or
changed in the PC. 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 recording 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. Because of our widespread penetration in the PC games'
market, hackers have targeted and cracked 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 release new product versions approximately
three times per year incorporating new anti-hacking features.
Our SafeDisc technology is patent protected, and is compliant with
Philips' worldwide Yellowbook CD-ROM standard. We believe that SafeDisc is the
only copy protection technology that has received Philips' certification for
compliance.
SafeCast is a software DRM system that 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. The combination of
license terms and persistent protection enables publishers to implement new
licensing models such as subscriptions, rentals, and protected pre-release
programs.
MUSIC TECHNOLOGY DIVISION
In the audio CD market, CDS-100 and CDS-200 first session, or Redbook
copy protection technologies were developed by Midbar (now owned by Macrovision)
to prevent consumer electronic device music files (standard, uncompressed music
CD format) from being ripped by PCs. Each of the several CDS-100 and CDS-200
first session copy protection functions (e.g., coding, hiding and timing) is
covered by pending patent applications. Our second session, or Yellowbook
solution, CDS-300, utilizes an authentication scheme based upon our SafeDisc
product described above, which is covered by a patent and a pending patent
application (for disc-based rights authentication). This solution is designed to
interface with third party DRM systems such as Microsoft's Windows Media Player
(and potentially with Real Network's media player and Sony's Open Magic Gate
DRM), and to enable consumers to play copy protected CDs on their PCs, and
ultimately to download music tracks to their PC's hard disc drive and export
tracks to portable player devices.
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 acquired other
companies and technologies to supplement our research and development
expenditures.
In 2002, 2001 and 2000, our expenses for research and development were
$11.9 million, $9.3 million and $7.8 million, respectively.
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INTELLECTUAL PROPERTY RIGHTS
PATENTS ISSUED & Pending. We hold 76 U.S. patents and have 58 U.S.
patent applications pending. Of the issued or allowed patents, 44 relate to our
copy protection technologies, 18 relate to video scrambling, seven relate to
audio scrambling, five relate to electronic license management and two relate to
DRM technology (namely content usage control, tracking, and e-transactions). Of
the pending patent applications, four relate to consumer software copy
protection and six relate to audio copy protection. The last of our issued U.S.
patents expires in 2019. The last of our core group of analog copy protection
patents expires in the year 2017. We have filed numerous applications for
additional claims and improvement patents to extend the current expiration
dates. We also have 515 foreign patents issued and 400 foreign patent
applications pending in 40 countries. Of the issued foreign patents, 399 relate
to our copy protection technologies, 88 relate to video scrambling, 24 relate to
audio scrambling, and three relate to electronic license management and DRM.
CIRCUMVENTION TECHNOLOGY PATENTS. Included in the patents related to our
copy protection technologies are 15 U.S. and 96 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.
COMPETITION
VIDEO TECHNOLOGY DIVISION
Our video copy protection technologies are proprietary and have broad
international patent coverage. We believe that there are currently no
significant analog video copy protection competitors. We have the only analog
copy protection scheme that has been widely deployed on commercial products that
significantly distorts or inhibits copying by VHS VCRs, DVD recorders and
personal video recorders. Currently, our video copy protection technology is
embedded in nearly 100% of all DVD players and nearly 90% of digital set-top
boxes worldwide. While it is possible that a competitive video copy protection
technology could be developed in the future, we believe it would take years for
the competitive technology to be tested and accepted by hardware manufacturers
and ultimately to begin to be embedded into the consumer electronic devices. By
the time this would happen, it is unlikely any other analog copy protection
technology would displace our copy protection infrastructure and our extensive
video copy protection "ecosystem."
Our technology is designed to inhibit or prevent unauthorized consumer
copying; it is not designed to prevent professional piracy. We believe that our
customers are very concerned with professional piracy of their video, audio and
software products and their need to address professional piracy presents a
certain level of competition to our video copy protection business, to the
extent that some content owners may decide to devote more of their resources to
fighting professional video piracy instead of using our copy protection to deter
unauthorized consumer copying.
In addition, with the increase in online movie and music distribution
over the Internet, other digital content protection or DRM technologies may
present significant competition to our video copy protection business, such as
DRM offerings by Microsoft, RealNetworks and Sony.
ENTERPRISE SOFTWARE DIVISION
Our primary competition in the ELM market currently comes from
independent software vendors who develop their own ELM solutions or electronic
software distribution technology. Other more traditional competitors include
electronic licensing technology vendors (e.g., NetQuartz, Softwrap), as well as
companies that have historically offered hardware dongle products and
supplemented them with ELM offerings (e.g., Rainbow, Aladdin). We believe that
these companies together have penetrated less than 15% of the potential ELM
market. Operating system developers (e.g., Microsoft, Sun) already integrate
limited license management functionality into their products; potentially, they
could expand this functionality, which could pose an increased competitive
threat. Similarly, microprocessor suppliers may choose to integrate rights
management solutions into their products, and software resellers could also
begin to develop their own ELM solutions.
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CONSUMER SOFTWARE DIVISION
We believe that there are a limited number of competitors in our
SafeDisc consumer software copy protection market, including StarForce
Technologies, a Russian company, and Sony's DADC optical disk manufacturing
subsidiary. We believe we are the market share leader due to our strong
intellectual property position and extensive customer base. There are a limited
number of competitors, including Aladdin and XtreamLok, in our SafeCast digital
rights management market, where we believe we have captured the leading market
share.
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 and Intel, may
develop or license copy protection modules or rights management systems that are
internal to the PC or other consumer electronic devices. Few of them have made
any significant inroads, with the exception of Microsoft and Real Networks in
the audio DRM space.
MUSIC TECHNOLOGY DIVISION
We believe that there are a limited number of direct competitors in the
audio copy protection and rights management market, including SunnComm, Sony,
and First4Internet, some of which have greater financial and other resources
than we have. To date, taking into account our acquisition of Midbar, we have
captured a significant market share of the CDs produced worldwide to which audio
CD copy protection has been applied. It is important to note that in 2002, less
than 50 million music CDs out of a total of more than 1 billion music CDs
produced included copy protection technology from any supplier, including
Macrovision and Midbar. In January 2003, Microsoft announced the release of its
Windows Media Data Session Toolkit ("WMDST") with a second session DRM solution
that can to be deployed independently of our solutions. The announcement
included SunnComm as the first company to integrate a third party music CD copy
protection technology with Microsoft's WMDST. We believe that SunnComm uses
technology that is competitive with our CDS-100 and CDS-200 technologies. It is
possible that Microsoft may develop or acquire copy protection and rights
management solutions that compete with our offerings.
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, music CD,
digital PPV/VOD, ELM and consumer software customers in various ways:
o We support our licensed duplicators and replicators with hardware and
software installation assistance and quality control. In addition, we
support licensed duplicator/replicator sales personnel by providing sales
training and literature, and by participating in trade shows;
o We support the efforts of television, VCR and DVD hardware manufacturers,
digital PPV/VOD system operators and PPV/VOD 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 and audio
copy protection technologies on representative samples of consumer
televisions, VCRs, DVD players and PC drives, and music CD player and
recorder devices to determine whether modifications or enhancements may be
necessary;
o We provide training and professional services to assist our independent
software vendor licensees in wrapping their executables with our SafeDisc
and SafeCast modules;
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o We provide support and maintenance, training, integration and software
development services to customers 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 CDS (audio
copy protection and authentication) toolkits; and
o We test for SafeDisc and CDS compatibility and effectiveness with a variety
of PC and CD-ROM drive software and hardware.
We have minimal manufacturing operations. Our strategy is to license our
technologies to third parties that manufacture products or software
incorporating our technologies. Our manufacturing operations are limited to low
volume video and audio copy protection hardware products that require in-house
system integration and quality control efforts.
STRATEGIC INVESTMENTS
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, 2002, we owned
approximately 11.5% of Digimarc, which translated to a valuation of $22.8
million. During 2002, we determined that the decline in value of Digimarc stock
was other-than-temporary and took a charge to earnings of $1.8 million as a
result.
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.
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 duel-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,
2002, we held approximately 10.3% of the outstanding shares of TTR, which
translated to a carrying value of $339,000.
During 2002, we determined that the decline in value of TTR stock was
other-than-temporary and took a charge to earnings of $3.8 million as a result.
In November 2002, we signed an agreement with TTR to acquire patents and
other assets for approximately $5.3 million in cash and the surrender of our
stock in TTR. We expect this transaction to close in the second quarter of 2003.
iVAST. In June 2001, we invested $5.0 million to acquire an 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. As of December 31, 2002, we owned approximately
15.6% of the outstanding shares of iVAST.
NTRU CRYPTOSYSTEMS. In August 2001, we invested $1.5 million to acquire
an 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. As of December 31, 2002, we owned
approximately 2.3% of the outstanding shares of NTRU Cryptosystems.
In December 2002, we received information that NTRU Cryptosystems would
be returning cash to investors and suspending business operations. We recorded
an impairment charge of $938,000 in December 2002 to reduce the value of our
investment to $562,000 which is the net realizable value based on the cash we
expect to receive.
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COMMAND AUDIO CORPORATION, DIGITAL FOUNTAIN AND WIDEVINE TECHNOLOGIES.
We had previously acquired minority equity interests in Command Audio
Corporation, Digital Fountain and Widevine Technologies. During 2002, consistent
with our policy for evaluating recoverability of these investments, we concluded
that impairment of our investments was other-than-temporary. Accordingly, we
wrote off the book value of these investments during 2002 and took an aggregate
charge to earnings of $10.7 million relating to them for the year ended December
31, 2002.
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 carrying value of these investments during 2001
and took an aggregate charge to earnings of $6.9 million for the year ended
December 31, 2001.
These strategic investments, valued at $28.7 million as of December 31,
2002, represented 8.9% and 16.9% of our total assets as of December 31, 2002 and
2001, respectively. NTRU Cryptosystems and iVAST are privately held companies.
There is no active trading market for their securities and our investment in
them is illiquid. In total we wrote off $17.2 million and $6.9 million
respectively related to impairments that were other-than-temporary for the years
ended December 31, 2002 and 2001. There were no comparable write-offs in 2000.
Looking forward, we may continue to evaluate strategic investment
opportunities on a selective basis that we feel may broaden our market reach or
technology portfolio. We may never have an opportunity to realize a return on
either current or future investments and may be required to write off all or
part of these investments.
EMPLOYEES
As of December 31, 2002, we had 283 employees. Of these employees, 108
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.
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.
17
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 various video formats:
prerecorded videocassettes, DVDs and digital pay per view or video on demand
(PPV/VOD) programs. These fees represented 63.1%, 63.0%, and 60.9% of our net
revenues during 2002, 2001 and 2000, respectively.
Any future growth in revenues from these fees will depend on (a) growth
in the various media formats, (b) increased use of our video copy protection
technology on a larger number of videocassettes, DVDs or digital PPV programs,
or (c) increases in usage fees or royalties. 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. In the past we have seen our usage fees decline over time. Even
though we have contracts with 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 able to sustain our level of net revenues, or our rate of
revenue growth, on a quarterly or annual basis. In addition, we may be required
to delay or extend recognition of revenue on more complex licensing arrangements
as required under generally accepted accounting principles. 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 that 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;
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o The acceptance of our electronic licensing and DRM software by software
vendors and end-user organizations;
o The acceptance of our new music copy protection technologies by major music
labels in the U.S. market, Europe and Asia, and consumer reactions;
o The timing of releases of computer software CD-ROM multimedia titles;
o The extent to which various hacking technologies are viewed by our
customers to undermine our technologies; and
o The extent to which we are able to transition our market leading position
in optical media (i.e., packaged media) copy protection and our experience
in DRM to digital content distribution via the Internet.
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 and from music copy protection 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, and is becoming increasingly 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. Only one customer accounted for 11.4% of our net revenues in 2002,
no single customer accounted for more than 10% of our net revenues in 2001, and
one customer accounted for 10.3% of our net revenues in 2000, the Motion Picture
Association of America studios as a group accounted for 42.2%, 33.2% and 24.8%
of our net revenues in 2002, 2001 and 2000, 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.
Our major customers may have a large influence on industry standards and
the widespread adoption of new technologies. The selection of alternative
technologies to ours could harm our business.
WE DEPEND ON SIGNING HIGH-VALUE LICENSE AGREEMENTS DURING THE REPORTING PERIOD
FROM MAJOR SOFTWARE CUSTOMERS FOR OUR FLEXLM 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 FLEXlm Electronic License
Management revenues are generated from perpetual licenses, under which license
fee revenue is generally 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 the term of the license, which is generally 12 months. We expect
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that as we pursue more ISV customers in the mainstream enterprise software
market that we may engage in more custom software development projects that may
extend our revenue recognition by linking it to completion of this customized
software and formalized customer acceptance.
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 34.2%, 45.2%, and
42.3% of our video technology net revenues in 2002, 2001, and 2000,
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 acceptance and
deployment of our copy protection and DRM solutions for music CDs, digital PPV
networks, DVDs, and consumer software. Worldwide adoption of our FLEXlm 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 digital content and software, which may
make our copy protection technology less effective and reduce the demand for it.
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 changes in, or weakening of copyright and intellectual property (patent)
laws and support for copy protection and DRM technologies;
o tariffs or taxes and other trade barriers and restrictions;
o fluctuations in our net effective income tax rate driven by changes in the
percentage of revenues that we derive from international sources;
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, music, PPV and
other applications requiring our copy protection solutions or if regulations
governing our international businesses change. For example, our products are
eligible for export under the U.S. Export Administration Act and U.S. export
regulations. The company has implemented a program to comply with these laws and
regulations, but cannot guarantee that any particular product can be exported to
any particular location at any particular time. 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.
20
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;
o diversion of management and technical resources;
o our discontinuing the use and sale of infringing products;
o our expending significant resources to develop non-infringing technology;
and
o our 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 2017. 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. A number
of companies with extensive financial resources have developed intellectual
property in the digital rights management field, including Intertrust, Philips,
Sony, ContentGuard and Microsoft. Such competitive threats could harm our
business.
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 and software. 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 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. Although 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
21
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. We expect to encounter similar
challenges in the music copy protection business. 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.
LEGISLATIVE INITIATIVES SEEKING TO WEAKEN COPYRIGHT LAW COULD HARM OUR BUSINESS.
Consumer rights advocates and other constituencies are challenging
copyright law, notably the U.S. Digital Millennium Copyright Act, through both
legislative and judicial actions. If copyright law is compromised, or devices
that can circumvent our technology are permitted by law and become prevalent,
this could result in reduced demand for our video copy protection technologies
in particular, and our business would be harmed.
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. For companies we have acquired in the past and companies
we acquire 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, Command Audio, Digital Fountain, iVAST, NTRU
Cryptosystems, and Widevine Technologies. These investments, totaling $28.7
million, represented 8.9% of our total assets as of December 31, 2002. Command
Audio, 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. During 2002 and 2001, we wrote
off $17.2 million and $6.9 million, respectively, of strategic investments
resulting from impairment that was other-than-temporary. There were no
comparable write-offs in 2000.
INVESTMENT IN NEW TECHNOLOGIES, MARKET DEVELOPMENT AND ADMINISTRATIVE
INFRASTRUCTURE COULD RESULT IN LOWER MARGINS.
We intend to continue to pursue our intellectual property-based
licensing model, which has historically been characterized by high margins and
recurring revenues. Our operating margins, though very high in relative terms,
have fallen over the last four quarters, and it is possible we could see margins
erode further as we continue to invest in new
22
technologies, market areas or administrative infrastructure. While we look for
acquisition transactions that will expand our copy protection and rights
management capabilities, acquisition activities could also cause operating
margins to fall depending on the acquiree's operating model.
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 independent software vendor 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 SOME OF OUR
MUSIC COPY PROTECTION 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 audio copy protection and
authentication generator at licensed replication facilities; and
o allow replicators to run specialized quality assurance tests to confirm the
SafeDisc or audio protection technologies are 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 approximately
120 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.
WE MUST ESTABLISH AND MAINTAIN LICENSING RELATIONSHIPS WITH COMPANIES OTHER THAN
CONTENT OWNERS OR SOFTWARE PUBLISHERS TO CONTINUE TO BUILD AND SUPPORT A
WORLDWIDE COPY PROTECTION ECOSYSTEM AND 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 DVD and CD authoring facilities, mastering houses and replicators;
o DVD and CD authoring tools software companies;
o DVD and CD hardware manufacturers;
o videocassette duplicators;
o international distributors of videocassettes;
o semiconductor and equipment manufacturers;
o operators of digital PPV networks;
o consumer electronics and digital PPV set-top hardware manufacturers; and
o DRM suppliers, especially in the music business.
23
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.
Some of our third party license arrangements will require that we
license others' technologies and or integrate our solutions with others. As an
example, our customers will expect that our music copy protection,
authentication, and controlled burning technologies will be integrated with
various DRM solutions. If these third parties choose not to support integration
efforts or delay the integration, our business could be harmed.
OUR PRODUCTS COULD HAVE 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.
In protecting copyrights and other intellectual property rights of our
customers, our products affect consumer use of our customers' products.
Consumers may view this negatively and discontinue or threaten to discontinue
use of our customers' products unless our customers stop using our technologies.
This may cause a decline in demand for our products or legal actions against us
by our customers or consumers. Third-party consumers are not likely to be
subject to the liability-limiting provisions that are contained in our contracts
with our customers.
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 and MacroSafe, are designed to
support using the Internet to deliver, deploy, activate or pay for software or
digital media. 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 and digital media. 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:
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
24
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 USE OF THE INTERNET FOR DELIVERY OF VIDEO AND AUDIO PROGRAMMING INCREASES,
OUR BUSINESS MAY SUFFER.
Some of our products, such as video, audio and packaged software copy
protection, are designed to be applied to packaged media, and we receive
royalties based on the number of units produced. If delivery of such products
using the Internet were to increase, our revenues from packaged media may be
adversely affected and not replaced by Internet-based revenues. In this event,
our business could be seriously harmed.
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. 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, 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 currently have a high percentage of
our employees and executives who have underwater stock options, and we have a
shortage of new options available to satisfy the long-range incentive
expectations of many of our key employees. In the upcoming Proxy for our annual
meeting, we will be submitting proposals to expand the employee option pool and
to implement an employee option tender to replace in 6 months plus 1 day certain
underwater options with smaller numbers of new options. We believe that a
failure by shareholders to support these proposals may lead to the loss of key
executives and employees that could harm our business.
CALAMITIES OR TERRORIST ATTACKS IN SILICON VALLEY, AS WELL AS THE U.K. OR OTHER
COUNTRIES IN WHICH OUR OFFICES ARE LOCATED COULD DISRUPT OUR BUSINESS AND
ADVERSELY AFFECT OUR OPERATIONS.
Our headquarters office facilities in Santa Clara, California 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. A terrorist attack targeting Silicon
Valley, as well as the U.K. or other countries in which our offices are located
could disrupt our business and substantially affect our operations.
INDUSTRY RISKS
IF CONSUMER REACTION TO MUSIC COPY PROTECTION AND DIGITAL RIGHTS MANAGEMENT
TECHNOLOGIES IS UNFAVORABLE, OUR REVENUE POTENTIAL WILL BE ADVERSELY
AFFECTED.
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. To date, we have seen limited
acceptance of our technology in Europe and Japan. The music labels have not
moved to deploy the technology in the U.S. because they completely do not
believe they have adequately tested the second session solution, nor are they
completely satisfied with effectiveness and playability levels of the first
session (Redbook) solution. If the music labels conclude that shipping
increasingly meaningful volumes of CDs that include our technologies generate
unacceptable consumer backlash, our revenue potential will be adversely
affected.
There may be consumer resistance to the adoption of DRM technology in
consumer software. There has been significant media attention in recent months
regarding the implementation of SafeCast by one of our customers, a major
consumer software vendor. This customer is now the defendant in a consumer class
action lawsuit arising from its use of our SafeCast technology. Consumer
resistance to this technology, further negative media coverage and legal actions
against our customers and us may slow broad adoption of this technology and harm
our business.
WE LICENSE TECHNOLOGY FOR DIGITAL VOD AND 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.
25
While our copy protection capability is embedded in more than 100
million digital set-top boxes manufactured by the leading digital set-top box
manufacturers, only nine 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.
Further, consumers may react negatively to copy protected PPV or VOD
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.
While there is no guaranty that the DVD CCA will select a technology in
this testing and evaluation process, and in fact the selection has been
progressively delayed since the summer of 2002, 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 under development by the VWM
Companies is not selected 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 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 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.
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 publishers have
experienced macroeconomic pressures over the last year. Unit sales of PCs have
slowed; major PC suppliers have announced weaker financial results than
expected. Several PC software publishers have reported financial difficulties
and experienced management and employee turnover. In 2002 the volume of PC games
declined while the volume of games sold for console platforms increased
significantly. If economic conditions in this segment continue to be difficult,
demand for our copy protection and rights management
26
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. Several 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 ENTERED THE ELM MARKET, AND MARKET CONDITIONS ARE DIFFERENT FROM THE
ENTERTAINMENT SPACE.
We acquired GLOBEtrotter Software, Inc. in August 2000. This business
has been renamed Macrovision's Enterprise Software Division. Its major product
line is FLEXlm, an electronic license management (ELM) software product that is
integrated into independent software vendors' offerings to allow 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 HAVE ENTERED 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.
In November 2002 we acquired the assets of Midbar Tech (1998) Ltd. We
have also agreed to purchase certain assets of TTR Technologies, Inc. These
companies were engaged in music CD copy protection and rights management. We are
operating under a strategic relationship with TTR Technologies, Inc. to develop
and market a copy protection system that inhibited casual copying or "ripping"
of Redbook format music CDs. Midbar had been a primary competitor in the market
and had licensed its technology to major record labels in Europe and Japan.
Patents we have acquired and are acquiring from both Midbar and TTR cover
Redbook copy protection and controlled burning - two technologies that we
believe are fundamental to success in the music copy protection business. A
number of competitors and potential competitors may be developing similar or
alternative music copy protection solutions, including Microsoft. 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.
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.
We believe that our DVD digital-to-analog copy protection and
videocassette copy protection systems currently have no competitors. It is
possible, however, that competitive copy protection technologies could be
developed in the future. Increased competition would be likely to result in
price reductions and loss of market share, either of which could harm our
business.
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
27
copy protection systems; CSS - a content scrambling system for the DVD format;
the non-proprietary CGMS trigger bits; Intel's High Definition Copy Protection
("HDCP") encryption for both the Digital Display Working Group's Digital Video
Interfaces ("DVI") and DHMI Licensing, LLC's High Definition Multimedia
Interface ("HDMI"). With the exception of CGMS, these systems are not directly
competitive, as some apply to future products, 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. Additionally, they may compete from the standpoint
of content owners believing they have a limited budget for copy protection, and
they may choose to spend their copy protection dollars on only a few
technologies.
The DVD Copy Control Association's ("DVD CCA") Board members failed to
select either the Video Watermarking ("VWM") Group or Toshiba technologies in
August 2002 as an industry-wide watermarking standard. The selection process has
now moved to the larger Content Protection Advisory Council ("CPAC"), which
plans a vote in May 2003. If there is not a positive outcome from this vote,
then the difficulties in introducing digital watermarking to the marketplace
could be significantly compounded, and an industry-wide watermarking decision
may never be made, and our future business would be harmed.
Our primary competition in the ELM market currently comes from
independent software vendors who 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 SecureRom Sony's DADC optical disk
manufacturing subsidiary, and StarForce Technologies, a Russian company.
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.
In the consumer software DRM market, as in the enterprise software ELM
market there is substantial competition from customer implemented internally
developed solutions, as from small companies such as Australian company
XtreamLok.
DRM solutions for consumer software, video, and audio have also
attracted a number of companies and significant venture capital, including Sony
and Philips recent acquisition of Intertrust Technologies, Microsoft, Content
Guard, and Real Networks. It is possible that companies with extensive financial
resources may develop or acquire copy protection and rights management solutions
that compete with our offerings, or may have a controlling patent position which
would negatively impact our cost basis, or may give away their DRM technologies
as in the case of the Windows Media Player.
Several of our competitors in the audio copy protection and rights
management market, including SunnComm, Sony, Setec and First4Internet 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;
28
o competitors or their customers;
o governmental regulatory and copyright action;
o developments with respect to patents or proprietary rights;
o changes in financial estimates or coverage by securities analysts; and
o general market conditions.
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 electronics or
software vendor companies' business combinations, evolving industry standards,
consumer rights activists "wins" on Capitol Hill or in the courts, or other
developments could cause the market price of our common stock to fluctuate
substantially.
In addition, 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.
Further, the military conflict in Iraq, additional acts of terrorism and
related political instability and economic uncertainty may adversely affect the
global financial markets.
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"). Pro forma
earnings are non-GAAP financial measurements. 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. However, we urge investors to carefully review the
GAAP financial information included as part of our Quarterly Reports on Form
10-Q and our Annual Reports on Form 10-K that are filed with the SEC, as well as
our quarterly earnings releases, and compare the GAAP financial information with
the pro forma financial results disclosed in our quarterly earnings releases and
investor calls, as well as in some of our other reports. If we decide to curtail
this pro forma presentation in our quarterly earnings press releases, the market
price of our stock could be affected.
WE DO NOT EXPENSE STOCK-BASED COMPENSATION.
We believe that employee stock options are an important element of total
compensation. We account 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 comply with the disclosure provisions of (iii) Statement of
Financial Accounting Standard No. 123 ("SFAS No. 123"), "Accounting for
Stock-Based Compensation." A change in accounting principles generally accepted
in the United States of America which requires employee stock-based compensation
arrangements to be accounted for as period expense (in a manner different to APB
No. 25 and FIN 44) may have a material, negative impact upon our future
earnings. This could cause the market price of our stock to be affected.
29
ITEM 2. PROPERTIES.
As of March 4, 2002, our principal U.S. operations were merged into an
86,785 square foot building in Santa Clara, California. Most 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 in this location, with a small number of individuals
operating out of their home offices. 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 Frankfurt, Germany; Tokyo, Japan; Seoul, Korea;
Hong Kong; Taipei, Taiwan; and Tel Aviv, Israel.
ITEM 3. LEGAL PROCEEDINGS.
We are involved in legal proceedings related to some of our intellectual
property rights.
GLOBETROTTER V. RAINBOW TECHNOLOGIES, ELAN & KEN GREER
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. 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. In a ruling on September
24, 2001, Judge Fogel denied our 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.
On January 18, 2002, we filed a summary judgment motion to dismiss some
of the counterclaims from Rainbow et al. and Judge Fogel granted our motion to
dismiss. On June 3, 2002, we filed another summary judgment motion to dismiss
additional counterclaims from Rainbow et al. and our motion to dismiss was later
denied. On July 22, 2002, we filed three more summary judgment motions to
dismiss additional counterclaims from Rainbow et al. On August 26, 2002, Judge
Fogel granted two of our motions. On October 7, 2002, Judge Fogel held a hearing
on the third motion. While a decision was pending on the third motion, on
September 30, 2002 we filed yet two more motions to dismiss all remaining
counterclaims and a request for leave to file motion for reconsideration of the
patent infringement case or in the alternative for leave to supplement the
record. A hearing was held on November 4, 2002. On or about November 18, 2002,
Judge Fogel granted all of our motions for summary judgment in full and
dismissed all of the claims against Matt Christiano and us.
On December 9, 2002, Ken Greer and Elan filed a notice to appeal the
summary judgment of all their counterclaims by Judge Fogel. In response, on
December 23, 2002, we filed a notice to appeal the summary judgment of all its
patent infringement claims against Ken Greer, Elan and Rainbow. On or about
January 2, 2003, Rainbow filed a notice to appeal the summary judgment of all of
its counterclaims. We have reached a general agreement with Rainbow to dismiss
all cross-appeals between Rainbow and us. A final dismissal still needs to be
completed. The cross-appeals between us, on
30
the one hand, and Ken Greer and Elan, on the other, remain active. The briefs
associated with these remaining appeals are expected on or around March 31,
2003.
If an adverse ruling is ultimately reached on the remaining appeals in a
trial court, significant monetary damages may be levied against us, which could
have a material adverse effect on our business, consolidated financial position,
results of operations or cash flows.
MACROVISION CORPORATION V. VITEC AUDIO AND VIDEO GMBH
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 would require technical expert witnesses.
The Court selected Professor Dr. Ing. M. Plantholt as its expert witness. On
January 27, 2003, Professor Plantholt submitted his technical opinion to the
Court. Although the English translation is not yet available, our German
litigation counsel has indicated that Professor Plantholt's opinion may not be
favorable to us. 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 addition, we may be obligated to pay some of ViTec's
attorney fees estimated to be US$25,000.
KRYPTON CO., LTD. V. MACROVISION CORPORATION
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 appealed this decision to the Tokyo High Court, and 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 High Court regarding its earlier decision. On March 3, 2003, the Tokyo
High Court rejected Krypton's arguments and reaffirmed its earlier decision.
Krypton may appeal the decision to the Japanese Supreme Court. Even if an
adverse ruling ultimately were reached on this invalidation claim, it would not
have a material adverse effect on our business.
DIGIMARC V. VERANCE CORPORATION
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 us 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 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. On September 26, 2002, the parties Joint Motion to Dismiss was
granted by the Court, and the action was dismissed.
YIELD DYNAMICS, INC. V. MACROVISION CORPORATION AND GLOBETROTTER SOFTWARE, INC
On October 17, 2002, Yield Dynamics, Inc. filed a federal court action
in the Northern District of California, San Jose Division, against us and our
subsidiary Globetrotter Software, Inc. Yield Dynamics alleges that it created a
software interface to allow its Genesis software product to work with our FLEXlm
software and distributed the FLEXlm software containing this code without
permission. Yield Dynamics has asserted claims of copyright infringement, trade
secret misappropriation, common law unfair competition, and unfair competition
under California's Business and Professions Code. Yield Dynamics seeks an
injunction, a constructive trust on receipts from the licensing or sale or
products containing the interface code, and actual, compensatory and punitive
damages. We answered Yield Dynamic's complaint and have asserted a counterclaim
for declaratory relief. The action is currently in the initial stages of
discovery.
31
Although we do not expect a material adverse result, we are unable to
provide an estimate of the range or amount of potential loss in the event of an
adverse ruling. We intend to contest the case vigorously.
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.
As of December 31, 2002, it was not possible to estimate the liability,
if any, in connection with these matters. Accordingly, no accruals for these
contingencies have been recorded.
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, 2002.
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.
HIGH LOW
---- ---
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
2002
----
First Quarter $ 38.020 $ 22.830
Second Quarter $ 27.120 $ 11.660
Third Quarter $ 14.990 $ 8.980
Fourth Quarter $ 20.700 $ 9.760
As of March 25, 2003, there were 109 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 25, 2003,
there were 48,553,015 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.
32
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected consolidated financial data and
other operating information. The financial data does not purport to indicate
results of operations as of any future date or for any future period. The
financial data 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,
----------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
(in thousands, except per share data)
Consolidated Statements of Income Data:
Net revenues $102,262 $ 98,813 $ 80,116 $ 52,076 $ 36,446
---------- ---------- ---------- ---------- ----------
Costs and expenses:
Cost of revenues 10,285 7,980 7,222 5,788 2,435
Research and development 11,880 9,285 7,822 6,463 4,072
Selling and marketing 20,720 18,138 15,037 12,713 9,652
General and administrative 15,035 13,245 12,717 7,169 7,437
Amortization of goodwill and other intangibles
from acquisitions (1) 273 8,738 3,081 697 -
Amortization of deferred stock-based compensation
(2) 6,261 9,591 15,533 - -
In-process research and development (3)(4) 6,000 - - 4,285 -
Restructuring expenses - 2,214 - - -
---------- ---------- ---------- ---------- ----------
Total costs and expenses 70,454 69,191 61,412 37,115 23,596
---------- ---------- ---------- ---------- ----------
Operating income 31,808 29,622 18,704 14,961 12,850
Impairment losses on investments 17,210 6,860 - - -
Interest and other income (expense), net 7,318 10,397 10,714 1,634 1,179
---------- ---------- ---------- ---------- ----------
Income before income taxes 21,916 33,159 29,418 16,595 14,029
Income taxes 9,827 13,974 15,825 4,108 4,020
---------- ---------- ---------- ---------- ----------
Net income $ 12,089 $ 19,185 $ 13,593 $ 12,487 $ 10,009
========== ========== ========== ========== ==========
Basic earnings per share $ 0.24 $ 0.38 $ 0.28 $ 0.28 $ 0.25
========== ========== ========== ========== ==========
Shares used in computing basic earnings per share (1) 50,046 50,216 49,135 45,031 40,850
========== ========== ========== ========== ==========
Diluted earnings per share $ 0.24 $ 0.37 $ 0.26 $ 0.27 $ 0.23
========== ========== ========== ========== ==========
Shares used in computing diluted earnings per share
(1) 50,602 51,746 51,386 47,096 43,046
========== ========== ========== ========== ==========
(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.
(4) In connection with the acquisition of Midbar Tech (1998) Ltd. in
November 2002, we allocated and expensed $6.0 million of the purchase
price to in-process research and development projects.
33
Year Ended December 31,
---------------------------------------------------------
2002 2001 2000 1999 1998
----------- ---------- --------- ---------- ---------
AMORTIZATION OF DEFERRED STOCK-BASED COMPENSATION (in thousands)
Expense:
Cost of revenues $ 395 $ 468 $ 428 $ - $ -
Research and development 1,205 1,999 3,064 - -
Selling and marketing 3,502 5,219 10,645 - -
General and administrative 1,159 1,905 1,396 - -
----------- ---------- --------- ---------- ---------
$ 6,261 $ 9,591 $ 15,533 $ - $ -
=========== ========== ========= ========== =========
December 31,
---------------------------------------------------------
2002 2001 2000 1999 1998
----------- ---------- --------- ---------- ---------
CONSOLIDATED BALANCE SHEET DATA: (in thousands)
Cash, cash equivalents, short and long term investments $210,376 $231,048 $217,441 $ 36,162 $27,483
Working capital 191,862 144,676 123,895 38,860 29,431
Total assets 324,666 335,586 296,438 132,690 70,530
Long-term obligations, net of current portion 448 33 56 133 367
Total stockholders' equity 296,859 318,200 275,975 102,273 60,292
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE FOLLOWING COMMENTARY SHOULD BE READ IN CONJUNCTION WITH THE
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES CONTAINED ELSEWHERE IN THIS
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
Macrovision Corporation was 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, CDs, digital PPV programs and consumer software. We derive royalty-based
licensing revenue from multiple sources, including video content owners,
consumer software publishers, music labels, 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 independent software
asset management tools for business through the acquisition of Globetrotter
Software Inc. In 2002, we enhanced our presence in the audio copy protection
market with our acquisition of the assets of Midbar Tech (1998) Ltd.
The following table provides net revenue information by product line
(dollars in thousands):
YEAR ENDED DECEMBER 31,
------------------------------------------
2002 2001 2000
------------ ----------- -----------
Video Technology Division:
DVD $ 45,987 $ 37,610 $ 20,867
Videocassette 7,611 11,509 12,899
Pay-Per-View 10,971 13,207 15,062
Consumer Software Division 10,142 10,062 8,372
Enterprise Software Division 26,894 25,643 21,770
Music Technology Division 400 - -
Other 257 782 1,146
------------ ----------- -----------
Total $ 102,262 $ 98,813 $ 80,116
============ =========== ===========
34
The following table provides percentage of net revenue information by
product line:
YEAR ENDED DECEMBER 31,
--------------------------------------
2002 2001 2000
------------ ----------- -----------
Video Technology Division:
DVD 45.0% 38.0% 26.0%
Videocassette 7.4 11.6 16.1
Pay-Per-View 10.7 13.4 18.8
Consumer Software Division 9.9 10.2 10.5
Enterprise Software Division 26.3 26.0 27.2
Music Technology Division 0.4 - -
Other 0.3 0.8 1.4
------------ ----------- ------------
Total 100.0% 100.0% 100.0%
============ =========== ============
VIDEO TECHNOLOGY DIVISION
Our customers include the home video divisions of member companies of
the Motion Picture Association of America ("Hollywood studios"), 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 Hollywood
studios or other content owners. Royalties from Hollywood studios represented a
significant portion of such fees in 2002, 2001and 2000
DVD COPY PROTECTION. Our customers include member companies of the
Hollywood studios 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
45.0%, 38.0% and 26.0% of our net revenues in 2002, 2001 and 2000, 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. We
expect this trend to continue in 2003.
VIDEOCASSETTE COPY PROTECTION. As expected, in 2002 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 7.4%, 11.6% and 16.1% of our net revenues in 2002, 2001 and 2000,
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. We offer 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 most of our digital PPV
copy protection revenues from hardware royalties, and we derive a small portion
of our PPV revenues from up-front license fees, and PPV programming royalties.
Digital PPV copy protection revenues were 10.7%, 13.4% and 18.8% of our net
revenues in 2002, 2001 and 2000, 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. In 2003 we expect small incremental revenue
streams from royalties from VOD set top boxes and from transaction-based VOD
programming royalties. We expect our PPV/VOD copy protection revenues in the
future to vary, as future results will depend on expanded adoption of this
technology in the United States.
CONSUMER SOFTWARE DIVISION
Customers implementing our Consumer Software Division technology include
major PC game and educational software publishers. We typically receive license
fees based upon the number of copy protected CD-ROMs that are produced by PC
game and educational software publishers, and license and maintenance revenues
from application software vendors for our SafeCast DRM solution. Consumer
software copy protection revenues represented 9.9%, 10.2% and 10.5% of our net
revenues in 2002, 2001 and 2000, respectively. Due to increased market
acceptance of our SafeCast solution, we expect revenues from Consumer Software
Copy Protection to increase in 2003.
35
ENTERPRISE SOFTWARE DIVISION
In August 2000, we acquired Globetrotter Software, Inc., a leading
supplier of enterprise 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 the year ended December 31, 2000 include Globetrotter's
results of operations for the full year. The Enterprise Software Division
generates its revenue from licensing its software and providing services for the
support and maintenance of this software. Revenues from this business segment
were 26.3%, 26.0% and 27.2% of our net revenues in 2002, 2001 and 2000,
respectively. Our revenues increased from $25.6 million in 2001 to 26.9 million
in 2002 in spite of our customer base of independent software vendors having
experienced declines in sales as their corporate customers reduced enterprise
software expenditures in 2002. Demand for our technology is driven, to some
degree, by end-user demand for software applications. While revenues have
increased in each of the last three years, if economic conditions for software
continue to be difficult or worsen, demand for our ELM technology could decline.
MUSIC TECHNOLOGY DIVISION
In November 2002, we acquired the assets and operations of Midbar Tech
(1998) Ltd., a leading supplier of copy protection solutions for the music
industry, for approximately $17.8 million in cash and related acquisition costs.
In addition, we have agreed to an additional maximum payout of $8.0 million
based on a percentage of net revunues of the Music Technology Division through
December 31, 2004. The transaction has been accounted for as the purchase of a
business. In connection with the purchase we recorded goodwill of $6.9 million
and identifiable intangibles of $4.9 million.
In connection with the acquisition of Midbar, we recorded a charge of
$6.0 million for in-process research and development costs ("IPRD"). The value
allocated to the project identified as IPRD was charged to operations in the
fourth quarter of 2002. At the acquisition date, Midbar's major in-process
project was the development of CDS-300, BurnProtect, and BurnShield. This
technology had not yet reached technological feasibility. The technological
feasibility of the in-process products is established when the enterprise has
completed all planning, designing, coding and testing activities that are
necessary to establish that the product can be produced to meet its design
specifications.
At the date of the acquisition, the Company expected to invest
approximately $393,000 of additional development costs in these products. The
Company currently expects to complete the project by the end of fiscal 2003 and
does not expect a significant change in the estimated completion costs. We
obtained an independent appraiser's valuation to determine the amounts allocated
to purchased technology and in-process research and development. The valuation
analysis utilized the Income Approach that takes into consideration discounted
future cash flows. This approach also takes into consideration earnings
remaining after deducting from cash flows related to the in-process technology,
the market rates of return on contributory assets including assembled workforce,
customer accounts and existing technology. The cash flows are then discounted to
present value at an appropriate rate. Discount rates are determined by an
analysis of the risks associated with each of the identified intangible assets.
The weighted average discount rate used for IPRD was approximately 35%, a
premium over the estimated weighted-average cost of capital of approximately 5%.
The resulting net cash flows to which the discount rate was applied are based on
management's estimates of revenues, operating expenses, and income taxes from
such acquired technology.
Music copy protection revenues represented 0.4% of our net revenues in
2002. We expect revenues from our Music Technology Division to increase in 2003.
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 and costs of equipment used to apply our technology. Also
included in cost of revenues are software product support costs, patent defense
costs, amortization of licensed technologies, amortization of certain
intangibles from acquisitions 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 enterprise 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.
We have identified the accounting policies below as critical to our
business operations and the understanding of our results of operations.
36
REVENUE RECOGNITION
Our revenue mainly consists of royalty fees on copy-protected products
on a per unit basis, licenses of our copy protection technology, licenses for
our software products, and related maintenance and services revenues.
ROYALTY REVENUES
Royalty revenue from the replication of videocassettes, digital
versatile discs ("DVDs"), and compact disks ("CDs") is recognized when realized
or realizable and earned. We recognize royalty revenue on an as reported basis
when we receive royalty reports. We have established significant experience with
certain customers to reasonably estimate current period volume for purposes of
making an accurate revenue accrual, and royalty revenue from these customers is
accrued as earned. Advanced royalty fees attributable to minimum guaranteed copy
protected volumes or shared revenues are deferred until earned. In the case of
agreements with minimum guaranteed royalty 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.
TECHNOLOGY LICENSING REVENUES
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.
SOFTWARE LICENSING REVENUES
We recognize revenue on our software products in accordance with
Statements of Position ("SOP") 97-2, Software Revenue Recognition, as amended by
SOP 98-4 and 98-9. We recognize 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 us remain; the fee is fixed and
determinable; and collectibility is probable. We consider all arrangements with
payment terms extending beyond six months to be not fixed and determinable, and
revenue is recognized as payments become due from the customer for such
arrangements. We assess collectibility based on a number of factors, including
the customer's past payment history and current creditworthiness. If
collectibility is not considered probable, revenue is recognized when the fee is
collected from the customer.
For license agreements in which non-standard customer acceptance clauses
are 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, we account for the delivered elements in accordance
with the "residual method." Under the residual method, the fair value of 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. We also enter into term license agreements in which
the license fee is recognized ratably over the term of the license period
(generally less than two years).
When licenses are sold together with consulting and implementation
services, license fees are recognized upon delivery provided that (1) the above
criteria have been met, (2) payment of the license fees is not dependent upon
performance of the consulting and implementation services, and (3) the services
are not essential to the functionality of the software. For arrangements that do
not meet the above criteria, both the license and services revenue are
recognized in accordance with the provisions of SOP 81-1, "Accounting for
Performance of Construction-Type and Certain Production-Type Contracts."
PROFESSIONAL SERVICES REVENUES
We provide consulting and training services to our customers. Revenue
from such services is generally recognized as the services are performed.
37
MAINTENANCE REVENUES
Maintenance agreements generally call for us to provide technical
support and software updates to customers. Maintenance revenue is deferred and
recognized ratably over the maintenance contract period and included in services
revenue in the accompanying financial statements.
VALUATION OF STRATEGIC INVESTMENTS
As of December 31, 2002 and 2001, the adjusted cost of our strategic
investments totaled $28.7 million and $58.1 million, respectively. 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. For investments in public companies, we
compare our basis in the investment to the average trading prices of the
security over the prior six months to determine if an other-than-temporary
impairment has occurred. If the six-month average is less than the current cost
basis, we record a charge to the statement of income for the difference between
the market price at period end and the current cost basis. 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 other-than-temporary
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,
$17.2 million and $6.9 million of other-than-temporary impairment losses were
recorded during the years ended December 31, 2002 and 2001, respectively.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the excess of costs over fair value of assets of
businesses acquired. We adopted the provisions of SFAS No. 142, "Goodwill and
Other Intangible Assets," as of January 1, 2002. Goodwill and intangible assets
acquired in a purchase business combination and determined to have an indefinite
useful life are not amortized, but instead are tested for impairment at least
annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also
requires that intangible assets with estimable useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 144, "Accounting for
Impairment or Disposal of Long-Lived Assets."
In connection with SFAS No. 142's transitional goodwill impairment
evaluation, we are required to perform an assessment of whether there was an
indication that goodwill is impaired as of the date of adoption. To accomplish
this, we were required to identify our reporting units and determine the
carrying value of each reporting unit by assigning the assets and liabilities,
including the existing goodwill and intangible assets, to those reporting units
as of January 1, 2002. We were required to determine the fair value of each
reporting unit and compare it to the carrying amount of the reporting unit
within six months of January 1, 2002. To the extent the carrying amount of a
reporting unit exceeded the fair value of the reporting unit, we would be
required to perform the second step of the transitional impairment test, as this
is an indication that the reporting unit goodwill may be impaired. The second
step was required for one reporting unit. In this step, we compared the implied
fair value of the reporting unit goodwill with the carrying amount of the
reporting unit goodwill, both of which were measured as of the date of adoption.
The implied fair value of goodwill was determined by allocating the fair value
of the reporting unit to all of the assets (recognized and unrecognized) and
liabilities of the reporting unit in a manner similar to a purchase price
allocation, in accordance with SFAS No. 141, "Business Combinations." The
residual fair value after this allocation was the implied fair value of the
reporting unit goodwill. The implied fair value of each reporting unit exceeded
its carrying amount and we were not required to recognize an impairment loss.
Prior to the adoption of SFAS No. 142, goodwill was amortized on a
straight-line basis over the expected periods to be benefited, generally 7
years, and assessed for recoverability by determining whether the amortization
of the goodwill balance over its remaining life could be recovered through
undiscounted future operating cash flows of the acquired
38
operation. All other intangible assets were amortized on a straight-line basis
from 3 to 7 years. The amount of goodwill and other intangible asset impairment
is measured based on projected discounted future operating cash flows using a
discount rate reflecting our average cost of funds.
IMPAIRMENT OF LONG-LIVED ASSETS
SFAS No. 144 provides a single accounting model for long-lived assets to
be disposed of. SFAS No. 144 also changes the criteria for classifying an asset
as held for sale; and broadens the scope of businesses to be disposed of that
qualify for reporting as discontinued operations and changes the timing of
recognizing losses on such operations. We adopted SFAS No. 144 on January 1,
2002. The adoption of SFAS No. 144 did not affect our financial statements.
In accordance with SFAS No. 144, long-lived assets, such as property,
plant, and equipment, and purchased intangibles subject to amortization, are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to estimated undiscounted future cash flows expected to be generated by
the asset. If the carrying amount of an asset exceeds its estimated future cash
flows, an impairment charge is recognized by the amount by which the carrying
amount of the asset exceeds the fair value of the asset. Assets to be disposed
of would be separately presented in the balance sheet and reported at the lower
of the carrying amount or fair value less costs to sell, and are no longer
depreciated. The assets and liabilities of a disposed group classified as held
for sale would be presented separately in the appropriate asset and liability
sections of the balance sheet.
Goodwill and intangible assets not subject to amortization are tested
annually for impairment, and are tested for impairment more frequently if events
and circumstances indicate that the asset might be impaired. An impairment loss
is recognized to the extent that the carrying amount exceeds the asset's fair
value.
Prior to the adoption of SFAS No. 144, we accounted for long-lived
assets in accordance with SFAS No. 121, "Accounting for Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of."
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, 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, international situations (such as currency devaluation), and changes in
our customer payment history 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.
INCOME TAXES
We account for income taxes using the asset and liability method. As of
December 31, 2002 and 2001, deferred tax assets net of valuation allowances,
totaled $18.7 million and $5.8 million, respectively. 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. Our effective tax rate is directly affected by the
relative proportions of domestic and international revenue and income before
taxes, as well as the estimated level of annual pre-tax income. We are also
subject to changing tax laws in the multiple jurisdictions in which we operate.
39
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,
--------------------------------------
2002 2001 2000
------------ ------------ ----------
License revenues 89.9% 90.7% 89.5%
Service revenues 10.1 9.3 10.5
------------ ------------ ----------
Revenues 100.0 100.0 100.0
------------ ------------ ----------
Costs and expenses:
Cost of revenues - license fees 6.0 4.9 5.8
Cost of revenues - service fees 1.9 1.0 1.0
Cost of revenues - amortization of intangibles from acquisitions 2.2 2.2 2.2
Research and development 11.6 9.4 9.8
Selling and marketing 20.3 18.4 18.8
General and administrative 14.7 13.4 15.9
Amortization of goodwill and other intangibles from acquisitions 0.2 8.8 3.8
Amortization of deferred stock-based compensation 6.1 9.7 19.4
In-process research and development 5.9 -- --
Restructuring expenses -- 2.2 --
------------ ------------ ----------
Total costs and expenses 68.9 70.0 76.7
------------ ------------ ----------
Operating income 31.1 30.0 23.3
Impairment losses on investments 16.8 7.0 --
Interest and other income, net 7.1 10.5 13.4
------------ ------------ ----------
Income before income taxes 21.4 33.5 36.7
Income taxes 9.6 14.1 19.7
------------ ------------ ----------
Net income 11.8% 19.4% 17.0%
============ ============ ==========
COMPARISON OF YEARS ENDED DECEMBER 31, 2002 AND 2001
The following table provides revenue information by specific product
segments for the periods indicated (dollars in thousands):
YEAR ENDED DECEMBER 31,
----------------------------
$ %
2002 2001 CHANGE CHANGE
------------ ------------ ----------- -----------
Video Technology Division
DVD $ 45,987 $ 37,610 $ 8,377 22.3%
Videocassette 7,611 11,509 (3,898) (33.9)
Pay-Per-View 10,971 13,207 (2,236) (16.9)
Consumer Software Division 10,142 10,062 80 0.8
Enterprise Software Division 26,894 25,643 1,251 4.9
Music Technology Division 400 - 400 100.0
Other 257 782 (525) (67.1)
------------ ------------ -----------
Total Net Revenue $ 102,262 $ 98,813 $ 3,449 3.5%
============ ============ ===========
NET REVENUES. Our net revenues for 2002 increased 3.5% to $102.3 million
in 2002 from $98.8 million in 2001. This moderate increase is primarily driven
by increased revenues in the Video Technology and Enterprise Software divisions.
Video's DVD copy protection revenues increased $8.4 million or 22.3% from $37.6
million in 2001 to $46.0 million in 2002, due to the continued strong growth of
the DVD format and continued high penetration among Hollywood studio customers.
This increase in DVD revenues was substantially offset by continuing decreases
in videocassette and PPV copy protection revenues. Revenues from videocassette
copy protection decreased $3.9 million or 33.9% from $11.5 million in 2001 to
$7.6 million in 2000, 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 $2.2 million or 16.9%
from $13.2 million in 2001 to $11.0 million in 2002 due to the continuing slow
demand for digital set-top
40
boxes. Revenues from our Enterprise Software Division increased $1.3 million or
4.9% from $25.6 million in 2001 to $26.9 million in 2002 primarily due to
increased market penetration despite the difficult economic environment for
enterprise software. Increases in Consumer Software and Music Technology
divisions were offset by the decrease in Other revenue. Our DVD copy protection
revenues in 2002 were also reduced by a $2.3 million refund resulting from a
customer's self-reporting errors detected in 2002. Revenue from this customer
was previously recognized only upon cash receipt.
LICENSE REVENUES. Our license revenues for 2002 increased modestly by
2.5% compared to 2001 primarily due to increases in our revenues derived by our
Video Technology Division in the DVD copy protection area. This was offset by
decreases in our copy protection revenues for videocassettes and PPV solutions.
We also had an increase in license revenues from our Music Technology Division,
which was formed in 2002.
SERVICE REVENUES. Our service revenues for 2002 increased by 12.9%
compared to 2001 primarily due to increases in consulting revenues and, to a
lesser extent, an increase in maintenance revenues. In 2002, we expanded the
headcount of our consulting group to offer additional consulting services to our
customers, which resulted in the increase in revenues.
COST OF REVENUES - LICENSE FEES. Cost of revenues from license fees as a
percentage of license revenues increased from 5.4% for 2001 to 6.6% for 2002.
This increase was primarily due to higher patent defense costs relating to the
Rainbow litigation. Cost of revenues increased $1.3 million from $4.8 million in
2001 to $6.1 million in 2002. Cost of revenues includes items such as product
costs, duplicator and replicator fees, video copy protection processor costs,
patent amortization on internally developed patents, patent defense costs and
licensing expenses. We anticipate our gross margin on license fees may increase
in 2003 as a result of expected lower patent defense costs.
COST OF REVENUES - SERVICE FEES. Cost of revenues from service fees as a
percentage of service revenues increased from 11.3% for 2001 to 18.5% for 2002.
Cost of revenues increased $0.9 million from $1.0 million in 2001 to $1.9
million in 2002. This increase was primarily due to the increase in our
consulting practice which required increased hiring of technical consultants in
2002, which resulted in higher employee related expenses. We anticipate our cost
of revenues - service fees may increase in 2002 as we increase our headcount in
professional services practice.
COST OF REVENUES - AMORTIZATION OF INTANGIBLES FROM ACQUISITIONS. Cost
of revenues from amortization of intangibles in 2002 were consistent with 2001.
We anticipate our amortization of intangibles from acquisitions included in cost
of revenues will increase in 2003 primarily due to the acquisition of Midbar
Tech (1998) Ltd. Also, if our acquisition of TTR closes in 2003, this will
result in additional increases in the amortization of intangibles included in
cost of revenues.
RESEARCH AND DEVELOPMENT. Research and development expenses increased by
$2.6 million or 27.9% from $9.3 million in 2001 to $11.9 million in 2002. The
increase is primarily due to increased research and development activities in
our Video Technology, Consumer Software, Enterprise Software and Music
Technology Divisions. Research and development expenses increased as a
percentage of net revenues from 9.4% in 2001 to 11.6% in 2002. 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 $2.6
million or 14.2% from $18.1 million in 2001 to $20.7 million in 2002. This
increase was primarily due to increased business development activities for our
MacroSafe and music technologies and increased commission costs associated with
higher revenue levels. Selling and marketing expenses increased as a percentage
of net revenues from 18.4% in 2001 to 20.3% in 2002. Selling and marketing
expenses are expected to increase in absolute terms as we continue to expand our
efforts in selling and marketing our Consumer Software, Enterprise Software,
Music Technology and other digital rights management products.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
increased by $1.8 million or 13.5% from $13.2 million in 2001 to $15.0 million
in 2002, primarily due to increased facilities costs associated with our new
office space. General and administrative expenses increased as a percentage of
net revenues from 13.4% in 2001 to 14.7% in 2002.
AMORTIZATION OF INTANGIBLES FROM ACQUISITIONS. In accordance with new
accounting guidance, Statement of Financial Accounting Standards No. ("SFAS")
142, "Goodwill and Other Intangible Assets," goodwill and workforce in place
that was subsumed by goodwill, were not amortized beginning January 1,
2002. As a result, amortization expense decreased $8.5 million or 96.9% overall
in 2002 as compared to 2001 which included $8.1 million in goodwill
amortization.
41
We acquired the net assets of Midbar Tech (1998) Ltd. ("Midbar") in
November 2002 for approximately $17.8 million in cash. In addition, we have
agreed to an additional maximum payout of $8.0 million based on a percentage of
the net revenues of the Music Technology Division until December 31, 2004. The
transaction was accounted for as a purchase and the purchase price was allocated
to existing technology, existing contracts, patents and trademarks. We recorded
$6.9 million of goodwill from this transaction and recorded a $6.0 million
charge for purchased in-process research and development. We amortize
intangibles, with the exception of goodwill, relating to the acquisition of net
assets of Midbar on a straight-line basis over three to five years based on the
expected useful lives of existing technology, existing contracts, patents and
trademarks. The impact of amortization of intangible assets related to Midbar
for the year ended December 31, 2002 was not significant, due to our acquisition
occurring near year-end.
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 of which we
were required to pay out $1.2 million in 2001 and none in 2002. The purchase
price was allocated to workforce in place, which was subsumed by goodwill upon
adoption of SFAS No. 142, PtS's existing contracts and goodwill. We amortize the
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, 2002 and 2001.
Amortization of these intangible assets decreased to $506,000 in 2002 from $7.9
million in 2001 due to the implementation of SFAS 142. There was no impairment
associated with PtS goodwill.
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 2002 and 2001 was $6.3
million and $9.6 million, respectively. The expense associated with this
stock-based compensation will continue to result in substantial non-cash
compensation charges to future earnings through 2004.
RESTRUCTURING EXPENSES. During fourth quarter 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 for the year
ended December 31, 2001. The charge consisted of cash severance payments and
non-cash compensation expense relating to the accelerated vesting of certain
stock options. There were no comparable charges in 2002 and no liabilities
associated with this restructuring remain as of December 31, 2002.
IMPAIRMENT LOSSES ON INVESTMENTS. During 2002 and 2001, we recorded
charges totaling $17.2 million and $6.9 million, relating to
other-than-temporary impairment of certain strategic investments.
INTEREST AND OTHER INCOME, NET. Interest and other income decreased
$3.1million or 29.6% to $7.3 million in 2002 from $10.4 million in 2001,
primarily from declining interest rates.
INCOME TAXES. We recorded income taxes of $9.8 million and $14.0 million
for 2002 and 2001, respectively. Income tax expense represents combined federal
and state taxes at effective rates of 44.8% and 42.1% for 2002 and 2001,
respectively. The increase in the effective tax rate was due to changes in tax
jurisdictions where our income was earned.
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 Technology Division
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 Division 10,062 8,372 1,690 20.2
Enterprise Software Division 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%
============= ============= ===========
42
NET REVENUES. Our net revenues for 2001 increased 23.3% from $80.1
million in 2000 to $98.8 million in 2001 driven primarily by the increase in DVD
copy protection revenues in our Video Technology Division. DVD copy protection
revenues increased $16.7 million or 80.2% from $20.9 million in 2000 to $37.6
million in 2001, showing continued strong growth of the DVD format and 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 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(R) business. Revenues from our
Enterprise 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 a decrease in royalties from our pay TV analog scrambling
technology shipments into Brazil by one of our licensees.
LICENSE REVENUES. Our license revenues for 2001 increased by 25.1%
compared to 2000 primarily due to increases in our revenues derived by our Video
Technology Division in the DVD copy protection area. This was offset by
decreases in our copy protection revenues from videocassettes and PPV solutions.
We also had an increase in license revenues from our Consumer and Enterprise
Software Divisions, all of which were the result of strong demand in 2001 for
our products in these areas.
SERVICE REVENUES. Our service revenues for 2001 increased by 8.2%
compared to 2000 primarily due to an increase in maintenance revenues associated
with the increase in license revenues in our Enterprise Software Division.
COST OF REVENUES - LICENSE FEES. Cost of revenues from license fees as a
percentage of license revenues decreased from 6.5% for 2000 to 5.4% for 2001.
This decrease was primarily due to increased revenues in 2001 and efficiencies.
Cost of revenues increased $4.7 million from $4.8 million in 2000 to $1.0
million in 2001 primarily due to the increase in our revenue, which resulted in
higher costs. Cost of revenues includes items such as product costs, duplicator
and replicator fees, video copy protection processor costs, patent amortization
on internally developed patents, patent defense costs and licensing expenses.
COST OF REVENUES - SERVICE FEES. Cost of revenues from service fees as a
percentage of service revenues increased from 9.1% for 2000 to 11.3% for 2001.
Cost of revenues increased from $0.8 million in 2000 to $1.0 million in 2001.
This increase was primarily due to increased costs and increased headcount.
COST OF REVENUES - AMORTIZATION OF INTANGIBLES FROM ACQUISITIONS. Cost
of revenues from amortization of intangibles in 2001 increased $0.3 million
primarily due to the timing of acquisitions that resulted in a larger amount of
amortization in 2001 compared to 2000.
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 was primarily due to research and development activities in our Video
Technology, Consumer Software and Enterprise 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 due to the increase in revenue.
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 as
increased costs were on a significantly higher revenue base.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES FROM ACQUISITIONS.
Amortization of goodwill and other intangible assets increased $5.7 million in
2001 as compared to 2000 as a result of the October 2000 acquisition of PtS.
43
AMORTIZATION OF DEFERRED STOCK-BASED COMPENSATION. The amortization of
the Globetrotter related deferred stock-based compensation for 2001 and 2000 was
$9.6 million and $15.5 million, respectively.
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. There were no restructuring
charges during 2000 comparable to the Fourth Quarter 2001 charge of $2.2
million.
IMPAIRMENT LOSSES ON STRATEGIC INVESTMENTS. During 2001, we recorded
charges totaling $6.9 million, relating to other-than-temporary impairment of
certain strategic investments, compared to none in 2000.
INTEREST AND OTHER INCOME, NET. Interest and other income decreased
$317,000 or 3% to $10.4 million in 2001 from $10.7 million in 2000, 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.
44
QUARTERLY RESULTS OF OPERATIONS
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)
------------------------------------------ --------------------------------------------
2002 2001
------------------------------------------ --------------------------------------------
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
--------- --------- --------- --------- ---------- --------- --------- ---------
Net Revenues $23,666 $24,940 $23,497 $30,159 $22,974 $25,764 $23,043 $27,032
Costs and Expenses:
Cost of revenues 2,203 2,453 2,584 3,045 2,513 1,968 1,581 1,918
Research and development 2,537 2,832 3,049 3,462 2,322 2,528 1,990 2,445
Selling and marketing 4,760 4,582 5,097 6,281 4,040 4,796 4,434 4,868
General and administrative 3,048 3,618 3,633 4,736 3,168 3,719 3,063 3,295
Amortization of goodwill
and other intangibles
from acquisitions 149 124 - - 2,162 2,150 2,185 2,241
Amortization of deferred
stock-based compensation (1) 2,083 2,041 1,206 931 3,031 2,210 2,194 2,156
Restructuring expense
In-process research and
development - - - 6,000 - - 2,214
--------- --------- --------- --------- ---------- --------- --------- ---------
Total costs and expenses 14,780 15,650 15,569 24,455 17,236 17,371 15,447 19,137
Operating income 8,886 9,290 7,928 5,704 5,738 8,393 7,596 7,895
Interest and other income, net 2,101 2,067 1,632 1,518 2,696 2,844 2,472 2,385
Impairment losses on
investments (5,477) - (6,795) (4,938) (1,160) (2,200) - (3,500)
--------- --------- --------- --------- ---------- --------- --------- ---------
Income before income taxes 5,510 11,357 2,765 2,284 7,274 9,037 10,068 6,780
Income Taxes 2,536 4,770 1,161 1,360 3,648 3,981 3,665 2,680
Net Income $ 2,974 $ 6,587 $ 1,604 $ 924 $ 3,626 $ 5,056 $ 6,403 $ 4,100
========= ========= ========= ========= ========== ========= ========= =========
Basic EPS $ 0.06 $ 0.13 $ 0.03 $ 0.02 $ 0.07 $ 0.10 $ 0.13 $ 0.08
========= ========= ========= ========= ========== ========= ========= =========
Diluted EPS $ 0.06 $ 0.13 $ 0.03 $ 0.02 $ 0.07 $ 0.10 $ 0.12 $ 0.08
========= ========= ========= ========= ========== ========= ========= =========
(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 $ 80 $ 80 $ 117 $ 117 $ 117 $ 117
Research and development 444 403 220 138 505 505 505 484
Selling and marketing 1,257 1,257 642 347 1,342 1,292 1,300 1,285
General and administrative 265 264 264 366 1,067 296 272 270
--------- --------- --------- --------- ---------- --------- --------- ---------
$ 2,083 $ 2,041 $ 1,206 $ 931 $ 3,031 $ 2,210 $ 2,194 $ 2,156
========= ========= ========= ========= ========== ========= ========= =========
45
QUARTERLY RESULTS OF OPERATIONS AS A % OF REVENUE
(UNAUDITED)
---------------------------------------- ----------------------------------------
2002 2001
---------------------------------------- ----------------------------------------
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 9.3 9.8 11.0 10.1 10.9 7.6 6.9 7.1
Research and development 10.7 11.4 13.0 11.5 10.1 9.8 8.6 9.0
Selling and marketing 20.1 18.4 21.7 20.8 17.6 18.6 19.2 18.0
General and administrative 12.9 14.5 15.5 15.7 13.8 14.4 13.3 12.2
Amortization of intangibles from
acquisitions 0.7 0.5 - - 9.4 8.4 9.5 8.3
Amortization of deferred
stock-based compensation 8.8 8.2 5.1 3.1 13.2 8.6 9.5 8.0
Restructuring expense - - - - - - - 8.2
In-process research and
development - - - 19.9 - - - -
-------- -------- -------- -------- -------- -------- -------- --------
Total costs and expenses 62.5 62.8 66.3 81.1 75.0 67.4 67.0 70.8
Operating income 37.5 37.2 33.7 18.9 25.0 32.6 33.0 29.2
Interest and other income, net 8.9 8.3 6.9 5.0 11.7 11.0 10.7 8.8
Impairment losses on investments (23.1) - (28.9) (16.4) (5.0) (8.5) - (12.9)
-------- -------- -------- -------- -------- -------- -------- --------
Income before income taxes 23.3 45.5 11.7 7.6 31.7 35.1 43.7 25.1
Income Taxes 10.7 19.1 4.9 4.5 15.9 15.5 15.9 9.9
-------- -------- -------- -------- -------- -------- -------- --------
Net Income 12.6% 26.4% 6.8% 3.1% 15.8% 19.6% 27.8% 15.2%
======== ======== ======== ======== ======== ======== ======== ========
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 enterprise
license management business. Our operating activities provided net cash of $55.1
million, $35.0 million and $36.5 million in 2002, 2001 and 2000, respectively.
Cash provided by operating activities increased $20.1 million from $35.0 million
in 2001 to $55.1 million in 2002. The increase is primarily due to income
generated from operations, net of non-cash operating charges for depreciation
and amortization, impairment losses on investments, amortization of stock based
compensation and intangible assets, and in-process research and development
write-offs, as well as an increase in other liabilities. 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 provided (used) net cash of $51.8 million, ($38.4)
million, and ($165.1) million in 2002, 2001 and 2000, respectively. Cash
provided by (used in) investing activities increased $90.2 million from ($38.4)
million in 2001 to $51.8 million in 2002. The increase is mainly due to fewer
purchases of long-term marketable securities in 2002. We made capital
expenditures of $3.9 million, $3.7 million and $1.7 million in 2002, 2001 and
2000, respectively. Capital expenditures in 2002 were primarily leasehold
improvements and furniture and fixtures for our new office space. Capital
expenditures in 2001 included the purchase and implementation of a new
enterprise resource planning ("ERP") system. We
46
also paid $761,000, $2.7 million, and $811,000 in 2002, 2001 and 2000,
respectively, related to patents and other intangibles during those periods.
Net cash provided by (used in) financing activities was $(34.6) million,
$7.2 million and $146.3 million in 2002, 2001 and 2000, respectively. The
decrease in net cash provided by financing activities from $7.2 million in 2001
to $(34.6) million in 2002 is primarily due to the use of $38.5 million to
repurchase 3.0 million shares of treasury stock. As of December 31, 2002, 2.0
million shares remained authorized for repurchase. 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, 2002, we had $98.7 million in cash and cash equivalents,
$73.0 million in short-term investments and $38.7 million in long-term
marketable investment securities, which includes the fair market value of our
holdings in Digimarc and TTR. We have no material commitments for capital
expenditures but anticipate that capital expenditures for the next 12 months
will aggregate approximately $3.4 million. We also have future minimum lease
payments of approximately $29.3 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.
In November 2002, we acquired the assets and operations of Midbar Tech
(1998) Ltd., a leading supplier of copy protection solutions for the music
industry, for approximately $17.8 million in cash and related acquisition costs.
In addition, we are subject to an additional maximum payout of $8.0 million
based on a percentage of net revenues of the Music Technology Division until
December 31, 2004.
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, 2002 were as follows (in thousands):
Operating
Leases
-----------
2003 $ 2,942
2004 2,981
2005 2,981
2006 3,067
2007 3,173
2008 and thereafter 14,108
-----------
Total $ 29,252
===========
Because a significant portion of our cash inflows were generated by
operations during 2002, 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 electronic license management products, or due to other
business risks discussed in the "Risk Factor" section. In addition, we are
subject to an additional maximum payout of $8.0 million related to our
acquisition of the assets and operations of Midbar Tech (1998) Ltd. in November
2002.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143
addresses financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. This statement applies to legal obligations
47
associated with the retirement of long-lived assets that result from the
acquisition, construction, development, or normal use of an asset. The Statement
will be effective for fiscal years beginning after June 15, 2002. The adoption
of SFAS No. 143 is not expected to have a material effect on our financial
position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." Among other provisions, SFAS No. 145 rescinds SFAS No. 4,
"Reporting Gains and Losses from Extinguishment of Debt." Accordingly, gains or
losses from extinguishment of debt shall not be reported as extraordinary items
unless the extinguishment qualifies as an extraordinary item under the criteria
of APB No. 30. Gains or losses from extinguishment of debt that do not meet the
criteria of APB No. 30 should be reclassified to income from operations in all
prior periods presented. SFAS No. 145 is effective for fiscal years beginning
after May 15, 2002. We did not have any debt extinguishments as of December 31,
2002.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supercedes Emerging Issues Task Force, or EITF, Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (Including Certain Costs Incurred in a Restructuring)." This Statement
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred and establishes that fair
value is the objective for initial measurement of the liabilities. This
Statement will be effective for exit or disposal activities that are initiated
after December 31, 2002. The adoption of SFAS No. 146 is not expected to have a
material effect on our financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure-an amendment to FASB
Statement No. 123, Accounting for Stock-Based Compensation." SFAS No. 148
provides alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No.123 to
require more prominent and more frequent disclosures in financial statements
about the effects of stock-based compensation. The transition guidance and
annual disclosure provisions of SFAS No. 148 are effective for fiscal years
ending after December 15, 2002. The interim disclosure provisions are effective
for financial reports containing financial statements for interim periods
beginning after December 15, 2002. We did not adopt the fair value method of
accounting for stock-based compensation and thus we are not affected by the
provisions of this Statement relating to methods of transition to the fair value
method. We will adopt the interim disclosure provisions for our interim
financial statements beginning with the period ending March 31, 2003.
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN No.
45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others." FIN No. 45 expands on
the accounting guidance of FASB Statements No. 5, 57, and 107 and incorporates
without change the provisions FASB Interpretation No. 34, which is being
superseded. FIN No. 45 will affect leasing transactions involving residual
guarantees, vendor and manufacturer guarantees, and tax and environmental
indemnities. All such guarantees will need to be disclosed in the notes to the
financial statements starting with the period ending after December 15, 2002.
Existing guarantees will be grandfathered and will not be recognized on the
balance sheet. The initial recognition and measurement provision are effective
prospectively for guarantees issued or modified on or after January 1, 2003,
which should not have a material effect on our financial position or results of
operations.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN
No. 46"), "Consolidation of Variable Interest Entities - An Interpretation of
ARB No. 51." FIN 46 requires that a variable interest entity to be consolidated
by a company if that company is subject to a majority of the risk of loss from
the variable interest entity's activities or is entitled to receive a majority
of the entity's residual returns or both. A variable interest entity is a
corporation, partnership, trust, or any other legal structure used for business
purposes that either: (a) does not have equity investors with voting rights, or
(b) has equity investors that do not provide sufficient financial resources for
the entity to support its activities. The consolidation requirements of FIN No.
46 apply immediately to variable interest entities created after January 31,
2003 or for entities in which an interest is acquired after January 31, 2003.
The consolidation requirements of FIN No. 46 apply to older entities in the
first fiscal year or interim period beginning after June 15, 2003. Disclosure
requirements apply to any financial statements issued after January 31, 2003. We
had no variable interest entities as of December 31, 2002.
48
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 $77.6 million as
of December 31, 2002. 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 $281,000 decrease (approximately
0.2%) in the fair value of our available-for-sale securities as of December 31,
2002. 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, as well
as expenses, 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., Japan and Israel
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
Command Audio, Digimarc, Digital Fountain, InterActual, iVAST, NTRU
Cryptosystems, RioPort, Inc., SecureMedia, Widevine Technologies and TTR. These
investments, totaling $28.7 million and $58.1 million, represented 8.9% and
16.9% of our total assets as of December 31, 2002 and 2001, respectively.
Digimarc and TTR, which are publicly traded companies, are subject to price
fluctuations based on the public market. Command Audio, 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 2002 and 2001, we wrote off $17.2 million and $6.9
million, respectively, of strategic investments resulting from impairment that
was other-than-temporary. No strategic investments were written off in 2000. In
November 2002, we signed an agreement with TTR to acquire patents and other
assets for approximately $5.3 million in cash and the surrender of our stock in
TTR. This agreement supersedes the prior Alliance Agreement and the royalty
obligations contained therein. We expect this transaction to close in the second
quarter of 2003, subject to meeting certain closing conditions. As of December
31, 2002, the Company's investment in TTR stock had a carrying value of
$339,000.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY 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.
49
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS.
The information required by this item is incorporated by reference from
the information under the captions "Information About Directors and Executive
Officers" and "Proposal 1: Election of Directors," 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 2003 Annual Meeting of
Stockholders (the "Proxy Statement") to be held on May 27, 2003.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated by reference to
the information under the caption "Information About Directors and Executive
Officers" to be contained in the Proxy Statement for the 2003 Annual Meeting of
Stockholders to be held on May 27, 2003.
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 "Information About Macrovision Stock
Ownership" to be contained in the Proxy Statement for the 2003 Annual Meeting of
Stockholders to be held on May 27, 2003.
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 2003 Annual Meeting
of Stockholders to be held on May 27, 2003.
ITEM 14. CONTROLS AND PROCEDURES.
(a) Macrovision Corporation (the " Company") maintains disclosure controls
and procedures that are designed to ensure that information required
to be disclosed in the Company's Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified
in the SEC's rules and forms, and that such information is accumulated
and communicated to the Company's management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosure based closely on
the definition of "disclosure controls and procedures" in Rule
13a-14(c). In designing and evaluating the disclosure controls and
procedures, management recognized that any controls and procedures, no
matter how well designed and operated, can provide only reasonable
assurance of achieving the desired control objectives, and management
necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
Within 90 days prior to the filing date of this report, the Company
carried out an evaluation, under the supervision and with participation
of the Company's management, including the Company's Chief Executive
Officer and the Company's Chief Financial Officer, of the effectiveness
of the design and operation of the Company's disclosure controls and
procedures. Based on the foregoing, the Company's Chief Executive
Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures were effective.
(b) There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect the
internal controls subsequent to the date the Company completed its
evaluation.
50
PART IV
ITEM 15. 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 Independent Auditors' Report (See F-2)
o Consolidated Balance Sheets at December 31, 2002 and 2001
(See F-3)
o Consolidated Statements of Income for the Years Ended
December 31, 2002, 2001 and 2000 (see F-4)
o Consolidated Statement of Stockholders' Equity and
Comprehensive Income (Loss) for the Years Ended December 31,
2002, 2001 and 2000 (see F-5)
o Consolidated Statements of Cash Flows for the Years Ended
December 31, 2002, 2001 and 2000 (See F-6)
o Notes to Consolidated Financial Statements (See F-7)
2. 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 (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 S-K, certain schedules have been omitted
but will be furnished supplementally to the Commission upon request).
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
(incorporated by reference to Exhibit 2.01 to our Form 8-K dated as of
July 6, 1999. Pursuant to Item 601(b)(2) of Regulation S-K, certain
schedules have been omitted but will be furnished supplementally to the
Commission upon request).*
2.03 Business Sale Agreement among Productivity through Software plc, C-Dilla
Limited, Mr. John Rowlinson and Macrovision Corporation dated October 4,
2000 (incorporated by reference to Exhibit 2.03 to our Form 10-K filed on
April 2, 2001. Pursuant to Item 601(b)(2) of Regulation S-K, certain
schedules have been omitted but will be furnished supplementally to the
Commission upon request.)*
2.04 Asset Purchase Agreement among TTR Technologies, Inc., TTR Technologies,
Ltd., Macrovision Corporation and Macrovision Europe Ltd. dated November
4, 2002 (incorporated by reference to Exhibit 1 to Schedule 13D/A filed on
November 8, 2002. Pursuant to Item 601(b)(2) of Regulation S-K, certain
schedules have been omitted but will be furnished supplementally to the
Commission upon request).
2.05 Voting Agreement entered into as of November 4, 2002 by and between
Macrovision Corporation, Macrovision Europe Ltd. and Sam Brill (the Chief
Operating Officer of TTR Technologies, Inc. (incorporated by reference to
Exhibit 2 to Schedule 13D/A filed on November 8, 2002).
2.06 Noncompetition Agreement executed and delivered as of November 4, 2002 by
TTR Technologies, Inc. and TTR Technologies, Ltd. in favor and for the
benefit of Macrovision Corporation, Macrovision Europe Ltd. and the other
Indemnities (incorporated by reference to Exhibit 3 to Schedule 13D/A
filed on November 8, 2002).
2.07 Asset Purchase Agreement by and between Midbar Tech (1998) Ltd. and
Macrovision Europe Ltd. dated November 4, 2002. (Pursuant to Item
601(b)(2) of Regulation S-K, certain schedules have been omitted but will
be furnished supplementally to the Commission upon request).**
3.01 Amended and Restated Certificate of Incorporation of Macrovision
Corporation (incorporated by reference to Exhibit 3.02 to our Registration
Statement on Form SB-2 (Registration No. 333-19373), which was declared
effective on March 12, 1997).
3.02 Certificate of Amendment to the Amended and Restated Certificate of
Incorporation of Macrovision Corporation (incorporated by reference to
Exhibit 3.02 to our Form 10-K filed on April 2, 2001).
3.03 Amended and Restated Bylaws of Macrovision Corporation, amended as of
October 27, 2000 (incorporated by reference to Exhibit 3.03 to our Form
10-K filed on April 2, 2001).
51
10.01 Macrovision Corporation's 1996 Equity Incentive Plan and related
documents (incorporated by reference to Exhibit 10.02 to our Registration
Statement on Form SB-2 (Registration No. 333-19373), which was declared
effective on March 12, 1997).
10.02 Macrovision Corporation's 2000 Equity Incentive Plan (incorporated by
reference to Exhibit 4.1 to our Registration Statement on Form S-8).
10.03 Macrovision Corporation's 1996 Directors Stock Option Plan (incorporated
by reference to Exhibit 4.2 to our Registration Statement on Form S-8).
10.04 Macrovision Corporation's 1996 Employee Stock Purchase Plan and related
documents (incorporated by reference to Exhibit 4.3 to our Registration
Statement on Form S-8).
10.05 Macrovision Corporation's Executive Incentive Plan (incorporated by
reference to Exhibit 10.05 to our Registration Statement on Form SB-2
(Registration No. 333-19373), which was declared effective on March
12, 1997).
10.06 Software Marketing License and Development Agreement between Macrovision
Corporation and C-Dilla Limited dated February 19, 1998 (incorporated by
reference to Exhibit 10.02 to our Form 10-QSB filed on May 15, 1998).*
10.07 Subscription Agreement between Macrovision Corporation and C-Dilla
Limited dated February 17, 1998 (incorporated by reference to Exhibit
10.01 to our Form 10-QSB/A filed on June 23, 1998).*
10.08 Letter Agreement dated November 24, 1999 between Macrovision Corporation
and TTR Technologies, Inc (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).*
10.09 Digimarc Corporation Series C Preferred Stock Purchase Agreement by and
among Digimarc Corporation and the Several Purchasers Named in Schedule I
(incorporated by reference to Exhibit 1 to our Schedule 13-D filed on
June 23, 2000).
10.10 Promissory Note dated January 7, 1997 executed by Command Audio
Corporation (incorporated by reference to Exhibit 10.26 to our Form 10-K
filed on April 2, 2001).
10.11 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 (incorporated by reference to Exhibit 10.33 to our Form 10-K
filed on April 2, 2001).
10.12 Termination of Standard Office Lease dated March 19, 2002 (incorporated
by reference to Exhibit 10.40 to our Form 10-Q filed on August 14, 2002).
10.13 Lease Between WB Airport Technology, L.L.C. ("Landlord") and Macrovision
Corporation ("Tenant") (incorporated by reference to Exhibit 10.39 to our
Form 10-K filed on April 2, 2001).
10.14 Form of Indemnification Agreement to be entered into by Macrovision
Corporation with each of its directors and executive officers
(incorporated by reference to Exhibit 10.7 to our Form 10-K filed on
April 2, 2001).
10.15 Offer Letter to Ian R. Halifax dated October 8, 1999 (incorporated by
reference to Exhibit 10.7 to our Form 10-K filed on April 2, 2001).
10.16 Executive Severance and Arbitration Agreement entered into as of June 24,
2002 by and between Macrovision Corporation and Ian R. Halifax
(incorporated by reference to Exhibit 10.42 to our Form 10-Q filed on
August 14, 2002).
10.17 Key Employee Agreement dated August 31, 2000 for Matthew Christiano
(incorporated by reference to Exhibit 10.31 to our Form 10-K filed on
April 2, 2001).
10.18 Amendment to Key Employee Agreement effective June 21, 2002 for Matthew
Christiano (incorporated by reference to Exhibit 10.41 to our Form 10-Q
filed on August 14, 2002).
10.19 Executive Severance and Arbitration Agreement dated April 30, 2001
between Macrovision Corporation and William Krepick (incorporated by
reference to Exhibit 10.34 to our Form 10-K filed on April 2, 2001).
10.20 Executive Severance and Arbitration Agreement dated April 30, 2001
between Macrovision Corporation and Brian Dunn (incorporated by reference
to Exhibit 10.35 to our Form 10-K filed on April 2, 2001.
52
10.21 Executive Severance and Arbitration Agreement dated April 30, 2001
between Macrovision Corporation and Carol Flaherty (incorporated by
reference to Exhibit 10.36 to our Form 10-K filed on April 2, 2001).
10.22 Executive Severance and Arbitration Agreement dated April 27, 2001
between Macrovision Corporation and Mark Belinsky (incorporated by
reference to Exhibit 10.37 to our Form 10-K filed on April 2, 2001).
10.23 Employment Protection Agreement dated April 27, 2001 between Macrovision
Corporation and Mark Belinsky (incorporated by reference to Exhibit 10.38
to our Form 10-K filed on April 2, 2001).
10.24 Offer Letter to Dan Stickel dated August 9, 2002 (incorporated by
reference to Exhibit 10.43 to our Form 10-Q filed on November 14, 2002).
10.25 Charter of the Audit Committee of the Board of Directors (incorporated
by reference to Annex D to our 2002 Definitive Proxy Statement filed on
April 30, 2002 pursuant to Schedule 14A).
21.01 List of subsidiaries.
23.01 Consent of KPMG LLP, Independent Auditors.
99.01 Certification Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002
(18 U.S.C. Section 1350, as adopted).
99.02 Certification Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002
(18 U.S.C. Section 1350, as adopted).
- --------------------------
* 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.
** The Registrant has requested condfidential treatment for certain protiions of
this exhibit.
(b) Reports on Form 8-K:
We filed three Form 8-Ks during the fourth quarter of 2002, relating
to: (a) Macrovision's agreement to acquire the assets and operations of Midbar
Tech (1998) Ltd. in a cash transaction, and that it had signed a definitive
agreement with TTR Technologies, Inc. (Nasdaq: TTRE) to acquire TTR's music copy
protection and DRM assets and to terminate an Alliance Agreement between the two
companies (filed November 5, 2002); (b) a final judgment had been entered in
favor of Globetrotter Software, Inc. on the counterclaims in Globetrotter
Software v. Elan Computer Group, Case No. 98-20419 JF (filed November 20,2002);
and (c) the closing of the Midbar Tech (1998) Ltd. transaction effective
November 30, 2002 (filed December 4, 2002).
53
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 31st day of March,
2003.
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 31, 2003
- --------------------------------- and Chief Financial Officer
Ian R. Halifax
ADDITIONAL DIRECTORS:
/s/ John O. Ryan Chairman of the Board of Directors March 31, 2003
- ---------------------------------
John O. Ryan
/s/ William A. Krepick Director March 31, 2003
- ---------------------------------
William A. Krepick
/s/ Matthew Christiano Director March 31, 2003
- ---------------------------------
Matthew Christiano
/s/ Donna S. Birks Director March 31, 2003
- ---------------------------------
Donna S. Birks
/s/ William N. Stirlen Director March 31, 2003
- ---------------------------------
William N. Stirlen
/s/ Thomas Wertheimer Director March 31, 2003
- ---------------------------------
Thomas Wertheimer
/s/ Steven G. Blank Director March 31, 2003
- ---------------------------------
Steven G. Blank
54
CERTIFICATIONS
I, William A. Krepick, certify that:
1. I have reviewed this annual report on Form 10-K of Macrovision Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
- ----------------------
/s/ William A. Krepick
--------------------------
William A. Krepick
Chief Executive Officer
55
I, Ian R. Halifax, certify that:
1. I have reviewed this annual report on Form 10-K of Macrovision Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
- ----------------------
/s/ Ian R. Halifax
------------------------
Ian R. Halifax
Chief Financial Officer
56
MACROVISION CORPORATION
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Independent Auditors' Report 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
INDEPENDENT AUDITORS' REPORT
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, 2002 and 2001, 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, 2002. 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, 2002 and 2001, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2002 in conformity with accounting principles
generally accepted in the United States of America.
As discussed in Note 1 of the notes to the accompanying consolidated
financial statements, effective January 1, 2002 the Company adopted the
provisions of Statement of Financial Accounting Standard No. 142, "Goodwill and
Other Intangible Assets."
/s/ KPMG LLP
Mountain View, California
February 20, 2003
F-2
MACROVISION CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share data)
ASSETS
DECEMBER 31,
-----------------------------
2002 2001
-------------- --------------
Current assets:
Cash and cash equivalents $ 98,691 $ 26,112
Short-term investments 72,989 83,456
Accounts receivable, net of allowance for doubtful accounts of
$1,657 in 2002 and $1,747 in 2001 28,237 28,033
Inventories 404 342
Income taxes receivable 9,242 12,675
Deferred tax assets 4,695 5,287
Prepaid expenses and other current assets 4,963 6,124
-------------- --------------
Total current assets 219,221 162,029
Long-term marketable investment securities 38,696 121,480
Property and equipment, net 6,106 4,337
Patents, net 4,593 4,594
Goodwill 24,673 16,405
Other intangibles from acquisitions, net 11,368 8,546
Deferred tax assets 13,971 545
Other assets 6,038 17,650
-------------- --------------
$ 324,666 $ 335,586
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,269 $ 2,955
Accrued expenses 15,523 4,843
Deferred revenue 8,567 9,555
-------------- --------------
Total current liabilities 27,359 17,353
Notes payable 17 33
Other 431 --
-------------- --------------
27,807 17,386
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;
51,424,526 shares issued and 48,424,526 outstanding as of
December 31, 2002, and 50,818,986 shares issued and outstanding 51 51
as of December 31, 2001
Treasury stock, 3,000,000 shares at cost (38,450) --
Additional paid-in capital 284,031 280,529
Deferred stock-based compensation (3,024) (10,526)
Accumulated other comprehensive income 1,933 7,917
Retained earnings 52,318 40,229
-------------- --------------
Total stockholders' equity 296,859 318,200
-------------- --------------
$ 324,666 $ 335,586
============== ==============
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,
----------------------------------------------
2002 2001 2000
--------------- ------------- --------------
Revenues:
Licenses 91,935 89,670 71,664
Services 10,327 9,143 8,452
--------------- ------------- --------------
Total revenues $ 102,262 $ 98,813 $ 80,116
Cost of revenues:
License fees 6,102 4,811 4,652
Service fees 1,912 1,037 773
Amortization of intangibles from acquisitions 2,271 2,132 1,797
--------------- ------------- --------------
Total cost of revenues 10,285 7,980 7,222
--------------- ------------- --------------
Gross profit 91,977 90,833 72,894
Operating expenses:
Research and development 11,880 9,285 7,822
Selling and marketing 20,720 18,138 15,037
General and administrative 15,035 13,245 12,717
Amortization of intangibles from acquisitions 273 8,738 3,081
Amortization of deferred stock-based compensation* 6,261 9,591 15,533
In-process research and development 6,000 -- --
Restructuring expenses -- 2,214 --
--------------- ------------- --------------
Total operating expenses 60,169 61,211 54,190
--------------- ------------- --------------
Operating income 31,808 29,622 18,704
Impairment losses on investments 17,210 6,860 --
Interest and other income, net 7,318 10,397 10,714
--------------- ------------- --------------
Income before income taxes 21,916 33,159 29,418
Income taxes 9,827 13,974 15,825
--------------- ------------- --------------
Net income $ 12,089 $ 19,185 $ 13,593
=============== ============= ==============
Basic net earnings per share $ 0.24 $ 0.38 $ 0.28
=============== ============= ==============
Shares used in computing basic net earnings per share 50,046 50,216 49,135
=============== ============= ==============
Diluted net earnings per share $ 0.24 $ 0.37 $ 0.26
=============== ============= ==============
Shares used in computing diluted net earnings per share 50,602 51,746 51,386
=============== ============= ==============
* The allocation of the amortization of deferred stock-based compensation
relates to the expense categories as set forth below:
YEAR ENDED DECEMBER 31,
----------------------------------------------
2002 2001 2000
--------------- ------------- --------------
Cost of revenues $ 395 $ 468 $ 428
Research and development 1,205 1,999 3,064
Selling and marketing 3,502 5,219 10,645
General and administrative 1,159 1,905 1,396
--------------- ------------- --------------
$ 6,261 $ 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)
COMMON STOCK TREASURY STOCK ADDITIONAL STOCKHOLDER DEFERRED
SHARES AMOUNT SHARES AMOUNT PAID-IN CAPITAL RECEIVABLE COMPENSATION
---------------------------------------------------------------------------------
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 1,203,768 1 4,633 (297) --
options
Issuance of common stock under employee stock 73,943 -- 728 -- --
purchase plan
Issuance of common stock in secondary public 2,874,000 3 146,101 -- --
offering, net issuance costs of $565
Directors fees paid in stock 150 -- 15 -- --
Distribution to shareholders -- -- -- -- --
Deferred stock-based compensation related to -- -- 37,938 -- (37,938)
Globetrotter
Other deferred stock-based compensation -- -- 225 -- (225)
Amortization of deferred stock-based -- -- -- -- 15,533
compensation
Amortization of other deferred stock-based -- -- -- -- 225
compensation
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 943,882 1 5,813 -- --
options
Repayment of stockholder note -- -- -- 297 --
Issuance of common stock under employee stock 57,003 -- 1,158 -- --
purchase plan
Reversal of unamortized deferred stock-based
compensation related to stock option
forfeitures -- -- (1,361) -- 1,361
Compensation expense related to accelerated -- -- 837 -- 927
vesting of severed employee stock options
Amortization of deferred stock-based -- -- -- -- 9,591
compensation
Tax benefit associated with stock plans -- -- 7,341 -- --
---------- ----- ----------- --------- -------- ------- ---------
Balances as of December 31, 2001 50,818,986 $ 51 -- $ -- $280,529 $ -- $(10,526)
---------- ----- ----------- --------- -------- ------- ---------
Comprehensive income (loss):
Net income
Translation adjustment
Unrealized loss in investments, net
Total comprehensive income
Issuance of common stock upon exercise of 516,260 -- 2,621 -- --
options
Issuance of common stock under employee stock 89,280 -- 1,291 -- --
purchase plan
Stock repurchase -- (3,000,000) (38,450) -- -- --
Reversal of unamortized deferred stock-based
compensation related to Stock option
forfeitures -- -- (1,234) -- 1,234
Compensation expense related to accelerated --
vesting of severed employee stock options -- -- -- 7
Amortization of deferred stock-based -- -- -- -- 6,261
compensation
Tax benefit associated with stock plans -- -- 824 -- --
---------- ----- ----------- --------- -------- ------- ---------
Balances as of December 31, 2001 51,424,526 $ 51 (3,000,000) $(38,450) $284,031 $ -- $ (3,024)
========== ===== =========== ========= ======== ======= =========
ACCUMULATED
OTHER TOTAL
COMPREHENSIVE RETAINED STOCKHOLDERS'
INCOME (LOSS) EARNINGS EQUITY
-----------------------------------------------
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 -- -- 4,337
options
Issuance of common stock under employee stock -- -- 728
purchase plan
Issuance of common stock in secondary public -- -- 146,104
offering, net issuance costs of $565
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 -- -- 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 stock option
forfeitures -- -- --
Compensation expense related to accelerated
vesting of severed employee stock options -- -- 1,764
Amortization of deferred stock-based
compensation -- -- 9,591
Tax benefit associated with stock plans -- -- 7,341
--------- --------- --------
Balances as of December 31, 2001 $ 7,917 $ 40,229 $318,200
--------- --------- --------
Comprehensive income (loss):
Net income 12,089 12,089
Translation adjustment 2,021 2,021
Unrealized loss in investments, net (8,005) (8,005)
--------
Total comprehensive income 6,105
--------
Issuance of common stock upon exercise of -- -- 2,621
options
Issuance of common stock under employee stock
purchase plan -- -- 1,291
Stock repurchase -- -- (38,450)
Reversal of unamortized deferred stock-based
compensation related to Stock option
forfeitures -- -- --
Compensation expense related to accelerated
vesting of severed employee stock options -- -- 7
Amortization of deferred stock-based
compensation -- -- 6,261
Tax benefit associated with stock plans -- -- 824
--------- --------- --------
Balances as of December 31, 2002 $ 1,933 $ 52,318 $296,859
--------- --------- --------
See accompanying notes to consolidated financial statements.
F-5
MACROVISION CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
--------------------------------------------
2002 2001 2000
------------- ------------- -------------
Cash flows from operating activities:
Net income $ 12,089 $ 19,185 $ 13,593
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization 2,957 1,806 1,708
Amortization of intangibles from acquisitions 2,544 10,870 4,878
Amortization of deferred stock-based compensation 6,261 9,591 15,758
Impairment losses on investments 17,210 6,860 --
Restructuring expenses -- 2,214 --
Tax benefit from stock options 824 7,341 13,349
Loss on disposal of fixed assets -- -- 722
In-process research and development 6,000 -- --
Changes in operating assets and liabilities, net of assets and
liabilities acquired:
Accounts receivable, net (129) (12,221) (2,974)
Deferred revenue (1,074) 1,190 (1,425)
Other assets (3,264) (8,905) (7,068)
Accounts payable, accrued expenses, and other long-term liabilities 11,724 (2,933) (2,084)
------------- ------------- -------------
Net cash provided by operating activities 55,142 34,998 36,457
------------- ------------- -------------
Cash flows from investing activities:
Purchases of long-term marketable investment securities -- (116,583) (115,592)
Purchases of short-term investments (184,814) (184,015) (152,231)
Sales or maturities of long-term marketable investments 64,408 100,496 59,347
Sales or maturities of short-term investments 194,563 186,221 97,898
Purchases of property and equipment (3,874) (3,686) (1,740)
Payments for patents and acquired software technology (761) (2,684) (811)
Minority equity investments in private companies -- (17,000) (28,410)
Acquisition of net assets of PtS -- (1,163) (23,536)
Acquisition of net assets of Midbar (17,762) -- --
------------- ------------- -------------
Net cash provided by (used in) investing activities 51,760 (38,414) (165,075)
------------- ------------- -------------
Cash flows from financing activities:
Loan proceeds received from related party -- -- 555
Proceeds from issuance of common stock upon exercise of options 2,621 5,814 4,634
Proceeds from issuance of common stock under employee stock purchase plan 1,291 1,158 728
Stock repurchase (38,450) -- --
Repayment (loan) of stockholder note receivable -- 297 (297)
Proceeds from sale of common stock, net of issuance costs -- -- 146,104
Cash distribution to stockholders -- -- (5,858)
Other, net (28) (21) 451
------------- ------------- -------------
Net cash (used in) provided by financing activities (34,566) 7,248 146,317
------------- ------------- -------------
Effect of exchange rate changes on cash 243 (129) --
Net increase in cash and cash equivalents 72,579 3,703 17,699
Cash and cash equivalents at beginning of year 26,112 22,409 4,710
------------- ------------- -------------
Cash and cash equivalents at end of year $ 98,691 $ 26,112 $ 22,409
============= ============= =============
Cash paid during the year:
Interest $ -- $ 1 $ 5
============= ============= =============
Income taxes $ 9,761 $ 19,806 $ 10,273
============= ============= =============
See accompanying notes to consolidated financial statements.
F-6
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2001 AND 2000
(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
Macrovision Corporation develops and markets copy protection, rights
management and enterprise 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 November 30, 2002, the Company acquired substantially all of the assets
and operations of Midbar Tech (1998) Ltd. The Company paid approximately $17.8
million in cash and additional related acquisition costs. In addition, the
Company is subject to an additional maximum payment of $8.0 million based on a
percentage of the net revenues of the Music Technology Division until December
31, 2004. The purchase price was allocated to in-process technology ($6.0
million), existing technology ($0.5 million), existing contracts ($2.6 million),
patents ($1.6 million), trademarks ($0.2 million) and goodwill ($6.9 million).
The in-process technology of $6.0 million was charged to operations in 2002. The
intangible assets for existing technology, existing contracts, patents and
trademarks are being amortized on a straight-line basis over five years. The
Company amortized $97,000 of intangibles in 2002.
In November 2002, the Company signed an agreement with TTR to acquire
patents and other assets for approximately $5.3 million in cash and the
surrender of its stock in TTR. The Company expects this transaction to close in
the second quarter of 2003, subject to certain closing conditions being met. As
of December 31, 2002, the Company's investment in TTR stock had a carrying value
of $339,000 and is included in "Long-term marketable investment securities" on
the balance sheet.
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 PtS's existing contracts and goodwill. The Company amortizes these
intangibles on a straight-line basis over three years. The Company amortized
$506,000 of other intangibles in 2002 and $7.9 million of goodwill and other
intangibles in 2001. As a result of adopting SFAS 142, goodwill and certain
intangibles with indefinite useful lives ceased January 1, 2002.
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.
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
F-7
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, goodwill and other intangible
assets, long-lived 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 debt and equity
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.
The Company accounts for its publicly traded investments in accordance with
Statement of Financial Accounting Standards (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, 2002 and
2001, 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,
----------------------
2002 2001
---------- ----------
Cash equivalents - money market funds $ 89,056 $ 20,976
---------- ----------
Investments:
Corporate bonds 46,980 124,357
United States government bonds and agency securities 41,522 39,708
Equity investments 23,183 40,871
---------- ----------
111,685 204,936
---------- ----------
$ 200,741 $ 225,912
========== ==========
As of December 31, 2002 and 2001, government and corporate bond securities
and equity investments totaling $38.7 million and $121.5 million respectively,
were classified as long-term marketable investment securities.
As of December 31, 2002 and 2001, the difference between the fair value and
the amortized cost of available-for-sale securities were unrealized gains of
$397,000 and $13,906,000, respectively. As of December 31, 2002 and 2001, the
unrealized gain, net of taxes, was $235,000 and $8,240,000, 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). In 2002, the Company recorded charges
of $5.6 million relating to other-than-temporary impairments of marketable
equity investments. As of December 31, 2002 and 2001, the weighted average
portfolio duration and contractual maturity for the bond securities was
approximately four months and thirteen 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.
F-8
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 the purchase of internal use software should be capitalized,
including costs of software configuration and enhancements. Approximately
$312,000 and $1.1 million was capitalized during the year ended December 31,
2002 and 2001. This has been classified on the consolidated balance sheet as a
component of property and equipment.
PATENTS
Patent application costs of $2.1 million and $1.8 million for the years
ended December 31, 2002 and 2001, 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.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the excess of costs over fair value of assets of
businesses acquired. The Company adopted the provisions of SFAS No. 142,
"Goodwill and Other Intangible Assets," as of January 1, 2002. Goodwill and
intangible assets acquired in a purchase business combination and determined to
have an indefinite useful life are not amortized, but instead are tested for
impairment at least annually in accordance with the provisions of SFAS No. 142.
SFAS No. 142 also requires that intangible assets with estimable useful lives be
amortized over their respective estimated useful lives to their estimated
residual values, and reviewed for impairment in accordance with SFAS No. 144,
"Accounting for Impairment or Disposal of Long-Lived Assets."
In connection with SFAS No. 142's transitional goodwill impairment
evaluation, we were required to perform an assessment of whether there was an
indication that goodwill was impaired as of the date of adoption. To accomplish
this, we were required to identify our reporting units and determine the
carrying value of each reporting unit by assigning the assets and liabilities,
including the existing goodwill and intangible assets, to those reporting units
as of January 1, 2002. Additionally, during October 2002, the Company completed
its annual impairment analysis of goodwill. Based on the results of the
transitional and annual impairment analysis, the Company determined that no
indicators of impairment existed for its reporting units. As of December 31,
2002, we had four reporting units. Prior to December 2002, we had three
reporting units, and in December 2002 we established the Music Technology
Division, which became our fourth reporting unit. We were required to determine
the fair value of each reporting unit and compare it to the carrying amount of
the reporting unit within six months of January 1, 2002.
Prior to the adoption of SFAS No. 142, goodwill was amortized on a
straight-line basis over the expected periods to be benefited, generally 7
years, and assessed for recoverability by determining whether the amortization
of the goodwill balance over its remaining life could be recovered through
undiscounted future operating cash flows of the acquired operation. All other
intangible assets were amortized on a straight-line basis from 3 to 7 years.
The following table summarizes the effect on the Company's net income and
income per share if SFAS No. 142 had been adopted prior to January 1, 2002.
Year Ended December 31
-------------------------------------------
2002 2001 2000
----------- ----------- ------------
Net income, as reported $ 12,089 $ 19,185 $ 13,593
Add back:
Amortization of goodwill, net of tax - 4,715 1,156
----------- ----------- ------------
Adjusted net income $ 12,089 $ 23,900 $ 14,749
=========== =========== ============
Basic net income per share, as reported $ 0.24 $ 0.38 $ 0.28
Basic net income per share, adjusted $ 0.24 $ 0.48 $ 0.30
Diluted net income per share, as reported $ 0.24 $ 0.37 $ 0.26
Diluted net income per share, adjusted $ 0.24 $ 0.46 $ 0.29
Shares used in computing:
Basic 50,046 50,216 49,135
Diluted 50,602 51,746 51,386
F-9
The following table summarizes the Company's goodwill and intangible assets
as of December 31, 2001 (in thousands):
2001
-----------------------------------------------------------------
ACCUMULATED
GROSS COSTS AMORTIZATION NET
-------------------- -------------------- -----------------
Amortized intangibles:
Existing technology $ 11,669 $ (4,237) $ 7,432
Non-compete agreements 1,788 (1,515) 273
Existing contracts 1,424 (583) 841
Patents and trademarks - - -
-------------------- -------------------- ------------------
Total $ 14,881 $ (6,335) $ 8,546
==================== ==================== ==================
Goodwill $ 27,470 $ (11,065) $ 16,405
The following tables summarize the Company's goodwill and intangible assets
as of December 31, 2002 and the estimated amortization expense through the year
2007 (in thousands):
2002
-----------------------------------------------------------------
ACCUMULATED
GROSS COSTS AMORTIZATION NET
-------------------- -------------------- -----------------
Amortized intangibles:
Existing technology $ 12,186 $ (5,917) $ 6,268
Non-compete agreements 1,788 (1,788) -
Existing contracts 4,150 (882) 3,268
Patents and trademarks 1,861 (30) 1,832
-------------------- -------------------- ------------------
Total $ 19,985 $ (8,617) $ 11,368
==================== ==================== ==================
Goodwill* $ 37,088 $(12,415) $ 24,673
*Amortization ceased effective January 1, 2002 upon the adoption of SFAS
142.
Year ending Amortization
Expenses
----------------
2003 $ 3,245
2004 3,155
2005 2,870
2006 1,755
2007 342
----------------
Total amortization expense $ 11,367
================
IMPAIRMENT OF LONG-LIVED ASSETS
SFAS No. 144 provides a single accounting model for long-lived assets to be
disposed of. SFAS No. 144 also changes the criteria for classifying an asset as
held for sale; and broadens the scope of businesses to be disposed of that
qualify for reporting as discontinued operations and changes the timing of
recognizing losses on such operations. We adopted SFAS No. 144 on January 1,
2002. The adoption of SFAS No. 144 did not affect our financial statements.
In accordance with SFAS No. 144, long-lived assets, such as property,
plant, and equipment, and purchased intangibles subject to amortization, are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to estimated undiscounted future cash flows expected to be generated by
the asset. If the carrying amount of an asset exceeds its estimated future cash
flows, an impairment charge is recognized by the amount by which the carrying
amount of the asset exceeds the fair value of the asset. Assets to be disposed
of would be separately presented in the balance sheet and reported at the lower
of the carrying amount or fair value less costs to sell, and are no longer
depreciated. The assets and liabilities of a disposed group classified as held
for sale would be presented separately in the appropriate asset and liability
sections of the balance sheet.
F-10
Goodwill and intangible assets not subject to amortization are tested
annually for impairment, and are tested for impairment more frequently if events
and circumstances indicate that the asset might be impaired. An impairment loss
is recognized to the extent that the carrying amount exceeds the asset's fair
value.
Prior to the adoption of SFAS No. 144, we accounted for long-lived assets
in accordance with SFAS No. 121, "Accounting for Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of."
OTHER ASSETS
The Company has made strategic minority investments in privately held
companies and accounts for such investments under the cost method. These
investments are included in "Other Assets" on the balance sheet, and totaled
$5.6 million and $17.2 million as of December 31, 2002 and 2001, respectively.
DEFERRED REVENUE
Deferred revenue represents amounts received from customers under certain
license, maintenance and service agreements for which the revenue earnings
process has not been completed.
COMPREHENSIVE INCOME
Comprehensive income (loss) includes net income, foreign currency
translation gains and losses and other unrealized gains and losses on marketable
investment securities that have been excluded from the determination of net
income. The Company has reported the components of comprehensive income (loss)
on its consolidated statements of stockholders' equity.
REVENUE RECOGNITION
The Company's revenue consists of royalty fees on copy-protected products
on a per unit basis, licenses of the Company's copy protection technology,
licenses for the Company's software products, and related maintenance and
services revenues.
ROYALTY REVENUES
Royalty revenue from the replication of videocassettes, digital versatile
discs ("DVDs"), and compact disks ("CDs") is recognized when realized or
realizable and earned. The Company has established significant experience with
certain customers to reasonably estimate current period volume for purposes of
making an accurate revenue accrual, accordingly, royalty revenue from these
customers is recognized as earned. Advanced royalty fees attributable to minimum
copy quantities or shared revenues are deferred until earned. In the case of
agreements with minimum guaranteed royalty payments with no specified volume,
revenue is recognized on a straight-line basis over the life of the agreement.
TECHNOLOGY LICENSING REVENUES
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 or determinable license
fee is considered probable.
SOFTWARE LICENSING REVENUES
The Company recognizes revenue on its software products in accordance with
SOP 97-2, Software Revenue Recognition, as amended by 98-9. 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. The Company considers all
arrangements with payment terms extending beyond six months to not be fixed or
determinable, and, accordingly, revenue is recognized as amounts under such
arrangements become due and payable. The Company assesses collectibility based
on a number of factors, including the customer's past payment history and
current creditworthiness. If collectibility is not considered probable, revenue
is recognized when the fee is collected from the customer.
For license agreements in which non-standard customer acceptance clauses
are 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
F-11
undelivered elements, the Company accounts for the delivered elements in
accordance with the "residual method." Under the residual method, the fair value
of 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. The Company also enters into term license
agreements in which the license fee is recognized ratably over the term of the
license period (generally less than two years).
When licenses are sold together with consulting and implementation
services, license fees are recognized upon delivery provided that (1) the above
criteria have been met, (2) payment of the license fees is not dependent upon
performance of the consulting and implementation services, and (3) the services
are not essential to the functionality of the software. For arrangements that do
not meet the above criteria, both the license and services revenue are
recognized in accordance with the provisions of SOP 81-1 "Accounting for
Performance of Construction-Type and Certain Production-Type Contracts."
PROFESSIONAL SERVICES REVENUES
The Company provides consulting and training services to its customers.
Revenue from such services is generally recognized as the services are
performed.
MAINTENANCE REVENUES
Maintenance agreements generally call for the Company to provide technical
support and software updates to customers. Maintenance revenue is deferred and
recognized ratably over the maintenance contract period and included in services
revenue in the accompanying financial statements.
COST OF REVENUES
LICENSE FEES
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 on a specified fixed
service fee or on a per unit basis when 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 - license fees also
includes items such as product costs, videocassette copy protection processor
costs, royalty expense and software licensing fees and software product support.
Cost of revenues - license fees also includes outside legal costs of $1,766,000,
$836,000 and $970,000 in 2002, 2001 and 2000, respectively, associated with
litigation to enforce the Company's patents. Amortization of patents is also
included in cost of license revenues.
SERVICE FEES
Cost of revenues - service fees includes the cost of technical support for
our products, which primarily consists of direct costs and related overhead for
employees providing technical support and professional services to our
customers, as well as any third party consultants who provide such services on
our behalf.
AMORTIZATION OF INTANGIBLES FROM ACQUISITIONS
Cost of revenues - amortization of intangibles from acquisitions includes
amortization of certain intangibles from acquisitions. The amortization included
here includes amortization from purchased existing technology, existing
contracts, and patents and trademarks.
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.
F-12
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 2002, 2001 and 2000, 42.2%,
33.2% and 24.8%, respectively, of the Company's business was 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, 34.2%, 45.2% and 42.3% of the Company's sales in 2002,
2001 and 2000, 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. For
the Company's investments in public companies (Digimarc and TTR), the carrying
value is the market price of shares as represented on a national exchange at
period end.
The Company performs ongoing credit evaluations of its customers as
necessary. One customer accounted for 11.4% of net revenues for the year ended
December 31, 2002. No one customer accounted for more than 10% of net revenue
for the year ended December 31, 2001. One customer accounted for 10.3% of net
revenues for the year ended December 31, 2000. At December 31, 2002, receivables
from four separate customers were approximately 11%, 11%, 11% and 12% of
accounts receivable, respectively. In 2001, 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.
DECEMBER 31,
----------------------------
2002 2001 2000
-------- -------- --------
(In thousands)
Basic EPS - weighted average number of common shares outstanding 50,046 50,216 49,135
Effect of dilutive common equivalent shares - stock options outstanding 556 1,530 2,251
-------- -------- --------
Diluted EPS - weighted average number of common shares and common share
equivalents outstanding 50,602 51,746 51,386
======== ======== ========
In 2002, 2001 and 2000, 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
3,747,000, 1,441,000, and 171,000, respectively. The weighted average exercise
price of these options for 2002, 2001, and 2000 was $45.33, $69.74, and $93.31,
respectively.
F-13
RESEARCH AND DEVELOPMENT
Expenditures for research and development are expensed as incurred. Under
SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased
or Otherwise Marketed," costs incurred in the research and development of
software products are expensed as incurred until technological feasibility has
been established. The unamortized costs are compared to the net realizable value
at each balance sheet date, and to the extent the unamortized costs exceed the
net realizable value, they are written off. The Company had no capitalized costs
under this statement as of December 31, 2002.
STOCK BASED COMPENSATION
The Company accounts for employee stock-based compensation arrangements in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees," Financial Accounting
Standards Board Interpretation ("FASB") 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 Statement of
Financial Accounting Standards 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."
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,
----------------------------------------
2002 2001 2000
------------ ------------ -----------
Net income, as reported $ 12,089 $ 19,185 $ 13,593
Add stock-based employee compensation expense
included in reported net income, net of tax 3,456 5,553 7,176
Deduct total stock-based employee compensation
expenses determined under fair-value-based
method for all rewards, net of related tax
effects (22,619) (25,437) (13,699)
------------ ------------ -----------
Net income (loss), pro forma $ (7,074) $ (699) $ 7,070
============ ============ ===========
Basic net income (loss) per share As reported .24 .38 .28
Adjusted pro forma (.14) (.01) .14
Diluted net income (loss) per share As reported .24 .37 .26
Adjusted pro forma (.14) (.01) .14
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.
F-14
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,
-------------------------------------
2002 2001 2000
------------ ----------- -----------
OPTION PLANS: None None None
Dividends 3.27 years 3.81 years 3.73 years
Expected term 4.79% 6.66% 6.18%
Risk free interest rate 73.5% 100.4% 85.7%
Volatility rate
ESPP PLAN: None None None
Dividends 1.25 years 1.25 years 1.25 years
Expected term 3.12% 5.79% 5.97%
Risk free interest rate 75.3% 77.1% 67.4%
Volatility rate
VALUATION OF STRATEGIC INVESTMENTS
As of December 31, 2002 and 2001, the adjusted cost of our strategic
investments totaled $28.7 million and $58.1 million, respectively. We review our
investments in non-public companies and estimate the amount of any
other-than-temporary 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 other-than-temporary
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 the
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.
DERIVATIVES
In June 2000, the 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 2000, 2001 or 2002.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. This statement applies to legal obligations associated with the
retirement of long-lived assets that result from the acquisition, construction,
development, or normal use of an asset. The Statement will be effective for
fiscal years beginning after June 15, 2002.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." Among other provisions, SFAS No. 145 rescinds SFAS No. 4,
"Reporting Gains and Losses from Extinguishment of Debt." Accordingly, gains or
losses from extinguishment of debt shall not be reported as extraordinary items
unless the extinguishment qualifies as an extraordinary item under the criteria
of APB No. 30. Gains or losses from
F-15
extinguishment of debt that do not meet the criteria of APB No. 30 should be
reclassified to income from operations in all prior periods presented. SFAS No.
145 is effective for fiscal years beginning after May 15, 2002.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supercedes Emerging Issues Task Force, or EITF, Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (Including Certain Costs Incurred in a Restructuring)." This Statement
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred and establishes that fair
value is the objective for initial measurement of the liabilities. This
Statement will be effective for exit or disposal activities that are initiated
after December 31, 2002.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure-an amendment to FASB Statement No. 123,
Accounting for Stock-Based Compensation." SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No.123 to require more prominent and
more frequent disclosures in financial statements about the effects of
stock-based compensation. The transition guidance and annual disclosure
provisions of SFAS No. 148 are effective for fiscal years ending after December
15, 2002. The interim disclosure provisions are effective for financial reports
containing financial statements for interim periods beginning after December 15,
2002. The Company did not adopt the fair value method of accounting for
stock-based compensation and thus is not affected by the provisions of this
Statement relating to methods of transition to the fair value method. The
Company will adopt the interim disclosure provisions for its interim financial
statements beginning with the period ending March 31, 2003.
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN No.
45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others." FIN No. 45 expands on
the accounting guidance of FASB Statements No. 5, 57, and 107 and incorporates
without change the provisions FASB Interpretation No. 34, which is being
superseded. FIN No. 45 will affect leasing transactions involving residual
guarantees, vendor and manufacturer guarantees, and tax and environmental
indemnities. All such guarantees will need to be disclosed in the notes to the
financial statements starting with the period ending after December 15, 2002.
Existing guarantees will be grandfathered and will not be recognized on the
balance sheet. The initial recognition and measurement provision are effective
prospectively for guarantees issued or modified on or after January 1, 2003,
which should not have a material effect on the Company's financial position or
results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN No. 46"),
"Consolidation of Variable Interest Entities - An Interpretation of ARB No. 51."
FIN 46 requires that a variable interest entity to be consolidated by a company
if that company is subject to a majority of the risk of loss from the variable
interest entity's activities or is entitled to receive a majority of the
entity's residual returns or both. A variable interest entity is a corporation,
partnership, trust, or any other legal structure used for business purposes that
either: (a) does not have equity investors with voting rights, or (b) has equity
investors that do not provide sufficient financial resources for the entity to
support its activities. The consolidation requirements of FIN No. 46 apply
immediately to variable interest entities created after January 31, 2003 or for
entities in which an interest is acquired after January 31, 2003. The
consolidation requirements of FIN No. 46 apply to older entities in the first
fiscal year or interim period beginning after June 15, 2003. Disclosure
requirements apply to any financial statements issued after January 31, 2003.
The Company had no variable interest entities as of December 31, 2002.
(2) Financial Statement Details
INVENTORIES
Inventories consisted of the following (in thousands):
DECEMBER 31,
----------------------
2002 2001
---------- ----------
Raw materials $ 150 $ 33
Finished goods 254 309
---------- ----------
$ 404 $ 342
========== ==========
F-16
PROPERTY AND EQUIPMENT, NET
Property and equipment consisted of the following (in thousands):
December 31,
------------------------
2002 2001
----------- -----------
Machinery and equipment $ 3,979 $ 7,265
Leasehold improvements 1,999 1,281
Furniture and fixtures 6,913 1,601
----------- -----------
12,891 10,147
Less accumulated depreciation and amortization 6,785 5,810
----------- -----------
$ 6,106 $ 4,337
=========== ===========
OTHER ASSETS
Other assets include investments in non-marketable securities of privately
held companies. 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 achievement of business plans, objectives, and current market conditions,
among other factors. 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 2002, consistent with our policy for
evaluating recoverability of these investments, we concluded that impairment of
our investments in Widevine, Command Audio Corporation, Digital Fountain and
NTRU Cryptosystems was other-than-temporary. Accordingly, we wrote off the book
value of these investments during 2002 and took an aggregate charge to earnings
of $11.6 million for the year ended December 31, 2002. This was in addition to a
change of $5.6 million for impairments on our investments in TTR and Digimarc,
which are publicly traded companies. During 2001, 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,
---------------------------
2002 2001
-------------- -----------
Minority equity investments $ 5,562 $ 17,188
Deposits and other assets 476 462
-------------- -----------
$ 6,038 $ 17,650
============== ===========
ACCRUED EXPENSES
Accrued expenses consisted of the following (in thousands):
December 31,
---------------------------
2002 2001
------------ ------------
Accrued compensation $ 4,678 $ 2,704
Restructuring reserve -- 196
Customer refund payable 1,551 --
Accrued professional fees 803 716
Income taxes payable and other accrued taxes 6,616 666
Other accrued liabilities 1,875 561
------------ ------------
$ 15,523 $ 4,843
============ ============
F-17
INTEREST AND OTHER INCOME, NET
Interest and other income, net, consisted of the following (in thousands):
YEAR ENDED DECEMBER 31,
--------------------------------
2002 2001 2000
--------- --------- ---------
Interest income $ 7,081 $ 10,590 $ 10,913
Interest expense -- (1) (5)
Other income (expense) 237 (192) (194)
--------- --------- ---------
$ 7,318 $ 10,397 $ 10,714
========= ========= =========
ALLOWANCE FOR DOUBTFUL ACCOUNTS (IN THOUSANDS):
BALANCE AT CHARGED TO
BEGINNING OF COSTS AND BALANCE AT END
PERIOD EXPENSES DEDUCTIONS OF PERIOD
---------------- ----------------- ------------- -----------------
2002 $ 1,747 621 711 $ 1,657
2001 $ 1,145 995 393 $ 1,747
2000 $ 1,059 274 188 $ 1,145
(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
Cash paid (82) -- (114) (196)
----------------- -------------------- ----------------- ------------------
Balance at December 31, 2002 $ -- $ -- $ -- $ --
================== ==================== ================= ==================
(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 for a total of $25.3 million. Digimarc completed an initial public
offering in December 1999, and the Company owned approximately 11.5% of the
outstanding shares of Digimarc as of December 31, 2002. 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 $2.0 million. As of December
31, 2002 the Company has paid a total of $2.0 million under this agreement.
Amounts expensed under this agreement are included in cost of revenues - license
fees.
F-18
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. This amount was
included as a reduction in research and development expense in 2000. As of
December 31, 2002, the Company holds approximately 10.3% of the outstanding
shares of TTR. In November 2002, the Company signed a definitive agreement with
TTR to acquire patents and other assets for approximately $5.3 million in cash
as well as its stock in TTR. The Company expects this transaction to close in
the second quarter of 2003, subject to certain closing conditions being met. As
of December 31, 2002, the Company's investment in TTR stock had a carrying value
of $339,000.
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 $245,000, $635,000,
and $538,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
As of December 31, 2002, this lease agreement has been terminated.
(5) STOCKHOLDERS' EQUITY
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 $146.1 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
"1996 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 1996 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 1996 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 1996 Equity Incentive Plan permits
the grant of either incentive or nonqualified stock options at the then current
market price. Options granted under the 1996 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
F-19
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 2002, 2001 and 2000, the Company
issued 89,280, 57,003 and 73,943 shares, respectively, pursuant to the Purchase
Plan. In June 2002, an additional 250,000 shares of common stock were reserved
for issuance under 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 was increased from
4,500,000 to 6,300,000 in June 2002, 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. In June 2002, an additional 200,000 shares
were reserved for issuance under the Directors Plan. The Company's stockholders
approved the Directors Plan in February 1997 and approved the share increases in
August 2000 and June 2002. 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 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 2002, 2001 and 2000, the Company granted options to purchase 85,000,
75,000 and 30,000 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 2002, 2001 and 2000 relating to the Globetrotter totaled $6.3
million, $9.6 million and $15.5 million, respectively.
STOCK REPURCHASE PROGRAM
In May 2002, the Board authorized a 5.0 million share repurchase program,
which allowed the Company to purchase shares in the open market from
time-to-time at prevailing market prices, through block trades or otherwise, or
in negotiated transactions off the market, at the discretion of the Company's
management. Through December 31, 2002, the Company had repurchased 3.0 million
shares at a total cost of $38.5 million. As of December 31, 2002, 2.0 million
shares remained authorized for repurchase.
F-20
Activity under the Company's option plans is as follows:
WEIGHTED-AVERAGE
NUMBER OF SHARES EXERCISE PRICE
------------------ ----------------
Outstanding as of December 31, 1999 3,427,898 7.92
Granted 1,786,788 39.09
Canceled (184,828) 18.35
Exercised (1,203,768) 3.86
------------------
Outstanding as of December 31, 2000 3,826,090 23.27
Granted 2,091,505 45.59
Canceled (299,308) 47.18
Exercised (943,882) 6.20
------------------
Outstanding as of December 31, 2001 4,674,405 43.71
Granted 2,354,625 21.31
Canceled (377,467) 38.98
Exercised (516,260) 5.24
------------------
Outstanding as of December 31, 2002 6,135,303 32.24
==================
December 31,
----------------------------------------------------
2002 2001 2000
-------------- -------------- -------------
Options exercisable at end of year 2,283,744 1,117,695 648,634
Weighted average fair value of options granted during the period $ 11.24 $ 32.18 $ 47.75
The following table summarizes information about stock options outstanding
as of December 31, 2002:
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 - $ 12.910 1,309,485 6.51 $ 9.34 1,125,674 $ 9.52
$ 13.100 - $ 25.300 2,234,843 9.23 $ 21.17 190,714 $ 21.98
$ 26.300 - $ 63.600 1,727,579 8.42 $ 40.13 548,041 $ 43.96
$ 64.320 - $102.313 863,396 7.89 $ 79.35 419,315 $ 79.80
--------------- ----------------
6,135,303 8.24 $ 32.24 2,283,744 $ 31.73
=============== ================
F-21
(6) INCOME TAXES
The components of income before provision for (benefit from) income tax are
as follows:
Year Ended December 31,
-------------------------------------------------
(in thousands) 2002 2001 2000
--------------- ---------------- --------------
Domestic income $ 9,696 $ 23,370 $ 29,768
Foreign income (loss) 12,220 9,789 (350)
Income before provision for income taxes $ 21,916 $ 33,159 $ 29,418
Income tax expense for the years ended December 31, 2002, 2001 and 2000
consisted of the following (in thousands):
DECEMBER 31,
------------------------------------
2002 2001 2000
----------- ---------- -----------
Current:
Federal $ 13,607 $ 6,183 $ 4,931
State 1,432 1,200 592
Foreign 1,289 1,763 1,339
----------- ---------- -----------
Total current 16,328 9,146 6,862
----------- ---------- -----------
Deferred:
Federal (6,295) (1,936) (3,793)
State (1,030) (577) (593)
----------- ---------- -----------
Total deferred tax expense (7,325) (2,513) (4,386)
----------- ---------- -----------
Charges in lieu of income taxes associated with the exercise of stock
options 824 7,341 13,349
----------- ---------- -----------
Total tax expense $ 9,827 $ 13,974 $ 15,825
=========== ========== ===========
Income tax expense for the years ended December 31, 2002, 2001, and 2000,
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,
-----------------------------------
2002 2001 2000
---------- ---------- -----------
Federal tax statutory rate $ 7,670 $ 11,606 $ 10,296
State taxes 160 976 1,399
Income tax credits (286) (258) (374)
Foreign tax differential 2,305 917 (129)
Exempt interest (849) (306) (376)
Nondeductible expenses related to acquisition of Globetrotter -- -- 1,480
Deferred Stock Compensation 804 -- --
Globetrotter pre-merger loss -- -- 2,649
Change in valuation allowance -- 1,440 --
Others 23 (401) 880
---------- ---------- -----------
Total tax expense $ 9,827 $ 13,974 $ 15,825
========== ========== ===========
F-22
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,
-------------------------
2002 2001
------------ ------------
Deferred tax assets:
Accruals, reserves and others $ 523 $ 1,878
Allowance for doubtful accounts 571 666
Property and equipment 364 720
Deferred revenue 1,358 1,304
Intangible assets 7,821 5,719
State taxes 332 --
Impairment losses on investments 9,442 2,724
Net operating losses 1,544 1,544
------------ ------------
Gross deferred tax assets 21,955 14,555
Valuation allowance (1,440) (1,440)
------------ ------------
Total deferred tax assets 20,515 13,115
Deferred tax liabilities:
Patents (1,670) (1,617)
Sec. 481 adjustment (21) --
Unrealized gains (158) (5,666)
------------ ------------
Total deferred tax liabilities (1,849) (7,283)
------------ ------------
Net deferred tax assets $ 18,666 $ 5,832
============ ============
There was no change in the total valuation allowance for the year ended
December 31, 2002 or 2001. In 2000, a valuation allowance of $1.4 million was
established. Net deferred tax assets as of December 31, 2002 include a deferred
tax liability of approximately $158,000 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, 2002.
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 $12.3 million at December 31, 2002. The
amount of income tax liability that would result had such earnings been
repatriated is estimated to be approximately $2.8 million.
F-23
(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, 2002 were as follows (in thousands):
Operating
Leases
------------
2003 $ 2,942
2004 2,981
2005 2,981
2006 3,067
2007 3,173
2008 and thereafter 14,108
------------
Total $ 29,252
============
Rent expense was $3,720,000, $1,488,000, and $1,278,000 for the years ended
December 31, 2002, 2001 and 2000, 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 $11,000 in
2002. 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 $2,200, $2,100 and $2,100 in 2002, 2001, and 2000,
respectively. For employees over 50 years of age, the contribution limit was
$12,000 in 2002 and the Company's maximum annual matching contribution was
$2,400. Matching contributions aggregated $157,000, $204,000 and $80,000 for the
years ended December 31, 2002, 2001 and 2000, respectively, and are fully vested
after three years of service.
SOFTWARE INDEMNIFICATION
The Company sells software licenses and services to its customers under
contracts. Each contract contains the relevant terms of the contractual
arrangement with the customer, and generally includes certain provisions for
indemnifying the customer against losses, expenses, and liabilities from damages
that may be awarded against the customer in the event the Company's software is
found to infringe upon a patent, copyright, trademark, or other proprietary
right of a third party.
As of December 31, 2002, the Company has not been subject to any material
infringement claims and does not have any infringement claims pending.
F-24
(8) SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in four industry segments as follows: video copy
protection (the "Video Technology Division"), music copy protection (the "Music
Technology Division"), consumer software copy protection (the "Consumer Software
Division") and electronic license management ("ELM") software (the "Enterprise
Software Division"). These are the operating segments that are regularly
evaluated by the chief executive officer in deciding how to allocate resources
and in assessing performance. In the video copy protection segment, the Company
licenses its copy protection technologies for videocassette, DVD and digital
pay-per-view applications. In December 2002, we formed the Music Technology
Division to address the needs of the music industry. In the music copy
protection segment, the Company licenses its copy protection technologies for
CDs. 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.
The following segment reporting information of the Company is provided (in
thousands):
REVENUE BY SIGNIFICANT PRODUCT GROUP:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2002 2001 2000
---------------- ---------------- ---------------
Video Technology Division:
DVD $ 45,987 $ 37,610 $ 20,867
Videocassette 7,611 11,509 12,899
Pay-Per-View 10,971 13,207 15,062
---------------- ---------------- ---------------
Total 64,569 62,326 48,828
Consumer Software Division 10,142 10,062 8,372
Enterprise Software Division 26,894 25,643 21,770
Music Technology Division 400 - -
Other 257 782 1,146
---------------- ---------------- ---------------
Total $ 102,262 $ 98,813 $ 80,116
================ ================ ===============
OPERATING INCOME:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2002 2001 2000
---------------- ---------------- ---------------
Video Copy Protection $ 55,548 $ 55,055 $ 40,973
Consumer Software Copy Protection 5,014 5,572 3,417
Electronic License Management Software 13,912 13,753 14,828
Music Copy Protection (235) -- --
Other (711) 447 436
---------------- ---------------- ---------------
Segment income 73,528 74,827 59,654
Research and development 11,880 9,285 7,822
General and administrative 15,035 13,245 12,717
Amortization of goodwill and other intangibles from
acquisitions 2,544 10,870 4,878
Amortization of deferred stock-based compensation 6,261 9,591 15,533
In-process research and development 6,000 -- --
Restructuring expenses -- 2,214 --
---------------- ---------------- ---------------
Operating income $ 31,808 $ 29,622 $ 18,704
================ ================ ===============
F-25
In 1999, the Company acquired $4.8 million of goodwill in the Consumer
Software Copy Protection segment. In 2000, the Company acquired $22.2 million of
goodwill in the Electronic License Management Software segment. In November
2002, the Company acquired $6.9 million of goodwill in the Music Copy Protection
segment. There have been no write-offs or write-downs of goodwill in any of
these segments.
INFORMATION ON REVENUE BY GEOGRAPHIC AREAS:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2002 2001 2000
---------------- ---------------- ---------------
United States $ 67,326 $ 54,169 $ 46,245
International 34,936 44,645 33,871
---------------- ---------------- ---------------
Total Revenue $ 102,262 $ 98,813 $ 80,116
================ ================ ===============
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.
GLOBETROTTER V. RAINBOW TECHNOLOGIES, ELAN & KEN GREER
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. 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. 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.
On January 18, 2002, the Company filed a summary judgment motion to dismiss
some of the counterclaims from Rainbow et al. and Judge Fogel granted the
Company's motion to dismiss. On June 3, 2002, the Company filed another summary
judgment motion to dismiss additional counterclaims from Rainbow et al. and the
Company's motion to dismiss was later denied. On July 22, 2002, the Company
filed three more summary judgment motions to dismiss additional counterclaims
from Rainbow et al. On August 26, 2002, Judge Fogel granted two of the Company's
motions. On October 7, 2002, Judge Fogel held a hearing on the third motion.
While a decision was pending on the third motion, on September 30, 2002 the
Company filed yet two more motions to dismiss all remaining counterclaims and a
request for leave to file motion for reconsideration of the patent infringement
case or in the alternative for leave to supplement the record. A hearing was
held on November 4, 2002. On or about November 18, 2002, Judge Fogel granted all
of the Company's motions for summary judgment in full and dismissed all of the
claims against Globetrotter and Matt Christiano.
On December 9, 2002, Ken Greer and Elan filed a notice to appeal the
summary judgment of all their counterclaims by Judge Fogel. In response, on
December 23, 2002, the Company filed a notice to appeal the summary judgment of
F-26
all its patent infringement claims against Ken Greer, Elan and Rainbow. On or
about January 2, 2003, Rainbow filed a notice to appeal the summary judgment of
all of its counterclaims. The Company and Rainbow have reached a general
agreement to dismiss all cross-appeals between Globetrotter and Rainbow. A final
dismissal still needs to be completed. The cross-appeals between Globetrotter
versus Ken Greer and Elan remain active. The briefs associated with these
remaining appeals are expected on or around March 31, 2003.
If an adverse ruling is ultimately reached on the remaining appeals in a
trial court, significant monetary damages may be levied against the Company,
which could have a material adverse effect on the Company's business,
consolidated financial position, results of operations or cash flows.
MACROVISION CORPORATION V. VITEC AUDIO AND VIDEO GMBH
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 the Company's patents. 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 would require
technical expert witnesses. The Court selected Professor Dr. Ing. M. Plantholt
as its expert witness. On January 27, 2003, Professor Plantholt submitted his
technical opinion to the Court. Although the English translation is not yet
available, the Company's German litigation counsel has communicated to the
Company that Professor Plantholt's opinion may not be favorable to the Company.
In the event of an adverse ruling, the Company may incur a corresponding decline
in demand for its video copy protection technology, which could harm its
business in Germany. In addition, the Company may be obligated to pay some of
ViTec's attorney fees estimated to be US$25,000.
KRYPTON CO., LTD. V. MACROVISION CORPORATION
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 appealed this decision to the
Tokyo High Court, and 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. On March 3, 2003 (unaudited), the Tokyo High
Court rejected Krypton's arguments and reaffirmed its earlier decision. Krypton
may appeal the decision to the Japanese Supreme Court. Even if an adverse ruling
ultimately were reached on this invalidation claim, it would not have a material
adverse effect on the Company's business.
DIGIMARC V. VERANCE CORPORATION
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. 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. On September 26, 2002, the parties Joint Motion to Dismiss
was granted by the Court, and the action was dismissed.
YIELD DYNAMICS, INC. V. MACROVISION CORPORATION AND GLOBETROTTER SOFTWARE, INC.
On October 17, 2002, Yield Dynamics, Inc. filed a federal court action in
the Northern District of California, San Jose Division, against us and
Globetrotter Software, Inc. Yield Dynamics alleges that it created a software
interface to allow its Genesis software product to work with our FLEXlm software
and distributed FLEXlm software containing this code without Yield Dynamics'
permission. Yield Dynamics has asserted claims of copyright infringement, trade
secret misappropriation, common law unfair competition, and unfair competition
under California's Business and Professions Code. Yield Dynamics seeks an
injunction, a constructive trust on receipts from the licensing or sale or
products containing the interface code, and actual, compensatory and punitive
damages.
F-27
We answered Yield Dynamic's complaint and have asserted a counterclaim for
declaratory relief. The action is currently in the initial stages of discovery.
Although we do not expect a material adverse result, we are unable to
provide an estimate of the range or amount of potential loss in the event of an
adverse ruling. We intend to contest the case vigorously.
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.
As of December 31, 2002, it was not possible to estimate the liability, if
any, in connection with these matters. Accordingly, no accruals for these
contingencies have been recorded.
F-28