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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2003
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________ to ________
Commission file number: 000-22023
MACROVISION CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 77-0156161
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2830 De La Cruz Boulevard, Santa Clara, CA 95050
(Address of principal executive offices) (Zip Code)
(408) 743-8600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding as of May 1, 2003
Common stock, $0.001 par value 48,553,871
MACROVISION CORPORATION
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION
Page
Item 1. Financial Statements.
Condensed Consolidated Balance Sheets as of March 31, 2003
and December 31, 2002. 1
Condensed Consolidated Statements of Income
for the Three Months Ended March 31, 2003 and 2002. 2
Condensed Consolidated Statements of Cash Flows
for the Three Months Ended March 31, 2003 and 2002. 3
Notes to Condensed Consolidated Financial Statements. 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations. 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk. 26
Item 4. Controls and Procedures. 27
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. 28
Item 2. Changes in Securities and Use of Proceeds. 30
Item 3. Defaults Upon Senior Securities. 30
Item 4. Submission of Matters to a Vote of Security Holders. 30
Item 5. Other Information. 30
Item 6. Exhibits and Reports on Form 8-K. 30
Signatures 31
i
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
MARCH 31, DECEMBER 31,
2003 2002
-------------------- -------------------
ASSETS
Current assets:
Cash and cash equivalents $ 73,625 $ 98,691
Short-term investments 67,175 72,989
Accounts receivable, net of allowance for doubtful accounts of
$1,410 and $1,657, respectively 24,538 28,237
Income taxes receivable 9,355 9,242
Deferred tax assets 4,734 4,695
Prepaid expenses and other current assets 5,010 5,367
-------------------- -------------------
Total current assets 184,437 219,221
Long-term marketable investment securities 88,261 38,696
Property and equipment, net 6,091 6,106
Patents, net 4,652 4,593
Goodwill 24,581 24,673
Other intangibles from acquisitions, net 10,455 11,368
Deferred tax assets 13,563 13,971
Other assets 6,043 6,038
-------------------- -------------------
$ 338,083 $ 324,666
==================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,850 $ 3,269
Deferred revenue 9,964 8,567
Other current liabilities 17,450 15,523
-------------------- -------------------
Total current liabilities 31,264 27,359
Notes payable 17 17
Other non current liabilities 699 431
-------------------- -------------------
Total Liabilities 31,980 27,807
Stockholders' equity:
Common stock 52 51
Treasury stock, at cost (38,450) (38,450)
Additional paid-in-capital 285,318 284,031
Deferred stock-based compensation (2,256) (3,024)
Accumulated other comprehensive income 2,176 1,933
Retained earnings 59,263 52,318
-------------------- -------------------
Total stockholders' equity 306,103 296,859
-------------------- -------------------
$ 338,083 $ 324,666
==================== ===================
See the accompanying notes to these condensed consolidated financial statements.
1
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
------------------------------------
2003 2002
----------------- -----------------
Revenues:
Licenses $ 25,242 $ 21,211
Services 2,810 2,455
----------------- -----------------
Total revenues 28,052 23,666
Cost of revenues:
License fees 939 1,165
Service fees 543 498
Amortization of intangibles from acquisitions 856 540
----------------- -----------------
Total cost of revenues 2,338 2,203
----------------- -----------------
Gross profit 25,714 21,463
Operating expenses:
Research and development 3,743 2,537
Selling and marketing 6,404 4,760
General and administrative 4,324 3,048
Amortization of intangibles from acquisitions - 149
Amortization of deferred stock based compensation* 768 2,083
----------------- -----------------
Total operating expenses 15,239 12,577
----------------- -----------------
Operating income 10,475 8,886
Impairment losses on investments - (5,477)
Interest and other income, net 1,100 2,101
----------------- -----------------
Income before income taxes 11,575 5,510
Income taxes 4,630 2,536
----------------- -----------------
Net income $ 6,945 $ 2,974
================= =================
Basic net earnings per share $ 0.14 $ 0.06
================= =================
Shares used in computing basic net earnings per share 48,514 50,971
================= =================
Diluted net earnings per share $ 0.14 $ 0.06
================= =================
Shares used in computing diluted net earnings per share 48,722 51,545
================= =================
* The allocation of the amortization of deferred stock-based compensation relates to the
expense categories as set forth below:
--------------------------------------
THREE MONTHS ENDED
MARCH 31,
--------------------------------------
2003 2002
----------------- -----------------
Cost of revenues $ 80 $ 117
Research and development 138 444
Selling and marketing 347 1,257
General and administrative 203 265
----------------- -----------------
$ 768 $ 2,083
================= =================
See the accompanying notes to these condensed consolidated financial statements.
2
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------------------------------
2003 2002
---------------------- --------------------
Cash flows from operating activities:
Net income $ 6,945 $ 2,974
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 725 525
Amortization of goodwill and other intangibles from
acquisitions 856 689
Amortization of deferred stock-based compensation 768 2,083
Tax benefit from stock options 112 765
Impairment losses on investments - 5,477
Changes in operating assets and liabilities:
Accounts receivable,net 3,785 (1,714)
Deferred revenue 1,328 (908)
Other assets 235 840
Other liabilities 2,751 298
---------------------- --------------------
Net cash provided by operating activities 17,505 11,029
Cash flows from investing activities:
Purchases of long-term marketable investment securities (56,142) -
Sales or maturities of long-term marketable investment
securities 7,578 20,130
Purchases of short-term investments (48,089) (38,809)
Sales or maturities of short-term investments 53,807 36,996
Acquisition of property and equipment (538) (2,070)
Other investing activities (548) (181)
---------------------- --------------------
Net cash used in investing activities (43,932) 16,066
Cash flows from financing activities:
Proceeds from issuance of common stock from options and
stock purchase plans 1,169 1,656
---------------------- --------------------
Net cash provided by financing activities 1,169 1,656
Effect of exchange rate changes on cash and cash equivalents 192 (20)
---------------------- --------------------
Net increase in cash and cash equivalents (25,066) 28,731
Cash and cash equivalents at beginning of period 98,691 26,112
---------------------- --------------------
Cash and cash equivalents at end of period $ 73,625 $ 54,843
====================== ====================
Supplemental cash flow information:
Income taxes paid $ 1,094 $ -
See the accompanying notes to these condensed consolidated financial statements.
3
MACROVISION CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared by Macrovision Corporation and its subsidiaries (the
"Company") in accordance with the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures, normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America, have been
condensed or omitted in accordance with such rules and regulations. However, the
Company believes the disclosures are adequate to make the information not
misleading. In the opinion of management, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments, consisting only of
normal recurring adjustments, except as described in Notes 3 and 4, which in the
opinion of management are considered necessary to present fairly the results for
the periods presented. This quarterly report on Form 10-Q should be read in
conjunction with the audited financial statements and notes thereto and other
disclosures, including those items disclosed under the caption "Risk Factors,"
contained in the Company's Annual Report on Form 10-K for the year ended
December 31, 2002.
The consolidated results of operations for the interim periods
presented are not necessarily indicative of the results expected for the entire
year ending December 31, 2003 or any other future interim period.
Certain prior period amounts have been reclassified on the December 31,
2002 condensed consolidated balance sheet and the March 31, 2002 condensed
consolidated statement of income to conform to the current period presentation.
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 ("FASB") Interpretation No. 44 ("FIN 44"), "Accounting for
Certain Transactions Involving Stock Compensation - an Interpretation of APB
Opinion No. 25," and complies with the disclosure provisions of 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."
4
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):
THREE MONTHS ENDED
MARCH 31,
-----------------------------
2003 2002
------------- -------------
Net income, as reported $ 6,945 $ 2,974
Add stock-based employee compensation expense
included in reported net income, net of tax 461 1,125
Deduct total stock-based employee compensation
expenses determined under fair-value-based
method for all rewards, net of related tax
effects (7,814) (11,412)
------------- -------------
Net loss, pro forma $ (408) $ (7,313)
============= =============
Basic net income (loss) per share As reported 0.14 0.06
Adjusted pro forma (0.01) (0.14)
Diluted net income (loss) per share As reported 0.14 0.06
Adjusted pro forma (0.01) (0.14)
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.
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:
THREE MONTHS ENDED
MARCH 31,
--------------------------------
2003 2002
--------------- ---------------
OPTION PLANS:
Dividends None None
Expected term 3.31 years 3.36 years
Risk free interest rate 3.75% 3.95%
Volatility rate 77.30% 73.50%
ESPP PLAN:
Dividends None None
Expected term 1.44 years 1.33 years
Risk free interest rate 2.76% 4.54%
Volatility rate 75.90% 83.50%
The weighted average fair value of options granted during the three
months ended March 31, 2003 and 2002 were $12.23 and $32.66, respectively.
5
NOTE 2 - REVENUE RECOGNITION
The Company's revenue primarily 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. We rely on royalty reports from third parties as our
basis for revenue recognition. In our DVD, videocassette, and consumer software
businesses, 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. Revenue from customers in our pay-per-view ("PPV") and
Music Technology Division is currently recognized only as reported, due to the
timing of receipt of reports in PPV, and the embryonic stage and volume
volatility of the audio market. 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 Statement of Position ("SOP") 97-2, "Software Revenue Recognition," as
amended by SOP 98-9 "Modification of SOP 97-2." 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 or 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 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 ratably over
the maintenance contract period. The Company also enters into term
6
license agreements in which the license fee is recognized ratably over the term
of the license period (generally one year).
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 where
the services are essential to the functionality of the software, 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, except in situations where services are included in an arrangement
accounted for under SOP 81-1.
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 (which is
generally one year) and included in services revenue in the accompanying
financial statements.
NOTE 3 - INVESTMENTS IN MARKETABLE SECURITIES
The Company accounts for its publicly traded investments in accordance
with Statement of Financial Accounting Standard ("SFAS") No. 115, "Accounting
for Certain Investments in Debt and Equity Securities." Management determines
the appropriate classification of investment securities at the time of purchase
and re-evaluates such designation as of each balance sheet date. The Company
enters into certain equity investments for the promotion of business and
strategic objectives, and typically does not attempt to reduce or eliminate the
inherent market risks associated with these investments. As of March 31, 2003
and December 31, 2002, all marketable 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.
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.
Realized losses and declines in value judged to be other-than-temporary
for available-for-sale securities are reported as non-operating expenses under
the caption "Impairment losses on investments." The Company performs regular
reviews, in accordance with Company policy, of the value of its public company
strategic investments. The cost of securities sold is based on the specific
identification method. Realized gains, interest and dividends on securities
classified as available-for-sale are included in other income.
During the three months ended March 31, 2002, the Company recorded
charges of $2.5 million from other than temporary declines in the fair value of
long-term marketable securities in public companies. This was in addition to a
charge of $3.0 million from impairment charges related to investments in
non-public
7
companies (see Note 4). There were no charges related to other than temporary
declines in the fair value of long-term marketable securities for the three
months ended March 31, 2003.
NOTE 4 - OTHER ASSETS
The Company has made certain strategic investments that it intends to
hold for the long term and monitors whether there has been a decline in value
that is considered other than temporary. The Company reviews its investments in
non-public companies and estimates the amount of any other-than-temporary
impairment incurred during the current period based on specific analysis of each
investment, considering the activities of and events occurring at each of the
underlying portfolio companies during the period. The Company's 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, each investment is reviewed
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 considered 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 non-public-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.
During the three months ended March 31, 2002, the Company recorded
charges of $3.0 million relating to impairment losses considered to be other
than temporary declines in the value of certain strategic long term investments
in non-public companies. The charge of $3.0 million for the three months ended
March 31, 2002 represented approximately 5.4% of our total strategic investments
in non-public and public companies at March 31, 2002. This amount has been
recorded on the condensed consolidated statements of income as impairment losses
on investments. During the three months ended March 31, 2003, no charges were
recorded relating to impairment losses of strategic long-term investments.
NOTE 5 - EARNINGS PER SHARE
Basic earnings per share ("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 potential common shares
outstanding during the period except for periods of operating loss for which no
potential common shares are included because their effect would be
anti-dilutive. Dilutive potential common shares consist of common stock issuable
upon exercise of stock options using the treasury stock method. The following is
a reconciliation of the shares used in the computation of basic and diluted EPS
(in thousands):
8
THREE MONTHS ENDED
MARCH 31,
2003 2002
-------------- -------------
Basic EPS - weighted average number of
common shares outstanding 48,514 50,971
Effect of dilutive common shares - stock
options outstanding 208 574
-------------- -------------
Diluted EPS - weighted average number of
common shares and common share
equivalents outstanding 48,722 51,545
============== =============
Anti-dilutive shares excluded 4,878 2,251
============== =============
The anti-dilutive shares excluded from the diluted EPS calculation
noted in the above table represent stock options where the exercise price was
greater than the average market price for the periods presented.
NOTE 6 - TREASURY STOCK
In May 2002, the Board of Directors authorized a stock repurchase
program for up to 5.0 million shares of the Company's common stock. Purchases of
the stock may be made, from time-to-time, in the open market at prevailing
market prices, at the discretion of Company management and as monitored by the
Audit Committee of the Company's Board of Directors. The Company's repurchases
of shares of common stock have been recorded as treasury stock at cost and
result in a reduction of stockholders' equity. As of March 31, 2003, treasury
stock consisted of 3.0 million shares of common stock that the Company had
repurchased, with a cost basis of approximately $38.5 million. As of March 31,
2003, 2.0 million shares remained authorized for repurchase.
NOTE 7 - RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the 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 retirement of long-lived assets that result
from the acquisition, construction, development, or normal use of an asset. The
Company adopted the statement effective January 1, 2003 without material effect
on its financial position or results of operations.
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 Company adopted the provisions of this statement
effective January 1, 2003 without material effect on its financial position or
results of operations.
9
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 has adopted the interim disclosure provisions for its
interim financial statements beginning with the period ending March 31, 2003.
In November 2002, the FASB issued FIN No. 45 ("FIN 45"), "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN 45 expands on the accounting guidance
of FASB Statements No. 5, 57, and 107 and incorporates without change the
provisions of FIN No. 34, which is being superseded. FIN 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. The Company adopted the provisions of this
statement effective January 1, 2003 without material effect on its financial
position or results of operations.
In January 2003, the FASB issued FIN 46 ("FIN 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 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 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
March 31, 2003.
10
NOTE 8 - COMPREHENSIVE INCOME
The components of comprehensive income, net of taxes, are as follows
(dollars in thousands):
THREE MONTHS ENDED
MARCH 31,
--------------------------------
2003 2002
-------------- --------------
Net income $ 6,945 $ 2,974
Other comprehensive income (loss):
Unrealized gains on investments 536 819
Foreign currency translation adjustments (293) (327)
-------------- --------------
Comprehensive income $ 7,188 $ 3,466
============== ==============
NOTE 9 - SEGMENT AND GEOGRAPHIC INFORMATION
Segment income is based on segment revenue less the respective
segment's cost of revenues and selling and marketing expenses. The following
segment reporting information of the Company is provided (dollars in thousands):
NET REVENUES:
THREE MONTHS ENDED
MARCH 31,
----------------------------------
2003 2002
---------------- --------------
Video Technology Division
DVD $ 13,929 $ 10,599
Videocassette 1,737 1,519
Pay-Per-View 2,958 3,148
Consumer Software Division 1,709 2,086
Enterprise Software Division 6,949 6,228
Music Technology Division 762 -
Other 8 86
---------------- --------------
$ 28,052 $ 23,666
================ ==============
SEGMENT INCOME:
THREE MONTHS ENDED
MARCH 31,
----------------------------------
2003 2002
---------------- --------------
Video Technology Division $ 16,292 $ 13,369
Consumer Software Division 591 800
Enterprise Software Division 3,557 3,249
Music Technology Division (138) -
Other (136) (175)
---------------- --------------
Segment income 20,166 17,243
Research and development 3,743 2,537
General and administrative 4,324 3,048
Amortization of goodwill and other
intangibles from acquisitions 856 689
Amortization of deferred stock-based
compensation 768 2,083
---------------- --------------
$ 10,475 $ 8,886
================ ==============
11
INFORMATION ON NET REVENUES BY GEOGRAPHIC AREA:
THREE MONTHS ENDED
MARCH 31,
-------------------------------
2003 2002
-------------- -------------
United States $ 16,836 $ 10,784
International 11,216 12,882
-------------------------------
$ 28,052 $ 23,666
============== =============
Geographic area information is based upon country of destination for
products shipped and country of contract holder for royalties and license fees.
NOTE 10 - 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. On August 31, 2000, the Company acquired
Globetrotter.
In 1999 and 2001, the Federal District Court granted the partial
summary judgment motions for Rainbow et al that essentially dismissed the patent
infringement case against Rainbow et al.
In 2002, the Company filed a series of summary judgment motions to
dismiss some of the counterclaims from Rainbow et al. The Federal District Court
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
all its patent infringement claims against Ken Greer, Elan and Rainbow. On
January 2, 2003, Rainbow filed a notice to appeal the summary judgment of all of
its counterclaims. On March 5, 2003, we entered into a stipulated agreement with
Rainbow to dismiss all cross-appeals between Rainbow and us. On March 31, 2003,
Ken Greer and Elan filed an appeal brief to appeal the summary judgment of its
counterclaims. In the brief, Elan indicated it was abandoning its appeal of the
summary judgment order. This leaves only Ken Greer's appeal and our
cross-appeal. We anticipate filing our appeal brief sometime in early May 2003.
12
If an adverse ruling is ultimately reached on the remaining appeals and
the case is returned to 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, 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.
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 the Company
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 that the Company 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 of products containing the interface code, and actual,
compensatory and punitive damages. The Company answered Yield Dynamic's
complaint and has asserted a counterclaim for declaratory relief. The action is
currently in the initial stages of discovery.
13
Although the Company does not expect a material adverse result, it is
unable to provide an estimate of the range or amount of potential loss in the
event of an adverse ruling. The Company intends 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 March 31, 2003, it was not possible to estimate the liability, if
any, in connection with these matters. Accordingly, no accruals for these
contingencies have been recorded.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING COMMENTARY SHOULD BE READ IN CONJUNCTION WITH THE
FINANCIAL STATEMENTS AND RELATED NOTES CONTAINED IN THE COMPANY'S ANNUAL REPORT
ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2002 AS FILED WITH THE SEC. 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," "EXPECTS," "PLANS," "ANTICIPATES,"
"BELIEVES," "ESTIMATES," "PREDICTS," "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
FACTORS SET FORTH UNDER THE CAPTION "RISK FACTORS" IN OUR ANNUAL REPORT ON FORM
10-K FOR THE YEAR ENDED DECEMBER 31, 2002.
OVERVIEW
We were founded in 1983 to develop copy protection and video security
solutions for major motion picture studios and independent video producers. Our
initial products were designed to prevent the unauthorized duplication and
distribution of videocassettes. We have expanded our copy protection
technologies to address the unauthorized copying and distribution of DVDs, 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 Enterprise License
Management ("ELM") solutions for software vendors and 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 revenues information by product line
(dollars in thousands):
THREE MONTHS ENDED
MARCH 31, CHANGE
--------------------------------- ----------------------------
2003 2002 $ %
--------------- -------------- ------------ ------------
Video Technology Division
DVD $ 13,929 $ 10,599 $ 3,330 31.4%
Videocassette 1,737 1,519 218 14.4
Pay-Per-View 2,958 3,148 (190) (6.0)
Consumer Software Division 1,709 2,086 (377) (18.1)
Enterprise Software Division 6,949 6,228 721 11.6
Music Technology Division 762 - 762 100.0
Other 8 86 (78) (90.7)
--------------- -------------- ------------ ------------
Total $ 28,052 $ 23,666 $ 4,386 18.6%
=============== ============== ============ ------------
15
The following table provides percentage of net revenue information by
product line:
THREE MONTHS ENDED
MARCH 31,
------------------------------
2003 2002
-------------- ------------
Video Technology Division
DVD 49.7% 44.8%
Videocassette 6.2 6.4
Pay-Per-View 10.5 13.3
Consumer Software Division 6.1 8.8
Enterprise Software Division 24.8 26.3
Music Technology Division 2.7 -
Other - 0.4
-------------- ------------
Total 100.0% 100.0%
============== ============
VIDEO TECHNOLOGY DIVISION.
Our customers have included the home video divisions of member
companies of the Motion Picture Association of America ("MPAA"), videocassette
duplication and DVD replication companies and a number of low volume content
owners, such as independent producers of exercise, sports, educational,
documentary and corporate video programs ("Special Interest"). We typically
receive per unit royalties based upon the number of copy-protected
videocassettes or DVDs that are produced by MPAA studios or other content
owners.
DVD COPY PROTECTION. In 1997, we introduced copy protection for DVDs.
Our customers have included member companies of the MPAA and Special Interest
rights owners. Our customers pay per unit royalties for DVD copy protection.
Additionally, we derive license fees from DVD hardware manufacturers. DVD copy
protection revenue represented 49.7% and 44.8% of our net revenues for the three
months ended March 31, 2003 and 2002, respectively. The increase in DVD copy
protection revenue is due to the increase in numbers of DVDs sold and continued
growth in demand for our DVD copy protection solution. We expect these trends to
continue as long as the growth in DVD demand exceeds future declines in our DVD
copy protection average unit royalties and usage rates.
VIDEOCASSETTE COPY PROTECTION. In 2003, we expect the trend of
Hollywood studios investing proportionally more in copy protecting their DVD
titles compared to VHS releases to continue. Videocassette copy protection
revenues represented 6.2% and 6.4% of our net revenues for the three months
ended March 31, 2003 and 2002, respectively. While our revenues in this area
during the three months ended March 31, 2003 increased compared to the same
period in the prior year, we believe videocassette copy protection revenues will
continue its prior decline as a percentage of our revenues and in absolute
terms, as the studios focus more of their resources on the DVD business line.
We expect that revenues from the MPAA studios will continue to account
for a substantial portion of our net revenues for the foreseeable future. We
also 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.
16
PPV COPY PROTECTION. In 1993, we introduced digital PPV copy protection
to satellite and cable system operators and to the equipment manufacturers that
supply the satellite and cable industries. We derive a majority of our digital
PPV copy protection revenues from hardware royalties, and the balance from
either up-front license fees or transaction royalties associated with copy
protected PPV programming. Digital PPV revenues were 10.5% and 13.3% of our net
revenues for the three months ended March 31, 2003 and 2002, respectively. Our
agreements with digital PPV system operators entitle us to transaction-based
royalty payments when copy protection for digital PPV programming is activated.
The decrease in our PPV copy protection revenues is due to the continued weak
digital cable and digital satellite business on a worldwide basis. We believe
that revenues from PPV Copy Protection in total and as a percentage of our total
revenues will continue to vary in the future.
CONSUMER SOFTWARE DIVISION.
We entered into the market for copy protection of consumer software in
1998, when we introduced our CD-ROM consumer software copy protection
technology, called SafeDisc. Customers implementing SafeDisc include major PC
game and educational software publishers. We typically receive unit royalties
based upon the number of copy protected CD-ROMs that are produced by PC game and
educational software publishers. SafeCast is an electronic software distribution
product that facilitates web-based purchases and delivery of consumer-oriented
software. In recent quarters we have seen increased market adoption of SafeCast.
Consumer software division revenues represented 6.1% and 8.8% of our net
revenues for the three months ended March 31, 2003 and 2002, respectively. The
decrease in revenue is due to a reduction of royalty revenues we received from
our customers using our SafeDisc product. We believe that revenues from our
Consumer Software Division in total and as a percentage of our total revenues
will continue to vary in the future.
ENTERPRISE SOFTWARE DIVISION.
We entered the market for electronic license management of enterprise
software in August 2000. Our Enterprise Software Division generates its revenue
from licensing its software and providing services related to the support and
maintenance of this software. Revenues from this business segment were 24.8% and
26.3% of our net revenues for the three months ended March 31, 2003 and 2002,
respectively. Despite difficult economic conditions for enterprise software
companies, our revenue for the three months ended March 31, 2003 has increased
compared to the same period in the prior year. We believe that revenues from our
Enterprise Software Division in total and as a percentage of our total revenues
will continue to vary in the future.
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 additional contingent consideration up to $8.0
million based on a percentage of net revenues 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 in November, we recorded
goodwill of $6.9 million and identifiable intangibles of $4.9 million. In the
first quarter of 2003, we also recorded additional goodwill of $0.3 million
which represents payments we are required to make to Midbar Tech (1998) Ltd.
shareholders based on a percentage of the net revenues of our Music Technology
Division, as noted above. Our copy protection products in this area are used by
customers for copy protection, authentication, and rights management for music
CDs. Music Technology revenues were 2.7% of our net revenues for the three
months ended March 31, 2003. We had no revenues from Music Technology during the
three months ended March 31, 2002. We expect revenues from our Music Technology
Division to increase in the future.
17
SEASONALITY OF BUSINESS.
We have experienced significant seasonality in our business, and our
consolidated 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.
We believe that this trend has been principally due to the tendency of certain
of our customers to release new video, audio, and consumer software titles
during the year-end holiday shopping season, while our operating expenses are
incurred more evenly throughout the year. In addition, revenues tend to be lower
in the summer months, particularly in Europe.
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, direct
labor and benefit costs of employees time spent on billable consulting or
training, 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.
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.
REVENUE RECOGNITION
Our revenue primarily consists of royalty fees on copy-protected
products on a per unit basis, licenses for our copy protection technologies,
licenses for our software products, and related maintenance and services
revenues.
ROYALTY REVENUES
Royalty revenue from the replication of videocassettes, DVDs, and CDs
is recognized when realized or realizable and earned. We rely on royalty reports
from third parties as our basis for revenue recognition. In our DVD,
videocassette, and consumer software businesses, we have established
18
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. Revenue from
customers in our PPV and Music Technology Division is recognized only as
reported, due to the timing of receipt of reports in PPV, and the embryonic
stage and volume volatility of the audio market. 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 and determinable
license fee is considered probable.
SOFTWARE LICENSING REVENUES
We recognize revenue on our software products in accordance with SOP
97-2, "Software Revenue Recognition," as amended by SOP 98-9 "Modification of
SOP 97-2." 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 not to be fixed or determinable and,
accordingly, revenue is recognized as payments become due from the customer
under 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 one year).
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 where
services are essential to the functionality of the software, 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."
19
PROFESSIONAL SERVICES REVENUES
We provide consulting and training services to our customers. Revenue
from such services is generally recognized as the services are performed, except
in instances where services are included in an arrangement accounted for under
SOP 81-1.
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 (which is generally one
year) and included in services revenue in the accompanying financial statements.
VALUATION OF STRATEGIC INVESTMENTS
As of March 31, 2003, the adjusted cost of our strategic investments
totaled $28.7 million. This included our investments in public and non-public
companies.
We review our investments in non-public companies and estimate the
amount of any impairment incurred during the current period 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 daily
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.
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 non-public-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,
$5.5 million of other-than-temporary impairment losses were recorded during the
three months ended March 31, 2002. This included a $2.5 million charge for an
investment in a public company and a $3.0 million charge for an investment in a
non-public company. No impairment losses were recorded during the three months
ended March 31, 2003.
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
20
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 our impairment analysis to be performed annually in
our fourth quarter, we are required to perform an assessment of whether there is
an indication that goodwill is impaired. To accomplish this, we are required to
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. To the extent the carrying amount of a reporting unit exceeds
its fair value, we would be required to perform the second step of the
impairment analysis, as this is an indication that the reporting unit goodwill
may be impaired. In this step, we compare the implied fair value of the
reporting unit goodwill with the carrying amount of the reporting unit goodwill.
The implied fair value of goodwill is 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 is the implied fair value of the
reporting unit goodwill. To the extent the implied fair value of goodwill of
each reporting is less than its carrying amount we would be required to
recognize an impairment loss.
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 assets might be impaired. An impairment loss
is recognized to the extent that the carrying amount exceeds the asset's fair
value.
IMPAIRMENT OF LONG-LIVED ASSETS
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 group may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the
carrying amount of an asset group to estimated undiscounted future cash flows
expected to be generated by the asset group. If the carrying amount of an asset
group exceeds its estimated future cash flows, an impairment charge is
recognized by the amount by which the carrying amount of the asset group exceeds
the fair value of the asset group. 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 would no longer be 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.
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.
21
INCOME TAXES
We account for income taxes using the asset and liability method. As of
March 31, 2003 deferred tax assets net of valuation allowances, totaled $18.3
million. Deferred tax assets, related valuation allowances and deferred tax
liabilities are determined separately by tax jurisdiction. We believe sufficient
uncertainty exists regarding our ability to realize our 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.
RESULTS OF OPERATIONS
NET REVENUES. Our net revenues increased 18.5% from $23.7 million in
the first quarter of 2002 to $28.1 million in the first quarter of 2003. DVD
copy protection revenues increased $3.3 million or 31.4% from $10.6 million in
the first quarter of 2003 to $13.9 million in the first quarter of 2003, due to
the continued growth in demand of the DVD format and a strong hit title release
schedule that more than offset modest declines in our average unit royalties.
Revenues from videocassette copy protection increased $0.2 million or 14.4% from
$1.5 million in the first quarter of 2002 to $1.7 million in the first quarter
of 2003, due to strong demand for certain copy protected title releases on the
VHS format. Digital PPV copy protection revenues decreased $0.1 million or 6.0 %
from $3.1 million in the first quarter of 2002 to $3.0 million in the first
quarter of 2003 due to the continued weak digital cable and digital satellite
business on a worldwide basis. Consumer Software Division revenues decreased
$0.4 million, or 18.1% from $2.1 million in the first quarter of 2002 to $1.7
million in the first quarter of 2003 primarily due to a reduction of royalty
revenues from customers utilizing our SafeDisc product. Revenues from our
Enterprise Software Division revenues increased $0.7 million, or 11.6 % from
$6.2 million in the first quarter of 2002 to $6.9 million in the first quarter
of 2003 primarily due to an increase in annual licensing and maintenance
revenues. Other revenue from legacy video encryption businesses decreased
$78,000 or 90.7% from $86,000 in the first quarter of 2002 to $8,000 in the
first quarter of 2003 as fewer customers ordered these products.
LICENSE REVENUES. Our license revenues increased by $4.0 million or
19.0% from $21.2 million in the first quarter of 2002 to $25.2 million in the
first quarter of 2003. This increase was primarily due to increases in our
revenues derived by our Video Technology Division in the DVD copy protection
area. We also received license revenues from our Music Technology Division,
which was formed in November 2002, and had as an increase in license revenues in
our Enterprise Software Division.
SERVICE REVENUES. Our service revenues increased by $0.3 million or
14.5% from $2.5 million in the first quarter of 2002 to $2.8 million in the
first quarter of 2003. The increase is primarily due to an increase in
maintenance revenues in our Enterprise Software Division, as well as an increase
in consulting revenue.
22
COST OF REVENUES - LICENSE FEES. Cost of revenues from license fees
decreased by $0.3 million or 19.4% from $1.2 million in the first quarter of
2002 to $0.9 million in the first quarter of 2003. As a percentage of license
revenues, cost of revenues from license fees decreased from 5.5% in the first
quarter of 2002 to 3.7% in the first quarter of 2003. This decrease was
primarily due to lower patent defense costs relating to the Rainbow litigation
in the first quarter of 2003 compared to the first quarter of 2002 (see Note 11
of Notes to Condensed Consolidated Financial Statements).
COST OF REVENUES - SERVICE FEES. Cost of revenues from service fees
increased by $45,000 or 9.0% from $498,000 in the first quarter of 2002 to
$543,000 in the first quarter of 2003. Cost of revenues from service fees as a
percentage of service revenues decreased from 20.3% for the first quarter of
2002 to 19.3% for the first quarter of 2003. This increase in absolute terms was
primarily due to the increase in the size of our consulting practice which
required increased hiring of technical consultants, which resulted in higher
employee related expenses. Additionally, this increase was partially offset by
the deferral of certain costs totaling $161,000 directly associated with a
customer contract currently being accounted for under the completed contract
provisions of SOP 81-1. We anticipate our cost of revenues from service fees
will increase in the future.
COST OF REVENUES - AMORTIZATION OF INTANGIBLES FROM ACQUISITIONS. Cost
of revenues from amortization of intangibles from acquisitions increased by $0.4
million or 58.5% from $0.5 million in the first quarter of 2002 to $0.9 million
in the first quarter of 2003. This increase was primarily due to the acquisition
of Midbar Tech (1998) Ltd., which increased our intangible assets subject to
amortization. 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 $1.2 million or 47.5% from $2.5 million in the first quarter of 2002 to $3.7
million in the first quarter of 2003. The increase is primarily due to increased
headcount and increased costs for contractors and consultants as we increase our
research and development efforts. These increases were primarily in our Music
Technology Division, which includes headcount related to our November 2002
acquisition of Midbar Tech (1998) Ltd. Research and development expenses
increased as a percentage of net revenues from 10.7% in the first quarter of
2002 to 13.3% in the first quarter of 2003. We expect research and development
expenses to continue to increase in absolute terms over the prior year periods
as a result of expected increases in research and development activity as we
invest in the development of new technologies across all our business areas.
SELLING AND MARKETING. Selling and marketing expenses increased by $1.6
million or 34.5% from $4.8 million in the first quarter of 2002 to $6.4 million
in the first quarter of 2003. This increase was primarily due to higher
compensation expenses and increased headcount, as well as increased advertising
costs. Selling and marketing expenses increased as a percentage of net revenues
from 20.1% in the first quarter of 2002 to 22.8% in the first quarter of 2003.
We expect selling and marketing expenses to continue to increase in absolute
terms in the future.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
increased by $1.3 million or 41.9% from $3.0 million in the first quarter of
2002 to $4.3 million in the first quarter of 2003. The increase is due primarily
to higher compensation expense and increased headcount, increased Directors' and
Officers' insurance, as well as increased legal fees (excluding legal fees for
patent defense which are included in cost of sales for license fees). General
and administrative expenses increased as a percentage of net revenues from 12.9%
in the first quarter of 2002 to 15.4% in the first quarter of 2003. We expect
our general and administrative expenses to increase moderately in absolute terms
in the future as we continue to support the expansion of our business and comply
with the requirements of Sarbanes-Oxley.
23
AMORTIZATION OF INTANGIBLES FROM ACQUISITIONS. We amortize intangibles
relating to the acquisition of C-Dilla in June of 1999 on a straight-line basis
over three to seven years based on expected useful lives of existing products
and technologies and non-compete agreements. We amortized $149,000 in the first
quarter of 2002 related to non-compete agreements. There was no comparable
amortization in the first quarter of 2003. We also amortized $417,000 in each of
the first quarters of 2003 and 2002 related to intangibles for existing products
and technologies. These amounts are included in our cost of revenues.
We also amortize intangibles relating to the acquisition of net assets
of Productivity through Software plc ("PtS"), the European distributor for the
Enterprise Software Division, on a straight-line basis over three years based on
the expected useful lives of the existing customer base. We amortized $133,000
and $123,000 in the first quarter of 2003 and 2002, respectively. These amounts
are included in our cost of sales.
We amortize intangibles relating to the acquisition of Midbar Tech
(1998) Ltd. in November 2002 on a straight-line basis over three to five years
based on expected useful lives of existing technology, existing contracts,
patents and trademarks. We amortized $306,000 in the first quarter of 2003. This
amount is included in our cost of sales.
AMORTIZATION OF DEFERRED STOCK-BASED COMPENSATION. In connection with
the acquisition of Globetrotter, approximately 783,742 Globetrotter employee
stock options were exchanged for Macrovision stock options, resulting in a
deferred stock-based compensation charge of approximately $37.9 million. The
amortization of the deferred stock-based compensation for the first quarters of
2003 and 2002 were $0.8 million and $2.1 million, respectively. The decrease in
amortization from the first quarter of 2002 to 2003 was due to stock option
forfeitures as certain former Globetrotter employees left the Company. The
expense associated with this stock-based compensation will continue to result in
substantial non-cash compensation charges to future earnings through 2004.
IMPAIRMENT LOSSES ON INVESTMENTS. During the first quarter of 2002 we
recorded a charge totaling $5.5 million relating to other than temporary
impairments in our public and non-public company investments. No comparable
charges were recorded in the first quarter of 2003.
INTEREST AND OTHER INCOME, NET. Interest and other income decreased
$1.0 million or 47.7% from $2.1 million in the first quarter of 2002 to $1.1
million in the first quarter of 2003. The decrease is due primarily to lower
interest rates.
INCOME TAXES. For the first quarter of 2003, we recorded income taxes
of $4.6 million, compared to income taxes for the first quarter of 2002 of $2.5
million. The effective tax rate for the first quarter of 2003 and 2002 was 40.0%
and 46.0%, respectively. The effective tax rate of 40.0% reflects our current
estimate of domestic and international revenue and income before taxes, as well
as the estimated level of pre-tax income for fiscal 2003. 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 a
reduction in the amortization of deferred stock-based compensation, which is not
tax deductible.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations primarily from cash generated by
operations, principally our copy protection businesses and our electronic
license management business. Our operating activities provided net cash of $17.5
million and $11.0 million in the three months ended March 31, 2003 and 2002,
respectively. Cash provided by operating activities increased primarily due to
increases in net income and increased collections, as well as an increase in our
liabilities. The availability of cash generated by our
24
operations could be affected by, but not limited to, those factors set forth
under the caption "Risk Factors" in our Annual Report on Form 10-K for the year
ended December 31, 2002.
Investing activities used net cash of $43.9 million in the three months
ended March 31, 2003 and provided net cash of $16.1 million in the three months
ended March 31, 2002. Cash from investing activities decreased from the prior
year period mainly from the maturity of short-term marketable investments and
investments in money market funds that were reinvested in longer term
investments for more favorable interest rates. The decrease in capital
expenditures of $1.5 million is primarily due to leasehold improvements and
furniture and fixtures for our new office space, which occurred in the first
quarter of 2002 resulting in a larger amount of capital expenditures in that
quarter when compared to the first quarter of 2003.
Net cash provided by financing activities was $1.2 million and $1.7
million in the three months ended March 31, 2003 and 2002, respectively, from
the issuance of common stock from options and stock purchase plans.
At March 31, 2003, we had $73.6 million in cash and cash equivalents,
$67.2 million in short-term investments and $88.3 million in long-term
marketable investment securities, which includes the fair market value of our
strategic investments in two public companies, Digimarc and TTR Technologies. 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. The decrease in cash, cash equivalents and short term
investments is mainly due to the maturity of short term marketable investments
and investments in money market funds which were reinvested in longer term
investments for more favorable interest rates, offset by favorable cash flow
provided by operations.
The increase in long-term marketable investment securities is due to
the maturity of short term investments and reinvestment of money market funds
into longer term investments mentioned above, and also the increase in market
value of Digimarc and TTR Technologies. We have no material commitments for
capital expenditures and anticipate that capital expenditures for the remainder
of the year will not exceed $3.0 million. We also have future minimum lease
payments of approximately $28.6 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.
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 additional contingent consideration up to $8.0
million based on a percentage of net revenues of the Music Technology Division
until December 31, 2004.
In November 2002, we signed an agreement with TTR Technologies 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, subject to meeting certain closing conditions. As of March 31,
2003, the Company's investment in TTR stock had a carrying value of $0.7
million.
Because a significant portion of our cash inflows were generated by
operations, 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
including, but not limited to, those
25
factors set forth under the caption "Risk Factors" in our Annual Report on Form
10-K for the year ended December 31, 2002.
In May 2002, the Board of Directors authorized a 5.0 million share
repurchase program which allowed us 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 our management.
Our repurchases of shares of common stock have been recorded as treasury stock
and resulted in a reduction of stockholders' equity. Through March 31, 2003, we
had repurchased 3.0 million shares at a total cost of $38.5 million. As of March
31, 2003, 2.0 million shares remained authorized for repurchase.
CONTRACTUAL OBLIGATIONS.
The Company leases its facilities and certain equipment pursuant to
non-cancelable operating lease agreements. Future minimum lease payments
pursuant to these leases as of March 31, 2003 were as follows (in thousands):
Operating
Leases
------------
2003 $ 2,254
2004 3,015
2005 2,988
2006 3,061
2007 3,168
2008 and thereafter 14,082
------------
Total $ 28,568
============
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 7 of Notes to Condensed Consolidated Financial Statements.
ITEM 3. 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 $229.1 million as
of March 31, 2003. 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 $632,000 decrease (approximately
0.3%) in the fair value of our available-for-sale securities as of March 31,
2003.
26
FOREIGN EXCHANGE RATES. Due to our reliance on international and export
sales, we are subject to the risks of fluctuations in currency exchange rates.
Because a substantial majority of our international and export revenues are
typically denominated in U.S. dollars, fluctuations in currency exchange rates
could cause our products to become relatively more expensive to customers in a
particular country, leading to a reduction in sales or profitability in that
country. Our subsidiaries in the U.K. and Japan operate in their local currency,
which mitigates a portion of the exposure related to the respective currency
royalties collected.
STRATEGIC INVESTMENTS. We currently hold minority equity interests in
Command Audio, Digimarc, Digital Fountain, InterActual, iVAST, NTRU
Cryptosystems, RioPort, Inc., SecureMedia, Widevine Technologies and TTR. These
investments, with a carrying value totaling $29.8 million (which included $5.6
million for investments in non-public companies), represented 8.8% of our total
assets as of March 31, 2003. 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 non-public 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
non-public companies, and we may in the future be required to write off all or
part of one or more of these investments. During the three months ended March
31, 2002, we recorded charges of $5.5 million relating to other than temporary
impairments in our public and non-public company investments. No charges were
recorded for the three months ended March 31, 2003. These charges relate to some
of the investments listed above. 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, subject to meeting certain closing conditions. As of
March 31, 2003, our investment in TTR stock had a carrying value of $0.7
million.
ITEM 4. CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. 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 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) CHANGES IN INTERNAL CONTROLS. 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.
27
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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. On August 31, 2000, the Company acquired
Globetrotter.
In 1999 and 2001, the Federal District Court granted the partial
summary judgment motions for Rainbow et al that essentially dismissed the patent
infringement case against Rainbow et al.
In 2002, the Company filed a series of summary judgment motions to
dismiss some of the counterclaims from Rainbow et al. The Federal District Court
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
all its patent infringement claims against Ken Greer, Elan and Rainbow. On
January 2, 2003, Rainbow filed a notice to appeal the summary judgment of all of
its counterclaims. On March 5, 2003, we entered into a stipulated agreement with
Rainbow to dismiss all cross-appeals between Rainbow and us. On March 31, 2003,
Ken Greer and Elan filed an appeal brief to appeal the summary judgment of its
counterclaims. In the brief, Elan indicated it was abandoning its appeal of the
summary judgment order. This leaves only Ken Greer's appeal and our
cross-appeal. We anticipate filing our appeal brief sometime in early May 2003.
If an adverse ruling is ultimately reached on the remaining appeals and
the case is returned to 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
28
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, 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.
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 the Company
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 that the Company 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 of products containing the interface code, and actual,
compensatory and punitive damages. The Company answered Yield Dynamic's
complaint and has asserted a counterclaim for declaratory relief. The action is
currently in the initial stages of discovery.
Although the Company does not expect a material adverse result, it is
unable to provide an estimate of the range or amount of potential loss in the
event of an adverse ruling. The Company intends 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 March 31, 2003, it was not possible to estimate the liability, if
any, in connection with these matters. Accordingly, no accruals for these
contingencies have been recorded.
29
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.1 Offer letter to Steven Weinstein dated October 9, 2002.*
99.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (18 U.S.C. Section 1350, as adopted).
99.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (18 U.S.C. Section 1350, as adopted).
-------------------------------------------------------------------
* The Company has requested confidential treatment for certain
portions of this Exhibit.
(b) Reports on Form 8-K.
During the quarter ended March 31, 2003, the Company filed
two reports on Form 8-K. On January 9, 2003, the Company
reported on Form 8-K its press release concerning the
appointment of Steven Weinstein as Macrovision's Chief
Technology Officer. On January 22, 2003, the Company
reported on Form 8-K its press release concerning revenue
and earnings results for the fourth quarter of 2002, as
well as revenue and earnings estimates for 2003.
30
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Macrovision Corporation
AUTHORIZED OFFICER:
Date: May 9, 2003 By: /s/ William A. Krepick
-------------------- ---------------------------------------
William A. Krepick
President and Chief Executive Officer
PRINCIPAL FINANCIAL OFFICER AND CHIEF ACCOUNTING OFFICER:
Date: May 9, 2003 By: /s/ Ian R. Halifax
-------------------- ---------------------------------------
Ian R. Halifax
Vice President, Finance and Administration,
Chief Financial Officer and Secretary
31
CERTIFICATIONS
I, William A. Krepick, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Macrovision
Corporation;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers 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 quarterly 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
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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 officers and I have indicated in this
quarterly 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: May 9, 2003
/s/ William A. Krepick
--------------------------
William A. Krepick
Chief Executive Officer
32
I, Ian R. Halifax, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Macrovision
Corporation;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers 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 quarterly 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
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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 officers and I have indicated in this
quarterly 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: May 9, 2003
/s/ Ian R. Halifax
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Ian R. Halifax
Chief Financial Officer
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