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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 September 30, 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 Identification No.)
incorporation or organization)
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 by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act).
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 November 3, 2003
Common stock, $0.001 par value 48,929,972
MACROVISION CORPORATION
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION
Page
Item 1. Financial Statements.
Condensed Consolidated Balance Sheets as of September 30, 2003
and December 31, 2002. 1
Condensed Consolidated Statements of Income
for the Three and Nine Month Periods Ended September 30, 2003 and 2002. 2
Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 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. 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk. 31
Item 4. Controls and Procedures. 32
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. 33
Item 2. Changes in Securities and Use of Proceeds. 35
Item 3. Defaults Upon Senior Securities. 35
Item 4. Submission of Matters to a Vote of Security Holders. 35
Item 5. Other Information. 35
Item 6. Exhibits and Reports on Form 8-K. 36
Signatures 37
i
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2003 2002
-------------------- -------------------
ASSETS
Current assets:
Cash and cash equivalents $ 32,573 $ 98,691
Short-term investments 82,818 72,989
Accounts receivable, net of allowance for doubtful accounts of
$1,603 and $1,657, respectively 24,613 28,237
Income taxes receivable 10,665 9,242
Deferred tax assets 4,848 4,695
Prepaid expenses and other current assets 5,677 5,367
-------------------- -------------------
Total current assets 161,194 219,221
Long-term marketable investment securities 138,414 38,696
Property and equipment, net 6,380 6,106
Patents, net 10,482 4,593
Goodwill 26,804 24,673
Other intangibles from acquisitions, net 8,702 11,368
Deferred tax assets 11,149 13,971
Other assets 1,102 6,038
-------------------- -------------------
$ 364,227 $ 324,666
==================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,165 $ 3,269
Deferred revenue 10,257 8,567
Other current liabilities 19,450 15,523
-------------------- -------------------
Total current liabilities 33,872 27,359
Notes payable 17 17
Other non current liabilities 897 431
-------------------- -------------------
Total Liabilities 34,786 27,807
Stockholders' equity:
Common stock 52 51
Treasury stock, at cost (38,450) (38,450)
Additional paid-in-capital 290,067 284,031
Deferred stock-based compensation (713) (3,024)
Accumulated other comprehensive income 7,162 1,933
Retained earnings 71,323 52,318
-------------------- -------------------
Total stockholders' equity 329,441 296,859
-------------------- -------------------
$ 364,227 $ 324,666
==================== ===================
See the accompanying notes to these condensed consolidated financial statements.
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------ ------------------------------------
2003 2002 2003 2002
----------------- ----------------- ----------------- -----------------
Revenues:
Licenses $ 28,210 $ 20,920 $ 79,675 $ 64,514
Services 3,006 2,577 8,805 7,589
----------------- ----------------- ----------------- -----------------
Total revenues 31,216 23,497 88,480 72,103
Cost of revenues:
Licenses 1,273 1,576 3,395 4,264
Services 625 489 1,765 1,352
Amortization of intangibles from acquisitions 855 519 2,567 1,599
----------------- ----------------- ----------------- -----------------
Total cost of revenues 2,753 2,584 7,727 7,215
----------------- ----------------- ----------------- -----------------
Gross profit 28,463 20,913 80,753 64,888
Operating expenses:
Research and development 4,177 3,049 12,076 8,418
Selling and marketing 6,539 5,097 19,415 14,439
General and administrative 4,612 3,633 13,584 10,299
In-process research and development 624 - 624 -
Amortization of intangibles from acquisitions - - - 298
Amortization of deferred stock-based compensation* 609 1,206 2,129 5,330
----------------- ----------------- ----------------- -----------------
Total operating expenses 16,561 12,985 47,828 38,784
----------------- ----------------- ----------------- -----------------
Operating income 11,902 7,928 32,925 26,104
Impairment losses on investments, net (294) (6,795) (4,144) (12,272)
Interest and other income, net 842 1,632 2,895 5,800
----------------- ----------------- ----------------- -----------------
Income before income taxes 12,450 2,765 31,676 19,632
Income taxes 4,981 1,161 12,671 8,467
----------------- ----------------- ----------------- -----------------
Net income $ 7,469 $ 1,604 $ 19,005 $ 11,165
================= ================= ================= =================
Basic net earnings per share $ 0.15 $ 0.03 $ 0.39 $ 0.22
================= ================= ================= =================
Shares used in computing basic net earnings per share 48,846 49,720 48,661 50,599
================= ================= ================= =================
Diluted net earnings per share $ 0.15 $ 0.03 $ 0.39 $ 0.22
================= ================= ================= =================
Shares used in computing diluted net earnings per share 49,742 49,720 49,318 51,166
================= ================= ================= =================
* The allocation of the amortization of deferred stock-based compensation relates to employees in the following
categories as set forth below:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------ ------------------------------------
2003 2002 2003 2002
----------------- ----------------- ----------------- -----------------
Cost of revenues $ 79 $ 80 $ 240 $ 314
Research and development 138 220 414 1,067
Selling and marketing 189 642 867 3,156
General and administrative 203 264 608 793
----------------- ----------------- ----------------- -----------------
$ 609 $ 1,206 $ 2,129 $ 5,330
================= ================= ================= =================
See the accompanying notes to these condensed consolidated financial statements.
2
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------------------
2003 2002
---------------------- --------------------
Cash flows from operating activities:
Net income $ 19,005 $ 11,165
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 2,267 2,033
Amortization of intangibles from acquisitions 2,567 1,897
Amortization of deferred stock-based compensation 2,129 5,330
Tax benefit from stock option exercises 1,423 1,419
In-process research & development 624 -
Impairment losses on investments, net 4,144 12,272
Changes in operating assets and liabilities:
Accounts receivable, net 3,683 3,767
Deferred revenue 1,595 285
Other assets 256 3,158
Other liabilities 3,113 472
---------------------- --------------------
Net cash provided by operating activities 40,806 41,798
Cash flows from investing activities:
Purchases of long and short term investments (324,267) (137,003)
Sales or maturities of long and short term investments 221,193 190,467
Purchases of property and equipment (1,715) (3,627)
Acquisition of TTR assets and patents (5,050) -
Contingent consideration for Midbar acquisition (480) -
Acquisition of peer to peer assets and related acquisition
costs (800) -
Other investing activities (1,020) (578)
---------------------- --------------------
Net cash (used in) provided by investing activities (112,139) 49,259
Cash flows from financing activities:
Proceeds from issuance of common stock from options and
stock purchase plans 4,775 3,667
Treasury stock acquisitions - (38,450)
---------------------- --------------------
Net cash provided by (used in) financing activities 4,775 (34,783)
Effect of exchange rate changes on cash and cash equivalents 440 332
---------------------- --------------------
Net (decrease) increase in cash and cash equivalents (66,118) 56,606
Cash and cash equivalents at beginning of period 98,691 26,112
---------------------- --------------------
Cash and cash equivalents at end of period $ 32,573 $ 82,718
====================== ====================
Supplemental cash flow information:
Income taxes paid $ 6,866 $ 6,383
TTR common stock surrendered in exchange for patents $ 602 $ -
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 4 and 5, 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 September
30, 2002 condensed consolidated statements 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 Statement of
Financial Accounting Standards ("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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
2003 2002 2003 2002
-------------- -------------- --------------- -------------
Net income, as reported $ 7,469 $ 1,604 $ 19,005 $ 11,165
Add stock-based employee compensation
expense included in reported net
income, net of related tax effects 365 699 1,277 3,038
Deduct total stock-based employee
compensation expenses determined under
fair-value-based method for all
rewards, net of related tax effects (5,777) (9,118) (20,456) (30,006)
-------------- -------------- --------------- -------------
Net income (loss), pro forma $ 2,057 $ (6,815) $ (174) $ (15,803)
============== ============== =============== =============
Basic net income (loss) per share As reported $ 0.15 $ 0.03 $ 0.39 $ 0.22
Adjusted pro forma $ 0.04 $ (0.14) $ -- $ (0.31)
Diluted net income (loss) per share As reported $ 0.15 $ 0.03 $ 0.39 $ 0.22
Adjusted pro forma $ 0.04 $ (0.14) $ -- $ (0.31)
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- ---------------------------------
2003 2002 2003 2002
--------------- -------------- --------------- ---------------
OPTION PLANS:
Dividends None None None None
Expected term 3.4 years 3.2 years 3.2 years 3.2 years
Risk free interest rate 2.2% 5.3% 3.5% 4.9%
Volatility rate 74.2% 73.6% 76.2% 73.5%
ESPP PLAN:
Dividends None None None None
Expected term 1.5 years 1.3 years 1.3 years 1.3 years
Risk free interest rate 2.6% 2.8% 2.7% 2.9%
Volatility rate 74.9% 76.3% 75.6% 76.9%
The weighted average fair value of options granted during the three
months ended September 30, 2003 and 2002 was $10.71 and $7.37, respectively. The
weighted average fair value of options granted during the nine months ended
September 30, 2003 and 2002 was $8.04 and $11.56, respectively. The weighted
average fair value of an ESPP share purchase right during the three months ended
September 30, 2003 and 2002 were $7.43 and $9.23, respectively. The weighted
average fair value of an ESPP share purchase right during the nine months ended
September 30, 2003 and 2002 were $7.98 and $9.95, 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 ELM (electronic license
management) and DRM (digital rights management) software products, and related
maintenance and services revenues.
ROYALTY REVENUES
Royalty revenue from the replication of copy protected 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 copy protection 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
pay-per-view ("PPV") and Music Technology 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
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."
6
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 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 of the product 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." Arrangements that
allow the Company to make reasonably dependable estimates relative to contract
costs and the extent of progress toward completion are accounted for using the
percentage-of-completion method. Arrangements that do not allow the Company to
make reasonably dependable estimates are accounted for using the
completed-contracts-method.
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. Professional services revenues are included in
services revenue in the accompanying condensed consolidated financial
statements.
MAINTENANCE REVENUES
Maintenance agreements generally call for the Company to provide
technical support and unspecified 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 condensed consolidated financial statements.
NOTE 3 - ASSET PURCHASES AND BUSINESS COMBINATIONS
In November 2002, the Company 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, the Company is subject to additional contingent
consideration up to $8.0 million based on a percentage of revenues derived from
our sales of Music Technology products until 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. During the nine months ended September 30, 2003, we
recorded additional goodwill of approximately $787,000 which represents
contingent consideration payments we are required to make to Midbar Tech (1998)
Ltd. shareholders based on a percentage of the revenues from sales of our Music
Technology products, as noted above.
In May 2003, the Company acquired patents and other assets of TTR
Technologies, Inc. ("TTR") for $5.1 million in cash and the surrender of
1,880,937 shares of TTR common stock, with a fair value of $602,000, that the
Company originally purchased in January 2000. The total purchase price of $5.7
million has been allocated to patents and other intangibles. The Company
recorded a realized gain of $395,000 for the excess of the market value of such
TTR stock on the closing date of the acquisition
7
over the adjusted cost basis of such stock. This gain has been included in
"Impairment losses on investments, net" in the accompanying condensed
consolidated financial statements.
In August 2003, the Company acquired intellectual property and other
assets, including patents, existing contracts, and software code that can be
used to track and manage content in the peer-to-peer, or P2P, file sharing
space. The Company paid $720,000 in cash, $80,000 of acquisition costs and an
additional payment of $80,000 due on the first anniversary of the closing date
for a total purchase price of $880,000. In addition, the Company has agreed to a
maximum payment of $140,000 if certain milestones are achieved by May 28, 2004.
The purchase price was allocated to in-process technology, core technology and
employment agreements. The in-process technology of $624,000 has been charged to
operations during the three and nine months ended September 30, 2003.
NOTE 4 - INVESTMENTS IN MARKETABLE SECURITIES
The Company accounts for its publicly traded investments in accordance
with 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 September 30, 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 accumulated other
comprehensive income as a separate component of stockholders' equity.
All marketable debt securities with remaining maturities over one year
or which the Company's intent is to retain its investment 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, net." 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. Interest and dividends on securities classified
as available-for-sale are included in other income.
During the three months ended September 30, 2002, the Company recorded
charges of $3.1 million relating to impairment losses considered to be
other-than-temporary declines in the value of certain strategic long-term
investments in public companies. During the nine months ended September 30,
2003, the Company recorded a realized gain of $395,000 from the surrender of the
Company's stock in TTR, a strategic long-term investment in a public company.
During the nine months ended September 30, 2002, the Company recorded charges of
$5.6 million relating to impairment losses considered to be other-than-temporary
declines in the value of certain strategic long-term investments in public
companies.
NOTE 5 - 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
8
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, such as a recent financing round,
management estimates the impairment and/or the net realizable value of the
portfolio investment based on a hypothetical liquidation at book value approach
as of the reporting date. 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 September 30, 2003 and 2002, the Company
recorded charges of $294,000 and $3.7 million, respectively, relating to
impairment losses considered to be other-than-temporary declines in the value of
certain strategic long term investments in non-public companies. During the nine
months ended September 30, 2003 and 2002, the Company recorded charges of $4.5
million and $6.7 million, respectively, relating to impairment losses considered
to be other-than-temporary declines in the value of certain strategic long term
investments in non-public companies.
NOTE 6 - 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):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
Basic EPS - weighted average number of common
shares outstanding 48,846 49,720 48,661 50,599
Effect of dilutive potential common shares -
stock options outstanding 896 - 657 567
-------------- -------------- -------------- --------------
Diluted EPS - weighted average number of
common shares and dilutive potential
common shares outstanding 49,742 49,720 49,318 51,166
============== ============== ============== ==============
Anti-dilutive shares excluded 3,827 5,194 4,233 3,622
============== ============== ============== ==============
Weighted average exercise price of
anti-dilutive shares $ 41.79 $ 37.00 $ 40.86 $ 46.35
============== ============== ============== ==============
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.
9
NOTE 7 - OFFER TO EXCHANGE OUTSTANDING STOCK OPTIONS TO PURCHASE COMMON STOCK
On May 27, 2003, the Company's stockholders approved a program to
permit the exchange of stock options issued under the 2000 Equity Plan and the
1996 Equity Incentive Plan having an exercise price greater than $28.00 for a
lesser number of new options to be granted at least six months and one day from
the cancellation of the surrendered options (the "Option Exchange Program").
On August 20, 2003, the Company implemented the Option Exchange Program
by filing a Tender Offer Statement with the U.S. Securities and Exchange
Commission. The Option Exchange Program was offered from August 20, 2003 to
September 19, 2003. On September 19, 2003, pursuant to the Option Exchange
Program, the Company accepted for cancellation, options to purchase 969,215
shares of common stock. Eligible employees, subject to their continued
employment with the Company on the grant date of the new options, will receive
new options to purchase approximately 337,211 shares of common stock in exchange
for such cancelled options.
The Company has designed the Option Exchange Program so that the
Company will not need to record compensation expense from the issuance of new
stock options under current accounting principles.
NOTE 8 - 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 September 30, 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
September 30, 2003, 2.0 million shares remained authorized for repurchase.
NOTE 9 - 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 EITF 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 is 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.
10
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 No. 46 ("FIN 46"), "Consolidation
of Variable Interest Entities - An Interpretation of Accounting Research
Bulletin No. 51." FIN 46 requires an investor with a majority of the variable
interests (primary beneficiary) in a variable interest entity (VIE) to
consolidate the entity and also requires majority and significant variable
interest investors to provide certain disclosures. A VIE is an entity in which
the voting equity investors do not have a controlling financial interest, or the
equity investment at risk is insufficient to finance the entity's activities
without receiving additional subordinated financial support from other parties.
For arrangements entered into with VIEs created prior to January 31, 2003, the
provisions of FIN 46 were originally effective as of the beginning of the three
months ended September 27, 2003, however, the FASB subsequently delayed the
effective date of this provision until the first interim or annual period ending
after December 15, 2003. The provisions of FIN 46 were effective immediately for
all arrangements entered into with new VIEs created after January 31, 2003. The
Company had no investments in variable interest entities as of September 30,
2003.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS
No. 150 establishes standards for how companies classify and measure certain
financial instruments with characteristics of both liabilities and equity. It
requires companies to classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances.) SFAS No. 150 is effective
beginning the third quarter of fiscal 2003. The Company has adopted this
standard without a material effect on its financial position or results of
operations.
In November 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue 00-21, "Multiple-Deliverable Revenue Arrangements." EITF
00-21 addresses how to account for arrangements that may involve the delivery or
performance of multiple products, services and/or rights to use assets. The
consensus mandates how to identify whether goods or services or both, which are
to be
11
delivered separately in a bundled sales arrangement, should be accounted for
separately because they are "separate units of accounting." The guidance can
affect the timing of revenue recognition for such arrangements, even though it
does not change rules governing the timing or patterns of revenue recognition of
individual items accounted for separately. The Company adopted the provisions of
EITF 00-21, effective July 1, 2003, without material effect on its financial
position or results of operations.
NOTE 10 - COMPREHENSIVE INCOME
The components of comprehensive income, net of taxes, are as follows
(dollars in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ----------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- ----------------
Net income $ 7,469 $ 1,604 $ 19,005 $ 11,165
Other comprehensive income (loss):
Unrealized gains (losses) on investments (1,274) 3,100 4,010 (7,433)
Foreign currency translation adjustments 118 533 1,219 1,314
-------------- -------------- -------------- ----------------
Comprehensive income $ 6,313 $ 5,237 $ 24,234 $ 5,046
============== ============== ============== ================
NOTE 11 - SEGMENT AND GEOGRAPHIC INFORMATION
On June 17, 2003, the Company announced a reorganization into two
business units, effective July 1, 2003: the Entertainment Technologies Group and
the Software Technologies Group. The reorganization was done to improve customer
focus, consolidate resources, and effect synergies in sales, marketing, customer
support and research and development. The Entertainment Technologies Group
reflects the merger of the Video Technology and Music Technology Divisions,
along with the SafeDisc(R) portion of our Consumer Software Division. The
SafeDisc(R) business has been renamed Games. The Software Technologies Group
reflects the merger of the Enterprise Software Division and the SafeCast(R)
business that was also a part of our Consumer Software Division. SafeCast(R) has
been renamed Consumer Licensing. The Company has historically reported segment
operating income results for the Video Technology, Consumer Software, Enterprise
Software and Music Technology Divisions. Beginning with the third quarter of
2003, the Company reports operating income results for the Entertainment
Technologies Group and Software Technologies Group. The Company continues to
report separate revenue results for various product lines under the
Entertainment Technologies Group (DVD, Videocassettes, PPV, Music and Games) and
the Software Technologies Group (Enterprise Licensing and Consumer Licensing)
Segment revenue and segment income results have been reclassified for prior
periods to conform to the current period presentation.
12
REVENUES:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ---------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- --------------
Entertainment Technologies Group
Video Technology
DVD $ 15,926 $ 10,158 $ 44,069 $ 31,902
Videocassette 1,335 1,770 4,343 5,728
Pay-Per-View 2,845 3,051 8,502 8,766
Games 1,183 1,514 3,640 4,947
Music Technology 1,246 - 3,093 -
Other 3 81 81 211
--------------- --------------- --------------- --------------
Total Entertainment Technologies Group 22,538 16,574 63,728 51,554
--------------- --------------- --------------- --------------
Software Technologies Group
Enterprise Licensing 8,151 6,584 22,202 19,575
Consumer Licensing 527 339 2,550 974
--------------- --------------- --------------- --------------
Total Software Technologies Group 8,678 6,923 24,752 20,549
--------------- --------------- --------------- --------------
Total Revenue $ 31,216 $ 23,497 $ 88,480 $ 72,103
=============== =============== =============== ==============
Segment income is based on segment revenue less the respective
segment's cost of revenues, excluding amortization of intangibles, and selling
and marketing expenses. The following segment reporting information of the
Company is provided (dollars in thousands):
SEGMENT INCOME:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- -----------------------------------
2003 2002 2003 2002
-------------- -------------- ---------------- ---------------
Entertainment Technologies Group $ 18,162 $ 13,967 $ 52,494 $ 44,242
Software Technologies Group 4,904 2,541 11,925 8,338
Other (287) (173) (514) (532)
-------------- -------------- ---------------- ---------------
Segment income 22,779 16,335 63,905 52,048
Research and development 4,177 3,049 12,076 8,418
General and administrative 4,612 3,633 13,584 10,299
In-process research and development 624 - 624 -
Amortization of intangibles from
acquisitions 855 519 2,567 1,897
Amortization of deferred stock-based
compensation 609 1,206 2,129 5,330
-------------- -------------- ---------------- ---------------
Total Operating Income $ 11,902 $ 7,928 $ 32,925 $ 26,104
============== ============== ================ ===============
INFORMATION ON REVENUES BY GEOGRAPHIC AREA:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- -------------
United States $ 18,192 $ 15,065 $ 50,645 $ 47,102
International 13,024 8,432 37,835 25,001
-------------- -------------- -------------- -------------
Total Revenue $ 31,216 $ 23,497 $ 88,480 $ 72,103
============== ============== ============== =============
13
Geographic area information is based upon country of destination for
products shipped and country of contract holder for royalties and license fees.
NOTE 12 - 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, the Company 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. The Company filed an appeal brief on May 12, 2003. Both
parties subsequently filed reply briefs in July 2003. An oral hearing has been
scheduled for December 3, 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,
14
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, and an English translation was made available to the
Company on July 3, 2003. The Company is reviewing the opinion and is considering
its options. A hearing before the Court of Appeal in Dusseldorf is scheduled for
March 4, 2004. 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 $25,000.
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 against the Company and Globetrotter
Software, Inc. Yield Dynamics alleged that it created a software interface to
allow its Genesis software product to work with our FLEXLM software and that the
Company distributed this code without Yield Dynamics' permission. Yield Dynamics
asserted claims of copyright infringement, trade secret misappropriation, common
law unfair competition, and unfair competition under California's Business and
Professions Code. Yield Dynamics was seeking 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 asserted a counterclaim for declaratory relief. On
October 21, 2003, the parties filed with the court a joint stipulated request
for the dismissal of the above action with prejudice. The parties are awaiting
entry of the dismissal by the court, which the Company expects to occur shortly.
Macrovision Corporation v. Media Markt TV - Hifi - Elektro GmbH
- ---------------------------------------------------------------
On September 26, 2003, the Company initiated an ex parte interim
injunction, in the District Court of Frankfurt, Germany, against the Frankfurt
outlet of Media Markt TV-Hifi-Elektro GmbH to prohibit the sale of Macro 2000, a
copy protection circumvention device. The Company sought the injunction under
the newly-enacted German Copyright Directive that prohibits copy protection
circumvention devices in that country. The court granted the injunction on
September 29, 2003. On October 13, 2003, Media Markt signed a declaration that
it would not appeal the injunction, and, as a consequence, removed all units of
Macro 2000 from its outlets in Germany.
As of November 4, 2003, Macro 2000 was voluntarily removed from sale on
the websites of four additional German consumer electronics retailers: ZGV Lauf
Zentral-Vertrieb GmbH, SPYNET Electronic, Funkstrom Grosshandels GmbH, and
Conrad Electronic GmbH.
USPTO Interference Proceeding Between Macrovision Corporation and InterTrust
- ----------------------------------------------------------------------------
Technologies
- ------------
The Company received notice on September 4, 2003 from the United States
Patent and Trademark Office ("USPTO") declaring an interference between the
Company's U.S. Patent No. 5,845,281 (the "281 patent") together with two of its
continuation applications, and a patent application determined to be from
InterTrust Technologies Corporation. An interference is declared by the USPTO
when two or more parties claim the same patentable invention. An interference
proceeding will be held to determine the patentability of the involved patent
and applications and who was the first inventor, since in the United States the
first party to invent is granted the patent. This process is still in its
initial stages, and is anticipated to take at least a year.
15
The Company's `281 patent and its continuation applications have a
priority filing date of February 1, 1995. The InterTrust application is a
continuation of application No. 08/388,107 (now abandoned) and as a consequence
potentially has a priority filing date of February 13, 1995, 12 days later than
the Company's priority filing date. Because of the proximity of these priority
filing dates, the interference proceeding by the USPTO will attempt to determine
who invented first.
European and Japanese counterpart patent applications of the Company's
`281 patent also enjoy the priority filing date of February 1, 1995. But unlike
the U.S. with its "first to invent" rule, Europe and Japan have a "first to
file" rule, meaning that the Company's `281 patent with an earlier priority
filing date is automatically given priority of invention.
The Company's `281 patent and its continuation applications are in the
field of digital rights management, a field that the Company expects will play a
significant role in its future, and are not associated with the Company's
existing copy protection business.
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 September 30, 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.
16
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
Macrovision Corporation, a Delaware corporation founded in 1983,
develops and licenses rights management and copy protection technologies. Our
customers include major Hollywood studios, independent video producers,
enterprise and consumer software vendors, music labels, digital set-top box
manufacturers and digital pay-per-view network operators. We provide content
owners with the means to market, distribute, manage and protect video, software
and audio content. Our video copy protection technology is used to copy protect
DVDs, videocassettes, digital set-top box and personal video recorder platforms.
Our SafeDisc product is used to copy protect CDs for software publishers
primarily in the PC games software market. Our Music Technology products are
used to copy protect music CDs. Our Enterprise Licensing Software products
provide electronic license management solutions for software vendors and
software asset management tools for business. Our Consumer Licensing Software
products provide software publishers with control over the distribution and
usage of both packaged media and Internet-delivered software or licenses.
On June 17, 2003, we announced our reorganization into two business
units, effective July 1, 2003: the Entertainment Technologies Group and the
Software Technologies Group. The reorganization was done to improve customer
focus, consolidate resources, and effect synergies in sales, marketing, customer
support and research and development. The Entertainment Technologies Group
reflects the merger of the Video Technology and Music Technology divisions,
along with the SafeDisc(R) portion of our Consumer Software Division. The
SafeDisc(R) business has been renamed Games. The Software Technologies Group
reflects the merger of the Enterprise Software Division and the SafeCast(R)
business that was also a part of our Consumer Software Division. SafeCast(R) has
been renamed Consumer Licensing. We have historically reported segment operating
income results for our Video Technology, Consumer Software, Enterprise Software
and Music Technology divisions. Beginning with the third quarter of 2003, we
report operating income results for the Entertainment Technologies Group and
Software Technologies Group. We continue to report separate revenue results for
various product lines under the Entertainment Technologies Group (DVD,
Videocassettes, PPV, Music and Games) and the Software Technologies Group
(Enterprise Licensing and Software Licensing.) Segment revenue and segment
income results have been reclassified for prior periods to conform to the
current period presentation.
17
The following table provides revenues information by product line (dollars in
thousands):
THREE MONTHS ENDED
SEPTEMBER 30, CHANGE
--------------------------------- ----------------------------
2003 2002 $ %
--------------- -------------- ------------ ------------
Entertainment Technologies Group
Video Technology
DVD $ 15,926 $ 10,158 $ 5,768 56.8%
Videocassette 1,335 1,770 (435) (24.6)
Pay-Per-View 2,845 3,051 (206) (6.8)
Games 1,183 1,514 (331) (21.9)
Music Technology 1,246 - 1,246 N/A
Other 3 81 (78) (96.3)
--------------- -------------- ------------
Total Entertainment Technologies Group 22,538 16,574 5,964 36.0
Software Technologies Group
Enterprise Licensing 8,151 6,584 1,567 23.8
Consumer Licensing 527 339 188 55.5
--------------- -------------- ------------
Total Software Technologies Group 8,678 6,923 1,755 25.4
--------------- -------------- ------------
Total Revenue $ 31,216 $ 23,497 $ 7,719 32.9%
=============== ============== ============
NINE MONTHS ENDED
SEPTEMBER 30, CHANGE
--------------------------------- ----------------------------
2003 2002 $ %
--------------- -------------- ------------ ------------
Entertainment Technologies Group
Video Technology
DVD $ 44,069 $ 31,902 $ 12,167 38.1%
Videocassette 4,343 5,728 (1,385) (24.2)
Pay-Per-View 8,502 8,766 (264) (3.0)
Games 3,640 4,947 (1,307) (26.4)
Music Technology 3,093 - 3,093 N/A
Other 81 211 (130) (61.6)
--------------- -------------- ------------
Total Entertainment Technologies Group 63,728 51,554 12,174 23.6
Software Technologies Group
Enterprise Licensing 22,202 19,575 2,627 13.4
Consumer Licensing 2,550 974 1,576 161.8
--------------- -------------- ------------
Total Software Technologies Group 24,752 20,549 4,203 20.5
--------------- -------------- ------------
Total Revenue $ 88,480 $ 72,103 $ 16,377 22.7%
=============== ============== ============
18
The following table provides percentage of net revenue information by product
line:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ -----------------------------
2003 2002 2003 2002
------------- ------------- ------------- ------------
Entertainment Technologies Group
Video Technology
DVD 51.0% 43.2% 49.8% 44.2%
Videocassette 4.3 7.5 4.9 7.9
Pay-Per-View 9.1 13.0 9.6 12.2
Games 3.8 6.5 4.1 6.9
Music Technology 4.0 - 3.5 -
Other - 0.3 0.1 0.3
------------- ------------- ------------- ------------
Total Entertainment Technologies Group 72.2 70.5 72.0 71.5
Software Technologies Group
Enterprise Licensing 26.1 28.0 25.1 27.1
Consumer Licensing 1.7 1.5 2.9 1.4
------------- ------------- ------------- ------------
Total Software Technologies Group 27.8 29.5 28.0 28.5
------------- ------------- ------------- ------------
Total Revenue 100.0% 100.0% 100.0% 100.0%
============= ============= ============= ============
ENTERTAINMENT TECHNOLOGIES GROUP.
VIDEO TECHNOLOGY.
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 special interest
content owners, such as independent producers of exercise, sports, educational,
documentary and corporate video programs. 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. Our customers for DVD copy protection 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 51.0% and 43.2% of our revenues for the three months ended September
30, 2003 and 2002, respectively, and 49.8% and 44.2% of our revenues for the
nine months ended September 30, 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 any future
declines in our DVD copy protection average unit royalties and usage rates.
VIDEOCASSETTE COPY PROTECTION. In 2003, the trend of Hollywood studios
investing proportionally more in copy protecting their DVD titles compared to
VHS releases has continued. Videocassette copy protection revenues represented
4.3% and 7.5% of our revenues for the three months ended September 30, 2003 and
2002, respectively, and 4.9% and 7.9% of our revenues for the nine months ended
September 30, 2003 and 2002, respectively. We believe videocassette copy
protection revenues will continue to decline as a percentage of our revenues and
in absolute terms, as the studios focus more of their resources on the DVD
business line.
19
We expect that revenues from the MPAA studios will continue to account
for a substantial portion of our revenues for the foreseeable future. We have
agreements with certain MPAA home video companies for copy protection of a
substantial part of their DVDs and/or videocassettes 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 revenues and operating income, and our business would be harmed.
PPV COPY PROTECTION. Our customers for digital PPV copy protection are
satellite and cable system operators and equipment manufacturers that supply the
satellite and cable industries. We derive a majority of our digital PPV copy
protection revenues from digital set-top box hardware royalties, and the balance
from either up-front license fees or transaction royalties associated with copy
protected PPV programming. Our agreements with digital PPV system operators
entitle us to transaction-based royalty payments when copy protection for
digital PPV programming is activated. Digital PPV revenues were 9.1% and 13.0%
of our revenues for the three months ended September 30, 2003 and 2002,
respectively, and 9.6% and 12.2% of our revenues for the nine months ended
September 30, 2003 and 2002, respectively. 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 will continue to vary both in total and as a percentage of our total
revenues.
GAMES.
Customers implementing our CD-ROM copy protection technology,
SafeDisc(R), are primarily major PC-based game publishers. We typically receive
unit royalties based upon the number of copy protected CD-ROMs that are produced
by PC game publishers. Our Games revenues were 3.8% and 6.5% of our revenues for
the three months ended September 30, 2003 and 2002, respectively, and 4.1% and
6.9% of our revenues for the nine months ended September 30, 2003 and 2002. The
decrease in our Games revenue is primarily due to the reduction in volumes copy
protected as well as declining per unit prices. We believe that revenues from
our Games products will continue to vary both in total and as a percentage of
our total revenues.
MUSIC TECHNOLOGY.
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 revenues from sales of our Music Technology
products 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.
For the nine months ended September 30, 2003, we recorded additional goodwill of
approximately $787,000 which represents contingent consideration payments we are
required to make to Midbar Tech (1998) Ltd. shareholders based on a percentage
of the revenues from sales of our Music Technology products, as noted above. In
May 2003, we acquired the patents and other assets of TTR for $5.1 million in
cash and the surrender of 1,880,937 shares of TTR common stock that we
originally purchased in January 2000. We recorded a realized gain of $395,000
for the excess of the market value of such TTR stock on the closing date of the
acquisition over the adjusted cost basis of such stock. Our copy protection
products in this area are used by customers for copy protection, authentication,
and rights management for music CDs. Music Technology's revenues were 4.0% and
3.5% of our revenues for the three and nine months ended September 30, 2003,
respectively. Currently, all of our Music Technology revenue is from
international territories. Additional product features, currently under
development, are required for the product to be accepted in the United States.
We had no revenues from Music Technology products during the periods ended
September 30, 2002. We believe that revenues from our Music Technology products
will continue to vary in the future both in total and as a percentage of our
total revenues.
20
SOFTWARE TECHNOLOGIES GROUP.
ENTERPRISE LICENSING.
Our Enterprise Licensing products generate revenue from licensing
software and providing services related to the support and maintenance of this
software. Revenues from Enterprise Licensing were 26.1% and 28.0% of our
revenues for the three months ended September 30, 2003 and 2002, respectively,
and 25.1% and 27.1% of our revenues for the nine months ended September 30, 2003
and 2002, respectively. Despite difficult economic conditions for enterprise
software companies, our revenues, in absolute terms, for the three and nine
months ended September 30, 2003 have increased compared to the same periods in
the prior year. We believe that revenues from Enterprise Licensing products will
continue to vary both in total and as a percentage of our total revenues.
CONSUMER LICENSING.
Our consumer licensing product, SafeCast(R), facilitates web-based
purchases and delivery and product activation of consumer-oriented software. Our
Consumer Licensing products generate revenue from licensing software and
providing services related to the support and maintenance of this software.
Revenues from Consumer Licensing were 1.7% and 1.5% of our revenues for the
three months ended September 30, 2003 and 2002, respectively, and 2.9% and 1.4%
of our revenues for the nine months ended September 30, 2003 and 2002,
respectively. The increase in Consumer Licensing revenues is due to the
increased market adoption of SafeCast(R). We believe that revenues from our
Consumer Licensing products will continue to vary both in total and as a
percentage of our total revenues.
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 manufacture and 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 CDs
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 and recruiting 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
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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
United States. 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 our customers and third parties as our basis for revenue recognition. In
our DVD, videocassette, and consumer software businesses, we have 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 our
PPV and Music Technology products 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
Technology licensing revenue, which applies principally to DVD and PC
sub-assembly manufacturers, digital PPV, cable and satellite system operators,
and digital 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
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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 of the product 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." Arrangements that allow the Company to make
reasonably dependable estimates relative to contract costs and the extent of
progress toward completion are accounted for using the percentage-of-completion
method. Arrangements that do not allow the Company to make reasonably dependable
estimates are accounted for using the completed-contracts method. Because the
completed-contracts method precludes recognition of performance under the
contract as the work progresses, it does not reflect current financial
performance when the contract extends beyond one accounting period, and it
therefore may result in uneven recognition of revenue and gross margin.
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. Professional services revenues are included in services revenue in the
accompanying condensed consolidated financial statements.
MAINTENANCE REVENUES
Maintenance agreements generally call for us to provide technical
support and unspecified 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
condensed consolidated financial statements.
VALUATION OF STRATEGIC INVESTMENTS
As of September 30, 2003, the adjusted cost of our strategic
investments totaled $30.2 million. This included our investments in public and
non-public companies. Our investments in public and non-public companies are
classified on the balance sheet as "Long term marketable investment securities"
and "Other assets," respectively.
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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, such as a recent financing round,
management estimates the impairment and/or the net realizable value of the
portfolio investment based on a hypothetical liquidation at book value approach
as of the reporting date. 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, $294,000 and $4.5 million of
other-than-temporary impairment losses from investments in non-public companies
were recorded during the three and nine months ended September 30, 2003,
respectively. This was partially offset by $395,000 of realized gains from the
surrender of our stock in TTR (see Note 3 of Notes to Condensed Consolidated
Financial Statements.) For the three and nine months ended September 30, 2002,
respectively, $6.8 million and $12.3 million of other-than-temporary impairment
losses were recorded. This included $3.1 million and $5.6 million, respectively,
of charges for investments in public companies for the three and nine months
ended September 30, 2002.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the excess of costs over fair value of assets of
businesses acquired. We account for goodwill under the provisions of SFAS No.
142, "Goodwill and Other Intangible Assets." Goodwill and intangible assets
acquired in a purchase business combination and determined to have an indefinite
useful life are not amortized, but instead are tested for impairment at least
annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also
requires that intangible assets with estimable useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 144, "Accounting for
Impairment or Disposal of Long-Lived Assets."
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. During the nine
months ended September 30, 2003, there were no triggering events which required
us to test for impairment prior to our annual impairment analysis.
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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.
IMPAIRMENT OF LONG-LIVED ASSETS
In accordance with SFAS No. 144, long-lived assets, such as property
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 in 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 disposal group classified as held for sale would be presented
separately in the appropriate asset and liability sections of the balance sheet.
For the nine months ended September 30, 2003 and 2002, no impairment charges
were recorded for long-lived assets.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Management estimates the collectibility of our accounts receivable on
an account-by-account basis. We record an increase in the allowance for doubtful
accounts when the prospect of collecting a specific account receivable becomes
doubtful. In addition, we establish a non-specific reserve, using a specified
percentage of the outstanding balance of all such accounts based on historical
bad debt loss experience. Management specifically analyzes accounts receivable
and historical bad debts experience, customer creditworthiness, current economic
trends, international situations (such as currency devaluation), and changes in
our customer payment history when evaluating the adequacy of the allowance for
doubtful accounts. If the financial condition of our customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.
INCOME TAXES
We account for income taxes using the asset and liability method. As of
September 30, 2003 deferred tax assets net of valuation allowances, totaled
$16.0 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
25
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
REVENUES. Total revenues for the three and nine month periods ended
September 30, 2003 increased 32.9% and 22.7%, respectively, from the
corresponding prior year periods. DVD copy protection revenues for the three and
nine month periods ended September 30, 2003 increased 56.8% and 38.1%,
respectively, from the corresponding prior year periods due to the continued
growth in demand of the DVD format, a strong hit title release schedule that
more than offset modest declines in our average unit royalties and decreased
usage by certain Hollywood studios. Our DVD copy protection revenues in 2002
were reduced by a $2.3 million refund resulting from a customer's self-reporting
error detected in 2002. During the second quarter of 2003 and the nine months
ended September 30, 2003, the increase in DVD copy protection revenues included
approximately $917,000 in revenue in a partial resolution of this customer
overreporting claim. Additionally, during the third quarter of 2003 and the nine
months ended September 30, 2003, the increase in DVD copy protection revenues
included approximately $458,000 resulting from royalty audit activity that
detected underreporting by certain replicators in prior periods. We periodically
review selected replicator royalty records to substantiate royalties reported.
We intend to continue this activity in the future. Revenues from videocassette
copy protection for the three and nine month periods ended September 30, 2003
decreased 24.6% and 24.2%, respectively, from the corresponding prior year
periods reflecting the continuing trend for Hollywood studios to invest more
proportionally in copy protecting their DVD titles compared to VHS releases.
Digital PPV copy protection revenues for the three and nine months ended
September 30, 2003 decreased 6.8% and 3.0%, respectively, from the corresponding
prior year periods, due to the continued weak digital cable and digital
satellite business on a worldwide basis. Revenue from Games for the three and
nine month periods ended September 30, 2003 decreased 21.9% and 26.4%,
respectively, from the corresponding prior year periods, due primarily to the
reduction in volumes copy protected as well as declining per unit prices. The
increase in Music Technology revenue is from our acquisition of Midbar in
November 2002. Enterprise Licensing revenues for the three and nine months ended
September 30, 2003 increased 23.8% and 13.4%, respectively, from the
corresponding prior year periods, due primarily to an increase in licensing and
maintenance volume. Consumer software licensing revenues for the three and nine
months ended September 30, 2003 increased 55.5% and 161.8%, respectively, from
the corresponding prior year periods, due primarily to the increased adoption of
our SafeCast technology by major consumer software vendors.
LICENSE REVENUES. Our license revenues for the three and nine months
ended September 30, 2003 increased 34.8% and 23.5%, respectively, from the
corresponding prior year periods primarily due to increases in our revenues
derived by Video Technology products in the DVD copy protection area, revenues
from Music Technology products and increases in revenues in our Software
Technologies Group.
SERVICE REVENUES. Our service revenues for the three and nine months
ended September 30, 2003 increased 16.6% and 16.0%, respectively, from the
corresponding prior year periods primarily due to an increase in maintenance
revenues in our Software Technologies Group.
COST OF REVENUES - LICENSES. Cost of revenues from license fees for the
three and nine months ended September 30, 2003 decreased $303,000 and $869,000,
respectively, from the
26
corresponding prior year periods. As a percentage of license revenues, cost of
revenues from license fees decreased from 7.5% in the third quarter of 2002 to
4.5% in the third quarter of 2003. As a percentage of license revenues, cost of
revenues from license fees decreased from 6.6% for the nine months ended
September 30, 2002 to 4.3% for the nine months ended September 30, 2003. The
decreases are primarily due to lower patent defense costs relating to the
Rainbow litigation in 2003 compared to corresponding prior year periods in 2002
(see Note 12 of Notes to Condensed Consolidated Financial Statements).
COST OF REVENUES - SERVICES. Cost of revenues from service fees for the
three and nine months ended September 30, 2003 increased $136,000 and $413,000,
respectively, from the corresponding prior year periods. As a percentage of
service revenues, cost of revenues from service fees increased from 19.0% in the
third quarter of 2002 to 20.8% in the third quarter of 2003. As a percentage of
service revenues, cost of revenues from service fees increased from 17.8% for
the nine months ended September 30, 2002 to 20.0% for the nine months ended
September 30, 2003. The increases are primarily due to the increase in headcount
of our software customer support group. We anticipate our cost of revenues from
service fees will increase in the future.
During the nine months ended September 30, 2003, we deferred direct
costs totaling $655,000 associated with a customer contract being accounted for
under the completed contract provisions of SOP 81-1. Upon completion of this
contract, we will recognize all deferred revenue and costs.
COST OF REVENUES - AMORTIZATION OF INTANGIBLES FROM ACQUISITIONS. Cost
of revenues from amortization of intangibles from acquisitions for the three and
nine months ended September 30, 2003 increased $336,000 and $968,000,
respectively, from the corresponding prior year periods. This increase was
primarily due to the acquisition of Midbar Tech (1998) Ltd., which increased our
intangible assets subject to amortization.
RESEARCH AND DEVELOPMENT. Research and development expenses increased
by $1.1 million or 37.0% from $3.0 million in the third quarter of 2002 to $4.2
million in the third quarter of 2003. Research and development expenses
increased by $3.7 million for the nine months ended September 30, 2003 or 43.5%
from $8.4 million for the nine months ended September 30, 2002 to $12.1 million
for the nine months ended September 30, 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
support of our Music Technology products, including headcount related to our
November 2002 acquisition of Midbar Tech (1998) Ltd. Research and development
expenses increased as a percentage of revenues from 13.0% in the third quarter
of 2002 to 13.4% in the third quarter of 2003 and from 11.7% for the nine months
ended September 30, 2002 to 13.6% for the nine months ended September 30, 2003.
We expect research and development expenses to continue to increase in absolute
terms and as a percentage of revenues 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 $1.4
million or 28.3% from $5.1 million in the third quarter of 2002 to $6.5 million
in the third quarter of 2003. Selling and marketing expenses increased by $5.0
million or 34.5% from $14.4 million for the nine months ended September 30, 2002
to $19.4 million for the nine months ended September 30, 2003. This increase was
primarily due to higher compensation expenses and increased headcount. Despite
the increase in headcount, selling and marketing expenses decreased as a
percentage of revenues from 21.7% in the third quarter of 2002 to 20.9% in the
third quarter of 2003 due primarily to the increase in revenue. Selling and
marketing expenses increased as a percentage of revenues from 20.0% for the nine
months ended September 30, 2002 to 21.9% for the nine months ended September 30,
2003. We expect selling and marketing expenses to continue to increase in
absolute terms and as a percentage of revenues in the future as we continue to
strengthen our sales and marketing organization.
27
GENERAL AND ADMINISTRATIVE. General and administrative expenses
increased by $1.0 million or 26.9% from $3.6 million in the third quarter of
2002 to $4.6 million in the third quarter of 2003. General and administrative
expenses increased by $3.3 million or 31.9% from $10.3 million for the nine
months ended September 30, 2002 to $13.6 million for the nine months ended
September 30, 2003. The increase is due primarily to higher compensation expense
and increased headcount. Despite the increase in headcount and compensation
expense, general and administrative expenses decreased as a percentage of
revenues from 15.5% in the third quarter of 2002 to 14.8% in the third quarter
of 2003 due primarily to the increase in revenues. General and administrative
expenses increased as a percentage of revenues from 14.3% for the nine months
ended September 30, 2002 to 15.4% for the nine months ended September 30, 2003.
We expect our general and administrative expenses to increase in absolute terms
in the future as we continue to support the expansion of our business and comply
with the requirements of the Sarbanes-Oxley Act of 2002.
AMORTIZATION OF INTANGIBLES FROM ACQUISITIONS. We amortize intangibles
relating to the acquisition of C-Dilla in June 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 $298,000 for the nine
months ended September 30, 2002 related to non-compete agreements. There was no
amortization relating to non-compete agreements in the third quarter of 2002 and
the nine months ended September 30, 2003. Amortization of intangibles related to
non-compete agreements has been included in operating expenses. We amortized
$417,000 and $389,000 in the third quarters of 2003 and 2002, respectively, and
$1.3 million and $1.2 million for the nine months ended September 30, 2003 and
2002, respectively, related to intangibles for existing products and
technologies. Amortization of intangibles relating to existing products and
technologies has been 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 our
enterprise license management products, on a straight-line basis over three
years based on the expected useful lives of the existing customer base. We
amortized $136,000 and $130,000 in the third quarters of 2003 and 2002,
respectively, and $405,000 and $374,000 for the nine months ended September 30,
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 $302,000 and $912,000 in the three and nine
months ended September 30, 2003, respectively. These amounts are included in our
cost of sales.
AMORTIZATION OF DEFERRED STOCK-BASED COMPENSATION. In connection with
the acquisition of Globetrotter in August 2000, 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 third quarters of 2003 and 2002 were $609,000 and $1.2
million, respectively. The amortization of the deferred stock-based compensation
for the nine months ended September 30, 2003 and 2002 were $2.1 million and $5.3
million, respectively. The decrease in amortization from the corresponding prior
year periods to 2003 was due primarily to stock options becoming fully vested in
2002. The expense associated with this stock-based compensation will continue to
result in substantial non-cash compensation charges to future earnings through
2004.
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IMPAIRMENT LOSSES ON INVESTMENTS, NET. During the third quarter of 2003
and 2002, we recorded charges totaling $294,000 and $6.8 million, respectively,
relating to other than temporary impairments in our public and non-public
company investments. During the nine months ended September 30, 2003 and 2002,
we recorded charges totaling $4.1 million and $12.3 million, respectively,
relating to other than temporary impairments in our public and non-public
company investments.
INTEREST AND OTHER INCOME, NET. Interest and other income decreased
$790,000 or 48.4% from $1.6 million in the third quarter of 2002 to $842,000 in
the third quarter of 2003. Interest and other income decreased $2.9 million or
50.1% from $5.8 million for the nine months ended September 30, 2002 to $2.9
million for the nine months ended September 30, 2003. The decrease is due
primarily to lower interest rates.
INCOME TAXES. For the third quarter of 2003, we recorded income taxes
of $5.0 million, compared to income taxes for the third quarter of 2002 of $1.2
million. 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 from 2002 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 $40.8
million and $41.8 million in the nine months ended September 30, 2003 and 2002,
respectively. Cash provided by operating activities decreased primarily due to a
reduction in net income after excluding non-cash charges. The availability of
cash generated by our 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 $112.1 million in the nine months
ended September 30, 2003 and provided net cash of $49.3 million in the nine
months ended September 30, 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. In addition, during the nine
months ended September 30, 2003, the Company used $6.3 million in investing
activities for the acquisition of TTR assets and patents, acquisition of P2P
file sharing technology assets and Midbar contingent consideration. The decrease
in capital expenditures of $1.9 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 the nine months ended September 30, 2002 when compared to the
nine months ended September 30, 2003.
Net cash provided by financing activities from stock option exercises
and employee stock program purchases was $4.8 million for the nine months ended
September 30, 2003. Net cash used in financing activities was $34.8 million for
the nine months ended September 30, 2002. The increase in cash provided by
financing activities is due to $38.5 million used to repurchase 3.0 million
shares of treasury stock during the nine months ended September 30, 2002. There
were no repurchases of treasury stock during the nine months ended September 30,
2003.
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At September 30, 2003, we had $32.6 million in cash and cash
equivalents, $82.8 million in short-term investments and $138.4 million in
long-term marketable investment securities, which included $29.8 million in fair
market value of our strategic investment in Digimarc, a public company. At
December 31, 2002, we had $98.7 million in cash and cash equivalents, $73.0
million in short-term investments and $38.7 million in long-term marketable
investment securities, which included the fair market value of our strategic
investments in two public companies: Digimarc and TTR. The decrease in cash and
cash equivalents is mainly due to the re-investment of money market funds in
longer term investments for more favorable interest rates.
The increase in long-term marketable investment securities is due to
the reinvestment of money market funds into longer term investments mentioned
above, and also the increase in market value of Digimarc, partially offset by
the disposition of TTR Technologies in the second quarter of 2003 (See Note 3 of
Notes to Condensed Consolidated Financial Statements.) We have no material
commitments for capital expenditures and anticipate that capital expenditures
for the remainder of the year will not exceed $1.7 million. We also have future
minimum lease payments of approximately $32.0 million under operating leases.
During the third quarter of 2003, we moved our UK office to a larger building
and expanded our Japan office. 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 revenues derived from our sales of Music
Technology products until December 31, 2004. During the nine months ended
September 30, 2003, we have paid $480,000 of such contingent consideration.
In May 2003, we acquired patents and other assets of TTR Technologies,
Inc. ("TTR") for $5.1 million in cash and the surrender of 1,880,937 shares of
TTR common stock that we purchased in January 2000. We recorded a realized gain
of $395,000 for the excess of the market value of such TTR stock on the asset
acquisition date over the adjusted cost basis of such stock. This gain has been
included in "Impairment losses on investments, net" in the accompanying
condensed consolidated financial statements.
In August 2003, we acquired intellectual property and other assets,
including patents, existing contracts, and software code that can be used to
track and manage content in the peer-to-peer, or P2P, file sharing space. We
paid $720,000 in cash, $80,000 of acquisition costs and an additional payment of
$80,000 due on the first anniversary of the closing date for a total purchase
price of $880,000. In addition, we have agreed to a maximum payment of $140,000
if certain milestones are achieved by May 28, 2004. The purchase price was
allocated to in-process technology, core technology and employment agreements.
The in-process technology of $624,000 has been charged to operations during the
three and nine months ended September 30, 2003.
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 factors set forth under the caption "Risk
Factors" in our Annual Report on Form 10-K for the year ended December 31, 2002.
30
In May 2002, the Board of Directors authorized a 5.0 million share
repurchase program which has 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
September 30, 2003, we had repurchased 3.0 million shares at a total cost of
$38.5 million. As of September 30, 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 September 30, 2003 were as follows (in
thousands):
Operating
Leases
------------
2003 $ 867
2004 3,495
2005 3,451
2006 3,445
2007 3,553
2008 and thereafter 17,152
------------
Total $ 31,963
============
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 9 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 investment securities of $253.8 million as
of September 30, 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 $1.0 million decrease
(approximately 0.5%) in the fair value of our available-for-sale securities as
of September 30, 2003.
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
31
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 portion of our revenues that are denominated in such currencies.
STRATEGIC INVESTMENTS. We currently hold minority equity interests in
Command Audio, Digimarc, Digital Fountain, InterActual, iVAST, NTRU
Cryptosystems, SecureMedia and Widevine Technologies. These investments, with a
carrying value totaling $30.2 million (which included $29.8 million for our
investment in Digimarc and $404,000 for investments in non-public companies),
represented 8.3% of our total assets as of September 30, 2003. Digimarc, a
publicly traded company, is 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. As of September 30, 2003, the carrying value of these non-public
companies is $404,000, which consists of the carrying value of iVAST. All other
non-public companies listed have no carrying value as of September 30, 2003. 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 the remaining carrying value of our investment in iVAST. During the nine
months ended September 30, 2003, the Company recorded total net charges of $4.1
million relating to impairment losses considered to be other than temporary
declines in the value of certain strategic long term investments. This included
$4.5 million of charges in non-public companies and $395,000 of realized gains
from the surrender of TTR stock. During the nine months ended September 30,
2002, we recorded charges of $12.3 million relating to other than temporary
impairments in our public and non-public company investments.
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-15(e). 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.
As of the end of the quarter ended September 30, 2003, 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. During the quarter ended September 30,
2003, there have been no changes in the Company's internal controls or
in other factors that have materially affected or are reasonably likely
to materially affect the internal controls.
32
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are involved in legal proceedings related to some of our
intellectual property rights.
Globetrotter v. Rainbow Technologies, Elan & Ken Greer
- ------------------------------------------------------
In November 1997, Globetrotter filed a patent infringement lawsuit
(Case No. C-98-20419-JF/EAI) in the Federal District Court for the Northern
District of California against Elan Computer Group and its founder, Ken Greer,
alleging infringement of one of its patents and unfair competition and trade
practices. In March 1998, Rainbow Technologies North America, Inc. entered into
an agreement to purchase certain assets of Elan and entered into a litigation
cooperation agreement with Elan regarding the pending Globetrotter litigation.
On or around September 1998, Globetrotter filed a patent infringement suit
against Rainbow Technologies, which was subsequently consolidated with the
action against Elan Computer Group and Ken Greer. Rainbow Technologies and Ken
Greer filed separate counterclaims against Globetrotter and its founder, Matthew
Christiano, alleging antitrust violations, unfair competition, tortious
interference with business relations, and trade libel. Rainbow Technologies and
Ken Greer are seeking compensatory damages, punitive damages, injunctive relief,
and disgorgement of profits. On August 31, 2000, we 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, we 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, we 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 filed our appeal brief on May 12, 2003. Both parties
subsequently filed reply briefs in July 2003. An oral hearing has been scheduled
for December 3, 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 us, which could have a material adverse effect on our business,
consolidated financial position, results of operations or cash flows.
Macrovision Corporation v. ViTec Audio and Video GmbH
- -----------------------------------------------------
We initiated a patent infringement lawsuit in the District Court of
Dusseldorf in March 1999 against ViTec Audio und Video GmbH, a German company
that manufactures what the Company believes to be a video copy protection
circumvention device. ViTec filed a reply brief arguing that its product does
not infringe our patents. The case was heard in the District Court of
Dusseldorf, Germany. The District Court of Dusseldorf ruled adversely against
us. We appealed the District Court's ruling in
33
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, and an English translation was
made available to us on July 3, 2003. We are reviewing the opinion and are
considering our options. A hearing before the Court of Appeal in Dusseldorf is
scheduled for March 4, 2004. In the event of an adverse ruling, we may incur a
corresponding decline in demand for its video copy protection technology, which
could harm its business in Germany. In addition, we may be obligated to pay some
of ViTec's attorney fees estimated to be $25,000.
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 against us. Yield Dynamics alleged that
it created a software interface to allow its Genesis software product to work
with our FLEXLM software and that we distributed this code without Yield
Dynamics' permission. Yield Dynamics asserted claims of copyright infringement,
trade secret misappropriation, common law unfair competition, and unfair
competition under California's Business and Professions Code. Yield Dynamics was
seeking an injunction, a constructive trust on receipts from the licensing or
sale of products containing the interface code, and actual, compensatory and
punitive damages. We answered Yield Dynamic's complaint and asserted a
counterclaim for declaratory relief. On October 21, 2003, the parties filed with
the court a joint stipulated request for the dismissal of the above action with
prejudice. The parties are awaiting entry of the dismissal by the court, which
we expect to occur shortly.
Macrovision Corporation v. Media Markt TV - Hifi - Elektro GmbH
- ---------------------------------------------------------------
On September 26, 2003, we initiated an ex parte interim injunction, in
the District Court of Frankfurt, Germany, against the Frankfurt outlet of Media
Markt TV-Hifi-Elektro GmbH to prohibit the sale of Macro 2000, a copy protection
circumvention device. We sought the injunction under the newly-enacted German
Copyright Directive that prohibits copy protection circumvention devices in that
country. The court granted the injunction on September 29, 2003. On October 13,
2003, Media Markt signed a declaration that it would not appeal the injunction,
and, as a consequence, removed all units of Macro 2000 from its outlets in
Germany.
As of November 4, 2003, Macro 2000 was voluntarily removed from sale on
the websites of four additional German consumer electronics retailers: ZGV Lauf
Zentral-Vertrieb GmbH, SPYNET Electronic, Funkstrom Grosshandels GmbH, and
Conrad Electronic GmbH.
USPTO Interference Proceeding Between Macrovision Corporation and InterTrust
- ----------------------------------------------------------------------------
Technologies
- ------------
We received notice on September 4, 2003 from the United States Patent
and Trademark Office ("USPTO") declaring an interference between the Company's
U.S. Patent No. 5,845,281 (the "281 patent") together with two of its
continuation applications, and a patent application determined to be from
InterTrust Technologies Corporation. An interference is declared by the USPTO
when two or more parties claim the same patentable invention. An interference
proceeding will be held to determine the patentability of the involved patent
and applications and who was the first inventor, since in the United States the
first party to invent is granted the patent. This process is still in its
initial stages, and is anticipated to take at least a year.
34
Our `281 patent and our continuation applications have a priority
filing date of February 1, 1995. The InterTrust application is a continuation of
application No. 08/388,107 (now abandoned) and as a consequence potentially has
a priority filing date of February 13, 1995, 12 days later than our priority
filing date. Because of the proximity of these priority filing dates, the
interference proceeding by the USPTO will attempt to determine who invented
first.
European and Japanese counterpart patent applications of the Company's
`281 patent also enjoy the priority filing date of February 1, 1995. But unlike
the U.S. with its "first to invent" rule, Europe and Japan have a "first to
file" rule, meaning that our `281 patent with an earlier priority filing date is
automatically given priority of invention.
Our `281 patent and its continuation applications are in the field of
digital rights management, a field that we expect will play a significant role
in its future. They are not associated with our existing copy protection
business.
From time to time we have been involved in other disputes and legal
actions arising in the ordinary course of business. In management's opinion,
none of these other disputes and legal actions is expected to have a material
impact on our consolidated financial position, results of operation or cash
flow.
As of September 30, 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.
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
35
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
31.1 Rule 13a-14(a)/15d-14(a) Certification.
31.2 Rule 13a-14(a)/15d-14(a) Certification.
32.1 Section 1350 Certification.
32.2 Section 1350 Certification.
------------------------------------------------------------------
(b) Reports on Form 8-K.
During the quarter ended September 30, 2003, the
Company filed one report on Form 8-K. On August 1,
2003, the Company reported on Form 8-K, under items
7, 9 and 12, its press release concerning revenue and
earnings results for the second quarter of 2003, as
well as revenue and earnings estimates for 2003.
36
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: November 12, 2003 By: /s/ William A. Krepick
--------------------- ---------------------------------------------
William A. Krepick
President and Chief Executive Officer
PRINCIPAL FINANCIAL OFFICER AND CHIEF ACCOUNTING OFFICER:
Date: November 12, 2003 By: /s/ Ian R. Halifax
--------------------- ----------------------------------------------
Ian R. Halifax
Vice President, Finance and Administration,
Chief Financial Officer and Secretary
37