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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 June 30, 2004
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 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 July 30, 2004
Common stock, $0.001 par value 49,420,454
MACROVISION CORPORATION
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION
Page
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2004
and December 31, 2003 1
Condensed Consolidated Statements of Income
for the Three and Six Months Ended June 30, 2004 and 2003 2
Condensed Consolidated Statements of Cash Flows
for the Six Months Ended June 30, 2004 and 2003 3
Notes to Condensed Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk 30
Item 4. Controls and Procedures 31
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 32
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities 34
Item 3. Defaults Upon Senior Securities 34
Item 4. Submission of Matters to a Vote of Security Holders 34
Item 5. Other Information 34
Item 6. Exhibits and Reports on Form 8-K 35
Signatures 36
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
JUNE 30, DECEMBER 31,
2004 2003
-------------------- -------------------
ASSETS
Current assets:
Cash and cash equivalents $ 140,350 $ 27,918
Short-term investments 64,234 95,563
Accounts receivable, net of allowance for doubtful accounts of
$2,356 and $2,147, respectively 22,266 30,169
Income taxes receivable 4,412 3,410
Deferred tax assets 6,671 6,599
Prepaid expenses and other current assets 6,973 5,070
-------------------- -------------------
Total current assets 244,906 168,729
Long-term marketable investment securities 97,833 146,151
Property and equipment, net 7,575 6,689
Patents, net 11,010 10,826
Goodwill 29,434 28,630
Other intangibles from acquisitions, net 7,040 8,512
Deferred tax assets 15,429 15,121
Other assets 748 908
-------------------- -------------------
$ 413,975 $ 385,566
==================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,660 $ 4,457
Deferred revenue 12,325 10,333
Other current liabilities 26,097 25,936
-------------------- -------------------
Total current liabilities 44,082 40,726
Other non current liabilities 1,022 874
-------------------- -------------------
Total liabilities 45,104 41,600
Stockholders' equity:
Common stock 52 52
Treasury stock, at cost (38,450) (38,450)
Additional paid-in-capital 297,104 292,507
Deferred stock-based compensation -- (185)
Accumulated other comprehensive income 8,540 8,028
Retained earnings 101,625 82,014
-------------------- -------------------
Total stockholders' equity 368,871 343,966
-------------------- -------------------
$ 413,975 $ 385,566
==================== ===================
See the accompanying notes to these condensed consolidated financial statements.
1
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------------ ------------------------------------
2004 2003 2004 2003
----------------- ----------------- ----------------- -----------------
Revenues:
Licenses $ 32,008 $ 26,223 $ 66,831 $ 51,465
Services 3,662 2,989 6,821 5,799
----------------- ----------------- ----------------- -----------------
Total revenues 35,670 29,212 73,652 57,264
Cost of revenues:
License fees 1,445 1,183 3,029 2,122
Service fees 1,018 597 1,739 1,140
Amortization of intangibles from acquisitions 777 856 1,556 1,712
----------------- ----------------- ----------------- -----------------
Total cost of revenues 3,240 2,636 6,324 4,974
----------------- ----------------- ----------------- -----------------
Gross profit 32,430 26,576 67,328 52,290
Operating expenses:
Research and development 5,708 4,156 11,295 7,899
Selling and marketing 8,770 6,472 17,326 12,876
General and administrative 5,120 4,648 10,633 8,972
Amortization of deferred stock-based compensation* -- 752 185 1,520
----------------- ----------------- ----------------- -----------------
Total operating expenses 19,598 16,028 39,439 31,267
----------------- ----------------- -----------------
Operating income 12,832 10,548 27,889 21,023
Impairment losses on investments -- (4,286) (180) (4,286)
Gains on strategic investments -- 436 1,220 436
Interest and other income, net 985 953 1,713 2,053
----------------- ----------------- ----------------- -----------------
Income before income taxes 13,817 7,651 30,642 19,226
Income taxes 4,974 3,060 11,031 7,690
----------------- ----------------- ----------------- -----------------
Net income $ 8,843 $ 4,591 $ 19,611 $ 11,536
================= ================= ================= =================
Basic net earnings per share $ 0.18 $ 0.09 $ 0.40 $ 0.24
================= ================= ================= =================
Shares used in computing basic net earnings per share 49,357 48,619 49,301 48,566
================= ================= ================= =================
Diluted net earnings per share $ 0.18 $ 0.09 $ 0.39 $ 0.24
================= ================= ================= =================
Shares used in computing diluted net earnings per share 50,411 49,299 50,311 49,038
================= ================= ================= =================
* The allocation of the amortization of deferred stock-based compensation relates to the expense categories as set forth below:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------------ ------------------------------------
2004 2003 2004 2003
----------------- ----------------- ----------------- -----------------
Cost of revenues $ -- $ 80 $ 27 $ 160
Research and development -- 138 53 277
Selling and marketing -- 331 36 677
General and administrative -- 203 69 406
----------------- ----------------- ----------------- -----------------
$ -- $ 752 $ 185 $ 1,520
================= ================= ================= =================
See the accompanying notes to these condensed consolidated financial statements.
2
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
----------------------------------------------
2004 2003
---------------------- --------------------
Cash flows from operating activities:
Net income $ 19,611 $ 11,536
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 1,932 1,390
Amortization of intangibles from acquisitions 1,556 1,712
Amortization of deferred stock-based compensation 185 1,520
Tax benefit from stock options exercises 1,002 591
Impairment losses on investments, net of gains 180 3,850
Changes in operating assets and liabilities:
Accounts receivable, net 7,969 5,079
Deferred revenue 1,980 2,568
Other assets (2,957) 2,562
Other liabilities 1,865 273
---------------------- --------------------
Net cash provided by operating activities 33,323 31,081
Cash flows from investing activities:
Purchases of long and short-term investments (193,477) (218,405)
Sales or maturities of long and short-term investments 272,490 128,699
Acquisition of property and equipment (2,181) (751)
Acquisition of TTR patents and other assets -- (5,050)
Payments for patents (624) (442)
Contingent consideration for Midbar acquisition (723) --
---------------------- --------------------
Net cash provided by (used in) investing activities 75,485 (95,949)
Cash flows from financing activities:
Proceeds from issuance of common stock from options and
stock purchase plans 3,595 2,491
---------------------- --------------------
Net cash provided by financing activities 3,595 2,491
Effect of exchange rate changes on cash and cash equivalents 29 221
---------------------- --------------------
Net increase (decrease) in cash and cash equivalents 112,432 (62,156)
Cash and cash equivalents at beginning of period 27,918 98,691
---------------------- --------------------
Cash and cash equivalents at end of period $ 140,350 $ 36,535
====================== ====================
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, 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, 2003.
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, 2004 or any other future interim period.
NOTE 2 - REVENUE RECOGNITION
The Company's revenue consists of royalty fees on copy-protected
products on a per unit basis, licenses of the Company's copy protection
technology, licenses for the Company's software products, and related
maintenance and services revenues.
ROYALTY REVENUES
Royalty revenue from the replication of videocassettes, digital
versatile discs ("DVDs"), and compact disks ("CDs") is recognized when realized
or realizable and earned. The Company relies on royalty reports from third
parties as its basis for revenue recognition. In the Company's DVD,
videocassette, and PC games product lines, it 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, provided there is persuasive
evidence of an arrangement and that collection of a fixed or determinable fee is
considered probable. Revenue from customers in pay-per-view ("PPV") and music
technology is currently recognized only as reported, due to timing of receipt of
reports in PPV, and the embryonic stage and volume volatility of the market for
the Company's music technology products. 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 set-top decoder manufacturers, is
4
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 remain; the fee is fixed or determinable; and collectibility is
probable. The Company considers 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. The
Company assesses collectibility based on a number of factors, including the
customer's past payment history and current creditworthiness. If collectibility
is not considered probable, revenue is recognized when the fee is collected from
the customer.
For license agreements in which non-standard customer acceptance clauses
are a condition to earning the license fees, revenue is not recognized until
acceptance occurs. For arrangements containing multiple elements, such as
software license fees, consulting services and maintenance, or multiple products
and where vendor-specific objective evidence of fair value ("VSOE") exists for
all undelivered elements, the Company accounts for the delivered elements in
accordance with the "residual method." Under the residual method, the fair value
of the undelivered elements is deferred and the remaining portion of the
arrangement fee is recognized as revenue. For arrangements containing multiple
elements where VSOE does not exist, all revenue is deferred until such time that
VSOE is evidenced or all elements of the arrangement have been delivered, or if
the only undelivered element is maintenance where VSOE exists, maintenance
revenue is recognized pro rata over the maintenance contract period. The Company
also enters into term license agreements in which the license fee is recognized
ratably over the term of the license period (generally 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 of costs and progress 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
The Company provides consulting and training services to its 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.
5
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
(generally one year) and is included in services revenue in the accompanying
condensed consolidated financial statements.
NOTE 3 - EQUITY BASED COMPENSATION
The Company accounts for employee stock-based compensation arrangements
using the intrinsic value method. 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 Statement of Financial Accounting Standards
(SFAS) No. 123, "Accounting for Stock-Based Compensation," 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------ ------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- --------------
Net income, as reported $ 8,843 $ 4,591 $ 19,611 $ 11,536
Add: stock-based employee compensation
expense included in reported net income,
net of related tax effects -- 451 118 912
Deduct: total stock-based employee
compensation expenses determined under
fair-value-based method for all rewards,
net of related tax effects (4,954) (6,550) (8,225) (14,304)
-------------- -------------- -------------- --------------
Net income (loss), pro forma $ 3,889 $ (1,508) $ 11,504 $ (1,856)
============== ============== ============== ==============
Basic net earnings (loss) per share As reported $ 0.18 $ 0.09 $ 0.40 $ 0.24
Adjusted pro forma $ 0.08 $ (0.03) $ 0.23 $ (0.04)
Diluted net earnings (loss) per share As reported $ 0.18 $ 0.09 $ 0.39 $ 0.24
Adjusted pro forma $ 0.08 $ (0.03) $ 0.23 $ (0.04)
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 for the year ending
December 31, 2004, in future years or in any future interim period.
6
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
Company's option plans and employee stock purchase plan:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------- --------------------------------
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
OPTION PLANS:
Dividends None None None None
Expected term 2.09 years 2.83 years 2.54 years 3.20 years
Risk free interest rate 2.32% 4.36% 1.82% 3.89%
Volatility rate 72.7% 75.4% 73.4% 76.9%
ESPP PLAN:
Dividends None None None None
Expected term 1.69 years 1.5 years 1.59 years 1.33 years
Risk free interest rate 2.10% 2.71% 2.23% 2.81%
Volatility rate 74.2% 75.2% 74.2% 75.8%
The weighted average fair value of options granted during the three
months ended June 30, 2004 and 2003 were $8.25 and $8.81, respectively. The
weighted average fair value of an ESPP purchase share right granted during the
three months ended June 30, 2004 and 2003 were $8.16 and $7.16, respectively.
The weighted average fair value of options granted during the six months
ended June 30, 2004 and 2003 were $8.47 and $7.13, respectively. The weighted
average fair value of an ESPP purchase share right granted during the six months
ended June 30, 2004 and 2003 were $7.86 and $7.81, respectively.
NOTE 4 - ASSET PURCHASE
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 was 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 over the adjusted cost basis of such
stock. This gain has been included in "Gains on strategic investments" in the
accompanying condensed consolidated financial statements.
NOTE 5 - STRATEGIC INVESTMENTS
As of June 30, 2004 and December 31, 2003, the adjusted cost of the
Company's strategic investments totaled $26.9 million and $27.0 million,
respectively. The Company's strategic investments include public and non-public
companies. Investments in public and non-public companies are classified on the
balance sheet as "Long-term marketable investment securities" and "Other
assets," respectively.
As of June 30, 2004, the adjusted cost of the Company's strategic
investments consisted of its investment in Digimarc, a publicly traded company.
In addition, the Company holds investments in a number of other privately held
companies, which have no carrying value as of June 30, 2004.
7
The Company originally invested $5.0 million in iVast in 2001. The
Company performs regular reviews of its strategic investments for indicators of
impairment. Impairment charges have been recorded when it has been determined
that an other-than-temporary impairment has occurred. 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. Based on these measurements, the Company recorded $180,000 and
$4.3 million of other-than-temporary impairment losses relating to its
investment in iVast during the first quarter of 2004 and the second quarter of
2003, respectively. As of March 31, 2004 and June 30, 2004, the Company's
investment in iVast had no remaining carrying value.
The Company did not record any gains nor charges for
other-than-temporary impairments related to its strategic investments during the
three months ended June 30, 2004.
The Company received $1.2 million in cash for its interest in
InterActual Technologies, which was acquired by a third party during the first
quarter of 2004. In fiscal year 2001, this strategic investment had been fully
impaired. Accordingly, during the first quarter of 2004, the Company recorded a
gain on strategic investments of $1.2 million.
During the three and six months ended June 30, 2003, the Company
recorded a realized gain of $395,000 from the surrender of the Company's stock
in TTR, a public company strategic investment (see Note 4). In addition, during
the three and six months ended June 30, 2003, the Company recorded a realized
gain of $41,000 representing distributions received in excess of its book value
for its investment in NTRU Cryptosystems.
NOTE 6 - EARNINGS PER SHARE
Basic net earnings per share ("EPS") is computed using the weighted
average number of common shares outstanding during the period. Diluted net 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 net
EPS (in thousands, except per share data):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------- --------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- --------------
Basic net EPS - weighted average number of
common shares outstanding 49,357 48,619 49,301 48,566
Effect of dilutive potential common shares -
stock options outstanding 1,054 680 1,010 472
-------------- -------------- -------------- --------------
Diluted net EPS - weighted average number of
common shares and potential common shares
outstanding 50,411 49,299 50,311 49,038
============== ============== ============== ==============
Anti-dilutive shares excluded 2,394 4,151 2,448 4,335
============== ============== ============== ==============
Weighted average exercise price of
anti-dilutive shares $ 33.26 $ 41.81 $ 34.02 $ 40.90
============== ============== ============== ==============
8
The anti-dilutive shares excluded from the diluted net EPS calculation
noted in the above table represent stock options where the exercise price was
greater than the average market price for the periods presented.
NOTE 7 - RECENT ACCOUNTING PRONOUNCEMENTS
In December 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable
Interest Entities - An Interpretation of Accounting Research Bulletin No. 51"
("FIN 46R"). FIN 46R 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.
Application of FIN 46R is required in financial statements of companies that
have interests in variable interest entities or potential variable interest
entities commonly referred to as special purpose entities for periods ending
after December 15, 2003. Application by companies for all other types of
entities is required in financial statements for periods ending after March 15,
2004. The Company had no investments in VIEs as of June 30, 2004.
In December 2003, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition." SAB No. 104
updates interpretive guidance in the codification of staff accounting bulletins
to provide consistent accounting guidance on revenue recognition. The principal
revisions relate to the deletion of interpretive material no longer necessary
because of private sector developments in generally accepted accounting
principles in the United States of America, and the incorporation of certain
sections of the SEC's "Revenue Recognition in Financial Statements -- Frequently
Asked Questions and Answers" document. The adoption of SAB No. 104 had no
material impact on the Company's financial position or results of operations.
In December 2003, the FASB issued SFAS No. 132 (revised 2003),
"Employers' Disclosures about Pensions and Other Postretirement Benefits." SFAS
No. 132 (revised 2003) revises employers' disclosures about pension plans and
other postretirement benefit plans. It does not change the measurement or
recognition of those plans required by SFAS No. 87, "Employers' Accounting for
Pensions," No. 88, "Employers' Accounting for Settlements and Curtailments of
Defined Benefit Pension Plans and for Termination Benefits," and No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions." This
statement retains the disclosure requirements contained in SFAS No. 132,
"Employers' Disclosures about Pensions and Other Postretirement Benefits," which
it replaces. It requires additional disclosures to those in the original SFAS
No. 132 about the assets, obligations, cash flows, and net periodic benefit cost
of defined benefit pension plans and other defined benefit postretirement plans.
The required information should be provided separately for pension plans and for
other postretirement benefit plans. SFAS No. 123 (revised 2003) is effective for
financial statements with fiscal years ending after December 15, 2003. The
Company had no pension plans or other postretirement benefit plans as of June
30, 2004.
In March 2004, the FASB issued EITF Issue No. 03-1 ("EITF 03-1") "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments." EITF 03-1 includes new guidance for evaluating and recording
impairment losses on debt and equity instruments, as well as new disclosure
requirements for investments that are deemed to be temporarily impaired. The
accounting guidance provided in EITF 03-1 is effective for fiscal periods
beginning after June 15, 2004, while the disclosure requirements are effective
for annual periods ending after December 1, 2003. The Company adopted the
disclosure requirements in the year ended December 31, 2003. The Company will
adopt the accounting guidance effective July 1, 2004. The Company does not
expect the adoption of EITF 03-1 to have a material impact on its financial
position or results of operations.
9
NOTE 8 - 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. On March 22, 2004, employees with continued employment
with the Company were granted new options to purchase 319,749 shares of common
stock in exchange for such cancelled options. Key executive officers and
directors of the Company were not eligible to participate in the Option Exchange
Program.
The Company designed the Option Exchange Program so that the Company did
not need to record compensation expense from the issuance of new stock options
under current generally accepted accounting principles in the United States.
10
NOTE 9 - COMPREHENSIVE INCOME
The components of comprehensive income, net of taxes, are as follows (in
thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------- --------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- --------------
Net income $ 8,843 $ 4,591 $ 19,611 $ 11,536
Other comprehensive income (loss):
Unrealized gains on investments 826 4,749 766 5,285
Foreign currency translation adjustments (577) 1,393 (254) 1,100
-------------- -------------- -------------- --------------
Comprehensive income $ 9,092 $ 10,733 $ 20,123 $ 17,921
============== ============== ============== ==============
NOTE 10 - 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 product lines,
along with the SafeDisc portion of the consumer software group. The SafeDisc
product line has been renamed PC games technology. The Company's Hawkeye
peer-to-peer file management service that was introduced in the second quarter
of 2004 is also included in the Entertainment Technologies Group. The Software
Technologies Group reflects the merger of the Enterprise Software Licensing
Management product line and the SafeCast product line that was also a part of
the consumer software group. Revenues have been reclassified for prior periods
to conform to the current period presentation.
Segment income is based on segment revenue less the respective segment's
cost of revenues, excluding amortization of intangibles from acquisitions,
selling and marketing expenses and research and development expenses. The
following segment reporting information of the Company is provided (in
thousands):
REVENUES:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- --------------
Entertainment Technologies Group $ 23,663 $ 20,681 $ 48,322 $ 41,190
Software Technologies Group 12,007 8,531 25,330 16,074
-------------- -------------- -------------- --------------
$ 35,670 $ 29,212 $ 73,652 $ 57,264
============== ============== ============== ==============
11
INCOME BEFORE INCOME TAXES:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- --------------
Entertainment Technologies Group $ 15,670 $ 14,440 $ 31,791 $ 29,044
Software Technologies Group 3,707 2,602 9,619 4,590
Other (648) (238) (1,147) (407)
-------------- -------------- -------------- --------------
Segment income 18,729 16,804 40,263 33,227
General and administrative (5,120) (4,648) (10,633) (8,972)
Amortization of intangibles from acquisitions (777) (856) (1,556) (1,712)
Amortization of deferred stock-based
compensation -- (752) (185) (1,520)
Impairment losses on investments -- (4,286) (180) (4,286)
Gains on strategic investments -- 436 1,220 436
Interest and other income, net 985 953 1,713 2,053
-------------- -------------- -------------- --------------
$ 13,817 $ 7,651 $ 30,642 $ 19,226
============== ============== ============== ==============
INFORMATION ON REVENUES BY GEOGRAPHIC AREA:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- --------------
United States $ 20,171 $ 15,617 $ 41,439 $ 32,453
International 15,499 13,595 32,213 24,811
-------------- -------------- -------------- --------------
$ 35,670 $ 29,212 $ 73,652 $ 57,264
============== ============== ============== ==============
Geographic area information is based upon country of destination for
products shipped and country of contract holder for royalties and license fees.
12
NOTE 11 - 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, tortuous
interference with business relations, and trade libel. Rainbow Technologies and
Ken Greer sought 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. 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 the Company. On
March 31, 2003, Elan filed an appeal brief abandoning its appeal of the summary
judgment order. This left only Ken Greer's appeal and the Company's
cross-appeal. On March 23, 2004, the Court of Appeal of the Federal Circuit
("CAFC") ruled in the Company's favor in both the patent infringement and
counterclaims appeals related to the appeals of the Ken Greer and Elan
litigation. The CAFC ruled that the Northern California District Court was
correct in dismissing the counterclaims against the Company and Globetrotter and
the District Court was incorrect in dismissing the patent infringement against
Ken Greer and Elan. The patent infringement claim was remanded back to the
District Court for adjudication. On May 28, 2004, Elan and Greer agreed to
settle the lawsuit with the Company. A settlement agreement was executed by Elan
and Greer in which Elan and Greer acknowledged the validity of the Company's
U.S. Patent No. 5,390,297 (the '297 patent) and admitted that Elan's license
management software product practiced the prevention function of the `297
patent. Elan, Greer, and the Company agreed to dismiss all claims and on June 8,
2004, and the Company filed a motion for dismissal with the Court, which the
parties expect to be granted in the third quarter of 2004.
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,
13
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. A hearing before the Court of Appeal in Dusseldorf was
scheduled for March 4, 2004, but was postponed by the Court. The new date for
the hearing will be in late 2004. The Company filed a reply brief in response to
the expert technical opinion with the Court of Appeals on June 9, 2004. The
deadline for ViTec to file its reply brief is August 16, 2004, but the Company
expects ViTec to request an extension.
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 the
Company's business in Germany. In addition, the Company may be obligated to pay
some of ViTec's attorney fees estimated to be $25,000.
USPTO INTERFERENCE PROCEEDINGS 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 the
Company's continuation applications, and a patent application determined to be
from InterTrust Technologies Corporation. On December 19, 2003, the Company
received notice from the USPTO declaring an additional interference between two
continuation applications related to the `281 patent and four issued U.S.
patents from InterTrust. The `281 patent and its continuation applications are
in the field of digital rights management, and are not associated with the
Company's existing copy protection business.
An interference is declared by the USPTO when two or more parties claim
the same patentable invention. In the United States, the party who can prove
earliest inventorship is granted the patent. An interference proceeding has
commenced to determine the rightful inventorship of the involved patents and
patent applications. The `281 patent and its continuation applications have a
priority filing date of February 1, 1995. The InterTrust patents and patent
application have a priority filing date of February 13, 1995. The Administrative
Patent Judge ("APJ") has decided to proceed with the second interference first.
The Company's filing date is prior to InterTrust's filing date, therefore the
Company has been designated the senior party in the interference. InterTrust
submitted its proof of inventorship in a brief filed on June 24, 2004. The
Company responded with its brief filed on July 14, 2004. Interference procedural
rules allow each party to file rebuttals to the other party's brief,
cross-examine witnesses offered up by the other party and file various motions
and objections during this initial phase of the interference. This initial phase
is anticipated to continue for at least the next several months. Following the
close of this initial phase, both parties will have an opportunity for an oral
hearing, which the Company anticipates will occur in late 2004. Following the
oral hearing, the Company estimates that the APJ will issue a judgment in early
2005.
MACROVISION VS. 321 STUDIOS LLC
On January 7, 2004, the Company initiated a lawsuit in the Southern
District of New York against 321 Studios LLC, a producer of cloning software
products, alleging that 321 Studios infringes the Company's patented copy
protection technology and also violates the U.S. Digital Millennium Copyright
Act of 1998 ("DMCA"). On May 11, 2004, the Company was granted a preliminary
injunction barring 321 Studios from selling various versions of its DVD copying
software. The Company has notified various large retailers of 321 Studios'
products of the issuance of the preliminary injunction and requested
14
removal of 321 Studios' products enjoined by the preliminary injunction. Based
on subsequent investigations, the Company believes that the preliminary
injunction has been effective in removing 321 Studios' enjoined products from
the marketplace. On June 4, 2004, 321 Studios filed a notice of interlocutory
appeal, which the Company plans to oppose. The Company anticipates that the
court will issue findings of fact and conclusions of law in the case by the end
of the third quarter of 2004.
As of June 30, 2004, it was not possible to estimate the liability, if
any, in connection with these matters. Accordingly, no accruals for these
contingencies have been recorded.
From time to time the Company has been involved in other disputes and
legal actions arising in the ordinary course of business. In management's
opinion, none of these other disputes and legal actions is expected to have a
material impact on the Company's consolidated financial position, results of
operations or cash flows.
NOTE 12 - SUBSEQUENT EVENTS
In July 2004, the Company acquired the operations and certain assets of
InstallShield Software Corporation for approximately $76.0 million in cash and
additional related acquisition costs. The Company also assumed certain
liabilities as part of the acquisition. An additional contingent payment of up
to $20.0 million may be required to be made by the Company based on
post-acquisition revenue performance through June 30, 2005. Any additional
contingent consideration would be required to be paid in the third quarter of
2005.
As of July 31, 2004, the Company's investment in Digimarc decreased $8.7
million from its value as of June 30, 2004 due to a decline in the share price
of Digimarc stock subsequent to June 30, 2004. For investments in public
companies, at each quarter end, the Company compares its 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, the Company records a charge to the
statement of income for the difference between the market price at period end
and the current cost basis. In the event the share price of Digimarc does not
recover in the future, an other-than-temporary impairment charge may be incurred
for this item in future periods.
15
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, 2003 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, 2003.
OVERVIEW
Macrovision Corporation, a Delaware corporation founded in 1983,
develops and licenses copy protection, electronic licensing and rights
management technologies. Our customers include major Hollywood studios,
independent video producers, hardware and software vendors, music labels,
consumer electronic, PC and digital set-top box manufacturers and digital
pay-per-view (PPV) and video-on-demand (VOD) 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 hard drive recorder platforms. Our
SafeDisc product is used to copy protect CD-ROMs for software publishers
primarily in the PC games software market. Our music technology products are
used to copy protect music CDs. Our software products provide license management
solutions for software vendors and software asset management tools for business.
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 product lines,
along with the SafeDisc portion of the consumer software group. The SafeDisc
product line has been renamed PC games technology. Our peer-to-peer file
management service, Hawkeye, which was introduced in the second quarter of 2004,
is also included in the Entertainment Technologies Group. The Software
Technologies Group reflects the merger of the Enterprise Software Licensing
Management product line and the SafeCast product line that was also a part of
the consumer software group. Revenues have been reclassified for prior periods
to conform to the current period presentation. In July 2004, we acquired the
operations and certain assets of InstallShield Software Corporation. The
InstallShield product line will be a part of the Software Technologies Group.
16
The following table provides revenue information by business unit
(dollars in thousands):
THREE MONTHS ENDED
JUNE 30,
----------------------------------
2004 2003 $ CHANGE % CHANGE
--------------- --------------- --------------- ---------------
Entertainment Technologies Group $ 23,663 $ 20,681 $ 2,982 14.4%
Software Technologies Group 12,007 8,531 3,476 40.7
--------------- --------------- ---------------
$ 35,670 $ 29,212 $ 6,458 22.1
=============== =============== ===============
SIX MONTHS ENDED
JUNE 30,
----------------------------------
2004 2003 $ CHANGE % CHANGE
--------------- --------------- --------------- ---------------
Entertainment Technologies Group $ 48,322 $ 41,190 $ 7,132 17.3%
Software Technologies Group 25,330 16,074 9,256 57.6
--------------- --------------- ---------------
$ 73,652 $ 57,264 $ 16,388 28.6
=============== =============== ===============
The following table provides percentage of revenue information by
business unit:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------- -----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Entertainment Technologies Group 66.3% 70.8% 65.6% 71.9%
Software Technologies Group 33.7 29.2 34.4 28.1
------------ ------------ ------------ ------------
100.0% 100.0% 100.0% 100.0%
============ ============ ============ ============
ENTERTAINMENT TECHNOLOGIES GROUP
Our entertainment technologies group generates revenue from the home
video divisions of member companies of the 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. Royalties from MPAA studios represented 32.6%
and 35.3% of our revenues for the three months ended June 30, 2004 and 2003,
respectively, and 32.1% and 36.8% of our revenues for the six months ended June
30, 2004 and 2003, respectively. Our entertainment technology group also
generates revenues from digital PPV copy protection from customers in the
satellite and cable system operators and equipment manufacturers that supply
cable and satellite industries. Most of our PPV revenues are generated from
royalties on digital set top boxes. In addition, our entertainment technologies
group generates revenues from customers implementing our CD-ROM copy protection
technology on PC games, as well as customers in the music industry who implement
our copy technology on compact discs.
Revenues from our entertainment technologies group increased $3.0
million, or 14.4% from the three months ended June 30, 2003 to the three months
ended June 30, 2004, and increased $7.1 million or 17.3% from the six months
ended June 30, 2003 to the six months ended June 30, 2004. The increase is
primarily due to the increase in numbers of DVDs sold and continued strong
demand for our DVD copy
17
protection solution. To a lesser extent, this increase was also due to an
increase in PPV revenues, primarily from royalties due to strong demand from
consumers, especially in international territories, for digital cable and
digital satellite operators' businesses. During the first quarter of 2004, we
recognized approximately $2.2 million of revenue from studio volume replicated
during the fourth quarter of 2003. During the second quarter of 2004, we
recognized approximately $1.2 million of revenue from studio volume replicated
during the first quarter of 2004. We were not able to record this revenue in the
quarter in which it was replicated due to delays in payment of amounts resulting
from prolonged contract negotiations. 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 three and six months ended June 30, 2003, the
increase in DVD copy protection revenues included approximately $917,000 in
revenue from the resolution of this customer's over reporting claim.
From the three and six months ended June 30, 2003 to 2004, videocassette
copy protection revenues have continued to decrease in absolute terms as the
trend of MPAA studios investing proportionally more in copy protecting their DVD
titles compared to VHS releases has continued. PC Games technology revenues have
also decreased during these periods due to increased competition, resulting in a
reduction in volumes copy protected by our technology as well as declining per
unit prices. Revenues from our music copy protection technology products
decreased from the three months ended June 30, 2003 to the three months ended
June 30, 2004 and increased from the six months ended June 30, 2003 to the six
months ended June 30, 2004. These decreases partially offset the increase in
revenue from our DVD and PPV copy protection solutions.
We believe that revenues from our entertainment technologies group will
increase in absolute terms and continue to be a significant part of our
revenues.
SOFTWARE TECHNOLOGIES GROUP
Our software products generate revenue from licensing software and
providing services related to the support and maintenance of this software.
Revenues from our software technologies group increased 40.7% from the three
months ended June 30, 2003 to the three months ended June 30, 2004, and
increased 57.6% from the six months ended June 30, 2003 to the six months ended
June 30, 2004. Such increases are the result of our increased market penetration
and the investment in additional sales personnel for our software technologies
group. We believe that revenues from our software technologies group will
continue to increase in total, but may vary as a percentage of our total
revenues. We believe that, as a result of our acquisition of InstallShield in
July 2004, future revenues from our software technologies group will increase in
absolute terms and as a percentage of our total revenues in future quarters.
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 of the following year, 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 PC games titles during the year-end holiday shopping season, while
our operating expenses are incurred more evenly throughout the year. In
addition, revenues generally have tended to be lower in the summer months,
particularly in Europe.
18
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 overhead and 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 overhead and
facilities costs. Our general and administrative expenses are comprised
primarily of employee compensation and benefits, consulting and recruiting fees,
travel, professional fees and an allocation of overhead and facilities costs.
CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES
The discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements. These
condensed consolidated financial statements have been prepared 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. 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, allowance for
doubtful accounts, valuation of strategic 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 consists of royalty fees on copy-protected products on a per
unit basis, licenses for our copy protection technologies, licenses for our
software products, and related maintenance and services revenues.
ROYALTY REVENUES
Royalty revenue from the replication of videocassettes, DVDs, and CDs is
recognized when realized or realizable and earned. We rely on royalty reports
from third parties as our basis for revenue recognition. In our DVD,
videocassette, and PC games product lines, 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, provided there is persuasive
evidence of an arrangement and that collection of a fixed or determinable fee is
considered probable. 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 market for our music technology
products. Advanced royalty fees attributable to minimum copy quantities or
shared revenues are deferred until earned. In the case of agreements with
minimum
19
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 product has
occurred; no significant obligations remain; the fee is fixed or 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 for all undelivered elements, all revenue is deferred
until such time as VSOE for all undelivered elements is evidenced or all
elements of the arrangement have been delivered, or if the only undelivered
element is maintenance where VSOE exists, 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 us 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 us to make reasonably dependable
estimates of costs and progress 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.
20
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 (generally
one year) and is included in services revenue in the accompanying condensed
consolidated financial statements.
VALUATION OF STRATEGIC INVESTMENTS
As of June 30, 2004 and December 31, 2003, the adjusted cost of our
strategic investments totaled $26.9 million and $27.0 million, respectively.
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.
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, at each quarter end, 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, an
impairment charge is recorded. 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.
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. Based on these measurements, we
recorded $180,000 of other-than-temporary impairment losses relating to our
investment in iVast during the first quarter of 2004. As of June 30, 2004, our
investment in iVast had no remaining carrying value. There were no
other-than-temporary impairment losses during the quarter ended June 30, 2004.
21
During the first quarter of 2004, we received $1.2 million in cash for
our interest in InterActual Technologies, which was acquired by a third party
during the period. In fiscal year 2001, this strategic investment had been fully
impaired. Accordingly, during the first quarter of 2004, we recorded a gain on
strategic investments of $1.2 million.
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. In the first half
of 2004 and fiscal year 2003, there were no triggering events that required us
to test for impairment prior to our annual impairment analysis.
In connection with our impairment analysis 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 unit is less than its carrying amount we would be required to
recognize an impairment loss. In October 2002 and October 2003, we completed our
annual impairment analyses of goodwill. Based on the results of the annual
impairment analysis, we determined that no indicators of impairment existed for
our reporting units and no impairment charges were recorded for goodwill as of
December 31, 2002 and 2003. The next annual impairment analysis will be
performed in October 2004.
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
22
asset and liability sections of the balance sheet. In the first half of 2004 and
2003, no impairment charges were recorded for long-lived assets.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We estimate 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. We specifically analyze 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
June 30, 2004 and December 31, 2003, deferred tax assets net of valuation
allowances, totaled $22.1 million and $21.7 million, respectively. Deferred tax
assets, related valuation allowances and deferred tax liabilities are determined
separately by tax jurisdiction. We believe sufficient uncertainty exists
regarding our ability to realize our deferred tax assets in certain foreign
jurisdictions and, accordingly, a valuation allowance has been established
against the deferred tax assets in those jurisdictions. We believe that it is
more likely than not that the results of future operations will generate
sufficient taxable income to utilize these deferred tax assets, net of valuation
allowance. While we have considered future taxable income and ongoing prudent
and feasible tax planning strategies in assessing the need for any valuation
allowance, in the event we were to determine that we will be able to realize our
deferred tax assets in the future in excess of the net recorded amount, an
adjustment to the valuation allowance 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 valuation allowance 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.
23
RESULTS OF OPERATIONS
The following table provides information on our results of operations
(dollars in thousands):
THREE MONTHS ENDED
JUNE 30,
-------------------------------------
2004 2003 $ CHANGE % CHANGE
----------------- ---------------- ---------------- ----------------
Revenues:
Licenses $ 32,008 $ 26,223 $ 5,785 22.1%
Services 3,662 2,989 673 22.5
----------------- ---------------- ----------------
Total revenues 35,670 29,212 6,458 22.1
Cost of revenues:
License fees 1,445 1,183 262 22.1
Service fees 1,018 597 421 70.5
Amortization of intangibles from
acquisitions 777 856 (79) (9.2)
----------------- ---------------- ----------------
Total cost of revenues 3,240 2,636 604 22.9
----------------- ---------------- ----------------
Gross profit 32,430 26,576 5,854 22.0
Operating expenses:
Research and development 5,708 4,156 1,552 37.3
Selling and marketing 8,770 6,472 2,298 35.5
General and administrative 5,120 4,648 472 10.2
Amortization of deferred stock
based compensation -- 752 (752) (100.0)
----------------- ---------------- ----------------
Total operating expenses 19,598 16,028 3,570 22.3
----------------- ---------------- ----------------
Operating income 12,832 10,548 2,284 21.7
Impairment losses on investments -- (4,286) 4,286 100.0
Gains on strategic investments -- 436 (436) (100.0)
Interest and other income, net 985 953 32 3.4
----------------- ---------------- ----------------
Income before income taxes 13,817 7,651 6,166 80.6
Income taxes 4,974 3,060 1,914 62.5
----------------- ---------------- ----------------
Net income $ 8,843 $ 4,591 $ 4,252 92.6
================= ================ ================
24
SIX MONTHS ENDED
JUNE 30,
-------------------------------------
2004 2003 $ CHANGE % CHANGE
----------------- ---------------- ---------------- ----------------
Revenues:
Licenses $ 66,831 $ 51,465 $ 15,366 29.9%
Services 6,821 5,799 1,022 17.6
----------------- ---------------- ----------------
Total revenues 73,652 57,264 16,388 28.6
Cost of revenues:
License fees 3,029 2,122 907 42.7
Service fees 1,739 1,140 599 52.5
Amortization of intangibles from
acquisitions 1,556 1,712 (156) (9.1)
----------------- ---------------- ----------------
Total cost of revenues 6,324 4,974 1,350 27.1
----------------- ---------------- ----------------
Gross profit 67,328 52,290 15,038 28.8
Operating expenses:
Research and development 11,295 7,899 3,396 43.0
Selling and marketing 17,326 12,876 4,450 34.6
General and administrative 10,633 8,972 1,661 18.5
Amortization of deferred stock
based compensation 185 1,520 (1,335) (87.8)
----------------- ---------------- ----------------
Total operating expenses 39,439 31,267 8,172 26.1
----------------- ---------------- ----------------
Operating income 27,889 21,023 6,866 32.7
Impairment losses on investments (180) (4,286) 4,106 95.8
Gains on strategic investments 1,220 436 784 179.8
Interest and other income, net 1,713 2,053 (340) (16.6)
----------------- ---------------- ----------------
Income before income taxes 30,642 19,226 11,416 59.4
Income taxes 11,031 7,690 3,341 43.4
----------------- ---------------- ----------------
Net income $ 19,611 $ 11,536 $ 8,075 70.0
================= ================ ================
LICENSE REVENUES. Our license revenues increased $5.8 million or 22.1%
from the three months ended June 30, 2003 to the three months ended June 30,
2004, and increased $15.4 million or 29.9% from the six months ended June 30,
2003 to the six months ended June 30, 2004. The increase is primarily due to the
increase in numbers of DVDs sold and continued strong demand for our DVD copy
protection solution. To a lesser extent, this increase was also due to an
increase in PPV revenues, primarily from royalties due to strong demand from
consumers, especially in international territories, for digital cable and
digital satellite operators' businesses. During the first quarter of 2004, we
recognized approximately $2.2 million of revenue from studio volume replicated
during the fourth quarter of 2003. During the second quarter of 2004, we
recognized approximately $1.2 million of revenue from studio volume replicated
during the first quarter of 2004. We were not able to record this revenue in the
quarter in which it was replicated due to delays in payment of amounts resulting
from prolonged contract negotiations. 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 three and six months ended June 30, 2003, the
increase in DVD copy protection revenues included approximately $917,000 in
revenue in the resolution of this customer's overreporting claim. From the three
and six months ended June 30, 2003 to 2004, videocassette copy protection
revenues have continued to decrease in absolute terms as the trend of MPAA
studios investing proportionally more in copy protecting their DVD titles
compared to VHS releases has continued. PC Games technology revenues have also
decreased during these periods due to increased competition, resulting in a
reduction in volumes copy protected by us as well as declining per unit prices.
Revenues from our music copy protection technology products decreased from the
three months ended June 30, 2003 to the three months ended June 30, 2004 and
increased from the six months ended June 30, 2003 to the six months ended June
30, 2004. These decreases partially offset the increase in revenue from our DVD
and PPV copy protection solutions. The increases in revenue from our
25
software technologies group are primarily due to increased market penetration
and the investment in additional sales personnel for our software technologies
group.
SERVICE REVENUES. Our service revenues increased $673,000 or 22.5% from
the three months ended June 30, 2003 to the three months ended June 30, 2004,
and $1.0 million or 17.6% from the six months ended June 30, 2003 to the six
months ended June 30, 2004. The increases in service revenues are primarily due
to increases in consulting revenue due to the growth of our professional
services consulting practice for software as well as increases in maintenance
revenues. The increases in maintenance revenues are a result of the increased
market penetration in our software technologies group.
COST OF REVENUES - LICENSE FEES. Cost of revenues from license fees as a
percentage of license revenues were 4.5% for the three months ended June 30,
2003 and 2004, and increased from 4.1% for the six months ended June 30, 2003 to
4.5% for the six months ended June 30, 2004. Cost of revenues from license fees
increased $262,000 or 22.1% from the three months ended June 30, 2003 to the
three months ended June 30, 2004, and increased $907,000 or 42.7% from the six
months ended June 30, 2003 to the six months ended June 30, 2004. This increase
was primarily due to higher patent amortization costs from the acquisition of
patents from TTR in May 2003 and higher patent defense costs. Cost of revenues
includes items such as product costs, duplicator and replicator fees, video copy
protection processor costs, patent amortization on internally developed patents,
patent defense costs and licensing expenses.
COST OF REVENUES - SERVICE FEES. Cost of revenues from service fees as a
percentage of service revenues increased from 20.0% for the three months ended
June 30, 2003 to 27.8% for the three months ended June 30, 2004, and increased
from 19.7% for the six months ended June 30, 2003 to 25.5% for the six months
ended June 30, 2004. Cost of revenues from service fees increased $421,000 or
70.5% from the three months ended June 30, 2003 to the three months ended June
30, 2004, and increased $599,000 or 52.5% for the six months ended June 30, 2003
to the six months ended June 30, 2004. This increase is primarily due to the
expansion of our consulting and customer service groups to support the increased
activity in our software technologies group. We anticipate our cost of revenues
from service fees may increase as we continue to increase activity in our
consulting practice and seek to expand our customer base.
COST OF REVENUES - AMORTIZATION OF INTANGIBLES FROM ACQUISITIONS. Cost
of revenues from amortization of intangibles decreased $79,000 from the three
months ended June 30, 2003 to the three months ended June 30, 2004, and
decreased $156,000 from the six months ended June 30, 2003 to the six months
ended June 30, 2004. The decrease is primarily due to intangibles from the PtS
acquisition becoming fully amortized in the third quarter of 2003. The decrease
is partially offset by the amortization of intangibles from the acquisition of
assets relating to peer-to-peer file sharing tracking and control in August
2003.
RESEARCH AND DEVELOPMENT. Research and development expenses increased by
$1.6 million or 37.3% from the three months ended June 30, 2003 to the three
months ended June 30, 2004, and increased $3.4 million or 43.0% from the six
months ended June 30, 2003 to the six months ended June 30, 2004. The increase
is primarily due to increased research and development activities for our video
technology, music technology, peer-to-peer file sharing tracking and control and
software products. Research and development expenses increased as a percentage
of revenues from 14.2% in the three months ended June 30, 2003 to 16.0% in the
three months ended June 30, 2004, and increased from 13.8% in the six months
ended June 30, 2003 to 15.3% in the six months ended June 30, 2004. We expect
research and development expenses 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 develop new technologies in
our entertainment and software technologies groups.
26
SELLING AND MARKETING. Selling and marketing expenses increased by $2.3
million or 35.5% from the three months ended June 30, 2003 to the three months
ended June 30, 2004, and increased $4.5 million or 34.6% from the six months
ended June 30, 2003 to the six months ended June 30, 2004. This increase was
primarily due to increased business development activities for our entertainment
and software technologies products on an overall basis and increased commission
costs associated with higher revenue levels. Selling and marketing expenses
increased as a percentage of revenues from 22.2% in the three months ended June
30, 2003 to 24.6% for the three months ended June 30, 2004, and increased from
22.5% from the six months ended June 30, 2003 to 23.5% for the six months ended
June 30, 2004. Selling and marketing expenses are expected to increase in
absolute terms and as a percentage of revenues as we continue to expand our
efforts in selling and marketing our software, music, PC Games and other digital
rights management products.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
increased by $472,000 or 10.2% from the three months ended June 30, 2003 to the
three months ended June 30, 2004, and increased $1.7 million or 18.5% from the
six months ended June 30, 2003 to the six months ended June 30, 2004. The
increases in general and administrative expenses are primarily due to increased
headcount and related costs to support the overall growth of our business units.
The increase is also due to costs of compliance with the Sarbanes-Oxley Act of
2002 requirements. General and administrative expenses decreased as a percentage
of revenues from 15.9% in the three months ended June 30, 2003 to 14.4% in the
three months ended June 30, 2004 and decreased from 15.7% in the six months
ended June 30, 2003 to 14.4% in the six months ended June 30, 2004. We expect
our general and administrative expenses to increase in absolute terms as we
continue to support the expansion of our business and comply with the
requirements of the Sarbanes-Oxley Act.
AMORTIZATION OF DEFERRED STOCK-BASED COMPENSATION. In connection with
the acquisition of Globetrotter in 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.
Amortization of deferred stock-based compensation decreased $752,000 from the
three months ended June 30, 2003 to the three months ended June 30, 2004, and
decreased $1.3 million from the six months ended June 30, 2003 to the six months
ended June 30, 2004. The decreases are due to the completion of the vesting
schedule for such stock options. The expense associated with amortization of
this stock-based compensation ended in the first quarter of 2004.
IMPAIRMENT LOSSES ON INVESTMENTS. For the three months ended June 30,
2004, we had no charges relating to other-than-temporary impairments in our
strategic investments. For the six months ended June 30, 2004, we recorded
$180,000 of impairment charges relating to an other-than-temporary impairment of
our investment in iVast. For the three and six months ended June 30, 2003, we
recorded $4.3 million of impairment charges relating to an other-than-temporary
impairment of our investment in iVast.
GAINS ON STRATEGIC INVESTMENTS. For the three months ended June 30,
2004, we had no gains on strategic investments. For the six months ended June
30, 2004, we received $1.2 million in cash for our interest in InterActual
Technologies, which was acquired by a third party during the first quarter of
2004. In fiscal year 2001, this strategic investment had been fully impaired.
Accordingly, during the six months ended June 30, 2004, we recorded a gain on
strategic investments of $1.2 million. For the three and six months ended June
30, 2003, we recorded a realized gain of $395,000 from the surrender of the
Company's stock in TTR, a public company strategic investment. In addition,
during the three and six months ended June 30, 2003, we recorded a realized gain
of $41,000 for distributions received in excess of its book value for our
investment in NTRU Cryptosystems.
INTEREST AND OTHER INCOME, NET. Interest and other income increased
$32,000 or 3.4% from the three months ended June 30, 2003 to three months ended
June 30, 2004. This increase is due to an
27
increase in the balance invested. Interest and other income decreased $340,000
or 16.6% from the six months ended June 30, 2003 to the six months ended June
30, 2004. This decrease is primarily from declining interest rates.
INCOME TAXES. Income tax expense represents combined federal, state and
foreign taxes at an effective rate of 36.0% for the three months and six months
ended June 30, 2004 compared to 40.0% for the three and six months ended 2003.
The decrease in the effective tax rates for these periods in 2004 compare to
2003 were primarily due to changes in tax jurisdictions where our income was
earned and the reduction in deferred stock-based compensation that is not tax
deductible.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations primarily from cash generated by
operations, principally our copy protection products and our enterprise license
management products. Our operating activities provided net cash of $33.3 million
and $31.1 million for the six months ended June 30, 2004 and 2003, respectively.
Cash provided by operating activities increased $2.2 million from the six months
ended June 30, 2003 to the six months ended June 30, 2004, primarily due to a
significant decrease in our accounts receivable during the six months ended June
30, 2004, resulting from an increase in collections of accounts receivable.
Investing activities provided (used) net cash of $75.5 million and
($95.9) million for the six months ended June 30, 2004 and 2003, respectively.
Cash provided by investing activities increased $171.4 million from the six
months ended June 30, 2003 to the six months ended June 30, 2004, primarily due
to an increase in net sales and maturities of long and short-term investments.
The increase in net sales and maturities of long and short-term investments is
due to the reinvestment of these investments into cash equivalents. We made
capital expenditures of $2.2 million and $751,000 during the six months ended
June 30, 2004 and 2003, respectively. Capital expenditures are primarily for
computer software and hardware.
Net cash provided by financing activities was $3.6 million and $2.5
million for the six months ended June 30, 2004 and 2003, respectively. The net
cash provided by financing activities is from proceeds of stock option exercises
and employee stock purchase plan purchases. In May 2002, our Board of Directors
authorized a share repurchase program, which allows us to purchase up to 5.0
million 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. We did not repurchase any treasury stock in the six months
ended June 30, 2004 and 2003. As of June 30, 2004, 2.0 million shares remained
authorized for repurchase.
At June 30, 2004, we had $140.4 million in cash and cash equivalents,
$64.2 million in short-term investments and $97.8 million in long-term
marketable investment securities, which includes $26.9 million in fair market
value of our holdings in Digimarc. Aside from our acquisition of InstallShield
Software Corporation, we anticipate that capital expenditures for the next 6
months will not exceed $2.5 million. We also have future minimum lease payments
of approximately $35.1 million under operating leases. We believe that the
current available funds and cash flows generated from operations will be
sufficient to meet our working capital and capital expenditure requirements for
the foreseeable future.
In July 2004, we acquired the operations and certain assets of
InstallShield Software Corporation for approximately $76.0 million in cash and
additional related acquisition costs. We also assumed certain liabilities as
part of the acquisition. An additional contingent payment of up to $20.0 million
may be
28
required to be made by us based on post-acquisition revenue performance through
June 30, 2005. Any additional contingent consideration would be required to be
paid in the third quarter of 2005.
We may also use cash to acquire or invest in additional businesses or to
obtain the rights to use certain technologies in the future.
In November 2002, we acquired the assets and operations of Midbar for
approximately $17.8 million in cash and related acquisition costs. In addition,
we are subject to an additional maximum payout of $8.0 million based on a
percentage of revenues derived from our sales of music technology products
through December 31, 2004. During the six months ended June 30, 2004, we paid
$723,000 of such contingent consideration in cash relating to revenues generated
in the second half of 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" contained in our Annual Report on Form 10-K for the year ended December
31, 2003.
CONTRACTUAL OBLIGATIONS
We lease facilities and certain equipment pursuant to non-cancelable
operating lease agreements. Future minimum lease payments pursuant to these
leases as of June 30, 2004 were as follows (in thousands):
Operating
Leases
-------------
Remainder of 2004 $ 2,024
2005 3,823
2006 3,748
2007 3,854
2008 3,920
2009 and thereafter 17,743
-------------
Total $ 35,112
=============
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable
Interest Entities - An Interpretation of Accounting Research Bulletin No. 51"
("FIN 46R"). FIN 46R 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.
Application of FIN 46R is required in financial statements of companies that
have interests in variable interest entities or potential variable interest
entities commonly referred to as special purpose entities for periods ending
after December 15, 2003. Application by companies for all other types of
entities is required in financial statements for periods ending after March 15,
2004. We had no investments in VIEs as of June 30, 2004.
29
In December 2003, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition." SAB No. 104
updates interpretive guidance in the codification of staff accounting bulletins
to provide consistent accounting guidance on revenue recognition. The principal
revisions relate to the deletion of interpretive material no longer necessary
because of private sector developments in generally accepted accounting
principles in the United States of America, and the incorporation of certain
sections of the SEC's "Revenue Recognition in Financial Statements -- Frequently
Asked Questions and Answers" document. The adoption of SAB No. 104 has had no
material impact on the Company's financial position or results of operations.
In December 2003, the FASB issued SFAS No. 132 (revised 2003),
"Employers' Disclosures about Pensions and Other Postretirement Benefits." SFAS
No. 132 (revised 2003) revises employers' disclosures about pension plans and
other postretirement benefit plans. It does not change the measurement or
recognition of those plans required by SFAS No. 87, "Employers' Accounting for
Pensions," No. 88, "Employers' Accounting for Settlements and Curtailments of
Defined Benefit Pension Plans and for Termination Benefits," and No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions." This
statement retains the disclosure requirements contained in SFAS No. 132,
"Employers' Disclosures about Pensions and Other Postretirement Benefits," which
it replaces. It requires additional disclosures to those in the original SFAS
No. 132 about the assets, obligations, cash flows, and net periodic benefit cost
of defined benefit pension plans and other defined benefit postretirement plans.
The required information should be provided separately for pension plans and for
other postretirement benefit plans. SFAS No. 123 (revised 2003) is effective for
financial statements with fiscal years ending after December 15, 2003. We had no
pension plans or other postretirement benefit plans as of June 30, 2004.
In March 2004, the FASB issued EITF Issue No. 03-1 ("EITF 03-1") "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments." EITF 03-1 includes new guidance for evaluating and recording
impairment losses on debt and equity instruments, as well as new disclosure
requirements for investments that are deemed to be temporarily impaired. The
accounting guidance provided in EITF 03-1 is effective for fiscal periods
beginning after June 15, 2004, while the disclosure requirements are effective
for annual periods ending after December 1, 2003. We adopted the disclosure
requirements in the year ended December 31, 2003. We will adopt the accounting
guidance effective July 1, 2004. We do not expect the adoption of EITF 03-1 to
have a material impact on its financial position or results of operations.
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 $302.4 million as
of June 30, 2004. 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 $649,000 decrease (approximately
0.4%) in the fair value of our fixed income available-for-sale securities as of
June 30, 2004. Yield risk is also reduced by targeting a weighted average
maturity of our portfolio at approximately 12 to 15 months so that the
portfolio's yield regenerates itself as portions of the portfolio mature.
30
FOREIGN EXCHANGE RATES. Due to our reliance on international and export
sales, we are subject to the risks of fluctuations in currency exchange rates.
Because a substantial majority of our international and export revenues, as well
as expenses, are typically denominated in U.S. dollars, fluctuations in currency
exchange rates could cause our products to become relatively more expensive to
customers in a particular country, leading to a reduction in sales or
profitability in that country. Our subsidiaries in the United Kingdom, Japan and
Israel operate in their local currency, which mitigates a portion of the
exposure related to the respective currency royalties collected.
STRATEGIC INVESTMENTS. We currently hold minority equity interests in a
number of companies. These investments, at book value totaling $26.9 million and
$27.0 million, represented 6.5% and 7.0% of our total assets as of June 30, 2004
and December 31, 2003, respectively. As of June 30, 2004, the adjusted cost of
our strategic investments consisted of our investment in Digimarc, a publicly
traded company. In addition, we hold investments in a number of other privately
held companies, which have no carrying value as of June 30, 2004. Digimarc is
subject to price fluctuations based on the public market. Because there is no
active trading market for the securities of privately held companies, our
investments in them are illiquid. During the six months ended June 30, 2004,
$180,000 of strategic investments resulting from impairment that was
other-than-temporary, was charged to operations.
As of July 31, 2004, the Company's investment in Digimarc decreased $8.7
million from its value as of June 30, 2004 due to a decline in the share price
of Digimarc stock subsequent to June 30, 2004. For investments in public
companies, at each quarter end, the Company compares its 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, the Company records a charge to the
statement of income for the difference between the market price at period end
and the current cost basis. In the event the share price of Digimarc does not
recover in the future, an other-than-temporary impairment charge may be incurred
for this item in future periods.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. We maintain disclosure
controls and procedures that are designed to ensure that information required to
be disclosed in our 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 management, including
our 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 period covered by this report, we carried out an
evaluation, under the supervision and with participation of management,
including our Chief Executive Officer and our Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based on the foregoing, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were
effective.
CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING. During the
quarter ended June 30, 2004, there have been no changes in our internal controls
over financial reporting that have materially affected, or are reasonably likely
to materially affect, these controls.
31
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, tortuous
interference with business relations, and trade libel. Rainbow Technologies and
Ken Greer sought 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 our 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. In response, on December 23, 2002,
we filed a notice to appeal the summary judgment of our 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, Elan filed an appeal
brief abandoning its appeal of the summary judgment order. This left only Ken
Greer's appeal and our cross-appeal. On March 23, 2004, the Court of Appeal of
the Federal Circuit ("CAFC") ruled in our favor in both the patent infringement
and counterclaims appeals related to the appeals of the Ken Greer and Elan
litigation. The CAFC ruled that the Northern California District Court was
correct in dismissing the counterclaims against us and Globetrotter and the
District Court was incorrect in dismissing the patent infringement against Ken
Greer and Elan. The patent infringement claim was remanded back to the District
Court for adjudication. On May 28, 2004, Elan and Greer agreed to settle the
lawsuit with us. A settlement agreement was executed by Elan and Greer in which
Elan and Greer acknowledged the validity of our U.S. Patent No. 5,390,297 (the
'297 patent) and admitted that Elan's license management software product
practiced the prevention function of the `297 patent. Elan, Greer, and
Macrovision agreed to dismiss all claims and on June 8, 2004, and we filed a
motion for dismissal with the Court, which the parties expect to be granted in
the third quarter of 2004.
MACROVISION CORPORATION V. VITEC AUDIO AND VIDEO GMBH
32
We initiated a patent infringement lawsuit in the District Court of
Dusseldorf in March 1999 against ViTec Audio und Video GmbH, a German company
that manufactures what we believe to be a video copy protection circumvention
device. ViTec filed a reply brief arguing that its product does not infringe our
patents. The case was heard in the District Court of Dusseldorf, Germany. The
District Court of Dusseldorf ruled adversely against us. We appealed the
District Court's ruling in July 2000 to the Court of Appeal in Dusseldorf. A
hearing took place in front of the Court of Appeal in Dusseldorf on August 23,
2001 in which the Court stated that because the appeal involves complex
technical subject matter, the Court would require technical expert witnesses.
The Court selected Professor Dr. Ing. M. Plantholt as its expert witness. On
January 27, 2003, Professor Plantholt submitted his technical opinion to the
Court, and an English translation was made available to us on July 3, 2003. A
hearing before the Court of Appeal in Dusseldorf was scheduled for March 4,
2004, but was postponed by the Court. The new date for the hearing will be in
late 2004. We filed a reply brief in response to the expert technical opinion
with the Court of Appeals on June 9, 2004. The deadline for ViTec to file its
reply brief is August 16, 2004, but we expect ViTec to request an extension.
In the event of an adverse ruling, we may incur a corresponding decline
in demand for our video copy protection technology, which could harm our
business in Germany. In addition, we may be obligated to pay some of ViTec's
attorney fees estimated to be $25,000.
USPTO INTERFERENCE PROCEEDINGS 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 our U.S. Patent
No. 5,845,281 (the "`281 patent") together with two of our continuation
applications, and a patent application determined to be from InterTrust
Technologies Corporation. On December 19, 2003, we received notice from the
USPTO declaring an additional interference between two continuation applications
related to the `281 patent and four issued U.S. patents from InterTrust. The
`281 patent and its continuation applications are in the field of digital rights
management, and are not associated with our existing copy protection business.
An interference is declared by the USPTO when two or more parties claim
the same patentable invention. In the United States, the party who can prove
earliest inventorship is granted the patent. An interference proceeding has
commenced to determine the rightful inventorship of the involved patents and
patent applications. The `281 patent and its continuation applications have a
priority filing date of February 1, 1995. The InterTrust patents and patent
application have a priority filing date of February 13, 1995. The Administrative
Patent Judge ("APJ") has decided to proceed with the second interference first.
Our filing date is prior to InterTrust's filing date, therefore we have been
designated the senior party in the interference. InterTrust submitted its proof
of inventorship in a brief filed on June 24, 2004. We responded with our brief
filed on July 14, 2004. Interference procedural rules allow each party to file
rebuttals to the other party's brief, cross-examine witnesses offered up by the
other party and file various motions and objections during this initial phase of
the interference. This initial phase is anticipated to continue for at least the
next several months. Following the close of this initial phase, both parties
will have an opportunity for an oral hearing, which we anticipate will occur in
late 2004. Following the oral hearing, we estimate that the APJ will issue a
judgment in early 2005.
MACROVISION VS. 321 STUDIOS LLC
On January 7, 2004, we initiated a lawsuit in the Southern District of
New York against 321 Studios LLC, a producer of cloning software products,
alleging that 321 Studios infringes our patented copy protection technology and
also violates the U.S. Digital Millennium Copyright Act of 1998 ("DMCA"). On May
11, 2004, we were granted a preliminary injunction barring 321 Studios from
selling various versions of its DVD copying software. We have notified various
large retailers of 321
33
Studios' products of the issuance of the preliminary injunction and requested
removal of 321 Studios' products enjoined by the preliminary injunction. Based
on subsequent investigations, we believe that the preliminary injunction has
been effective in removing 321 Studios' enjoined products from the marketplace.
On June 4, 2004, 321 Studios filed a notice of interlocutory appeal, which we
plan to oppose. We anticipate that the court will issue findings of fact and
conclusions of law in the case by the end of the third quarter of 2004.
As of June 30, 2004, it was not possible to estimate the liability, if
any, in connection with these matters. Accordingly, no accruals for these
contingencies have been recorded.
From time to time we have been involved in other disputes and legal
actions arising in the ordinary course of business. In our opinion, none of
these other disputes and legal actions is expected to have a material impact on
our consolidated financial position, results of operation or cash flow.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the annual meeting of stockholders held by Macrovision on May 25,
2004, each of the following individuals was elected to the board of directors to
hold office until the 2005 annual meeting of stockholders, or until a successor
is duly elected and qualified or the director's earlier death, resignation or
removal:
VOTES FOR VOTES WITHHELD
--------------- --------------------
John O. Ryan 31,540,862 12,517,010
William A. Krepick 32,137,484 11,920,388
Matt Christiano 30,108,495 13,949,377
Donna S. Birks 25,231,007 18,826,865
William N. Stirlen 37,963,630 6,094,242
Thomas Wertheimer 37,964,060 6,093,812
Steven G. Blank 38,576,453 5,481,419
In addition, the proposal to ratify the appointment of KPMG, LLP as
Macrovision's auditors for the year ending December 31, 2004 was approved by the
following vote:
VOTES FOR VOTES AGAINST ABSENTIONS
--------------- ------------------- ----------------
41,836,809 2,204,311 16,751
ITEM 5. OTHER INFORMATION
None
34
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
31.01 Rule 13a-15(e)/15d-15(e) Certification
31.02 Rule 13a-15(e)/15d-15(e) Certification
32.01 Section 1350 Certification
32.02 Section 1350 Certification
(b) Reports on Form 8-K.
Macrovision filed a report on Form 8-K on May 3, 2004 announcing our
financial results for the quarter ended March 31, 2004 and providing updated
guidance for fiscal year 2004, and included the related press release.
Macrovision filed a report on Form 8-K on June 17, 2004 announcing that
it had signed a definitive agreement to acquire the assets and operations of
privately held InstallShield Software Corporation, and included the related
press release.
35
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: August 6, 2004 By: /s/ William A. Krepick
----------------------- ---------------------------------------
William A. Krepick
President and Chief Executive Officer
PRINCIPAL FINANCIAL OFFICER AND CHIEF ACCOUNTING OFFICER:
Date: August 6, 2004 By: /s/ Ian R. Halifax
----------------------- ---------------------------------------
Ian R. Halifax
Executive Vice President, Finance and
Administration, Chief Financial Officer
and Secretary
36