Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding as of October 29, 2004
Common stock, $0.001 par value 49,727,993
MACROVISION CORPORATION
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION
Page
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2004
and December 31, 2003 1
Condensed Consolidated Statements of Income
for the Three and Nine Months Ended September 30, 2004 and 2003 2
Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 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 18
Item 3. Quantitative and Qualitative Disclosures about Market Risk 35
Item 4. Controls and Procedures 35
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 39
Item 3. Defaults Upon Senior Securities 39
Item 4. Submission of Matters to a Vote of Security Holders 39
Item 5. Other Information 39
Item 6. Exhibits 39
Signatures 40
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2004 2003
-------------------- -------------------
ASSETS
Current assets:
Cash and cash equivalents $ 70,673 $ 27,918
Short-term investments 88,791 95,563
Accounts receivable, net of allowance for doubtful accounts of
$2,701 and $2,147, respectively 31,105 30,169
Income taxes receivable 5,292 3,410
Deferred tax assets 6,641 6,599
Prepaid expenses and other current assets 8,646 5,070
Restricted cash 851 --
-------------------- -------------------
Total current assets 211,999 168,729
Long-term marketable investment securities 63,747 146,151
Property and equipment, net 8,561 6,689
Patents, net 10,721 10,826
Goodwill 73,535 28,630
Other intangibles from acquisitions, net 33,410 8,512
Deferred tax assets 15,392 15,121
Other assets 833 908
-------------------- -------------------
$ 418,198 $ 385,566
==================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,178 $ 4,457
Deferred revenue 15,437 10,333
Other current liabilities 25,442 25,936
-------------------- -------------------
Total current liabilities 45,057 40,726
Other non current liabilities 881 874
-------------------- -------------------
Total liabilities 45,938 41,600
Stockholders' equity:
Common stock 53 52
Treasury stock, at cost (38,450) (38,450)
Additional paid-in-capital 301,362 292,507
Deferred stock-based compensation -- (185)
Accumulated other comprehensive income 6,346 8,028
Retained earnings 102,949 82,014
-------------------- -------------------
Total stockholders' equity 372,260 343,966
-------------------- -------------------
$ 418,198 $ 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------ ------------------------------------
2004 2003 2004 2003
----------------- ----------------- ----------------- -----------------
Revenues:
Licenses $ 42,119 $ 28,210 $ 108,950 $ 79,675
Services 6,740 3,006 13,561 8,805
----------------- ----------------- ----------------- -----------------
Total revenues 48,859 31,216 122,511 88,480
Cost of revenues:
License fees 2,737 1,273 5,766 3,395
Service fees 3,338 625 5,077 1,765
Amortization of intangibles from acquisitions 2,403 855 3,959 2,567
----------------- ----------------- ----------------- -----------------
Total cost of revenues 8,478 2,753 14,802 7,727
----------------- ----------------- ----------------- -----------------
Gross profit 40,381 28,463 107,709 80,753
Operating expenses:
Research and development 8,409 4,177 19,704 12,076
Selling and marketing 11,227 6,539 28,553 19,415
General and administrative 6,635 4,612 17,268 13,584
In-process research and development 5,400 624 5,400 624
Amortization of deferred stock-based compensation* -- 609 185 2,129
----------------- ----------------- ----------------- -----------------
Total operating expenses 31,671 16,561 71,110 47,828
----------------- ----------------- ----------------- -----------------
Operating income 8,710 11,902 36,599 32,925
Impairment losses on strategic investments (5,298) (310) (5,478) (4,596)
Gains on strategic investments -- 16 1,220 452
Interest and other income, net 755 842 2,468 2,895
----------------- ----------------- ----------------- -----------------
Income before income taxes 4,167 12,450 34,809 31,676
Income taxes 2,843 4,981 13,874 12,671
----------------- ----------------- ----------------- -----------------
Net income $ 1,324 $ 7,469 $ 20,935 $ 19,005
================= ================= ================= =================
Basic net earnings per share $ 0.03 $ 0.15 $ 0.42 $ 0.39
================= ================= ================= =================
Shares used in computing basic net earnings per share 49,577 48,846 49,394 48,661
================= ================= ================= =================
Diluted net earnings per share $ 0.03 $ 0.15 $ 0.42 $ 0.39
================= ================= ================= =================
Shares used in computing diluted net earnings per share 50,671 49,742 50,430 49,318
================= ================= ================= =================
* The allocation of the amortization of deferred stock-based compensation relates to the expense categories as set forth below:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------ ------------------------------------
2004 2003 2004 2003
----------------- ----------------- ----------------- -----------------
Cost of revenues $ -- $ 79 $ 27 $ 240
Research and development -- 138 53 414
Selling and marketing -- 189 36 867
General and administrative -- 203 69 608
----------------- ----------------- ----------------- -----------------
$ -- $ 609 $ 185 $ 2,129
================= ================= ================= =================
See the accompanying notes to these condensed consolidated financial statements.
2
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------------------------
2004 2003
-------------------- --------------------
Cash flows from operating activities:
Net income $ 20,935 $ 19,005
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 3,401 2,267
Amortization of intangibles from acquisitions 3,959 2,567
Amortization of deferred stock-based compensation 185 2,129
Tax benefit from stock options exercises 1,882 1,423
Impairment losses on strategic investments 5,478 4,596
Gains on strategic investments (1,220) (452)
Deferred tax expense 3,341 --
In-process research and development 5,400 624
Changes in operating assets and liabilities:
Accounts receivable, net 1,837 3,683
Deferred revenue 2,925 1,595
Other assets (5,070) 199
Other liabilities (6,757) 3,113
-------------------- --------------------
Net cash provided by operating activities 36,296 40,749
Cash flows from investing activities:
Purchases of long and short-term investments (244,823) (324,267)
Sales or maturities of long and short-term investments 324,860 221,193
Acquisition of property and equipment (3,318) (1,715)
Acquisition of TTR patents and other assets -- (5,050)
Payments for patents (898) (902)
Proceeds from sale of strategic investments 1,220 57
Contingent consideration for Midbar acquisition (783) (480)
Acquisition of peer to peer assets and related acquisition
costs, net of cash acquired -- (800)
Acquisition of InstallShield Corporation and related
acquisition costs, net of cash acquired (75,952) --
Increase in restricted cash (851) --
Other investing activities -- (118)
-------------------- --------------------
Net cash used in investing activities (545) (112,082)
Cash flows from financing activities:
Proceeds from issuance of common stock from options and stock
purchase plans 6,974 4,775
-------------------- --------------------
Net cash provided by financing activities 6,974 4,775
Effect of exchange rate changes on cash and cash equivalents 30 440
-------------------- --------------------
Net increase (decrease) in cash and cash equivalents 42,755 (66,118)
Cash and cash equivalents at beginning of period 27,918 98,691
-------------------- --------------------
Cash and cash equivalents at end of period $ 70,673 $ 32,573
==================== ====================
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, for any future year, or for 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 content 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 guaranteed
quantities of licensed units or royalties based on a percentage of licensed
product sales 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.
4
TECHNOLOGY LICENSING REVENUES
Technology licensing revenue, which applies principally to DVD and PC
sub-assembly manufacturers; digital PPV, cable and satellite system operators;
digital set-top decoder manufacturers; and content owners who utilize the
Hawkeye peer-to-peer network content management service is recognized upon
establishment of persuasive evidence of an arrangement, performance of all
significant obligations and determination that collection of a fixed or
determinable license fee is considered probable.
SOFTWARE LICENSING REVENUES
The Company sells its software value management solutions through our
direct sales force and through resellers. 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 offers resellers the right of return
on its packaged products under certain policies and programs. The Company
estimates and records reserves for product returns as an offset to revenue. 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 and payable 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 ("VSOE") of fair value 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 of fair value does not exist, all revenue is deferred until
such time that VSOE of fair value is evidenced or all elements of the
arrangement have been delivered, or if the only undelivered element is
maintenance where VSOE of fair value 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.
5
PROFESSIONAL SERVICES REVENUES
The Company provides consulting and training services to its software
vendor and enterprise 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 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 earnings per share as reported would have been reduced to the pro
forma amounts indicated below (in thousands, except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
2004 2003 2004 2003
-------------- ------------- -------------- --------------
Net income, as reported $ 1,324 $ 7,469 $ 20,935 $ 19,005
Add: stock-based employee compensation
expense included in reported net income,
net of related tax effects -- 365 111 1,277
Deduct: total stock-based employee
compensation expenses determined under
fair-value-based method for all rewards,
net of related tax effects (6,444) (5,777) (14,669) (20,456)
-------------- ------------- -------------- --------------
Net income (loss), pro forma $ (5,120) $ 2,057 $ 6,377 $ (174)
============== ============= ============== ==============
Basic net earnings (loss) per share As reported $ 0.03 $ 0.15 $ 0.42 $ 0.39
Adjusted pro forma $ (0.10) $ 0.04 $ 0.13 $ --
Diluted net earnings (loss) per share As reported $ 0.03 $ 0.15 $ 0.42 $ 0.39
Adjusted pro forma $ (0.10) $ 0.04 $ 0.13 $ --
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- ---------------------------------
2004 2003 2004 2003
--------------- -------------- --------------- ---------------
OPTION PLANS:
Dividends None None None None
Expected term 2.3 years 3.4 years 2.4 years 3.2 years
Risk free interest rate 2.7% 2.2% 2.3% 3.5%
Volatility rate 69.2% 74.2% 71.0% 76.2%
ESPP PLAN:
Dividends None None None None
Expected term 1.4 years 1.5 years 1.4 years 1.3 years
Risk free interest rate 2.2% 2.6% 2.3% 2.7%
Volatility rate 70.3% 74.9% 70.8% 75.6%
The weighted average fair values of options granted during the three months
ended September 30, 2004 and 2003 were $9.89 and $10.71, respectively. The
weighted average fair values of an ESPP purchase share right granted during the
three months ended September 30, 2004 and 2003 were $9.19 and $7.43,
respectively.
The weighted average fair values of options granted during the nine months
ended September 30, 2004 and 2003 were $9.29 and $8.04, respectively. The
weighted average fair values of an ESPP purchase share right granted during the
nine months ended September 30, 2004 and 2003 were $8.94 and $7.98,
respectively.
NOTE 4 - BUSINESS COMBINATION AND ASSET PURCHASES
In July 2004, the Company acquired the operations and certain assets of
InstallShield Software Corporation ("InstallShield") for approximately $77.1
million in cash, including 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. InstallShield is a leading provider of software installation tools. The
acquisition of InstallShield expands the Company's product portfolio in the
Software value management category and enables the Company to reach
InstallShield's large software developer customer base. InstallShield has been
integrated into the Company's Software Technologies Group. The accompanying
condensed consolidated statements of income include the results of operations of
InstallShield since July 1, 2004, the effective date of the acquisition.
7
The following is a summary of the estimated fair values of the tangible
assets acquired and liabilities assumed at the date of the acquisition (in
thousands):
AS OF JULY 1, 2004
----------------------------
Cash and cash equivalents $ 1,134
Accounts receivable, net 2,713
Property and equipment, net 738
Other assets 532
----------------------------
Total tangible assets acquired 5,117
----------------------------
Deferred revenue (2,172)
Other liabilities (3,937)
----------------------------
Total liabilities assumed (6,109)
----------------------------
Net liabilities assumed $ (992)
============================
In July 2004, $851,000 of cash was restricted primarily relating to certain
liabilities assumed as part of the acquisition of InstallShield. This amount has
been classified as "Restricted cash" on the condensed consolidated balance sheet
as of September 30, 2004.
The following is a summary of goodwill and identifiable intangible assets
acquired in the acquisition of InstallShield (in thousands):
AMORTIZATION PERIOD IN
INTANGIBLE ASSET $ YEARS
- ---------------------------- -------------------- ----------------------
Existing technology $ 20,100 4
In-process technology 5,400 --
Maintenance agreements 200 3
Distribution agreements 2,000 6
Trade Name/Trademarks 6,500 6
Goodwill 43,881 Not Applicable
--------------------
Total $ 78,081
====================
The weighted average amortization period for amortizable InstallShield
intangible assets is 4.6 years. The in-process technology of $5.4 million has
been charged to operations during the three and nine months ended September 30,
2004.
In August 2003, the Company acquired intellectual property and other
assets, including patents, existing contracts, and software code that can be
used to track and manage content in the peer-to-peer, or P2P, file sharing
space. The Company paid $720,000 in cash, $80,000 of acquisition costs and an
additional payment of $80,000 due on the first anniversary of the closing date
for a total purchase price of $880,000. In addition, during the nine months
ended September 30, 2004, the Company paid $95,000 upon the achievement of
certain milestones. The purchase price was allocated to in-process technology,
core technology and employment agreements. The in-process technology of $624,000
has been charged to operations during the three and nine months ended September
30, 2003.
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
8
$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 for the nine months
ended September 30, 2003.
NOTE 5 - STRATEGIC INVESTMENTS
As of September 30, 2004 and December 31, 2003, the adjusted cost of the
Company's strategic investments totaled $18.2 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.
The following table summarizes the Company's goodwill from acquisitions as of
September 30, 2004 (in thousands):
Goodwill, net at January 1, 2004 $ 28,630
Acquisition of InstallShield 43,881
Midbar contingent consideration 683
Changes due to foreign currency exchange rates 341
--------------------
Goodwill, net at September 30, 2004 $ 73,535
====================
As of September 30, 2004, the adjusted cost of the Company's strategic
investments consisted solely of its investment in Digimarc, a publicly traded
company. Additionally, the Company holds investments in a number of other
privately held companies, which have no carrying value as of September 30, 2004.
The Company performs regular reviews of its strategic investments for indicators
of impairment. Impairment charges are recorded when it has been determined that
an other-than-temporary impairment has occurred.
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, a charge is recorded to the statement of income for the difference
between the market price at period end and the current cost basis. During the
three and nine months ended September 30, 2004, the Company recorded an
other-than temporary impairment loss of $5.3 million on its investment in
Digimarc.
For equity investments in non-public companies for which there is no market
where their value is readily determinable, the Company reviews 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 the Company considers 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. 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 $0 and $310,000 of
other-than-temporary impairment losses relating to its investment in iVast
during the three months ended September 30, 2004 and 2003, respectively, and
$180,000 and $4.6 million of other-than-temporary impairment losses relating to
its investment in iVast during the nine months ended September 30, 2004 and
2003, respectively. The Company originally invested $5.0 million in iVast in
2001. As of September 30, 2004, the Company's investment in iVast had no
remaining carrying value.
The Company received $1.2 million in cash for its interest in InterActual
Technologies, the assets of which were 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. The Company did not
record any gains related to its strategic investments during the three months
ended September 30, 2004.
9
During the nine months ended September 30, 2003, the Company recorded a
realized gain of $395,000 from the surrender of the Company's stock in TTR, a
public company strategic investment (see Note 4). In addition, during the three
and nine months ended September 30, 2003, the Company recorded realized gains of
$16,000 and $57,000, respectively, representing distributions received in excess
of its book value for its investment in NTRU Cryptosystems.
NOTE 7 - INCOME TAXES
The Company accounts for income taxes using the asset and liability method.
As of September 30, 2004 and December 31, 2003, deferred tax assets net of
valuation allowances, totaled $22.0 million and $21.7 million, respectively.
Deferred tax assets, related valuation allowances and deferred tax liabilities
are determined separately by tax jurisdiction. The Company believes that
sufficient uncertainty exists regarding its ability to realize its deferred tax
assets in certain foreign jurisdictions and, accordingly, a valuation allowance
has been established against the deferred tax assets in those jurisdictions.
During the quarter ended September 30, 2004, the Company determined that
sufficient uncertainty existed regarding its ability to realize its deferred tax
assets related to captial loss carryforwards; therefore, a valuation allowance
was established against such deferred tax assets. The Company recorded income
tax expense of $3.3 million during the three and nine months ended September 30,
2004 as result of the increase in valuation allowance.
The Company believes 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 the Company has
considered future taxable income and ongoing prudent and feasible tax planning
strategies in assessing the need for any valuation allowance, in the event the
Company was to determine that it would be able to realize its 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 the Company determine that it would not be able to
realize all or part of its net deferred tax assets in the future, an adjustment
to the valuation allowance would be charged to income in the period such
determination was made. The Company's 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. The Company is
also subject to changing tax laws in the multiple jurisdictions in which it
operates.
Including the charge of $3.3 million during the quarter ended September 30,
2004, the annual effective rate for the year is estimated to be approximately
36% of pretax income. Income tax expense represents combined federal, state and
foreign taxes at effective rates of 68% and 40% for the three and nine months
ended September 30, 2004, respectively, compared to 40% for the three and nine
months ended September 30, 2003. The change in effective tax rates for those
periods in 2004 compared to 2003 were primarily due to the increase in valuation
allowance and the change in tax jurisdictions where the Company's income was
earned.
10
NOTE 7 - 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- --------------
Basic net EPS - weighted average number of
common shares outstanding 49,577 48,846 49,394 48,661
Effect of dilutive potential common shares -
stock options outstanding 1,094 896 1,036 657
-------------- -------------- -------------- --------------
Diluted net EPS - weighted average number of
common shares and potential common shares
outstanding 50,671 49,742 50,430 49,318
============== ============== ============== ==============
Anti-dilutive shares excluded 3,322 3,827 2,770 4,233
============== ============== ============== ==============
Weighted average exercise price of
anti-dilutive shares $ 30.24 $ 41.79 $ 32.38 $ 40.86
============== ============== ============== ==============
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 8 - 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 September 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
11
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 covered by
SFAS No. 132 as of September 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 was effective for other-than-temporary
impairment evaluations made in reporting periods beginning after June 15, 2004.
However, this guidance has been delayed to an unknown date by FSP EITF Issue
03-1-1, "Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, "The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain Investments."
The disclosure requirements continue to be effective for annual periods ending
after December 15, 2003, for investments accounted for under SFAS No. 115
"Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No.
115.") For all other investments within the scope of EITF 03-1, the disclosures
continue to be effective in annual financial statements for fiscal years ending
after June 15, 2004. The additional disclosures for cost method investments
continue to be effective for fiscal years ending after June 15, 2004. The
Company adopted the disclosure requirements for investments accounted for under
SFAS 115 in the year ended December 31, 2003. For all other investments within
the scope of EITF 03-1, the Company will adopt the disclosure requirements for
the year ending December 31, 2004. The Company is uncertain of the effect of
adopting the accounting guidance under EITF 03-1.
In July 2004, the FASB issued EITF Issue No. 02-14 ("EITF 02-14") "Whether
an Investor Should Apply the Equity Method of Accounting to Investments Other
Than Common Stock." EITF 02-14 includes new guidance for determining whether the
equity method of accounting applies when an investor does not have an investment
in voting common stock of an investee but exercises significant influence
through other means, how the equity method should be applied to investments
other than common stock, and for securities with a readily determinable fair
market value, how the scope provisions of APB Opinion No. 18, THE EQUITY METHOD
OF ACCOUNTING FOR INVESTMENTS IN COMMON STOCK, and FASB Statement No. 115,
ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES, interact. The
accounting guidance provided in EITF 02-14 is effective for reporting periods
beginning after September 15, 2004. The Company will adopt the accounting
guidance effective October 1, 2004. The Company does not expect the adoption of
EITF 02-14 to have a material impact on its financial position or results of
operations.
12
NOTE 9 - 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 who 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.
NOTE 10 - COMPREHENSIVE (LOSS) INCOME
The components of comprehensive income, net of taxes, are as follows (in
thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- --------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- --------------
Net income $ 1,324 $ 7,469 $ 20,935 $ 19,005
Other comprehensive income (loss):
Unrealized (losses) gains on investments (2,051) (1,274) (2,306) 4,010
Foreign currency translation adjustments (143) 118 624 1,219
-------------- -------------- -------------- --------------
Comprehensive (loss) income $ (870) $ 6,313 $ 19,253 $ 24,234
============== ============== ============== ==============
NOTE 11 - SEGMENT AND GEOGRAPHIC INFORMATION
The Company is organized in two business units, the Entertainment
Technologies Group and the Software Technologies Group. The Entertainment
Technologies Group licenses content protection technology to video, music, and
PC games content owners. 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 develops
and markets the Company's Software value management solutions which include the
FLEXnet suite of electronic license management, electronic license delivery, and
software asset management products, as well as the recently acquired
InstallShield Installer, Update Service, and Admin Studio products.
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
13
development expenses. The following segment reporting information of the Company
is provided (in thousands):
REVENUES:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ---------------------------------
2004 2003 2004 2003
--------------- --------------- --------------- --------------
Entertainment Technologies Group $ 27,375 $ 22,538 $ 75,697 $ 63,728
Software Technologies Group 21,484 8,678 46,814 24,752
--------------- --------------- --------------- --------------
$ 48,859 $ 31,216 $ 122,511 $ 88,480
=============== =============== =============== ==============
INCOME BEFORE INCOME TAXES:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- -------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- -------------
Entertainment Technologies Group $ 17,900 $ 15,921 $ 49,690 $ 44,965
Software Technologies Group 6,419 3,036 16,021 7,626
Other (1,171) (355) (2,300) (762)
-------------- -------------- -------------- -------------
Segment income 23,148 18,602 63,411 51,829
General and administrative (6,635) (4,612) (17,268) (13,584)
In-process research and development (5,400) (624) (5,400) (624)
Amortization of intangibles from acquisitions (2,403) (855) (3,959) (2,567)
Amortization of deferred stock-based
compensation -- (609) (185) (2,129)
Impairment losses on strategic investments (5,298) (310) (5,478) (4,596)
Gains on strategic investments -- 16 1,220 452
Interest and other income, net 755 842 2,468 2,895
-------------- -------------- -------------- -------------
$ 4,167 $ 12,450 $ 34,809 $ 31,676
============== ============== ============== =============
INFORMATION ON REVENUES BY GEOGRAPHIC AREA:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- -------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- -------------
United States $ 27,915 $ 18,192 $ 69,354 $ 50,645
International 20,944 13,024 53,157 37,835
-------------- -------------- -------------- -------------
$ 48,859 $ 31,216 $122,511 $ 88,480
============== ============== ============== =============
Geographic area information is based upon country of destination for
products shipped and country of contract holder for royalties and license fees.
NOTE 12 - CONTINGENCIES
The Company is involved in legal proceedings related to some of its
intellectual property rights.
GLOBETROTTER V. RAINBOW TECHNOLOGIES, ELAN & KEN GREER
In November 1997, Globetrotter filed a patent infringement lawsuit (Case
No. C-98-20419-JF/EAI) in the Federal District Court for the Northern District
of California against Elan Computer Group
14
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. In September 1998, Globetrotter filed a patent
infringement suit against Rainbow Technologies, which was 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, Federal District Court granted
the Company's motions for summary judgment and dismissed all of the claims
against Globetrotter and Matt Christiano.
In December 2002 and January 2003, Ken Greer and Elan appealed the summary
judgment of their counterclaims. The Company appealed the summary judgment of
its patent infringement claims against Ken Greer, Elan and Rainbow; and Rainbow
appealed the summary judgment of its counterclaims. In March 2003, the Company
entered into a stipulated agreement with Rainbow to dismiss all cross-appeals
between Rainbow and the Company and Elan filed a brief abandoning its appeal.
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 ruled in the Company's favor in
both the patent infringement and counterclaims appeals holding that the Federal
District Court was correct in dismissing the counterclaims against the Company
and Globetrotter but was incorrect in dismissing the patent infringement claim
against Ken Greer and Elan. The patent infringement claim was remanded to the
Federal District Court for adjudication. On May 28, 2004, Elan, Greer and the
Company agreed to settle the lawsuit and dismiss all claims. A settlement
agreement was executed 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. On June 8, 2004, the Company filed a motion for dismissal with the
Court, which the parties expect to be granted in late 2004 or early 2005.
MACROVISION CORPORATION V. VITEC AUDIO AND VIDEO GMBH
The Company initiated a patent infringement lawsuit in the District Court
of Dusseldorf in March 1999 against ViTec Audio und Video GmbH, a German company
that manufactures what the Company believes to be a video copy protection
circumvention device. ViTec filed a reply brief arguing that its product does
not infringe the Company's patents. The case was heard in the District Court of
Dusseldorf, Germany. The District Court of Dusseldorf ruled adversely against
the Company. The Company appealed the District Court's ruling in July 2000 to
the Court of Appeal in Dusseldorf. A hearing took place in front of the Court of
Appeal in Dusseldorf on August 23, 2001 in which the Court stated that because
the appeal involves complex technical subject matter, the Court would require
technical expert witnesses. The Court selected Professor Dr. Ing. M. Plantholt
as its expert witness. On January 27, 2003, Professor Plantholt submitted his
technical opinion to the Court, and an English translation was made available to
the Company on July 3, 2003. The Company filed a brief in response to the expert
technical opinion with the Court of Appeals on June 9, 2004 and ViTec filed its
reply brief on September 14, 2004. The Company plans to file a reply brief in
response to ViTec's brief prior to oral proceedings scheduled for November 11,
2004.
15
In the event of an adverse ruling, the Company may incur a corresponding
decline in demand for its video copy protection technology, which could harm its
business in Germany. In addition, the Company may be obligated to pay ViTec's
attorney fees.
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 its
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 of 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.
Because the Company's filing date is prior to InterTrust's filing date, 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 early 2005. Following the
oral hearing, the Company estimates that the APJ will issue a judgment later in
2005. InterTrust had also brought an inequitable conduct motion against the
Company alleging misconduct during the original prosecution of the `281 patent.
However, the Company successfully obtained the dismissal of this motion in
September 2004.
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. On June 4, 2004, 321 Studios filed a notice of interlocutory appeal,
which the Company opposed. The Company anticipates that the court will issue
findings of fact and conclusions of law in the case by the end of the fourth
quarter of 2004. The Company has notified various large retailers of 321
Studios' products of the issuance of the preliminary injunction and requested
removal of 321 Studios' products enjoined by the preliminary injunction. 321
Studios has announced cessation of its operations and has discontinued sales
and/or distribution of enjoined products.
16
BIS ADVANCED SOFTWARE SYSTEMS, LTD. VS. INSTALLSHIELD SOFTWARE CORPORATION ET.
AL.
On September 9, 2004, BIS Advanced Software Systems, Ltd. filed a patent
infringement lawsuit against a small group of companies, including
InstallShield. The Company acquired the operations and certain assets of
InstallShield on July 1, 2004. InstallShield was served with the complaint on
September 27, 2004. The BIS patent (6,401,239) allegedly relates to a vBuild
product that InstallShield licensed from Red Bend Software and sold as an add-on
product. InstallShield discontinued sales of this product in early 2004 and the
patent does not appear to implicate any current core InstallShield products. The
Company is in the process of conducting a preliminarily review of the coverage
of the patent claims and intends to vigorously defend this suit.
As of September 30, 2004, for all the abovementioned matters, it was not
possible to estimate the liability, if any, in connection with the pending
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 the Company's opinion,
none of these other disputes and legal actions is expected to have a material
impact on its consolidated financial position, results of operation or cash
flow.
17
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 OUR 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 digital media content protection, rights management and software
value management technologies. Software value management solutions are those
various software infrastructure tools that provide software developers with
embedded pricing, licensing, rights management, installation, compliance, and
update capabilities and enterprise end user IT organizations with software asset
management, updating, and packaging functionality. Our customers include: major
Hollywood studios; independent video producers; hardware and software vendors;
music labels; consumer electronic, PC and digital set-top box manufacturers;
digital pay-per-view (PPV) and video-on-demand (VOD) network operators; and
enterprise IT organizations. We provide entertainment content owners and
software developers with the means to market, distribute, manage and protect
video, software and audio content.
Our copy protection technologies are deployed on various media formats,
distribution platforms, and hardware devices including: DVDs, videocassettes,
music CDs, and games on CD-ROMs; DVD players and recorders, digital set-top box
and hard drive recorders; and cable/satellite/telco networks and Internet
Protocol delivery platforms. Most of our software value management solutions are
incorporated into other software vendors' products, and other products are sold
as software asset management tools for enterprise IT organizations.
We are organized in two business units, the Entertainment Technologies
Group and the Software Technologies Group. The Entertainment Technologies Group
licenses content protection technology to video, music, and PC games content
owners. Our 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 develops and markets our Software value
management solutions which include the FLEXnet suite of electronic license
management, electronic license delivery, and software asset management products,
as well as the recently acquired InstallShield Installer, Update Service, and
Admin Studio products.
18
The following table provides revenue information by business unit (dollars
in thousands):
THREE MONTHS ENDED
SEPTEMBER 30,
-----------------------------------
2004 2003 $ CHANGE % CHANGE
--------------- ---------------- -------------- --------------
Entertainment Technologies Group $ 27,375 $ 22,538 $ 4,837 21.5%
Software Technologies Group 21,484 8,678 12,806 147.6
--------------- ---------------- --------------
$ 48,859 $ 31,216 $ 17,643 56.5
=============== ================ ==============
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------------
2004 2003 $ CHANGE % CHANGE
--------------- ---------------- -------------- --------------
Entertainment Technologies Group $ 75,697 $ 63,728 $ 11,969 18.8%
Software Technologies Group 46,814 24,752 22,062 89.1
--------------- ---------------- --------------
$ 122,511 $ 88,480 $ 34,031 38.5
=============== ================ ==============
The following table provides percentage of revenue information by business
unit:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
Entertainment Technologies Group 56.0% 72.2% 61.8% 72.0%
Software Technologies Group 44.0 27.8 38.2 28.0
------------- ------------- ------------- -------------
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 26.5%
and 36.6% of our revenues for the three months ended September 30, 2004 and
2003, respectively, and 29.8% and 36.7% of our revenues for the nine months
ended September 30, 2004 and 2003, respectively. Our Entertainment Technologies
Group also generates revenues from licensing digital PPV and video-on-demand
(VOD) content protection solutions to satellite and cable system operators and
equipment manufacturers that supply cable and satellite industries. Most of our
PPV content protection revenues are generated from royalties on digital set top
boxes. We also receive one-time and annual license fees from set top box, DVD,
and personal video recorder manufacturers. 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 $4.8 million,
or 21.5% from the three months ended September 30, 2003 to the three months
ended September 30, 2004, and increased $12.0 million or 18.8% from the nine
months ended September 30, 2003 to the nine months ended
19
September 30, 2004. The increases are primarily due to the increase in numbers
of DVDs sold and continued strong demand for our DVD copy protection solution
despite declining unit royalties over the past two years. 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. During the third quarter of 2004 we
recognized approximately $1.7 million of revenue from studio volume replicated
during the first two quarters of 2004. We were not able to record these revenues
in the quarter in which the volumes were replicated due to prolonged contract
negotiations. During the second quarter of 2003 and the nine months ended
September 30, 2003, the increase in DVD copy protection revenues included
approximately $917,000 in revenue from the resolution of one customer's over
reporting claim. Additionally, during the three and nine months ended September
30, 2003, DVD copy protection revenues included approximately $458,000 resulting
from royalty audit activity that detected underreporting by certain replicators
in prior periods.
We actively engage in intellectual property compliance and enforcement
activities focused on identifying third parties who have underreported to us the
amount of royalties owed under license agreements with us. As a result, from
time to time, we may not receive timely replicator reports and therefore, we
recognize revenues that relate to activities from prior periods. These royalty
recoveries may cause revenues to be higher than expected during a particular
reporting period and may not occur in subsequent periods. We cannot predict the
amount or timing of such revenues.
To a lesser extent, the increases in revenue from our Entertainment
Technologies Group are also due to an increase in PPV and music technology
revenues. The increase in PPV revenue is primarily from royalties and license
fees from set top box manufacturers due to strong demand from consumers,
especially in international territories, for digital cable and digital satellite
operators' businesses. The increase in music copy protection technology products
is due to continuing use in Asia and Europe, and to a particular technology
license for our controlled burning feature with an international on-line e-music
store customer.
From the three and nine months ended September 30, 2003 to 2004,
videocassette copy protection revenues have continued to decrease in absolute
terms as the trend of MPAA studios to discontinue copy protecting their VHS
releases has continued. Our PC Games technology revenues have decreased from the
nine months ended September 30, 2003 to 2004 due to increased competition,
resulting in a reduction in volumes copy protected by our technology as well as
declining per unit prices. Despite the increased competition, PC games revenues
have increased modestly from the three months ended September 30, 2003 to 2004.
We believe that total revenues from our Entertainment Technologies Group in
future quarters will increase in absolute terms and continue to be a significant
part of our revenues, although our DVD per unit royalties will continue to
decline and our DVD revenues may decline in absolute terms.
20
SOFTWARE TECHNOLOGIES GROUP
Our software products generate revenue from licensing software value
management solutions and providing services related to the support and
maintenance of this software. Revenues from our Software Technologies Group
increased $12.8 million or 147.6% from the three months ended September 30, 2003
to the three months ended September 30, 2004, and increased $22.1 million or
89.1% from the nine months ended September 30, 2003 to the nine months ended
September 30, 2004. For the three months ended September 30, 2003 to the three
months ended September 30, 2004, 100% of the increase in our Software
Technologies Group revenue is due to the inclusion of InstallShield since July
1, 2004, and 47.6% of the increase is due to increased sales of our FLEXnet
license management solutions resulting from the impact of broad based product
and marketing programs and additional sales personnel in our Software
Technologies Group. For the nine months ended September 30, 2003 to the nine
months ended September 30, 2004, 54.1% of the increase in our Software
Technologies Group revenue is due to increased sales of our FLEXnet license
management solutions resulting from the impact of broad based product and
marketing programs and additional sales personnel in our Software Technologies
Group, and 35.0% of the increase is due to the inclusion of InstallShield since
July 1, 2004. We believe that revenues from our Software Technologies Group will
continue to increase in future quarters in absolute terms and as a percentage of
our total REVENUES.
SEASONALITY OF BUSINESS
We have experienced significant seasonality in our business, and our
consolidated financial condition and results of operations are likely to be
affected by seasonality in the future. We have typically experienced our highest
revenues in the fourth quarter of each calendar year followed by lower revenues
and operating income in the first quarter 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.
COSTS AND EXPENSES
Our cost of revenues in our Entertainment Technologies Group 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. Our cost of revenues in our Software Technologies
Group includes software product support costs, direct labor and benefit costs of
employees' time spent on billable consulting or training, the cost of producing
and shipping CDs containing our software and certain license fees paid to third
parties. Cost of revenues also include patent defense costs, amortization of
licensed technologies and 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.
21
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 content 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 guaranteed quantities of
licensed units or royalties based on a percentage of licensed product sales 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;
digital set-top decoder manufacturers; and content owners who utilize our
Hawkeye peer-to-peer network content management service 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.
22
SOFTWARE LICENSING REVENUES
We sell our software value management solutions through our direct sales
force and through resellers. 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 offer resellers the right of
return on our packaged products under certain policies and programs. We estimate
and record reserves for product returns as an offset to revenue. 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 and
payable 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 ("VSOE") of fair value 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 of fair value does not exist for all undelivered elements, all
revenue is deferred until such time as VSOE of fair value 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 of fair value 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.
PROFESSIONAL SERVICES REVENUES
We provide consulting and training services to our software vendor and
enterprise 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.
23
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 September 30, 2004 and December 31, 2003, the adjusted cost of our
strategic investments totaled $18.2 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. Based on such methods, we recorded an other-than temporary
impairment of $5.3 million on our investment in Digimarc during the three and
nine months ended September 30, 2004.
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 September 30, 2004,
our investment in iVast had no remaining carrying value.
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.
24
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the excess of cost 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 nine months
ended September 30, 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 2004 annual impairment analysis has been
scheduled for October 2004 and is currently in progress at the time of this
filing.
IMPAIRMENT OF LONG-LIVED ASSETS
In accordance with SFAS No. 144, long-lived assets, such as property and
equipment, and purchased intangibles subject to amortization, are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset group may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset group to estimated undiscounted future cash flows expected to be
generated by the asset group. If the carrying amount of an asset group exceeds
its estimated future cash flows, an impairment charge is recognized in the
amount by which the carrying amount of the asset group exceeds the fair value of
the asset group. Assets to be disposed of would be separately presented in the
balance sheet and reported at the lower of the carrying amount or fair value
less costs to sell, and would no longer be depreciated. The assets and
liabilities of a disposal group classified as held for sale would be presented
separately in the appropriate asset and liability sections of the balance sheet.
During the nine months ended September 30, 2004 and fiscal year 2003, no
impairment charges were recorded for long-lived assets.
25
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
September 30, 2004 and December 31, 2003, deferred tax assets net of valuation
allowances, totaled $22.0 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. During the quarter ended
September 30, 2004, we determined that sufficient uncertainty existed regarding
our ability to realize our deferred tax assets related to capital loss
carryforwards; therefore, a valuation allowance was established against such
deferred tax assets. We recorded income tax expense of $3.3 million during the
three and nine months ended September 30, 2004 as result of the increase in
valuation allowance.
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.
Including the charge of $3.3 million during the quarter ended September 30,
2004, the annual effective rate for 2004 is estimated to be approximately 36% of
pretax income. Income tax expense represents combined federal, state and foreign
taxes at effective rates of 68% and 40% for the three and nine months ended
September 30, 2004, respectively, compared to 40% for the three and nine months
ended September 30, 2003. The change in effective tax rates for those periods in
2004 compared to 2003 were primarily due to the increase in valuation allowance
and the change in tax jurisdictions where our income was earned.
26
RESULTS OF OPERATIONS
The following table provides information on our results of operations
(dollars in thousands):
THREE MONTHS ENDED
SEPTEMBER 30,
-------------------------------------
2004 2003 $ CHANGE % CHANGE
----------------- ---------------- ----------------- ---------------
Revenues:
Licenses $ 42,119 $ 28,210 $ 13,909 49.3%
Services 6,740 3,006 3,734 124.2
----------------- ---------------- -----------------
Total revenues 48,859 31,216 17,643 56.5
Cost of revenues:
License fees 2,737 1,273 1,464 115.0
Service fees 3,338 625 2,713 434.1
Amortization of intangibles from
acquisitions 2,403 855 1,548 181.1
----------------- ---------------- -----------------
Total cost of revenues 8,478 2,753 5,725 208.0
----------------- ---------------- -----------------
Gross profit 40,381 28,463 11,918 41.9
Operating expenses:
Research and development 8,409 4,177 4,232 101.3
Selling and marketing 11,227 6,539 4,688 71.7
General and administrative 6,635 4,612 2,023 43.9
In-process research and development 5,400 624 4,776 765.4
Amortization of deferred stock based
compensation -- 609 (609) (100.0)
----------------- ---------------- -----------------
Total operating expenses 31,671 16,561 15,110 91.2
----------------- ---------------- -----------------
Operating income 8,710 11,902 (3,192) (26.8)
Impairment losses on strategic
investments (5,298) (310) (4,988) (1,609.0)
Gains on strategic investments -- 16 (16) (100.0)
Interest and other income, net 755 842 (87) (10.3)
----------------- ---------------- -----------------
Income before income taxes 4,167 12,450 (8,283) (66.5)
Income taxes 2,843 4,981 (2,138) (42.9)
----------------- ---------------- -----------------
Net income $ 1,324 $ 7,469 $ (6,145) (82.3)
================= ================ =================
27
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------------
2004 2003 $ CHANGE % CHANGE
------------------- ---------------- --------------- --------------
Revenues:
Licenses $ 108,950 $ 79,675 $ 29,275 36.7%
Services 13,561 8,805 4,756 54.0
------------------- ---------------- ---------------
Total revenues 122,511 88,480 34,031 38.5
Cost of revenues:
License fees 5,766 3,395 2,371 69.8
Service fees 5,077 1,765 3,312 187.6
Amortization of intangibles from
acquisitions 3,959 2,567 1,392 54.2
------------------- ---------------- ---------------
Total cost of revenues 14,802 7,727 7,075 91.6
------------------- ---------------- ---------------
Gross profit 107,709 80,753 26,956 33.4
Operating expenses:
Research and development 19,704 12,076 7,628 63.2
Selling and marketing 28,553 19,415 9,138 47.1
General and administrative 17,268 13,584 3,684 27.1
In-process research and development 5,400 624 4,776 765.4
Amortization of deferred stock based
compensation 185 2,129 (1,944) (91.3)
------------------- ---------------- ---------------
Total operating expenses 71,110 47,828 23,282 48.7
------------------- ---------------- ---------------
Operating income 36,599 32,925 3,674 11.2
Impairment losses on investments (5,478) (4,596) (882) (19.2)
Gains on strategic investments 1,220 452 768 169.9
Interest and other income, net 2,468 2,895 (427) (14.7)
------------------- ---------------- ---------------
Income before income taxes 34,809 31,676 3,133 9.9
Income taxes 13,874 12,671 1,203 9.5
------------------- ---------------- ---------------
Net income $ 20,935 $ 19,005 $ 1,930 10.2
=================== ================ ===============
LICENSE REVENUES. Our license revenues increased $13.9 million or 49.3%
from the three months ended September 30, 2003 to the three months ended
September 30, 2004, and increased $29.3 million or 36.7% from the nine months
ended September 30, 2003 to the nine months ended September 30, 2004.
For the three months ended September 30, 2003 to the three months ended
September 30, 2004, 27.2% of the increase in license revenues is primarily due
to higher revenue from our DVD, PPV, music content protection and FLEXnet
products. For the three months ended September 30, 2003 to the three months
ended September 30, 2004, 22.1% of the increase in license revenues is due to
the inclusion of InstallShield revenue since July 1, 2004.
For the nine months ended September 30, 2003 to the nine months ended
September 30, 2004, 28.9% of the increase in license revenues is primarily due
to higher revenue from our DVD, PPV, music content protection and FLEXnet
products. For the nine months ended September 30, 2003 to the nine months ended
September 30, 2004, 7.8% of the increase is due to the inclusion of
InstallShield revenue since July 1, 2004.
DVD revenues are higher due to the continued growth in demand of the DVD
format, a strong hit release schedule that more than offset modest declines in
our average unit royalties and decreased usage by certain Hollywood studios.
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. During the third
quarter of 2004 we recognized approximately $1.7 million of revenue from studio
volume replicated during the first two quarters of 2004. We were not able
28
to record these revenues in the quarter in which the volumes were replicated due
to prolonged contract negotiations. During the second quarter of 2003 and the
nine months ended September 30, 2003, the increase in DVD copy protection
revenues included approximately $917,000 in revenue from the resolution of one
customer's over reporting claim. During the three and nine months ended
September 30, 2003, DVD copy protection revenues included approximately $458,000
resulting from royalty audit activity that detected underreporting by certain
replicators in prior periods. The increase in license revenues is also due to an
increase in PPV revenue, primarily from royalties and license fees from digital
set top boxes due to strong demand from consumers, especially in international
territories, for digital cable and digital satellite operators' businesses. The
increase in music copy protection technology products is due to continuing use
in Asia and Europe, and to a particular technology license for our controlled
burning feature with an international on-line e-music store customer.
Excluding the inclusion of InstallShield since July 1, 2004, the increases
in license revenue from our Software Technologies Group are primarily due to
increased sales of our FLEXnet license management solutions resulting from the
impact of broad based product and marketing programs and additional sales
personnel in our Software Technologies Group.
SERVICE REVENUES. Our service revenues increased $3.7 million or 124.2%
from the three months ended September 30, 2003 to the three months ended
September 30, 2004, and $4.8 million or 54.0% from the nine months ended
September 30, 2003 to the nine months ended September 30, 2004. For the three
months ended September 30, 2003 to the three months ended September 30, 2004,
43.0% of the increase in service revenues is primarily due to the growth of our
professional services practice which has generated higher consulting revenue and
our increased market penetration has resulted in higher maintenance revenue.
81.2% of the increase in service revenues is primarily due to the inclusion of
InstallShield since July 1, 2004. For the nine months ended September 30, 2003
to the nine months ended September 30, 2004, 27.7% of the increase in service
revenues is primarily due to the inclusion of InstallShield since July 1, 2004,
and 26.3% is due to the growth of our professional services practice which has
generated higher consulting revenue and our increased market penetration has
resulted in higher maintenance revenue.
COST OF REVENUES - LICENSE FEES. Cost of revenues from license fees as a
percentage of license revenues increased from 4.5% for the three months ended
September 30, 2003 to 6.5% for the three months ended September 30, 2004, and
increased from 4.3% for the nine months ended September 30, 2003 to 5.3% for the
nine months ended September 30, 2004. Cost of revenues from license fees
increased $1.5 million or 115.0% from the three months ended September 30, 2003
to the three months ended September 30, 2004, and increased $2.4 million or
69.8% from the nine months ended September 30, 2003 to the nine months ended
September 30, 2004. The increases are primarily due to higher patent defense
costs and higher patent amortization costs. To a lesser extent, the increase is
due to the inclusion of InstallShield since July 1, 2004. 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, licensing expenses and the cost of producing and shipping
CDs containing our software.
COST OF REVENUES - SERVICE FEES. Cost of revenues from service fees as a
percentage of service revenues increased from 20.8% for the three months ended
September 30, 2003 to 49.5% for the three months ended September 30, 2004, and
increased from 20.0% for the nine months ended September 30, 2003 to 37.4% for
the nine months ended September 30, 2004. Cost of revenues from service fees
increased $2.7 million or 434.1% from the three months ended September 30, 2003
to the three months ended September 30, 2004, and increased $3.3 million or
187.6% for the nine months ended September 30, 2003 to the nine months ended
September 30, 2004. The increases are primarily due to the expansion of our
professional services group to support additional consulting and implementation
projects for
29
our FLEXnet solutions. The increases are also due to the inclusion of
InstallShield since July 1, 2004. 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 increased $1.5 million from the three
months ended September 30, 2003 to the three months ended September 30, 2004,
and increased $1.4 million from the nine months ended September 30, 2003 to the
nine months ended September 30, 2004. The increase is primarily due to the
amortization of intangibles from the acquisition of InstallShield in July 2004.
RESEARCH AND DEVELOPMENT. Research and development expenses increased by
$4.2 million or 101.3% from the three months ended September 30, 2003 to the
three months ended September 30, 2004, and increased $7.6 million or 63.2% from
the nine months ended September 30, 2003 to the nine months ended September 30,
2004. The increase is primarily due to increased research and development
activities for our video technology, music technology, peer-to-peer network
content management and software value management products resulting in higher
costs. The increases are also due to the inclusion of InstallShield since July
1, 2004. Research and development expenses increased as a percentage of revenues
from 13.4% in the three months ended September 30, 2003 to 17.2% in the three
months ended September 30, 2004, and increased from 13.6% in the nine months
ended September 30, 2003 to 16.1% in the nine months ended September 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 to support customer/market demand
for new technologies from our Entertainment Technologies Group and Software
Technologies Group.
SELLING AND MARKETING. Selling and marketing expenses increased by $4.7
million or 71.7% from the three months ended September 30, 2003 to the three
months ended September 30, 2004, and increased $9.1 million or 47.1% from the
nine months ended September 30, 2003 to the nine months ended September 30,
2004. The increases are due to higher costs from increased business development
activities for our entertainment and software technologies products on an
overall basis as well as increased commission costs associated with higher
revenue levels. The increases are also due to the inclusion of InstallShield
since July 1, 2004. Selling and marketing expenses increased as a percentage of
revenues from 20.9% in the three months ended September 30, 2003 to 23.0% for
the three months ended September 30, 2004, and increased from 21.9% from the
nine months ended September 30, 2003 to 23.3% for the nine months ended
September 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 to increase our market share and grow our business.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
by $2.0 million or 43.9% from the three months ended September 30, 2003 to the
three months ended September 30, 2004, and increased $3.7 million or 27.1% from
the nine months ended September 30, 2003 to the nine months ended September 30,
2004. The increases are primarily due to increased headcount and related costs
to support the overall growth of our business units and higher costs for
compliance with the Sarbanes-Oxley Act of 2002. To a lesser extent, the increase
is also due to the inclusion of InstallShield since July 1, 2004. General and
administrative expenses decreased as a percentage of revenues from 14.8% in the
three months ended September 30, 2003 to 13.6% in the three months ended
September 30, 2004 and decreased from 15.4% in the nine months ended September
30, 2003 to 14.1% in the nine months ended September 30, 2004. We expect our
general and administrative expenses to increase in absolute terms as we continue
to support the expansion of our business, to integrate the administrative and
systems infrastructure between InstallShield and Macrovision, and to comply with
the requirements of the Sarbanes-Oxley Act of 2002.
30
IN-PROCESS RESEARCH AND DEVELOPMENT. In connection with the acquisition of
InstallShield in July 2004, $5.4 million was charged to in-process research and
development in the three and nine months ended September 30, 2004. In connection
with the acquisition of intellectual property and other assets in the
peer-to-peer space, $624,000 was charged to in-process research and development
in the three and nine months ended September 30, 2003.
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 $609,000 from the
three months ended September 30, 2003 to the three months ended September 30,
2004, and decreased $1.9 million from the nine months ended September 30, 2003
to the nine months ended September 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 STRATEGIC INVESTMENTS. For the three months ended
September 30, 2004, we recorded $5.3 million in charges relating to an
other-than-temporary impairment in our investment in Digimarc. For the nine
months ended September 30, 2004, we recorded $5.5 million in charges relating to
other-than-temporary impairments in our investments in Digimarc and iVast. For
the three and nine months ended September 30, 2003, we recorded $310,000 and
$4.6 million, respectively, of charges relating to other-than-temporary
impairments of our investment in iVast.
GAINS ON STRATEGIC INVESTMENTS. For the three months ended September 30,
2004, we had no gains on strategic investments. For the nine months ended
September 30, 2004, we received $1.2 million in cash for our interest in
InterActual Technologies, the assets of which were 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 nine months ended September 30,
2004, we recorded a gain on strategic investments of $1.2 million. During the
three months ended September 30, 2003, we recorded a realized gain of $16,000
for distributions received in excess of its book value for our investment in
NTRU Cryptosystems, a private company strategic investment. During the nine
months ended September 30, 2003, we recorded a realized gain of $395,000 from
the surrender of our stock in TTR, a public company strategic investment and a
realized gain of $57,000 for distributions received in excess of its book value
for our investment in NTRU Cryptosystems, a private company strategic
investment.
INTEREST AND OTHER INCOME, NET. Interest and other income decreased $87,000
or 10.3% from the three months ended September 30, 2003 to the three months
ended September 30, 2004. This decrease is primarily due to a decrease in the
amounts invested, which were used to fund the InstallShield acquisition.
Interest and other income decreased $427,000 or 14.7% from the nine months ended
September 30, 2003 to the nine months ended September 30, 2004. This decrease is
primarily due to declining interest rates and a decrease in the amounts
invested.
INCOME TAXES. Including the charge of $3.3 million during the quarter ended
September 30, 2004, the annual effective rate for the year is estimated to be
approximately 36% of pretax income. Income tax expense represents combined
federal, state and foreign taxes at effective rates of 68% and 40% for the three
and nine months ended September 30, 2004, respectively, compared to 40% for the
three and nine months ended September 30, 2003. The change in effective tax
rates for those periods in 2004 compared to 2003 were primarily due to the
increase in valuation allowance and the change in tax jurisdictions where our
income was earned.
31
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations primarily from cash generated by
operations, principally our copy protection products and our software value
management products. Our operating activities provided net cash of $36.3 million
and $40.7 million for the nine months ended September 30, 2004 and 2003,
respectively. Cash provided by operating activities decreased $4.5 million from
the nine months ended September 30, 2003 to the nine months ended September 30,
2004, primarily due to tax payments made during the year.
Investing activities used net cash of $545,000 and $112.1 million for the
nine months ended September 30, 2004 and 2003, respectively. Cash used in
investing activities decreased $111.5 million from the nine months ended
September 30, 2003 to the nine months ended September 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 use of proceeds to acquire InstallShield in July 2004. We made capital
expenditures of $3.3 million and $1.7 million during the nine months ended
September 30, 2004 and 2003, respectively. Capital expenditures are primarily
for computer software and hardware.
In July 2004, we acquired the operations and certain assets of
InstallShield Software Corporation ("InstallShield") for approximately $77.1
million in cash, including 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 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.
InstallShield is a leading provider of software installation tools. The
acquisition of InstallShield expands our product portfolio in the software value
management category and enables us to reach InstallShield's large software
developer customer base. InstallShield's personnel, operations, and products
have been integrated into our Software Technologies Group.
Net cash provided by financing activities was $7.0 million and $4.8 million
for the nine months ended September 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 nine
months ended September 30, 2004 and 2003. As of September 30, 2004, 2.0 million
shares remained authorized for repurchase.
At September 30, 2004, we had $70.7 million in cash and cash equivalents,
$88.8 million in short-term investments, $63.7 million in long-term marketable
investment securities, which includes $18.2 million in fair market value of our
holdings in Digimarc, and $851,000 in restricted cash. We anticipate that
capital expenditures for the next quarter will not exceed $1.3 million. We also
have future minimum lease payments of approximately $37.7 million under
operating leases. We believe that the current available funds and cash flows
generated from operations will be sufficient to meet our working capital and
capital expenditure requirements for the foreseeable future.
We may also use cash to acquire or invest in 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
32
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 nine months
ended September 30, 2004, we paid $783,000 of such contingent consideration in
cash relating to revenues generated in 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
software value 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 September 30, 2004 were as follows (in thousands):
Operating
Leases
------------
Remainder of 2004 $ 1,225
2005 4,596
2006 4,552
2007 4,686
2008 4,828
2009 and thereafter 17,780
------------
Total $ 37,667
============
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 September 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
33
Statements -- Frequently Asked Questions and Answers" document. The adoption of
SAB No. 104 has had no material impact on our 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. 132 (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 covered by SFAS No.132 as of
September 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 was effective for other-than-temporary
impairment evaluations made in reporting periods beginning after June 15, 2004.
However, this guidance has been delayed to an unknown date by FSP EITF Issue
03-1-1, "Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, "The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain Investments."
The disclosure requirements continue to be effective for annual periods ending
after December 15, 2003, for investments accounted for under SFAS No. 115
"Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No.
115.") For all other investments within the scope of EITF 03-1, the disclosures
continue to be effective in annual financial statements for fiscal years ending
after June 15, 2004. The additional disclosures for cost method investments
continue to be effective for fiscal years ending after June 15, 2004. We adopted
the disclosure requirements for investments accounted for under SFAS 115 in the
year ended December 31, 2003. For all other investments within the scope of EITF
03-1, we will adopt the disclosure requirements for the year ending December 31,
2004. We are uncertain of the effect of adopting the accounting guidance under
EITF 03-1.
In July 2004, the FASB issued EITF Issue No. 02-14 ("EITF 02-14") "Whether
an Investor Should Apply the Equity Method of Accounting to Investments Other
Than Common Stock." EITF 02-14 includes new guidance for determining whether the
equity method of accounting applies when an investor does not have an investment
in voting common stock of an investee but exercises significant influence
through other means, how the equity method should be applied to investments
other than common stock, and for securities with a readily determinable fair
market value, how the scope provisions of APB Opinion No. 18, THE EQUITY METHOD
OF ACCOUNTING FOR INVESTMENTS IN COMMON STOCK, and FASB Statement No. 115,
ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES, interact. The
accounting guidance provided in EITF 02-14 is effective for reporting periods
beginning after September 15, 2004. We will adopt the accounting guidance
effective October 1, 2004. We do not expect the adoption of EITF 02-14 to have a
material impact on its financial position or results of operations.
34
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 and restricted cash
of $224.1 million as of September 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 $560,000 decrease (approximately
0.3%) in the fair value of our fixed income available-for-sale securities as of
September 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.
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 $18.2 million and
$27.0 million, represented 4.4% and 7.0% of our total assets as of September 30,
2004 and December 31, 2003, respectively. As of September 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 September 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 three and nine
months ended September 30, 2004, we charged $5.3 million and $5.5 million,
respectively, of impairments that were other-than-temporary to operations.
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
35
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
sufficiently effective to ensure that the information disclosed by us in this
report was recorded, processed, summarized and reported within the time periods
and guidelines specified in the SEC's rules and forms.
CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING. During the quarter
ended September 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.
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.
In September 1998, Globetrotter filed a patent infringement suit against Rainbow
Technologies, which was 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, Federal District Court granted
our motions for summary judgment and dismissed all of the claims against
Globetrotter and Matt Christiano.
In December 2002 and January 2003, Ken Greer and Elan appealed the summary
judgment of their counterclaims. We appealed the summary judgment of our patent
infringement claims against Ken Greer, Elan and Rainbow; and Rainbow appealed
the summary judgment of its counterclaims. In March 2003, we entered into a
stipulated agreement with Rainbow to dismiss all cross-appeals between Rainbow
and us and Elan filed a brief abandoning its appeal. This left only Ken Greer's
appeal and our cross-appeal. On March 23, 2004, the Court of Appeal of the
Federal Circuit ruled in our favor in both the
36
patent infringement and counterclaims appeals holding that the Federal District
Court was correct in dismissing the counterclaims against us and Globetrotter
but was incorrect in dismissing the patent infringement claim against Ken Greer
and Elan. The patent infringement claim was remanded to theFederal District
Court for adjudication. On May 28, 2004, Elan, Greer and the We agreed to settle
the lawsuit and dismiss all claims. A settlement agreement was executed 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. On June 8, 2004, we filed
a motion for dismissal with the Court, which the parties expect to be granted in
late 2004 or early 2005.
MACROVISION CORPORATION V. VITEC AUDIO AND VIDEO GMBH
We initiated a patent infringement lawsuit in the District Court of
Dusseldorf in March 1999 against ViTec Audio und Video GmbH, a German company
that manufactures what we believe to be a video copy protection circumvention
device. ViTec filed a reply brief arguing that its product does not infringe our
patents. The case was heard in the District Court of Dusseldorf, Germany. The
District Court of Dusseldorf ruled adversely against us. We appealed the
District Court's ruling in July 2000 to the Court of Appeal in Dusseldorf. A
hearing took place in front of the Court of Appeal in Dusseldorf on August 23,
2001 in which the Court stated that because the appeal involves complex
technical subject matter, the Court would require technical expert witnesses.
The Court selected Professor Dr. Ing. M. Plantholt as its expert witness. On
January 27, 2003, Professor Plantholt submitted his technical opinion to the
Court, and an English translation was made available to us on July 3, 2003. We
filed a brief in response to the expert technical opinion with the Court of
Appeals on June 9, 2004 and ViTec filed its reply brief on September 14, 2004.
We plan to file a reply brief in response to ViTec's brief prior to oral
proceedings scheduled for November 11, 2004.
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 ViTec's attorney fees.
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 its 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 of 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.
Because our filing date is prior to InterTrust's filing date, 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
37
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 early 2005. Following the oral hearing, we estimate
that the APJ will issue a judgment later in 2005. InterTrust had also brought an
inequitable conduct motion against us alleging misconduct during the original
prosecution of the `281 patent. However, we successfully obtained the dismissal
of this motion in September 2004.
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. On June 4, 2004, 321 Studios filed
a notice of interlocutory appeal, which we opposed. We anticipate that the court
will issue findings of fact and conclusions of law in the case by the end of the
fourth quarter of 2004. We have notified various large retailers of 321 Studios'
products of the issuance of the preliminary injunction and requested removal of
321 Studios' products enjoined by the preliminary injunction. 321 Studios has
announced cessation of its operations and has discontinued sales and/or
distribution of enjoined products.
BIS ADVANCED SOFTWARE SYSTEMS, LTD. VS. INSTALLSHIELD SOFTWARE CORPORATION ET.
AL.
On September 9, 2004, BIS Advanced Software Systems, Ltd. filed a patent
infringement lawsuit against a small group of companies, including
InstallShield. We acquired the operations and certain assets of InstallShield on
July 1, 2004. InstallShield was served with the complaint on September 27, 2004.
The BIS patent (6,401,239) allegedly relates to a vBuild product that
InstallShield licensed from Red Bend Software and sold as an add-on product.
InstallShield discontinued sales of this product in early 2004 and the patent
does not appear to implicate any current core InstallShield products. We are in
the process of conducting a preliminarily review of the coverage of the patent
claims and intend to vigorously defend this suit.
As of September 30, 2004, for all the abovementioned matters, it was not
possible to estimate the liability, if any, in connection with the pending
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.
38
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
Exhibit No. Exhibit
- ----------------------- -------------------------------------------------
31.01 Rule 13a-14(a)/15d-14(a) Certification
31.02 Rule 13a-14(a)/15d-14(a) Certification
32.01 Section 1350 Certification
32.02 Section 1350 Certification
39
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Macrovision Corporation
AUTHORIZED OFFICER:
Date: November 8, 2004 By: /s/ William A. Krepick
------------------------- ---------------------------------------
William A. Krepick
President and Chief Executive Officer
PRINCIPAL FINANCIAL OFFICER AND CHIEF ACCOUNTING OFFICER:
Date: November 8, 2004 By: /s/ Ian R. Halifax
------------------------- ---------------------------------------
Ian R. Halifax
Executive Vice President, Finance and
Administration, Chief Financial Officer
and Secretary
40