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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
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) 562-8400
(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 May 1, 2005
Common stock, $0.001 par value 50,449,193
MACROVISION CORPORATION
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION
Page
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2005
and December 31, 2004 1
Condensed Consolidated Statements of Income
for the Three Months Ended March 31, 2005 2
Condensed Consolidated Statements of Cash Flows
for the Three Months Ended March 31, 2005 3
Notes to Condensed Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk 28
Item 4. Controls and Procedures 29
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 32
Item 3. Defaults Upon Senior Securities 32
Item 4. Submission of Matters to a Vote of Security Holders 32
Item 5. Other Information 33
Item 6. Exhibits 33
Signatures 34
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
MARCH 31, DECEMBER 31,
2005 2004
-------------------- -------------------
ASSETS
Current assets:
Cash and cash equivalents $ 113,740 $ 104,957
Restricted cash -- 859
Short-term investments 122,449 101,299
Accounts receivable, net of allowance for doubtful accounts of
$2,701 and $2,147, respectively 39,047 41,468
Income taxes receivable 1,705 1,705
Deferred tax assets 6,414 6,368
Prepaid expenses and other current assets 5,857 4,570
-------------------- -------------------
Total current assets 289,212 261,226
Long-term marketable investment securities 29,024 47,414
Property and equipment, net 9,381 9,295
Goodwill 74,188 74,529
Other intangibles from acquisitions, net 28,724 31,185
Deferred tax assets 17,033 17,151
Patents and other assets 11,537 11,673
-------------------- -------------------
$ 459,099 $ 452,473
==================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,127 $ 5,907
Accrued expenses 27,558 32,639
Deferred revenue 18,032 14,604
-------------------- -------------------
Total current liabilities 50,717 53,150
Other non current liabilities 1,553 979
-------------------- -------------------
Total liabilities 52,270 54,129
Stockholders' equity:
Common stock 53 53
Treasury stock, at cost (38,450) (38,450)
Additional paid-in-capital 316,133 311,643
Accumulated other comprehensive income 7,637 9,109
Retained earnings 121,456 115,989
-------------------- -------------------
Total stockholders' equity 406,829 398,344
-------------------- -------------------
$ 459,099 $ 452,473
==================== ===================
See the accompanying notes to these condensed consolidated financial statements.
1
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
---------------------------------------
2005 2004
------------------- ------------------
Revenues:
Licenses $ 44,228 $ 34,823
Services 7,029 3,159
------------------- ------------------
Total revenues 51,257 37,982
Cost of revenues:
License fees 2,234 1,584
Service fees 3,144 721
Amortization of intangibles from acquisitions 2,416 779
------------------- ------------------
Total cost of revenues 7,794 3,084
------------------- ------------------
Gross profit 43,463 34,898
Operating expenses:
Research and development 8,697 5,587
Selling and marketing 12,922 8,556
General and administrative 8,426 5,513
Amortization of deferred stock-based compensation -- 185
------------------- ------------------
Total operating expenses 30,045 19,841
------------------- ------------------
Operating income 13,418 15,057
Impairment losses on strategic investments (5,822) (180)
Gains on strategic investments 96 1,220
Interest and other income, net 937 728
------------------- ------------------
Income before income taxes 8,629 16,825
Income taxes 3,162 6,057
------------------- ------------------
Net income $ 5,467 $ 10,768
=================== ==================
Basic net earnings per share $ 0.11 $ 0.22
=================== ==================
Shares used in computing basic net earnings per share 50,349 49,244
=================== ==================
Diluted net earnings per share $ 0.11 $ 0.21
=================== ==================
Shares used in computing diluted net earnings per share 51,341 50,210
=================== ==================
See the accompanying notes to these condensed consolidated financial statements.
2
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
--------------------------------------------
2005 2004
-------------------- --------------------
Cash flows from operating activities:
Net income $ 5,467 $ 10,768
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 1,366 1,066
Amortization of intangibles from acquisitions 2,416 779
Amortization of deferred stock-based compensation -- 185
Tax benefit from stock options exercises 663 618
Impairment losses on strategic investments 5,822 180
Gains on strategic investments (96) (1,220)
Deferred tax expense 358 --
Changes in operating assets and liabilities:
Accounts receivable, net 2,354 (2,665)
Deferred revenue 3,531 1,795
Other assets (1,958) (1,134)
Other liabilities (4,817) (192)
-------------------- --------------------
Net cash provided by operating activities 15,106 10,180
Cash flows from investing activities:
Purchases of long and short-term investments (68,965) (132,401)
Sales or maturities of long and short-term investments 59,668 155,431
Acquisition of property and equipment (1,066) (806)
Payments for patents (297) (318)
Proceeds from sale of strategic investments 96 1,220
Contingent consideration for Midbar acquisition (497) (723)
Decrease in restricted cash 859 --
-------------------- --------------------
Net cash (used in) provided by investing activities (10,202) 22,403
Cash flows from financing activities:
Proceeds from issuance of common stock from options and stock
purchase plans 3,827 2,357
-------------------- --------------------
Net cash provided by financing activities 3,827 2,357
Effect of exchange rate changes on cash and cash equivalents 52 129
-------------------- --------------------
Net increase in cash and cash equivalents 8,783 35,069
Cash and cash equivalents at beginning of period 104,957 27,918
-------------------- --------------------
Cash and cash equivalents at end of period $ 113,740 $ 62,987
==================== ====================
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, 2004.
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, 2005, for any future year, or for any other future interim
period.
NOTE 2 - 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):
4
THREE MONTHS ENDED
MARCH 31,
------------------------------
2005 2004
-------------- -------------
Net income, as reported $ 5,467 $ 10,768
Add: stock-based employee compensation
expense included in reported net income,
net of related tax effects -- 111
Deduct: total stock-based employee
compensation expenses determined under
fair-value-based method for all rewards,
net of related tax effects (2,852) (1,964)
-------------- -------------
Net income, pro forma $ 2,615 $ 8,915
============== =============
Basic net earnings per share As reported $ 0.11 $ 0.22
Adjusted pro forma $ 0.05 $ 0.18
Diluted net earnings per share As reported $ 0.11 $ 0.21
Adjusted pro forma $ 0.05 $ 0.18
In most cases, options vest over three 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, 2005, in future years or in any future interim
period.
5
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
MARCH 31,
--------------------------------
2005 2004
--------------- --------------
OPTION PLANS:
Dividends None None
Expected term 2.3 years 2.6 years
Risk free interest rate 3.3% 1.7%
Volatility rate 61.7% 73.5%
ESPP PLAN:
Dividends None None
Expected term 1.3 years 1.6 years
Risk free interest rate 2.4% 2.2%
Volatility rate 68.5% 74.1%
The weighted average fair values of options granted during the three
months ended March 31, 2005 and 2004 were $8.92 and $8.51, respectively. The
weighted average fair values of an ESPP purchase share right granted during the
three months ended March 31, 2005 and 2004 were $9.79 and $7.86, respectively.
NOTE 3 - BUSINESS COMBINATION AND ASSET PURCHASES
As of December 31, 2004, $859,000 of cash was restricted, primarily
relating to certain liabilities assumed as part of the acquisition of
InstallShield. During the quarter ended March 31, 2005, this amount was released
and is no longer restricted as of March 31, 2005.
The following table summarizes the Company's goodwill from acquisitions as of
March 31, 2005 (in thousands):
Goodwill, net at January 1, 2005 $ 74,529
Changes due to foreign currency exchange rates (341)
--------------------
Goodwill, net at March 31, 2005 $ 74,188
====================
NOTE 4 - STRATEGIC INVESTMENTS
As of March 31, 2005 and December 31, 2004, the adjusted cost of the
Company's strategic investments totaled $12.4 million and $18.8 million,
respectively. The Company's strategic investments include public and non-public
companies. Investments in public and non-public companies are classified on the
condensed consolidated balance sheets as "Long-term marketable investment
securities" and "Other assets," respectively.
As of March 31, 2005, 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 March 31, 2005. The
6
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
quarter ended March 31, 2005, the Company recorded an other-than temporary
impairment loss of $5.8 million on its investment in Digimarc. During the
quarter ended March 31, 2004, there were no other-than temporary impairment
losses on strategic investments in public companies.
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. If it is determined that
an other-than-temporary impairment has occured 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, the Company recorded
$180,000 of other-than-temporary impairment losses relating to the balance of
its investment in iVast during the quarter ended March 31, 2004. As of March 31,
2005 and December 31, 2004, the Company's strategic investments in non-public
companies 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 quarter ended March 31, 2004. In fiscal year 2001, this strategic
investment had been fully impaired. Accordingly, during the quarter ended March
31, 2004, the Company recorded a gain on strategic investments of $1.2 million.
During the quarter ended March 31, 2005, the Company received a final
distribution for its interest in InterActual Technologies, and has recorded a
gain on strategic investments of $96,000.
NOTE 5 - 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):
7
THREE MONTHS ENDED
MARCH 31,
---------------------------------
2005 2004
-------------- --------------
Basic net EPS - weighted average number of common shares outstanding 50,349 49,244
Effect of dilutive potential common shares - stock options outstanding 992 966
-------------- --------------
Diluted net EPS - weighted average number of common shares and potential
common shares outstanding 51,341 50,210
============== ==============
Anti-dilutive shares excluded 2,943 2,501
============== ==============
Weighted average exercise price of anti-dilutive shares $ 30.98 $ 34.76
============== ==============
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 6 - RECENT ACCOUNTING PRONOUNCEMENTS
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 provides new guidance for assessing impairment losses on
investments. Additionally, EITF 03-1 includes new disclosure requirements for
investments that are deemed to be temporarily impaired. In September 2004, the
FASB delayed the accounting provisions of EITF 03-1; however the disclosure
requirements remain effective for annual periods ending after June 15, 2004. The
Company adopted the disclosure requirements under EITF 03-1 in 2004. The Company
will evaluate the impact of EITF 03-1 once final guidance is issued.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), or SFAS
123R, "Share-Based Payment." This statement replaces SFAS 123, "Accounting for
Stock-Based Compensation" and supersedes Accounting Principles Board's Opinion
No. 25 (ABP 25), "Accounting for Stock Issued to Employees." SFAS 123R requires
the Company to measure the cost its employee stock-based compensation awards
granted after the effective date based on the grant date fair value of those
awards and to record that cost as compensation expense over the period during
which the employee is required to perform services in exchange for the award
(generally over the vesting period of the award). SFAS 123R addresses all forms
of share-based payments awards, including shares issued under employee stock
purchase plans, stock options, restricted stock and stock appreciation rights.
In addition, the Company will be required to record compensation expense (as
previous awards continue to vest) for the unvested portion of previously granted
awards that remain outstanding at the date of adoption. In April 2005, the SEC
changed the effective date of FAS 123R from the first interim period or fiscal
year beginning after June 15, 2005 to the first annual fiscal period beginning
after June 15, 2005. Therefore, the Company is required to implement the
standard no later than January 1, 2006. SFAS 123R permits public companies to
adopt its requirements using the following methods: (1) a "modified prospective"
method in which compensation cost is recognized beginning with the effective
date (a) based on the requirements of SFAS 123R for all share-based payments
granted after the effective date and (b) based on the requirements of SFAS 123
for all awards granted to employees prior to the effective date of SFAS 123R
that remain
8
unvested on the effective date; or (2) a "modified retrospective" method which
includes the requirements of the modified prospective method described above,
but also permits entities to restate their financial statement based on the
amounts previously recognized under SFAS 123 for purposes of pro forma
disclosures for either (a) all prior periods presented or (b) prior interim
periods of the year of adoption.
The Company is currently evaluating the alternative methods of adoption
as described above. As permitted by SFAS 123, the Company currently accounts for
share-based payments to employees using APB 25's intrinsic value method and, as
such, generally recognizes no compensation cost for employee stock options.
Accordingly, the adoption of SFAS 123R's fair value method will have a
significant impact on the Company's results of operations, although it will have
no impact on cash flow. The impact of adoption of SFAS 123R cannot be predicted
at this time because it will depend on levels of share-based payments granted in
the future. See "Note 2 - Equity Based Compensation" for information related to
the pro forma effects on the Company's reported net income and net income per
share of applying the fair value recognition provisions of the previous SFAS 123
to stock-based employee compensation.
In December 2004, the FASB issued Financial Staff Position (FSP) No. FAS
109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004" (FSP 109-2). On October
22, 2004, the American Jobs Creation Act of 2004 (the "Act") was signed into
law. The Act creates a temporary incentive for U.S. corporations to repatriate
accumulated income earned abroad by including an 85 percent deduction for
certain foreign earnings that are repatriated, as defined in the Act, at an
effective federal tax cost of 5.25 percent. FSP 109-2 is effective immediately
and provides accounting and disclosure guidance for the repatriation provision.
FSP 109-2 allows companies additional time to evaluate the effects of the law on
its unremitted earnings for the purpose of applying the "indefinite reversal
criteria" under APB 23, "Accounting for Income Taxes - Special Areas," and
requires explanatory disclosures from companies that have not yet completed the
evaluation. The Company is in the process of evaluating whether it will
repatriate any foreign earnings under the Act and, if so, the amount that it
will repatriate. However, the Company does not expect to be able to complete
this evaluation until after Congress or the Treasury Department provides
additional clarifying language on key elements of the provision. Based on the
Company's preliminary analysis as of December 31, 2004, the range of possible
amounts that is considered for repatriation under this provision is between zero
and $30 million. The related potential range of income tax is between zero and
approximately $2 million. The Company expects to determine the amounts and
sources of foreign earnings to be repatriated, if any, during 2005.
9
NOTE 7 - COMPREHENSIVE INCOME
The components of comprehensive income, net of taxes, are as follows (in
thousands):
THREE MONTHS ENDED
MARCH 31,
---------------------------------
2005 2004
-------------- --------------
Net income $ 5,467 $ 10,768
Other comprehensive income (loss):
Unrealized losses on investments (429) (1,081)
Foreign currency translation adjustments (1,043) 1,344
-------------- --------------
Comprehensive income $ 3,995 $ 11,031
============== ==============
NOTE 8 - INCOME TAXES
The Company accounts for income taxes using the asset and liability
method. The Company recorded income tax expense of $3.2 million for the quarter
ended March 31, 2005. During the quarter ended March 31 2005, the Company
determined that sufficient uncertainty existed regarding its ability to realize
its deferred tax assets related to capital loss carryforwards; therefore, the
valuation allowance was increased by $358,000 for such deferred tax assets. As
of March 31, 2005, deferred tax assets net of valuation allowances, totaled
$23.4 million.
In assessing the realizability of deferred tax assets, management considered
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible, as well as tax planning
strategies. Based on projections of future taxable income over the periods in
which the deferred tax assets are deductible and the history of the Company's
profitability, management believes that it is more likely than not that the
Company will realize the benefits of the deferred tax assets, net of valuation
allowance as of March 31, 2005.
On October 22, 2204, the American Jobs Creation Act ("AJCA") was signed into
law. The AJCA introduced a limited time 85% dividends received deduction on the
repatriation of certain foreign earnings, as defined in the AJCA, at an
effective tax cost of 5.25 percent federal tax rate on the repatriated earnings.
State, local and foreign taxes could apply as well. To qualify for the
deduction, the earnings must be reinvested in the United States pursuant to a
domestic reinvestment plan established by the Company's chief executive officer
and approved by the Company's board of directors. Additionally, certain other
criteria, as outlined in the AJCA, must also be met. Based on preliminary
analysis as of December 31, 2004, the range of possible amounts that the Company
is considering for repatriation under this provision is between zero and $30
million.
NOTE 9 - LEASE COMMITMENTS
The Company signed agreements that extended the lease for its corporate
headquarters for an additional five years and committed to additional office
space in an adjacent building. The term for the additional office space
commenced February 2005. Both leases are operating leases and will expire in
January 2017. The Company has recorded rent expense on a straight-line basis
based on contractual lease payments from January 2005 through January 2017. The
Company occupied the new office space in April 2005. The Company's aggregate
future minimum lease payments pursuant to these leases, and other facilities and
equipment leases, pursuant to non-cancellable operating lease agreements as of
March 31, 2005 were as follows (in thousands):
Operating
Leases
------------
Remainder of 2005 $ 3,999
2006 5,306
2007 5,478
2008 5,610
2009 4,895
2010 and thereafter 24,035
------------
Total $ 49,323
============
NOTE 10 - 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 develops and markets the ActiveReach(TM) suite of content
value management solutions to video, music, and PC games content
10
owners. The Entertainment Technologies Group's products include content
protection and rights management solutions for optical discs; VHS cassettes;
digital set top boxes for cable/satellite TV; a variety of PC and consumer
electronics video playback and record devices; and peer-to-peer networks. The
Software Technologies Group develops and markets the Company's software value
management solutions to independent software vendors and enterprise IT
departments. The Company's software technologies 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 development expenses. The
Company does not identify or allocate its assets, including capital
expenditures, by segment. Accordingly, assets are not reported by segment
because the information is not available and is not reviewed by the chief
operating decision maker to make decisions about resources to be allocated among
business units or to assess their performance. The following segment reporting
information of the Company is provided (in thousands):
REVENUES:
THREE MONTHS ENDED
MARCH 31,
----------------------------------
2005 2004
--------------- ---------------
Entertainment Technologies Group:
Video $ 23,112 $ 22,574
Other 1,694 2,085
--------------- ---------------
Total Entertainment Technologies Group 24,806 24,659
Software Technologies Group 26,451 13,323
--------------- ---------------
$ 51,257 $ 37,982
=============== ===============
INCOME BEFORE INCOME TAXES:
THREE MONTHS ENDED
MARCH 31,
----------------------------------
2005 2004
--------------- ---------------
Entertainment Technologies Group $ 15,313 $ 16,119
Software Technologies Group 9,896 5,913
Other (949) (498)
--------------- ---------------
Segment income 24,260 21,534
General and administrative (8,426) (5,513)
Amortization of intangibles from acquisitions (2,416) (779)
Amortization of deferred stock-based compensation -- (185)
Impairment losses on strategic investments (5,822) (180)
Gains on strategic investments 96 1,220
Interest and other income, net 937 728
--------------- ---------------
$ 8,629 $ 16,825
=============== ===============
11
INFORMATION ON REVENUES BY GEOGRAPHIC AREA:
THREE MONTHS ENDED
MARCH 31,
----------------------------------
2005 2004
--------------- ---------------
United States $ 29,504 $ 21,268
International 21,753 16,714
--------------- ---------------
$ 51,257 $ 37,982
================ ===============
Geographic area information is based upon country of destination for
products shipped and country of contract holder for royalties and license fees.
NOTE 11 - CONTINGENCIES
The Company is involved in legal proceedings related to some of its
intellectual property rights.
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 its 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. The Administrative Patent Judge
("APJ") decided to proceed with the second interference first. During 2004, the
parties each filed their briefs, filed rebuttals to the other party's brief,
cross-examined witnesses offered up by the other party and filed various motions
and objections during this pre-hearing phase of the interference. On January 6,
2005, following the close of this pre-hearing phase, an oral hearing was
conducted. On April 11, 2005, the APJ issued a decision in the second
interference that was adverse to the Company. As a result of this decision, the
Company may have to forfeit a portion of its United States patent claims. At
this time, the Company is considering various options to appeal this decision.
The first patent interference action is yet to be heard. In the first
patent interference case, InterTrust had also brought an inequitable conduct
motion against the Company alleging errors during the original prosecution of
the `281 patent. The APJ initially dismissed the motion, but then gave
InterTrust an opportunity to re-file the motion. In the fourth quarter of 2004,
InterTrust re-filed its inequitable conduct motion and the Company filed a
rebuttal brief. On December 9, 2004, the parties presented their arguments on
the inequitable conduct motion before the APJ. The Company anticipates the APJ
will render a decision on the inequitable conduct motion in the second quarter
of 2005. The Company believes it has meritorious defenses to the motion asserted
against it and intends to vigorously defend against the inequitable conduct
motion.
The Company has a family of international patents and patent
applications related to the U.S. cases involved in the interference. The U.S.
patent interference affects only U.S. patents and U.S.
12
pending patent applications. The international cases are proceeding to grant in
Europe and Japan. A corresponding patent has already issued in Sweden (Patent
No. 9500355) and a European patent application was recently indicated by the
Examiner as allowable and is expected to be granted in the third quarter of
2005. These international cases have the benefit of the February 1, 1995
priority date and broad patent claim coverage.
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 infringed the Company's patented copy
protection technology and also violated the U.S. Digital Millennium Copyright
Act of 1998. 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. On March 23, 2005, 321 Studios was granted leave to withdraw
its answer to the complaint, placing it in default and terminating its appeal.
The Company has notified various large retailers and other resellers 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 claimed to have
discontinued sales and/or distribution of enjoined products. The Company
anticipates that the court will enter final judgment against 321 Studios,
including a permanent injunction, in the third quarter of 2005. The Company
intends to vigorously pursue this action to protect its patented copy protection
technology.
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.
Further, Red Bend Software has agreed to indemnify InstallShield and defend the
suit for Macrovision. The Company is monitoring the progress of the suit and the
actions taken by Red Bend on its behalf.
MACROVISION CORPORATION. VS. SSA GLOBAL TECHNOLOGIES, INC., AND BAAN U.S.A.,
INC.
On February 11, 2005, the Company filed a patent infringement lawsuit
against SSA Global et al. The patent involved is United States Patent No.
5,390,297 (the "'297 Patent"), entitled "System for Controlling the Number of
Concurrent Copies of a Program in a Network Based on the Number of Available
Licenses." The Company disputes the unauthorized use of the patented technology
by SSA Global and its affiliate, BAAN U.S.A. and intends to vigorously pursue
this action to protect its patent rights.
As of March 31, 2005, 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.
13
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.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING COMMENTARY SHOULD BE READ IN CONJUNCTION WITH THE
FINANCIAL STATEMENTS AND RELATED NOTES CONTAINED IN OUR ANNUAL REPORT ON FORM
10-K FOR THE YEAR ENDED DECEMBER 31, 2004 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, 2004. WE SPECIFICALLY DISCLAIM ANY OBLIGATION TO
UPDATE SUCH FORWARD-LOOKING STATEMENTS.
OVERVIEW
Macrovision Corporation, a Delaware corporation founded in 1983,
provides digital product value management offerings to entertainment producers,
software publishers, and their customers. 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
PPV and VOD network operators and enterprise IT organizations. We provide
content owners with the means to market, distribute, manage and protect video,
software and audio content.
Our content protection technologies are deployed on various media
formats, distribution platforms, and hardware devices including: DVDs,
videocassettes, music CDs, and games on CD-ROMs and DVDs, DVD players and
recorders, digital set-top box and hard drive recorders, PVRs, media center PCs,
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.
The Company is organized in two business units, the Entertainment
Technologies Group and the Software Technologies Group. The Entertainment
Technologies Group develops and markets the ActiveReach(TM) suite of content
value management solutions to video, music, and PC games content owners. The
Entertainment Technologies Group's products include content protection and
rights management solutions for optical discs; VHS cassettes; digital set top
boxes for cable/satellite TV; a variety of PC and consumer electronics video
playback and record devices; and peer-to-peer networks. The Software
Technologies Group develops and markets the Company's software value management
solutions to independent software vendors and enterprise IT departments. The
Company's software technologies include the FLEXnet(TM) 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.
15
The following table provides revenue information by business unit
(dollars in thousands):
THREE MONTHS ENDED
MARCH 31,
-----------------------------------
2005 2004 $ CHANGE % CHANGE
--------------- ---------------- -------------- --------------
Entertainment Technologies Group $ 24,806 $ 24,659 $ 147 1%
Software Technologies Group 26,451 13,323 13,128 99%
--------------- ---------------- --------------
$ 51,257 $ 37,982 $ 13,275 35%
=============== ================ ==============
The following table provides percentage of revenue information by
business unit:
THREE MONTHS ENDED
MARCH 31,
------------------------------
2005 2004
------------- -------------
Entertainment Technologies Group 48% 65%
Software Technologies Group 52 35
------------- -------------
100% 100%
============= =============
ENTERTAINMENT TECHNOLOGIES GROUP
Our Entertainment Technologies Group generates revenue from the home
video divisions of member companies of the Motion Picture Association of America
("MPAA"), videocassette duplication and DVD replication companies and a number
of "special interest" content owners, such as independent producers of exercise,
sports, educational, documentary and corporate video programs. We typically
receive per unit royalties based upon the number of copy-protected
videocassettes or DVDs that are produced by MPAA studios or other content
owners. Our Entertainment Technologies Group also generates revenues from
licensing digital pay-per-view ("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 receive one-time and annual license fees from set top box, DVD, and
personal video recorder manufacturers. We will also receive transaction fees
from PPV and VOD systems when they are activated. 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. During the first
quarter of 2005, we generated a small amount of revenue from our Hawkeye(TM) P2P
anti-piracy service.
Revenues from our Entertainment Technologies Group were comparable to
the prior year's quarter. Revenues from our video content protection
technologies represented 45% and 59% of our net revenues during the quarters
ended March 31, 2005 and 2004, respectively. The flat revenues in our
Entertainment Technologies Group are primarily due to an increase in PPV and VOD
revenues, a small decrease in our DVD copy protection revenues, and a decrease
in our music copy protection revenues. During the first quarter of 2004, we
recognized approximately $2.2 million of revenue from studio DVD
16
volume replicated and copy protected during the fourth quarter of 2003. We were
not able to record these revenues in the year in which the volumes were
replicated due to prolonged contract negotiations. For the first quarter of 2005
we did not recognize any revenue replicated in prior periods.
We actively engage in intellectual property compliance and enforcement
activities focused on identifying third parties who have under reported 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
may 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.
We believe that total revenues from our Entertainment Technologies Group
in the future will not show material growth, until we sign new contracts and
generate more business for our new products: CDS-300(TM); Hawkeye and RipGuard
DVD(TM).
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 $13.1 million or 99% in the quarter ended March 31, 2005 as compared
with quarter ended March 31, 2004. The increase in our Software Technologies
Group revenue is due to the inclusion of $9.4 million of revenues from our
InstallShield operations, acquired on July 1, 2004, and increased sales of our
FLEXnet Publisher license management solutions resulting from the impact of
broad based product and marketing programs. We believe that revenues from our
Software Technologies Group will continue to increase in the future in absolute
terms.
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 subsequent quarters of the following year. We believe
that this trend in our Entertainment Technologies business 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
our Software Technologies business, we have found that typical software and
enterprise customers tend to spend up to one-third of their annual capital
budgets in the fourth calendar quarter. 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 replicator fees and patent related litigation expense. Fees paid to
licensed duplicators and replicators that produce videocassettes, DVDs, and CDs
for content owners include fees paid to help offset costs of reporting copy-
protected volumes and costs of equipment used to apply our technology. In
addition, 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 includes 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
17
allocation of overhead and facilities costs. Our selling and marketing expenses
are comprised primarily of employee compensation and benefits, consulting and
recruiting fees, travel, advertising and an allocation of overhead and
facilities costs. Our general and administrative expenses are comprised
primarily of employee compensation and benefits, consulting and recruiting fees,
travel, professional fees and an allocation of overhead and facilities costs.
CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES
The discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements. These
condensed consolidated financial statements have been prepared in accordance
with the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures, normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America, have been condensed or omitted in accordance
with such rules and regulations. The preparation of these financial statements
requires management to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate our
estimates, including those related to revenue recognition, allowance for
doubtful accounts, valuation of strategic investments, intangible assets and
income taxes. Our estimates are based on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances.
Actual results may differ from these estimates.
We have identified the accounting policies below as critical to our
business operations and the understanding of our results of operations.
REVENUE RECOGNITION
Our revenue consists of royalty fees on copy-protected products on a per
unit basis, licenses for our content protection technologies, licenses for our
software value management products, and related maintenance and services
revenues.
ROYALTY REVENUES
Royalty revenue from the replication of videocassettes, DVDs, and CDs is
recognized when realized or realizable and earned. We rely on royalty reports
from our customers and/or 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 anti-piracy service is recognized upon
18
establishment of persuasive evidence of an arrangement, performance of all
significant obligations and determination that collection of a fixed and
determinable license fee is considered probable.
SOFTWARE LICENSING REVENUES
We sell our software value management solutions through our direct sales
force and through resellers. We recognize revenue on our software products in
accordance with Statements of Position ("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 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 as our term license
agreements are 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. For each of the periods ended March 31, 2004 and 2005, we used the
completed-contracts method for all such arrangements.
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.
19
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 March 31, 2005 and December 31, 2004, the adjusted cost of our
strategic investments totaled $12.4 million and $18.8 million, respectively.
This included our investments in public and non-public companies. Our
investments in public and non-public companies are classified on the condensed
consolidated 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 $5.8 million on our investment in Digimarc during the three months
ended March 31, 2005.
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, $180,000 of other-than-temporary impairment
losses from investments in non-public companies were recorded during the quarter
ended March 31, 2004. As of
20
March 31, 2005 and December 31, 2004, our investments in non-public companies
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, we recorded a gain on strategic investments of $1.2
million in the first quarter of 2004. During the quarter ended March 31, 2005,
we received additional distributions for our interest in InterActual
Technologies, and have recorded a gain on strategic investments of $96,000.
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. During the first
quarters of 2005 and 2004, 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 2004, we completed our most recent
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.
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
21
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 quarters ended March 31, 2005 and 2004, no impairment charges were
recorded for long-lived assets.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We estimate the collectibility of our accounts receivable on an
account-by-account basis. We record an increase in the allowance for doubtful
accounts when the prospect of collecting a specific account receivable becomes
doubtful. In addition, we establish a non-specific reserve, using a specified
percentage of the outstanding balance of all such accounts based on historical
bad debt loss experience. We specifically analyze accounts receivable and
historical bad debts experience, customer creditworthiness, current economic
trends, international situations (such as currency devaluation), and changes in
our customer payment history when evaluating the adequacy of the allowance for
doubtful accounts. If the financial condition of our customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.
INCOME TAXES
We account for income taxes using the asset and liability method. Under
this method, income tax expense is recognized for the amount of taxes payable or
refundable for the current year and for deferred tax liabilities and assets for
the future tax consequences of events that have been recognized in an entity's
financial statements or tax returns. Management must make assumptions, judgments
and estimates to determine our current provision for income taxes and also our
deferred tax assets and liabilities and any valuation allowance to be recorded
against a deferred tax asset. Our judgments, assumptions and estimates relative
to the current provision take into account current tax laws, our interpretation
of current tax laws and possible outcomes of current and future audits conducted
by foreign and domestic tax authorities. Changes in tax law or our
interpretation of tax laws and the resolution of current and future tax audits
could significantly impact the amount provided for income taxes in our condensed
consolidated financial statements.
Our assumptions, judgments and estimates relative to the value of a
deferred tax asset take into account predictions of the category and amount of
future taxable income. 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. 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 the excess of the net
recorded amount, an adjustment to the valuation allowance would increase income
in the period such determination was made. Deferred tax assets, related
valuation allowances and deferred tax liabilities are determined separately by
tax jurisdiction. 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, the estimated
level of annual pre-tax income, and any of the assumptions, judgments and
estimates mentioned above.
22
During the quarter ended March 31, 2005, the Company determined that
sufficient uncertainty existed regarding its ability to realize its deferred tax
assets related to capital loss carryforwards. Therefore, the valuation allowance
was increased by $358,000 for such deferred tax assets.
RESULTS OF OPERATIONS
The following table provides information on our results of operations
(dollars in thousands):
THREE MONTHS ENDED
MARCH 31,
--------------------------------
2005 2004 $ CHANGE % CHANGE
--------------- ------------- -------------- -------------
Revenues:
Licenses $44,228 $34,823 $ 9,405 27%
Services 7,029 3,159 3,870 123%
--------------- ------------- --------------
51,257 37,982 13,275 35%
Cost of revenues:
License fees 2,234 1,584 650 41%
Service fees 3,144 721 2,423 336%
Amortization of intangibles from acquisitions 2,416 779 1,637 210%
--------------- ------------- --------------
7,794 3,084 4,710 153%
--------------- ------------- --------------
Gross profit 43,463 34,898 8,565 25%
Operating expenses:
Research and development 8,697 5,587 3,110 56%
Selling and marketing 12,922 8,556 4,366 51%
General and administrative 8,426 5,513 2,913 53%
Amortization of deferred stock-based compensation -- 185 (185) (100)%
--------------- ------------- --------------
Total operating expenses 30,045 19,841 10,204 51%
--------------- ------------- --------------
Operating income 13,418 15,057 (1,639) (11)%
Impairment losses on strategic investments (5,822) (180) (5,642) 3134%
Gains on strategic investments 96 1,220 (1,124) (92)%
Interest and other income, net 937 728 209 29%
--------------- ------------- --------------
Income before income taxes 8,629 16,825 (8,196) (49)%
Income taxes 3,162 6,057 (2,895) (48)%
--------------- ------------- --------------
Net income $ 5,467 $ 10,768 $ (5,301) (49)%
=============== ============= ==============
LICENSE REVENUES. Our license revenues increased $9.4 million or 27%
from the three months ended March 31, 2004 to the three months ended March 31,
2005. The increase is primarily due to the inclusion of InstallShield product
revenue, which was acquired on July 1, 2004. Our Entertainment Technologies
Group revenues for the first quarter of 2005 were essentially flat compared with
the first quarter of 2004. During the quarter ended March 31, 2004, we
recognized approximately $2.2 million of revenue from studio DVD volume that was
copy protected and replicated during the fourth quarter of 2003. We were not
able to record these revenues in the year in which the volumes were replicated
due to prolonged contract negotiations. During the quarter ended March 31, 2005,
we did not recognize any revenue replicated in prior periods.
23
SERVICE REVENUES. Our service revenues for the quarter ended March 31,
2005 increased $3.9 million or 123% from the quarter ended March 31, 2004. The
increase is primarily due to the inclusion of InstallShield maintenance and
consulting services. To a lesser extent, the increase is also due to higher
maintenance revenue from FLEXnet Publisher products as the customer base
continues to grow.
COST OF REVENUES - LICENSE FEES. Cost of revenues from license fees as a
percentage of license revenues were 5% for the quarter ended March 31, 2005.
This was consistent with the quarter ended March 31, 2004. Cost of revenue
increased $650,000 from the quarter ended March 31, 2004 to the quarter ended
March 31, 2005. The increase is primarily due to higher patent defense costs,
partially offset by a decrease in replicator fees. Cost of revenues includes
items such as product costs 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 23% for the three months ended
March 31, 2004 to 45% for the three months ended March 31, 2005. The increases
are primarily due to costs associated with additional personnel and
infrastructure from our acquisition of InstallShield on July 1, 2004. To a
lesser extent, the increases are also due to higher costs associated with the
expansion of our professional services group to support additional consulting
and implementation projects for our FLEXnet solutions. 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 $1.6 million from the
three months ended March 31, 2004 to the three months ended March 31, 2005. 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
$3.1 million or 56% from the three months ended March 31, 2004 to the three
months ended March 31, 2005. The increases are primarily due to costs associated
with additional personnel and infrastructure from our acquisition of
InstallShield on July 1, 2004. The increases are also due to increased research
and development activities for our video content technology, music technology,
peer-to-peer anti-piracy and software value management products resulting in
higher costs. Research and development expenses increased as a percentage of net
revenues from 15% in the three months ended March 31, 2004 to 17% in the three
months ended March 31, 2005. We expect research and development expenses to
increase in absolute terms over the prior year periods as a result of expected
increases in research and development activity 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 $4.4
million or 51% from the three months ended March 31, 2004 to the three months
ended March 31, 2005. The increases are primarily due to costs associated with
additional personnel and infrastructure from our acquisition of InstallShield on
July 1, 2004. To a lesser extent, the increase is due to increased business
development activities for our entertainment and software technologies products.
Selling and marketing expenses increased as a percentage of revenues from 23% in
the three months ended March 31, 2004 to 25% for the three months ended March
31, 2005. Selling and marketing expenses are expected to increase in absolute
terms as we continue to expand our efforts to increase our market share and grow
our business.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
increased $2.9 million or 53% from the three months ended March 31, 2004 to the
three months ended March 31, 2005. The increases are primarily due to costs
incurred for compliance with the Sarbanes-Oxley Act of 2002. To a lesser
24
extent, the increase is also due to costs associated with additional personnel
and infrastructure from our acquisition of InstallShield on July 1, 2004.
General and administrative expenses increased as a percentage of revenues from
15% in the three months ended March 31, 2004 to 16% in the three months ended
March 31, 2005. 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. We intend to reduce this expense as a percentage of revenue over time.
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 $185,000 from the
three months ended March 31, 2004 to the three months ended March 31, 2005. 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
March 31, 2005, we recorded $5.8 million in charges relating to an
other-than-temporary impairment in our investment in Digimarc. For the three
months ended March 31, 2004, we recorded $180,000 in charges relating to
other-than-temporary impairments in our investment in iVast.
GAINS ON STRATEGIC INVESTMENTS. For the three months ended March 31,
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 three months ended March 31, 2004, we
recorded a gain on strategic investments of $1.2 million. During the three
months ended March 31, 2005, we recorded an additional gain of $96,000 for our
investment in InterActual Technologies.
INTEREST AND OTHER INCOME, NET. Interest and other income increased
$209,000 or 29% from the three months ended March 31, 2004 to the three months
ended March 31, 2005. This increase is primarily due to higher interest rates.
INCOME TAXES. Income tax expense represents combined federal, state and
foreign taxes at effective rates of 37% and 36% for the three months ended March
31, 2005 and 2004, respectively. The change in effective tax rates from 2004 to
2005 is primarily due to the change in tax jurisdictions where our income was
earned and the increase in valuation allowance.
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 $15.1 million
and $10.2 million for the three months ended March 31, 2005 and 2004,
respectively. This reflects an increase of $4.9 million from the three months
ended March 31, 2004 to the three months ended March 31, 2005, primarily due to
stronger cash collections during the first quarter of 2005.
Investing activities (used) provided net cash of $(10.2) million and
$22.4 million for the three months ended March 31, 2005 and 2004, respectively.
Cash flow from investing activities decreased $32.6 million from the three
months March 31, 2004 to the three months ended March 31, 2005, primarily due to
an increase in net purchases of
25
long and short-term investments. The increase in net purchases of long and
short-term investments is due to the investment of excess cash on hand. We made
capital expenditures of $1.1 million and $806,000 during the three months ended
March 31, 2005 and 2004, respectively. Capital expenditures are primarily for
computer equipment, leasehold improvements and furniture and fixtures for
additional office space.
Net cash provided by financing activities was $3.8 million and $2.4
million for the three months ended March 31, 2005 and 2004, 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. In 2002, we repurchased 3.0 million
shares of common stock under this program, which have been recorded as treasury
stock and resulted in a reduction of stockholders' equity. We did not repurchase
any treasury stock during the three months ended March 31, 2005 and 2004.
At March 31, 2005, we had $113.7 million in cash and cash equivalents,
$122.4 million in short-term investments and $29.0 million in long-term
marketable investment securities, which includes $12.4 million in fair market
value of our holdings in Digimarc. We anticipate that capital expenditures for
the next three quarters will not exceed $9.0 million. We also have future
minimum lease payments of approximately $49.3 million under operating leases. We
believe that the current available funds and cash flows generated from
operations will be sufficient to meet our working capital and capital
expenditure requirements for the foreseeable future.
We may also use cash to acquire or invest in 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 Tech
(1998) for approximately $17.8 million in cash and related acquisition costs. In
addition, we are subject to an additional maximum payout of $8.0 million based
on a percentage of revenues derived from our sales of music technology products
through December 31, 2004. During the three months ended March 31, 2005 and
2004, we paid $497,000 and $723,000, respectively, of such contingent
consideration in cash relating to revenues generated in 2003. The final
contingent consideration payment was made during the quarter ended March 31,
2005.
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 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.
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 content value management and
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, 2004.
CONTRACTUAL OBLIGATIONS
We signed agreements that extended the lease for our corporate
headquarters for an additional five years and committed to additional office
space in an adjacent building. The term for the additional office space
commenced February 2005. Both leases are operating leases and will expire in
January 2017. We have recorded rent expense on a straight-line basis based on
contractual minimum lease payments from January 2005 through January 2017. We
occupied the new office space in April 2005. Our aggregate future minimum lease
payments pursuant to these leases, and other facilities and equipment leases,
pursuant to non-cancellable operating lease agreements as of March 31, 2005 were
as follows (in thousands):
26
Operating
Leases
------------
Remainder of 2005 $3,999
2006 5,306
2007 5,478
2008 5,610
2009 4,895
2010 and thereafter 24,035
------------
Total $ 49,323
============
RECENT ACCOUNTING PRONOUNCEMENTS
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 provides new guidance for assessing impairment losses on
investments. Additionally, EITF 03-1 includes new disclosure requirements for
investments that are deemed to be temporarily impaired. In September 2004, the
FASB delayed the accounting provisions of EITF 03-1; however the disclosure
requirements remain effective for annual periods ending after June 15, 2004. We
adopted the disclosure requirements under EITF 03-1 in 2004. We will evaluate
the impact of EITF 03-1 once final guidance is issued.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), or SFAS
123R, "Share-Based Payment." This statement replaces SFAS 123, "Accounting for
Stock-Based Compensation" and supersedes Accounting Principles Board's Opinion
No. 25 (ABP 25), "Accounting for Stock Issued to Employees." SFAS 123R requires
us to measure the cost its employee stock-based compensation awards granted
after the effective date based on the grant date fair value of those awards and
to record that cost as compensation expense over the period during which the
employee is required to perform services in exchange for the award (generally
over the vesting period of the award). SFAS 123R addresses all forms of
share-based payments awards, including shares issued under employee stock
purchase plans, stock options, restricted stock and stock appreciation rights.
In addition, we will be required to record compensation expense (as previous
awards continue to vest) for the unvested portion of previously granted awards
that remain outstanding at the date of adoption. In April 2005, the SEC changed
the effective date of FAS 123R from the first interim period or fiscal year
beginning after June 15, 2005 to the first annual fiscal period beginning after
June 15, 2005. Therefore, we are required to implement the standard no later
than January 1, 2006. SFAS 123R permits public companies to adopt its
requirements using the following methods: (1) a "modified prospective" method in
which compensation cost is recognized beginning with the effective date (a)
based on the requirements of SFAS 123R for all share-based payments granted
after the effective date and (b) based on the requirements of SFAS 123 for all
awards granted to employees prior to the effective date of SFAS 123R that remain
unvested on the effective date; or (2) a "modified retrospective" method which
includes the requirements of the modified prospective method described above,
but also permits entities to restate their financial statement based on the
amounts previously recognized under SFAS 123 for purposes of pro forma
disclosures for either (a) all prior periods presented or (b) prior interim
periods of the year of adoption.
We are currently evaluating the alternative methods of adoption as
described above. As permitted by SFAS 123, we currently account for share-based
payments to employees using APB 25's intrinsic value method and, as such,
generally recognize no compensation cost for employee stock options.
Accordingly, the adoption of SFAS 123R's fair value method will have a
significant impact on our result of operations, although it will have no impact
on our cash flow. The impact of
27
adoption of SFAS 123R cannot be predicted at this time because it will depend on
levels of share-based payments granted in the future.
In December 2004, the FASB issued Financial Staff Position (FSP) No. FAS
109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004" (FSP 109-2). On October
22, 2004, the American Jobs Creation Act of 2004 (the "Act") was signed into
law. The Act creates a temporary incentive for U.S. corporations to repatriate
accumulated income earned abroad by including an 85 percent deduction for
certain foreign earnings that are repatriated, as defined in the Act, at an
effective federal tax cost of 5.25 percent. FSP 109-2 is effective immediately
and provides accounting and disclosure guidance for the repatriation provision.
FSP 109-2 allows companies additional time to evaluate the effects of the law on
its unremitted earnings for the purpose of applying the "indefinite reversal
criteria" under APB 23, "Accounting for Income Taxes - Special Areas," and
requires explanatory disclosures from companies that have not yet completed the
evaluation. We are in the process of evaluating whether it will repatriate any
foreign earnings under the Act and, if so, the amount that it will repatriate.
However, we do not expect to be able to complete this evaluation until after
Congress or the Treasury Department provides additional clarifying language on
key elements of the provision. Based on our preliminary analysis as of December
31, 2004, the range of possible amounts that is considered for repatriation
under this provision is between zero and $30 million. The related potential
range of income tax is between zero and approximately $2 million. We expect to
determine the amounts and sources of foreign earnings to be repatriated, if any,
during 2005.
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 $265.2 million as of
March 31, 2005. 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 $316,000 decrease (approximately
0.2%) in the fair value of our fixed income available-for-sale securities as of
March 31, 2005. Yield risk is also reduced by targeting a weighted average
maturity of our portfolio at 12 months so that the portfolio's yield regenerates
itself as portions of the portfolio mature.
FOREIGN EXCHANGE RATES. Due to our reliance on international and export
sales, we are subject to the risks of fluctuations in currency exchange rates.
Because a substantial majority of our international and export revenues, as well
as expenses, are typically denominated in U.S. dollars, fluctuations in currency
exchange rates could cause our products to become relatively more expensive to
customers in a particular country, leading to a reduction in sales or
profitability in that country. Our subsidiaries in the United Kingdom, Japan
operate in their local currency, which mitigates a portion of the exposure
related to the respective currency royalties collected.
28
STRATEGIC INVESTMENTS. We currently hold minority equity interests in a
number of companies. These investments, at book value totaling $12.4 million and
$18.8 million, represented 3% and 4% of our total assets as of March 31, 2005
and December 31, 2004, respectively. As of March 31, 2005, 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 March 31, 2005. 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 months ended March 31, 2005
and 2004, we charged $5.8 million and $180,000, respectively, of impairments
that were other-than-temporary to operations.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE 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 Acting Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Exchange Act). In evaluating the
disclosure controls and procedures, management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
necessarily is required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures. Based on their evaluation, our
Chief Executive Officer and Acting Chief Financial Officer concluded that our
disclosure controls and procedures are effective to ensure that the information
required to be disclosed by us in reports that we file or submit under the
Exchange Act is 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 March 31, 2005, 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.
29
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are involved in legal proceedings related to some of our intellectual
property rights.
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. The Administrative Patent Judge
("APJ") decided to proceed with the second interference first. During 2004, the
parties each filed their briefs, filed rebuttals to the other party's brief,
cross-examined witnesses offered up by the other party and filed various motions
and objections during this pre-hearing phase of the interference. On January 6,
2005, following the close of this pre-hearing phase, an oral hearing was
conducted. On April 11, 2005, the APJ issued a decision in the second
interference that was adverse to Macrovision. As a result of this decision,
Macrovision may have to forfeit a portion of its United States patent claims. At
this time, we are considering various options to appeal this decision.
The first patent interference action is yet to be heard. In the first
patent interference case, InterTrust had also brought an inequitable conduct
motion against us alleging errors during the original prosecution of the `281
patent. The APJ initially dismissed the motion, but then gave InterTrust an
opportunity to re-file the motion. In the fourth quarter of 2004, InterTrust
re-filed its inequitable conduct motion and we filed a rebuttal brief. On
December 9, 2004, the parties presented their arguments on the inequitable
conduct motion before the APJ. We anticipate the APJ will render a decision on
the inequitable conduct motion in the second quarter of 2005. We believe we have
meritorious defenses to the motion asserted against us and intend to vigorously
defend against the inequitable conduct motion.
We have a family of international patents and patent applications
related to the U.S. cases involved in the interference. The U.S. patent
interference affects only U.S. patents and U.S. pending patent applications. The
international cases are proceeding to grant in Europe and Japan. A corresponding
patent has already issued in Sweden (Patent No. 9500355) and a European patent
application was recently indicated by the Examiner as allowable and is expected
to be granted in the third quarter of 2005. These international cases have the
benefit of the February 1, 1995 priority date and broad patent claim coverage.
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. On May 11,
2004, we were granted a preliminary injunction barring 321 Studios from selling
various
30
versions of its DVD copying software. On June 4, 2004, 321 Studios filed a
notice of interlocutory appeal, which we opposed. On March 23, 2005, 321 Studios
was granted leave to withdraw its answer to the complaint, placing it in default
and terminating its appeal. We have notified various large retailers and other
resellers 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
claimed to have discontinued sales and/or distribution of enjoined products. We
anticipate that the court will enter final judgment against 321 Studios,
including a permanent injunction, in the third quarter of 2005. We intend to
vigorously pursue this action to protect our patented copy protection
technology.
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. Further,
Red Bend Software has agreed to indemnify InstallShield and defend the suit for
Macrovision. We are monitoring the progress of the suit and the actions taken by
Red Bend on our behalf.
MACROVISION CORPORATION. VS. SSA GLOBAL TECHNOLOGIES, INC., AND BAAN U.S.A.,
INC.
On February 11, 2005, Macrovision filed a patent infringement lawsuit
against SSA Global et al. The patent involved is United States Patent No.
5,390,297 (the "'297 Patent"), entitled "System for Controlling the Number of
Concurrent Copies of a Program in a Network Based on the Number of Available
Licenses." Macrovision disputes the unauthorized use of the patented technology
by SSA Global and its affiliate, BAAN U.S.A. Inc. and intends to vigorously
pursue this action to protect our patent rights.
As of March 31, 2005, 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.
31
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) Issuer Purchases of Securities
The table below sets forth the information with respect to purchases of
our common stock made by or on behalf of us during the quarter ended March 31,
2005.
Total Number of
Shares Purchased as Part
Total Number of of Publicly Announced
Period Shares Purchased Price Paid Per Share Plans or Programs (3)
---------------------------------- -------------------- ---------------------------- ----------------------------
January 1-31, 2005
Repurchase Program (1) -- -- --
Employee transactions (2) 2,074 $ 23.71 N/A
February 1-28, 2005
Repurchase Program (1) -- -- --
Employee transactions (2) -- -- N/A
March 1-31, 2005
Repurchase Program (1) -- -- --
Employee transactions (2) -- -- N/A
-------------------- ----------------------------
Total
Repurchase Program (1) -- -- --
Employee transactions (2) 2,074 $ 23.71 N/A
(1) Our board of directors authorized the repurchase of 5 million shares of
common stock in May 2002. Such authorization does not have an expiration date,
and at present, there is no intention to modify or otherwise rescind such
authorization. In 2002, we repurchased 3 million shares of common stock under
this program. No other repurchases have been done under this program to date.
(2) Includes shares delivered by or deducted from holders of employee stock
options who exercised options (granted under the Company's equity incentive
plan) in satisfaction of the exercise price of such options. The Company's
equity incentive plan provides that the value of the shares delivered or
attested to, or withheld, shall be fair market closing value of the Company's
common stock on the date the relevant transaction occurs. The shares repurchased
are retired and recorded as reductions against common stock and additional paid
in capital.
(3) Share purchases under publicly announced programs are made pursuant to open
market purchases at prevailing market prices, through block trades or otherwise,
or in privately negotiated transactions as market conditions warrant and at
prices the Company deems appropriate in the discretion of our management.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
32
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
Exhibit No. Exhibit
- ------------- ----------------------------------------------------------------
31.01 Certification of the Chief Executive Officer pursuant to
Securities Exchange Act Rules 13a-15(e) and 15d-15(e) as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.02 Certification of the Principal Financial Officer pursuant to
Securities Exchange Act Rules 13a-15(e) and 15d-15(e) as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.01 Certification of the Chief Executive Officer pursuant to 18
U.S.C Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.02 Certification of the Principal Financial Officer pursuant to 18
U.S.C Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
33
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Macrovision Corporation
AUTHORIZED OFFICER:
Date: May 10, 2005 By: /s/ William A. Krepick
-------------------- ---------------------------------------
William A. Krepick
President and Chief Executive Officer
PRINCIPAL FINANCIAL OFFICER AND CHIEF ACCOUNTING OFFICER:
Date: May 10, 2005 By: /s/ George M. Monk
-------------------- ---------------------------------------
George M. Monk
Acting Chief Financial Officer
34