Discussions of some of the matters contained in
this Annual Report on Form 10-K for Macrovision Corporation (“Macrovision,” “we” or “us”) may constitute forward-looking
statements within the meaning of the Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934,
as amended, and as such, may involve risks and uncertainties. Some of these discussions are contained under the captions “Item 1. Business”
and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We have based these forward-looking
statements on our current expectations and projections about future events, which include implementing our business strategy, developing and
introducing new technologies, obtaining and expanding market acceptance of the technologies we offer, and competition in our
markets.
In some cases, you can identify these
forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,”
“anticipate,” “believe,” “estimate,” “future,” “predict,” “potential,” “intend,”
or “continue,” and similar expressions. These statements are based on the beliefs and assumptions of our management and on information
currently available to our management. Our actual results, performance and achievements may differ materially from the results, performance and
achievements expressed or implied in such forward-looking statements. For a discussion of some of the factors that might cause such a difference, see
“Item 1. Business — Risk Factors.” We specifically disclaim any obligation to update such forward-looking
statements.
PART I
Macrovision Corporation, a Delaware corporation
founded in 1983, provides digital product value management offerings to entertainment producers, software publishers, and their customers. Value
management solutions include anti-piracy technologies and services, embedded licensing technologies, usage monitoring for enterprises, and a host of
related technologies and services from installation to update to back-office entitlement management. Our customers include: major Hollywood studios;
independent video producers; hardware and software vendors; music labels; consumer electronic, PC and digital set-top box manufacturers; digital
pay-per-view (“PPV”) and video-on-demand (“VOD”) network operators; and enterprise IT organizations.
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 digital video recorders (“DVRs”), digital set-top box and hard drive recorders, personal video 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.
We own or have rights to various copyrights,
trademarks and trade names used in our business. These include Macrovision®, ActiveReach™, AdminStudio®,
Cactus Data Shield™, Colorstripe™, FLEXbill™, Flex Certified™, FLEXenabled™,
FLEXlm®, FLEXnetTM,, GLOBEtrotter®, Hawkeye™, InstallShield®,
RipGuard™, RipGuard DVD™, SafeAudio™, SafeAuthenticate®, SafeCast®,
SafeDisc®, SafeDVD™, SAFESTREAM™, SafeWrite™, SAMsuite™ and SOFTSUMMIT®
and Update Service.
Industry Background
Content owners lose billions of dollars every year
to casual copying and professional or bootleg piracy and Internet/P2P piracy. The latest data available from the Motion Picture Association of America
(“MPAA”) estimated that the U.S. motion picture industry loses in excess of $3.5 billion annual due to packaged media piracy. In addition,
the International Intellectual Property Alliance estimated that copyright piracy, not including Internet piracy, around the world inflicts $20–$22
billion in annual losses to the U.S. copyright industries. According to the Business Software Alliance (“BSA”) and International Data
Corporation (“IDC”) report of September 2004, worldwide PC software piracy accounts for approximately $29 billion in lost
sales
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annually. This problem is the focus of our
technologies. Piracy prevention is one of many ways that content owners are looking to further monetize their digital products.
Consumers’ ability to make unauthorized copies
of video, audio and software content has increased due to the proliferation of inexpensive, easy-to-use devices, such as VCRs, CD and DVD recorders,
audio CD recorders (“CD-Rs”) and PC based hard drive recorders that allow in-home copying of videocassettes, DVDs, digital PPV/VOD programs,
CD/DVD-ROMs, desktop software, and audio CDs. The industry shift towards digital media, PC-based entertainment platforms, digital portable devices,
Internet downloads and the proliferation of peer-to-peer file sharing networks renders content and copyright owners increasingly vulnerable to
unauthorized use of their content. As technological advances facilitate digital downloads and digital copying, motion picture studios, music labels,
cable television program distributors and software games publishers have become more concerned with protecting their intellectual property. Amidst the
backdrop of the race to digital media and digital hardware, the threat of analog copying does not diminish as the quality of digital-to-analog copies
is very close to the original digital program. In fact, content owners face a triple threat of consumer piracy today which is sometimes characterized
by three ‘holes’ into which they see their legitimate revenues disappear: analog; digital; and network holes. The analog hole refers to
unauthorized content which is either in analog format to begin with, or is converted from digital to analog — and is subsequently copied and then
passed along in analog format or reconverted back to digital format. The digital hole refers to unauthorized content that is ‘ripped’ from
an optic disc to a PC hard drive and then either uploaded to a P2P file sharing service or burned to a DVD-R or CD-R disc. The network hole refers to
unauthorized content that is traded freely over P2P networks.
Independent software vendors and systems vendors are
similarly concerned about unlicensed or illicit use of their application software, both in the enterprise environment (where license terms may be lost
in the midst of corporate IT confusion or ignored) and at home (where PC software may be copied and redistributed). In the software industry,
publishers are seeking ways to flexibly price and package their products in order to reach a larger share of the available market. Furthermore, as
software complexity grows, publishers are seeking ways to simplify their customers’ software experience. Enterprise customers are particularly
focused on reducing their total cost of ownership of software and reducing their support burden. Tools that provide a simple installation, activation
and maintenance experience are winning favor with these enterprise customers.
Macrovision Business
We are organized into two business units, the
Entertainment Technologies Group and the Software Technologies Group.
Entertainment Technologies Group
The Entertainment Technologies Group licenses
digital content value management solutions that include content protection, authentication and digital rights management (“DRM”) technologies
to video, music, and PC games content owners. Our Hawkeye peer-to-peer file sharing antipiracy service and our RipGuard content protection technologies
that were introduced in 2004 are included in the Entertainment Technologies Group.
Video Technology
Motion picture studios wish to maximize the economic
value from each feature film or other video program over its copyright life. According to the Digital Entertainment Group and Adams Media Research,
consumers spent $24.5 billion in 2004 to own or rent movies, primarily on DVD in the United States. Understanding & Solutions Ltd. projects a 15%
annual increase in DVD unit shipments to over 1.6 billion discs in 2005 in the United States and a 15% annual increase to over 2.48 billion discs in
2005 worldwide. The rapid growth of the DVD format presents major revenue opportunities for the studios, as well as serious copy protection concerns.
Various consumer copying studies show that studios and video retailers lose theatrical, DVD, PPV, and VOD revenues when consumers make copies of
movies, whether from VHS or
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DVD rentals, PPV or VOD releases or downloads
from peer-to-peer (“P2P”) file sharing networks. Any household that owns a DVD recorder (“DVD-R”), PVR, PC, media center or a VCR
is capable of making unauthorized high quality digital and analog copies unless that content is properly copy protected against this variety of
threats.
Our business originated in analog video copy
protection, which continues to be the leading revenue generator for our Entertainment Technologies Group. Our analog copy protection (“ACP”)
technology has been used to copy protect over 4.2 billion videocassettes worldwide since 1985 and over 4.3 billion DVDs worldwide since 1997. Most MPAA
studios use our video content protection technology to protect some or all movie releases on videocassette or DVD. We believe that our technology is
accepted as the de facto industry standard for analog video copy protection.
Recordable DVD Copy Protection. DVD-video
recorders that allow recording onto DVD recordable blank media started selling to consumers in 2003, and sales of these DVD recorders and PC/DVD
recorder/ re-recordable drives reached approximately 50 million units worldwide at the end of 2004. Our copy protection technology inhibits the
duplication of DVDs using these devices. All DVD recording devices that we have tested to-date do not make a digital DVD copy from the analog video
output of a Macrovision-enabled DVD playback device when playing a Macrovision copy-protected DVD disc. Because almost all the installed DVD playback
devices are Macrovision-enabled and have only an analog output, our copy protection technology inhibits DVD-R copying in addition to VCR
copying.
PC Ripping. Software that “rips”
digital content from a Content Scramble System (CSS) protected optical disc to a PC hard drive is widely available in electronics stores and from
Internet sites, with many of these products being available free-of-charge. This class of software technology, known as DeCSS rippers, breaks the CSS
encryption code that is used on most movie DVDs, and often circumvents the Macrovision analog copy protection. Therefore, we believe such software
packages are illegal because they either violate the U.S. Digital Millennium Copyright Act of 1998 (“DMCA”) or infringe our patents.
Nevertheless many consumers acquire this type of software and add hacker software available on the Internet, and may engage in unauthorized ripping and
copying activities. Our RipGuard DVD technology, which was introduced in the fourth quarter of 2004, can be added to the DVD at the time of
manufacturer and is designed to inhibit ripping by PCs.
DVD-to-VHS Copy Protection. According to the
Digital Entertainment Group, based on data from the Consumer Electronics Association, as of the end of 2004, approximately 127 million DVD playback
devices are in American homes. The Digital Entertainment Group estimates that more than 80% of U.S. households will have at least one DVD player by the
end of 2005. In addition, 90% of U.S. homes also have a VCR. Without effective copy protection, any VCR can, when combined with a DVD playback device,
make VHS copies of a non-copy protected DVD. These copies are almost equal in quality to professionally prerecorded videocassettes. Virtually 100% of
DVD playback devices in use since the DVD format introduction to the market in 1997 are designed to output Macrovision copy-protected analog video if
the device plays a Macrovision copy-protected original DVD disc. Therefore, our copy protection technology can effectively inhibit DVD to VCR
copying.
VHS Copy Protection. Even with the focus on
digital media and growth in DVD, VCR sales remain strong as prices fall. With continued shipments of VCR devices to the market, we believe that VCRs
will remain a home copying threat to video content owners for many years to come. Our copy protection technology still serves its original purpose of
inhibiting VCR-to-VCR copying.
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VOD and PPV Copy
Protection. Digital PPV/VOD services enable consumers to
purchase and view movies and other programming in their homes through cable or satellite systems, or Internet-based download services. Studios have
realized the importance of copy protection in digital PPV/VOD networks because VHS and DVD-R recorders can be used to make high quality VHS and DVD
copies from the source analog video signal. Most digital PPV/VOD system operators have implemented our copy protection capability in their digital
set-top boxes at the request of the Hollywood studios.
Our technology enables consumers to view PPV/VOD
programs but inhibits unauthorized copying or significantly distorts unauthorized copies of the program when copies are attempted by both DVD and VHS
recording devices. To date, our copy protection technology has been embedded in over 145 million digital set-top boxes and DVRs worldwide, representing
nearly 90% of total digital set-top boxes deployed. Our technology is dormant until it is activated by system operators for specific PPV or VOD movies.
During the past five years, our video content protection technology has been activated by PPV system operators in Western Europe and Japan and in 2004,
our technology was activated by a PPV system operator in Canada.
VOD is an emerging service, with approximately 20
million U.S. households currently enabled to view VOD, and an estimated total of 25 million U.S households expected to be VOD enabled by the end of
2005. We are working with several major MPAA studios and system operators to enable copy protection activation for VOD services in the
U.S.
It has become common practice among many consumers
to copy their DVD, PPV or VOD content onto PVRs and media center PCs. To protect content in such circumstances, Macrovision introduced ACPe, a
derivative technology of our analog copy protection technology that is designed to inhibit the storage of protected content onto these hard drive
devices or control content storage time to be in accordance with rules defined by copyright owners.
Music Technology
The music industry is at a digital crossroads. Music
industry CD sales fell approximately 10% year-over-year from 2001 to 2003, according to the International Federation of Phonographic Industries
(“IFPI”). In 2004, there has been a slight recovery in music sales, primarily due to the emergence of legitimate online music download
stores. The continued decline in CD sales in various key music markets is attributed to the high penetration of personal computer-based CD-burners,
proliferation of peer-to-peer file sharing services and the historical lack of commercial adoption of copy protection and DRM technologies.
Approximately 30% of recordings sold worldwide are reportedly illegal copies, resulting in an estimated $4.5 billion of lost industry sales in 2003
alone, according to IFPI’s “Music Piracy Report 2004.” In addition, peer-to-peer file sharing of music continues to be problematic. IFPI
estimates there were approximately 100 million unauthorized music files on traditional web and file transfer protocol sites on the Internet and
approximately 800 million unauthorized files on peer-to-peer networks at the end of 2003.
Consequently, the music industry is pursuing
multiple initiatives to reverse the year-over-year sales declines, including CD copy protection and digital rights management technologies. Since early
2000, music labels have expressed interest in technology that would prevent the copying of music CDs to a PC or CD-R device, or downloading from
peer-to-peer networks. We are developing and marketing technologies to address these needs.
Peer-to-Peer File Sharing Content Management
Technology
Jupiter Research reported that in July 2004, 23.4
million people downloaded music, video and software files over free Internet peer-to-peer file sharing networks. Content owners believe they have been
harmed by the free and unauthorized file sharing over these networks to such an extent that they have initiated lawsuits against several of the file
sharing networks and even the individual consumers themselves. Our CDS-300
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content protection technology is designed to
inhibit unauthorized content from being made available over P2P networks. In addition, our new Hawkeye technology, which was introduced in the second
quarter of 2004, is designed to protect copyrighted content from being traded over the P2P file sharing networks.
PC Games Technology
With the proliferation of inexpensive high capacity
CD-ROM burners, and the increase in broadband Internet connections to the home and small office, individual consumers now have ready means for
unauthorized copying and distribution of desktop software on a broad scale. In fact, unauthorized downloads of application and entertainment software
frequently meet or exceed the volume of downloads of music from Internet file sharing services. As a result, application software and interactive
entertainment (primarily games) software companies are facing an unprecedented loss of revenues due to unauthorized consumer copying of CD/DVD-ROM
software and unauthorized file sharing over the Internet. Our SafeDisc Advanced technology addresses this problem.
Software Technologies Group
The Software Technologies Group develops and markets
our software value management solutions to hardware and software vendors and their enterprise customers. Our InstallShield Installer, Update Service,
and Admin Studio products that we acquired as a result of the purchase of the assets of InstallShield Software Corporation in 2004 have been added to
our FLEXnet Publisher and FLEXnet Manager products within our Software Technologies Group.
Software and Hardware
Manufacturers
Software and hardware manufacturers have access to a
variety of tools with which to design and develop software. However, when such software needs to be delivered to customers, manufacturers have
primarily relied on homemade solutions to handle electronic downloading, advanced installation, embedded licensing enforcement, automatic updates, and
back-office tracking of entitlements. This not only places restrictions on the business models with which manufacturers can engage their customers, but
also can lead to general business problems such as confusion as to which updates are needed and difficulty with installations.
BSA estimates that worldwide software piracy was
roughly 29% for software sold in 2003, and a 2004 study by IDC found that only 4% of enterprises actively try to monitor their compliance with their
software contracts. In 2003, IDC reaffirmed its estimate that license managed software would grow at almost twice the rate of the overall market. We
believe that Macrovision is positioned to benefit from this market growth due to our current market leadership, installed base of customers and broad
product set. IDC has said that Macrovision’s core FLEXnet solutions benefit everyone in the industry from software publishers and their partners
to their customers.
Enterprise End-Users
Enterprise IT teams are looking for ways to keep
their software end-users as productive as possible while minimizing their support costs. Larger organizations that purchase significant volumes of
software want to optimize those purchases, ensuring they purchase enough licenses to fulfill the needs of their end-users while at the same time
ensuring they do not waste money by continuing to license unnecessary assets. These enterprises seek reporting software that can provide detailed usage
information to guide them in their purchase decisions. Additionally, larger organizations that purchase significant volumes of software often have
trouble complying with the purchase terms of their software. They desire automated solutions that help them stay within the bounds of their purchased
licenses, and allow them to flexibly expand those bounds as needed (for example, via usage-based overdraft capabilities). Moreover, they seek
management solutions that enable them to minimize the manual labor associated with managing large numbers of licenses and to maximize the reliability
and availability of those licenses. Larger organizations also face significant challenges in rolling out
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software products to their thousands of
employees and need to ensure that software is deployed easily without productivity loss to the enterprise. Prior to deployment, they typically need to
repackage their software to set preferred options and default locations, as well as to check for potential conflicts with their other
software.
Macrovision Solutions
We develop and market a broad array of digital
product value management technologies for each of our business lines. The rapid expansion of broadband Internet connections for consumers and small
businesses and the continued tightening of enterprise IT budgets may result in the adoption of new licensing and distribution models for our solutions.
We believe this has created a large market opportunity for our value management solutions.
Entertainment Technologies Group
Video Technology
Our ACP technologies allow consumers to view
programming stored on prerecorded videocassettes and DVDs or transmitted as digital PPV or VOD programs via cable or satellite, but deter unauthorized
consumer copying of such programming on both VCRs and recordable DVD devices. Videocassettes and DVDs are encoded with our video copy protection signal
as they are manufactured. The result is that videocassettes and DVDs that are encoded with our copy protection signal will play normally on an analog
TV set, but will cause generally unwatchable copies to be made on the vast majority of VCRs, and will shut down the analog-to-digital recording circuit
of DVD recording devices, which include DVD-R devices and personal computers.
While our ACP technology addresses the analog hole,
Macrovision has developed another video content protection technology, known as RipGuard DVD, to address the digital hole. This new hole was created by
a class of piracy tools known as DeCSS rippers. Our RipGuard technology, which is applied to the DVD at the time of manufacture, is designed to prevent
unauthorized optical disc copying (ripping) on PCs without requiring any modification to the PC. Together, ACP and RipGuard DVD are designed to close
the analog and digital holes, and thus offer a comprehensive content protection solution.
In addition to our ACP solution for PPV/VOD
applications, we have introduced our ACPe rights management solution, which allows content owners to both copy protect their PPV/VOD movies, as well as
control the time that the content may be stored on personal video recorder hard drives, which are built into many digital set top
boxes.
Our optic disc content protection technologies are
licensed to 373 DVD and PC manufacturers, 382 DVD authoring houses, 123 replication facilities, 227 VHS commercial duplication facilities, 135 digital
set-top box and hard drive recorder manufacturers and 65 semiconductor component suppliers worldwide.
Music Technology
We are actively involved in developing and marketing
various technologies to meet the needs of emerging music delivery systems such as downloading and streaming via the Internet, as well as technologies
to prevent the unauthorized copying of music CDs. Our music products combine the technologies that are the subject of patents developed internally,
patents acquired from Midbar Tech (1998) Ltd. in November 2002 and patents acquired from TTR Technologies, Inc. in May 2003. Our CDS-300 v8 product
provides music labels with “passive” copy protection that inhibits the consumer from copying music to a personal computer for subsequent
redistribution on Internet based file sharing services. In addition, we utilize a proprietary “active” copy protection solution on the same
CD that enables music files to be copied to a personal computer hard disk and be managed/played via Windows Media Player (or other DRM system) but
controls (at the copyright owner’s option) subsequent transfer to portable devices, CD-Rs, and the Internet, and subsequent burning of copied
CDs.
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The CDS-100, CDS-200 and CDS-300 solutions have been
used on over 400 million music CDs worldwide through 2004. Of the total number of copy protected CDs produced worldwide, approximately 60% were
distributed in the Asia Pacific region (principally Japan), 35% in Western Europe, and 5% in North America, South America, and the rest of the world
combined. The CDS-300 v8 product is currently being introduced by several of the major music labels in international territories. We believe that we
are well positioned to develop and market unique solutions that meet the needs of the consumer, the artist, the publisher and the music
label.
Peer-to-Peer File Sharing Content Management
Technology
Our Hawkeye technology is designed to protect
copyrighted content by making it difficult, if not impossible, to download Hawkeye-protected music and video files from P2P file sharing networks.
Content owners are able to designate which music tracks, music albums or movies they want to protect, and our technology is activated as a service to
find and protect those specific files on various file sharing networks.
PC Games Technology
Our SafeDisc Advanced technology is designed to
prevent the copying of CD/DVD-ROM computer software by encrypting executable files, embedding an authenticating digital signature and adding
multi-layered anti-hacking software. This is a proprietary software-based copy protection solution that does not require any changes to standard PC or
CD/DVD-ROM hardware. Because SafeDisc Advanced is designed to operate while the disc is in the CD/DVD-ROM drive, it is ideally suited to PC games and
education software and is not applicable for console games like Sony Playstation or Microsoft Xbox. The technology is licensed directly to software
publishers, and to mastering and replication facilities that embed our patented digital signature in a CD/DVD-ROM during the manufacturing process.
SafeDisc Advanced has been licensed to 132 replicators worldwide, and is estimated to have been used on more than 300 million CD/DVD-ROMs since
1998.
Software Technologies Group
Software and Hardware
Manufacturers
We provide an extensive set of software value
management solutions, ranging from installation technologies to license management to update services to packaging/distribution conflict management. By
incorporating our technologies into their products, manufacturers are able to improve their ability to provide a standard and seamless installation and
activation experience, simplify product-marketing strategies, reduce unpaid usage and lower costs associated with product development, distribution,
and delivery. We also offer manufacturers back-office products to help them better manage the entitlements they have granted their customers, as well
as a hosted update service that enables manufacturers to keep their deployed products up to date. Most of these offerings are marketed as modules of
our FLEXnet Publisher platform.
As a result of our acquisition of the assets of
InstallShield Software Corporation in July 2004, our product offerings have increased. Our InstallShield Installer product is a multi-platform
installer solution that is incorporated into our customers’ software applications to allow them to build a simple, effective installation solution
inside their own application. Our Update Service product allows software developers to message end-user PCs regarding updates and promotions, and also
provides them with a mechanism to automatically deliver updates over the Internet.
Enterprise End-Users
Complementing our FLEXnet Publisher offerings for
manufacturers, we offer FLEXnet Manager for enterprise customers, to help such customers better manage their FLEXenabled products. FLEXnet Manager
captures and analyzes software usage data to help enterprises determine where to allocate their
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software purchases and related costs and helps
administer software access rights (electronic licenses) over global networks.
We also offer the AdminStudio family of products to
help enterprise system administrators prepare various software applications and upgrades for deployment across the enterprise (via repackaging and
patch impact management). It is used as a front-end preparation tool to assess whether there are any software application conflicts with other
installed software prior to deploying to all the end user PCs.
The Macrovision Growth Strategy
Leverage Key Customer Relationships. We
currently maintain relationships with customers in various industry and market segments, including:
• |
|
Video, music and PC games’ content providers such as the
major Hollywood studios, independent movie producers, major record labels and independent record labels, and PC games publishers and
distributors; |
• |
|
Hardware and software vendors, as well as enterprise
organizations that use their products; |
• |
|
Content distributors such as the leading cable and satellite
television system operators; and |
• |
|
Consumer electronics manufacturers of DVD players, CD and DVD
drives, personal video recorders (“PVR”), and digital set-top boxes. |
We intend to build our business by capitalizing on
these customer relationships and targeting them for delivery of our existing and future digital product value management technologies.
Introduce New Product Applications and
Technologies. We intend to develop additional product value management solutions to sell to our extensive customer base. We have committed
significant resources to expand our technology base, to enhance our existing products, to introduce additional products and to participate in industry
standard-setting efforts and organizations. We intend to pursue opportunities in the following areas:
• |
|
Current optical formats such as DVD, digital video and
CDs; |
• |
|
Future optical formats; |
• |
|
Internet downloaded and streamed audio, video and software
files; |
• |
|
Peer-to-peer file sharing antipiracy and commerce
enablement; |
• |
|
DRM licensing and interoperability |
• |
|
CD-ROM, CD-Rs, DVD-ROM, DVD-Rs; |
• |
|
Electronic license management and delivery solutions for
software vendors; Installation, product activation and update service solutions for software vendors; |
• |
|
Software asset management and packaging solutions for enterprise
customers; and |
• |
|
Improved authentication, compression, and encryption
technologies. |
Expand and Protect Patent Position. We
believe that our future success will depend on our ability to continue to introduce proprietary solutions for rights management and copy protection
technologies that can be supplemented by enabling features that will incent consumers and users to pay for legitimate video, audio and software
products, rather than trying to get them for free in an unauthorized fashion. We have patented many of these proprietary solutions, and our patents
underpin our strong competitive position and financial model. We also have acquired key software rights management and copy protection patents. We use
patents to limit the proliferation of devices that circumvent our video content protection technologies, and we have initiated legal actions relating
to infringement of these patents. We intend to continue to obtain patents and to protect
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and defend our patented technologies
aggressively, including developing and obtaining patents covering a number of processes and devices that unauthorized parties could use to circumvent
our DRM and copy protection technologies.
Continue To Make Strategic Acquisitions. We
intend to continue to expand our technology portfolio by pursuing licensing arrangements, joint ventures and strategic acquisitions of companies whose
technologies or proprietary rights complement our digital content value management or software value management technologies.
We have made a number of acquisitions since 1999. We
acquired C-Dilla, Ltd. of the UK in June 1999 in order to enter the application software copy protection, license management and DRM business; in
August 2000, we acquired Globetrotter Software, Inc., which facilitated our entry into enterprise electronic license management and software asset
management business; in October 2000, we acquired Productivity through Software plc (“PtS”) of the UK, which was a distributor of our
enterprise software solutions; in July 2001, we acquired the intellectual property and technology assets of AudioSoft, Inc., and in September 2001, we
acquired the intellectual property and technology assets of MediaDNA, Inc., both of which provided us with significant intellectual property in the DRM
business; in November 2002, we acquired the assets of Midbar Tech (1998) Ltd., which provided us with significant intellectual property and key
personnel skilled in music copy protection and controlled disc burning applications; in May 2003, we acquired certain assets of TTR Technologies, Inc.
to further enhance our intellectual property relating to music copy protection; in August 2003, we acquired intellectual property and other assets,
including patents and software that can be used to track and manage content in the peer-to-peer file sharing space; and in July 2004, we acquired the
intellectual property and assets of InstallShield Software Corporation, which provided us with the ability to expand our product portfolio in the
software value management category and reach a large software developer customer base.
Technology Licensing, Sales and Marketing
Technology Licensing. We have built, and
continue to add to, a large patent portfolio that helps differentiate our products and is important to our license driven business model. We generate
recurring revenues from a variety of sources by licensing our portfolio of digital content value management and software value management technologies.
We believe that content owners and software vendors utilize our solutions to secure their content or software and to ensure that their end-user
customers pay them for the use of such content or software. We receive royalties and recurring revenues as follows:
• |
|
Video, music and PC games content owners typically pay us a
per-unit licensing fee for the right to use our proprietary copy protection technologies for DVDs, videocassettes, music CDs and CD-ROM games and a
service-based fee for the right to use our peer-to-peer file sharing content management technologies; |
• |
|
Software vendors and enterprise end-user customers pay us a fee
to license our technology using either time-based licenses or perpetual licenses combined with annual maintenance fees; |
• |
|
Consumer software publishers pay us a per-unit licensing fee to
use our technology for CD-ROM copy protection and time-based or perpetual licenses for our DRM technology; |
• |
|
Digital set-top box and digital PVR manufacturers license our
video content protection technologies for an up-front fee and a per-unit royalty, a portion of which may be tied to product activation by system
operators; |
• |
|
Cable and satellite television system operators pay us a
one-time license fee for the right to incorporate our video content protection technology into their networks for PPV or VOD services. In addition, we
are entitled to transaction-based royalty payments when copy protection for digital PPV or VOD programming is activated by system operators and copy
protected programs are purchased by subscribers; and |
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• |
|
DVD hardware manufacturers (DVD consumer electronic player
manufacturers and PC DVD drive suppliers) license our technology for an up-front fee and annual license fee. |
Sales and Marketing. We market our digital
content value management and software value management solutions directly to content owners and software vendors in both the video and software
markets. We also license our software asset management solutions directly to end-user enterprise customers. We supplement our direct sales efforts with
reseller programs and service partnerships among VHS, DVD, and CD duplicator, replicator and authoring organizations, and third party professional
services, value added reseller, and systems integrator organizations in our enterprise software business. We also utilize a variety of marketing
initiatives, including trade show participation, trade advertisements, industry education and newsletters. As part of our FLEXnet platform, we
established alliances with several partner companies to extend the FLEXnet ecosystem to include other third-party services and solutions. We have a
worldwide network of resellers who help us sell our InstallShield products.
Our primary locations for product development,
business strategy, and operations are in our Santa Clara (California), Schaumburg (Illinois) and Maidenhead (United Kingdom) offices. We have sales and
support operations through our U.S. sales force, and through our offices in the United Kingdom, Netherlands, Germany, France, Israel, Japan, Taiwan,
Hong Kong, and Korea.
Customers
Entertainment Technologies
Group
Video Technology
Video Content. We license our video content
protection technology to the major motion picture studios and also to “special interest” customers that include independent video producers
and corporations. Our copy protection technology for videocassettes and DVDs is used by the following leading major motion picture studios and home
video suppliers:
• |
|
Lions Gate Entertainment |
• |
|
Buena Vista Home Video (Disney) |
• |
|
Twentieth Century Fox Home Entertainment |
• |
|
Universal Studios Home Video (NBC) |
• |
|
Warner Brothers Home Video |
No customer accounted for more than 10% of our net
revenues in 2004. One customer accounted for more than 10% of our net revenues in each of 2003 and 2002.
PPV/VOD System Operators. There are 23 system
operators who have licensed or specified Macrovision’s digital PPV copy protection technology for incorporation into their networks,
including:
• |
|
British Sky Broadcasting Group (UK) |
• |
|
BS Conditional Access Systems (Digital BS Broadcast)
(Japan) |
• |
|
DirecTV (North America) |
• |
|
EchoStar Communications (USA) |
• |
|
Galaxy Satellite Broadcast (Hong Kong) |
• |
|
Korea Digital Satellite Broadcast (Korea) |
• |
|
LodgeNet Entertainment (USA) |
• |
|
Premiere Fernsehen (Germany) |
• |
|
Shaw Cablesystmes (Canada) |
These system operators have paid a one-time license
fee to us and have entered into agreements with us pursuant to which we are entitled to transaction-based royalty payments at such time as copy
protection for digital PPV or VOD programming is activated. Although 23 system operators have specified Macrovision technology for incorporation into
their networks, only 13 international system operators have activated our copy protection in their networks, while the majority of U.S. systems
operators have not yet activated copy
10
protection, even though the technology is included in their
network infrastructure. In 2004, Shaw Cablesystems in Canada became the first North American cable operator to activate our PPV/VOD copy protection
technology. We are in discussions with a number of major studios and system operators to activate VOD copy protection in the U.S.
Consumer Electronics Hardware Manufacturers.
We believe that our DVD copy protection technology is universally utilized as the analog-to-analog and analog-to-digital copy protection solution that
satisfies the principles established by the DVD licensing and standards group, and has been tested and accepted for compatibility with TV sets by
leading consumer electronics companies. As of December 31, 2004, 373 companies that manufacture DVD players or PC/DVD-ROM drives had signed agreements
with us to incorporate our DVD copy protection technology into their hardware, including both Sony and Microsoft for their DVD-based game consoles
PlayStation®2 and Xbox™.
Our PPV/VOD copy protection technology is embedded
in more than 145 million digital set-top boxes currently in use worldwide, which we believe represents approximately 90% of all digital set-top boxes.
We have licensed our copy protection technology for digital PPV/VOD to 107 set-top box and 28 DVR manufacturers, including:
• |
|
Advanced Digital Broadcast |
• |
|
EchoStar Communications |
• |
|
Nokia Multimedia Terminals OY |
• |
|
Philips Business Electronics |
We have also authorized 65 semiconductor companies
to incorporate our digital PPV/VOD and DVD copy protection technologies into their semiconductor and reference designs. These companies generally pay
us a one-time service fee to verify correct implementation of our video content protection technology in digital-to-analog application specific
integrated circuits (“ASICs”) that are embedded in digital set-top boxes and DVD hardware. They are authorized to sell these
Macrovision-capable ASICs to Macrovision-licensed DVD hardware manufacturers and to Macrovision-licensed digital set-top box and hard drive recorder
(sometimes referred to as “digital video recorder”) manufacturers.
New Video Technologies. As of December 31,
2004, one of our customers began using our Hawkeye P2P services to protect select movies and several movie studios began testing our RipGuard DVD rip
control solution.
Music Technology
CDS-100 and CDS-200 have been utilized on music CDs
by all four major music labels (i.e., Universal, Warner, Sony/BMG, and EMI) in Europe and/or Japan, and by Avex, Pony Canyon and others in
Japan. The CDS processor, which our customers use to apply our copy protection technologies to their CDs, has been installed in 56 manufacturing plants
worldwide, including plants in North America, Europe and Japan. In 2004, we introduced our latest digital media management content protection solution,
CDS-300 v8, which was tested by the studios in late 2004. CDS-300 v8 will be available in 2005.
11
PC Games Technology
Our copy protection technology for consumer software
is used by leading software (primarily games) publishers, including the following:
• |
|
CDV Software Entertainment |
Our consumer software customers have a wide choice
of licensed replicators that they can use throughout the world and 132 mastering facilities and replicators have been licensed and have installed
SafeDisc mastering and quality assurance systems from authorized suppliers of these systems.
Software Technologies Group
Software and Hardware
Manufacturers
We believe that FLEXnet Publisher, our software
value management product for manufacturers, is the industry leader. We have licensed our FLEXnet-related technologies in a range of market segments to
more than 3,800 software and hardware manufacturers, including:
In addition, we believe that our InstallShield
installer is the industry leader, having been sold to over 55,000 customers. All of the top 100 software publishers use InstallShield.
Enterprise End-Users
In addition we have licensed software asset
management products to over 1,500 corporate end-users, enabling these end-users to deploy, manage, and track the software they have purchased from our
software vendor customers. Examples of such corporate end-user customers include:
12
Similarly, we have licensed our AdminStudio line to
over 4,000 enterprise customers, including:
Technology
Entertainment Technologies
Group
Video Technology
Our technology was originally designed to prevent
unauthorized copying of VHS and PPV/VOD programming to VCRs without impacting the original playback. We expanded this to inhibit unauthorized
DVD-to-VHS copying. Hardware manufacturers have designed their DVD-R devices to recognize our copy protection signal to inhibit DVD-to-DVD copying as
well. The majority of the recently introduced PVRs, DVD/VCR combo units, DVD recorders and PVR/DVD-R combo units comply with the DMCA, which requires
that manufacturers must design their recording devices to sense widely used copy protection technologies, and, as a result, they recognize
Macrovision’s proprietary analog copy protection process and disable digital recording onto DVD discs.
DVD and Digital PPV/VOD Copy Protection. The
DVD and digital PPV/VOD versions of our video content protection technologies employ proprietary electronic pulses placed in analog video streams and a
second patented copy protection process called Colorstripe. Colorstripe affects the color playback circuit of a VCR causing colored horizontal stripes
to appear in the picture of an unauthorized copy. The combination of the two processes provides a higher level of effectiveness than that provided by
either process alone. In addition, Colorstripe is more effective against circumvention by most “black box” circumvention devices that were
sold in the past. Copy protection is implemented in DVD and digital PPV/VOD applications by embedding a copy protection signal generator integrated
circuit within the DVD player or digital set-top box. The copy protection circuits remain dormant until activated by data commands, which are either
embedded in the DVD disc or sent along with the PPV movie transmission to the subscriber’s set-top box or hard drive recorder. The integrated
circuit is activated by copy protection control codes, which are embedded into the DVD media or the PPV transmission. Once the integrated circuit is
activated, it adds the copy protection signal to the analog output of the DVD player or digital set-top box. As with videocassette copy protection,
consumers are able to see a clear picture on their television sets, but generally cannot make a usable videocassette copy on a VCR, and DVD recorders
do not make DVD copies when they sense Macrovision copy protection signals at their analog inputs.
ACPe Content Management. Our ACPe technology
can be used by content owners to control how long their PPV/VOD content may be stored on compliant digital set top box PVR units and home media center
PC hard drives.
RipGuard DVD Rip Control Content Protection.
RipGuard DVD is the digital copy protection counterpart of our ACP technology. It is designed to inhibit software ripper programs that operate on a
consumer’s PC. It can be used in conjunction with ACP to give a combination analog and digital copy protection solution for optical discs.
Ripguard DVD is a unilateral content protection solution, in that it is applied to the DVD disc at the time of manufacture, and is designed to have no
impact on the quality of the displayed video and requires no hardware or special software on the PC or DVD player device.
13
Music Technology
In the audio CD market, CDS-100 and CDS-200 copy
protection technologies were developed to inhibit consumer electronic device music files (standard, uncompressed music CD format) from being ripped by
PCs. Each of the several CDS-100 and CDS-200 copy protection functions (e.g., coding, hiding and timing) is covered by pending patent
applications. Our CDS-300 v8 product incorporates an active license manager solution that requires automatic transfer of software code from the CD to
the PC hard drive, which is both consumer and rights owner friendly and can be used with any DRM.
Peer-to-Peer File Sharing Content Management
Technology
Our Hawkeye technology can be used to protect
copyrighted content by controlling the unauthorized file sharing of all types of digital content, including video and music, over P2P
networks.
PC Games Technology
Each CD/DVD-ROM published with the patented SafeDisc
Advanced technology is premastered with encrypted executable files and contains authenticating instructions and a unique SafeDisc digital signature.
The digital signature, which is designed to prevent copying by CD recorders or transfer from a CD/DVD-ROM to a hard disc drive, is added to each
original disc during the mastering/replication process. SafeDisc is a “unilateral” copy protection solution, which means that all of the copy
protection technology resides on the CD/DVD-ROM and nothing has to be added to or changed in the PC. When a user inserts an original SafeDisc-protected
disc in a CD/DVD-ROM drive, the authentication software reads the digital signature, allowing the program to be decrypted and run normally. The digital
signature and authentication process is transparent to the user. If a consumer or pirate uses a CD recording device or professional mastering equipment
to duplicate a CD/DVD-ROM and make an unauthorized copy, SafeDisc is designed to inhibit the transfer of the digital signature to the copy. If someone
attempts to use such an unauthorized copy, the digital signature cannot be found, decryption will not take place and the copy will not
run.
SafeDisc also contains anti-hacking technology which
is designed to prevent the compromise of its security features. Because of our widespread penetration in the PC games’ market, hackers have
targeted and cracked several versions of SafeDisc. For us to continue to be successful in this market, we must continually stay a step ahead of the
hacker community. We have released new product versions approximately two to three times per year incorporating new anti-hacking
features.
Software Technologies Group
Software and Hardware
Manufacturers
FLEXnet Publisher enables software publishers and
hardware manufacturers to price, package, and protect their software. Using FLEXnet Publisher, customers can electronically generate, track, and
enforce their software licenses and guard against unauthorized use by implementing product activation or copy protection. FLEXnet Publisher also
enables software publishers to generate additional revenue by offering their customers a broad choice of pricing and licensing models, including
subscription- and usage-based models.
Software and hardware vendors integrate FLEXnet
Publisher™ solutions into their products to monitor or control a customer’s compliance with a product’s license terms. Terms of
the license are typically stored in an authenticated license file that resides either on the local computer’s hard disk drive or on a
network-connected central server. Compliance with those license rights is automatically monitored. The software vendor may choose to block users from
running a product if doing so violates or exceeds the license rights, or simply provide notification to the user or system administrator when product
use has exceeded the customer’s license rights. This allows end user customers to buy software licenses using much more flexible license terms
than traditional one-computer-one-license or site license approaches. These terms may include floating licenses
14
(where a specific number of licenses are shared over a network),
product suites (where several product licenses are combined to be licensed as a single product) and demo licenses (where a prospective customer has
full functional use of a product, but the right to use expires on a specific date or after a specific number of uses). With FLEXnet Publisher, software
vendors can enable users to “activate” previously unlicensed copies of the software over the Internet, or by typing in a series of digits
read over the phone. Electronic licensing can also record the use of licensed software into a transaction log, which is authenticated and encrypted so
software vendors and customers can use this information as a basis for pay-per-use or other usage-based pricing or licensing.
Software and hardware vendors apply our
InstallShield technology to their finished products, in effect “wrapping” the application for installation. When the end-user runs the
installation program, it asks the user a number of questions and places the program files in the correct locations, configuring the program to run as
requested.
Our Update Service technology is implemented as a
program that resides on the end-user’s machine. It periodically checks the Internet for updates and downloads them as configured. End-users and/or
their IT department system administration group can control how frequently (if at all) they want the service to check for updates, and what to do with
those updates when available.
Enterprise End-Users
Macrovision’s asset management software enables
larger organizations to more effectively manage their licensed software, by providing interfaces to control licensed servers and set alerts to
important licensing events. Moreover, this software can read and interpret the usage transaction logs described in the preceding section, enabling
customers to better manage their FLEXenabled software assets and to allocate software-related costs to different departments or projects within the
company. Our AdminStudio technology helps enterprise system administrators prepare various software applications and upgrades for deployment across the
enterprise.
Research and Development
Our internal research and development efforts are
focused on developing enhancements to existing products, new applications for our current technologies and new technologies related to our various
digital product value management offerings. Our core competencies are in electronic license management and license delivery software, installer
software, anti-hacking software, digital and analog video and audio engineering, copy protection engineering and optical media formats. We have
acquired other companies and technologies to supplement our research and development expenditures. In 2004, 2003 and 2002, our expenses for research
and development were $28.7 million, $17.2 million and $11.9 million, respectively.
Intellectual Property Rights
Patents Issued & Pending. We hold 100
U.S. patents and have 80 U.S. patent applications pending. Of the issued patents, 38 relate to our copy protection technologies, 24 relate to video
scrambling, 12 relate to audio scrambling, seven relate to electronic license management and five relate to DRM technology (namely content usage
control, tracking, and e-transactions). Of the pending patent applications, 40 relate to our copy protection technologies, six relate to video
scrambling, 13 relate to audio scrambling, 10 relate to electronic license management and eight relate to DRM technology. The last of our issued U.S.
patents expires in 2022. The last of our core group of analog copy protection patents expires in the year 2021. We also have 783 foreign patents issued
and 336 foreign patent applications pending in 51 countries. Of the issued foreign patents, 499 relate to our copy protection technologies, 113 relate
to video scrambling, 43 relate to audio scrambling, and 22 relate to electronic license management and DRM.
Circumvention Technology Patents. Included in
the patents related to our copy protection technologies are 14 U.S. and 106 foreign patents covering a number of processes and devices that
unauthorized parties could
15
use to circumvent our video content protection
technologies. We also have three U.S. and 24 foreign circumvention technology patents pending. We have historically used these patents to limit the
proliferation of devices intended to circumvent our video content protection technologies. We have initiated a number of patent infringement lawsuits
against manufacturers and distributors of such devices. See “Legal Proceedings.”
Competition
Entertainment Technologies
Group
Video Technology
Our video content protection technologies are
proprietary and have broad U.S. and international patent coverage. We believe that there are currently no significant analog video copy protection
competitors. We have the only analog copy protection scheme that has been widely deployed on commercial products that significantly distorts or
inhibits copying by VHS VCRs, DVD recorders and hard drive recorders. Currently, our video content protection technology is embedded in nearly 100% of
all DVD players and nearly 90% of digital set-top boxes worldwide. While it is possible that a competitive video content protection technology could be
developed and deployed, we believe it would take years for the competitive technology to be tested and accepted by hardware manufacturers and
ultimately to begin to be embedded into the consumer electronic devices. By the time this would happen, it is unlikely any other analog copy protection
technology would displace our copy protection infrastructure and our extensive video copy protection “ecosystem.”
Our technology is designed to inhibit or prevent
unauthorized consumer copying; it is not designed to prevent professional piracy. We believe that our customers are very concerned with professional
piracy of their video, audio and software products. We believe that our customers’ assessment of the relative threats of professional versus
consumer piracy may present a certain level of competition to our video copy protection business, to the extent that some content owners may decide to
devote more of their resources to fighting professional video piracy instead of using our copy protection to deter unauthorized consumer
copying.
With the increase in online movie and music
distribution over the Internet, and with the continuing advance of digital content and high definition formats, our analog video content protection
technologies that protect standard definition content on optical media and digital PPV/VOD signals may be viewed by our customers as being less
important than the other digital and network copy protection solutions. As a result, other Internet-based digital content protection or DRM
technologies may present significant competition to our video copy protection business, such as DRM offerings by Intertrust, Microsoft, RealNetworks,
Contentguard and Sony. In addition, Sony’s ARccOS product may present competition to our RipGuard DVD business. Competitors may also bundle their
products with their own replication services, and by doing so, those competitors may be able to offer lower prices for the combined offering and
therefore studios may switch to such replication facilities.
Music Technology
We believe that there are a limited number of direct
competitors in the audio copy protection and rights management market, including SunnComm, Sony, First4Internet and Settec, with Sony having
substantially greater financial and other resources than we have. To date, we believe we have a significant market share of the CDs produced worldwide
to which audio CD copy protection has been applied. In 2004, only 180 million music CDs out of a total of approximately 2.3 billion music CDs produced
included copy protection technology from any supplier, including Macrovision.
In January 2003, Microsoft announced the release of
its Windows Media® Data Session Toolkit (“WMDST”) with a DRM solution that can to be deployed independently of our solutions.
The announcement included SunnComm as the first company to integrate a third party music CD copy protection technology with Microsoft’s WMDST. We
believe that SunnComm uses technology that is competitive with our CDS-100 and
16
CDS-200 technologies. It is possible that
Microsoft may develop or acquire copy protection and rights management solutions that compete with our offerings. We have a non-exclusive agreement
with Microsoft to allow their Windows Media Player and WMDST to interoperate with our CDS-300 solution.
Peer-to-Peer File Sharing Content Management
Technology
We believe there are two primary competitors in the
P2P file sharing content management market: MediaDefender and Loudeye’s Overpeer Division. While these competitors were the first in this market
and are very competitive in terms of pricing, we believe that our Hawkeye technology has the advantage of being able to more efficiently scale the
solution to accommodate growing numbers of simultaneous titles/tracks that are copy protected.
PC Games Technology
We believe that there are a limited number of
competitors in our SafeDisc Advanced consumer software copy protection market, including Sony SecuROM (developed and marketed by Sony’s DADC
optical disk manufacturing subsidiary), StarForce Technologies, Settec and Smarte Solutions.
Software Technologies Group
Publisher Value
Management
Our primary competition in the publisher value
management market comes from customers and prospects that develop their own homemade solutions. We have other more traditional competitors in various
subcomponents of our offerings, including SafeNet (who acquired Rainbow Technologies, and has a small license management offering) and Altiris (who
acquired Wise and has a small installer offering). There are other much smaller competitors as well, including companies such as XtreamLok and
Softwrap. Operating system developers such as Microsoft, IBM and Sun already integrate limited license management and installation functionality into
their products, and they could expand this functionality, which could pose an increased competitive threat. Similarly, microprocessor suppliers may
choose to integrate rights management solutions into their products, and software resellers could also begin to develop their own electronic license
management solutions.
Enterprise End-User Software Asset
Management
Macrovision provides software asset management
solutions to help end users monitor FLEXenabled applications. Because we encrypt the FLEXnet usage log files, we are the only ones authorized to read
and interpret the FLEXnet usage log files for purposes of software asset management. We believe that there are currently no significant competitors in
this particular software asset management area. In the larger market of software asset management in general, products such as CA Unicenter and IBM
Tivoli offer related and sometimes overlapping functionality.
For our InstallShield heritage products, we believe
our primary competitors are Altiris (for our AdminStudio and Windows installer business) and ZeroG (for our non-Windows installer business). Altiris
acquired Wise’s PackageStudio product and we believe that PackageStudio currently outsells AdminStudio, in part due to historical distribution
arrangements established before the Altiris acquisition. ZeroG is a small private company that focuses on non-windows-based deployment
solutions.
Operations and Technical Support
We have technical support and certification
operations to support our DVD manufacturer licensees, set-top box licensees, authorized semiconductor manufacturers, and our other hardware licensees.
We provide technical support and professional services to our independent software vendor customers and end users during pre-sale, implementation and
maintenance phases of our contracts.
17
We provide a variety of technical support to our
content value management and software value management customers, including:
• |
|
We support our licensed duplicators and replicators with
hardware and software installation assistance and quality assurance. In addition, we support licensed duplicator/replicator sales personnel by
providing sales training and marketing literature, and by participating in trade shows; |
• |
|
We provide pre- and post-sales professional services and
technical support, post-sales technical support, maintenance support, training, integration and software development services to customers
incorporating FLEXnet and InstallShield in their applications, as well as to enterprises who use our FLEXnet Manager and Admin Studio
solutions; |
• |
|
We support the efforts of television, VCR and DVD hardware
manufacturers, digital PPV/VOD system operators and PPV/VOD set-top box manufacturers to design hardware that properly incorporates and is compatible
with our video content protection technologies; |
• |
|
We assist semiconductor manufacturers in incorporating and
certifying our video content protection technologies into a variety of digital video integrated circuits; |
• |
|
We regularly test the effectiveness and transparency of our
video, audio and PC games copy protection technologies on representative samples of consumer televisions, VCRs, DVD players and PC drives, and music CD
player and recorder devices to determine whether modifications or enhancements may be necessary; |
• |
|
We provide training and professional services to assist our
independent software vendor licensees in wrapping their executables with our SafeDisc modules; |
• |
|
We provide training and application support for the SafeDisc,
CDS, and Ripguard software toolkits; and |
• |
|
We test for SafeDisc, CDS, and Ripguard compatibility and
effectiveness with a variety of PC and CD-ROM drive software and hardware. |
Our strategy is to license our technologies to third
parties that manufacture products or software incorporating our technologies. For our InstallShield products, we contract with outside replicators to
produce, package, and fulfill orders. Our manufacturing operations are limited to low volume video and audio copy protection processors used by third
party replicators that require in-house system integration and quality control efforts.
Legislative and Regulatory Actions
A number of government and legislative initiatives
have been enacted in recent years to encourage development and implementation of technologies that protect the rights and intellectual property of the
content owners.
In the United States, Congress enacted the Digital
Millennium Copyright Act (“DMCA”) in October 1998. This law required all VCRs to comply with analog copy protection technologies that are in
widespread use, such as those covered in our patents, beginning in May 2000. The DMCA includes a clause that outlaws all circumvention devices and
technologies that could be used to defeat widely used copy protection technologies. Based on our recent tests of new DVD recorder devices, we believe
that manufacturers have designed them so they will not record analog input that is Macrovision copy-protected. Hence, our technology prevents copying
on both VCRs and DVD-R devices. We also believe that software “ripper” products, when they include circumvention of copy protection or CSS
encryption, are illegal under the law. In addition, we believe that software ripper companies who update their ripper products in order to circumvent
RipGuard may be in violation of the anti-circumvention provisions of the DMCA. The U.S. law is based on a set of guidelines for amending basic
copyright laws to deal with the protection of digital media. The guidelines were adopted in 1996 by the World Intellectual Property Organization, an
agency of the United Nations.
18
Several countries in Europe have adopted a similar
EU-wide copyright directive, which includes a provision aimed at controlling hardware and software circumvention devices and technologies. Individual
countries’ legislatures are currently discussing these new copyright initiatives. The implementation of the Copyright Directive throughout Europe
is continuing, with more countries enacting legislation. To date, Austria, Denmark, Germany, Greece, Italy and UK have implemented the Copyright
Directive. The Directive brings into effect prohibitions on the manufacture, import, distribution, sale and marketing of circumvention devices and
services. Macrovision has already taken action under the newly enacted German and UK Copyright Acts and obtained injunctions against a number of
retailers to stop sales of devices that circumvent Macrovision’s technology.
In Japan, a revision to the Japanese copyright law
went into effect in October 1999 prohibiting the sale, manufacture, and import of circumvention devices. In addition, an industry directive that became
effective in 1997 requires all digital recording devices to be responsive to analog copy protection technologies that utilize automatic gain control
techniques, such as those covered by our patents.
Strategic Investments
We have made strategic investments in companies with
complementary technologies and markets where we felt we could broaden our market reach or technology portfolio. The adjusted cost of our strategic
investments as of December 31, 2004 was $18.8 million and consisted of investments in the following company:
Digimarc Corporation (Nasdaq: DMRC). In
December 1997, we made our initial investment and signed a joint development agreement with Digimarc Corporation, a provider of patented digital
watermarking technologies that allow digital code to be embedded in traditional and digital content, including movies, photographic images and
documents such as financial instruments, passports and event tickets. We made two subsequent investments in June 1999 and October 2000, for a total of
$25.3 million. Digimarc completed an initial public offering in December 1999. As of December 31, 2004, we owned approximately approximately 9.8% of
Digimarc, which translated to a valuation of $18.8 million. During 2002, we determined that the decline in value of Digimarc stock was
other-than-temporary and took a charge to earnings of $1.8 million as a result. There were no charges taken in 2003. During 2004, we determined that
the decline in value of Digimarc stock was other-than-temporary and took a charge to earnings of $5.3 million as a result.
In addition to the above investment, we have made
and hold strategic investments in other companies that have been written down and have no recorded value as of December 31, 2004.
Our strategic investments represented 4.1% and 7.0%
of our total assets as of December 31, 2004 and 2003, respectively. In total, we wrote off $5.5 million, $4.8 million and $17.2 million for the years
ended December 31, 2004, 2003 and 2002, respectively, related to impairments that were other-than-temporary, in an aggregate of eleven companies. In
the future, we may continue to evaluate and make such minority investments for strategic purposes. We may never have an opportunity to realize a return
on either current or future investments and may be required to write off all or part of these investments.
Employees
As of December 31, 2004, we had 606 full-time
employees. Of these employees, 189 are based outside of the United States. We expect to hire additional employees in 2005, particularly in engineering,
marketing, sales and support. None of our employees is covered by a collective bargaining agreement or is represented by a labor union. We have not
experienced any organized work stoppages. We believe that our future success will depend in part upon the continued service of our key employees and on
our continued ability to hire and retain qualified personnel. We may not be able to retain our key employees and may not be successful in attracting
and retaining sufficient numbers of qualified personnel to conduct our business in the future. Our ability to hire and retain qualified personnel may
be adversely affected if we decide not to offer broad-based stock options in response to Financial Accounting Standards Board (“FASB”)
directives for stock option expensing.
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Available Information
Our Internet website is located at
http://www.macrovision.com. We make available free of charge on our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably
practicable after we electronically file such material with, or otherwise furnish it to, the Securities and Exchange Commission (the “SEC”).
The reference to our Internet website does not constitute incorporation by reference of the information contained on or hyperlinked from our Internet
website and should not be considered part of this document.
The public may also read and copy any materials we
file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. The public may obtain information on the
operation of the Public Reference Rooms by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet website that contains reports, proxy
and information statements and other information regarding issuers that file electronically with the SEC. The SEC’s Internet website is located at
http://www.sec.gov.
RISK FACTORS
In addition to the other information contained in
this Annual Report on Form 10-K, you should consider carefully the following risks. If any of these risks occurs, our business, financial condition or
operating results could be adversely affected.
Company Risks
The success of our business depends on the continued use by major movie studios
of our video content protection technology.
If major motion picture studios were to determine
that the benefits of our technology do not justify the cost of licensing the technology, then demand for our technology would decline. Historically, we
derive a majority of our net revenues and operating income from fees for the application of our patented video content protection technology to various
video formats: prerecorded videocassettes, DVDs and digital pay-per-view or video-on-demand (PPV/VOD) programs.
Any future growth in revenues from these fees will
depend on (a) growth in the various media formats, (b) increased use of our video content protection technology on a larger number of videocassettes,
DVDs, digital PPV/VOD programs or PCs, or (c) increases in usage fees or royalties. To increase or maintain our market penetration, we must continue to
persuade content owners that the cost of licensing the technology is outweighed by the increase in revenues that content owners and retailers gain as a
result of using content protection, such as revenues from additional sales of the copy protected material or subsequent revenues from other
distribution channels.
The retail prices of DVDs are falling. As retail
prices drop, consumers trend toward purchases rather than rental of DVDs, therefore studios face substantial increases in marketing costs which creates
increased pressure to trim manufacturing expenses. This includes cutting back in their content protection usage, as well as negotiated reductions in
their usage fees. Recently, diminishing margins that studios have been experiencing have contributed to a reduction in the prices we can charge them to
include our video content protection technology in their products. As such, although we have not experienced a decline in total revenue, we have seen
our usage fees on a per unit basis decline over time. Even though we have contracts with minimum annual volume commitments, it is possible for some
studios to copy protect a smaller percentage of their titles and still achieve their minimum volume commitments. In addition, some studios choose to
copy protect selected titles, or choose to not use any copy protection, and their actions may influence other studios to do the same, which could harm
our business.
We have been successful historically in licensing
our content protection technologies to control unauthorized casual consumer copying. Other content piracy sources include camcorders in movie
theaters,
20
peer-to-peer file sharing services and PC-based
DVD copying software. To the extent that our customers spend money to prevent or litigate against these other piracy sources, they may reduce spending
on our technology. Additionally, if our customers are unable to prevent their content from becoming available through these other piracy sources, they
may consider our technology to be less valuable. In either event, our business would be harmed.
Any decline in demand for our video content
protection technology, including a change of video content protection policy by the major motion picture studios, or a decline in sales of prerecorded
videocassettes and DVDs that are encoded with our video content protection technology, or additional declines in our average unit royalties, would have
a material adverse effect on our business. If several of the motion picture studios withdraw their support for our content protection technologies or
otherwise determine not to copy protect a significant portion of prerecorded videocassettes, DVD or digital PPV/VOD programs, our business would be
harmed.
Our operating results may fluctuate, which may adversely affect the price of our
common stock.
Our quarterly and annual revenues, expenses and
operating results could vary significantly in the future and period-to-period comparisons should not be relied upon as indications of future
performance. Due to limited visibility in predicting software licensing revenues and, particularly, revenues that are generated from perpetual licenses
(under which license fee revenue is recognized upfront on a one-time basis), we may experience volatility in revenues which may cause us to not be able
to sustain our level of net revenues, or our rate of revenue growth, on a quarterly or annual basis. In addition, we may be required to delay or extend
recognition of revenue on more complex licensing arrangements as required under generally accepted accounting principles in the United States.
Fluctuations in our operating results may cause the price of our common stock to decline.
Further, we may not be in a position to anticipate a
decline in revenues in any quarter until late in the quarter. This is primarily due to the delay inherent in reporting from certain licensees and
closing of new sales agreements, resulting in potential volatility in the price of our common stock. Other factors that could affect our operating
results include:
• |
|
The timing and number of releases of popular movies on
videocassettes, DVDs or by digital PPV/VOD transmission; |
• |
|
The ability of the MPAA studios utilizing our content protection
technology to produce one or more “blockbuster” titles on an annual basis; |
• |
|
The acceptance of our content protection technologies by major
motion picture studios and software companies; |
• |
|
Expenses related to, and the financial impact of, possible
acquisitions of other businesses; |
• |
|
The acceptance of our software value management (electronic
licensing, installation, update service, software asset management, packaging) solutions by software vendors and end-user organizations; |
• |
|
The acceptance of our new music content protection technologies
by major music labels in the U.S. market, Europe and Asia, and the impact of consumer activist organizations; |
• |
|
The extent to which new content technologies or formats replace
technologies to which our solutions are targeted; |
• |
|
Adverse changes in the level of economic activity in the United
States or other major economies in which we do business as a result of the threat of terrorism, military actions taken by the United States or its
allies, or generally weak and uncertain economic and industry conditions; |
• |
|
The timing and popularity of releases of computer software
CD-ROM multimedia titles; |
21
• |
|
The extent to which various hacking technologies are viewed by
our customers to undermine and devalue our technologies; and |
• |
|
The extent to which we are able to transition our market leading
position in optical media (i.e., packaged media) content protection and our DRM patents into digital content value management via the
Internet. |
We experience seasonality in our operating results, which may affect the price
of our common stock.
Because of the nature of the products that we offer,
we have experienced significant seasonality in our business, and our business is likely to be affected by seasonality in the future. We have typically
experienced our highest revenues in the fourth quarter of each calendar year followed by lower revenues and operating income in the first quarter, and
at times in subsequent quarters, of the next year. We believe that this trend has been principally due to the tendency of our customers to release
their more popular movies, games and music during the year-end holiday shopping season as well as the pronounced fourth quarter seasonality in the
software business. Our revenues generally have tended to be lower in the summer months, particularly in Europe.
We depend on a small number of key customers for a high percentage of our
revenues and the loss of a significant customer could result in a substantial decline in our revenues and profits.
Our customer base and our net revenues is highly
concentrated among a limited number of customers, primarily due to the fact that the MPAA studios dominate the motion picture industry and the loss of
any one customer would have a significant adverse impact on our business. Historically, we have derived the majority of our net revenues from a
relatively small number of customers. No customer accounted for more than 10% of our net revenues in 2004, one customer accounted for 10.2% of our net
revenues in 2003 and one customer accounted for 11.4% of our net revenues in 2002.
We expect that revenues from the MPAA studios will
continue to account for a substantial portion of our net revenues for the foreseeable future. We have multi-year agreements with some of the major home
video companies for copy protection of a substantial part of their videocassettes and/or DVDs in the U.S. These agreements expire at various times from
2005 to 2007, and may or may not be renewed, or, if renewed, may be at substantially reduced per unit prices and on other terms less favorable to us
than the existing agreements. Changes in management, ownership or control of the MPAA studios could affect the renewal of their contracts with us. The
failure of any one of these customers to renew its contract or to enter into a new contract with us on terms that are favorable to us would likely
result in a substantial decline in our net revenues and operating income, and our business would be harmed.
We depend on signing and in some cases completing high-value license agreements
during the reporting period from major software customers for our FLEXnet product and the inability to sign or complete these agreements could result
in a decline or deferral of our revenues and profits.
Currently, a material portion of our FLEXnet
revenues are generated from perpetual licenses, under which license fee revenue is generally recognized up front on a one-time basis, combined with an
annual maintenance fee that is ratably recognized over the 12-month period. Failure to close a small number of high-value perpetual licenses during any
period could result in a decline in our revenues and profits. We currently offer our customers the choice between a perpetual license and an annual (or
time based) license, the latter of which results in ratable recognition of the license fee over the term of the license, which is generally 12
months.
Additionally, in the future, we believe an
increasing portion of our FLEXnet revenues may be generated from custom software development projects and recognized when the projects are completed.
We expect that as we pursue more independent software vendor customers in the mainstream enterprise software market, we
22
may engage in more custom software development projects, which
may delay our revenue recognition by linking it to completion of software and formalized customer acceptance.
We have limited control over existing and potential customers’ and
licensees’ decisions to include our technology in their product offerings.
In general we are dependent on our customers and
licensees — including producers and distributors of content for music, films, videos, software and games — to incorporate our technology into
their products. Although we have license agreements with many of these companies, many of these license agreements do not require any minimum purchase
commitments, or are on a non-exclusive basis, or do not require incorporation of our technology in their products. Furthermore, while we may be
successful in obtaining mandatory status for our technology in one or more industry standards, there is no guarantee that products associated with
these standards will be successful in the market. Our licensees and other manufacturers might not utilize our technology in the future. If this were to
occur, our business would be harmed.
A significant portion of our revenues is derived from international sales.
Economic, political, regulatory and other risks associated with our international business could have an adverse effect on our operating
results.
International and export sales together represented
42.2%, 42.2% and 34.2% of our consolidated net revenues in 2004, 2003 and 2002, respectively. We expect that international and export sales will
continue to represent a substantial portion of our net revenues for the foreseeable future. Our future growth will depend to a large extent on
worldwide acceptance and deployment of our content protection and DRM solutions for music CDs, digital PPV networks, DVDs, and consumer software.
Worldwide adoption of our FLEXnet software value management solutions will also be an important driver of future growth.
To the extent that foreign governments impose
restrictions on importation of programming, technology or components from the U.S., the requirement for content protection and rights management
solutions in these markets could diminish. In addition, the laws of some foreign countries may not protect our intellectual property rights to the same
extent as do the laws of the U.S., which increases the risk of unauthorized use of our technologies and the ready availability or use of circumvention
technologies. Such laws also may not be conducive to copyright protection of digital content and software, which may make our content protection
technology less effective and reduce the demand for it.
Because we sell our products worldwide, our business
is subject to the risks associated with conducting business internationally, including:
• |
|
foreign government regulation; |
• |
|
changes in diplomatic and trade relationships; |
• |
|
changes in, or imposition of, foreign laws and regulatory
requirements; |
• |
|
changes in, or weakening of copyright and intellectual property
(patent) laws and support for content protection and DRM technologies; |
• |
|
difficulty of effective enforcement of contractual provisions in
local jurisdictions; |
• |
|
tariffs or taxes and other trade barriers and
restrictions; |
• |
|
fluctuations in our net effective income tax rate driven by
changes in the percentage of revenues that we derive from international sources; |
• |
|
changes in a specific country’s or region’s political
or economic condition, including changes resulting from the threat of terrorism; |
• |
|
difficulty in staffing and managing foreign operations;
and |
• |
|
fluctuations in foreign currency exchange rates. |
23
Our business could be materially adversely affected
if foreign markets do not continue to develop, if we do not receive additional orders to supply our technologies or products for use in foreign
prerecorded video, music, PPV and other applications requiring our content protection solutions or if regulations governing our international
businesses change. For example, our products are eligible for export under the U.S. Export Administration Act and U.S. export regulations. We have
implemented a program to comply with these laws and regulations, but cannot guarantee that any particular product can be exported to any particular
location at any particular time. Any changes to the statute or the regulations with respect to export of encryption technologies could require us to
redesign our products or technologies or prevent us from selling our products and licensing our technologies internationally.
If we fail to develop and deliver innovative technologies in response to changes
in the entertainment industry, our business could decline.
The markets for our products and technologies are
characterized by rapid change and technological evolution. We will need to continue to expend considerable resources on research and development in the
future in order to continue to design and deliver enduring, innovative entertainment products and technologies. Despite our efforts, we may not be able
to develop and effectively market new products, technologies and services that adequately or competitively address the needs of the changing
marketplace. In addition, we may not correctly identify new or changing market trends at an early enough stage to capitalize on market opportunities.
At times such changes can be dramatic, such as the shift from VHS videocassettes to DVDs for consumer playback of movies in homes and elsewhere. Our
future success depends to a great extent on our ability to develop and deliver innovative technologies that are widely adopted in response to changes
in the entertainment industry and that are compatible with the technologies or products introduced by other entertainment industry participants. If we
are unsuccessful in developing and delivering new technologies, our business would be harmed.
Our success is heavily dependent upon our proprietary
technologies.
We believe that our future success will depend on
our ability to continue to introduce proprietary solutions for digital content value management and software value management technologies that can be
supplemented by enabling features that will incent consumers and users to pay for legitimate video, audio and software products, rather than trying to
get them for free in an unauthorized fashion. We rely on a combination of patent, trademark, copyright and trade secret laws, nondisclosure and other
contractual provisions, and technical measures to protect our intellectual property rights. Our patents, trademarks or copyrights may be challenged and
invalidated or circumvented. Our patents may not be of sufficient scope or strength or be issued in all countries where products incorporating our
technologies can be sold. The last of our core group of analog copy protection patents expire in the year 2017. In many cases, we have filed
applications to expand our patent claims and for improvement patents to extend the current expiration dates, however, expiration of some of our patents
may harm our business. If we are not successful in protecting our intellectual property, our business would be harmed.
Others may develop technologies that are similar or
superior to our technologies, duplicate our technologies or design around our patents. A number of companies with extensive financial resources have
developed intellectual property in the digital rights management field, including InterTrust, Philips, Sony, ContentGuard, IBM and Microsoft. Such
competitive threats could harm our business.
Effective intellectual property protection may be
unavailable or limited in some foreign countries. Despite efforts to protect our proprietary rights, unauthorized parties may attempt to copy or
otherwise use aspects of processes and devices that we regard as proprietary. Policing unauthorized use of our proprietary information is difficult,
and the steps we have taken may not prevent misappropriation of our technologies.
24
We may initiate patent infringement or patent interference actions or other
litigation to protect our intellectual property, which could be costly and harm our business.
Litigation may be necessary in the future to enforce
our patents and other intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of
others. For a description of our current legal proceedings, see “Legal Proceedings.”
We, and many of our current and potential
competitors, dedicate substantial resources to protection and enforcement of intellectual property rights, especially patents in the area of digital
rights management technologies. We believe that companies will continue to take steps to protect these technologies, including, but not limited to,
seeking patent protection. As a result, disputes regarding the ownership of these technologies and the associated rights are likely to arise in the
future and may be very costly. Companies in the technology and content-related industries have frequently resorted to litigation regarding intellectual
property rights. We may be forced to litigate to determine the validity and scope of other parties’ proprietary rights. Any such litigation could
be very costly and could distract our management from focusing on operating our business. The existence and/or outcome of such litigation could harm
our business.
We may be subject to intellectual property infringement claims or other
litigation, which are costly to defend and could limit our ability to use certain technologies in the future.
From time to time we receive claims and inquiries
from third parties alleging that our internally developed technology, technology we have acquired or technology we license from third parties may
infringe other third parties’ proprietary rights, especially patents. Third parties have also asserted and most likely will continue to assert
claims against us alleging infringement of copyrights, trademark rights or other proprietary rights, or alleging unfair competition or violations of
privacy rights. We could be required to spend significant amounts of time and money to defend ourselves against such claims. If any of these claims
were to prevail, we could be forced to pay damages, comply with injunctions, or stop distributing our products and services while we re-engineer them
or seek licenses to necessary technology, which might not be available on reasonable terms or at all. We could also be subject to claims for
indemnification resulting from infringement claims made against our customers and strategic partners, which could increase our defense costs and
potential damages. Any of these events could require us to change our business practices and harm our business.
Litigation could harm our business and result
in:
• |
|
substantial settlement or related costs, including
indemnification of customers; |
• |
|
diversion of management and technical resources; |
• |
|
our discontinuing the use and sale of infringing
products; |
• |
|
our expending significant resources to develop non-infringing
technology; and |
• |
|
our obtaining licenses to infringed technology. |
We are entering into a new business for the
protection and enablement of audio, video and software content on the Internet and P2P networks. We believe that there is and will continue to be an
increasing level of litigation to determine the applicability of current laws to, and impact of new technologies on, the use and distribution of
content over the Internet and P2P networks and through new devices, especially as it relates to the music, motion picture and software industries. P2P
network providers and consumer activist groups have been very active in litigation against attempts to restrict the free use and distribution of
content over the Internet and P2P networks. As we develop products and services that protect, provide or enable the provision of content in such ways,
the risk of litigation against us may increase.
25
It may be time-consuming and costly to enforce our patents against devices and
hacking techniques that attempt to circumvent our content protection technology, and our failure to control them could harm our
business.
We use our patents to limit the proliferation of
devices and technologies intended to circumvent our video content protection technologies. In the past, we have initiated a number of patent
infringement disputes against manufacturers and distributors of these devices and software. In the event of an adverse ruling in such litigation, the
value of our video protection technology may decline due to the legal availability of such a circumvention device, or we may have to obtain rights to
the offending devices to protect the value of our technology. The legal availability of circumvention devices could result in the increased
proliferation of devices that defeat our content protection technology and a decline in demand for our technologies, which could have a material
adverse effect on our business.
A limited number of DVD manufacturers may build
products that either do not contain our content protection technology, or include features that allow consumers to bypass content protection. Although
we believe this is in contravention of the DMCA, as well as the basic DVD CSS license, proliferation of these products could cause a decline in demand
for our technologies, which could harm our business.
Any legal or other enforcement action that we may
initiate could be time-consuming to pursue, involve costly litigation, divert management’s attention from operations or may not be successful. See
“Legal Proceedings.”
In the PC games copy protection segment, a number of
individuals have developed and posted SafeDisc Advanced hacks on the Internet, or CD cloning software. If we are not able to develop frequent SafeDisc
Advanced software releases and new digital signatures, which deter the hackers from developing circumvention or cloning techniques, our customers could
reduce their usage of our technology because it was compromised. We expect to encounter similar challenges with our CDS-300 music content protection
product, our Ripguard DVD anti-ripper product and our Hawkeye P2P file sharing antipiracy service.
CGMS-A is an alternative analog copy protection
technology for which we have patents that apply in the United States. We believe this technology has applicability in protecting digital content within
home media centers, Internet downloads, and digital PPV/VOD broadcasts. We plan to license these patents to both content owners and hardware
manufacturers. If our patents are contested, we may find that the cost in terms of litigation expense, management diversion, and reduced customer
goodwill may offset the revenue potential and could harm our business.
Legislative initiatives seeking to weaken copyright law or new governmental
regulation and resulting legal uncertainties could harm our business.
Consumer rights advocates and other constituencies
are challenging copyright law, notably the U.S. Digital Millennium Copyright Act of 1998, through both legislative and judicial actions. Legal
uncertainties surrounding the application of the DMCA may adversely affect our business. If copyright law is compromised, or devices that can
circumvent our technology are permitted by law and become prevalent, this could result in reduced demand for our technologies, and our business would
be harmed.
Many laws and regulations are pending and may be
adopted in the United States, individual states and local jurisdictions and other countries with respect to the Internet. These laws may relate to many
areas that impact our business, including copyright and other intellectual property rights and digital rights management. These types of regulations
are likely to differ between countries and other political and geographic divisions. Other countries and political organizations are likely to impose
or favor more and different regulation than that which has been proposed in the United States, thus furthering the complexity of regulations. In
addition, state and local governments may impose regulations in addition to, inconsistent with, or stricter than federal regulations. Changes to or the
interpretation of these laws could expose us to increased litigation risk, substantial defense costs and other liabilities. It is not possible to
predict whether or when such legislation
26
may be adopted, and the adoption of such laws or regulations,
and uncertainties associated with their validity, interpretation, applicability and enforcement, could materially and adversely affect our
business.
Our relationships with entertainment industry participants are particularly
important to our businesses, and if we fail to maintain such relationships our business could be materially harmed.
If we fail to maintain and expand our relationships
with a broad range of participants throughout the entertainment industry, including motion picture studios, broadcasters, video game designers, music
producers and manufacturers of consumer electronics products, our business and prospects could be materially harmed. Relationships have historically
played an important role in the entertainment industries that we serve. If we fail to maintain and strengthen these relationships, these entertainment
industry participants may not purchase and use our technologies, which could materially harm our business and prospects. In addition to directly
providing a substantial portion of our revenue, these relationships are also critical to our ability to have our technologies adopted as industry
standards. Moreover, if we fail to maintain our relationships, or if we are not able to develop relationships in new markets in which we intend to
compete in the future, including markets for new technologies and expanding geographic markets, our business, operating results and prospects could be
materially and adversely affected. In addition, if major industry participants form strategic relationships that exclude us, our business and prospects
could be materially adversely affected.
We must establish and maintain licensing relationships with companies other than
content owners or software publishers to continue to build and support a worldwide content value management ecosystem and to expand our business, and
failure to do so could harm our business prospects.
Our future success will depend upon our ability to
establish and maintain licensing relationships with companies in related business fields, including:
• |
|
DVD and CD authoring facilities, mastering houses and
replicators; |
• |
|
DVD and CD authoring tools software companies and replicator
test equipment suppliers; |
• |
|
DVD and CD hardware manufacturers; |
• |
|
videocassette duplicators; |
• |
|
semiconductor and equipment manufacturers; |
• |
|
operators of digital PPV and VOD networks; |
• |
|
consumer electronics, digital PPV/VOD set-top hardware
manufacturers, and PC manufacturers; and |
• |
|
DRM suppliers, especially in the music business. |
Substantially all of our license agreements are
non-exclusive, and therefore our licensees are free to enter into similar agreements with third parties, including our competitors. Our licensees may
develop or pursue alternative technologies either on their own or in collaboration with others, including our competitors.
Some of our third party license arrangements will
require that we license others’ technologies and/or integrate our solutions with others. As an example, our customers will expect that our music
copy protection, authentication, and controlled burning technologies will be integrated with various DRM solutions. In addition, we rely on third
parties to report usage and volume information to us. Delays, errors or omissions in this information could harm our business. If these third parties
choose not to support integration efforts or delay the integration, our business could be harmed.
27
We must continue to provide satisfactory support and maintenance services to our
software value management customers.
Our future success will depend on our ability to
provide adequate software support and maintenance services to our independent software vendor electronic license management customers. As they release
new applications or modify their software to run on new platforms, it is important that their businesses not be disrupted as a result of inadequate
support from us. Failure to deliver such services could harm our business.
We depend on third parties to implement and support our SafeDisc Advanced, our
CDS-300 music copy protection, and our Ripguard DVD anti-ripper software modules within their optic disc encoding and quality assurance
equipment.
We rely on third party vendors such as DCA, Eclipse,
Media Morphics and CD Associates to develop and incorporate software modules that will:
• |
|
apply the various digital signature, formatting, and copy
protection technology at licensed replication facilities; and |
• |
|
allow replicators to run specialized quality assurance tests to
confirm our technologies are applied. |
Our operations could be disrupted if our
relationships with third party vendors are disrupted or if their products are defective, not available or not accepted by licensed replicators. This
could result in a loss of customer orders and revenue.
Our various digital content value management
solutions are available in more than 132 of the world’s largest mastering and replication facilities, and are designed to be fully compatible with
standard CD manufacturing processes. Nevertheless, we rely on such third parties to properly apply these technologies to optical media-based content on
behalf of our customers and to properly perform quality assurance testing with respect to such content. Any improper application of the technology or
improper quality assurance testing by such third party mastering and replication facilities may result in content that does not contain our copy
protection technology or may result in other defects in the rights holders content, and may therefore, result in a loss of revenue or a claim against
us by the content owner.
We rely on our licensees and others to accurately prepare manufacturing reports
in determining our licensing revenue, and if these reports are inaccurate, our operating results could be materially adversely affected.
Our licensing revenue is generated primarily from
content owners who license our technologies and incorporate them in their products. Under our existing arrangements, these licensees typically pay us a
per-unit licensing fee based on the number of units of product they manufacture that incorporates our technologies. We depend on third party
replicators to properly apply our content protection technology to content on behalf of our customers, to properly perform quality assurance testing
with respect to such content and to accurately report the number of copy protected units manufactured. In collecting our license fees, preparing our
financial reports, projections and budgets and directing our sales and product development efforts, we rely on those manufacturing reports from our
customers and their replicators. However, it is often difficult for us to independently determine whether or not our licensees are reporting shipments
accurately and audits are generally expensive and time consuming and initiating audits could harm our customer relationships. To the extent that our
licensees understate or fail to report the number of products incorporating our technologies that they ship, we will not collect and recognize revenue
to which we are entitled, which could adversely affect our operating results. To the extent that these same parties improperly report and overstate the
number of products incorporating our technologies that they ship, we may have to issue credits for past revenue, which could adversely affect our
operating results.
28
Our operating results may fluctuate depending upon when we receive manufacturing
reports from our licensees.
Our quarterly operating results may fluctuate
depending upon when we receive royalty reports from our licensees. We recognize a portion of our license revenue only after we receive royalty reports
from our licensees regarding the manufacture of their products that incorporate our technologies. As a result, the timing of our revenue is dependent
upon the timing of our receipt of those reports. In addition, it is not uncommon for royalty reports to include corrective or retroactive royalties
that cover extended periods of time. Furthermore, there have been times in the past when we have recognized an unusually large amount of licensing
revenue from a licensee in a given quarter because not all of our revenue recognition criteria were met in prior periods. This can result in a large
amount of licensing revenue from a licensee being recorded in a given quarter that is not necessarily indicative of the amounts of licensing revenue to
be received from that licensee in future quarters, thus causing fluctuations in our operating results.
We are exposed to risks associated with expanding our technology base through
strategic acquisitions and investments.
We have expanded our technology base in the past
through strategic acquisitions and investments in companies with complementary technologies or intellectual property and intend to do so in the future.
Acquisitions always hold special challenges in terms of successful integration of technologies, products and employees. For companies we have acquired
in the past and companies we acquire in the future, we may not be able to incorporate any acquired services, products or technologies with our existing
operations, or integrate personnel from the acquired businesses, in which case our business could be harmed.
Negotiating or completing any potential future
acquisitions, and integrating past and potential future assets and acquisitions, could cause significant diversions of management time and resources.
Financing for future acquisitions may not be available on favorable terms, or at all. If we identify an appropriate acquisition candidate for any of
our businesses, we may not be able to negotiate the terms of the acquisition successfully, finance the acquisition or integrate the acquired business,
products, technologies or employees into our existing business and operations. Future acquisitions may not be well-received by the investment
community, which may cause our stock price to fall. We have not entered into any agreements regarding any future acquisitions and cannot ensure that we
will be able to identify or complete any acquisition in the future.
If we acquire businesses, new products or
technologies in the future, we may be required to amortize significant amounts of identifiable intangible assets and we may record significant amounts
of goodwill that will be subject to annual testing for impairment. We have in the past and may in the future be required to write off all or part of
one or more of these investments that could harm our business. If we consummate one or more significant future acquisitions in which the consideration
consists of stock or other securities, our existing stockholders’ ownership could be significantly diluted. If we were to proceed with one or more
significant future acquisitions in which the consideration included cash, we could be required to use a substantial portion of our available cash.
Acquisition activities could also cause operating margins to fall depending upon the financial models of the businesses acquired.
Our strategic investments may involve joint
development, joint marketing, or entry into new business ventures, or new technology licensing. Any joint development efforts may not result in the
successful introduction of any new products by us or a third party, and any joint marketing efforts may not result in increased demand for our
products. Further, any current or future strategic acquisitions and investments by us may not allow us to enter and compete effectively in new markets
or enhance our business in any current markets.
We currently hold minority equity interests in a
number of companies, including Digimarc, a public corporation. These strategic investments, totaling $18.8 million, represented 4.1% of our total
assets as of December 31, 2004. Other than Digimarc, our strategic investments are in privately held companies. There is no active trading market for
the securities of privately held companies and our investments in them are illiquid at best.
29
We have written off all of our investments in
such privately held companies and we may never have an opportunity to realize any return on our investments in them. Through December 31, 2001, we had
invested an aggregate of $53.3 million in strategic investments. Since December 31, 2001, we have not made any additional strategic investments. During
2004, 2003 and 2002, we wrote off $5.5 million, $4.8 million and $17.2 million, respectively, of strategic investments resulting from impairment that
was other-than-temporary.
Our products could be susceptible to errors or defects that could result in lost
revenues, liability or delayed or limited market acceptance.
We offer and develop a series of complex content
value management and software value management solutions, which we license to customers. The performance of these products typically involves working
with sophisticated software, computing and communications systems. Due to the complexity of these products offered and developed, and despite our
quality assurance testing, the products may contain undetected defects or errors that may affect the proper use or application of such products by the
customer. Any such defects or errors in existing or new products, and any inability to meet customer expectations in a timely manner, could result in
loss of revenue or market share, failure to achieve market acceptance, diversion of development resources, injury to our reputation, increased
insurance costs and increased service, any of which could materially harm our business.
In addition, we rely on the customer and third party
replicators to properly use our products to protect the software and applications to which our technology may be applied. Any improper use or
application of the software by the customer or the third party replicators may render our technologies useless and result in losses from claims arising
out of such improper use of the products.
Because customers rely on our products for copy
protection and digital rights management of their software and applications, defects or errors in our products may discourage customers from purchasing
our products. These defects or errors could also result in product liability or warranty claims. Although we attempt to reduce the risk of losses
resulting from these claims through warranty disclaimers and limitation of liability clauses in our agreements, these contractual provisions may not be
enforceable in every instance. Furthermore, although we maintain errors and omissions insurance, this insurance may not adequately cover these claims.
If a court refused to enforce the liability-limiting provisions of our contracts for any reason, or if liabilities arose that were not contractually
limited or adequately covered by insurance, our business could be materially harmed.
In protecting copyrights and other intellectual
property rights of our customers, our products affect consumer use of our customers’ products. Consumers may view this negatively and discontinue
or threaten to discontinue purchase or use of our customers’ products unless our customers stop using our technologies. This may cause a decline
in demand for our products or legal actions against us by our customers or consumers.
If use of the Internet for delivery of software does not increase as we
anticipate, our business may suffer.
Some of our products are designed to support using
the Internet to deliver, install, deploy, activate, update or pay for software or digital media. The revenues we generate from these products depend on
increased acceptance and use of the Internet as a medium of commerce, communications and delivery of software and digital media. Acceptance and use of
the Internet may not continue to develop at historical rates, and a sufficiently broad base of business customers may not adopt or continue to use the
Internet to conduct their operations. Demand and market acceptance for recently introduced services and products over the Internet are subject to a
high level of uncertainty, and there are few proven services and products. Our business could be seriously harmed if:
• |
|
The necessary communication and computer network technology
underlying the Internet and other online service does not effectively support any expansion that may occur; |
• |
|
New standards and protocols are not developed or adopted in a
timely manner; or |
30
• |
|
Concerns about security, reliability, cost, ease of use,
accessibility, quality of service, or other factors results in the Internet not becoming established as a viable commercial marketplace, inhibiting the
development of electronic commerce and reducing the need for and desirability of our products and services. |
If use of the Internet for delivery of video and audio programming increases,
our business may suffer.
Some of our products, such as video, audio and
packaged software copy protection, are designed to be applied to packaged media, and we receive royalties based on the number of units produced. If
electronic delivery of such products using the Internet were to increase, our revenues from packaged media may be adversely affected and not replaced
by Internet-based revenues. In this event, our business could be seriously harmed.
For our business to succeed, we need to attract and retain qualified employees
and manage our employee base effectively.
Our success depends on our ability to hire and
retain qualified employees and to manage our employee base effectively. Because of the specialized nature of our business, our future success will
depend upon our continuing ability to identify, attract, train and retain other highly skilled managerial, technical, sales and marketing personnel,
particularly as we enter new markets. We are implementing a senior management succession program in order to effectively plan for changes in our
executive officers over time but there can be no guarantee that we will find appropriate candidates. Competition for people with the skills that we
require is intense, particularly in the San Francisco Bay area where our headquarters are located, and the high cost of living in this area makes our
recruiting and compensation costs higher. In particular, due to the overall decline in technology market values and the resultant impact on our stock
price, using stock options as an incentive to hire and retain employees may be less effective. If we are unable to hire and retain qualified employees,
our business and operating results could be adversely affected.
Calamities or terrorist attacks in Silicon Valley, the U.K. or other countries
in which our offices are located could disrupt our business and adversely affect our operations.
Our headquarters office facilities in Santa Clara,
California are in areas of seismic activity near active earthquake faults. Any earthquake, fire or other calamity affecting our facilities may disrupt
our business and substantially affect our operations. A terrorist attack targeting Silicon Valley, the U.K. or other countries in which our offices are
located could disrupt our business and substantially affect our operations.
Our telephone and computer networks are subject to security and stability risks
that could harm our business and reputation and expose us to litigation or liability.
Online business activities depend on the ability to
transmit confidential information and licensed intellectual property securely over private and public networks. Any compromise of our ability to
transmit such information and data securely or reliably, and any costs associated with preventing or eliminating such problems, could harm our
business. Online transmissions are subject to a number of security and stability risks, including:
• |
|
our own or licensed encryption and authentication technology,
and access and security procedures, may be compromised, breached or otherwise be insufficient to ensure the security of customer information or
intellectual property; |
• |
|
we could experience unauthorized access, computer viruses,
system interference or destruction, “denial of service” attacks and other disruptive problems, whether intentional or accidental, that may
inhibit or prevent access to our websites or use of our products and services; |
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• |
|
someone could circumvent our security measures and
misappropriate our, our partners’ or our customers’ proprietary information or content or interrupt operations, or jeopardize our licensing
arrangements, which are contingent on our sustaining appropriate security protections; or |
• |
|
our computer systems could fail and lead to service
interruptions. |
The occurrence of any of these or similar events
could damage our business, hurt our ability to distribute products and services and collect revenue, threaten the proprietary or confidential nature of
our technology, harm our reputation, and expose us to litigation or liability. Because some of our technologies and businesses are intended to inhibit
use of or restrict access to our customers’ intellectual property, we may become the target of hackers or other persons whose use of or access to
our customers’ intellectual property is affected by our technologies. We may be required to expend significant capital or other resources to
protect against the threat of security breaches, hacker attacks or system malfunctions or to alleviate problems caused by such breaches, attacks or
failures.
We will incur increased costs and demands upon management as a result of
complying with the laws and regulations affecting public companies, which could affect our operating results.
We have incurred, and will continue to incur,
significant legal, accounting and other expenses associated with recently adopted corporate governance and public company reporting requirements,
including requirements under the Sarbanes-Oxley Act of 2002, as well as new rules implemented by the SEC and the Nasdaq. The expenses incurred by
public companies generally for reporting and corporate governance purposes have been increasing. As long as the SEC requires the current level of
compliance for public companies of our size, we expect these rules and regulations to increase our legal and financial compliance costs and to make
some activities more time-consuming and costly, although we are unable to currently estimate these costs with any degree of certainty. We do believe,
however, that we will be able to fund these costs out of our available working capital. We also expect these new rules and regulations may make it more
difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and
coverage or incur substantially higher costs to obtain the same or similar coverage than was previously available. As a result, it may be more
difficult for us to attract and retain qualified individuals to serve on our board of directors or as our executive officers.
If we fail to maintain proper and effective internal controls, our ability to
produce accurate financial statements could be impaired, which could increase our operating costs and affect our ability to operate our
business.
We have a complex business that is international in
scope. Ensuring that we have adequate internal financial and accounting controls and procedures in place to help ensure that we can produce accurate
financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. We are continually in the
process of documenting, reviewing and, if appropriate, improving our internal controls and procedures in connection with Section 404 of the
Sarbanes-Oxley Act of 2002, which requires annual management assessments of the effectiveness of our internal control over financial reporting and a
report by our independent registered public accountants addressing these assessments. If we or our independent registered public accountants identify
areas for further attention or improvement, implementing any appropriate changes to our internal controls may require specific compliance training of
our directors, officers and employees, entail substantial costs in order to modify our existing accounting systems, and take a significant period of
time to complete. Such changes may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that
adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially
impair our ability to operate our business.
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Changes in, or interpretations of, tax rules and regulations may adversely
affect our effective tax rates.
We are subject to income taxes in the U.S. and
foreign tax jurisdictions. Our future effective tax rates could be unfavorably affected by the changes in tax laws or the interpretation of tax laws,
by changes in the amount of revenue or earnings that we derive from international sources in countries with low statutory tax rates, or by changes in
the valuation of our deferred tax assets and liabilities. Unanticipated changes in our tax rates could affect our future results of
operations.
In addition, we are subject to examination of our
income tax returns by the Internal Revenue Service and other domestic and foreign tax jurisdictions. We regularly assess the likelihood of outcomes
resulting from these examinations to determine the adequacy of our provision for income taxes. In making such assessments, we exercise judgment in
estimating our provision for income taxes. While we believe our estimates are reasonable, we cannot assure you that the final determination from these
examinations will not be materially different from that reflected in our historical income tax provisions and accruals. Any adverse outcome from these
examinations may have an adverse effect on our business and operating results, which could cause the market price of our stock to
decline.
Industry Risks
If consumer reaction to music copy protection and digital rights management
technologies is unfavorable, our revenue potential may be adversely affected.
We entered the market for music CD copy protection
and rights management through the acquisition of the assets of Midbar Tech (1998) Ltd. and TTR Technologies, Inc. in 2002 and 2003, respectively.
Patents we acquired from both Midbar and TTR cover first session copy protection and controlled burning — two technologies that we believe are
fundamental to success in the music copy protection business. Our CDS-300 product incorporates an active license manager solution that requires
automatic transfer of software code from the CD to the PC hard drive. The consumer must ‘opt in’ to this action if they want to listen to
the CD on their PC. A number of competitors have developed similar or alternative music copy protection solutions. The solution we are marketing may
not achieve or sustain market acceptance, or may not meet, or continue to meet, the demands of the music industry.
It is possible that there could be significant
consumer resistance to audio copy protection, as consumers may feel that copy protection degrades the sound quality of the original or that they are
entitled to freely copy audio CDs, because no technology has been used in the past to prevent copying. It is not clear whether the major music labels
will deploy any copy protection solutions if there is sustained consumer resistance. To date, we have seen limited acceptance of our technology in
Europe and Japan. We believe that the major music labels have not moved to deploy the technology in the U.S. because they are concerned about
playability issues and negative consumer reaction. If the music labels conclude that shipping increasingly meaningful volumes of CDs that include our
technologies generate unacceptable consumer backlash, our revenue potential may be adversely affected. If the market for music CD copy protection fails
to develop, or develops more slowly than expected, if our solution does not achieve or sustain market acceptance or if there is significant and
sustained consumer resistance to this technology, our business would be harmed.
We license technology for digital VOD and PPV copy protection, and if this
market does not grow as anticipated or we are unable to serve this market effectively, our revenues may be adversely affected.
While our copy protection capability is embedded in
more than 145 million digital set-top boxes manufactured by the leading digital set-top box manufacturers, only 13 cable or satellite system operators
have activated copy protection for digital PPV or VOD programming. Our ability to expand our markets in additional home entertainment venues such as
digital PPV or VOD will depend in large part on the support of the major motion picture studios in advocating the incorporation and activation of copy
protection technology in the hardware and network infrastructure required to distribute such video programming. If the MPAA studios do not require copy
protection activation for PPV or VOD movies, or if PPV/VOD system operators
33
do not specify our copy protection in their set-top boxes, or if
the system operators do not activate copy protection in other digital PPV networks outside of Canada, Germany, Japan, Hong Kong or the United Kingdom,
then our business may be harmed.
Further, consumers may react negatively to copy
protected PPV or VOD programming because they may feel they are entitled to copy, having in the past routinely copied for later viewing analog cable
and satellite-delivered subscription television and PPV programs, as well as free broadcast programming. In addition, when incoming video signals are
routed through a VCR before reaching a TV set, the consumer may see impaired pictures while viewing a copy protected digital PPV program. If there is
consumer dissatisfaction that cannot be managed, or if there are technical compatibility problems, our business could be harmed.
Pricing pressures on the content owners that incorporate our technologies into
their products could limit the licensing fees we charge for our technologies, which could adversely affect our revenues.
The markets for the products in which our
technologies are incorporated are intensely competitive and price sensitive. Retail prices for such products that include our technology, such as DVDs
and CDs, have decreased significantly, and we expect prices to continue to decrease for the foreseeable future. In response, content owners have sought
to reduce their product costs, which can result in downward pressure on the licensing fees we charge our customers who incorporate our technologies
into the products they sell. A decline in the licensing fees we charge could materially and adversely affect our operating results.
If we are unable to compete effectively with existing or new competitors, we
could experience price reductions, fewer customers, reduced margins or loss of market share.
We believe that our DVD digital-to-analog copy
protection and videocassette copy protection systems currently have no competitors. It is possible, however, that competitive copy protection
technologies could be developed in the future. Increased competition would be likely to result in price reductions and loss of market share, either of
which could harm our business.
In the video market, there are a variety of
supplemental copy protection and encryption systems that provide partial copy protection for digital links (the DTLA 5C encryption technology); the 4C
pre-recorded media and recordable media copy protection systems; CSS, a content scrambling system for the DVD format; Intel’s High Definition Copy
Protection (“HDCP”) encryption for both the Digital Display Working Group’s Digital Video Interfaces (“DVI”) and HDMI
Licensing, LLC’s High Definition Multimedia Interface (“HDMI”). These systems are not directly competitive, as some apply to future
products, but they are sometimes confused with our analog copy protection and may create uncertainty in the minds of customers, thereby reducing or
delaying our licensing opportunities. Additionally, they may compete from the standpoint of content owners believing they have a limited budget for
copy protection, and they may choose to spend their copy protection dollars on only a few technologies.
Our primary competition in the electronic license
management market currently comes from our own prospective customers — those independent software vendors who believe they can develop their own
electronic license management solutions. In the event that software vendors succeed with their internal developments, or forego the implementation of
such applications, this would adversely affect our business. Other more traditional competitors include companies offering digital rights management,
electronic licensing, or electronic software distribution technology, as well as companies that have historically offered hardware dongle products and
are shifting to software-based protection. In addition, operating system developers or microprocessor suppliers may choose to integrate rights
management solutions into their products. Software resellers could also begin to develop their own electronic license management
solutions.
Our other software value management solutions,
namely our InstallShield Installer, Update Service, and Admin Studio have other competitors, but none of these competitors have the breadth of software
value management solutions that we do. In the Installer business, ZeroG and Altiris/Wise are competitors and
34
Altiris’ Package Studio is the primary
competition for our Admin Studio solution. Update Service appears to have no competition other than from our customers who believe they can develop
their own solutions.
There are a limited number of competitors in our
SafeDisc Advanced consumer software copy protection market, including SecureRom, Sony’s DADC optical disk manufacturing subsidiary, and StarForce
Technologies. However, it is possible that our own customers may develop software copy protection technologies on their own, or that personal computer
operating system and microprocessor companies may develop or license copy protection modules or systems that are internal to the PC or other consumer
electronic devices.
In the consumer software Product Activation market,
as in the enterprise software electronic license management market there is substantial competition from customer implemented internally developed
solutions, as from small companies such as Australian company XtreamLok, and software e-commerce vendors like Digital River.
DRM solutions for consumer software, video, and
audio have also attracted a number of companies and significant venture capital, including Intertrust Technologies (recently acquired by Sony and
Philips), Microsoft, Content Guard, and Real Networks. It is possible that companies with extensive financial resources may develop or acquire copy
protection and rights management solutions that compete with our offerings, or may have a controlling patent position which would negatively impact our
cost basis, or may give away their DRM technologies as in the case of the Windows Media Player.
Several of our competitors in the audio copy
protection and rights management market, including SunnComm, Sony, Settec and First4Internet have participated in early market trials with one or more
major record labels. New competitors or alliances among competitors may emerge and rapidly acquire significant market share in any of these areas. Our
competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements than we do, which could reduce
demand for our products or render them obsolete.
It may be more difficult for us, in the future, to have our technologies adopted
as individual industry standards to the extent that entertainment industry participants collaborate on the development of industry standard
technologies.
Increasingly, standards-setting organizations are
adopting or establishing technology standards for use in a wide-range of consumer electronics products. As a result, it is more difficult for
individual companies to have their technologies adopted wholesale as an informal industry standard. In addition, increasingly there are a large number
of companies, including ones that typically compete against one another, involved in the development of new technologies for use in consumer
entertainment products. As a result, these companies often license their collective intellectual property rights as a group, making it more difficult
for any single company to have its technologies adopted widely as a de facto industry standard or to have its technologies adopted as an exclusive,
explicit industry standard. Examples of this include MPEG-LA (DRM licensing); Advanced Access Control System (AACS) for next generation DVD encryption;
HD-DVD and BluRay DVD (next generation DVD formats). If our technologies are not supported by these standards bodies or patent pools, it may be more
difficult for us to grow our business in the future. Our major customers may have a large influence on industry standards and the widespread adoption
of new technologies. The selection of alternative technologies to ours or to those on which our technologies operate would harm our
business.
We have built a substantial business in the software value management space, and
market conditions are different from the entertainment digital product value management space.
Our Software Technologies Group’s major
products include FLEXnet Publisher and FLEXnet InstallShield. FLEXnet Publisher is licensed to software publishers as a software value management
product that enables these customers to offer multiple licensing models and automatically enforce compliance with license terms. FLEXnet InstallShield
is also sold to software publishers as an automatic installer to help them
35
with automatic and transparent installations of
their software on most Windows and non-Windows PCs and servers. There is no assurance of our ability to grow and be successful with these products and
if we are unsuccessful in the software value management market, our business would be harmed.
Major software vendors have experienced
deteriorating economic conditions as corporate customers have reduced capital expenditures. Demand for our software value management solutions is
driven, to some degree, by end-user demand for software applications. If economic conditions for software vendors continue to be difficult, demand for
our products could decline. This would result in lower revenues and operating income for this line of business.
In some cases, customers make a substantial capital
investment when purchasing our software and commit additional resources to installation and deployment. Potential customers spend significant time and
resources to determine which software to purchase. Selling our products sometimes requires an extensive sales effort because the decision to adopt our
software value management solutions generally involves several customer executives in various functions and geographic areas. Due to these factors, our
sales cycle is unpredictable, and the number of sales and amount of revenue generated from such sales varies from quarter to quarter.
The traditional application software business model
has been characterized by software vendors selling to enterprise IT departments who host the software on the enterprises’ servers and managed the
software from within the enterprise. With the initial success of the application service provider (“ASP”) business model, under which the
software application is hosted in remote servers and there is no server software resident in the enterprise, some industry experts have questioned
whether the ASP model will eventually replace the traditional application software business model. We believe it is too early to make this prediction,
however, because our software value management solutions are mostly tailored for the traditional software model, if the ASP model were to become very
popular, it could harm our business.
We have entered the market for digital
anti-ripper products and for peer-to-peer file sharing antipiracy products and we do not know if we will be successful in selling products for either
application.
In August 2003, we acquired intellectual property
and other assets, including patents and software that can be used to track and manage content in the peer-to-peer file sharing space. Our Hawkeye
technology, introduced in the second quarter of 2004, is designed to protect copyrighted content that is discovered being traded over the P2P file
sharing networks. Our RipGuard DVD technology, introduced in the fourth quarter of 2004, is designed to be added to the DVD at the time of manufacture
in order to prevent ripping by PCs. These solutions may not achieve or sustain market acceptance, or may not meet, or continue to meet, the demands of
the content owners. If the market for digital anti-ripper products or peer-to-peer antipiracy products fails to develop, or develops more slowly than
expected, if our solutions do not achieve or sustain market acceptance or if there is significant and sustained consumer resistance to this technology,
our business would be harmed.
Our business may be affected by peer-to-peer services on the
Internet.
Our business may be affected by “free”
peer-to-peer services, such as KaZaA, e-Donkey, Morpheus, Grokster and a variety of other similar services that allow computer users to connect with
each other and to copy/share many types of program files, including music and other media, from one another’s hard drives, all without securing
licenses from content providers. The legal status of these “free” services is uncertain, because although some courts have found that these
services violate copyright laws, other services have been found to not violate any copyright laws, particularly in the case of Grokster, which has been
appealed by the content owners to the U.S. Supreme Court. Additionally, enforcement efforts against those in violation have not effectively shut down
these services, and there can be no assurance that these services will ever be shut down. The ongoing presence of these “free” services
substantially impairs the marketability of legitimate services and of technologies that shut down other unauthorized sources of the program file
content, regardless of the ultimate resolution of their legal status. To the extent that consumers choose to utilize these peer-to
peer
36
services and do not purchase authentic packaged
media or authorized DRM downloads, it may adversely affect our business for packaged media copy protection.
Investment Risks
The price of our common stock may be volatile.
The market price of our common stock has been, and
in the future could be, significantly affected by factors such as:
• |
|
actual or anticipated fluctuations in operating
results; |
• |
|
announcements of technical innovations; |
• |
|
new products or new contracts; |
• |
|
competitors or their customers; |
• |
|
governmental regulatory and copyright action; |
• |
|
developments with respect to patents or proprietary
rights; |
• |
|
changes in financial estimates or coverage by securities
analysts; |
• |
|
changes in tax law or the interpretation of tax laws;
and |
• |
|
general market conditions. |
Announcements by the MPAA or its members, satellite
television operators, cable television operators or others regarding motion picture production or distribution, consumer electronics or software vendor
companies’ business combinations, evolving industry standards, consumer rights activists’ “wins” in government regulations or the
courts, or other developments could cause the market price of our common stock to fluctuate substantially.
There can be no assurance that our historic trading
prices and price/earnings ratios, or those of high technology companies in general, will be sustained. In the past, following periods of volatility in
the market price of a company’s securities, some companies have been named in class action suits.
Further, the military conflict in Iraq, additional
acts of terrorism and related political instability and economic uncertainty may adversely affect the global financial markets, which could cause the
market price of our common stock to fluctuate substantially.
We utilize pro forma reporting in our quarterly earnings press
releases.
We publish pro forma results in our quarterly
earnings press releases along with a reconciliation of pro forma earnings to earnings compiled in accordance with accounting principles generally
accepted in the United States (“GAAP”). Pro forma earnings are non-GAAP financial measurements. The reconciling items have adjusted GAAP net
income and GAAP earnings per share for certain non-cash, non-operating or non-recurring items and are described in detail in each such quarterly
earnings press release. We believe that this presentation may be useful to the investment community in analyzing the results of operations. We have not
included any such pro forma earnings or reconciliation to GAAP earnings in this annual report. The market price of our stock may fluctuate based on
future pro forma results. However, we urge investors to carefully review the GAAP financial information included as part of our Quarterly Reports on
Form 10-Q and our Annual Reports on Form 10-K that are filed with the SEC, as well as our quarterly earnings releases, and compare the GAAP financial
information with the pro forma financial results disclosed in our quarterly earnings releases and investor calls, as well as in some of our other
reports. If we decide to curtail this pro forma presentation in our quarterly earnings press releases, the market price of our stock could be
affected.
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If we continue to support broad-based employee stock option grants in the
future, recently adopted accounting standards that require companies to expense stock options will decrease our GAAP earnings and our stock price may
decline.
We believe that employee stock options are an
important element of total compensation. Effective July 1, 2005, the FASB has adopted new accounting rules that will require expensing of stock
options. Currently, we account for employee stock-based compensation arrangements in accordance with the provisions of (i) Accounting Principles Board
(“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” (ii) FASB Interpretation No. 44 (“FIN 44”),
“Accounting for Certain Transactions Involving Stock Compensation — an Interpretation of APB Opinion No. 25,” and comply with the
disclosure provisions of (iii) Statement of Financial Accounting Standard (“SFAS”) No. 123, “Accounting for Stock-Based
Compensation.” If we continue to support broad-based employee stock option grants after the July 1, 2005 change in GAAP which requires employee
stock-based compensation arrangements to be accounted for as an expense (in a manner different to APB No. 25 and FIN 44), the result may have a
material, negative impact upon our future earnings. Alternatively, if we cut back on employee stock option grants, we may lose an important benefit
that impacts the recruiting and retention of quality employees, and our business could be harmed. If we replace broad based employee option grants with
other types of performance based incentives, or restricted stock, we also will be required to report these incentives as expenses. Any of these
consequences could cause the market price of our stock to decline.
If our independent registered public accountants are unable to provide us with
an unqualified report as to the adequacy of our internal control over financial reporting for future year-end periods as required by Section 404 of the
Sarbanes-Oxley Act of 2002, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the
value of our stock.
As directed by Section 404 of the Sarbanes-Oxley Act
of 2002, the SEC adopted rules requiring public companies to include a report by management on our internal control over financial reporting in their
annual reports on Form 10-K that contains an assessment by our management of the effectiveness of internal control over financial reporting. In
addition, the public accounting firm auditing our financial statements must attest to and report on our management’s assessment of the
effectiveness of internal control over financial reporting. This requirement first applies to our annual report on Form 10-K for the fiscal year ending
December 31, 2004. While we continuously conduct a rigorous review of our internal control over financial reporting in order to comply with the Section
404 requirements, our independent registered public accountants may interpret the Section 404 requirements and the related rules and regulations
differently from how we interpret them, or our independent registered public accountants may not be satisfied with our internal control over financial
reporting or with the level at which these controls are documented, operated or reviewed in the future. In addition, the demand for competent audit
resources has grown dramatically as a result of the requirements of Section 404, and such demand may exceed available supply. Finally, in the event we
make a significant acquisition, or a series of smaller acquisitions, we may face significant challenges in implementing the required processes and
procedures in the acquired operations. As a result, our independent registered public accountants may decline or be unable to attest to
management’s assessment or may issue a qualified report in the future. This could result in an adverse reaction in the financial markets due to
investors’ perceptions that our internal controls are inadequate or that we are unable to produce accurate financial statements, which could cause
the market price of our shares to decline.
Our corporate headquarters consist of approximately
160,000 square feet located in Santa Clara, California. The leases for these premises expire on January 31, 2017. We also lease approximately 42,000
square feet in Schaumburg, Illinois pursuant to a lease that expires on January 31, 2009. Most U.S. sales, marketing and technical personnel for all
product divisions are in these locations, with a small number of individuals operating out of their home offices or a leased sales office in
Burlington, Massachusetts. We
38
believe that our existing facilities are
adequate to meet current requirements and that additional or substitute space will be available as needed to accommodate any expansion of
operations.
We also lease space for sales, marketing and
technical staff in Maidenhead, Cheshire and Bristol in the United Kingdom and in Tokyo, Japan; Seoul, Korea; Amsterdam, The Netherlands; Hong Kong;
Taipei, Taiwan; and Tel Aviv, Israel.
| ITEM 3. |
|
LEGAL PROCEEDINGS |
We are involved in legal proceedings related to some
of our intellectual property rights.
Macrovision Corporation v. ViTec Audio and Video GmbH
We initiated a patent infringement lawsuit in the
District Court of Dusseldorf in March 1999 against ViTec Audio und Video GmbH, a German company that manufactures what we believe to be a video copy
protection circumvention device. ViTec filed a reply brief arguing that its product does not infringe our patents. The case was heard in the District
Court of Dusseldorf, Germany and the Court ruled adversely against us. We appealed the District Court’s ruling in July 2000 to the Court of Appeal
in Dusseldorf. Following a series of hearings, the submission of a technical opinion from a Court appointed expert witness and briefs by both parties,
the Court of Appeals rendered a decision on January 20, 2005 rejecting Macrovision’s appeal and dismissing the case. The Court further ordered
Macrovision to pay the costs of the appeal, which are estimated to be 35,000 Euros. In view of the adverse ruling, we may incur a corresponding decline
in demand for our video content protection technology, which could harm our business in Germany.
USPTO Interference Proceedings Between Macrovision Corporation and InterTrust
Technologies
We received notice on September 4, 2003 from the
United States Patent and Trademark Office (“USPTO”) declaring an interference between our U.S. Patent No. 5,845,281 (the “‘281
patent”) together with two of its continuation applications, and a patent application determined to be from InterTrust Technologies Corporation.
On December 19, 2003, we received notice from the USPTO declaring an additional interference between two continuation applications related to the
‘281 patent and four issued U.S. patents of InterTrust. The ‘281 patent and its continuation applications are in the field of digital
rights management, and are not associated with our existing copy protection business.
An interference is declared by the USPTO when two or
more parties claim the same patentable invention. In the United States, the party who can prove earliest inventorship is granted the patent. An
interference proceeding has commenced to determine the rightful inventorship of the involved U.S. patents and patent applications. The ‘281
patent and its U.S. continuation applications have a priority filing date of February 1, 1995. The InterTrust patents and patent application have a
priority filing date of February 13, 1995. The Administrative Patent Judge (“APJ”) has decided to proceed with the second interference first.
Because our filing date is prior to InterTrust’s filing date, we have been designated the senior party in the interference. InterTrust submitted
its proof of inventorship in a brief filed on June 24, 2004. We responded with our brief filed on July 14, 2004. Interference procedural rules allow
each party to file rebuttals to the other party’s brief, cross-examine witnesses offered up by the other party and file various motions and
objections during this pre-hearing phase of the interference. This pre-hearing phase continued for several months. Following the close of this
pre-hearing phase, both parties had an opportunity for an oral hearing, which occurred on January 6, 2005. Following the oral hearing, we anticipate
that the APJ will issue a decision in the second interference case in the second quarter of 2005.
In the first patent interference case, InterTrust
had also brought an inequitable conduct motion against us alleging misconduct 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
39
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 allowed and is expected to be granted in the second quarter of 2005. These international cases
have the benefit of the early February 1, 1995 priority date and the broad patent claim coverage ultimately expected to issue in the U.S. following
resolution of the interference action.
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 versions of its DVD copying software. On June 4, 2004, 321 Studios filed a notice of interlocutory appeal,
which we opposed. 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 are awaiting the issuance of findings of fact and
conclusions of law by the court, which is expected by the second 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.
As of December 31, 2004, for all the above mentioned
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.
| ITEM 4. |
|
SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS |
We did not submit any matters to a vote of security
holders during the quarter ended December 31, 2004.
40
PART II
| ITEM 5. |
|
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS |
Price Range of Common Stock
Our common stock has been listed on the Nasdaq
National Market under the symbol “MVSN” since our initial public offering on March 13, 1997. The following table sets forth, for the periods
indicated, the reported high and low closing prices for our common stock.
|
|
|
|
High
|
|
Low
|
2003 |
|
|
|
|
|
|
|
|
|
|
First
Quarter |
|
|
|
$ |
17.67 |
|
|
$ |
10.89 |
|
Second
Quarter |
|
|
|
$ |
21.32 |
|
|
$ |
11.62 |
|
Third
Quarter |
|
|
|
$ |
23.50 |
|
|
$ |
17.97 |
|
Fourth
Quarter |
|
|
|
$ |
23.62 |
|
|
$ |
18.65 |
|
2004 |
|
|
|
|
|
|
|
|
|
|
First
Quarter |
|
|
|
$ |
26.89 |
|
|
$ |
17.06 |
|
Second
Quarter |
|
|
|
$ |
25.72 |
|
|
$ |
16.81 |
|
Third
Quarter |
|
|
|
$ |
25.02 |
|
|
$ |
20.64 |
|
Fourth
Quarter |
|
|
|
$ |
27.94 |
|
|
$ |
24.22 |
|
As of March 1, 2005, there were 93 holders of record
of our common stock, based upon information furnished by American Stock Transfer & Trust Company, the transfer agent for our securities. We
believe, based upon security positions listings, that there are approximately 6,733 beneficial owners of our common stock. As of March 1, 2005, there
were 50,387,148 shares of common stock outstanding.
Dividend Policy
We have not declared or paid any cash dividends on
our common stock since 1994. We do not anticipate paying any cash dividends on our common stock in the foreseeable future. We intend to retain all
earnings for use in our business operations and in expansion.
41
| ITEM 6. |
|
SELECTED FINANCIAL DATA |
The following table sets forth selected consolidated
financial data and other operating information. The financial data does not purport to indicate results of operations as of any future date or for any
future period. The financial data is derived from our consolidated financial statements and should be read in conjunction with the consolidated
financial statements, related notes and other financial information included herein.
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
|
2001
|
|
2000
|
|
|
|
|
(in thousands, except per share
data)
|
|
Consolidated Statements of Income Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
revenues |
|
|
|
$ |
182,099 |
|
|
$ |
128,346 |
|
|
$ |
102,262 |
|
|
$ |
98,813 |
|
|
$ |
80,116 |
|
Costs and
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of
revenues (1) |
|
|
|
|
22,660 |
|
|
|
11,447 |
|
|
|
10,285 |
|
|
|
7,980 |
|
|
|
7,222 |
|
Research and
development |
|
|
|
|
28,652 |
|
|
|
17,217 |
|
|
|
11,880 |
|
|
|
9,285 |
|
|
|
7,822 |
|
Selling and
marketing |
|
|
|
|
42,226 |
|
|
|
27,007 |
|
|
|
20,720 |
|
|
|
18,138 |
|
|
|
15,037 |
|
General and
administrative |
|
|
|
|
25,501 |
|
|
|
19,385 |
|
|
|
15,035 |
|
|
|
13,245 |
|
|
|
12,717 |
|
Amortization
of goodwill and other intangibles from acquisitions |
|
|
|
|
— |
|
|
|
— |
|
|
|
273 |
|
|
|
8,738 |
|
|
|
3,081 |
|
Amortization
of deferred stock-based compensation (2) |
|
|
|
|
185 |
|
|
|
2,656 |
|
|
|
6,261 |
|
|
|
9,591 |
|
|
|
15,533 |
|
In-process
research and development (3)(4)(5) |
|
|
|
|
5,400 |
|
|
|
624 |
|
|
|
6,000 |
|
|
|
— |
|
|
|
— |
|
Restructuring
expenses |
|
|
|
|
— |
|
|
|
— |
|
|
|
—- |
|
|
|
2,214 |
|
|
|
— |
|
Total costs
and expenses |
|
|
|
|
124,624 |
|
|
|
78,366 |
|
|
|
70,454 |
|
|
|
69,191 |
|
|
|
61,412 |
|
Operating
income |
|
|
|
|
57,475 |
|
|
|
50,010 |
|
|
|
31,808 |
|
|
|
29,622 |
|
|
|
18,704 |
|
Impairment
losses on strategic investments |
|
|
|
|
(5,478 |
) |
|
|
(4,820 |
) |
|
|
(17,210 |
) |
|
|
(6,860 |
) |
|
|
— |
|
Gains on
strategic investments |
|
|
|
|
1,220 |
|
|
|
452 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Interest and
other income, net |
|
|
|
|
4,173 |
|
|
|
3,852 |
|
|
|
7,318 |
|
|
|
10,397 |
|
|
|
10,714 |
|
Income before
income taxes |
|
|
|
|
57,390 |
|
|
|
49,494 |
|
|
|
21,916 |
|
|
|
33,159 |
|
|
|
29,418 |
|
Income
taxes |
|
|
|
|
20,660 |
|
|
|
22,553 |
|
|
|
9,827 |
|
|
|
13,974 |
|
|
|
15,825 |
|
Net
income |
|
|
|
$ |
36,730 |
|
|
$ |
26,941 |
|
|
$ |
12,089 |
|
|
$ |
19,185 |
|
|
$ |
13,593 |
|
Basic net
earnings per share |
|
|
|
$ |
0.74 |
|
|
$ |
0.55 |
|
|
$ |
0.24 |
|
|
$ |
0.38 |
|
|
$ |
0.28 |
|
Shares used
in computing basic net earnings per share |
|
|
|
|
49,516 |
|
|
|
48,754 |
|
|
|
50,046 |
|
|
|
50,216 |
|
|
|
49,135 |
|
Diluted net
earnings per share |
|
|
|
$ |
0.73 |
|
|
$ |
0.54 |
|
|
$ |
0.24 |
|
|
$ |
0.37 |
|
|
$ |
0.26 |
|
Shares used
in computing diluted net earnings per share |
|
|
|
|
50,619 |
|
|
|
49,518 |
|
|
|
50,602 |
|
|
|
51,746 |
|
|
|
51,386 |
|
| (1) |
|
See Note 1 of Notes to Consolidated Financial Statements. Cost
of revenues includes $6.4 million, $3.3 million, $2.3 million, $2.1 million and $1.8 million of amortization of intangibles from acquisitions during
2004, 2003, 2002, 2001 and 2000, respectively. |
| (2) |
|
The allocation of the amortization of deferred stock-based
compensation relates to the expense categories as set forth in the table below. |
| (3) |
|
In connection with the acquisition of Midbar Tech (1998) Ltd. in
November 2002, we allocated and expensed $6.0 million of the purchase price to in-process research and development projects. |
| (4) |
|
In connection with the acquisition of peer-to-peer assets in
August 2003, we allocated and expensed $624,000 of the purchase price to in-process research and development projects. |
| (5) |
|
In connection with the acquisition of InstallShield in July
2004, we allocated and expensed $5.4 million of the purchase price to in-process research and development projects. |
42
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
|
2001
|
|
2000
|
|
|
|
|
(in thousands)
|
|
Amortization of Deferred Stock-Based
Compensation Expense:
|
|
|
|
|
|
|
|
|
|
|
|
Cost of
revenues |
|
|
|
$ |
27 |
|
|
$ |
318 |
|
|
$ |
395 |
|
|
$ |
468 |
|
|
$ |
428 |
|
Research and
development |
|
|
|
|
53 |
|
|
|
551 |
|
|
|
1,205 |
|
|
|
1,999 |
|
|
|
3,064 |
|
Selling and
marketing |
|
|
|
|
36 |
|
|
|
975 |
|
|
|
3,502 |
|
|
|
5,219 |
|
|
|
10,645 |
|
General and
administrative |
|
|
|
|
69 |
|
|
|
812 |
|
|
|
1,159 |
|
|
|
1,905 |
|
|
|
1,396 |
|
|
|
|
|
$ |
185 |
|
|
$ |
2,656 |
|
|
$ |
6,261 |
|
|
$ |
9,591 |
|
|
$ |
15,533 |
|
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
|
2001
|
|
2000
|
|
|
|
|
(in thousands)
|
|
Consolidated Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash, cash
equivalents, short and long-term investments |
|
|
|
$ |
253,670 |
|
|
$ |
269,632 |
|
|
$ |
210,376 |
|
|
$ |
231,048 |
|
|
$ |
217,441 |
|
Working
capital |
|
|
|
|
208,076 |
|
|
|
125,248 |
|
|
|
191,862 |
|
|
|
144,676 |
|
|
|
123,895 |
|
Total
assets |
|
|
|
|
452,473 |
|
|
|
385,566 |
|
|
|
324,666 |
|
|
|
335,586 |
|
|
|
296,438 |
|
Long-term
obligations, net of current portion |
|
|
|
|
979 |
|
|
|
874 |
|
|
|
448 |
|
|
|
33 |
|
|
|
56 |
|
Total
stockholders’ equity |
|
|
|
|
398,344 |
|
|
|
341,211 |
|
|
|
296,859 |
|
|
|
318,200 |
|
|
|
275,975 |
|
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following commentary should be read in
conjunction with the Consolidated Financial Statements and related notes contained elsewhere in this Form 10-K. 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,” “expect,”
“plan,” “anticipate,” “believe,” “estimate,” “future,” “predict,” “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 set forth under
“Risk Factors” and elsewhere in this Form 10-K. 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.
We are organized in two business units, the
Entertainment Technologies Group and the Software Technologies Group. The Entertainment Technologies Group licenses digital content value
management
43
technology to video, music, and PC games content owners. Our
Hawkeye peer-to-peer file sharing antipiracy service that was introduced in the second quarter of 2004 is also included in the Entertainment
Technologies Group. The Software Technologies Group develops and markets our software value management solutions which include the FLEXnet suite of
electronic license management, electronic license delivery, and software asset management products, as well as the recently acquired InstallShield
Installer, Update Service, and Admin Studio products. Revenues have been reclassified for prior periods to conform to the current period
presentation.
The following table provides revenue information by
business unit for the periods indicated (dollars in thousands):
|
|
|
|
Year ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
Entertainment
Technologies Group |
|
|
|
$ |
110,711 |
|
|
$ |
91,380 |
|
|
$ |
72,897 |
|
Software
Technologies Group |
|
|
|
|
71,388 |
|
|
|
36,966 |
|
|
|
29,365 |
|
|
|
|
|
$ |
182,099 |
|
|
$ |
128,346 |
|
|
$ |
102,262 |
|
The following table provides percentage of revenue
information by business unit for the periods indicated:
|
|
|
|
Year ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
Entertainment
Technologies Group |
|
|
|
|
60.8 |
% |
|
|
71.2 |
% |
|
|
71.3 |
% |
Software
Technologies Group |
|
|
|
|
39.2 |
|
|
|
28.8 |
|
|
|
28.7 |
|
|
|
|
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
Entertainment Technologies Group
Our Entertainment Technologies Group generates
revenue from the home video divisions of member companies of the MPAA, videocassette duplication and DVD replication companies and a number of
“special interest” content owners, such as independent producers of exercise, sports, educational, documentary and corporate video programs.
We typically receive per unit royalties based upon the number of copy-protected videocassettes or DVDs that are produced by MPAA studios or other
content owners. Our Entertainment Technologies Group also generates revenues from licensing digital PPV and video-on-demand (VOD) content protection
solutions to satellite and cable system operators and equipment manufacturers that supply cable and satellite industries. Most of our PPV content
protection revenues are generated from royalties on digital set top boxes. We also receive one-time and annual license fees from set top box, DVD, and
personal video recorder manufacturers. In addition, our Entertainment Technologies Group generates revenues from customers implementing our CD-ROM copy
protection technology on PC games, as well as customers in the music industry who implement our copy technology on compact discs.
Revenues from our Entertainment Technologies Group
increased $19.3 million, or 21.2% from 2003 to 2004. Revenues from our video content protection technologies represented 55.2%, 63.3% and 63.1% of our
net revenues during 2004, 2003 and 2002, respectively. The increases in our video content protection technologies revenues are primarily due to the
increase in numbers of DVDs sold and continued strong demand for our DVD copy protection solution, despite declining unit royalties over the past two
years and to a lesser extent, the increases in revenue are also due to an increase in PPV and VOD revenues. During 2004, we recognized approximately
$2.2 million of revenue from studio volume replicated during 2003. We were not able to record these revenues in the year in which the volumes were
replicated due to prolonged contract negotiations. During 2003, DVD copy protection revenues included approximately $917,000 in revenue from the
resolution of one customer’s over reporting claim.
44
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 increase in absolute terms and continue to be a significant part of our revenues, although our
video copy protection per unit royalties may continue to decline.
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 $34.4 million or 93.1% in 2004 as compared with 2003. The increase in our Software Technologies Group revenue is
due to the inclusion of $17.7 million of revenues from our InstallShield operations since July 1, 2004 and increased sales of our FLEXnet Publisher
license management solutions resulting from the impact of broad based product and marketing programs and the efforts of sales personnel added during
the year. We believe that revenues from our Software Technologies Group will continue to increase in the future in absolute terms and as a percentage
of our total revenues due to increased sales of our FLEXnet and InstallShield solutions.
Seasonality of Business
We have experienced significant seasonality in our
business, and our consolidated financial condition and results of operations are likely to be affected by seasonality in the future. We have typically
experienced our highest revenues in the fourth quarter of each calendar year followed by lower revenues and operating income in the first quarter of
the following year, and at times in subsequent quarters. We believe that this trend 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 service fees and patent related litigation expense. Service 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 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.
45
Critical Accounting Policies and Use of Estimates
The discussion and analysis of our financial
condition and results of operations are based upon our consolidated financial statements. These 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 antipiracy service is recognized upon establishment of persuasive evidence of an arrangement,
performance of all significant obligations and determination that collection of a fixed and determinable license fee is considered
probable.
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
46
arrangements with payment terms extending beyond
six months not to be fixed or determinable and, accordingly, revenue is recognized as payments become due and payable from the customer under such
arrangements. We assess collectibility based on a number of factors, including the customer’s past payment history and current creditworthiness.
If collectibility is not considered probable, revenue is recognized when the fee is collected from the customer.
For license agreements in which non-standard
customer acceptance clauses are a condition to earning the license fees, revenue is not recognized until acceptance occurs. For arrangements containing
multiple elements, such as software license fees, consulting services and maintenance, or multiple products and where vendor-specific objective
evidence (“VSOE”) of fair value exists for all undelivered elements, we account for the delivered elements in accordance with the
“residual method.” Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the
arrangement fee is recognized as revenue. For arrangements containing multiple elements where VSOE of fair value does not exist for all undelivered
elements, all revenue is deferred until such time as VSOE of fair value for all undelivered elements is evidenced or all elements of the arrangement
have been delivered, or if the only undelivered element is maintenance where VSOE of fair value exists, maintenance revenue is recognized pro rata over
the maintenance contract period. We also enter into term license agreements in which the license fee is recognized ratably over the term of the license
period (generally one year).
When licenses are sold together with consulting and
implementation services, license fees are recognized upon delivery of the product provided that: (1) the above criteria have been met; (2) payment of
the license fees is not dependent upon performance of the consulting and implementation services; and (3) the services are not essential to the
functionality of the software. For arrangements where services are essential to the functionality of the software, both the license and services
revenue are recognized in accordance with the provisions of SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type
Contracts.” Arrangements that allow us to make reasonably dependable estimates relative to contract costs and the extent of progress toward
completion are accounted for using the percentage-of-completion method. Arrangements that do not allow us to make reasonably dependable estimates of
costs and progress are accounted for using the completed-contracts method. Because the completed-contracts method precludes recognition of performance
under the contract as the work progresses, it does not reflect current financial performance when the contract extends beyond one accounting period,
and it therefore may result in uneven recognition of revenue and gross margin. For each of the years ended December 31, 2003 and 2004, we used the
completed-contracts method for all such arrangements. For the year ended December 31, 2002, there were no 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 consolidated financial statements.
Maintenance Revenues
Maintenance agreements generally call for us to
provide technical support and unspecified software updates to customers. Maintenance revenue is deferred and recognized ratably over the maintenance
contract period (generally one year) and is included in services revenue in the accompanying consolidated financial statements.
Valuation of Strategic Investments
As of December 31, 2004 and 2003, the adjusted cost
of our strategic investments totaled $18.8 million and $27.0 million, respectively. This included our investments in public and non-public companies.
Our investments in public and non-public companies are classified on the balance sheet as “Long-term marketable investment securities” and
“Other assets,” respectively.
47
We review our investments in non-public companies
and estimate the amount of any impairment incurred during the current period based on specific analysis of each investment, considering the activities
of and events occurring at each of the underlying portfolio companies during the period. For investments in public companies, at each quarter end, we
compare our basis in the investment to the average daily trading prices of the security over the prior six months to determine if an
other-than-temporary impairment has occurred. If the six-month average is less than the current cost basis, we record a charge to the statement of
income for the difference between the market price at period end and the current cost basis. Based on such methods, we recorded an other-than temporary
impairment of $5.3 million on our investment in Digimarc during the twelve months ended December 31, 2004 and $5.6 million during the twelve months
ended December 31, 2002 relating to Digimarc and TTR.
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, $4.8 million
and $11.6 million of other-than-temporary impairment losses from investments in non-public companies were recorded during the years ended December 31,
2004, 2003 and 2002, respectively. As of December 31, 2004, our investments in non-public companies had no remaining carrying value.
In 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 2004. Also, in 2003, we recorded $395,000 of realized gains
from the surrender of our stock in TTR.
Goodwill and Other Intangible Assets
Goodwill represents the excess of cost over fair
value of assets of businesses acquired. We account for goodwill under the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets.”
Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but
instead are tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible
assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for
impairment in accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.”
Goodwill and intangible assets not subject to
amortization are tested annually for impairment, and are tested for impairment more frequently if events and circumstances indicate that the assets
might be impaired. In 2004, 2003 and 2002, 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
48
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, 2003 and 2002, we completed our
annual impairment analyses of goodwill. Based on the results of the annual impairment analysis, we determined that no indicators of impairment existed
for our reporting units and no impairment charges were recorded for goodwill during the years ended December 31, 2004, 2003 and 2002.
Impairment of Long-Lived Assets
In accordance with SFAS No. 144, long-lived assets,
such as property and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset group to estimated undiscounted future cash flows expected to be generated by the asset group. If the
carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying
amount of the asset group exceeds the fair value of the asset group. Assets to be disposed of would be separately presented in the balance sheet and
reported at the lower of the carrying amount or fair value less costs to sell, and would no longer be depreciated. The assets and liabilities of a
disposal group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet. In 2004,
2003 and 2002, 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, judgements 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 consolidated financial statements.
49
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.
Results of Operations
The following table sets forth selected consolidated
statements of income data expressed as a percentage of net revenues for the periods indicated:
|
|
|
|
Year ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Licenses |
|
|
|
|
88.1 |
% |
|
|
89.4 |
% |
|
|
89.9 |
% |
Services |
|
|
|
|
11.9 |
|
|
|
10.6 |
|
|
|
10.1 |
|
Total
revenues |
|
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
Cost of
revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Licenses |
|
|
|
|
4.5 |
|
|
|
3.9 |
|
|
|
6.0 |
|
Services |
|
|
|
|
4.4 |
|
|
|
2.4 |
|
|
|
1.9 |
|
Amortization
of intangibles from acquisitions |
|
|
|
|
3.5 |
|
|
|
2.6 |
|
|
|
2.2 |
|
Total cost of
revenues |
|
|
|
|
12.4 |
|
|
|
8.9 |
|
|
|
10.1 |
|
Gross
profit |
|
|
|
|
87.6 |
|
|
|
91.1 |
|
|
|
89.9 |
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and
development |
|
|
|
|
15.7 |
|
|
|
13.4 |
|
|
|
11.6 |
|
Selling and
marketing |
|
|
|
|
23.2 |
|
|
|
21.0 |
|
|
|
20.3 |
|
General and
administrative |
|
|
|
|
14.0 |
|
|
|
15.1 |
|
|
|
14.7 |
|
Amortization
of intangibles from acquisitions |
|
|
|
|
— |
|
|
|
— |
|
|
|
0.2 |
|
Amortization
of deferred stock-based compensation |
|
|
|
|
0.1 |
|
|
|
2.1 |
|
|
|
6.1 |
|
In-process
research and development |
|
|
|
|
3.0 |
|
|
|
0.5 |
|
|
|
5.9 |
|
Total
operating expenses |
|
|
|
|
56.0 |
|
|
|
52.1 |
|
|
|
58.8 |
|
Operating
income |
|
|
|
|
31.6 |
|
|
|
39.0 |
|
|
|
31.1 |
|
Interest and
other income, net |
|
|
|
|
2.3 |
|
|
|
3.0 |
|
|
|
7.1 |
|
Impairment
losses on strategic investments |
|
|
|
|
(3.0 |
) |
|
|
(3.8 |
) |
|
|
(16.8 |
) |
Gains on
strategic investments |
|
|
|
|
0.6 |
|
|
|
0.4 |
|
|
|
— |
|
Income before
income taxes |
|
|
|
|
31.5 |
|
|
|
38.6 |
|
|
|
21.4 |
|
Income
taxes |
|
|
|
|
11.3 |
|
|
|
17.6 |
|
|
|
9.6 |
|
Net
income |
|
|
|
|
20.2 |
% |
|
|
21.0 |
% |
|
|
11.8 |
% |
50
Comparison of Years Ended December 31, 2004 and 2003
The following table provides revenue information by
business unit for the periods indicated (dollars in thousands):
|
|
|
|
Year ended December 31,
|
|
$ |
|
% |
|
|
|
|
2004
|
|
2003
|
|
Change
|
|
Change
|
Entertainment
Technologies Group |
|
|
|
$ |
110,711 |
|
|
$ |
91,380 |
|
|
$ |
19,331 |
|
|
|
21.2 |
% |
Software
Technologies Group |
|
|
|
|
71,388 |
|
|
|
36,966 |
|
|
|
34,422 |
|
|
|
93.1 |
% |
Total Net
Revenue |
|
|
|
$ |
182,099 |
|
|
$ |
128,346 |
|
|
$ |
53,753 |
|
|
|
41.9 |
% |
License Revenues. Our license revenues for
2004 increased by $45.6 million or 39.7% compared to 2003 primarily due to higher revenue from our video content protection and software products. The
increase in license revenues is also due to $12.8 million in revenue from the inclusion of InstallShield product revenue since July 1,
2004.
Video content protection revenues are higher due to
the increase in numbers of DVDs sold and continued growth in demand of the DVD format, continued high penetration among Hollywood studio customers, a
strong hit release schedule that more than offset modest declines in our average unit royalties and decreased usage by certain Hollywood studios. Video
content protection revenues also increased due to higher PPV and VOD revenues primarily from royalties and license fees from digital set top boxes due
to strong demand from consumers, especially in international territories, for digital cable and digital satellite operators’ businesses. During
2004, we recognized approximately $2.2 million of revenue from studio volume replicated during 2003. We were not able to record these revenues in the
year in which the volumes were replicated due to prolonged contract negotiations. In 2003, DVD copy protection revenues included approximately $917,000
in revenue from the resolution of one customer’s over reporting claim. During 2004, we recognized $3.1 million in PPV revenue that was previously
deferred until North American system operators activated the VOD system.
Excluding the inclusion of InstallShield since July
1, 2004, the increases in license revenue from our Software Technologies Group are primarily due to increased sales of our FLEXnet Publisher license
management solutions resulting from the impact of broad based product and marketing programs and additional sales personnel in our Software
Technologies Group.
Service Revenues. Our service revenues for
2004 increased $8.1 million or 60.0% to $21.7 million compared to $13.5 million in 2003, primarily due to the growth of our professional services
practice which has generated higher consulting revenue and our increased market penetration has resulted in higher maintenance revenue. The increase in
service revenues is also due to $4.9 million from the inclusion of InstallShield since July 1, 2004.
Cost of Revenues — License Fees. Cost of
revenues from license fees as a percentage of license revenues increased to 5.1% for 2004 from 4.3% for 2003. Cost of revenues from license fees
increased $3.2 million to $8.2 million in 2004 from $5.0 million in 2003. The increases are primarily due to higher patent defense costs and higher
patent amortization costs. Cost of revenues includes items such as product costs, duplicator and replicator fees, video copy protection processor
costs, patent amortization on internally developed patents, patent defense costs, 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 to 37.3% for 2004 from 23.3% for 2003. Cost of revenues from service fees
increased $4.9 million to $8.1 million in 2004 from $3.2 million in 2003. The increases are primarily due to the expansion of our professional services
group to support additional consulting and implementation projects for our FLEXnet solutions. The increase is also due to $3.2 million in costs
associated with additional personnel and infrastructure from our acquisition of InstallShield since July 1, 2004. We anticipate our cost of
revenues
51
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 to $6.4 million in 2004 from $3.3 million in 2003. The
increase is primarily due to amortization of intangibles from the acquisition of InstallShield in July 2004.
We acquired the net assets of InstallShield in July
2004 for approximately $77.1 million in cash, including related acquisition costs. In addition, we have agreed to an additional maximum payout of $20.0
million contingent on post-acquisition performance through June 30, 2005. The transaction was accounted for as a purchase and approximately $28.8
million of the purchase price was allocated to existing technology, existing contracts, patents and trademarks. In addition, we recorded $43.1 million
of goodwill from this transaction and recorded a $5.4 million charge in 2004 for purchased in-process research and development. We amortize
intangibles, with the exception of goodwill, relating to the acquisition of net assets of InstallShield on a straight-line basis over three to six
years based on the expected useful lives of existing technology, existing contracts, patents and trademarks.
Research and Development. Research and
development expenses increased by $11.4 million or 66.4% to $28.7 million in 2004 from $17.2 million in 2003. The increase is primarily due to
increased research and development activities for our video technology, music technology, peer-to-peer antipiracy and software value management
products resulting in higher costs. The increases are also due to $4.5 million in costs associated with additional personnel and infrastructure from
our acquisition of InstallShield since July 1, 2004. Research and development expenses increased as a percentage of net revenues to 15.7% in 2004 from
13.4% in 2003. We expect research and development expenses to increase in absolute terms and as a percentage of revenues over the prior year periods as
a result of expected increases in research and development activity to support customer/market demand for new technologies from our Entertainment
Technologies Group and Software Technologies Group.
Selling and Marketing. Selling and marketing
expenses increased by $15.2 million, or 56.4%, to $42.2 million in 2004 from $27.0 million in 2003. The increases are due to higher costs from
increased business development activities for our entertainment and software technologies products on an overall basis as well as increased commission
costs associated with higher revenue levels. The increases are also due to $6.0 million in costs associated with additional personnel and
infrastructure from our acquisition of InstallShield since July 1, 2004. Selling and marketing expenses increased as a percentage of net revenues to
23.2% in 2004 from 21.0% in 2003. Selling and marketing expenses are expected to increase in absolute terms and as a percentage of revenues as we
continue to invest in additional sales personnel and expand our efforts to increase our market share and grow our business.
General and Administrative. General and
administrative expenses increased by $6.1 million, or 31.6%, to $25.5 million in 2004 from $19.4 million in 2003. The increases are primarily due to
increased headcount and related costs to support the overall growth of our business units and higher costs for compliance with the Sarbanes-Oxley Act
of 2002. To a lesser extent, the increase is also due to costs associated with additional personnel and infrastructure from our acquisition of
InstallShield since July 1, 2004. General and administrative expenses decreased as a percentage of net revenues to 14.0% in 2004 from 15.1% in 2003. We
expect our general and administrative expenses to increase in absolute terms and remain flat as a percentage of revenues 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.
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. The amortization of the deferred
stock-based compensation for 2004 and 2003 was $185,000 and $2.7 million,
52
respectively. The expense associated with
amortization of this stock-based compensation ended in the first quarter of 2004.
In-process research and development. In
connection with the acquisition of InstallShield in July 2004, $5.4 million was charged to in-process research and development in the year ended
December 31, 2004. In connection with the acquisition of intellectual property and other assets in the peer-to-peer file sharing space in August 2003,
$624,000 was charged to in-process research and development in 2003.
Impairment losses on strategic investments.
During 2004 and 2003, we recorded charges totaling $5.5 million and $4.8 million, respectively, relating to other-than-temporary impairment of certain
strategic investments. During 2004, we recorded $5.3 million and $180,000 in charges relating to other-than-temporary impairments in our investments in
Digimarc and iVast, respectively. During 2003, we recorded $4.8 million in charges relating to an other-than-temporary impairment in our investment in
iVast.
Gains on strategic investments. For the year
ended December 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 year ended
December 31, 2004, we recorded a gain on strategic investments of $1.2 million. During 2003, we recorded a realized gain of $395,000 from the surrender
of 1,880,937 shares of TTR common stock, which was used to acquire patents and other assets of TTR, a public company strategic investment, and a
realized gain of $57,000 for distributions received in excess of its book value for our investment in NTRU Cryptosystems, a private
company.
Interest and Other Income, Net. Interest and
other income increased $321,000, or 8.3%, to $4.2 million in 2004 from $3.9 million in 2003. This increase is primarily due to foreign exchange gains.
As the Euro grew strong against the US Dollar in 2004, we recorded a gain on our Euro bank balances where the functional currency was the US Dollar.
This increase was partially offset by a decrease in interest income due to a decline in our investment balances. The decline in our investment balances
was due to the acquisition of InstallShield.
Income Taxes. We recorded income tax expense
of $20.7 million and $22.6 million for 2004 and 2003, respectively. Income tax expense represents combined federal and state taxes at effective rates
of 36.0% and 45.6% for 2004 and 2003, respectively. The change in effective tax rate in 2004 compared to 2003 was primarily due to the increase in
valuation allowance and the higher portion of profits generated by our foreign operations.
Comparison of Years Ended December 31, 2003 and 2002
The following table provides revenue information by
business unit for the periods indicated (dollars in thousands):
|
|
|
|
Year ended December 31,
|
|
$ |
|
% |
|
|
|
|
2003
|
|
2002
|
|
Change
|
|
Change
|
Entertainment
Technologies Group |
|
|
|
$ |
91,380 |
|
|
$ |
72,897 |
|
|
$ |
18,483 |
|
|
|
25.4 |
% |
Software
Technologies Group |
|
|
|
|
36,966 |
|
|
|
29,365 |
|
|
|
7,601 |
|
|
|
25.9 |
% |
Total Net
Revenue |
|
|
|
$ |
128,346 |
|
|
$ |
102,262 |
|
|
$ |
26,084 |
|
|
|
25.5 |
% |
License Revenues. Our license revenues for
2003 increased by 24.9% compared to 2002 primarily due to increases in our revenues derived by our video content protection technology products,
primarily in the DVD copy protection area. This was offset by decreases in our copy protection revenues for videocassettes. During 2003, the increase
in video content protection revenues included approximately $917,000 in revenue as a partial resolution of this customer reporting claim. Our video
content protection revenues in 2002 were also reduced by a $2.3 million refund resulting from a customer’s self-reporting errors detected in 2002,
which revenue was previously recognized upon cash receipt. We also had increases in license revenues from our
53
Software Technologies Group primarily due to an
increase in licensing and maintenance volume and the increased market acceptance of our technology by major software vendors.
Service Revenues. Our service revenues for
2003 increased by 31.2% compared to 2002 primarily due to increases in maintenance revenues and, to a lesser extent, an increase in consulting
revenues.
Cost of Revenues — License Fees. Cost of
revenues from license fees as a percentage of license revenues decreased to 4.3% for 2003 from 6.6% for 2002. Cost of revenues from license fees
decreased $1.1 million to $5.0 million in 2003 from $6.1 million in 2002. This decrease was primarily due to decreased patent defense costs relating to
the Rainbow litigation. Cost of revenues includes items such as product costs, duplicator and replicator fees, video copy protection processor costs,
patent amortization on internally developed patents, patent defense costs and licensing expenses.
Cost of Revenues — Service Fees. Cost of
revenues from service fees as a percentage of service revenues increased to 23.3% for 2003 from 18.5% for 2002. Cost of revenues from service fees
increased $1.2 million to $3.2 million in 2003 from $1.9 million in 2002. This increase was primarily due to increased activity in our enterprise
software consulting practice.
Cost of Revenues — Amortization of
Intangibles from Acquisitions. Cost of revenues from amortization of intangibles increased to $3.3 million in 2003 from $2.3 million in 2002. The
increase is primarily due to amortization of intangibles from the Midbar acquisition that was completed in November 2002.
We acquired the net assets of Midbar in November
2002 for approximately $17.8 million in cash. In addition, we have agreed to an additional maximum payout of $8.0 million based on a percentage of the
net revenues of the music technology division through December 31, 2004. The transaction was accounted for as a purchase and approximately $4.9 million
of the purchase price was allocated to existing technology, existing contracts, patents and trademarks. In addition, we recorded $6.9 million of
goodwill from this transaction and recorded a $6.0 million charge in 2002 for purchased in-process research and development. In 2003, we recorded
additional goodwill of approximately $1.2 million for the contingent payment obligation based on sales of our music technology products through
December 31, 2003. We amortize intangibles, with the exception of goodwill, relating to the acquisition of net assets of Midbar on a straight-line
basis over three to five years based on the expected useful lives of existing technology, existing contracts, patents and trademarks.
In August 2003, we acquired intellectual property
and other assets, including patents and software that can be used to track and manage content in the peer-to-peer file sharing space. We paid $720,000
in cash, $80,000 of acquisition costs and an additional payment of $80,000 will be due on the first anniversary of the closing date for a total
purchase price of $880,000. In addition, we have agreed to a maximum payment of $140,000 if certain milestones are achieved by May 28, 2004. The
purchase price was allocated to in-process research and development, core technology and employment agreements. The in-process research and development
of $624,000 was expensed in 2003, and the balance of the purchase price has been allocated among the other intangible assets and is being amortized on
a straight-line basis over two to six years based on the expected useful lives of the intangibles.
Research and Development. Research and
development expenses increased by $5.3 million or 44.9% to $17.2 million in 2003 from $11.9 million in 2002. The increase is primarily due to increased
research and development activities for our video technology, music technology and software technology product lines. Research and development expenses
increased as a percentage of net revenues to 13.4% in 2003 from 11.6% in 2002.
Selling and Marketing. Selling and marketing
expenses increased by $6.3 million or 30.3% to $27.0 million in 2003 from $20.7 million in 2002. This increase was primarily due to increased business
development activities for our enterprise licensing and music technology product lines and increased commission costs associated with higher revenue
levels. Selling and marketing expenses increased as a percentage of net revenues to 21.0% in 2003 from 20.3% in 2002.
54
General and Administrative. General and
administrative expenses increased by $4.4 million or 28.9% to $19.4 million in 2003 from $15.0 million in 2002, primarily due to higher compensation
expense, increased headcount and increased costs associated with the compliance with Sarbanes-Oxley requirements. General and administrative expenses
increased as a percentage of net revenues to 15.1% in 2003 from 14.7% in 2002.
Amortization of Intangibles from
Acquisitions. Amortization of intangibles from acquisitions, other than those included in cost of revenues, decreased from $273,000 in 2002 to $0
in 2003 as the covenant not to compete in connection with the purchase of PtS was fully amortized during 2002. There was no amortization of intangibles
from acquisitions in operating expenses during 2003.
Amortization of Deferred Stock-Based
Compensation. In connection with the acquisition of Globetrotter in 2000, approximately 783,742 Globetrotter employee stock options were exchanged
for Macrovision stock options, resulting in a deferred stock-based compensation charge of approximately $37.9 million. The amortization of the deferred
stock-based compensation for 2003 and 2002 was $2.7 million and $6.3 million, respectively. The expense associated with amortization of this
stock-based compensation will end in the first quarter of 2004.
In-process research and development. In
connection with the acquisition of intellectual property and other assets in the peer-to-peer file sharing space in August 2003, $624,000 was charged
to in-process research and development in 2003. In connection with the acquisition of Midbar in November 2002, $6.0 million was charged to in-process
research and development in 2002.
Impairment losses and gains on strategic
investments. During 2003 and 2002, we recorded net charges totaling $4.4 million and $17.2 million, relating to other-than-temporary impairment of
certain strategic investments. During 2003, we determined that the decline in value of our iVAST stock was other-than-temporary and took a charge to
earnings of $4.8 million as a result. This was partially offset by a gain of $395,000 related to the surrender of 1,880,937 shares of TTR common stock,
which was used to acquire patents and other assets of TTR.
Interest and Other Income, Net. Interest and
other income decreased $3.5 million or 47.4% to $3.9 million in 2003 from $7.3 million in 2002, primarily from declining interest
rates.
Income Taxes. We recorded income tax expense
of $22.6 million and $9.8 million for 2003 and 2002, respectively. Income tax expense represents combined federal and state taxes at effective rates of
45.6% and 44.8% for 2003 and 2002, respectively. The increase in the effective tax rate was primarily due to changes in tax jurisdictions where our
income was earned and the composition of our expenses, including the reduction in amortization of deferred stock-based compensation.
55
Quarterly Results of Operations
The following table sets forth certain quarterly
unaudited consolidated financial data for the periods indicated, as well as the percentage of our net revenues represented by such data. The data have
been derived from our unaudited consolidated financial statements and, in the opinion of management, have been prepared on substantially the same basis
as the audited consolidated financial statements, and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair
presentation of such data. Such data should be read in conjunction with our audited consolidated financial statements and notes thereto appearing
elsewhere in this Form 10-K. The results of operations for any quarter are not necessarily indicative of the results to be expected for any future
period.
|
|
|
|
Quarter Ended (in thousands)
(Unaudited)
|
|
|
|
|
|
2004
|
|
2003
|
|
|
|
|
|
Q1
|
|
Q2
|
|
Q3
|
|
Q4
|
|
Q1
|
|
Q2
|
|
Q3
|
|
Q4
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Licenses |
|
|
|
$ |
34,823 |
|
|
$ |
32,008 |
|
|
$ |
42,119 |
|
|
$ |
51,472 |
|
|
$ |
25,242 |
|
|
$ |
26,223 |
|
|
$ |
28,210 |
|
|
$ |
35,124 |
|
Services |
|
|
|
|
3,159 |
|
|
|
3,662 |
|
|
|
6,740 |
|
|
|
8,116 |
|
|
|
2,810 |
|
|
|
2,989 |
|
|
|
3,006 |
|
|
|
4,742 |
|
Total
revenues |
|
|
|
|
37,982 |
|
|
|
35,670 |
|
|
|
48,859 |
|
|
|
59,588 |
|
|
|
28,052 |
|
|
|
29,212 |
|
|
|
31,216 |
|
|
|
39,866 |
|
Costs of
revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
License
fees |
|
|
|
|
1,584 |
|
|
|
1,445 |
|
|
|
2,737 |
|
|
|
2,429 |
|
|
|
939 |
|
|
|
1,183 |
|
|
|
1,273 |
|
|
|
1,581 |
|
Service
fees |
|
|
|
|
721 |
|
|
|
1,018 |
|
|
|
3,338 |
|
|
|
3,018 |
|
|
|
543 |
|
|
|
597 |
|
|
|
625 |
|
|
|
1,387 |
|
Amortization
of intangibles
from acquisitions |
|
|
|
|
779 |
|
|
|
777 |
|
|
|
2,403 |
|
|
|
2,411 |
|
|
|
856 |
|
|
|
856 |
|
|
|
855 |
|
|
|
752 |
|
Total cost of
revenues |
|
|
|
|
3,084 |
|
|
|
3,240 |
|
|
|
8,478 |
|
|
|
7,858 |
|
|
|
2,338 |
|
|
|
2,636 |
|
|
|
2,753 |
|
|
|
3,720 |
|
Gross
profit |
|
|
|
|
34,898 |
|
|
|
32,430 |
|
|
|
40,381 |
|
|
|
51,730 |
|
|
|
25,714 |
|
|
|
26,576 |
|
|
|
28,463 |
|
|
|
36,146 |
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and
development |
|
|
|
|
5,587 |
|
|
|
5,708 |
|
|
|
8,409 |
|
|
|
8,948 |
|
|
|
3,743 |
|
|
|
4,156 |
|
|
|
4,177 |
|
|
|
5,141 |
|
Selling and
marketing |
|
|
|
|
8,556 |
|
|
|
8,770 |
|
|
|
11,227 |
|
|
|
13,673 |
|
|
|
6,404 |
|
|
|
6,472 |
|
|
|
6,539 |
|
|
|
7,592 |
|
General and
administrative |
|
|
|
|
5,513 |
|
|
|
5,120 |
|
|
|
6,635 |
|
|
|
8,233 |
|
|
|
4,324 |
|
|
|
4,648 |
|
|
|
4,612 |
|
|
|
5,801 |
|
Amortization
of deferred stock-based compensation (1) |
|
|
|
|
185 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
768 |
|
|
|
752 |
|
|
|
609 |
|
|
|
527 |
|
In-process
research and development |
|
|
|
|
— |
|
|
|
— |
|
|
|
5,400 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
624 |
|
|
|
— |
|
Total
operating expenses |
|
|
|
|
19,841 |
|
|
|
19,598 |
|
|
|
31,671 |
|
|
|
30,854 |
|
|
|
15,239 |
|
|
|
16,028 |
|
|
|
16,561 |
|
|
|
19,061 |
|
Operating
income |
|
|
|
|
15,057 |
|
|
|
12,832 |
|
|
|
8,710 |
|
|
|
20,876 |
|
|
|
10,475 |
|
|
|
10,548 |
|
|
|
11,902 |
|
|
|
17,085 |
|
Interest and
other income, net |
|
|
|
|
728 |
|
|
|
985 |
|
|
|
755 |
|
|
|
1,705 |
|
|
|
1,100 |
|
|
|
953 |
|
|
|
842 |
|
|
|
957 |
|
Impairment
losses on investments |
|
|
|
|
(180 |
) |
|
|
— |
|
|
|
(5,298 |
) |
|
|
— |
|
|
|
— |
|
|
|
(4,286 |
) |
|
|
(310 |
) |
|
|
(224 |
) |
Gains on
strategic investments |
|
|
|
|
1,220 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
436 |
|
|
|
16 |
|
|
|
— |
|
Income before
income taxes |
|
|
|
|
16,825 |
|
|
|
13,817 |
|
|
|
4,167 |
|
|
|
22,581 |
|
|
|
11,575 |
|
|
|
7,651 |
|
|
|
12,450 |
|
|
|
17,818 |
|
Income
taxes |
|
|
|
|
6,057 |
|
|
|
4,974 |
|
|
|
2,843 |
|
|
|
6,786 |
|
|
|
4,630 |
|
|
|
3,060 |
|
|
|
4,981 |
|
|
|
9,882 |
|
Net
income |
|
|
|
$ |
10,768 |
|
|
$ |
8,843 |
|
|
$ |
1,324 |
|
|
$ |
15,795 |
|
|
$ |
6,945 |
|
|
$ |
4,591 |
|
|
$ |
7,469 |
|
|
$ |
7,936 |
|
Basic net
earnings per share |
|
|
|
$ |
0.22 |
|
|
$ |
0.18 |
|
|
$ |
0.03 |
|
|
$ |
0.32 |
|
|
$ |
0.14 |
|
|
$ |
0.09 |
|
|
$ |
0.15 |
|
|
$ |
0.16 |
|
Diluted net
earnings per share |
|
|
|
$ |
0.21 |
|
|
$ |
0.18 |
|
|
$ |
0.03 |
|
|
$ |
0.31 |
|
|
$ |
0.14 |
|
|
$ |
0.09 |
|
|
$ |
0.15 |
|
|
$ |
0.16 |
|
| (1) |
|
The allocation of the amortization of deferred stock-based
compensation relates to the expense categories as set forth below: |
Cost of
revenues |
|
|
|
$ |
27 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
80 |
|
|
$ |
80 |
|
|
$ |
79 |
|
|
$ |
79 |
|
Research and
development |
|
|
|
|
53 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
138 |
|
|
|
138 |
|
|
|
138 |
|
|
|
137 |
|
Selling and
marketing |
|
|
|
|
36 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
347 |
|
|
|
331 |
|
|
|
189 |
|
|
|
108 |
|
General and
administrative |
|
|
|
|
69 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
203 |
|
|
|
203 |
|
|
|
203 |
|
|
|
203 |
|
|
|
|
|
$ |
185 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
768 |
|
|
$ |
752 |
|
|
$ |
609 |
|
|
$ |
527 |
|
56
|
|
|
|
Quarterly Results of Operations as a % of Revenue
(Unaudited)
|
|
|
|
|
|
2004
|
|
2003
|
|
|
|
|
|
Q1
|
|
Q2
|
|
Q3
|
|
Q4
|
|
Q1
|
|
Q2
|
|
Q3
|
|
Q4
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Licenses |
|
|
|
|
91.7 |
|
|
|
89.7 |
|
|
|
86.2 |
|
|
|
86.4 |
|
|
|
90.0 |
|
|
|
89.8 |
|
|
|
90.4 |
|
|
|
88.1 |
|
Services |
|
|
|
|
8.3 |
|
|
|
10.3 |
|
|
|
13.8 |
|
|
|
13.6 |
|
|
|
10.0 |
|
|
|
10.2 |
|
|
|
9.6 |
|
|
|
11.9 |
|
Total
revenues |
|
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
Costs of
revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
License
fees |
|
|
|
|
4.2 |
|
|
|
4.1 |
|
|
|
5.6 |
|
|
|
4.1 |
|
|
|
3.3 |
|
|
|
4.0 |
|
|
|
4.1 |
|
|
|
4.0 |
|
Service
fees |
|
|
|
|
1.9 |
|
|
|
2.9 |
|
|
|
6.8 |
|
|
|
5.1 |
|
|
|
1.9 |
|
|
|
2.0 |
|
|
|
2.0 |
|
|
|
3.5 |
|
Amortization
of intangibles from acquisitions |
|
|
|
|
2.0 |
|
|
|
2.2 |
|
|
|
4.9 |
|
|
|
4.0 |
|
|
|
3.1 |
|
|
|
3.0 |
|
|
|
2.7 |
|
|
|
1.8 |
|
Total cost of
revenues |
|
|
|
|
8.1 |
|
|
|
9.1 |
|
|
|
17.4 |
|
|
|
13.2 |
|
|
|
8.3 |
|
|
|
9.0 |
|
|
|
8.8 |
|
|
|
9.3 |
|
Gross
profit |
|
|
|
|
91.9 |
|
|
|
90.9 |
|
|
|
82.6 |
|
|
|
86.8 |
|
|
|
91.7 |
|
|
|
91.0 |
|
|
|
91.2 |
|
|
|
90.7 |
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and
development |
|
|
|
|
14.7 |
|
|
|
16.0 |
|
|
|
17.2 |
|
|
|
15.0 |
|
|
|
13.4 |
|
|
|
14.2 |
|
|
|
13.4 |
|
|
|
12.9 |
|
Selling and
marketing |
|
|
|
|
22.5 |
|
|
|
24.6 |
|
|
|
23.0 |
|
|
|
22.9 |
|
|
|
22.8 |
|
|
|
22.2 |
|
|
|
20.9 |
|
|
|
19.0 |
|
General and
administrative |
|
|
|
|
14.5 |
|
|
|
14.4 |
|
|
|
13.6 |
|
|
|
13.8 |
|
|
|
15.4 |
|
|
|
15.9 |
|
|
|
14.8 |
|
|
|
14.6 |
|
Amortization
of deferred stock-based compensation |
|
|
|
|
0.5 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
2.8 |
|
|
|
2.6 |
|
|
|
2.0 |
|
|
|
1.3 |
|
In-process
research and development |
|
|
|
|
— |
|
|
|
— |
|
|
|
11.1 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
2.0 |
|
|
|
— |
|
Total
operating expenses |
|
|
|
|
52.2 |
|
|
|
54.9 |
|
|
|
64.8 |
|
|
|
51.8 |
|
|
|
54.4 |
|
|
|
54.9 |
|
|
|
53.1 |
|
|
|
47.8 |
|
Operating
income |
|
|
|
|
39.6 |
|
|
|
36.0 |
|
|
|
17.8 |
|
|
|
35.0 |
|
|
|
37.3 |
|
|
|
36.1 |
|
|
|
38.1 |
|
|
|
42.9 |
|
Interest and
other income, net |
|
|
|
|
1.9 |
|
|
|
2.8 |
|
|
|
1.5 |
|
|
|
2.9 |
|
|
|
3.9 |
|
|
|
3.3 |
|
|
|
2.7 |
|
|
|
2.4 |
|
Impairment
losses on investments, net |
|
|
|
|
(0.5 |
) |
|
|
— |
|
|
|
(10.8 |
) |
|
|
— |
|
|
|
— |
|
|
|
(14.7 |
) |
|
|
(1.0 |
) |
|
|
(0.6 |
) |
Gains on
strategic investments |
|
|
|
|
3.2 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
1.5 |
|
|
|
0.1 |
|
|
|
— |
|
Income before
income taxes |
|
|
|
|
44.3 |
|
|
|
38.7 |
|
|
|
8.5 |
|
|
|
37.9 |
|
|
|
41.3 |
|
|
|
26.2 |
|
|
|
39.9 |
|
|
|
44.7 |
|
Income
taxes |
|
|
|
|
15.9 |
|
|
|
13.9 |
|
|
|
5.8 |
|
|
|
11.4 |
|
|
|
16.5 |
|
|
|
10.5 |
|
|
|
16.0 |
|
|
|
24.8 |
|
Net
income |
|
|
|
|
28.4 |
% |
|
|
24.8 |
% |
|
|
2.7 |
% |
|
|
26.5 |
% |
|
|
24.8 |
% |
|
|
15.7 |
% |
|
|
23.9 |
% |
|
|
19.9 |
% |
Our operating results have fluctuated in the past,
and are expected to continue to fluctuate in the future, on an annual and quarterly basis as a result of a number of factors. Such factors include the
timing of release of popular titles on videocassettes or DVDs or by digital PPV transmission, the timing of release of popular computer games on
CD-ROM, the timing of a small number of our electronic license management high-value perpetual licenses during any period, the degree of acceptance of
our copy protection technologies by major motion picture studios and computer game publishers, the mix of products sold and technologies licensed, any
change in product or license pricing, the seasonality of revenues, changes in our operating expenses, personnel changes, the development of our direct
and indirect distribution channels, foreign currency exchange rates and general economic conditions. We may choose to reduce royalties and fees or
increase spending in response to competition or new technologies or elect to pursue new market opportunities. Because a high percentage f our operating
expenses are fixed, a small variation in the timing of recognition of revenues can cause significant variations in operating results from period to
period.
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 $59.7 million, $58.9 million and $55.1 million in 2004, 2003 and 2002, respectively. Cash provided by operating activities increased $0.8
million from $58.9 million in 2003 to $59.7 million in 2004. This increase was primarily due to the increase in net income partially offset by the
increase in accounts receivable. In addition, the availability of cash generated by our operations could be affected by other business risks discussed
in the “Risk Factor” section of this annual report.
57
Investing activities provided (used) net cash of
$1.3 million, $(137.2) million and $51.8 million in 2004, 2003 and 2002, respectively. Cash provided by (used in) investing activities increased $138.5
million from ($137.2) million in 2003 to $1.3 million in 2004. The increase is primarily due to a decline in amounts invested as we used approximately
$77.1 to acquire the operations and assets of InstallShield in July 2004. We made capital expenditures of $4.8 million, $2.8 million and $3.9 million
in 2004, 2003 and 2002, respectively. Capital expenditures are primarily for computer software and hardware. We also paid $1.1 million, $6.3 million
and $761,000 in 2004, 2003 and 2002, respectively, related to patents during those periods.
In July 2004, we acquired the operations and certain
assets of InstallShield Software Corporation (“InstallShield”) for approximately $77.1 million in cash, including related acquisition costs.
We also assumed certain liabilities as part of the acquisition. An additional contingent payment of up to $20.0 million may be required to be made by
us based on post-acquisition revenue performance through June 30, 2005. Any additional contingent consideration would be required to be paid in the
third quarter of 2005. InstallShield is a leading provider of software installation tools. The acquisition of InstallShield expands our product
portfolio in the software value management category and enables us to reach InstallShield’s large software developer customer base.
InstallShield’s personnel, operations, and products have been integrated into our Software Technologies Group.
Net cash provided by (used in) financing activities
was $15.2 million, $6.8 million and $(34.6) million in 2004, 2003 and 2002, respectively. The increase in net cash provided by financing activities
from $6.8 million in 2003 to $15.2 million in 2004 is primarily 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 shares of common stock in 2003 or 2004.
At December 31, 2004, we had $105.0 million in cash
and cash equivalents, $101.3 million in short-term investments, and $47.4 million in long-term marketable investment securities, which includes $18.8
million in fair market value of our holdings in Digimarc. We anticipate that capital expenditures for the next 12 months will aggregate approximately
$9.9 million in order to support the expansion of our office space and our operations infrastructure.
We also have future minimum lease payments of
approximately $50.9 million under operating leases. We believe that the current available funds and cash flows generated from operations will be
sufficient to meet our working capital and capital expenditure requirements for the foreseeable future. We may also use cash to acquire or invest in
additional businesses or to obtain the rights to use certain technologies in the future.
In November 2002, we acquired the assets and
operations of Midbar for approximately $17.8 million in cash and related acquisition costs. In addition, we are subject to an additional maximum payout
of $8.0 million based on a percentage of revenues derived from our sales of music technology products through December 31, 2004. During 2004 and 2003,
we paid $1.1 million and $480,000, respectively, of such contingent consideration in cash.
In August 2003, we acquired intellectual property
and other assets, including patents and software that can be used to track and manage content in the peer-to-peer file sharing space for $720,000 in
cash, $80,000 of acquisition costs and an additional payment of $80,000 due on the first anniversary of the closing date for total consideration of
$880,000. In addition, we agreed to a maximum payment of $140,000 if certain milestones were achieved by May 28, 2004.
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
58
fluctuations can occur as a result of decreases
in demand for our copy protection products, our software value management products, or due to other business risks including, but not limited to, those
factors set forth under the caption “Risk Factors” contained in this annual report.
Contractual Obligations
We lease facilities and certain equipment pursuant
to non-cancelable operating lease agreements. Future minimum lease payments pursuant to these leases as of December 31, 2004 were as follows (in
thousands):
|
|
|
|
Operating
Leases
|
2005 |
|
|
|
$ |
5,326 |
|
2006 |
|
|
|
|
5,345 |
|
2007 |
|
|
|
|
5,508 |
|
2008 |
|
|
|
|
5,641 |
|
2009 |
|
|
|
|
4,912 |
|
2010 and
thereafter |
|
|
|
|
24,150 |
|
Total |
|
|
|
$ |
50,882 |
|
Recently Issued Accounting Pronouncements
In December 2003, the Financial Accounting Standards
Board (FASB) issued FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities — An Interpretation of
Accounting Research Bulletin No. 51” (“FIN 46R”). FIN 46R requires an investor with a majority of the variable interests (primary
beneficiary) in a variable interest entity (“VIE”) to consolidate the entity and also requires majority and significant variable interest
investors to provide certain disclosures. A VIE is an entity in which the voting equity investors do not have a controlling financial interest, or the
equity investment at risk is insufficient to finance the entity’s activities without receiving additional subordinated financial support from
other parties. Application of FIN 46R is required in financial statements of companies that have interests in variable interest entities or potential
variable interest entities commonly referred to as special purpose entities for periods ending after December 15, 2003. Application by companies for
all other types of entities is required in financial statements for periods ending after March 15, 2004. We had no investments in VIEs as of December
31, 2004.
In December 2003, the Securities and Exchange
Commission (“SEC”) issued Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition.” SAB No. 104 updates interpretive guidance
in the codification of staff accounting bulletins to provide consistent accounting guidance on revenue recognition. The principal revisions relate to
the deletion of interpretive material no longer necessary because of private sector developments in generally accepted accounting principles in the
United States of America, and the incorporation of certain sections of the SEC’s “Revenue Recognition in Financial Statements —
Frequently Asked Questions and Answers” document. The adoption of SAB No. 104 has had no material impact on our financial position or results of
operations.
In December 2003, the FASB issued SFAS No. 132
(revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” SFAS No. 132 (revised 2003) revises
employers’ disclosures about pension plans and other postretirement benefit plans. It does not change the measurement or recognition of those
plans required by SFAS No. 87, “Employers’ Accounting for Pensions,” No. 88, “Employers’ Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for Termination Benefits,” and No. 106, “Employers’ Accounting for Postretirement
Benefits Other Than Pensions.” This statement retains the disclosure requirements contained in SFAS No. 132, “Employers’ Disclosures
about Pensions and Other Postretirement Benefits,” which it replaces. It requires additional disclosures to those in the original SFAS No. 132
about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement
plans. The required information should be provided
59
separately for pension plans and for other
postretirement benefit plans. SFAS No. 132 (revised 2003) is effective for financial statements with fiscal years ending after December 15, 2003. We
had no pension plans or other postretirement benefit plans covered by SFAS No.132 as of December 31, 2004.
In March 2004, the FASB issued EITF Issue No. 03-1
(“EITF 03-1”) “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF 03-1 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 have adopted the disclosure requirements under EITF 03-1 by the year ended December 31,
2004. We will evaluate the impact of EITF 03-1 once final guidance is issued.
In July 2004, the FASB issued EITF Issue No. 02-14
(“EITF 02-14”) “Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than Common Stock.” EITF
02-14 includes new guidance for determining whether the equity method of accounting applies when an investor does not have an investment in voting
common stock of an investee but exercises significant influence through other means, how the equity method should be applied to investments other than
common stock, and for securities with a readily determinable fair market value, how the scope provisions of APB Opinion No. 18, The Equity Method of
Accounting for Investments in Common Stock, and FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities,
interact. The accounting guidance provided in EITF 02-14 is effective for reporting periods beginning after September 15, 2004. We adopted the
accounting guidance effective October 1, 2004. The adoption of EITF 02-14 has had no material impact on our financial position or results of
operations.
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 will require
us to measure the cost our 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 option, 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. SFAS 123R is
effective for fiscal periods beginning after June 15, 2005. Therefore, we are required to implement the standard no later than our third fiscal quarter
which begins on July 1, 2005. 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 negative impact on our 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 1
— The Company and Summary of Significant Accounting Policies” for information related to the pro
60
forma effects on our 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. 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, the range of possible amounts that we are considering 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 7A. |
|
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK |
We are exposed to financial market risks, including
changes in interest rates, foreign currency exchange rates and security investments. Changes in these factors may cause fluctuations in our earnings
and cash flows. We evaluate and manage the exposure to these market risks as follows:
Fixed Income Investments. We have an
investment portfolio of fixed income securities, including those classified as cash equivalents, short-term investments and long-term marketable
investment securities of $195.3 million as of December 31, 2004. These securities are subject to interest rate fluctuations. An increase in interest
rates could adversely affect the market value of our fixed income securities.
We do not use derivative financial instruments in
our investment portfolio to manage interest rate risk. We limit our exposure to interest rate and credit risk, however, by establishing and strictly
monitoring clear policies and guidelines for our fixed income portfolios. The primary objective of these policies is to preserve principal while at the
same time maximizing yields, without significantly increasing risk. A hypothetical 50 basis point increase in interest rates would result in an
approximate $359,000 decrease (approximately 0.2%) in the fair value of our fixed income available-for-sale securities as of December 31, 2004. 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 Currency 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 U.K., Japan and Israel operate in their local currency, which mitigates a portion of the exposure related to the
respective currency collected.
Strategic Investments. We currently hold
minority equity interests in a number of companies. These investments, at book value totaling $18.8 million, $27.0 million and $28.7 million,
represented 4.1%, 7.0% and 8.9% of our total assets as of December 31, 2004, 2003 and 2002, respectively. As of December 31, 2004, the adjusted cost of
our strategic investments consisted of our investment in Digimarc, a publicly traded company. In addition, we hold investments in a number of other
privately held companies, which have no
61
carrying value as of December 31, 2004. Digimarc
is subject to price fluctuations based on the public market. Because there is no active trading market for the securities of privately held companies,
our investments in them are illiquid. As such, we may never have an opportunity to realize a return on our investment in these private companies, and
we may in the future be required to write off all or part of one or more of these investments. During 2004, 2003 and 2002, we wrote off $5.5 million,
$4.8 million and $17.2 million, respectively, of strategic investments resulting from impairment that was other-than-temporary. In 2004, the $5.5
million impairment loss was partially offset by a gain of $1.2 million related to the gain from the sale of InterActual Technologies. In 2003, the $4.8
million impairment loss was partially offset by a gain of $395,000 related to the surrender of 1,880,937 shares of TTR common stock, which was used to
acquire patents and other assets of TTR.
| ITEM 8. |
|
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
The information required by this item is submitted
in a separate section of this report beginning on F-1 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURES
None.
| ITEM 9A. |
|
CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of
our management, including our chief executive officer and our chief financial officer, we conducted an evaluation of our disclosure controls and
procedures, as such term is defined under Exchange Act Rule 13a-15(e). Based on this evaluation, our chief executive officer and our chief financial
officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this annual
report.
Management’s Report on Internal Control Over Financial
Reporting
Our management is responsible for establishing and
maintaining an adequate system of internal control over financial reporting. Our internal control over financial reporting includes those policies and
procedures that:
• |
|
pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of our assets; |
• |
|
provide reasonable assurance that transactions are recorded as
necessary to permit preparation of our financial statements in accordance with generally accepted accounting principles in the United States, and that
our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and |
• |
|
provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. |
Our management assessed the effectiveness of our
system of internal control over financial reporting as of December 31, 2004. In making this assessment, we used the framework in Internal Control
— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our
assessment and the criteria set forth by COSO, we believe that Macrovision maintained effective internal control over financial reporting as of
December 31, 2004. Our assessment of the effectiveness of our internal control over financial reporting has been audited by KPMG LLP, an independent
registered public accounting firm, as stated in their report which is included herein.
62
Inherent Limitations on Effectiveness of Controls
Our system of internal control over financial
reporting was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with accounting principles generally accepted in the United States.
All internal control systems, no matter how well
designed and operated, can provide only reasonable assurance with respect to financial statement preparation and presentation. Our management does not
expect that our disclosure controls and procedures will prevent all error and fraud. Further, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that all control issues within the company have been detected, even with
respect to those systems of internal control that are determined to be effective. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdown can occur because of simple error or mistake. The design of any system of controls also is based in
part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance
with the policies or procedures may deteriorate. Because of these inherent limitations in a cost-effective control system, misstatements due to error
or fraud may occur and not be detected. Our system contains self monitoring mechanisms, and actions are taken to correct deficiencies as they are
identified.
Internal Control Over Financial Reporting Associated With the InstallShield
Acquisition
We completed the acquisition of the assets of
InstallShield Software Corporation on July 1, 2004. Our management has not completed an assessment of the internal control over financial reporting of
our InstallShield operations as it was not possible to conduct a full assessment of InstallShield’s internal control over financial reporting in
the period between the completion of the acquisition and the date of our management’s assessment of our internal control over financial reporting.
Our conclusion in this Annual Report on Form 10-K regarding the effectiveness of our internal control over financial reporting as of December 31, 2004
does not include the internal control over financial reporting of InstallShield and its subsidiaries. The total revenues from the InstallShield
operations since July 1, 2004 represented approximately 9.7% of the related consolidated financial statement amounts for the year ended December 31,
2004. Total assets from InstallShield represented approximately 2.8% of the related consolidated financial statement amounts as of December 31,
2004.
Audit Committee Oversight
The Audit Committee of the Board of Directors, which
is comprised solely of independent directors, has oversight responsibility for our financial reporting process and the audits of our consolidated
financial statements and internal control over financial reporting. The Audit Committee meets regularly with management and with our internal auditors
and independent registered public accounting firm (collectively, the “accountants”) to review matters related to the quality and integrity of
our financial reporting, internal control over financial reporting (including compliance matters related to our Code of Personal and Business Conduct
and Ethics), and the nature, extent, and results of internal and external audits. Our accountants have full and free access and report directly to the
Audit Committee. The Audit Committee recommended, and the Board of Directors approved, that the audited consolidated financial statements be included
in this Annual Report on Form 10-K.
63
Changes in Internal Control Over Financial Reporting
In the course of auditing our 2004 financial
statements, we identified that at the end of 2003, we did not maintain adequate controls over the review of our tax provision related to U.S. taxation
on income earned outside of the United States, which impacted the income tax expense in the fourth quarter of 2003. Therefore, we decided to restate
our financial statements for the year ended 2003. The financial statement impact of the adjustment was confined to the fourth quarter of 2003 and did
not have any effect on subsequently reported quarterly financial results. We remediated this weakness in internal control over financial reporting in
the fourth quarter of 2004, by improving our review of our intercompany tax records and tax accrual position, and changing our methods of recordkeeping
of intercompany entries that relate to U.S. taxation on income earned outside the United States. We also hired a full-time tax director to lead this
function and we have engaged new external tax advisors. We believe that these corrective actions taken as a whole, have mitigated the control weakness
with respect to the review of our tax provision and that these measures have been effective to ensure that information required to be disclosed in this
Annual Report on Form 10-K for 2004 has been recorded, processed, summarized and reported correctly.
Report of Independent Registered Public Accounting Firm
The Board of
Directors and Stockholders of
Macrovision Corporation:
We have audited management’s assessment,
included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Macrovision Corporation
(‘Macrovision’) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in
Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Macrovision’s
management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of
Macrovision’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the
standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included
obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinion.
A company’s internal control over financial
reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial
reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material
effect on the financial statements.
64
Because of its inherent limitations, internal
control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, management’s assessment that
Macrovision Corporation maintained effective internal control over financial reporting as of December 31, 2004 is fairly stated, in all material
respects, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Also, in our opinion, Macrovision Corporation maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO).
Macrovision Corporation completed the acquisition of
the assets of InstallShield Software Corporation on July 1, 2004, and management excluded from its assessment of the effectiveness of Macrovision
Corporation’s internal control over financial reporting as of December 31, 2004, InstallShield’s internal control over financial reporting
which represented approximately 2.8% of total consolidated assets and approximately 9.7% of total consolidated revenues as of and for the year ended
December 31, 2004. Our audit of internal control over financial reporting of Macrovision also excluded an evaluation of the internal control over
financial reporting of InstallShield and its subsidiaries.
We have also audited, in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Macrovision Corporation and subsidiaries
as of December 31, 2004 and 2003 and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows
for each of the years in the three-year period ended December 31, 2004; and our report dated March 31, 2005 expressed an unqualified opinion on those
consolidated financial statements.
/s/ KPMG
LLP
Mountain View, California
March 31, 2005
| ITEM 9B. |
|
OTHER INFORMATION |
None.
65
PART III
| ITEM 10. |
|
DIRECTORS AND EXECUTIVE OFFICERS |
The information required by this item is
incorporated by reference from the information under the sections “Information About Directors,” “Information About our Executive
Officers” and “Proposal 1: Election of Directors,” to be contained in our proxy statement, which will be filed with the SEC in
connection with the solicitation of proxies for our 2005 Annual Meeting of Stockholders to be held on May 24, 2005 (the “2005 Annual Meeting of
Stockholders”).
In February 2004, we adopted a code of conduct and
ethics applicable to all of our directors and employees, including the principal executive officer, principal financial officer and principal
accounting officer. A copy of such code of conduct and ethics was filed as an Exhibit to our Annual Report on Form 10-K for the year ended December 31,
2003. If we make any substantive amendments to the code of conduct and ethics or grant any waiver, including implicit waiver, from a provision of the
code of conduct and ethics to our principal executive officer, principal financial officer or principal accounting officer, we will disclose the nature
of such amendment or waiver on our website at http:///www.macrovision.com or in a current report on Form 8-K that will be publicly
filed.
| ITEM 11. |
|
EXECUTIVE COMPENSATION |
The information required by this item is
incorporated by reference to the information under the section “Executive Compensation” to be contained in the proxy statement for the 2005
Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is
incorporated by reference to the information under the section “Security Ownership of Certain Beneficial Owners and Management” and
“Equity Plan Information” to be contained in the proxy statement for the 2005 Annual Meeting of Stockholders.
| ITEM 13. |
|
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS |
The information required by this item is
incorporated by reference to the information under the section “Certain Relationships and Related Transactions” to be contained in the proxy
statement for the 2005 Annual Meeting of Stockholders.
| ITEM 14. |
|
PRINCIPAL ACCOUNTANT FEES AND SERVICES |
The information required by this item is
incorporated by reference to the information under the caption “Principal Auditor Fees and Services” to be contained in the proxy statement
for the 2005 Annual Meeting of Stockholders.
66
PART IV
| ITEM 15. |
|
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES |
| (a) |
|
The following documents are filed as part of this
report: |
|
|
|
|
Page
|
• Report of Independent Registered Public Accounting Firm |
|
|
|
|
F-2 |
|
• Consolidated Balance Sheets |
|
|
|
|
F-3 |
|
• Consolidated Statements of Income |
|
|
|
|
F-4 |
|
• Consolidated Statements of Stockholders’ Equity and Comprehensive Income |
|
|
|
|
F-5 |
|
• Consolidated Statements of Cash Flows |
|
|
|
|
F-6 |
|
• Notes to Consolidated Financial Statements |
|
|
|
|
F-7 |
|
|
|
|
|
|
|
Incorporated by Reference
|
|
Exhibit
Number
|
|
|
|
Exhibit Description
|
|
Form
|
|
Date
|
|
Number
|
|
Filed
Herewith
|
2.01 |
|
|
|
Agreement and Plan of Merger with Globetrotter Software, Inc, GSI Acquisition Corp., Matthew Christiano and Sallie J. Calhoun dated June 19,
2000 |
|
DEF14A |
|
7/28/00 |
|
Annex
B |
|
|
|
|
2.02 |
|
|
|
Agreement For Sale of Shares relating to Ç-Dilla Limited dated as of June 18, 1999 by and among Macrovision and the shareholders of
Ç-Dilla Limited |
|
8-K |
|
7/6/99 |
|
2.01 |
|
|
|
|
2.03 |
|
|
|
Business Sale Agreement among Productivity through Software plc, Ç-Dilla Limited, Mr. John Rowlinson and Macrovision Corporation dated
October 4, 2000 * |
|
10-K |
|
4/2/01 |
|
2.03 |
|
|
|
|
2.04 |
|
|
|
Asset
Purchase Agreement among TTR Technologies, Inc., TTR Technologies, Ltd., Macrovision Corporation and Macrovision Europe Ltd. dated November 4,
2002 |
|
13D/A |
|
11/8/02 |
|
1 |
|
|
|
|
2.05 |
|
|
|
Noncompetition Agreement executed and delivered as of November 4, 2002 by TTR Technologies, Inc. and TTR Technologies, Ltd. in favor and for
the benefit of Macrovision Corporation, Macrovision Europe Ltd. and the other Indemnities |
|
13D/A |
|
11/8/02 |
|
3 |
|
|
|
|
2.06 |
|
|
|
Asset
Purchase Agreement by and between Midbar Tech (1998) Ltd. and Macrovision Europe Ltd. dated November 4, 2002 * |
|
10-K |
|
3/31/03 |
|
2.07 |
|
|
|
|
2.07 |
|
|
|
Asset
Purchase Agreement by and among InstallShield Software Corporation, Macrovision, Macrovision Europe Ltd. and Macrovision International Holding LP dated
June 16, 2004 |
|
8-K |
|
7/1/04 |
|
2.01 |
|
|
|
|
3.01 |
|
|
|
Amended and Restated Certificate of Incorporation of Macrovision Corporation |
|
SB-2 |
|
1/7/97 |
|
3.02 |
|
|
|
|
3.02 |
|
|
|
Certificate of Amendment to the Amended and Restated Certificate of Incorporation of Macrovision Corporation |
|
10-K |
|
4/2/01 |
|
3.02 |
|
|
|
|
3.03 |
|
|
|
Amended and Restated Bylaws of Macrovision Corporation, amended as of October 27, 2000 |
|
10-K |
|
4/2/01 |
|
3.03 |
|
|
|
|
10.01 |
|
|
|
Macrovision Corporation 1996 Equity Incentive Plan** |
|
SB-2/A |
|
2/11/97 |
|
10.02 |
|
67
|
|
|
|
|
|
Incorporated by Reference
|
|
Exhibit
Number
|
|
|
|
Exhibit Description
|
|
Form
|
|
Date
|
|
Number
|
|
Filed
Herewith
|
|
|
|
10.02 |
|
|
|
Macrovision Corporation 1996 Employee Stock Purchase Plan** |
|
S-8 |
|
11/5/03 |
|
4.1 |
|
|
|
|
10.03 |
|
|
|
Macrovision Corporation 1996 Directors Stock Option Plan** |
|
S-8 |
|
11/5/03 |
|
4.2 |
|
|
|
|
10.04 |
|
|
|
Macrovision Corporation 2000 Equity Incentive Plan** |
|
S-8 |
|
11/5/03 |
|
4.3 |
|
|
|
|
10.05 |
|
|
|
Macrovision Corporation Form of Executive Incentive Plan** |
|
10-K |
|
3/12/04 |
|
10.05 |
|
|
|
|
10.06 |
|
|
|
Software Marketing License and Development Agreement between Macrovision Corporation and Ç-Dilla Limited dated February 19, 1998
* |
|
10-QSB |
|
5/15/98 |
|
10.02 |
|
|
|
|
10.07 |
|
|
|
Subscription Agreement between Macrovision Corporation and Ç-Dilla Limited dated February 17, 1998 * |
|
10-QSB/A |
|
6/23/98 |
|
10.01 |
|
|
|
|
10.08 |
|
|
|
Lease
Between WB Airport Technology, L.L.C. (“Landlord”) and Macrovision Corporation (“Tenant”) dated August 2, 2001 |
|
10-Q |
|
11/13/01 |
|
10.39 |
|
|
|
|
10.09 |
|
|
|
First
Amendment to Lease between WB Airport Technology, L.L.C. (“Landlord”) and Macrovision Corporation (“Tenant”) dated December 13,
2004 |
|
|
|
|
|
|
|
X |
10.10 |
|
|
|
Second Amendment to Lease between WB Airport Technology, L.L.C. (“Landlord”) and Macrovision Corporation (“Tenant”) dated
December 13, 2004 |
|
|
|
|
|
|
|
X |
10.11 |
|
|
|
Lease
between WB Airport Technology, L.L.C. (“Landlord”) and Macrovision Corporation (“Tenant”) dated December 13, 2004 |
|
|
|
|
|
|
|
X |
10.12 |
|
|
|
Form
of Indemnification Agreement to be entered into by Macrovision Corporation with each of its directors and executive officers |
|
SB-2 |
|
1/7/97 |
|
10.8 |
|
|
|
|
10.13 |
|
|
|
Separation Date Agreement with Ian R. Halifax dated December 3, 2004 ** |
|
8-K |
|
12/3/04 |
|
10.1 |
|
|
|
|
10.14 |
|
|
|
Executive Severance and Arbitration Agreement dated April 30, 2001 between Macrovision Corporation and William Krepick ** |
|
10-Q |
|
11/13/01 |
|
10.34 |
|
|
|
|
10.15 |
|
|
|
Employment Agreement dated January 28, 2005 between Macrovision Corporation and William Krepick ** |
|
8-K |
|
2/2/05 |
|
10.01 |
|
|
|
|
10.16 |
|
|
|
Executive Severance and Arbitration Agreement dated April 30, 2001 between Macrovision Corporation and Carol Flaherty ** |
|
10-Q |
|
11/13/01 |
|
10.36 |
|
|
|
|
10.17 |
|
|
|
Executive Severance and Arbitration Agreement dated April 24, 2002 between Macrovision Corporation and Brian McPhail ** |
|
10-K |
|
3/12/04 |
|
10.14 |
|
|
|
|
10.18 |
|
|
|
Offer
Letter to Dan Stickel dated August 9, 2002 ** |
|
10-Q |
|
11/14/02 |
|
10.43 |
|
|
|
|
10.19 |
|
|
|
Executive Severance and Arbitration Agreement dated February 9, 2004 between Macrovision Corporation and Daniel E. Stickel** |
|
10-Q |
|
5/7/04 |
|
10.02 |
|
|
|
|
10.20 |
|
|
|
Offer
Letter to Steve Weinstein dated October 9, 2002 ** |
|
10-Q |
|
5/9/03 |
|
10.01 |
|
|
|
|
10.21 |
|
|
|
Executive Severance and Arbitration Agreement dated February 15, 2004 between Macrovision Corporation and Steven Weinstein** |
|
10-Q |
|
5/7/04 |
|
10.03 |
|
68
|
|
|
|
|
|
Incorporated by Reference
|
|
Exhibit
Number
|
|
|
|
Exhibit Description
|
|
Form
|
|
Date
|
|
Number
|
|
Filed
Herewith
|
|
|
|
10.22 |
|
|
|
Offer
Letter to James Wickett dated January 29, 2004** |
|
10-Q |
|
5/7/04 |
|
10.01 |
|
|
|
|
10.23 |
|
|
|
Executive Severance and Arbitration Agreement dated February 3, 2005 between Macrovision Corporation and James Wickett** |
|
8-K |
|
3/14/05 |
|
10.01 |
|
|
|
|
10.24 |
|
|
|
Offer
Letter to George Monk dated January 20, 2005** |
|
8-K |
|
1/21/05 |
|
10.01 |
|
|
|
|
10.25 |
|
|
|
Charter of the Audit Committee of the Board of Directors |
|
10-K |
|
3/12/04 |
|
10.17 |
|
|
|
|
10.26 |
|
|
|
Summary of Director Compensation** |
|
|
|
|
|
|
|
X |
14.01 |
|
|
|
Code
of Personal and Business Conduct and Ethics |
|
10-K |
|
3/12/04 |
|
14.01 |
|
|
|
|
21.01 |
|
|
|
List
of subsidiaries |
|
|
|
|
|
|
|
X |
23.01 |
|
|
|
Consent of KPMG LLP, Independent Registered Public Accounting Firm |
|
|
|
|
|
|
|
X |
31.01 |
|
|
|
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|
|
|
|
|
|
|
X |
31.02 |
|
|
|
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|
|
|
|
|
|
|
X |
32.01 |
|
|
|
Section 1350 Certification |
|
|
|
|
|
|
|
X |
32.02 |
|
|
|
Section 1350 Certification |
|
|
|
|
|
|
|
X |
| * |
|
Confidential treatment has been granted with respect to certain
portions of this Exhibit. These portions have been omitted from this filing and have been filed separately with the Securities and Exchange
Commission. |
| ** |
|
Management contract or compensatory plan or
arrangement. |
69
Signatures
Pursuant to the requirements of Section 13 or 15(d)
of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned thereunto duly authorized on
his 31st day of March, 2005.
MACROVISION CORPORATION
|
|
BY: /s/
WILLIAM A.
KREPICK
William A. Krepick
President and Chief Executive Officer
|
Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant, and in the capacities and on the date
indicated.
Name
|
|
|
|
Title
|
|
Date
|
Principal
Executive Officer:
|
|
|
|
|
|
|
|
|
|
|
|
/s/
WILLIAM A. KREPICK
William A. Krepick
|
|
|
|
President, Chief
Executive Officer and Director |
|
March 31,
2005 |
|
|
|
|
|
|
|
|
|
|
|
Principal Financial and Accounting Officer:
|
|
|
|
|
/s/
GEORGE M. MONK
George M. Monk
|
|
|
|
Acting Chief
Financial Officer
|
|
March 31,
2005 |
|
|
|
|
|
|
|
|
|
|
|
Additional
Directors:
|
|
|
|
|
|
|
|
|
|
|
|
/s/
JOHN O. RYAN
John O. Ryan
|
|
|
|
Chairman of the
Board of Directors |
|
March 31,
2005 |
|
/s/
DONNA S. BIRKS
Donna S. Birks
|
|
|
|
Director |
|
March 31,
2005 |
|
/s/
WILLIAM N. STIRLEN
William N. Stirlen
|
|
|
|
Director |
|
March 31,
2005 |
|
/s/
THOMAS WERTHEIMER
Thomas Wertheimer
|
|
|
|
Director |
|
March 31,
2005 |
|
/s/
STEVEN G. BLANK
Steven G. Blank
|
|
|
|
Director |
|
March 31,
2005 |
70
MACROVISION CORPORATION
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
|
|
|
|
PAGE
|
Report of
Independent Registered Public Accounting Firm |
|
|
|
|
F-2 |
|
Consolidated
Balance Sheets |
|
|
|
|
F-3 |
|
Consolidated
Statements of Income |
|
|
|
|
F-4 |
|
Consolidated
Statements of Stockholders’ Equity and Comprehensive Income |
|
|
|
|
F-5 |
|
Consolidated
Statements of Cash Flows |
|
|
|
|
F-6 |
|
Notes to
Consolidated Financial Statements |
|
|
|
|
F-7 |
|
F-1
Report of Independent Registered Public Accounting Firm
The Board of
Directors and Stockholders
Macrovision Corporation:
We have audited the accompanying consolidated
balance sheets of Macrovision Corporation and subsidiaries (the Company) as of December 31, 2004 and 2003, and the related consolidated statements of
income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2004.
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with the
standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial
statements referred to above present fairly, in all material respects, the financial position of Macrovision Corporation and subsidiaries as of
December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31,
2004 in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the internal control over financial reporting of
Macrovision Corporation as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 31, 2005 expressed an unqualified opinion on
management’s assessment of, and the effective operation of, internal control over financial reporting.
/s/ KPMG LLP
Mountain View, California
March 31, 2005
F-2
MACROVISION CORPORATION AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
(In thousands, except share data)
|
|
|
|
December 31,
|
|
|
|
|
|
2004
|
|
2003
|
ASSETS
|
Current
assets:
|
|
|
|
|
|
|
|
|
|
|
Cash and cash
equivalents |
|
|
|
$ |
104,957 |
|
|
$ |
27,918 |
|
Restricted
cash |
|
|
|
|
859 |
|
|
|
— |
|
Short-term
investments |
|
|
|
|
101,299 |
|
|
|
95,563 |
|
Accounts
receivable, net |
|
|
|
|
41,468 |
|
|
|
30,169 |
|
Income taxes
receivable |
|
|
|
|
1,705 |
|
|
|
3,410 |
|
Deferred tax
assets |
|
|
|
|
6,368 |
|
|
|
6,599 |
|
Prepaid
expenses and other current assets |
|
|
|
|
4,570 |
|
|
|
5,070 |
|
Total current
assets |
|
|
|
|
261,226 |
|
|
|
168,729 |
|
Long-term
marketable investment securities |
|
|
|
|
47,414 |
|
|
|
146,151 |
|
Property and
equipment, net |
|
|
|
|
9,295 |
|
|
|
6,689 |
|
Goodwill |
|
|
|
|
74,529 |
|
|
|
28,630 |
|
Other
intangibles from acquisitions, net |
|
|
|
|
31,185 |
|
|
|
8,512 |
|
Deferred tax
assets |
|
|
|
|
17,151 |
|
|
|
15,121 |
|
Patents and
other assets |
|
|
|
|
11,673 |
|
|
|
11,734 |
|
|
|
|
|
$ |
452,473 |
|
|
$ |
385,566 |
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
|
|
Accounts
payable |
|
|
|
$ |
5,907 |
|
|
$ |
4,457 |
|
Accrued
expenses |
|
|
|
|
32,639 |
|
|
|
28,691 |
|
Deferred
revenue |
|
|
|
|
14,604 |
|
|
|
10,333 |
|
Total current
liabilities |
|
|
|
|
53,150 |
|
|
|
43,481 |
|
Long term
liabilities |
|
|
|
|
979 |
|
|
|
874 |
|
|
|
|
|
|
54,129 |
|
|
|
44,355 |
|
Commitments and
contingencies (Notes 11 and 13)
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity:
|
|
|
|
|
|
|
|
|
|
|
Preferred
stock, $.001 par value, 5,000,000 shares authorized;
none issued |
|
|
|
|
— |
|
|
|
— |
|
Common stock,
$.001 par value, 250,000,000 shares authorized; 53,194,326 shares issued and 50,194,326 outstanding as of December 31, 2004, and 52,098,729 shares
issued and 49,098,729 outstanding as of December 31, 2003. |
|
|
|
|
53 |
|
|
|
52 |
|
Treasury
stock, 3,000,000 shares at cost |
|
|
|
|
(38,450 |
) |
|
|
(38,450 |
) |
Additional
paid-in capital |
|
|
|
|
311,643 |
|
|
|
292,507 |
|
Deferred
stock-based compensation |
|
|
|
|
— |
|
|
|
(185 |
) |
Accumulated
other comprehensive income |
|
|
|
|
9,109 |
|
|
|
8,028 |
|
Retained
earnings |
|
|
|
|
115,989 |
|
|
|
79,259 |
|
Total
stockholders’ equity |
|
|
|
|
398,344 |
|
|
|
341,211 |
|
|
|
|
|
$ |
452,473 |
|
|
$ |
385,566 |
|
See accompanying notes to consolidated financial statements.
F-3
MACROVISION CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share
data)
|
|
|
|
Year ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Licenses |
|
|
|
$ |
160,422 |
|
|
$ |
114,799 |
|
|
$ |
91,935 |
|
Services |
|
|
|
|
21,677 |
|
|
|
13,547 |
|
|
|
10,327 |
|
Total
revenues |
|
|
|
$ |
182,099 |
|
|
$ |
128,346 |
|
|
$ |
102,262 |
|
Cost of
revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
License
fees |
|
|
|
|
8,195 |
|
|
|
4,976 |
|
|
|
6,102 |
|
Service
fees |
|
|
|
|
8,095 |
|
|
|
3,152 |
|
|
|
1,912 |
|
Amortization
of intangibles from acquisitions |
|
|
|
|
6,370 |
|
|
|
3,319 |
|
|
|
2,271 |
|
Total cost of
revenues |
|
|
|
|
22,660 |
|
|
|
11,447 |
|
|
|
10,285 |
|
Gross
profit |
|
|
|
|
159,439 |
|
|
|
116,899 |
|
|
|
91,977 |
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and
development |
|
|
|
|
28,652 |
|
|
|
17,217 |
|
|
|
11,880 |
|
Selling and
marketing |
|
|
|
|
42,226 |
|
|
|
27,007 |
|
|
|
20,720 |
|
General and
administrative |
|
|
|
|
25,501 |
|
|
|
19,385 |
|
|
|
15,035 |
|
Amortization
of intangibles from acquisitions |
|
|
|
|
— |
|
|
|
— |
|
|
|
273 |
|
Amortization
of deferred stock-based compensation* |
|
|
|
|
185 |
|
|
|
2,656 |
|
|
|
6,261 |
|
In-process
research and development |
|
|
|
|
5,400 |
|
|
|
624 |
|
|
|
6,000 |
|
Total
operating expenses |
|
|
|
|
101,964 |
|
|
|
66,889 |
|
|
|
60,169 |
|
Operating
income |
|
|
|
|
57,475 |
|
|
|
50,010 |
|
|
|
31,808 |
|
Impairment
losses on strategic investments |
|
|
|
|
(5,478 |
) |
|
|
(4,820 |
) |
|
|
(17,210 |
) |
Gains on
strategic investments |
|
|
|
|
1,220 |
|
|
|
452 |
|
|
|
— |
|
Interest and
other income, net |
|
|
|
|
4,173 |
|
|
|
3,852 |
|
|
|
7,318 |
|
Income before
income taxes |
|
|
|
|
57,390 |
|
|
|
49,494 |
|
|
|
21,916 |
|
Income
taxes |
|
|
|
|
20,660 |
|
|
|
22,553 |
|
|
|
9,827 |
|
Net
income |
|
|
|
$ |
36,730 |
|
|
$ |
26,941 |
|
|
$ |
12,089 |
|
Basic net
earnings per share |
|
|
|
$ |
0.74 |
|
|
$ |
0.55 |
|
|
$ |
0.24 |
|
Shares used
in computing basic net earnings per share |
|
|
|
|
49,516 |
|
|
|
48,754 |
|
|
|
50,046 |
|
Diluted net
earnings per share |
|
|
|
$ |
0.73 |
|
|
$ |
0.54 |
|
|
$ |
0.24 |
|
Shares used
in computing diluted net earnings per share |
|
|
|
|
50,619 |
|
|
|
49,518 |
|
|
|
50,602 |
|
| * |
|
The allocation of the amortization of deferred stock-based
compensation relates to the expense categories as set forth below: |
|
|
|
|
Year ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
Cost of
revenues |
|
|
|
$ |
27 |
|
|
$ |
318 |
|
|
$ |
395 |
|
Research and
development |
|
|
|
|
53 |
|
|
|
551 |
|
|
|
1,205 |
|
Selling and
marketing |
|
|
|
|
36 |
|
|
|
975 |
|
|
|
3,502 |
|
General and
administrative |
|
|
|
|
69 |
|
|
|
812 |
|
|
|
1,159 |
|
|
|
|
|
$ |
185 |
|
|
$ |
2,656 |
|
|
$ |
6,261 |
|
See accompanying notes to consolidated financial statements.
F-4
MACROVISION CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
(In thousands, except share data)
|
|
|
|
Common Stock
|
|
Treasury Stock
|
|
Additional
paid-in |
|
Deferred
stock-based
|
|
Accumulated
other
comprehensive |
|
Retained |
|
Total
stockholders’ |
|
|
|
|
Shares
|
|
Amount
|
|
Shares
|
|
Amount
|
|
capital
|
|
compensation
|
|
income
|
|
earnings
|
|
equity
|
Balances as
of December 31, 2001 |
|
|
|
|
50,818,986 |
|
|
$ |
51 |
|
|
|
— |
|
|
|
— |
|
|
$ |
280,529 |
|
|
$ |
(10,526 |
) |
|
$ |
7,917 |
|
|
$ |
40,229 |
|
|
$ |
318,200 |
|
Comprehensive
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12,089 |
|
|
|
12,089 |
|
Translation
adjustment |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,021 |
|
|
|
|
|
|
|
2,021 |
|
Unrealized
loss in investments, net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(8,005 |
) |
|
|
|
|
|
|
(8,005 |
) |
Total
comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,105 |
|
Issuance of
common stock upon exercise of options |
|
|
|
|
516,260 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,621 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,621 |
|
Issuance of
common stock under employee stock purchase plan |
|
|
|
|
89,280 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,291 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,291 |
|
Stock
repurchase |
|
|
|
|
|
|
|
|
|
|
|
|
(3,000,000 |
) |
|
|
(38,450 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(38,450 |
) |
Reversal of
unamortized deferred stock-based compensation related to Stock option forfeitures |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,234 |
) |
|
|
1,234 |
|
|
|
|
|
|
|
|
|
|
|
— |
|
Compensation
expense related to accelerated vesting of severed employee stock options |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
7 |
|
Amortization
of deferred stock-based compensation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,261 |
|
|
|
|
|
|
|
|
|
|
|
6,261 |
|
Tax benefit
associated with stock plans |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
824 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
824 |
|
Balances as
of December 31, 2002 |
|
|
|
|
51,424,526 |
|
|
|
51 |
|
|
|
(3,000,000 |
) |
|
|
(38,450 |
) |
|
|
284,031 |
|
|
|
(3,024 |
) |
|
|
1,933 |
|
|
|
52,318 |
|
|
|
296,859 |
|
Comprehensive
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
26,941 |
|
|
|
26,941 |
|
Translation
adjustment |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,054 |
|
|
|
|
|
|
|
4,054 |
|
Unrealized
gain in investments, net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,041 |
|
|
|
|
|
|
|
2,041 |
|
Total
comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
33,036 |
|
Issuance of
common stock upon exercise of options |
|
|
|
|
458,346 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
4,733 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,734 |
|
Issuance of
common stock under employee stock purchase plan |
|
|
|
|
215,857 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,046 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,046 |
|
Reversal of
unamortized deferred stock-based compensation related to Stock option forfeitures |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(183 |
) |
|
|
183 |
|
|
|
|
|
|
|
|
|
|
|
— |
|
Amortization
of deferred stock-based compensation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,656 |
|
|
|
|
|
|
|
|
|
|
|
2,656 |
|
Tax benefit
associated with stock plans |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,880 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,880 |
|
Balances as
of December 31, 2003 |
|
|
|
|
52,098,729 |
|
|
|
52 |
|
|
|
(3,000,000 |
) |
|
|
(38,450 |
) |
|
|
292,507 |
|
|
|
(185 |
) |
|
|
8,028 |
|
|
|
79,259 |
|
|
|
341,211 |
|
Comprehensive
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
36,730 |
|
|
|
36,730 |
|
Translation
adjustment |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,145 |
|
|
|
|
|
|
|
3,145 |
|
Unrealized
losses in investments, net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,064 |
) |
|
|
|
|
|
|
(2,064 |
) |
Total
comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
37,811 |
|
Issuance of
common stock upon exercise of options |
|
|
|
|
805,101 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
12,032 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12,033 |
|
Issuance of
common stock under employee stock purchase plan |
|
|
|
|
290,496 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,202 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,202 |
|
Amortization
of deferred stock-based compensation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
185 |
|
|
|
|
|
|
|
|
|
|
|
185 |
|
Tax benefit
associated with stock plans |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,902 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,902 |
|
Balances as
of December 31, 2004 |
|
|
|
|
53,194,326 |
|
|
$ |
53 |
|
|
|
(3,000,000 |
) |
|
$ |
(38,450 |
) |
|
$ |
311,643 |
|
|
$ |
— |
|
|
$ |
9,109 |
|
|
$ |
115,989 |
|
|
$ |
398,344 |
|
See accompanying notes to consolidated financial statements.
F-5
MACROVISION CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(In thousands)
|
|
|
|
Year ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
Cash flows
from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income |
|
|
|
$ |
36,730 |
|
|
$ |
26,941 |
|
|
$ |
12,089 |
|
Adjustments
to reconcile net income to net cash provided by operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization |
|
|
|
|
4,755 |
|
|
|
3,652 |
|
|
|
2,957 |
|
Amortization
of intangibles from acquisitions |
|
|
|
|
6,370 |
|
|
|
3,319 |
|
|
|
2,544 |
|
Amortization
of deferred stock-based compensation |
|
|
|
|
185 |
|
|
|
2,656 |
|
|
|
6,261 |
|
Impairment
losses on strategic investments |
|
|
|
|
5,478 |
|
|
|
4,820 |
|
|
|
17,210 |
|
Gains on
strategic investments |
|
|
|
|
(1,220 |
) |
|
|
(452 |
) |
|
|
— |
|
Deferred tax
expense |
|
|
|
|
(1,981 |
) |
|
|
(4,415 |
) |
|
|
(7,325 |
) |
Tax benefit
from stock options |
|
|
|
|
3,902 |
|
|
|
1,880 |
|
|
|
824 |
|
In-process
research and development |
|
|
|
|
5,400 |
|
|
|
624 |
|
|
|
6,000 |
|
Changes in
operating assets and liabilities, net of assets and liabilities acquired:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable, net |
|
|
|
|
(8,312 |
) |
|
|
(1,527 |
) |
|
|
(129 |
) |
Deferred
revenue |
|
|
|
|
2,075 |
|
|
|
1,665 |
|
|
|
(1,074 |
) |
Prepaid
expenses, other current assets and other assets |
|
|
|
|
5,333 |
|
|
|
604 |
|
|
|
4,061 |
|
Accounts
payable, accrued expenses, and other long-term liabilities |
|
|
|
|
1,009 |
|
|
|
19,088 |
|
|
|
11,724 |
|
Net cash
provided by operating activities |
|
|
|
|
59,724 |
|
|
|
58,855 |
|
|
|
55,142 |
|
Cash flows
from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of
long and short term marketable investment securities |
|
|
|
|
(304,500 |
) |
|
|
(417,008 |
) |
|
|
(184,814 |
) |
Sales or
maturities of long and short term marketable investments |
|
|
|
|
388,344 |
|
|
|
290,169 |
|
|
|
258,971 |
|
Purchases of
property and equipment |
|
|
|
|
(4,837 |
) |
|
|
(2,804 |
) |
|
|
(3,874 |
) |
Payments for
patents |
|
|
|
|
(1,101 |
) |
|
|
(6,308 |
) |
|
|
(761 |
) |
Proceeds from
sale of strategic investments |
|
|
|
|
1,220 |
|
|
|
— |
|
|
|
— |
|
Acquisition
of Midbar net assets including contingent consideration |
|
|
|
|
(1,083 |
) |
|
|
(480 |
) |
|
|
(17,762 |
) |
Acquisition
of InstallShield Corp., net of cash acquired |
|
|
|
|
(75,930 |
) |
|
|
— |
|
|
|
— |
|
Acquisition
of peer-to-peer assets and related acquisition costs |
|
|
|
|
— |
|
|
|
(800 |
) |
|
|
— |
|
Increase in
restricted cash |
|
|
|
|
(859 |
) |
|
|
— |
|
|
|
— |
|
Other
investing activities |
|
|
|
|
— |
|
|
|
(14 |
) |
|
|
— |
|
Net cash
(used in) provided by investing activities |
|
|
|
|
1,254 |
|
|
|
(137,245 |
) |
|
|
51,760 |
|
Cash flows
from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from
exercise of options and other financing activities |
|
|
|
|
12,033 |
|
|
|
4,734 |
|
|
|
2,593 |
|
Proceeds from
stock issued under employee stock purchase plan |
|
|
|
|
3,202 |
|
|
|
2,046 |
|
|
|
1,291 |
|
Stock
repurchase |
|
|
|
|
— |
|
|
|
— |
|
|
|
(38,450 |
) |
Net cash
provided by (used in) financing activities |
|
|
|
|
15,235 |
|
|
|
6,780 |
|
|
|
(34,566 |
) |
Effect of
exchange rate changes on cash |
|
|
|
|
826 |
|
|
|
837 |
|
|
|
243 |
|
Net
(decrease) increase in cash and cash equivalents |
|
|
|
|
77,039 |
|
|
|
(70,773 |
) |
|
|
72,579 |
|
Cash and cash
equivalents at beginning of year |
|
|
|
|
27,918 |
|
|
|
98,691 |
|
|
|
26,112 |
|
Cash and cash
equivalents at end of year |
|
|
|
$ |
104,957 |
|
|
$ |
27,918 |
|
|
$ |
98,691 |
|
Cash paid
during the year:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
taxes |
|
|
|
$ |
20,561 |
|
|
$ |
8,238 |
|
|
$ |
9,761 |
|
TTR Common
Stock surrendered in exchange for patents |
|
|
|
$ |
— |
|
|
$ |
602 |
|
|
$ |
— |
|
See accompanying notes to consolidated financial statements.
F-6
MACROVISION CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial
Statements
December 31, 2004, 2003 and 2002
| (1) |
|
The Company and Summary of Significant Accounting
Policies |
The Company
Macrovision Corporation, a Delaware corporation
founded in 1983, provides digital product value management offerings to entertainment producers, software publishers, and their customers. Value
management solutions include anti-piracy technologies and services, embedded licensing technologies, usage monitoring for enterprises, and a host of
related technologies and services from installation to update to back-office entitlement management. Our customers include: major Hollywood studios;
independent video producers; hardware and software vendors; music labels; consumer electronic, PC and digital set-top box manufacturers; digital
pay-per-view (“PPV”) and video-on-demand (“VOD”) network operators; and enterprise IT organizations.
Basis of Presentation
The accompanying consolidated financial statements
include the accounts of Macrovision Corporation and its wholly owned subsidiaries after elimination of intercompany accounts and
transactions.
Certain prior year amounts have been reclassified to
conform to the current year presentation.
Use of Estimates
The preparation of consolidated financial statements
in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported
results of operations during the reporting period. On an ongoing basis, the Company evaluates its estimates, including those related to revenue
recognition, allowance for doubtful accounts, investments, goodwill and other intangible assets, long-lived assets and income taxes. Actual results
could differ from those estimates under different assumptions or conditions.
Cash, Cash Equivalents, and Investments
The Company considers all highly liquid investments
with maturities from date of purchase of three months or less to be cash equivalents. Cash and cash equivalents consist of cash on deposit with banks
and money market funds. All other liquid investments with maturities over three months and less than 12 months are classified as short-term
investments. Short-term investments consist of government bonds, government agency securities and corporate debt and equity securities. All marketable
securities with maturities over one year or which the Company’s intent is to retain for the long-term are classified as long-term marketable
investment securities.
The Company accounts for its publicly traded
investments in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity
Securities” and complies with the disclosure provisions of Emerging Issues Task Force (EITF) 03-01, “The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments.” Management determines the appropriate classification of investment securities at the time
of purchase and re-evaluates such designation as of each balance sheet date. The Company enters into certain equity investments for the promotion of
business and strategic objectives, and typically does not attempt to reduce or eliminate the inherent market risks associated with these investments.
As of December 31, 2004 and 2003, all investment securities were designated as “available-for-sale.” Available-for-sale securities are
carried at fair value based on quoted market prices, with unrealized gains and losses, reported in comprehensive income, as a separate component of
stockholders’ equity.
F-7
Realized gains and losses and declines in value
judged to be other-than-temporary for available-for-sale securities are reported in other income or expense as incurred. The cost of securities sold is
based on the specific identification method. Interest and dividends on securities classified as available-for-sale are also included in other
income.
The following is a summary of available-for-sale
securities (in thousands) as of December 31, 2004:
|
|
|
|
Cost
|
|
Unrealized
Gains
|
|
Unrealized
Losses
|
|
Fair
Value
|
Cash |
|
|
|
$ |
58,376 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
58,376 |
|
Cash
Equivalents — money markets |
|
|
|
|
46,581 |
|
|
|
— |
|
|
|
— |
|
|
|
46,581 |
|
Total cash
and cash equivalents |
|
|
|
$ |
104,957 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
104,957 |
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
US government
and agencies |
|
|
|
$ |
12,999 |
|
|
$ |
— |
|
|
$ |
(132 |
) |
|
$ |
12,867 |
|
US
municipalities |
|
|
|
|
79,075 |
|
|
|
20 |
|
|
|
(157 |
) |
|
|
78,938 |
|
Corporate
bonds |
|
|
|
|
10,387 |
|
|
|
69 |
|
|
|
— |
|
|
|
10,456 |
|
Auction rate
securities |
|
|
|
|
27,677 |
|
|
|
— |
|
|
|
— |
|
|
|
27,677 |
|
Equity
securities |
|
|
|
|
18,211 |
|
|
|
564 |
|
|
|
— |
|
|
|
18,775 |
|
Total
investments |
|
|
|
$ |
148,349 |
|
|
$ |
653 |
|
|
$ |
(289 |
) |
|
$ |
148,713 |
|
Short
term |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
101,299 |
|
Long
term |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
47,414 |
|
Total
investments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
148,713 |
|
The following is a summary of available-for-sale
securities (in thousands) as of December 31, 2003:
|
|
|
|
Cost
|
|
Unrealized
Gains
|
|
Unrealized
Losses
|
|
Fair
Value
|
Cash |
|
|
|
$ |
10,190 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
10,190 |
|
Cash
Equivalents — money markets |
|
|
|
|
17,728 |
|
|
|
— |
|
|
|
— |
|
|
|
17,728 |
|
Total cash
and cash equivalents |
|
|
|
$ |
27,918 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
27,918 |
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
US government
and agencies |
|
|
|
$ |
63,056 |
|
|
$ |
186 |
|
|
$ |
(10 |
) |
|
$ |
63,232 |
|
US
municipalities |
|
|
|
|
104,021 |
|
|
|
115 |
|
|
|
(24 |
) |
|
|
104,112 |
|
Corporate
bonds |
|
|
|
|
15,895 |
|
|
|
258 |
|
|
|
— |
|
|
|
16,153 |
|
Auction rate
securities |
|
|
|
|
31,439 |
|
|
|
— |
|
|
|
(14 |
) |
|
|
31,425 |
|
Equity
securities |
|
|
|
|
23,509 |
|
|
|
3,283 |
|
|
|
— |
|
|
|
26,792 |
|
Total
investments |
|
|
|
$ |
237,920 |
|
|
$ |
3,842 |
|
|
$ |
(48 |
) |
|
$ |
241,714 |
|
Short
term |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
95,563 |
|
Long
term |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
146,151 |
|
Total
investments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
241,714 |
|
In 2004 and 2002, we recognized $5.3 million and
$5.6 million, respectively, from other-than-temporary losses in the market value of our equity securities (See Note 5 — Strategic Investments).
There were no recognized losses from other-than-temporary declines in the market value of marketable securities in 2003.
F-8
The following table shows the gross unrealized
losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than temporarily impaired (in
thousands), aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position as
of December 31, 2003 and 2004.
|
|
|
|
December 31, 2004
|
|
|
|
|
|
Less than 12 Months
|
|
12 Months or Longer
|
|
Total
|
|
Description of Securities
|
|
|
|
Fair Value
|
|
Unrealized
Loss
|
|
Fair Value
|
|
Unrealized
Loss
|
|
Fair Value
|
|
Unrealized
Loss
|
US government
and agencies |
|
|
|
$ |
9,891 |
|
|
$ |
108 |
|
|
$ |
2,976 |
|
|
$ |
24 |
|
|
$ |
12,867 |
|
|
$ |
132 |
|
US
municipalities |
|
|
|
$ |
18,435 |
|
|
$ |
99 |
|
|
$ |
31,442 |
|
|
$ |
58 |
|
|
$ |
49,877 |
|
|
$ |
157 |
|
|
|
|
|
December 31, 2003
|
|
|
|
|
|
Less than 12 Months
|
|
12 Months or Longer
|
|
Total
|
|
Description of Securities
|
|
|
|
Fair Value
|
|
Unrealized
Loss
|
|
Fair Value
|
|
Unrealized
Loss
|
|
Fair Value
|
|
Unrealized
Loss
|
US government
and agencies |
|
|
|
$ |
2,989 |
|
|
$ |
10 |
|
|
|
— |
|
|
|
— |
|
|
$ |
2,989 |
|
|
$ |
10 |
|
US
municipalities |
|
|
|
$ |
23,966 |
|
|
$ |
24 |
|
|
|
— |
|
|
|
— |
|
|
$ |
23,966 |
|
|
$ |
24 |
|
Auction rate securities |
|
|
|
$ |
4,500 |
|
|
$ |
14 |
|
|
|
— |
|
|
|
— |
|
|
$ |
4,500 |
|
|
$ |
14 |
|
As of December 31, 2004 and 2003, the difference
between the fair value and the amortized cost of available-for-sale securities were unrealized gains of $358,000 and $3.8 million, respectively. As of
December 31, 2004 and 2003, the unrealized gain, net of taxes, was $212,000 and $2.3 million, respectively. These unrealized gains, net of deferred
income taxes, related to short-term and long-term government bonds and investment securities have been recorded as a component of comprehensive income.
As of December 31, 2004, the weighted average contractual maturity for debt securities was approximately 16 months.
Property and Equipment
Property and equipment are stated at cost, net of
accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of
the respective assets. Computer equipment and software are depreciated over three years. Furniture and fixtures are depreciated over five years.
Leasehold improvements and assets recorded under capital leases are amortized on a straight-line basis over the shorter of the assets’ useful
lives or lease terms.
Patents
Patent application costs of $2.7 million for each of
the years ended December 31, 2004 and 2003 are included in patents and other intangibles and are amortized using the straight-line method over the
shorter of the estimated useful life of the patent or 10 years.
|
|
|
|
December 31,
2004
|
|
December 31,
2003
|
Patents at
cost |
|
|
|
$ |
16,566 |
|
|
$ |
14,952 |
|
Accumulated
amortization |
|
|
|
|
(5,696 |
) |
|
|
(4,126 |
) |
Patents,
net |
|
|
|
$ |
10,870 |
|
|
$ |
10,826 |
|
Deferred Revenue
Deferred revenue represents amounts received from
customers under certain license, maintenance and service agreements for which the revenue earnings process has not been completed.
Comprehensive Income
Comprehensive income includes net income, foreign
currency translation adjustments and other unrealized gains and losses on marketable investment securities that have been excluded from the
determination of net income. The Company has reported the components of comprehensive income on its consolidated statements of stockholders’
equity.
F-9
Revenue Recognition
The Company’s revenue consists of royalty fees
on copy-protected products on a per unit basis, licenses of the Company’s content protection technology, licenses for the Company’s software
products, and related maintenance and services revenues.
Royalty Revenues
Royalty revenue from the replication of
videocassettes, DVDs and CDs is recognized when realized or realizable and earned. The Company relies on royalty reports from third parties as its
basis for revenue recognition. In the Company’s DVD, videocassette, and PC games product lines, it has established significant experience with
certain customers to reasonably estimate current period volume for purposes of making an accurate revenue accrual. Accordingly, royalty revenue from
these customers is recognized as earned, provided there is persuasive evidence of an arrangement and that collection of a fixed or determinable fee is
considered probable. Revenue from customers in pay-per-view (“PPV”) and music content protection technology is currently recognized only as
reported, due to timing of receipt of reports in PPV, and the embryonic stage and volume volatility of the market for the Company’s music
technology products. Advanced royalty fees attributable to minimum guaranteed quantities of licensed units or royalties based on a percentage of
licensed product sales are deferred until earned. In the case of agreements with minimum guaranteed royalty payments with no specified volume, revenue
is recognized on a straight-line basis over the life of the agreement.
Technology Licensing
Revenues
Technology licensing revenue, which applies
principally to DVD and PC sub-assembly manufacturers; digital PPV, cable and satellite system operators; digital set-top decoder manufacturers; and
content owners who utilize the Hawkeye peer-to-peer antipiracy service is recognized upon establishment of persuasive evidence of an arrangement,
performance of all significant obligations and determination that collection of a fixed or determinable license fee is considered
probable.
Software Licensing Revenues
The Company sells its software value management
solutions through our direct sales force and through resellers. The Company recognizes revenue on its software products in accordance with Statement of
Position (SOP) 97-2, “Software Revenue Recognition,” as amended by SOP 98-9 “Modification of SOP 97-2.” The Company recognizes
revenue when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery of the product has occurred; no significant
obligations remain; the fee is fixed or determinable; and collectibility is probable. The Company offers resellers the right of return on its packaged
products under certain policies and programs. The Company estimates and records reserves for product returns as an offset to revenue. The Company
generally considers arrangements with payment terms extending beyond six months not to be fixed or determinable and, accordingly, revenue is recognized
as payments become due and payable from the customer under such arrangements. The Company assesses collectibility based on a number of factors,
including the customer’s past payment history and current creditworthiness. If collectibility is not considered probable, revenue is recognized
when the fee is collected from the customer.
For license agreements in which non-standard
customer acceptance clauses are a condition to earning the license fees, revenue is not recognized until acceptance occurs. For arrangements containing
multiple elements, such as software license fees, consulting services and maintenance, or multiple products and where vendor-specific objective
evidence (“VSOE”) of fair value exists for all undelivered elements, the Company accounts for the delivered elements in accordance with the
“residual method.” Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the
arrangement fee is recognized as revenue. For arrangements containing multiple elements where VSOE of fair value does not exist, all revenue is
deferred until such time that VSOE of fair value is evidenced or all elements of the arrangement have been delivered, or if the only undelivered
element is maintenance where VSOE of fair value exists, maintenance revenue is recognized pro rata over the maintenance contract period. The Company
also enters into term license agreements in which the license fee is recognized ratably over the term of the license period (generally one
year).
F-10
When licenses are sold together with consulting and
implementation services, license fees are recognized upon delivery of the product provided that (1) the above criteria have been met, (2) payment of
the license fees is not dependent upon performance of the consulting and implementation services and (3) the services are not essential to the
functionality of the software. For arrangements where services are essential to the functionality of the software, both the license and services
revenue are recognized in accordance with the provisions of SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type
Contracts.” Arrangements that allow the Company to make reasonably dependable estimates relative to contract costs and the extent of progress
toward completion are accounted for using the percentage-of-completion method. Arrangements that do not allow the Company to make reasonably dependable
estimates of costs and progress are accounted for using the completed-contracts method. Because the completed-contracts method precludes recognition of
performance under the contract as the work progresses, it does not reflect current financial performance when the contract extends beyond one
accounting period, and it therefore may result in uneven recognition of revenue and gross margin. For each of the years ended December 31, 2003 and
2004, the Company used the completed-contracts method for all such arrangements. For the year ended December 31, 2002, there were no such
arrangements.
Professional Services
Revenues
The Company provides consulting and training
services to its software vendor and enterprise customers. Revenue from such services is generally recognized as the services are performed, except in
instances where services are included in an arrangement accounted for under SOP 81-1. Professional services revenues are included in services revenue
in the accompanying consolidated financial statements.
Maintenance Revenues
Maintenance agreements generally call for the
Company to provide technical support and unspecified software updates to customers. Maintenance revenue is deferred and recognized ratably over the
maintenance contract period (generally one year) and is included in services revenue in the accompanying consolidated financial
statements.
Cost of Revenues
License Fees
The Company has agreements with certain licensed
duplicators, DVD and CD replicators, DVD authoring facilities and CD mastering facilities utilized by customers of the Company’s video copy
protection and software copy protection technologies. The Company has agreed to pay these licensees on a specified fixed service fee or on a per unit
basis when utilizing the Company’s copy protection technologies to help offset the cost of operating the Company’s copy protection equipment
and reporting requirements of their contracts. Such amounts are charged to cost of revenues when incurred. Cost of revenues — license fees also
includes items such as product costs, videocassette copy protection processor costs, royalty expense and software licensing fees and software product
support. Cost of revenues — license fees also includes outside legal costs of $1.9 million, $692,000 and $1.8 million in 2004, 2003 and 2002,
respectively, associated with litigation to enforce the Company’s patents. Amortization of patents is also included in cost of revenues —
license fees.
Service Fees
Cost of revenues — service fees includes the
cost of technical support for the Company’s products, which primarily consists of direct costs and related overhead for employees providing
technical support and professional services to its customers, as well as any third party consultants who provide such services on the Company’s
behalf.
Amortization of Intangibles from
Acquisitions
Cost of revenues — amortization of intangibles
from acquisitions includes amortization of certain intangibles from acquisitions. This includes amortization from purchased existing technology,
existing contracts, and patents and trademarks.
F-11
Stock-Based Compensation
The Company accounts for employee stock-based
compensation arrangements in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock
Issued to Employees,” Financial Accounting Standards Board Interpretation (“FASB”) No. 44 (“FIN 44”), “Accounting for
Certain Transactions Involving Stock Compensation — an Interpretation of APB Opinion No. 25,” and complies with the disclosure provisions of
Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation.” The Company
accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
(“EITF”) No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services.”
If compensation cost for the Company’s
stock-based compensation plans had been determined in a manner consistent with the fair value approach described in SFAS No. 123, the Company’s
net income and net income per share as reported would have been reduced to the pro forma amounts indicated below (in thousands, except per share
data):
|
|
|
|
Year ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
Net income,
as reported |
|
|
|
$ |
36,730 |
|
|
$ |
26,941 |
|
|
$ |
12,089 |
|
Add
stock-based employee compensation expense included in reported net income, net of tax |
|
|
|
|
111 |
|
|
|
1,594 |
|
|
|
3,757 |
|
Deduct total
stock-based employee compensation expenses determined under fair-value-based method for all rewards, net of related tax effects |
|
|
|
|
(13,480 |
) |
|
|
(15,281 |
) |
|
|
(13,571 |
) |
Net income,
pro forma |
|
|
|
$ |
23,361 |
|
|
$ |
13,254 |
|
|
$ |
2,275 |
|
Basic net
income per share
As reported |
|
|
|
$ |
0.74 |
|
|
$ |
0.55 |
|
|
$ |
0.24 |
|
Adjusted pro
forma |
|
|
|
$ |
0.47 |
|
|
$ |
0.27 |
|
|
$ |
0.05 |
|
Diluted net
income per share
As reported |
|
|
|
$ |
0.73 |
|
|
$ |
0.54 |
|
|
$ |
0.24 |
|
Adjusted pro
forma |
|
|
|
$ |
0.46 |
|
|
$ |
0.27 |
|
|
$ |
0.04 |
|
Options vest over several years and new options are
generally granted each year. Because of these factors, the pro forma effect shown above may not be representative of the pro forma effect of SFAS No.
123 in future years.
The fair value of each option is estimated on the
date of grant using the Black-Scholes method with the following weighted average assumptions for the Option Plans and the ESPP Plan:
|
|
|
|
Year ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
Option
Plans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends |
|
|
|
|
None |
|
|
|
None |
|
|
|
None |
|
Expected
term |
|
|
|
2.4
years |
|
3.2
years |
|
3.3
years |
Risk free interest
rate |
|
|
|
|
2.3 |
% |
|
|
3.4 |
% |
|
|
4.8 |
% |
Volatility
rate |
|
|
|
|
70.6 |
% |
|
|
75.9 |
% |
|
|
73.5 |
% |
ESPP
Plan:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends |
|
|
|
|
None |
|
|
|
None |
|
|
|
None |
|
Expected
term |
|
|
|
1.4
years |
|
1.3
years |
|
1.3
years |
Risk free interest
rate |
|
|
|
|
2.3 |
% |
|
|
2.8 |
% |
|
|
3.1 |
% |
Volatility
rate |
|
|
|
|
70.8 |
% |
|
|
75.6 |
% |
|
|
75.3 |
% |
F-12
The following table shows the weighted average fair
value of options and ESPP purchase share rights using the fair value approach under SFAS 123:
|
|
|
|
December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
Weighted
average fair value of options granted during the period |
|
|
|
$ |
9.35 |
|
|
$ |
8.17 |
|
|
$ |
11.24 |
|
Weighted
average fair value of an ESPP purchase share right granted during the period |
|
|
|
$ |
8.94 |
|
|
$ |
7.76 |
|
|
$ |
9.95 |
|
Income Taxes
Income taxes are accounted for under the asset and
liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax carry forwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance for any tax benefits of
which future realization is uncertain.
Foreign Currency Translation and Transactions
The functional currency for the Company’s
foreign subsidiaries is the applicable local currency. The translation of foreign currency denominated financial statements into United States dollars
is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenues and expense accounts using an
average exchange rate for the respective periods. Adjustments resulting from such translation are included in comprehensive income. Gains or losses
resulting from foreign currency transactions included in the consolidated statements of income were not material in any of the periods
presented.
Business and Concentration of Credit Risk and Fair Value of Financial
Instruments
The Company licenses its video copy protection,
CD-ROM copy protection and electronic license management software to customers in the home videocassette, DVD, cable and satellite pay-per-view,
corporate communication markets, multimedia software markets and business software markets primarily in the United States, Europe, Japan, and the Far
East. In 2004, 2003 and 2002, 30.3%, 36.0% and 42.2%, respectively, of the Company’s business was attributed to the licensing of its video content
protection technology through MPAA movie studios. Accordingly, the ability of the Company to grow its video copy protection operations has been
dependent on MPAA movie studios’ continued success in the production and distribution of movies utilizing the Company’s technology. The
Company also licenses its digital PPV video content protection technologies to satellite and cable television operators and to the equipment
manufacturers that supply the satellite and cable television industries. The Company licenses its CD-ROM copy protection to publishers of software in
the multimedia and educational software and rights management application markets. With the acquisition of Globetrotter Software, Inc. the Company
began its business in electronic software license management software. The Company licenses software technology solutions to software and hardware
manufacturers and software asset management solutions to enterprise end-users. The Company also provides support, maintenance and consulting services.
In addition, 42.2%, 42.2% and 34.2% of the Company’s sales in 2004, 2003 and 2002, respectively, are from export or foreign
operations.
Financial instruments that potentially subject the
Company to significant concentrations of credit risk consist principally of cash, cash equivalents, marketable securities, trade accounts receivable
and long-term investments. The Company places its cash and cash equivalents and marketable securities in deposits and money market funds with various
high credit quality institutions. The carrying value of the Company’s financial instruments approximates fair market value due to the relatively
short maturities of those instruments. For the Company’s investments in public companies (Digimarc), the carrying value is the market price of
shares as represented on a national exchange at period end.
F-13
The Company performs ongoing credit evaluations of
its customers as necessary. The Company did not have any customers that were equal to or greater than 10% of net revenues for the year ended December
31, 2004. One customer accounted for 10.2% of net revenues for the year ended December 31, 2003 and one customer accounted for 11.4% of net revenues
for the year ended December 31, 2002. At December 31, 2004 and 2003, the Company did not have any customers that were equal to or greater than 10% of
accounts receivable.
Earnings Per Share
Basic EPS is computed using the weighted average
number of common shares outstanding during the period. Diluted EPS is computed using the weighted average number of common and dilutive common
equivalent shares outstanding during the period except for periods of operating loss for which no common share equivalents are included because their
effect would be anti-dilutive. Dilutive common equivalent shares consist of common stock issuable upon exercise of stock options using the treasury
stock method.
|
|
|
|
December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
(In thousands)
|
|
Basic EPS
— weighted average number of common shares outstanding |
|
|
|
|
49,516 |
|
|
|
48,754 |
|
|
|
50,046 |
|
Effect of
dilutive common equivalent shares — stock options outstanding |
|
|
|
|
1,103 |
|
|
|
764 |
|
|
|
556 |
|
Diluted EPS
— weighted average number of common shares and common share equivalents outstanding |
|
|
|
|
50,619 |
|
|
|
49,518 |
|
|
|
50,602 |
|
Weighted
average number of stock options excluded from diluted earnings per share calculation |
|
|
|
|
2,760 |
|
|
|
3,889 |
|
|
|
3,747 |
|
Weighted
average exercise price of stock options excluded from diluted earnings per share calculation |
|
|
|
$ |
32.23 |
|
|
$ |
39.73 |
|
|
$ |
45.33 |
|
Research and Development
Expenditures for research and development are
expensed as incurred. The Company had no capitalized costs under this statement as of December 31, 2004.
Advertising Expenses
The Company expenses all advertising costs as
incurred and classifies these costs under sales and marketing expense.
| (2) |
|
Financial Statement Details |
Property and Equipment, Net
Property and equipment consisted of the following
(in thousands):
|
|
|
|
December 31,
|
|
|
|
|
|
2004
|
|
2003
|
Computer equipment and
software |
|
|
|
$ |
17,512 |
|
|
$ |
10,927 |
|
Leasehold
improvements |
|
|
|
|
3,698 |
|
|
|
2,334 |
|
Furniture and
fixtures |
|
|
|
|
3,038 |
|
|
|
2,711 |
|
|
|
|
|
|
24,248 |
|
|
|
15,972 |
|
Less accumulated depreciation
and amortization |
|
|
|
|
14,953 |
|
|
|
9,283 |
|
|
|
|
|
$ |
9,295 |
|
|
$ |
6,689 |
|
F-14
Depreciation expense for the years ended December
31, 2004, 2003 and 2002 are $3.2 million, $2.4 million and $2.1 million, respectively.
Accrued Expenses
Accrued expenses consisted of the following (in
thousands):
|
|
|
|
December 31,
|
|
|
|
|
|
2004
|
|
2003
|
Accrued
compensation |
|
|
|
$ |
15,032 |
|
|
$ |
8,262 |
|
Income taxes
payable |
|
|
|
|
11,871 |
|
|
|
16,921 |
|
Other accrued
liabilities |
|
|
|
|
5,736 |
|
|
|
3,508 |
|
|
|
|
|
$ |
32,639 |
|
|
$ |
28,691 |
|
Interest and Other Income, Net
Interest and other income, net, consisted of the
following (in thousands):
|
|
|
|
Year ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
2002
|
|
Interest
income |
|
|
|
$ |
3,133 |
|
|
$ |
3,550 |
|
$7,081 |
|
Foreign currency
gains |
|
|
|
|
878 |
|
|
|
332 |
|
183 |
|
Other income
(expense) |
|
|
|
|
162 |
|
|
|
(30 |
) |
54 |
|
|
|
|
|
$ |
4,173 |
|
|
$ |
3,852 |
|
$7,318 |
|
Allowance for Doubtful Accounts (in thousands):
|
|
|
|
Balance at
Beginning of
Period
|
|
Charged to
Costs and
Expenses
|
|
Deductions
|
|
Balance at
End of Period
|
2004 |
|
|
|
$ |
2,147 |
|
|
$ |
924 |
|
|
$ |
366 |
|
|
$ |
2,705 |
|
2003 |
|
|
|
$ |
1,657 |
|
|
$ |
907 |
|
|
$ |
417 |
|
|
$ |
2,147 |
|
2002 |
|
|
|
$ |
1,747 |
|
|
$ |
621 |
|
|
$ |
711 |
|
|
$ |
1,657 |
|
| (3) |
|
Business Combinations and Asset Purchases |
InstallShield
In July 2004, the Company acquired the operations
and certain assets of InstallShield Software Corporation (“InstallShield”) for approximately $77.1 million in cash, including related
acquisition costs. The Company also assumed certain liabilities as part of the acquisition. An additional contingent payment of up to $20.0 million may
be required to be made by the Company based on post-acquisition revenue performance through June 30, 2005. Any additional contingent consideration
would be required to be paid in the third quarter of 2005. InstallShield is a leading provider of software installation tools. The acquisition of
InstallShield expands the Company’s product portfolio in the Software value management category and enables the Company to reach
InstallShield’s large software developer customer base. InstallShield has been integrated into the Company’s Software Technologies Group. The
accompanying consolidated statements of income include the results of operations of InstallShield since July 1, 2004, the effective date of the
acquisition.
As of December 31, 2004, $859,000 of cash and cash
equivalents was restricted, primarily relating to certain liabilities assumed as part of the acquisition of InstallShield. This amount has been
classified as “Restricted Cash” on the consolidated balance sheet.
F-15
The following is a summary of the estimated fair
values of the tangible assets acquired and liabilities assumed at the date of the acquisition (in thousands):
|
|
|
|
July 1,
2004
|
Cash and cash
equivalents |
|
|
|
$ |
1,134 |
|
Accounts
receivable, net |
|
|
|
|
2,713 |
|
Property and
equipment, net |
|
|
|
|
738 |
|
Other
assets |
|
|
|
|
1,213 |
|
Total
tangible assets acquired |
|
|
|
|
5,798 |
|
Deferred
revenue |
|
|
|
|
(2,132 |
) |
Other
liabilities |
|
|
|
|
(3,937 |
) |
Total
liabilities assumed |
|
|
|
|
(6,069 |
) |
Net
liabilities assumed |
|
|
|
$ |
(271 |
) |
The following is a summary of goodwill and
identifiable intangible assets acquired in the acquisition of InstallShield (in thousands):
Intangible Asset
|
|
|
|
$
|
|
Amortization Period
in Years
|
Existing
technology |
|
|
|
$ |
20,100 |
|
|
4 |
In-process
technology |
|
|
|
|
5,400 |
|
|
— |
Maintenance
agreements |
|
|
|
|
200 |
|
|
3 |
Distribution
agreements |
|
|
|
|
2,000 |
|
|
6 |
Trade
Name/Trademarks |
|
|
|
|
6,500 |
|
|
6 |
Goodwill |
|
|
|
|
43,135 |
|
|
Not Applicable |
Total |
|
|
|
|
77,335 |
|
|
|
|
|
Net liabilities
assumed |
|
|
|
|
(271 |
) |
|
|
|
|
Total purchase
price |
|
|
|
$ |
77,064 |
|
|
|
|
|
The weighted average amortization period for
amortizable InstallShield intangible assets is 4.6 years. The in-process technology of $5.4 million has been charged to operations during the year
ended December 31, 2004.
The following table shows supplemental unaudited
information as if the acquisition of InstallShield had been completed at the start of each fiscal year as presented:
|
|
|
|
Year Ended
December 31, 2004
(unaudited)
|
|
Year Ended
December 31, 2003
(unaudited)
|
Revenues |
|
|
|
$ |
200,997 |
|
|
$ |
163,833 |
|
Net income |
|
|
|
$ |
38,059 |
|
|
$ |
29,883 |
|
Basic net earnings per
share |
|
|
|
$ |
0.77 |
|
|
$ |
0.61 |
|
Diluted net earnings per
share |
|
|
|
$ |
0.75 |
|
|
$ |
0.60 |
|
Acquisition of peer-to-peer assets
In August 2003, the Company acquired intellectual
property and other assets, including patents, existing contracts, and software code that can be used to track and manage content in the peer-to-peer,
or P2P, file sharing space. The Company paid $720,000 in cash, $80,000 of acquisition costs and an additional payment of $80,000 due on the first
anniversary of the closing date for a total purchase price of $880,000. The purchase price was allocated to in-process technology, core technology and
employment agreements. The in-process technology of $624,000 was charged to operations during the year ended December 31, 2003.
F-16
Acquisition of TTR patents and other assets
In May 2003, the Company acquired patents and other
assets of TTR Technologies, Inc. (“TTR”) for approximately $5.1 million in cash and the surrender of 1,880,937 shares of TTR common stock,
with a fair value of $602,000, which the Company originally purchased in January 2000. The total purchase price of $5.7 million has been allocated to
patents and is being amortized on a straight line basis over seven years. The Company recorded a realized gain of $395,000 for the excess of the market
value of such TTR stock on the closing date of the acquisition over the adjusted cost basis of such stock. This gain has been included in “Gains
on strategic investments” in the accompanying consolidated financial statements.
Acquisition of Midbar net assets
In November 2002, the Company acquired the assets
and operations of Midbar Tech (1998) Ltd. for approximately $17.8 million in cash and additional related acquisition costs. In addition, the Company is
subject to additional contingent consideration up to $8.0 million based on a percentage of the net revenues derived from the Company’s sales of
music technology products until December 31, 2004. In connection with the purchase in November 2002, the Company recorded goodwill of $6.9 million and
identifiable intangibles of $4.9 million. The purchase price was allocated to in-process technology ($6.0 million), existing technology ($0.5 million),
existing contracts ($2.6 million), patents ($1.6 million), trademarks ($0.2 million) and goodwill ($6.9 million). The in-process technology of $6.0
million was charged to operations in 2002. The intangible assets for existing technology, existing contracts, patents and trademarks are being
amortized on a straight-line basis over three to five years based on the expected useful lives of the intangible assets. For the years ended December
31, 2004 and 2003, the Company recorded additional goodwill of $857,000 and $1.2 million, respectively, representing contingent consideration as noted
above.
| (4) |
|
Goodwill and Other Intangibles from
Acquisitions |
Goodwill represents the excess of costs over fair
value of assets of businesses acquired. The Company adopted the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” as of
January 1, 2002. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not
amortized, but instead are tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that
intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.”
In accordance with SFAS No. 144, long-lived assets,
such as property, plant, and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount
of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds
the fair value of the asset. 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 are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale
would be presented separately in the appropriate asset and liability sections of the balance sheet.
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 asset
might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value.
In connection with SFAS No. 142’s transitional
goodwill impairment evaluation, the Company performed assessments of whether there was an indication that goodwill was impaired for the years ended
December 31, 2004, 2003 and 2002. Based on the results of the annual impairment analysis, the Company determined that no indicators of impairment
existed for its reporting units.
F-17
The following tables summarize the Company’s
goodwill and other intangible assets from acquisitions as of December 31, 2004 and 2003 and the estimated amortization expense through the year 2009
and thereafter (in thousands):
|
|
|
|
December 31, 2004
|
|
|
|
|
|
Gross Costs
|
|
Accumulated
Amortization
|
|
Net
|
Amortized
intangibles:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Existing
technology |
|
|
|
$ |
32,621 |
|
|
$ |
(12,240 |
) |
|
$ |
20,381 |
|
Existing
contracts |
|
|
|
|
6,909 |
|
|
|
(3,357 |
) |
|
|
3,552 |
|
Patents and
trademarks |
|
|
|
|
8,716 |
|
|
|
(1,464 |
) |
|
|
7,252 |
|
|
|
|
|
$ |
48,246 |
|
|
$ |
(17,061 |
) |
|
$ |
31,185 |
|
|
|
|
|
December 31, 2003
|
|
|
|
|
|
Gross Costs
|
|
Accumulated
Amortization
|
|
Net
|
Amortized
intangibles:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Existing
technology |
|
|
|
$ |
12,474 |
|
|
$ |
(7,792 |
) |
|
$ |
4,682 |
|
Existing
contracts |
|
|
|
|
4,484 |
|
|
|
(2,270 |
) |
|
|
2,214 |
|
Patents and
trademarks |
|
|
|
|
2,063 |
|
|
|
(447 |
) |
|
|
1,616 |
|
|
|
|
|
$ |
20,809 |
|
|
$ |
(12,297 |
) |
|
$ |
8,512 |
|
Goodwill, net
at December 31, 2002 |
|
|
|
$ |
24,673 |
|
Midbar
contingent consideration |
|
|
|
|
1,227 |
|
Changes due
to foreign currency exchange rates |
|
|
|
|
2,730 |
|
Goodwill, net
at December 31, 2003 |
|
|
|
|
28,630 |
|
Acquisition
of InstallShield |
|
|
|
|
43,135 |
|
Midbar
contingent consideration |
|
|
|
|
857 |
|
Changes due
to foreign currency exchange rates |
|
|
|
|
1,907 |
|
Goodwill, net
at December 31, 2004 |
|
|
|
$ |
74,529 |
|
Year ending
|
|
|
|
Amortization
Expense
|
2005 |
|
|
|
$ |
9,674 |
|
2006 |
|
|
|
|
8,500 |
|
2007 |
|
|
|
|
6,931 |
|
2008 |
|
|
|
|
3,967 |
|
2009 and
thereafter |
|
|
|
|
2,113 |
|
Total
amortization expense |
|
|
|
$ |
31,185 |
|
| (5) |
|
Strategic Investments |
As of December 31, 2004 and December 31, 2003, the
adjusted cost of the Company’s strategic investments totaled $18.8 million and $27.0 million, respectively. The Company’s strategic
investments include public and non-public companies. Investments in public and non-public companies are classified on the balance sheet as
“Long-term marketable investment securities” and “Other assets,” respectively.
As of December 31, 2004, the adjusted cost of the
Company’s strategic investments consisted solely of its investment in Digimarc, a publicly traded company. Additionally, the Company holds
investments in a number of other privately held companies, which have no carrying value as of December 31, 2004. The Company performs regular reviews
of its strategic investments for indicators of impairment. Impairment charges are recorded when it has been determined that an other-than-temporary
impairment has occurred.
F-18
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 year ended December 31, 2004, the Company
recorded an other-than temporary impairment loss of $5.3 million on its investment in Digimarc. During the year ended December 31, 2002, the Company
recorded other-than temporary impairment losses of $5.6 million on its 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. In the absence of quantitative valuation metrics, such as a recent financing round, management estimates the impairment and/or the net
realizable value of the portfolio investment based on a hypothetical liquidation at book value approach as of the reporting date. Based on these
measurements, the Company recorded $180,000 and $4.8 million of other-than-temporary impairment losses relating to its investment in iVast during the
year ended December 31, 2004 and 2003, respectively. The Company originally invested $5.0 million in iVast in 2001. As of December 31, 2004, the
Company’s investment in iVast had no remaining carrying value. During the year ended December 31, 2002, the Company recorded $11.6 million of
other-than-temporary impairment losses relating to its strategic investments in non-public companies.
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 year ended December 31, 2004. In fiscal year 2001,
this strategic investment had been fully impaired. Accordingly, during the year ended December 31, 2004, the Company recorded a gain on strategic
investments of $1.2 million.
During the year ended December 31, 2003, the Company
recorded a realized gain of $395,000 from the surrender of the Company’s stock in TTR, a public company strategic investment. In addition, during
the year ended December 31, 2003, the Company recorded a realized gain of $57,000 representing distributions received in excess of its book value for
its investment in NTRU Cryptosystems.
| (6) |
|
Recent Accounting Pronouncements |
In December 2003, the Financial Accounting Standards
Board (FASB) issued FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities — An Interpretation of
Accounting Research Bulletin No. 51” (“FIN 46R”). FIN 46R requires an investor with a majority of the variable interests (primary
beneficiary) in a variable interest entity (“VIE”) to consolidate the entity and also requires majority and significant variable interest
investors to provide certain disclosures. A VIE is an entity in which the voting equity investors do not have a controlling financial interest, or the
equity investment at risk is insufficient to finance the entity’s activities without receiving additional subordinated financial support from
other parties. Application of FIN 46R is required in financial statements of companies that have interests in variable interest entities or potential
variable interest entities commonly referred to as special purpose entities for periods ending after December 15, 2003. Application by companies for
all other types of entities is required in financial statements for periods ending after March 15, 2004. The Company had no investments in VIEs as of
December 31, 2004.
In December 2003, the Securities and Exchange
Commission (“SEC”) issued Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition.” SAB No. 104 updates interpretive guidance
in the codification of staff accounting bulletins to provide consistent accounting guidance on revenue recognition. The principal revisions relate to
the deletion of interpretive material no longer necessary because of private sector developments in generally accepted accounting principles in the
United States of America, and the incorporation of certain sections of the SEC’s “Revenue Recognition in Financial Statements —
Frequently
F-19
Asked Questions and Answers” document. The adoption of SAB
No. 104 had no material impact on the Company’s financial position or results of operations.
In December 2003, the FASB issued SFAS No. 132
(revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” SFAS No. 132 (revised 2003) revises
employers’ disclosures about pension plans and other postretirement benefit plans. It does not change the measurement or recognition of those
plans required by SFAS No. 87, “Employers’ Accounting for Pensions,” No. 88, “Employers’ Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for Termination Benefits,” and No. 106, “Employers’ Accounting for Postretirement
Benefits Other Than Pensions.” This statement retains the disclosure requirements contained in SFAS No. 132, “Employers’ Disclosures
about Pensions and Other Postretirement Benefits,” which it replaces. It requires additional disclosures to those in the original SFAS No. 132
about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement
plans. The required information should be provided separately for pension plans and for other postretirement benefit plans. SFAS No. 123 (revised 2003)
is effective for financial statements with fiscal years ending after December 15, 2003. The Company had no pension plans or other postretirement
benefit plans covered by SFAS No. 132 as of December 31, 2004.
In March 2004, the FASB issued EITF Issue No. 03-1
(“EITF 03-1”) “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF 03-1 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 has adopted the disclosure requirements under EITF 03-1 and has included them in
“Note 1-The Company and Summary of Significant Accounting Policies.” The Company will evaluate the impact of EITF 03-1 once final guidance is
issued.
In July 2004, the FASB issued EITF Issue No. 02-14
(“EITF 02-14”) “Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than Common Stock.” EITF
02-14 includes new guidance for determining whether the equity method of accounting applies when an investor does not have an investment in voting
common stock of an investee but exercises significant influence through other means, how the equity method should be applied to investments other than
common stock, and for securities with a readily determinable fair market value, how the scope provisions of APB Opinion No. 18, The Equity Method of
Accounting for Investments in Common Stock, and FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities,
interact. The accounting guidance provided in EITF 02-14 is effective for reporting periods beginning after September 15, 2004. The Company adopted the
accounting guidance effective October 1, 2004. The adoption of EITF 02-14 has had no material impact on the Company’s financial position or
results of operations.
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 option, 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. SFAS 123R is effective for fiscal periods beginning after June 15, 2005. Therefore, the Company is required to implement the standard no
later than its third fiscal quarter which begins on July 1, 2005. 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
F-20
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 our result of operations, although it will have no negative impact on our 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 1 — The Company and Summary of Significant Accounting Policies” for information related to the pro forma effects on our
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, 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.
| (7) |
|
Transactions with Related Parties |
In December 1997, the Company made its initial
investment in Digimarc (Nasdaq, symbol DMRC), the business of which is digital watermark technology and applications. The Company made two subsequent
investments in June 1999 and October 2000 for a total of $25.3 million. Digimarc completed an initial public offering in December 1999. The Company
owned approximately 9.8% of the outstanding shares of Digimarc as of December 31, 2004. The Company has an agreement with Digimarc to jointly develop a
digital video watermarking copy protection solution to address digital-to-digital copying associated with next-generation recordable DVD and digital
videocassette recording devices. In addition, the Company had an exclusive marketing agreement with Digimarc through December 31, 2002, with minimum
royalty payments of $2.0 million, which we paid in 2000 and 2001 and included in cost of revenues — license fees. There were no royalty payments
in 2002.
In January 2000, the Company invested $4.0 million
to acquire a minority interest in TTR, a public company (Nasdaq, symbol TTRE). In addition, the Company entered into an agreement with TTR to jointly
develop and market a copy protection product designed to inhibit casual copying of music CDs using dual-deck CD recorder systems and personal computer
based CD-recordable drives. TTR is a provider of proprietary digital anti-piracy technologies and products. In May 2003, the Company acquired patents
and other assets of TTR for approximately $5.1 million and the surrender of 1,880,937 shares of TTR common stock, with a fair value of $602,000 (See
“Note 3 — Business Combinations and Asset Purchases”).
F-21
The Company leased certain of its premises in San
Jose, California from a related party. Rent paid to such related party amounted to $245,000 for the year ended December 31, 2002. As of December 31,
2002, this lease agreement was terminated.
| (8) |
|
Stock Option and Purchase Plans |
In December 1996, the Company adopted the 1996
Equity Incentive Plan (the “1996 Equity Incentive Plan”), which serves as the successor to the Company’s 1988 Stock Option Plan (the
“1988 Plan”). Pursuant to the 1996 Equity Incentive Plan, the Company’s Board of Directors reserved 5,088,888 shares of common stock for
issuance. In May 1998, an additional 1,600,000 shares were reserved by approval of the Board of Directors and stockholders. The 1996 Equity Incentive
Plan provides for the grant of stock options, stock appreciation rights, and restricted stock awards by the Company to employees, officers, directors,
consultants, independent contractors, and advisers of the Company. The 1996 Equity Incentive Plan permits the grant of either incentive or nonqualified
stock options at the then current market price. Options granted under the 1996 Equity Incentive Plan have a maximum term of ten years and generally
vest over the first, second and third years at the rate of 1/6, 1/3 and 1/2, respectively.
In December 1996, the Company’s Board of
Directors adopted the 1996 Employee Stock Purchase Plan (the “Purchase Plan”) and reserved 560,000 shares of common stock for issuance
thereunder. The Purchase Plan was effective upon the Company’s initial public offering in March 1997. The Purchase Plan permits eligible employees
to purchase common stock, through payroll deductions of between 1% and 20% of the employee’s compensation, at a price equal to 85% of the lower of
the fair market value of the common stock on the first day of the offering period or on the last day of the purchase period. The Company’s
stockholders approved the Purchase Plan in February 1997. In June 2002, an additional 250,000 shares of common stock were reserved for issuance under
the Purchase Plan. In April 2003, an additional 1,500,000 shares of common stock were reserved for issuance under the Purchase Plan.
In August 2000, the Company adopted the 2000 Equity
Incentive Plan, which serves as the successor to the Company’s 1996 Equity Incentive Plan. The total number of shares of Macrovision common stock
for which options and other stock awards may be granted under the 2000 Equity Incentive Plan was increased from 4,500,000 to 6,300,000 in June 2002,
and the maximum number of stock options that the Company may grant to any individual in any calendar year is 500,000, in each case subject to
adjustment as described below. The shares available for issuance under the 2000 Equity Incentive Plan may be authorized but unissued shares of common
stock or shares of common stock that the Company reacquires. If any options expire or are forfeited or canceled, the shares are added back to the total
number of shares available for issuance under the 2000 Equity Incentive Plan. All options granted under the 2000 Equity Incentive Plan since January
2003 have a maximum term of five years and vest over three years. In April 2003, an additional 4,000,000 shares of common stock were reserved for
issuance under the 2000 Equity Incentive Plan.
In December 1996, the Company’s Board of
Directors adopted the 1996 Directors Stock Option Plan (the “Directors Plan”) and reserved 240,000 shares of common stock for issuance
thereunder. In June 2000, the Board of Directors increased the number of shares of common stock reserved for issuance under the Directors Plan by
126,000 shares. In June 2002, an additional 200,000 shares were reserved for issuance under the Directors Plan. The Company’s stockholders
approved the Directors Plan in February 1997 and approved the share increases in August 2000 and June 2002. The Directors Plan provides each eligible
director an initial grant of a nonqualified option to purchase 40,000 shares (increased from 20,000 shares prior to 1999) of common stock on the date
the eligible director first becomes a director, with each initial option granted after 1999 vesting in monthly increments over a three-year period. The
Directors Plan provides for additional annual grants of nonqualified options to each eligible director to purchase 15,000 shares of common stock on
each anniversary of the date such person became a director, with monthly vesting over one year. All initial option grants have a maximum term of ten
years and all annual option grants on and after April 1, 2003 have a maximum term of five years. In April 2003, an additional 275,000 shares of common
stock were reserved for issuance under the Directors Plan.
F-22
The Company uses the intrinsic value-based method to
account for all of its employee stock-based compensation plans. Accordingly, compensation cost has been recognized in the accompanying consolidated
financial statements for its plans when the exercise price of each option was less than the fair value of the underlying common stock as of the grant
date for each stock option. With respect to the options assumed in connection with an acquisition in 2000, the Company recorded deferred stock-based
compensation of approximately $37.9 million, for the difference between the exercise price and the fair value of the stock underlying the options. This
amount is being amortized over the vesting period of the individual options, generally four years. Amortization expenses recognized in 2004, 2003 and
2002 relating to the Globetrotter acquisition totaled $185,000, $2.7 million and $6.3 million, respectively.
Activity under the Company’s option plans is as
follows:
|
|
|
|
Number of shares
|
|
Weighted-average
exercise price
|
Outstanding as of December
31, 2001 |
|
|
|
|
4,674,405 |
|
|
$ |
43.71 |
|
Granted |
|
|
|
|
2,354,625 |
|
|
$ |
21.31 |
|
Canceled |
|
|
|
|
(377,467 |
) |
|
$ |
38.98 |
|
Exercised |
|
|
|
|
(516,260 |
) |
|
$ |
5.24 |
|
Outstanding as of December
31, 2002 |
|
|
|
|
6,135,303 |
|
|
$ |
32.24 |
|
Granted |
|
|
|
|
2,028,917 |
|
|
$ |
15.61 |
|
Canceled |
|
|
|
|
(1,690,723 |
) |
|
$ |
52.47 |
|
Exercised |
|
|
|
|
(458,346 |
) |
|
$ |
10.27 |
|
Outstanding as of December
31, 2003 |
|
|
|
|
6,015,151 |
|
|
$ |
22.62 |
|
Granted |
|
|
|
|
3,405,999 |
|
|
$ |
21.97 |
|
Canceled |
|
|
|
|
(809,186 |
) |
|
$ |
31.29 |
|
Exercised |
|
|
|
|
(811,146 |
) |
|
$ |
15.00 |
|
Outstanding as of December
31, 2004 |
|
|
|
|
7,800,818 |
|
|
$ |
22.23 |
|
|
|
|
|
December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
Options
exercisable at end of year |
|
|
|
|
3,302,575 |
|
|
|
2,666,020 |
|
|
|
2,283,744 |
|
The following table summarizes information about
stock options outstanding as of December 31, 2004:
|
|
|
|
Outstanding
|
|
Exercisable
|
|
Range of exercise prices
|
|
|
|
Number
of shares
|
|
Weighted average
remaining
contractual life
|
|
Weighted average
exercise price
|
|
Number
exercisable
|
|
Weighted average
exercise price
|
$0.675–$12.910 |
|
|
|
|
1,342,717 |
|
|
|
3.79 |
|
|
$ |
10.71 |
|
|
|
944,000 |
|
|
$ |
10.17 |
|
$12.970–$17.700 |
|
|
|
|
1,621,990 |
|
|
|
5.40 |
|
|
$ |
16.82 |
|
|
|
420,589 |
|
|
$ |
15.58 |
|
$18.190–$22.330 |
|
|
|
|
1,537,306 |
|
|
|
4.31 |
|
|
$ |
21.02 |
|
|
|
266,351 |
|
|
$ |
19.77 |
|
$22.350–$25.020 |
|
|
|
|
1,432,992 |
|
|
|
4.59 |
|
|
$ |
24.53 |
|
|
|
79,575 |
|
|
$ |
23.67 |
|
$25.230–$28.990 |
|
|
|
|
1,361,421 |
|
|
|
6.86 |
|
|
$ |
26.70 |
|
|
|
1,089,026 |
|
|
$ |
26.91 |
|
$29.390–$102.313 |
|
|
|
|
504,392 |
|
|
|
5.97 |
|
|
$ |
55.42 |
|
|
|
503,034 |
|
|
$ |
55.48 |
|
|
|
|
|
|
7,800,818 |
|
|
|
5.05 |
|
|
$ |
22.23 |
|
|
|
3,302,575 |
|
|
$ |
24.38 |
|
Offer to Exchange Outstanding Stock Options to Purchase Common
Stock
On May 27, 2003, the Company’s stockholders
approved a program to permit the exchange of stock options issued under the 2000 Equity Plan and the 1996 Equity Incentive Plan having an exercise
price greater than $28.00 for a lesser number of new options to be granted at least six months and one day from the cancellation of the surrendered
options (the “Option Exchange Program”).
On August 20, 2003, the Company implemented the
Option Exchange Program by filing a Tender Offer Statement with the U.S. Securities and Exchange Commission. The Option Exchange Program was offered
from August 20, 2003 to September 19, 2003. On September 19, 2003, pursuant to the Option Exchange
F-23
Program, the Company accepted for cancellation,
options to purchase 969,215 shares of common stock. On March 22, 2004, employees who continued employment with the Company were granted new options to
purchase 319,749 shares of common stock in exchange for such cancelled options. Key executive officers and directors of the Company were not eligible
to participate in the Option Exchange Program.
The Company designed the Option Exchange Program so
that the Company did not need to record compensation expense from the issuance of new stock options under current generally accepted accounting
principles in the United States.
| (9) |
|
Stock Repurchase Program |
In May 2002, the Board of Directors authorized a
stock repurchase program for up to 5.0 million shares of the Company’s common stock. Purchases of the stock may be made, from time-to-time, in the
open market at prevailing market prices, at the discretion of Company management and as monitored by the Audit Committee of the Company’s Board of
Directors. The Company’s repurchases of shares of common stock have been recorded as treasury stock at cost and result in a reduction of
stockholders’ equity. As of December 31, 2004 and 2003, treasury stock consisted of 3.0 million shares of common stock that the Company had
repurchased, with a cost basis of approximately $38.5 million.
The components of income before income taxes are as
follows (in thousands):
|
|
|
|
December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
Domestic
income |
|
|
|
$ |
14,729 |
|
|
$ |
22,772 |
|
|
$ |
9,696 |
|
Foreign
income |
|
|
|
|
42,661 |
|
|
|
26,722 |
|
|
|
12,220 |
|
Income before
provision for income taxes |
|
|
|
$ |
57,390 |
|
|
$ |
49,494 |
|
|
$ |
21,916 |
|
Income tax expense for the years ended December 31,
2004, 2003 and 2002 consisted of the following (in thousands):
|
|
|
|
December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
|
|
|
$ |
13,271 |
|
|
$ |
19,844 |
|
|
$ |
13,607 |
|
State |
|
|
|
|
1,620 |
|
|
|
2,570 |
|
|
|
1,432 |
|
Foreign |
|
|
|
|
3,848 |
|
|
|
2,674 |
|
|
|
1,289 |
|
Total
current |
|
|
|
|
18,739 |
|
|
|
25,088 |
|
|
|
16,328 |
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
|
|
|
|
(1,017 |
) |
|
|
(3,056 |
) |
|
|
(6,295 |
) |
State |
|
|
|
|
(964 |
) |
|
|
(1,359 |
) |
|
|
(1,030 |
) |
Total
deferred tax benefit |
|
|
|
|
(1,981 |
) |
|
|
(4,415 |
) |
|
|
(7,325 |
) |
Charges in
lieu of income taxes associated with the exercise
of stock options |
|
|
|
|
3,902 |
|
|
|
1,880 |
|
|
|
824 |
|
Total tax
expense |
|
|
|
$ |
20,660 |
|
|
$ |
22,553 |
|
|
$ |
9,827 |
|
F-24
Income tax expense for the years ended December 31,
2004, 2003 and 2002 differed from the amounts computed by applying the U.S. federal income tax rate of 35% to pretax income as a result of the
following (in thousands):
|
|
|
|
December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
Federal tax
statutory rate |
|
|
|
$ |
20,086 |
|
|
$ |
17,323 |
|
|
$ |
7,670 |
|
State taxes,
net of federal benefit |
|
|
|
|
635 |
|
|
|
1,017 |
|
|
|
160 |
|
Income tax
credits |
|
|
|
|
— |
|
|
|
(78 |
) |
|
|
(286 |
) |
Foreign tax
differential |
|
|
|
|
(2,641 |
) |
|
|
4,465 |
|
|
|
2,305 |
|
Exempt
interest |
|
|
|
|
(824 |
) |
|
|
(888 |
) |
|
|
(849 |
) |
Deferred
stock compensation |
|
|
|
|
— |
|
|
|
676 |
|
|
|
804 |
|
Change in
valuation allowance |
|
|
|
|
3,341 |
|
|
|
— |
|
|
|
— |
|
Others |
|
|
|
|
63 |
|
|
|
38 |
|
|
|
23 |
|
Total tax
expense |
|
|
|
$ |
20,660 |
|
|
$ |
22,553 |
|
|
$ |
9,827 |
|
The tax effects of the temporary differences that
give rise to significant portions of the deferred tax assets and liabilities are presented below (in thousands):
|
|
|
|
December 31,
|
|
|
|
|
|
2004
|
|
2003
|
Deferred tax
assets:
|
|
|
|
|
|
|
|
|
|
|
Accruals, reserves and
others |
|
|
|
$ |
1,815 |
|
|
$ |
1,531 |
|
Allowance for doubtful
accounts |
|
|
|
|
932 |
|
|
|
819 |
|
Deferred
revenue |
|
|
|
|
3,962 |
|
|
|
3,346 |
|
Intangible
assets |
|
|
|
|
9,064 |
|
|
|
7,680 |
|
State
taxes |
|
|
|
|
567 |
|
|
|
919 |
|
Impairment losses on
investments |
|
|
|
|
11,663 |
|
|
|
9,987 |
|
Capital loss
carryforward |
|
|
|
|
1,293 |
|
|
|
1,355 |
|
Net operating loss
carryforwards |
|
|
|
|
1,540 |
|
|
|
1,542 |
|
Gross deferred tax
assets |
|
|
|
|
30,836 |
|
|
|
27,179 |
|
Valuation
allowance |
|
|
|
|
(4,781 |
) |
|
|
(1,440 |
) |
Total deferred tax
assets |
|
|
|
|
26,055 |
|
|
|
25,739 |
|
Deferred tax
liabilities:
|
|
|
|
|
|
|
|
|
|
|
Patents |
|
|
|
|
(1,950 |
) |
|
|
(1,900 |
) |
Property and
equipment |
|
|
|
|
(427 |
) |
|
|
(587 |
) |
Sec. 481
adjustment |
|
|
|
|
(7 |
) |
|
|
(14 |
) |
Unrealized
gains |
|
|
|
|
(152 |
) |
|
|
(1,518 |
) |
Total deferred tax
liabilities |
|
|
|
|
(2,536 |
) |
|
|
(4,019 |
) |
Net deferred tax
assets |
|
|
|
$ |
23,519 |
|
|
$ |
21,720 |
|
During the year ended December 31, 2004, 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 $3.3 million for such deferred tax assets.
In assessing the realizability of deferred tax
assets, management considers 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 these deductible differences, net of valuation allowances as of December 31,
2004.
F-25
Deferred tax liabilities have not been recognized
for undistributed earnings of foreign subsidiaries because it is management’s intention to reinvest such undistributed earnings outside the U.S.
indefinitely. Undistributed earnings of foreign subsidiaries for which deferred taxes have not been provided aggregate approximately $30 million at
December 31, 2004. The amount of income tax liability that would result had such earnings been repatriated is estimated to be approximately $7
million.
The Company believes that adequate amounts of tax
accruals have been provided based on currently available information.
On October 22, 2004, 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. 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.
The Company may elect to apply this provision to
qualifying earnings repatriations in fiscal 2005. The Company will evaluate the effects of the repatriation provision. 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. The Company expects to complete its evaluation of the effects of the repatriation provision within a reasonable period of time
following the publication of the additional clarifying language. The range of possible amounts that the Company is considering for repatriation under
this provision is between zero and $30 million. The related potential range of income tax is between zero and $2 million.
Leases
The Company leases its facilities and certain
equipment pursuant to noncancelable operating lease agreements expiring through 2017. Future minimum lease payments pursuant to these leases as of
December 31, 2004 were as follows (in thousands):
|
|
|
|
Operating
Leases
|
2005 |
|
|
|
$ |
5,326 |
|
2006 |
|
|
|
|
5,345 |
|
2007 |
|
|
|
|
5,508 |
|
2008 |
|
|
|
|
5,641 |
|
2009 |
|
|
|
|
4,912 |
|
2010 and
thereafter |
|
|
|
|
24,150 |
|
Total |
|
|
|
$ |
50,882 |
|
Rent expense was $5.4 million, $3.8 million and $3.7
million for the years ended December 31, 2004, 2003 and 2002, respectively.
Employee Benefit Plans
The Company has a 401(k) plan that allows eligible
employees to contribute up to 100% of their compensation, which contribution was limited to $13,000 in 2004. Employee contributions and earnings
thereon vest immediately. The Company is not required to contribute to the 401(k) plan, but has made voluntary contributions. The Company made matching
contributions to the 401(k) plan equal to 20% of each participating employee’s contribution, up to a maximum annual matching contribution of
$2,600, $2,400 and $2,200 in 2004, 2003, and 2002 respectively. For employees 50 years of age or older, the contribution limit was $16,000 in 2004 and
the Company’s maximum annual matching contribution was $3,200. Matching
F-26
contributions aggregated approximately $346,000,
$266,000 and $157,000 for the years ended December 31, 2004, 2003 and 2002, respectively, and are fully vested after three years of
service.
Indemnification
The Company sells software licenses and services to
its customers under contracts. Each contract contains the relevant terms of the contractual arrangement with the customer, and generally includes
certain provisions for indemnifying the customer against losses, expenses, and liabilities from damages that may be awarded against the customer in the
event the Company’s software is found to infringe upon a patent, copyright, trademark, or other proprietary right of a third
party.
| (12) |
|
Segment and Geographic Information |
The Company is organized in two business units, the
Entertainment Technologies Group and the Software Technologies Group. The Entertainment Technologies Group licenses content protection technology to
video, music, and PC games content owners. The Entertainment Technologies Group’s business activities in DVD, VHS and VOD are similar products and
have been grouped together as video content protection technologies. The Company’s Hawkeye peer-to-peer file antipiracy service that was
introduced in 2004 is also included in the Entertainment Technologies Group. The Software Technologies Group develops and markets the Company’s
software value management solutions which include the FLEXnet suite of electronic license management, electronic license delivery, and software asset
management products, as well as the recently acquired InstallShield Installer, Update Service, and Admin Studio products.
Segment income is based on segment revenue less the
respective segment’s cost of revenues, excluding amortization of intangibles from acquisitions, selling and marketing expenses and research and
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):
Revenue by Significant Product Group:
|
|
|
|
Year ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
Entertainment Technologies
Group:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Video |
|
|
|
$ |
100,592 |
|
|
$ |
81,268 |
|
|
$ |
64,569 |
|
Other |
|
|
|
|
10,119 |
|
|
|
10,112 |
|
|
|
8,328 |
|
Total Entertainment
Technologies Group |
|
|
|
|
110,711 |
|
|
|
91,380 |
|
|
|
72,897 |
|
Software Technologies
Group |
|
|
|
|
71,388 |
|
|
|
36,966 |
|
|
|
29,365 |
|
Total |
|
|
|
$ |
182,099 |
|
|
$ |
128,346 |
|
|
$ |
102,262 |
|
F-27
Income before income taxes:
|
|
|
|
Year ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
| Entertainment Technologies
Group |
|
|
|
$ |
74,984 |
|
|
$ |
64,077 |
|
|
$ |
54,130 |
|
Software Technologies
Group |
|
|
|
|
23,270 |
|
|
|
12,939 |
|
|
|
8,282 |
|
Other |
|
|
|
|
(3,323 |
) |
|
|
(1,022 |
) |
|
|
(764 |
) |
Segment
income |
|
|
|
|
94,931 |
|
|
|
75,994 |
|
|
|
61,648 |
|
General and
administrative |
|
|
|
|
(25,501 |
) |
|
|
(19,385 |
) |
|
|
(15,035 |
) |
Amortization of
intangibles from acquisitions |
|
|
|
|
(6,370 |
) |
|
|
(3,319 |
) |
|
|
(2,544 |
) |
Amortization of deferred
stock-based compensation |
|
|
|
|
(185 |
) |
|
|
(2,656 |
) |
|
|
(6,261 |
) |
In-process research and
development |
|
|
|
|
(5,400 |
) |
|
|
(624 |
) |
|
|
(6,000 |
) |
Impairment gains (losses)
on strategic investments |
|
|
|
|
(5,478 |
) |
|
|
(4,820 |
) |
|
|
(17,210 |
) |
Gains on strategic
investments |
|
|
|
|
1,220 |
|
|
|
452 |
|
|
|
— |
|
Interest and other income,
net |
|
|
|
|
4,173 |
|
|
|
3,852 |
|
|
|
7,318 |
|
Income before income
taxes |
|
|
|
$ |
57,390 |
|
|
$ |
49,494 |
|
|
$ |
21,916 |
|
|
|
|
|
ETG
|
|
STG
|
|
TOTAL
|
Goodwill, net at December
31, 2002 |
|
|
|
$ |
10,074 |
|
|
$ |
14,599 |
|
|
$ |
24,673 |
|
Midbar contingent
consideration |
|
|
|
|
1,227 |
|
|
|
— |
|
|
|
1,227 |
|
Changes due to foreign
currency exchange rates |
|
|
|
|
897 |
|
|
|
1,833 |
|
|
|
2,730 |
|
Goodwill, net at December
31, 2003 |
|
|
|
|
12,198 |
|
|
|
16,432 |
|
|
|
28,630 |
|
Acquisition of
InstallShield |
|
|
|
|
— |
|
|
|
43,135 |
|
|
|
43,135 |
|
Midbar contingent
consideration |
|
|
|
|
857 |
|
|
|
— |
|
|
|
857 |
|
Changes due to foreign
currency exchange rates |
|
|
|
|
685 |
|
|
|
1,222 |
|
|
|
1,907 |
|
Goodwill, net at December
31, 2004 |
|
|
|
$ |
13,740 |
|
|
$ |
60,789 |
|
|
$ |
74,529 |
|
Through its acquisitions, the Company acquired
goodwill of $6.9 million in 2002 and $4.8 million in 1999 in the Entertainment Technologies Group. During 2004 and 2003, the Company recorded
additional goodwill of $857,000 and $1.2 million, respectively in the Entertainment Technologies Group, representing contingent consideration payments
as discussed in “Note 3 — Business Combinations and Asset Purchases.” The Company acquired goodwill of $43.1 million in 2004 and $22.2
million in 2000 in the Software Technologies Group. There have been no write-offs or write-downs of goodwill in any of these segments.
Information on Revenue by Geographic Areas:
|
|
|
|
Year ended December 31,
|
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
United
States |
|
|
|
$ |
105,211 |
|
|
$ |
74,143 |
|
|
$ |
67,326 |
|
International |
|
|
|
|
76,888 |
|
|
|
54,203 |
|
|
|
34,936 |
|
Total
Revenue |
|
|
|
$ |
182,099 |
|
|
$ |
128,346 |
|
|
$ |
102,262 |
|
Geographic area information is based upon country of
destination for products shipped and country of contract holder for royalties and license fees.
F-28
Information on Long Lived Assets by Geographic Areas:
|
|
|
|
December 31,
2004
|
|
December 31,
2003
|
United
States
|
|
|
|
|
|
|
|
|
|
|
Property and Equipment,
net |
|
|
|
$ |
5,921 |
|
|
$ |
4,842 |
|
Patents,
net |
|
|
|
|
5,002 |
|
|
|
4,928 |
|
Goodwill,
net |
|
|
|
|
33,174 |
|
|
|
2,979 |
|
Intangibles from
Acquisitions, net |
|
|
|
|
21,190 |
|
|
|
4,098 |
|
Total United
States |
|
|
|
|
65,287 |
|
|
|
16,847 |
|
International
|
|
|
|
|
|
|
|
|
|
|
Property and Equipment,
net |
|
|
|
|
3,374 |
|
|
|
1,847 |
|
Patents,
net |
|
|
|
|
5,868 |
|
|
|
5,898 |
|
Goodwill,
net |
|
|
|
|
41,355 |
|
|
|
25,651 |
|
Intangibles from
Acquisitions, net |
|
|
|
|
9,995 |
|
|
|
4,414 |
|
Total
International |
|
|
|
|
60,592 |
|
|
|
37,810 |
|
Total Long Lived
Assets |
|
|
|
$ |
125,879 |
|
|
$ |
54,657 |
|
The Company is involved in legal proceedings related
to some of its intellectual property rights.
Macrovision Corporation v. ViTec Audio and Video GmbH
The Company initiated a patent infringement lawsuit
in the District Court of Dusseldorf in March 1999 against ViTec Audio und Video GmbH, a German company that manufactures what the Company believes to
be a video copy protection circumvention device. ViTec filed a reply brief arguing that its product does not infringe the Company’s patents. The
case was heard in the District Court of Dusseldorf, Germany and the Court ruled adversely against the Company. The Company appealed the District
Court’s ruling in July 2000 to the Court of Appeal in Dusseldorf. Following a series of hearings, the submission of a technical opinion from a
Court appointed expert witness and briefs by both parties, the Court of Appeals rendered a decision on January 20, 2005 rejecting the Company’s
appeal and dismissing the case. The Court further ordered the Company to pay the costs of the appeal, which are estimated to be 35,000 Euros. In view
of the adverse ruling, the Company may incur a corresponding decline in demand for its video content protection technology, which could harm the
Company’s business in Germany.
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. An
interference proceeding has commenced to determine the rightful inventorship of the involved U.S. patents and patent applications. The ‘281
patent and its U.S. continuation applications have a priority filing date of February 1, 1995. The InterTrust patents and patent application have a
priority filing date of February 13, 1995. The Administrative Patent Judge (“APJ”) has decided to proceed with the second interference first.
Because the Company’s filing date is prior to InterTrust’s filing date, the Company has been designated the senior party in the interference.
InterTrust submitted its proof of inventorship in a brief filed on June 24, 2004. The Company responded with its brief filed on July 14, 2004.
Interference procedural rules allow each party
F-29
to file rebuttals to the other party’s
brief, cross-examine witnesses offered up by the other party and file various motions and objections during this pre-hearing phase of the interference.
This pre-hearing phase continued for several months. Following the close of this pre-hearing phase, both parties had an opportunity for an oral
hearing, which occurred on January 6, 2005. Following the oral hearing, the Company anticipates that the APJ will issue a decision in the second
interference case in the second quarter of 2005.
In the first patent interference case, InterTrust
had also brought an inequitable conduct motion against the Company alleging misconduct 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 the Company 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. 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 allowed and is expected to be granted in the second quarter of 2005. These international
cases have the benefit of the early February 1, 1995 priority date and the broad patent claim coverage ultimately expected to issue in the U.S.
following resolution of the interference action.
Macrovision vs. 321 Studios LLC
On January 7, 2004, the Company initiated a lawsuit
in the Southern District of New York against 321 Studios LLC, a producer of cloning software products, alleging that 321 Studios infringes the
Company’s patented copy protection technology and also violates the U.S. Digital Millennium Copyright Act of 1998. On May 11, 2004, the Company
was granted a preliminary injunction barring 321 Studios from selling various versions of its DVD copying software. On June 4, 2004, 321 Studios filed
a notice of interlocutory appeal, which the Company opposed. The Company 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 is
awaiting the issuance of findings of fact and conclusions of law by the court, which is expected by the second 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
the Company’s behalf.
As of December 31, 2004, for all the abovementioned
matters, it was not possible to estimate the liability, if any, in connection with the pending matters. Accordingly, no accruals for these
contingencies have been recorded.
From time to time the Company has been involved in
other disputes and legal actions arising in the ordinary course of business. In the Company’s opinion, none of these other disputes and legal
actions is expected to have a material impact on its consolidated financial position, results of operation or cash flow.
F-30
As of March 25, 2004, the market value of the
Company’s investment in Digimarc decreased by $3.3 million from its value as of December 31, 2004 to $12.8 million due to a decline in the share
price of Digimarc stock subsequent to December 31, 2004. The Company is evaluating whether the decline should be considered other-than-temporary. If
the Company determines the decline to be other-than-temporary, it will recognize a loss in the consolidated statement of income for the three months
ending March 31, 2005.
F-31