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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 000-22023
Macrovision Corporation
(Exact name of registrant as specified in its charter)
DELAWARE 77-0156161
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
2830 De La Cruz Boulevard
Santa Clara, California 95050
(Address of principal executive offices) (Zip code)
(408) 743-8600
(Registrant's telephone number including area code)
Securities registered under Section 12(b) of the Exchange Act: None.
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $0.001 par value.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes |X| No |_|
Indicate by check if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein and will not be contained, to the best of
the Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
form 10-K. |_|
As of March 15, 2002, the aggregate market value of the voting and non-voting
common equity held by non-affiliates of the registrant, based on the closing
price for the registrant's common stock on that day, was approximately
$984,649,387.12.
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
As of March 15, 2002, there were 51,010,376 shares of the Registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain exhibits hereto have been specifically incorporated by reference herein
in Item 13 under Part III hereof. Certain portions of registrant's definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with the registrant's annual meeting of stockholders to be held on
May 23, 2002, are incorporated by reference in Items 10-13 of Part III hereof.
MACROVISION CORPORATION
FORM 10-K
INDEX
PART I
ITEM 1. BUSINESS............................................................ 1
ITEM 2. PROPERTIES.......................................................... 26
ITEM 3. LEGAL PROCEEDINGS................................................... 26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................. 28
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS............ 28
ITEM 6. SELECTED FINANCIAL DATA............................................. 29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS............................................... 30
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.......... 42
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................... 43
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE................................................ 43
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS.................................... 43
ITEM 11. EXECUTIVE COMPENSATION.............................................. 43
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...... 43
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...................... 43
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K..... 43
SIGNATURES................................................................ 46
DISCUSSIONS OF SOME OF THE MATTERS CONTAINED IN THIS ANNUAL REPORT ON FORM
10-K FOR THE 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
CONDITIONS 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," "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."
PART I
ITEM 1. BUSINESS.
Macrovision Corporation, a Delaware corporation founded in 1983, develops
and licenses rights management and copy protection technologies. Our customers
include major Hollywood studios, independent video producers, enterprise and
consumer software vendors, digital set-top box manufacturers and digital
pay-per-view ("PPV") network operators. We provide content owners with the means
to market, distribute, manage and protect video, software and audio content.
Our business originated in video copy protection. Our technology has been
used to copy protect over 3.4 billion videocassettes worldwide since 1985. In
1997, we expanded the application of our copy protection technology into the DVD
platform. Most Motion Picture Association of America studios use our video copy
protection technology to protect some or all movie releases on videocassette or
DVD. Our customers include Disney, Paramount, Columbia Tristar (Sony), Twentieth
Century Fox, Universal Studios, Warner Brothers and DreamWorks. We believe that
our technology is accepted as the DE FACTO industry standard for video copy
protection.
We also are in the business of consumer software copy protection. We offer
CD-ROM copy protection and rights management technologies to a variety of
software publishers in the PC games, home education, information publishing, and
desktop applications software markets.
As a result of our August 2000 acquisition of GLOBETROTTER Software, Inc.
("GLOBETROTTER"), we added a suite of electronic license delivery ("ELD") and
electronic license management ("ELM") technologies to our product portfolio.
These products encompass the areas of electronic license management, software
asset management and electronic license distribution.
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. In our video
copy protection business, we receive unit-based royalties on videocassettes,
DVDs, and set-top boxes. We obtain transaction or use-based royalties for PPV
movies, and license fees from a range of hardware manufacturers, digital
satellite and cable network operators. In our software businesses, we receive
unit-based royalties on CD-ROMs, a combination of time-based licenses and
perpetual licenses for our ELM technology, and recurring fees for maintenance.
To further expand our rights management and copy protection capabilities,
we have continued to foster our strategic relationship with Digimarc Corporation
("Digimarc"), a leading digital watermarking technology company, to develop a
copy protection solution to address next-generation, digital-to-digital copying.
We also continue to work with TTR Technologies, Inc. ("TTR"), a provider of
proprietary digital anti-piracy technologies and products, to develop copy
protection technologies for audio CDs, which represents a new market for us. We
have made strategic investments in iVAST, a developer of MPEG-4 based solutions
for the delivery of streaming media; NTRU Cryptosystems, a developer of security
solutions for developing consumer markets; and Digital Fountain, a developer of
solutions that address the data delivery market; as well as other companies with
complementary technologies or intellectual property. For additional
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information, see the "Strategic Investments" section on page 14. We intend to
continue to evaluate and pursue additional strategic relationships that are
complementary or additive to our existing technologies and served markets.
We own or have rights to various copyrights, trademarks and trade names
used in our business. These include Macrovision(R), GLOBETROTTER(R), FLEXlm(R),
SafeDisc(R), SafeCast(R), Colorstripe(TM), SafeAudio(TM), GTlicensing(TM),
SAMsuite(TM), FLEXbill(TM) and MacroSAFE(TM).
INDUSTRY BACKGROUND
The industry shift towards digital media renders content owners
increasingly vulnerable to unauthorized use of their content. Consumers' ability
to make unauthorized copies of video and audio content has increased due to the
proliferation of inexpensive, easy-to-use devices, such as VCRs, CD-ROM
recorders, audio CD recorders and personal video recorders that allow in-home
copying of videocassettes, DVDs, digital PPV programs, CD-ROMs, and audio CDs.
As technological advances facilitate digital copying at declining prices, motion
picture studios and music labels have become more concerned with protecting
their intellectual property. Independent software vendors ("ISVs") are similarly
concerned about unauthorized or illicit use of their software, be it in the
enterprise environment (where license parameters may be ignored) or at home
(where entertainment software may be copied and redistributed).
Content owners lose billions of dollars every year to casual copying and
piracy. The latest data available from the Motion Picture Association of America
estimates that in 2001 video piracy cost the major studios in excess of $3
billion in lost revenues, and this estimate does not include losses due to
Internet piracy.
As a result, a number of government and legislative initiatives have been
enacted in recent years to encourage technologies that protect the rights of
content owners.
In the United States, Congress enacted the Digital Millennium Copyright
Act in October 1998. This law requires 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. Recent effectiveness tests conducted by us in
the U.S. and by an independent third party in Europe in September 2000 and
August 2001 showed that over 95% of the VCRs manufactured in the U.S. and Europe
since 1999 comply and respond to our anticopy process. The Act includes a clause
that outlaws all circumvention devices and technologies that could be used to
defeat any type of copy protection technology. 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.
The European Union is continuing to discuss a proposed copyright
directive, which we believe includes a provision aimed at controlling hardware
and software circumvention devices and technologies.
In Japan, a revised copyright law that went into effect in October 1999
prohibits the sale, manufacture, and import of circumvention devices. The Japan
Industry Standard 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.
VIDEO
VHS COPY PROTECTION. Motion picture studios wish to maximize the economic
value from each feature film or other video program over its copyright life.
Independent studies show that studios and video retailers lose VHS and DVD
revenues when consumers make copies of movies, whether from home video or PPV
releases. The International Recording Media Association has estimated that 50%
of all households in the United States own two or more VCRs. These households
are capable of making unauthorized copies of prerecorded videocassettes. Because
over 90% of all U.S. households own at least one VCR, any of these households
that also owns a DVD player or a digital PPV set top box can make high quality
VHS copies directly from their DVD players or set-top boxes, unless programs are
copy protected. Even with the focus on digital media and growth in DVD, VCR
sales continue to grow as prices fall. With over 600 million VCRs shipped
throughout the world, and with this continued growth in VCR sales, we believe
that VCRs will remain a home copying threat to video content owners for many
years to come.
DVD COPY PROTECTION. DVD hardware and media became commercially available
in the United States in 1997 and, through the end of 2001, approximately 26.7
million DVD players had been shipped by manufacturers in North America,
according to the Consumer Electronics Association. The rapid growth of the DVD
format presents major revenue opportunities for the studios, as well as serious
copy protection concerns. Without effective copy protection, any one of the
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approximately 600 million VCRs throughout the world can, when combined with a
DVD player, make large numbers of videocassette copies of a non-copy protected
DVD. These copies are almost equal in quality to professionally prerecorded
videocassettes. Because of their superior picture quality, lower manufacturing
cost, relative ease of use and smaller size, DVDs are expected to supplant
videocassettes over time as the preferred home video distribution medium. As DVD
becomes the standard in home viewing, we expect the need for reliable copy
protection to remain important. The DVD Entertainment Group and the
International Recording Media Association estimate that 364 million DVD-Video
discs were shipped in the U.S. in 2001. Understanding & Solutions Ltd estimates
that 571 million DVD-Video discs were shipped to retail worldwide in 2001, with
an expected 44% annual increase to 824 million discs in 2002. At the end of
2001, it is estimated that approximately 25% of U.S. households have installed
DVD players.
PPV COPY PROTECTION. Digital PPV enables consumers to purchase and view
movies and other programming in their homes through cable or satellite systems.
Based on data from Paul Kagan & Associates, we believe that revenues at the
studio level from digital PPV, near video on demand ("NVOD"), anddirect
broadcast satellite ("DBS") were approximately $680 million in 2001 in the U.S.
By contrast, studio revenues from their home video business exceeded $13 billion
in 2001 in the U.S. PPV distribution offers motion picture studios higher profit
margins than they receive from home video rentals or sales. Studios have
realized the importance of copy protection in digital PPV networks, and many of
them have required digital PPV system operators to install copy protection
capability in their digital set-top boxes.
In an effort to protect home video revenues, studios typically release a
movie on PPV between one and three months after it is released on videocassette
or DVD. Digital PPV providers have demonstrated that they can substantially
increase the buy rates for PPV by offering subscribers up to 60 PPV channels per
cable/DBS system, and by promoting convenience of frequent start times and
greater variety of movies. In the U.S., the digital PPV system operators have
installed copy protection capability in their digital set top boxes. However,
they have indicated that they will not activate copy protection until the
studios release their movies to the PPV system operators at or closer to the
same time as they release them to home video. This standoff between the system
operators and the studios has had a negative impact on our potential revenues
and net income opportunities, although it is less of an issue in international
markets, where studios have been able to insist that PPV movies be copy
protected.
SOFTWARE
ELECTRONIC LICENSE MANAGEMENT ("ELM"). Software vendors who sell to
enterprise customers are also vulnerable to unauthorized use of their software.
Large organizations, which typically support many end user applications, may
inadvertently allow users to run applications beyond the scope of their license
terms; in other words, users may be obtaining "free" use of the software
vendor's application. As a result, software vendors may not be capturing all the
revenues they are due from their customers. This has led to increased focus on
capturing all software usage revenue that is due from end users, therefore
driving demand for technology solutions that manage and control an application's
usage in the end user environment. Electronic license management is a solution
to this problem. According to International Data Corporation, over 50% of
software revenue will be delivered using electronic licensing by 2003, and
virtually all software revenues will be derived from electronic licensing by
2008.
CONSUMER SOFTWARE. With the proliferation of inexpensive high capacity
PC-based hard disc drives, the increase of Internet connections to the home, and
the availability of higher bandwidth connections, consumers now have the means
to widely distribute software content. Many consumers have the capability to
copy from a CD-ROM, download computer software to their hard drives, copy those
downloaded files onto a CD-recorder device, and distribute the copied software
on CD-ROMs or electronically over the Internet. Recently, CD-recordable drives
have been introduced that are priced below $60 and are expected to become
standard features in personal computers in the near future. In addition, blank
CD-ROM discs can be purchased for less than 20 cents in the U.S. As a result,
computer software and PC-based video game companies are facing an additional
threat of lost revenues due to unauthorized consumer copying of CD-ROM software.
INTERNET. The Internet is increasingly being used as a means to distribute
content, particularly software and music. The proliferation of online content
providers, combined with new and evolving methods of online content delivery,
has created a large market opportunity for rights management and copy protection
solutions. We believe that there is a significant need for rights management
solutions that address these new Internet downloading and streaming business
models.
AUDIO. Major music labels have expressed interest in technology that would
prevent the copying of audio CDs to a PC or CD recordable device. Based on data
from the Record Industry Association of America and the International Federation
of Phonographic Industries, we believe that the music industry is a $40 billion
per year industry compared to the
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$21 billion per year home video industry. We believe that there has not
previously been an effective copy protection technology for audio, because of
the difficulty of developing a copy protection technique that does not interfere
with the playback of the original music. With the emergence of file-sharing
technologies, and the availability of low cost hardware that facilitates copying
of CDs, we believe that music labels are seeking a copy protection solution to
prevent losses due to casual copying and piracy.
MACROVISION SOLUTIONS
We develop and market a broad array of rights management and copy
protection technologies. We offer video copy protection technologies that
address the video content protection needs of motion picture studios and other
content owners, program distributors, and cable and satellite PPV system
operators. We provide ELM and ELD solutions to a range of software vendors,
including application developers, major systems suppliers and embedded software
vendors. We also supply software asset management technologies to enable end
user organizations to manage internal application usage. We offer CD-ROM copy
protection and rights management technologies to a variety of software
publishers in the PC games, home education, information publishing, and desktop
applications software markets. We are actively involved in developing and
acquiring various technologies to meet the needs of emerging delivery systems
such as downloading and streaming of media via the Internet, as well as
technologies to prevent the unauthorized copying of audio CDs.
VIDEO COPY PROTECTION. Our video copy protection technologies allow
consumers to view programming stored on prerecorded videocassettes, DVDs or
transmitted as digital PPV programs via cable or satellite, but deter
unauthorized consumer copying of such programming. Videocassettes are encoded
with our video copy protection signal as they are manufactured. Our licensed
copy protection signal generator equipment is installed in over 228 commercial
duplication facilities in 36 countries around the world. The unique patented
aspects of our copy protection signal are transparent to a TV set, but are
disruptive to the recording circuits of VCRs. The result is that videocassettes
encoded with our anticopy process will play normally on a TV set, but will cause
generally unwatchable copies to be made on the vast majority of VCRs. Our
patented technology takes advantage of the differences in TV signal processing
circuits, VCR playback circuits, and VCR recording circuits without the need for
the installation of any Macrovision components in VCRs.
In the DVD and digital PPV markets, we have implemented a more robust
version of our video copy protection technology. By utilizing another copy
protection component, called Colorstripe, we have made it more difficult for a
casual copier to defeat or circumvent our technology. In these digital video
applications, the copy protection is applied within the consumer device. The
copy protection signal generator is part of an integrated circuit that converts
digital video to analog video for output to a standard TV set or VCR. The copy
protection chips remain dormant until activated by data commands, which are
either embedded in the DVD or are sent along with the PPV movie transmission to
the subscriber's set-top box.
ELECTRONIC LICENSE MANAGEMENT. Our FLEXlm technology allows independent
software vendors to license their products in various ways, and to monitor the
usage and enforce compliance with license terms in an enterprise-wide intranet,
across an extranet or the public Internet, or within an application service
provider ("ASP") extranet environment. Once FLEXlm is integrated into the
software product, the product can be delivered across the Internet, as well as
through more traditional media, such as CD-ROM. The FLEXlm technology consists
of two processes that together perform the function of granting or refusing
license requests based on contents of a license file that describes authorized
license use within an organization.
Our GTlicensing technology is a license creation, distribution, and
tracking tool for software vendors, allowing vendors to ship and track licenses
online without direct human intervention. The system supports multi-tier
software distribution, including the capability for third party distributors to
sell software from participating vendors and allowing end-users to receive their
licenses across the Internet.
Our FLEXbill technology provides usage data to software vendors from their
participating customers. FLEXbill usage data enables pay-per-use billing and can
be used to implement a new set of licensing policies more accurately matched to
each customer's needs. Software vendors use FLEXbill to tailor product offerings
to each customer and to bill for the usage of this portfolio based on an
authenticated usage report.
Our SAMsuite technology is a software asset management solution, designed
for end-user companies that purchase large amounts of software from third
parties. SAMsuite captures and analyzes software usage data to help users
maximize their return on investment, and allocate related costs by project,
department or user, and administers license servers over global networks.
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CONSUMER SOFTWARE COPY PROTECTION AND RIGHTS MANAGEMENT. Our SafeDisc
technology seeks to prevent the copying of CD-ROM computer software by
encrypting the 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-ROM hardware. Because SafeDisc is designed to operate while
the disc is in the CD-ROM drive, it is ideally suited to PC games and home
education software. The technology is licensed directly to interactive software
publishers, and to mastering and replication facilities that embed our patented
digital signature in a CD-ROM during the manufacturing process. SafeDisc was
introduced in September 1998 and has been licensed to more than 100 replicators
worldwide.
Our SafeCast family of digital rights management products is designed to
provide software publishers with control over the distribution and usage of both
packaged media and Internet delivered software or licenses. It enables software
publishers to establish a variety of license terms, which persistently govern
the use of the software. These license terms can be used to manage every stage
of a software product's life cycle - from pre-release software, through trial
evaluations, and finally commercial distribution resulting in rental, purchase,
or subscriptions.
Our SafeWrap product is a post-development encryption wrapper for
Microsoft Windows software and is based upon technologies we developed for our
SafeDisc product. We refer to it as "tamper-proofing" software because it
protects files from being reverse engineered, disassembled, or modified.
SafeWrap also includes an optional application programming interface ("API"),
which offers additional security to allow individual functions to be encrypted
and decrypted when being executed.
PRODUCTS UNDER DEVELOPMENT
We have three primary new product development programs in progress: audio
CD copy protection (SafeAudio), digital video watermarking and a new secure
digital media distribution platform (MacroSAFE).
SAFEAUDIO. SafeAudio is a family of technologies used for protecting
traditional audio (Red Book) music content, without incurring the playability
and compatability drawbacks of other solutions. We also are currently developing
solutions for compressed (Yellow Book) content that can also be put on optical
media in conjunction with Digital Rights Management ("DRM") technologies. Our
Red Book copy protection is based on technologies from both Macrovision and TTR.
Our Yellow Book copy protection is based upon our SafeDisc technology. Our joint
development/joint marketing arrangement with TTR gives us the exclusive
worldwide rights to market TTR's audio copy protection technology. We shipped
Version 2 and Version 3 of SafeAudio in 2001, and also conducted extensive
testing with major music labels in the U.S. and Europe during that period.
Consumer resistance to audio copy protection has discouraged music labels from
adopting any copy protection solution to date, and, if there is sustained
consumer resistance, may continue to do so in the future.
DIGITAL VIDEO WATERMARKING. As a member of the VWM Companies (Digimarc,
Hitachi, NEC, Philips, Pioneer, Sony and Macrovision), we are jointly developing
a digital video watermarking solution to address the digital-to-digital copy
protection requirements associated with the next generation of DVD recording
devices. Digital watermarks embedded in movies and other video material will
provide basic copyright, record control and playback control information either
to allow or to disallow playback, viewing and copying onto another digital
device. The jointly developed technology is based on patents and related
intellectual property owned by the various VWM Companies. The VWM Companies'
solution can survive numerous transformations, such as from digital to analog
and back to digital, or from one video format to another. The digital watermarks
are designed to be imperceptible to the viewer, but to be read easily by special
purpose detection circuits that may ultimately be deployed in DVD digital
recorders and players. This jointly developed technology is intended to protect
movies and other video content from unauthorized reproduction using digital
recording devices. Macrovision has been selected as the exclusive licensing
administrator for the VWM Companies' digital watermarking solution.
MACROSAFE. During the 4th quarter of 2001 we announced MacroSAFE, a new
secure digital media distribution platform. MacroSAFE is a highly scalable and
flexible, open-standards-based, end-to-end solution for the secure distribution
of digital media. MacroSAFE includes a set of tools that enables rights holders,
distributors and service providers to create and support a range of business
models for the secure distribution of rich media to either a broad or very
targeted audience. It enables rights holders to market digital content in a
trusted environment for either downloads or streamed media.
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THE MACROVISION GROWTH STRATEGY
LEVERAGE KEY CUSTOMER RELATIONSHIPS. We currently maintain strong
relationships with customers in various industry and market segments, including:
o Video content providers such as the major Hollywood studios and
independent movie producers;
o Enterprise and consumer software vendors, serving both
business-to-business and business-to-consumer segments;
o Content distributors such as the leading cable and satellite
television system operators; and
o Consumer electronics manufacturers of DVD players, CD-ROM drives,
and digital set-top boxes.
We intend to build our business by capitalizing on these customer
relationships and delivering our existing and future rights management and copy
protection technologies.
INTRODUCE NEW PRODUCT APPLICATIONS AND TECHNOLOGIES. Simultaneously, we
intend to develop additional rights management solutions to sell to our
extensive customer base, thereby deriving incremental revenues. We have
committed significant resources to expand our technology base, to enhance our
existing products and to introduce additional products. We intend to continue
building our technologies and maintain our technology leadership by investing
significant resources in research and development, and by participating in
industry standard-setting efforts and organizations. We intend to pursue
opportunities for rights management and copy protection solutions in the
following areas:
o Digital video;
o Audio CDs;
o Internet downloaded and streamed audio and video files;
o Internet downloaded software files;
o CD-ROM;
o DVD-ROM;
o Electronic license delivery for enterprise software;
o Software asset management products for enterprise customers; and
o 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. We have patented many of
these proprietary solutions, and they underpin our strong competitive position
and financial model. We have acquired key software rights management and copy
protection patents. We use patents to limit the proliferation of devices that
circumvent our video copy protection technologies, and we have initiated legal
action relating to infringement of these patents. We intend to continue to
obtain patents and to protect 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 video copy
protection technologies.
CONTINUE TO MAKE STRATEGIC INVESTMENTS. We have made strategic equity
investments in public companies like Digimarc and TTR, as well as private
companies such as Command Audio Corporation ("CAC"), Digital Fountain, iVAST,
NTRU Cryptosystems, and Widevine Technologies. In 2001, we invested $17.0
million in private companies. We intend to continue to expand our technology
portfolio by pursuing licensing arrangements, joint ventures, strategic
investments and acquisitions of companies whose technologies or proprietary
rights complement our rights management and copy protection technologies.
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Our minority equity interests totaled $58.1 million and represented 16.9%
of our total assets as of December 31, 2001. There is no active trading market
for securities of our private company investments and our investments in them
are illiquid. 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 2001,
consistent with our policy for evaluating recoverability of these investments,
we concluded that impairment of our investments in AudioSoft, InterActual
Technologies, RioPort and SecureMedia was other than temporary. Accordingly, we
wrote off the book value of these investments during 2001 and took an aggregate
charge to earnings of $6.9 million for the year ended December 31, 2001.
MAINTAIN OUR HIGH-MARGIN REVENUE MODEL. In expanding our customer base and
technology portfolio, we intend to continue to pursue our intellectual
property-based licensing model which includes high margin and recurring
revenues. In assessing minority investments and acquisitions, we seek to
generate incremental revenues and operating income, preserving our profit
margins. Where possible, we look for acquisition transactions that will enlarge
our copy protection capabilities and minority investments that do not have a
detrimental impact on earnings.
TECHNOLOGY LICENSING, SALES AND MARKETING
TECHNOLOGY LICENSING. We license our portfolio of rights management and
copy protection technologies. We believe that content owners and software
vendors utilize our solutions to secure their content or software and to ensure
that they are paid for the use of such content or software by their end user
customers. We receive royalties and recurring revenues as follows:
o Video content owners typically pay us a per unit licensing fee for the
right to use our proprietary technology for videocassette and DVD copy
protection;
o Enterprise software vendors pay us to license our technology using either
time-based subscription or perpetual licenses with annual maintenance
fees;
o Consumer software publishers pay us a per unit licensing fee to use our
technology for CD-ROM copy protection, and transaction based, time-based,
or perpetual licenses for our DRM technology;
o Digital set-top box manufacturers license our video copy protection
technologies for an up-front fee and a per unit royalty;
o Cable and satellite television system operators pay us a one-time license
fee for the right to incorporate our video copy protection technology into
their networks for PPV services. In addition, we are entitled to
transaction-based royalty payments when copy protection for digital PPV
programming is activated by system operators; and
o DVD hardware manufacturers (DVD consumer electronic player manufacturers
and PC DVD ROM suppliers) license our technology for an up-front fee and
annual maintenance/certification fees.
SALES AND MARKETING. We market our rights management and copy protection
technologies directly to content owners and independent software vendors in both
the video and software markets. Our primary sales strategy is to sell at senior
levels, offering worldwide contracts that cover customers' international
operations. We supplement our direct sales efforts with reseller programs and
service partnerships among video duplicator and replicator organizations, and
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.
We develop worldwide product specifications and marketing programs for our
rights management and copy protection technologies in our Silicon Valley and
Woodley, United Kingdom offices, and sell and support our products and
technologies through our U.S. sales force, and through our offices in South
Ruislip, Woodley and Cheshire in the United Kingdom and in Tokyo, Japan, Hong
Kong and Taipei, Taiwan. In addition, we are in the process of establishing a
sales office in Seoul, Korea.
CUSTOMERS
VIDEO COPY PROTECTION
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VIDEO CONTENT. Our copy protection technology has been applied to more
than 3.4 billion videocassettes worldwide since 1985. Since the inception of DVD
in 1997, our copy protection has been applied to over 900 million DVDs,
including more than 500 million DVDs in 2001. Our copy protection technology for
videocassettes and DVDs is used by the following leading major motion picture
studios and home video suppliers:
o Artisan Home Entertainment; o Buena Vista Home Video (Disney);
o Columbia House; o Columbia TriStar Home Video (Sony
Pictures Entertainment)
o DreamWorks; o HBO Home Video;
o Lion's Gate; o Paramount Pictures;
o Twentieth Century Fox; o Universal Studios Home Video
(Vivendi); and
o Warner Brothers Home Video.
There were no customers that accounted for more than 10% of our net
revenues in 2001. One customer accounted for more than 10% of our net revenues
in 2000. No customer accounted for more than 10% of our net revenues in 1999.
The Motion Picture Association of America studios as a group accounted for
33.2%, 24.8% and 23.9% of our net revenues in 2001, 2000 and 1999, respectively.
We also license our video copy protection technology to "Special Interest"
customers that include independent video producers and corporations. Licensed
commercial duplicators act as distributors of our video copy protection
technology to "Special Interest" customers. Revenues from "Special Interest"
customers in the U.S. accounted for approximately 6%, 9% and 11% of our video
copy protection revenues in 2001, 2000, and 1999, respectively.
PPV SYSTEM OPERATORS. We have licensed our digital PPV copy protection
technology for incorporation into the networks of 19 system operators,
including:
o British Sky Broadcasting; o Cable and Wireless
Communications;
o Digital BS (Japan); o DIRECTV;
o DIRECTV Latin America; o EchoStar;
o Korea Digital Broadcast ("KDB"); o NTL;
o Pacific Century Cyberworks ("PCCW"); o Sky Latin America;
o SkyPerfecTV; and o Video Networks Ltd.
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 programming is activated. To this point, only seven international customers
(British Sky Broadcasting, Cable and Wireless Communications, Digital BS
(Japan), NTL, PCCW, SkyPerfecTV, and Video Networks Ltd.) have activated copy
protection in their networks. U.S. systems operators have not yet activated copy
protection, even though the technology is implemented in their network
infrastructure. Other notable system operators that have not signed license
agreements with us, but which are requiring Macrovision-capable set-top boxes in
their networks include: AT&T, Comcast, Cox Enterprises, Deutsche Telecom, Rogers
Cable, Time Warner, UPC and Via Digital.
CONSUMER ELECTRONICS HARDWARE MANUFACTURERS. We believe that our DVD copy
protection technology is currently the only digital-to-analog 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, 2001, 212
companies that manufacture DVD players or 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.
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Our PPV copy protection technology is embedded in more than 75 million
digital set-top boxes currently in use worldwide. We have licensed our copy
protection technology for digital PPV to 62 set-top box manufacturers,
including:
o A.B. Pace Micro Technology; o Acer;
o AT&T Network Systems; o Daewoo Electronic Co., Ltd.;
o DiviCom Corporation; o EchoStar Communications;
o Hughes; o Motorola (General Instrument
division);
o Nokia; o Philips;
o Scientific-Atlanta; o Sony; and
o THOMSON multimedia.
We have also authorized 63 semiconductor companies to incorporate our
digital PPV and DVD copy protection technologies into their semiconductor and
reference designs. These companies generally pay a one-time service fee to
verify correct implementation of our video copy 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 manufacturers.
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 on videocassettes and DVDs during the year-end holiday
shopping season. We anticipate that revenues from consumer software copy
protection and DRM technologies will continue to reflect this seasonal trend.
Our revenues generally have tended to be lower in the summer months,
particularly in Europe.
International and export sales together represented 45.2%, 42.3% and 40.2%
of our net revenues in 2001, 2000 and 1999, 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 deployment of digital PPV/VOD networks, DVDs, and
consumer software, and the use of copy protection in these media.
SOFTWARE
ELECTRONIC LICENSE MANAGEMENT. We believe our electronic license
management software is the industry leader. Worldwide adoption of our ELM
technology will be an important driver of future growth. We provide electronic
license delivery ("ELD") and electronic license management ("ELM") technology to
software companies in a range of market segments, with more than 2,500 ELM
software vendor customers worldwide, including:
o Autodesk; o Cadence;
o Cisco; o Rational Software;
o Sun Microsystems; o Sybase
o Synopsys Inc.; and o Wind River, Inc.
In addition we have licensed software asset management ("SAM")
companion products to over 500 corporate end users, which enable these end users
to deploy, manage, and track the software they have purchased from our software
vendor customers, as well as other third party software vendors. Examples of
such corporate end user customers include:
o BMW; o Eastman Kodak;
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o Ford Motor Company; o IBM;
o Lockheed Martin; o Nokia; and
o Royal Dutch Shell.
CONSUMER SOFTWARE PUBLISHERS. We entered the consumer software market in
1998 with our SafeDisc product, aimed at those applications that require the
CD-ROM to be inserted in the drive to run the application; typically PC games,
and home entertainment applications. In 2001 we extended the SafeDisc market
into professional applications and computer based training. We estimate that
over 60 million discs were copy-protected with SafeDisc in 2001. Our copy
protection technology for consumer software is used by the following leading
software publishers:
o Apple; o Electronic Arts;
o Eidos; o Hasbro;
o Havas; o Interplay;
o Lego; o Mattel;
o Microsoft; o Take 2;
o 3DO; and o Ubisoft.
Our consumer software customers have a wide choice of licensed replicators
that they can use throughout the world. Over 100 replicators have been licensed
and have installed SafeDisc mastering and quality assurance systems from
authorized suppliers of these systems.
To expand our SafeDisc business beyond our direct licensing program with
the major publishers, we have established a reseller program that allows
replicators to be SafeDisc value added resellers for the small publisher market.
We are beginning to see broad market adoption of our SafeCast family of
rights management products. SafeCast enables customers to creatively market,
sell and protect products delivered on CD ROMs, DVDs and via the Internet to
increase their revenues. Such customers include:
o Apple; o Autodesk;
o BBC; o Electronic Arts;
o Havas; and o Microsoft.
Although SafeCast is a more complex sale to software publishers, with a
longer sales cycle than SafeDisc, we believe that over time, as Internet
bandwidth increases, there will be increasing demand for this digital rights
management technology.
SafeWrap is a component-level implementation of multi-layered anti-hacking
elements that are developed for our SafeDisc product. In 2001 we saw early
adopter customers for this product, especially in new media and Internet
services. Such customers include:
o iVAST; and o RioPort, Inc.
In addition to revenue generated from the sale of our SafeWrap product to
iVast and RioPort, Inc., we made minority equity investments in both companies.
For additional information on these related parties, see the "Strategic
Investments" and "Risk Factor" sections on pages 14 and 16, respectively.
SafeAudio toolkit has been released to licensed authorized mastering and
replication facilities that will apply the process on behalf of rights holders
of audio content. SafeAudio provides content owners with an easy-to-implement
copy protection solution for CD audio discs that provides effective protection
against unauthorized disc copying or ripping of
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songs. We have not obtained significant customers for SafeAudio products, as the
major music labels continue to conduct market and lab testing.
TECHNOLOGY
VIDEOCASSETTE COPY PROTECTION. Effective video copy protection systems are
difficult to develop because of the need to address the dual requirements of
playability and effectiveness. High playability means that consumers must be
able to view the original copy-protected content using a VCR and a television
set without the need for any intervening devices, while high effectiveness
requires that the quality of an unauthorized copy must be reduced to such an
extent that it loses its entertainment value. The extent to which the
entertainment value is reduced varies, depending on the VCR model used to make
the copy and the VCR and television combination that plays the unauthorized
copy. To prevent VCRs from making good copies, the copy-protected video must
differ in some manner from the standard video signal because, by design, all
VCRs will make good copies from standard video signals. Television sets are
designed to play standard or near-standard video signals. As a result, there is
a risk that making a video signal non-standard in order to prevent copying will
decrease playability by causing some television sets to generate impaired or
distorted pictures. In the tradeoff between effectiveness and playability,
designers of copy protection systems must favor playability while maintaining
effectiveness.
Our videocassette copy protection technology involves the patented
technique of inserting a series of electronic pulses in and around the vertical
blanking interval of a standard video signal. The vertical blanking interval is
the blank space between the video fields that are refreshed at a rate of 60
fields per second. The copy protection pulses are embedded electronically in the
prerecorded content of the videocassettes in the process of videocassette
manufacture. The electronic pulses are not visible in the television picture.
The pulses are intended to affect the automatic gain control circuit in the
recording system of most VCRs, but not to affect a similar circuit in the
television set. Therefore, when the consumer plays a copy protected prerecorded
videocassette, the picture is clean and crisp, but when the consumer plays an
unauthorized copy of that same videocassette, the picture typically is very
distorted and has substantially reduced entertainment value. Our video copy
protection technology is effective against most casual copying, but generally
does not deter professional pirates who use professional duplication and video
processing equipment. Under the U.S. Digital Millennium Copyright Act of 1998,
all VCRs sold in the U.S. after May 2000 are required by law to respond to our
copy protection technology.
DVD AND DIGITAL PPV COPY PROTECTION. The DVD and digital PPV versions of
our video copy protection technologies employ both the electronic pulses used in
videocassettes 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
applications by embedding a copy protection signal generator integrated circuit
within the DVD player or digital set-top box. 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.
ELECTRONIC LICENSING. Software vendors integrate FLEXlm into their
products to monitor or control a customer's compliance with a product's license
terms. When embedding electronic licensing into a product, software vendors
define a customer's license rights in a human readable "license file". The
technology generates electronic license certificates that describe the license
rights of software users. Compliance with those license rights is automatically
monitored. The software vendor may choose to block users from running a product
if doing so violates the license rights, or simply provide notification to the
user or system administrator when license use has exceeded the customer's
license rights. This allows customers to buy and sell software licenses using
much more flexible license terms than traditional one-computer-one-license or
site license approaches. These terms may include floating licenses (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).
Independent software vendors integrate flexible electronic licensing
algorithms into their software rather than "hard-coding" license policies into
their products. This avoids the need to change a product's source code and to
support multiple releases when licensing terms change for a product. License
terms are described in a human readable text file as an electronic license
certificate, where marketing, sales, support or order administration staff
define licensing policies, without the need for software engineers to make
changes in software. Software vendors can include information identifying
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customer and other purchasing information as part of the license certificate.
This is done so that if the software and license were diverted to another
company, an audit trail is left, making discovery of improper use of the license
far more likely.
Electronic licensing also records the use of software licensing into a
transaction log called the "Report Log". The information in this log is
authenticated and compressed so software vendors and customers can use this
information as a basis for pay-per-use or other usage-based pricing or
licensing. In addition, customers may use this information to better manage
their software assets and to "bill back" software-related costs to different
departments or projects in the company. The SAMsuite product family contains
this functionality.
CONSUMER SOFTWARE COPY PROTECTION AND RIGHTS MANAGEMENT. Each CD-ROM
published with the SafeDisc technology is premastered with encrypted executable
files and contains authenticating instructions and a unique SafeDisc digital
signature. The digital signature, which cannot be copied by CD recorders or
transferred from a CD-ROM to a hard disc drive, or sent over the Internet, is
added to each original disc during the mastering/replication process. When a
user inserts an original SafeDisc-protected disc in a CD-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-recordable device or
professional mastering equipment to duplicate a CD-ROM and make an unauthorized
copy, SafeDisc is designed to inhibit the transfer of the digital signature to
the copy. If an unauthorized copy is made, decryption will not take place and
the copy will not run.
SafeDisc also contains anti-hacking technology to prevent the compromise
of its security features. The anti-hacking technology is designed not only to
deter consumer copying, but also to thwart hackers. Because of our widespread
penetration in the PC games' market, hackers have targeted and cracked, to
various degrees, 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 develop new product releases approximately three to four times per
year incorporating new anti-hacking features.
Our SafeDisc technology is protected by a patent, and is compliant with
Philips' worldwide Yellow Book CD-ROM standard. We believe that SafeDisc is the
only copy protection technology that has received Philips' certification for
compliance.
SafeCast is an electronic software distribution infrastructure which is
used primarily by developers of applications targeting the consumer and
small-office/home-office markets. SafeCast authenticates the end user's license
by transferring the software publisher's embedded digital rights management
technology from either a CD-ROM disc or from Internet downloaded software to the
user's PC hard drive at the time the application is initially installed.
SafeCast protects the launch of a licensed application by confirming that the
session conforms to the license terms established by the application's
publisher. The publisher establishes license terms that determine how the
application may be used.
SafeWrap is a component-level implementation of multi-layered anti-hacking
elements that is utilized in our SafeDisc product, and can be integrated with
third party software, DRM and portal products. We are currently evaluating other
technologies, both internally and externally developed, that we may choose to
use to enhance SafeWrap in the future.
In the audio CD market, SafeAudio has been jointly developed with TTR
Technologies, Inc. to provide a solution for Red Book CD audio copy protection.
Each of the three current SafeAudio functions (coding, hiding and timing) is
covered by pending patent applications. Our Yellow Book SafeAuthenticate
solution is based upon our SafeDisc product, which is covered by a patent and a
pending patent application (for disc-based rights authentication).
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 patentable technologies related to our various rights management markets
and copy protection products. Our core competencies are in encrypted software,
electronic license management and license delivery software, anti-hacking
software, digital and analog video and audio engineering, copy protection
engineering, watermarking and CD-ROM architecture. We have used our investments
in other companies to supplement our reseach and development expenditures.
In 2001, 2000 and 1999, our expenses for research and development were
$9.3 million, $7.8 million and $6.5 million, respectively.
INTELLECTUAL PROPERTY RIGHTS
12
PATENTS ISSUED & PENDING. We hold 62 U.S. patents and have 65 U.S. patent
applications pending. Of the issued or allowed patents, 36 relate to our copy
protection technologies, 15 relate to video scrambling, 4 relate to audio
scrambling, 5 relate to electronic license management and 2 relate to DRM
technology, namely content usage control, tracking, and e-transactions. Of the
pending patent applications, 4 relate to consumer software copy protection and 5
relate to audio copy protection. The last of our issued U.S. patents expires in
2018. The last of our core group of analog copy protection patents expires in
the year 2008. We have filed numerous applications for additional claims and
improvement patents to extend the current expiration dates. We also have 391
foreign patents issued and 407 foreign patent applications pending in 40
countries. Of the issued foreign patents, 299 relate to our copy protection
technologies, 64 relate to video scrambling, 24 relate to audio scrambling, and
4 relate to electronic license management.
CIRCUMVENTION TECHNOLOGY PATENTS. Included in the patents related to our
copy protection technologies are 14 U.S. and 68 foreign patents covering a
number of processes and devices that unauthorized parties could use to
circumvent our video copy protection technologies. We have historically used
these patents to limit the proliferation of devices intended to circumvent our
video copy protection technologies. We have initiated a number of patent
infringement lawsuits against manufacturers and distributors of such devices.
See "Legal Proceedings."
COMPETITION
VIDEO COPY PROTECTION. We believe that there are currently no significant
video copy protection competitors. Occasionally, companies have developed
hardware based on our technology for sale in limited foreign markets where we
have not sought patent protection. Our video copy protection technologies are
proprietary and have broad international patent coverage. It is possible,
however, that a competitive video copy protection technology could be developed
in the future. For example, one of our customers could attempt to promote
competition by supporting the development of alternative copy protection
technologies or solutions, including solutions that deter professional
duplication.
ELECTRONIC LICENSE MANAGEMENT. Our primary competition in the ELM market
currently comes from independent software vendors who try to develop their own
ELM solutions. 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.
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 ELM solutions.
CONSUMER SOFTWARE COPY PROTECTION AND DIGITAL RIGHTS MANAGEMENT. We
believe that there are a limited number of competitors in our SafeDisc consumer
software copy protection market, including LaserLock and Sony's DADC optical
disk manufacturing subsidiary. Neither of these companies appear to have made
significant penetration with major publishers in developed countries, and we
believe that we have captured the leading market share of the PC games market.
It is possible that our own customers may develop software copy protection
technologies on their own. It is also possible that personal computer operating
system and microprocessor companies like Microsoft, Red Hat, and Intel, may
develop or license copy protection modules or systems that are internal to the
PC or other consumer electronic devices.
DRM solutions for consumer software, video, and audio have attracted a
number of companies and significant venture capital. Few of them have made any
significant inroads - with the exception of Microsoft and Real Networks in the
audio DRM space. Two high profile DRM companies, Preview Systems and Intertrust
have had major setbacks in the DRM market. Preview sold its main product to
Aladdin Knowlege Systems, and Intertrust has had a series of significant
reductions in force. Our SafeWrap tamper-proofing technology is a new field of
activity in the DRM and IT industry. Customer needs are still being defined and
technologies for satisfying those needs are still being discovered. Many of
these technologies are highly complex and are just emerging. As the market is
still developing, it is still too early to determine the level of competition or
the size of the market.
We believe that there are a limited number of competitors in the audio
copy protection and rights management market, including SunnComm, Sony, and
MidBar. Each of these companies has participated in early market trials with one
or more major record labels. However, the market is still in its infancy and its
evolution remains to be seen. To date, no single vendor has captured a
measurable market share of the worldwide audio CD copy protection market.
We believe that our ability to compete depends on many factors both within
and beyond our control. These include the performance of our technology,
including ease of use, compatibility with installed base of PC and CD-ROM
13
drives and our ability to stay ahead of the efforts of hackers. We also rely on
the effectiveness of our sales and marketing efforts, including our ability to
establish and support a worldwide base of licensed replicators, and to provide
through third party replication equipment vendors the digital signature
technology and associated quality control systems.
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 during
pre-sale, implementation and maintenance phases of our contracts.
We provide technical support to our videocassette, DVD, digital PPV, ELM
and consumer software customers in various ways:
o We support our licensed duplicators with hardware installation
assistance and quality control. In addition, we support licensed
duplicator sales personnel by providing sales training and sales
incentive programs and literature and by participating in trade
shows;
o We support the efforts of television, VCR and DVD hardware
manufacturers, digital PPV system operators and PPV set-top box
manufacturers to design hardware that properly incorporates our
video copy protection technologies;
o We assist semiconductor manufacturers in incorporating our video
copy protection technologies into a variety of digital video
integrated circuits;
o We regularly test the effectiveness and transparency of our video
copy protection technologies on representative samples of consumer
televisions and VCRs to determine whether modifications or
enhancements may be necessary;
o We assist our software licensees in wrapping their executables with
our SafeDisc and SafeCast modules and in incorporating our
electronic license management software (FLEXlm) and electronic
license delivery software (GTlicensing) into their software
products;
o We provide training and application support for the SafeDisc and
SafeAudio toolkit; and
o We test for SafeDisc and SafeAudio compatibility with PC and CD-ROM
drive combinations.
We have minimal manufacturing operations. Our strategy is to license our
technologies to third parties that manufacture products incorporating our
technologies. Our manufacturing operations are limited to low volume video copy
protection hardware products that require in-house system integration and
quality control efforts.
STRATEGIC INVESTMENTS
We intend to expand our technology base through strategic investments in
companies with complementary technologies or intellectual property. We have made
strategic investments in the following companies:
DIGIMARC CORPORATION (NASDAQ: DMRC). In December 1997, we made our initial
investment in Digimarc. 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, 2001, we owned approximately 12.0%
of Digimarc. We have an agreement with Digimarc to jointly develop and market a
digital video watermarking copy protection solution to address the
digital-to-digital copying issues associated with the next generation of
recordable DVD and digital videocassette recording devices.
Digimarc is a leading provider of patented digital watermarking
technologies that allow imperceptible digital code to be embedded in traditional
and digital content, including movies, photographic images and documents such as
financial instruments, passports and event tickets. Digimarc's technologies
enable new communications capabilities related to protecting copyrights,
deterring counterfeiting or piracy and, directly linking physical content with
the Internet. Digimarc is also a member of the VWM Companies.
14
TTR TECHNOLOGIES, INC. (NASDAQ: TTRE). In January 2000, we invested $4.0
million to acquire a minority interest in TTR. In addition, we have 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. As of December 31,
2001, we held approximately 10.8% of the outstanding shares of TTR.
COMMAND AUDIO CORPORATION. In October 1995, Command Audio Corporation, or
CAC, was initially incorporated as our wholly-owned subsidiary to commercialize
a new audio-on-demand technology that allows consumers to control the timing and
content of specially formatted radio broadcasts. In August 1996, we divested all
but 19.8% of our ownership in CAC. We assigned to CAC all rights in specified
technology and released our reversion rights in technology that we had
previously assigned to CAC. CAC agreed to pay to us royalties equal to 2.0% of
its gross revenues for 12 years, beginning in 2001. As of December 31, 2001, we
have invested $3.7 million and own approximately 8.0% of the outstanding shares
of this private company.
IVAST. In June 2001, we invested $5.0 million to acquire a 15.7% ownership
interest in iVAST, a developer of MPEG-4 based solutions for the delivery of
streaming multimedia. The iVAST platform encompasses a full range of
functionality including, authoring, streaming, backend integration, playback and
interactivity. The platform is designed to support a wide range of broadband
enabled information appliances.
WIDEVINE TECHNOLOGIES. In August 2001, we invested $3.0 million to acquire
a 13.1% ownership interest in Widevine Technologies, which specializes in
Internet Protocol network security. Widevine Technologies has developed
technology that provides a single solution for secure storage, distribution,
delivery and control of digital data over every stage of an Internet
Protocol-based network.
NTRU CRYPTOSYSTEMS. In August 2001, we invested $1.5 million to acquire a
2.3% ownership interest in NTRU Cryptosystems, a developer of security solutions
for emerging consumer markets, providing security solutions in a variety of
software and hardware formats for all major hardware and software environments.
NTRU Cryptosystems is based on a fundamental mathematical innovation, which
makes efficient public key cryptography practical on a scale necessary for
consumer and embedded applications.
DIGITAL FOUNTAIN. In August 2001, we invested $4.0 million to acquire a
7.0% ownership interest in Digital Fountain, a developer of digital transport
solutions that address the data delivery market. The Digital Fountain solution
uses an advanced mathematical approach to transport data accurately, timely and
securely over the Internet.
AUDIOSOFT, INTERACTUAL TECHNOLOGIES, RIOPORT, INC. and SECURE MEDIA. We
had previously acquired minority equity interests in AudioSoft, Interactual
Technologies, RioPort, Inc. and Secure Media. During 2001, consistent with our
policy for evaluating recoverability of these investments, we concluded that
impairment of our investments in AudioSoft, InterActual Technologies, RioPort
and SecureMedia was other than temporary. Accordingly, we wrote off the book
value of these investments during 2001 and took an aggregate charge to earnings
of $6.9 million for the year ended December 31, 2001.
All of these strategic investments, totaling $58.1 million, represented
16.9% of our total assets as of December 31, 2001. CAC, iVAST, Widevine
Technologies, NTRU Cryptosystems and Digital Fountain are privately held
companies. There is no active trading market for their securities and our
investments in them are illiquid. We may never have an opportunity to realize a
return on our investment in these private companies. 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.
EMPLOYEES
As of December 31, 2001, we had 245 employees. Of these employees, 81 are
based outside of the U.S. 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 use a variety of incentive programs to motivate our employees,
including annual performance-based bonuses, stock purchase plans, stock options,
special recognition awards, and a package of other benefit programs including a
401(k) plan, medical/dental benefits, compensating time off for community
service and health club and educational reimbursement.
15
Our engineering teams develop new products and enhance existing offerings,
as well as contribute to our technical due diligence efforts when we make
strategic investments, conclude joint development agreements, or acquire rights
to third party technologies.
Our technical support staff provides customer sales support and conducts
extensive compatibility and effectiveness tests for our various rights
management and copy protection technologies. In addition, this staff runs an
extensive certification lab to confirm that our licensees have implemented our
video copy protection technologies correctly in integrated circuits and DVD or
set-top box hardware.
Our sales and marketing groups include senior executives who manage our
business lines and provide executive level account management to our major
customers. We also have a direct sales staff that works with our content owner
and software vendor customers. Our in-house legal department provides licensing
and patent counsel to our executives.
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 COPY 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 and our revenues would decline. We currently derive a majority of
our net revenues and operating income from fees for the application of our
patented video copy protection technology to prerecorded videocassettes, DVDs
and digital pay per view, or PPV programs. These fees represented 63.0%, 60.9%
and 61.4% of our net revenues during 2001, 2000 and 1999, respectively.
Any future growth in revenues from these fees will depend on the use of
our video copy protection technology on a larger number of videocassettes, DVDs
or digital PPV programs. 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 copy 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, studios face
increased pressure to trim operating expenses, which may include cutting back in
their copy protection usage, as well as negotiated reductions in their usage
fees. Even though we have long-term contracts with large, 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 may reconsider whether they want to continue to copy
protect their older catalog titles.
Any decline in demand for our video copy protection technology, including
a change of video copy protection policy by the major motion picture studios, or
a decline in sales of prerecorded videocassettes and DVDs that are encoded with
our video copy protection technology, or a material decline 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 copy protection
technologies or otherwise determine not to copy protect a significant portion of
prerecorded videocassettes, DVD or digital PPV 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
16
able to sustain our level of net revenues, or our rate of revenue growth, on a
quarterly or annual basis. 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.
Factors which could cause the price of our common stock to decline include:
o The timing of releases of popular movies on videocassettes, DVDs or
by digital PPV transmission;
o The ability of the Motion Picture Association of America studios to
produce one or more "blockbuster" titles on an annual basis;
o The degree of acceptance of our copy protection technologies by
major motion picture studios and software companies;
o The acceptance of our electronic licensing and DRM software by
software vendors and end-user organizations;
o The timing of releases of computer software CD-ROM multimedia
titles; and
o The extent to which various hacking technologies are viewed to be
successful by our customers.
The technology sector has experienced significant economic downturns,
exacerbated in part by a slowdown in U.S and foreign economies and by the
September 11, 2001 terrorist attacks in the U.S. As a consequence, our future
license fee revenue may experience fluctuations. Further softening in the
technology industry could affect our future results of operations, and may
affect the timing of orders from major customers.
WE EXPERIENCE SEASONALITY IN OUR OPERATING RESULTS, WHICH MAY AFFECT THE PRICE
OF OUR COMMON STOCK.
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 on videocassettes and DVDs during the year-end holiday
shopping season. We anticipate that revenues from consumer software copy
protection and DRM technologies will reflect this seasonal trend as well. 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 a majority of our net revenues is highly
concentrated among a limited number of customers, primarily due to the fact that
the Motion Picture Association of America 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. The Motion Picture
Association of America studios as a group accounted for 33.2%, 24.8% and 23.9%
of our net revenues in 2001, 2000 and 1999, respectively.
We expect that revenues from the Motion Picture Association of America
studios will continue to account for a substantial portion of our net revenues
for the foreseeable future. We have agreements with 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 ranging from 2003 to 2005. The
failure of any one of these customers to renew its contract or to enter into a
new contract with us on terms that are favorable to us would likely result in a
substantial decline in our net revenues and operating income, and our business
would be harmed.
17
WE DEPEND ON SIGNING HIGH-VALUE LICENSE AGREEMENTS DURING THE REPORTING PERIOD
FROM MAJOR SOFTWARE CUSTOMERS FOR OUR ELECTRONIC LICENSE MANAGEMENT PRODUCTS
AND THE INABILITY TO SIGN THESE AGREEMENTS COULD RESULT IN A DECLINE IN OUR
REVENUES AND PROFITS.
Currently, a material portion of our Electronic License Management
revenues are generated from perpetual licenses, under which license fee revenue
is recognized up front on a one-time basis. 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 a 12-month period. Annual
licenses provide better visibility into future revenues, and smoothes peaks and
troughs in revenue flows that result from perpetual licenses. If we are not able
to persuade major customers to adopt the annual (or time-based) model, and we
continue to rely on the capture of a number of high-value perpetual licenses in
a given period, we may experience higher volatility in our net revenues and
operating income.
WE ARE DEPENDENT ON INTERNATIONAL SALES FOR A SUBSTANTIAL AMOUNT OF OUR
REVENUE. WE FACE DIVERSE RISKS IN OUR INTERNATIONAL BUSINESS, WHICH COULD
ADVERSELY AFFECT OUR OPERATING RESULTS.
International and export sales together represented 45.2%, 42.3% and 40.2%
of our net revenues in 2001, 2000 and 1999, 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 deployment of digital PPV networks, DVDs, and
consumer software, and the use of copy protection in these media. Worldwide
adoption of our ELM technology 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 copy
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 video materials and digital media, which reduces the
need for our copy protection technology.
Due to our reliance on international and export sales, we are subject to
the risks of conducting business internationally, including:
o foreign government regulation;
o changes in diplomatic and trade relationships;
o changes in, or imposition of, regulatory requirements;
o tariffs or taxes and other trade barriers and restrictions;
o difficulty in staffing and managing foreign operations; and
o fluctuations in foreign currency exchange rates.
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, PPV and other
applications requiring our copy protection solutions or if regulations governing
our international business change. For example, under the U.S. Export
Administration Act of 1979, encryption algorithms such as those used in our
consumer software copy protection technology are classified as munitions and
subject to stringent export controls. 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.
POTENTIAL INTELLECTUAL PROPERTY CLAIMS AND LITIGATION COULD SUBJECT US TO
SIGNIFICANT LIABILITY FOR DAMAGES AND INVALIDATION OF OUR INTELLECTUAL
PROPERTY RIGHTS.
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. We are currently subject
to several legal proceedings. See "Legal Proceedings."
Litigation could harm our business and result in:
o substantial settlement or related costs, including indemnification
of customers;
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o diversion of management and technical resources;
o discontinuing the use and sale of infringing products;
o expending significant resources to develop non-infringing
technology; and
o obtaining licenses to infringed technology.
Our success is heavily dependent upon our proprietary technologies. 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 our products
can be sold. The last of our core group of analog copy protection patents expire
in the year 2008. 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.
Others may develop technologies that are similar or superior to our
technologies, duplicate our technologies or design around our patents. 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.
IT MAY BE TIME-CONSUMING AND COSTLY TO ENFORCE OUR PATENTS AGAINST DEVICES AND
HACKING TECHNIQUES THAT ATTEMPT TO CIRCUMVENT OUR COPY PROTECTION
TECHNOLOGY, AND OUR FAILURE TO CONTROL THEM COULD HARM OUR BUSINESS.
We use our patents to limit the proliferation of devices intended to
circumvent our video copy protection technologies. In the past, we have
initiated a number of patent infringement disputes against manufacturers and
distributors of these devices. Any legal action that we may initiate could be
time-consuming to pursue, result in costly litigation, and divert management's
attention from day-to-day operations.
We have one lawsuit of this type pending in Germany to require the
defendant to discontinue the sale of devices that circumvent our video copy
protection technologies, as we believe the device infringes one or more of our
circumvention patents. In the event of an adverse ruling in this litigation or
in any similar litigation, the value of our video protection 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 copy protection
technology and a decline in demand for our technologies, which could have a
material adverse effect on our business in Germany.
A limited number of DVD manufacturers may build products that either do
not contain our copy protection technology, or include features that allow
consumers to bypass copy protection. Though we believe this is in contravention
of the U.S. Digital Millennium Copyright Act, 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, result in costly
litigation, and divert management's attention from day-to-day activities.
In the electronic license management market, our products include patented
technologies. Any legal action that we may initiate regarding these patents may
be time-consuming to pursue, involve costly litigation, divert management's
attention from operations or may not be successful. See "Legal Proceedings."
In the consumer software copy protection segment, a number of individuals
have developed and posted SafeDisc hacks on the Internet, or CD cloning
software. If we are not able to develop frequent SafeDisc 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. Although the anti-circumvention provisions in the
U.S. Digital Millennium Copyright Act may be applicable to Internet service
providers who support the hacker sites, any legal action that we initiate could
be time-consuming to pursue, result in costly litigation, and divert
management's attention from day-to-day operations.
19
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. If we were to acquire any of these companies 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.
The negotiation, creation and management of the strategic relationships
typically involve a substantial commitment of our management time and resources.
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.
Our strategic investments typically 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, TTR, CAC, Digital Fountain, iVAST, NTRU Cryptosystems, and
Widevine Technologies. These investments, totaling $58.1 million, represented
16.9% of our total assets as of December 31, 2001. CAC, Digital Fountain, iVAST,
NTRU Cryptosystems, and Widevine Technologies are privately held companies.
There is no active trading market for the securities of these privately held
companies and our investments in them are illiquid. 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.
WE MUST CONTINUE TO PROVIDE SATISFACTORY SUPPORT AND MAINTENANCE SERVICES TO OUR
ELM CUSTOMERS.
Our future success will depend on our ability to provide adequate software
support and maintenance services to our ELM 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 SAFEDISC AND SAFEAUDIO
SOFTWARE MODULES WITHIN THEIR 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:
o apply the SafeDisc digital signature and SafeAudio protection
generator at licensed replication facilities; and
o allow replicators to run specialized quality assurance tests to
confirm the SafeDisc or SafeAudio technology is 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.
The SafeDisc CD copy protection technology is available to over 100 of the
world's largest mastering and replication facilities worldwide, and is designed
to be fully compatible with standard CD manufacturing processes. Nevertheless,
we rely on such third parties to properly apply the SafeDisc CD copy protection
technology to 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.
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WE MUST ESTABLISH AND MAINTAIN LICENSING RELATIONSHIPS WITH COMPANIES OTHER
THAN CONTENT OWNERS OR SOFTWARE PUBLISHERS TO CONTINUE 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:
o videocassette duplicators;
o international distributors of videocassettes;
o DVD and CD authoring facilities, mastering houses and replicators;
o DVD and CD authoring tools software companies;
o DVD and CD hardware manufacturers;
o semiconductor and equipment manufacturers;
o operators of digital PPV networks; and
o consumer electronics and digital PPV set-top hardware manufacturers.
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.
OUR PRODUCTS COULD HAVE UNKNOWN DEFECTS.
We offer and develop a series of complex copy protection and digital
rights management products, which we license to customers. Due to the complexity
of these products offered and developed, the products may contain undetected
defects or errors that may affect the proper use or application of such products
by the customer. Despite our quality assurance testing, defects or errors may
occur in existing or new products, which 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. The performance of
these products typically involves working with sophisticated software, computing
and communications systems. Our inability to meet customer expectations in a
timely manner could also result in a loss of, or delay in, revenue, loss of
market share, failure to achieve market acceptance, injury to our reputation and
increased costs. In addition, we rely on the customer and third party
replicators to properly use our products to protect the software and
applications to which the process may be applied. Any improper use or
application of the software by the customer or the third party replicators may
render the process 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.
IF USE OF THE INTERNET FOR DELIVERY OF SOFTWARE DOES NOT INCREASE AS WE
ANTICIPATE, OUR BUSINESS WILL SUFFER.
Some of our products, such as SafeCast, focus on using the Internet to
deliver, deploy, and pay for software. 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. 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:
21
o The necessary communication and computer network technology
underlying the Internet and other online service does not
effectively support any expansion that may occur;
o New standards and protocols are not developed or adopted in a timely
manner; or
o 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 WE DO NOT RETAIN OUR KEY EMPLOYEES AND ATTRACT NEW EMPLOYEES, OUR ABILITY TO
EXECUTE OUR BUSINESS STRATEGY WILL BE IMPAIRED.
We compete for employees in California's Silicon Valley, one of the most
challenging employer environments in the U.S. Hiring and retaining key personnel
is highly competitive. 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. In particular, we need to
attract senior software industry executives in anticipation of expanding our
software business through defining new software growth strategies and executing
on these strategies. We have searches underway for a Chief Operating Officer and
Board director in this regard. Additionally, our current stock option plan may
be deemed less effective in retaining employees due to the overall decline in
technology market values and the resultant impact on our stock price. We are
evaluating approaches to ensure effective retention tools are in place. The loss
of key employees or the inability to hire seasoned executives could harm our
business.
CALAMITIES, POWER SHORTAGES OR POWER INTERRUPTIONS AT OUR SILICON VALLEY OFFICE
COULD DISRUPT OUR BUSINESS AND ADVERSELY AFFECT OUR OPERATIONS.
We are in the process of consolidating the operations of our offices in
Sunnyvale, California and San Jose, California to a facility in Santa Clara,
California. These facilities 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.
We also rely on the major Northern California public utility, Pacific Gas
& Electric Company ("PG&E"), to supply electric power to our facilities. Due to
problems associated with the deregulation of the power industry in California,
customers of PG&E have been faced with increased electricity prices, power
shortages and, in some cases, rolling black-outs. To date, we have not been
materially adversely affected by such power black-outs. However, more
significant disruptions of our power supply may occur in the future. These
interruptions could delay delivery or development of our technologies or
increase our operating costs, in either case having a material adverse effect on
our operations. We do not presently have a backup power generating facility. The
inability to obtain electricity at cost effective rates would increase our
operating expenses and would decrease our operating income if we were unable to
pass along these costs to our customers in the price of our products.
INDUSTRY RISKS
WE LICENSE TECHNOLOGY FOR DIGITAL PPV COPY PROTECTION, AND IF THIS MARKET DOES
NOT GROW AS ANTICIPATED OR WE ARE UNABLE TO SERVE THIS MARKET EFFECTIVELY,
OUR REVENUES WILL BE ADVERSELY AFFECTED.
While our copy protection capability is embedded in more than 75 million
digital set-top boxes manufactured by the leading digital set-top box
manufacturers, only seven system operators have activated copy protection for
digital PPV programming. Our ability to expand our markets in additional home
entertainment venues such as digital PPV or video on demand ("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
Motion Picture Association of America studios do not require copy protection
activation for any of their PPV or VOD movies, or if PPV/VOD system operators 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 Japan, Hong Kong or the United Kingdom, then our business will be harmed.
22
Further, consumers may react negatively to copy protected PPV programming
because they may feel they have an entitlement 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 would be harmed.
POTENTIAL REVENUE MAY BE LOST IF THE VWM COMPANIES' DIGITAL VIDEO WATERMARKING
TECHNOLOGY IS NOT SELECTED AS AN INDUSTRY STANDARD OR OTHERWISE ACHIEVE
BROAD MARKET ACCEPTANCE.
In cooperation with Digimarc Corporation, Hitachi Ltd., Koninklijke
Philips N.V., NEC Corporation, Pioneer Corporation and Sony Corporation, we have
developed a digital video watermarking solution to address the
digital-to-digital copying issues associated with the next generation of DVD
recording devices. Our group (the "VWM Companies") has submitted a proposed
solution to the DVD Copy Control Association, or DVD CCA, which has assumed
responsibility for selecting the industry standard. Macrovision has been
selected as the exclusive licensing agent for the VWM Companies' watermarking
solution. Our group is competing with Toshiba Corporation, which has also
submitted a proposal to the DVD CCA.
The VWM Companies' digital watermarking technology may not be selected as
the standard by the DVD CCA. Our proposal was submitted in November 2001 in
response to the second set of Instructions to Bidders issued by the DVD CCA.
However, the DVD CCA issued similar Instructions in 1999, in response to which
the individual VWM Companies bid as two separate groups with competing
technologies: the Millennium group (Digimarc, Philips and Macrovision), and the
Galaxy group (Hitachi, IBM, NEC, Pioneer and Sony). The initial selection
process was delayed due to concerns over potential intellectual property
conflicts. Potential video content owners and hardware manufacturers did not
want to select either the Millennium group or the Galaxy group solution for fear
that they might be subject to patent infringement action by the other group. As
a result the Millennium and Galaxy groups joined forces in 2001 as the VWM
Companies and combined their technologies and patents into a best-of-breed
solution to alleviate this concern and submitted a joint bid in this second
round of testing and evaluation.
While there is no guaranty that the DVD CCA will select a technology in
this testing and evaluation process, if a selection is made, the group whose
digital video watermarking solution is selected will have a significant
advantage in licensing its technology to video content owners worldwide, and in
working with consumer electronics manufacturers, PC platform companies and their
suppliers to implement digital-to-digital copy protection. Even if the DVD CCA
adopts the VWM Companies' solution, other companies may elect to compete in this
market. If the solution being developed by the VWM Companies is not the selected
solution or otherwise is not widely adopted by studios or consumer electronics
manufacturers, our group will be at a competitive disadvantage in marketing our
solution. The solution being developed by our group may not achieve market
acceptance as the market and the standards for digital-to-digital copy
protection evolve. If this happens, our future revenue opportunities will be
negatively impacted.
THE CONTINUED RISKS OF PATENT INFRINGEMENT AND ANTITRUST LAWSUITS MAY REDUCE THE
CHANCES OF THE VWM COMPANIES' DIGITAL VIDEO WATERMARKING TECHNOLOGY FROM
BEING SELECTED AS AN INDUSTRY STANDARD OR OTHERWISE ACHIEVING MARKET
ACCEPTANCE.
We continue to discuss our solution and our implementation plans with the
studios and other industry participants, but risks of patent infringement
lawsuits still remain an issue for the studios and hardware companies. While the
VWM Companies' plan to minimize potential antitrust lawsuits by securing
approval from the Department of Justice with a Business Review Letter, there can
be no assurance that, even if this happens, we will eliminate antitrust risks.
If the VWM Companies are forced to defend against one or more antitrust lawsuits
our business could be significantly impacted.
On October 23 2001, Digimarc filed a patent infringement suit in the
United States District Court, District of Oregon against Verance Corporation
alleging infringement of certain patents owned by Digimarc. Verance's answer and
counter-claim included allegations of patent infringement and antitrust
counterclaims, including allegations that Digimarc conspired with Macrovision to
keep Verance out of the DVD CCA bidding process for selection of a digital
watermarking copy protection technology. Verance's second amended
cross-complaint, filed on or about March 25, 2002, specifically named us as a
party and pled additional allegations of patent infringement and antitrust
violations in connection with our bid to the DVD CCA as one of the VWM
Companies. In the event Verance succeeds on its cross-claims, we may be subject
to significant monetary damages as well as be precluded from licensing the VWM
Companies' jointly developed digital media copy protection technology.
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WE ENTERED THE MARKET FOR CONSUMER SOFTWARE COPY PROTECTION AND RIGHTS
MANAGEMENT, AND WE DO NOT KNOW IF OUR MOMENTUM WILL CONTINUE IN SELLING OUR
PRODUCTS IN THIS MARKET.
Both the markets for PC hardware and software games publishers have
experienced macroeconomic pressures over the last year. Unit sales of PC's have
slowed; major PC suppliers have announced weaker financial results than
expected. Several PC games software publishers have reported financial
difficulties and experienced management and employee turnover. If economic
conditions in this segment continue to be difficult, demand for our copy
protection and rights management solutions (which is linked to the volume of PC
games and consumer application software titles sold) could decline. This would
result in lower revenues and operating income for this line of business.
A number of competitors and potential competitors are developing CD-ROM
copy protection and DRM solutions. Many of these competitors and potential
competitors have substantially greater name recognition and financial, technical
and marketing resources than we do. If these competitors provide superior or
more cost-effective solutions, our business will be harmed.
WE HAVE RECENTLY ENTERED THE ELM MARKET, AND WE DO NOT KNOW IF WE WILL BE
SUCCESSFUL IN SELLING OUR PRODUCTS IN THIS MARKET.
We acquired GLOBETROTTER Software, Inc. in August 2000. GLOBETROTTER's
major product line is FLEXlm, a software product that is integrated into
independent software vendors' offerings, allowing them to license their software
products electronically, and monitor and enforce compliance with their licensed
use rights. A second product, GTlicensing allows software vendors to create,
ship and track electronic licenses online. Our third product, SAMSuite is an
end-user (enterprise) software asset management product. There is no assurance
of our ability to grow and be successful in this market and if we are
unsuccessful in this market, our business would be harmed.
Major software vendors have experienced deteriorating economic conditions
as corporate customers have reduced capital expenditures. Demand for our FLEXlm
technology 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 ELM technology 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 electronic licensing
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.
WE ARE ENTERING THE MARKET FOR MUSIC CD COPY PROTECTION AND RIGHTS MANAGEMENT,
AND WE DO NOT KNOW IF WE WILL BE SUCCESSFUL IN SELLING OUR PRODUCTS IN THIS
MARKET.
We entered into a strategic relationship with TTR Technologies, Inc. to
develop and market a copy protection system that will inhibit casual copying of
music CDs using dual-deck CD recorder systems or personal computer systems. A
number of competitors and potential competitors may be developing similar and
related music copy protection solutions. The solution we expect to market 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 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.
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.
IF WE ARE UNABLE TO COMPETE SUCCESSFULLY AGAINST COMPETITIVE TECHNOLOGIES THAT
MAY BE DEVELOPED IN THE FUTURE OUR BUSINESS WILL BE HARMED.
24
We believe that there are currently no significant videocassette copy
protection competitors other than companies that have occasionally developed
copy protection processor hardware based on our technology for sale in small
foreign markets, where we have not sought patent protection. It is possible,
however, that a competitive copy protection technology could be developed in the
future. For example, our customers could attempt to promote competition by
supporting the development of alternative copy protection technologies or
solutions, including solutions that deter professional duplication. Increased
competition would be likely to result in price reductions and loss of market
share, either of which could harm our business. We believe that our DVD
digital-to-analog copy protection system has no competitors, and because of the
widespread ecosystem that we have developed (semiconductor suppliers and DVD
manufacturer licensees), we believe it would be very difficult for a competitor
to enter this space.
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 - the basic content scrambling system for the
DVD format; the Digital Display Working Group's High Definition Copy Protection
("HDCP") encryption for Digital Video Interfaces ("DVI"). These systems are not
directly competitive, but they are sometimes confused with our analog copy
protection and the VWM Companies' watermarking systems, and may create
uncertainty in the minds of customers - thereby reducing or delaying our
licensing opportunities.
Our primary competition in the ELM market currently comes from independent
software vendors who try to develop their own ELM 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 historic