FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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ANNUAL REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
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TRANSITION REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 000-22023
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Macrovision Corporation |
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(Exact name of registrant as specified in its charter) |
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Delaware |
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77-0156161 |
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(State or other jurisdiction of incorporation or organization) |
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(I.R.S. Employer Identification Number) |
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2830 De La Cruz Boulevard |
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(Address of principal executive offices) (Zip code) |
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(408) 743-8600 |
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(Registrant’s telephone number including area code) |
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Securities registered under Section 12(b) of the Exchange Act: None |
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Securities registered under Section 12(g) of the Exchange Act: Common Stock, $0.001 par value |
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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 o
Indicate by check mark 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. x
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No o
As of March 1, 2004, 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 $962,571,745.
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 1, 2004, there were 49,273,828 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 25, 2004, are incorporated by reference in Items 10-14 of Part III hereof.
MACROVISION CORPORATION
FORM 10-K
INDEX
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ITEM 1. |
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ITEM 2. |
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ITEM 7. |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
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ITEM 7 A. |
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ITEM 8. |
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ITEM 9. |
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES |
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ITEM 9A. |
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ITEM 10. |
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ITEM 11. |
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ITEM 12. |
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT |
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ITEM 13. |
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ITEM 14. |
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ITEM 15. |
EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K |
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57 |
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Discussions of some of the matters contained in this Annual Report on Form 10-K for Macrovision Corporation (“Macrovision,” “we” or “us”) may constitute forward-looking statements within the meaning of the Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, and as such, may involve risks and uncertainties. Some of these discussions are contained under the captions “Item 1. Business” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We have based these forward-looking statements on our current expectations and projections about future events, which include implementing our business strategy, developing and introducing new technologies, obtaining and expanding market acceptance of the technologies we offer, and competition in our markets.
In some cases, you can identify these forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “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.”
Macrovision Corporation, a Delaware corporation founded in 1983, develops and licenses copy protection, electronic licensing and rights management technologies. Our customers include major Hollywood studios, independent video producers, hardware and software vendors, music labels, consumer electronic, PC and digital set-top box manufacturers and digital pay-per-view (“PPV”) and video-on-demand (“VOD”) network operators. We provide content owners with the means to market, distribute, manage and protect video, software and audio content.
Our business originated in video copy protection, which continues to be the leading revenue generator for our Entertainment Technologies Group. Our technology has been used to copy protect over four billion videocassettes worldwide since 1985 and over 2.7 billion DVDs worldwide since 1997. Most Motion Picture Association of America (“MPAA”) studios use our video copy protection technology to protect some or all movie releases on videocassette or DVD. We believe that our technology is accepted as the de facto industry standard for analog video copy protection.
Our Entertainment Technologies Group develops and licenses copy protection, authentication, and rights management technologies for music CDs. We also offer CD/DVD-ROM copy protection and digital rights management (“DRM”) technologies to a variety of software publishers in the PC games, education, information publishing, and desktop applications software markets.
Our Software Technologies Group provides electronic license management (“ELM”) and electronic license distribution (“ELD”) solutions to hardware and software vendors and their enterprise customers. International Data Corporation (“IDC”), the information technology market intelligence firm, has named Macrovision the clear leader in this field, with approximately 2,000 customers under maintenance. In 2003, we announced a major new initiative and licensing model, FLEXnet, which establishes our ELM and ELD solutions as a platform and enables us to form alliances with many of the leading companies providing complementary solutions, including Intel, InstallShield, Open Channel Solutions, Platform Computing and others. We expect to begin shipping FLEXnet in 2004.
Overall, we have built, and continue to add to, a large patent portfolio that helps differentiate our products and is important to our license driven business model. We generate recurring revenues from a variety of sources by licensing the use of our patented technologies. In our video copy protection business, we receive unit-based royalties for copy-protected videocassettes and DVDs and for set-top boxes and hard drive recorders that include our technologies. We obtain transaction or use-based royalties from digital satellite/cable network operators for copy protected PPV movies, and up-front and annual license fees from DVD and set-top box hardware manufacturers, and digital satellite/cable network operators. In our software businesses, we receive unit-based royalties on CD/DVD-ROMs, a combination of time-based licenses and perpetual licenses for our DRM and electronic license management technologies, and recurring fees for maintenance. For our music products we receive unit-based royalties for copy-protected music CDs.
We own or have rights to various copyrights, trademarks and trade names used in our business. These include Macrovision®, Cactus Data Shield™ (“CDS”), Colorstripe™, FLEXbill™, Flex Certified™, FLEXenabled™, FLEXlm®, FLEXnet™,, GLOBEtrotter®, GTlicensing™, SafeAudio™, SafeAuthenticate®, SafeCast®, SafeDisc®, SafeDVD™, SafeScan™, SAFESTREAM™, SafeWrite™, SAMsuite™ and SOFTSUMMIT™.
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Industry Background
Consumers’ ability to make unauthorized copies of video, audio and software content has increased due to the proliferation of inexpensive, easy-to-use devices, such as VCRs, CD and DVD recorders, audio CD recorders (“CD-Rs”) and hard drive recorders that allow in-home copying of videocassettes, DVDs, digital PPV/VOD programs, CD/DVD-ROMs, desktop software, and audio CDs. The industry shift towards digital media renders content and copyright owners increasingly vulnerable to unauthorized use of their content. As technological advances facilitate digital copying using devices that are becoming more readily available at declining prices, motion picture studios, music labels and software games publishers have become more concerned with protecting their intellectual property. Independent software vendors (“ISVs”) and systems vendors are similarly concerned about unlicensed or illicit use of their application software, both in the enterprise environment (where license parameters may be ignored) and at home (where PC software may be copied and redistributed).
Content owners lose billions of dollars every year to casual copying and professional or bootleg piracy. The latest data available from the MPAA estimates that the U.S. motion picture industry lost in excess of $3.5 billion in 2003 due to packaged media piracy. In addition, the International Intellectual Property Alliance (“IIPA”) estimated that copyright piracy, not including Internet piracy, around the world inflicts $20-$22 billion in annual losses to the U.S. copyright industries. This estimate also does not include losses arising from casual consumer copying or unauthorized use of entertainment and software programs. This is the focus of our technologies.
Macrovision Business
We operate in two business groups, which are the Entertainment Technologies Group and the Software Technologies Group.
Entertainment Technologies Group
Our Entertainment Technologies Group derives its revenue from three product lines: Video, Music and PC Games Technology.
Video Technology
Motion picture studios wish to maximize the economic value from each feature film or other video program over its copyright life. Adams Media Research reported that consumers spent more than $14.4 billion in 2003 to own movies, with DVD outselling VHS two to one in the United States. Understanding & Solutions Ltd. projects a 24% annual increase in DVD unit sales to over 1.5 billion discs in 2004 in the United States and a 26% annual increase to over 2.2 billion discs in 2004 worldwide. The rapid growth of the DVD format presents major revenue opportunities for the studios, as well as serious copy protection concerns. 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 or VOD releases. Any household that owns a VCR or DVD recorder (“DVD-R”) device is capable of making unauthorized high quality VHS or DVD copies directly from their DVD players or set-top boxes, unless programs are copy protected.
DVD-to-VHS Copy Protection. DVD hardware and media became commercially available in the United States in 1997. According to the Digital Entertainment Group (“DEG”) and Consumer Electronics Association (“CEA”), as of the end of 2003, approximately 100 million DVD playback devices are in American homes, including stand-alone players, DVD-ROM drives and DVD-capable videogame consoles. Most of these homes also have a VCR. In addition, DVD/VCR combination units are becoming more popular. Without effective copy protection, any VCR can, when combined with a DVD playback device, make VHS copies of a non-copy protected DVD. These copies are almost equal in quality to professionally prerecorded videocassettes. Virtually 100% of DVD playback devices sold and in use since the DVD format introduction to the market in 1997 in North America, Western Europe and Japan are designed to output Macrovision copy-protected analog video if the device plays a Macrovision copy-protected original DVD disc. Therefore, our copy protection technology can effectively inhibit DVD to VCR copying.
Recordable DVD Copy Protection. DVD-video recorders that allow recording onto DVD recordable blank media, started selling to consumers in 2003, and sales of these DVD recorders reached approximately 5.0 million units worldwide in 2003. According to estimates from IDC and Understanding and Solutions Ltd., DVD-video recorders sales should reach over 13.0 million units in 2004, with nearly 35% of such sales in the United States and 32% in Europe, the Middle East and Africa. Our copy protection technology inhibits the duplication of DVDs using these new devices. All DVD recording devices that we have tested to-date do not make a digital DVD copy from the analog video output of a compliant DVD playback device when playing a Macrovision copy-protected DVD disc. Because almost all the installed DVD playback devices have only an analog output, our copy protection technology inhibits DVD-R copying in addition to VCR copying.
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VOD and PPV Copy Protection. Digital PPV/VOD services enable consumers to purchase and view movies and other programming in their homes through cable or satellite systems. Studios have realized the importance of copy protection in digital PPV/VOD networks because VHS and DVD-R recorders can be used to make high quality VHS and DVD copies from the source video signal. Many of the studios have required digital PPV/VOD system operators to install copy protection capability in their digital set-top boxes.
Our technology enables consumers to view PPV/VOD programs but inhibits unauthorized copying or significantly distorts unauthorized copies of the program when copies are attempted by both DVD and VHS recording devices. To date, our copy protection technology has been embedded in over 117 million digital set-top boxes worldwide, representing nearly 90% of total digital set-top boxes deployed. Our technology is dormant until it is activated by system operators for specific PPV or VOD movies. During the past four years, our video copy protection technology has been activated by PPV system operators in Western Europe and Japan.
VOD is an emerging service, with approximately 10 million U.S. households currently enabled to view VOD, and an estimated 30 million expected to be VOD ready by 2005. We are working with several major MPAA studios and system operators to enable copy protection activation for VOD services in the U.S.
VHS Copy Protection. Even with the focus on digital media and growth in DVD, VCR sales remain strong as prices fall. With continued shipments of VCR devices to the market, we believe that VCRs will remain a home copying threat to video content owners for many years to come. Our copy protection technology still serves its original purpose of inhibiting VCR-to-VCR copying.
Music Technology
The music industry is at a digital crossroads. Music industry unit (“CD”) sales have been falling approximately 10% year-over-year for the past four years, according to the International Federation of Phonographic Industries (“IFPI”). The continued decline is attributed to the high penetration of personal computer-based CD-burners, proliferation of peer-to-peer file sharing services and the lack of commercially viable copy protection and DRM technologies. Approximately 30% of recordings sold worldwide are reportedly illegal copies, resulting in an estimated $4.6 billion of lost industry sales in 2003 alone, according to IFPI’s “Music Piracy Report 2003.” In addition, peer-to-peer file sharing of music continues to be problematic. IFPI estimates there were approximately 100 million infringing music files on traditional web and file transfer protocol sites on the Internet and approximately 800 million unauthorized files on peer-to-peer networks at the end of 2003.
Consequently, the music industry is pursuing multiple initiatives to reverse the year-over-year sales declines, including CD copy protection and digital rights management technologies. Since early 2000, music labels have expressed interest in technology that would prevent the copying of music CDs to a PC or CD-R device, or downloading from peer-to-peer networks. We are developing and marketing technologies to address these needs.
PC Games Technology
With the proliferation of inexpensive high capacity CD-ROM burners, and the increase in broadband Internet connections to the home and small office, individual consumers now have ready means for unauthorized copying and distribution of desktop software on a broad scale. In fact, unauthorized downloads of application and entertainment software frequently meet or exceed the volume of downloads of music from Internet file sharing services. As a result, application software and interactive entertainment (primarily games) software companies are facing an unprecedented loss of revenues due to unauthorized consumer copying of CD/DVD-ROM software and unauthorized file sharing over the Internet. Our SafeDisc technology addresses this problem.
Software Technologies Group
Our Software Technologies Group is focused on two main customer target groups: software and hardware manufacturers and enterprise end-users.
Software and Hardware Manufacturers
Software and hardware manufacturers need to package and protect their products using flexible methods to increase customer satisfaction and to maximize market penetration and profitability. Hardware manufacturers include computer, telecom, datacom and other equipment manufacturers that incorporate substantial software modules in their products. By offering their products in different forms and under different terms, manufacturers are able to put forward products that appeal to and make economic sense to different potential purchasers with varying needs and values. For example, heavy users of a software product may wish to purchase a single copy for each user, medium users may wish to purchase “floating licenses” that can be shared as needed, and light users may wish to
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pay based on actual usage. Electronic licensing can enable manufacturers to create a single version of each of their products with which they can flexibly and dynamically offer the types of business models their customers desire.
Some individual consumers and organizations attempt to make unauthorized use of software and software-enabled hardware products. Manufacturers attempt to discourage and prevent unauthorized use through means such as audits and, increasingly, electronic licensing. Additionally, manufacturers use electronic licensing to help corporate users comply with the terms of their contracts and avoid inadvertent overusage.
IDC estimates that software publishers shipped over $189 billion of software in 2003, of which 52% had some form of associated electronic licensing. Although many software publishers use their own, internally developed license management software, the leading publishers are increasingly recognizing that this is not their core competency and are opting to purchase third-party solutions, such as ourFLEXlm or SafeCast products. In 2003, IDC reaffirmed its estimate that license management software would grow at almost twice the rate of the overall software market, and we believe that Macrovision is positioned to benefit from this market growth due to our current market leadership, installed base of customers and broad product set.
Enterprise End-Users
Larger organizations that purchase significant volumes of software want to optimize those purchases, ensuring that they purchase enough licenses to make their operations as productive as possible, and at the same time ensuring that they do not waste money by continuing to license unnecessary assets. These enterprises seek reporting software that can provide detailed usage information to guide them in their purchase decisions.
Additionally, larger organizations that purchase significant volumes of software often have trouble complying with the purchase terms of their software. They desire automated solutions that help them stay within the bounds of their purchased licenses, and allow them to flexibly expand those bounds as needed (for example, via usage-based overdraft capabilities). Moreover, they seek management solutions that enable them to minimize the manual labor associated with managing large numbers of licenses and to maximize the reliability and availability of those licenses.
Macrovision Solutions
We develop and market a broad array of rights management and copy protection technologies for each of our business lines. The rapid expansion of broadband Internet connections for consumers and small businesses may result in the adoption of new licensing and distribution models for our solutions. We believe this has created a large market opportunity for our digital rights management and copy protection solutions.
Entertainment Technologies Group
Video Technology
Our video copy protection technologies allow consumers to view programming stored on prerecorded videocassettes and DVDs or transmitted as digital PPV or VOD programs via cable or satellite, but deter unauthorized consumer copying of such programming on both VCRs and recordable DVD devices. Videocassettes and DVDs are encoded with our video copy protection signal as they are manufactured. The unique patented aspects of our copy protection signal are transparent to an analog TV set, but are disruptive to the recording circuits of VCRs and act to turn off the recording operation of recordable DVD devices. The result is that videocassettes and DVDs that are encoded with our copy protection signal will play normally on an analog TV set, but will cause generally unwatchable copies to be made on the vast majority of VCRs, and will shut down the analog-to-digital recording circuit of DVD recording devices, which include DVD-R devices and personal computers. 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 VCR recording devices. However, both VCRs and DVD recording devices do need to be manufactured in accordance with the guidelines of the U.S. Digital Millennium Copyright Act of 1998 with respect to responding to Macrovision or other broadly adopted copy protection technologies.
In the DVD and digital PPV markets, we have implemented an enhanced 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 as part of an integrated circuit within the consumer device. The copy protection circuits remain dormant until activated by data commands, which are either embedded in the DVD disc or sent along with the PPV movie transmission to the subscriber’s set-top box or hard drive recorder. Our technology is licensed to 317 DVD manufacturers, 363 DVD authoring houses, 107 replication facilities, 237 VHS commercial duplication facilities, 111 digital set-top box and hard drive recorder manufacturers and 61 semiconductor component suppliers worldwide.
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Music Technology
We are actively involved in developing and marketing various technologies to meet the needs of emerging music delivery systems such as downloading and streaming via the Internet, as well as technologies to prevent the unauthorized copying of music CDs. Our current products (CDS-100™, CDS-200™, and CDS-300™) provide music labels with the following capabilities:
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First session copy protection, which inhibits the ability to copy music to a PC for subsequent redistribution on Internet based file sharing services; |
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Encrypted second session music files that can play on the PC, as long as the CD is in the PC CD/DVD-ROM drive; and |
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DRM technology that enables the second session music files to be copied to a personal computer hard disk and be managed/played via Windows Media Player and controls (at the copyright owner’s option) subsequent transfer to portable devices, CD-Rs, and the Internet. |
The CDS-100 and CDS-200 solutions have been used on over 200 million music CDs worldwide through 2003. Of the total number of copy protected CDs produced worldwide, approximately 60% were distributed in the Asia Pacific region (principally Japan), 35% in Western Europe, and 5% in North America, South America, and the rest of the world combined. The CDS-300 product was released in January 2004 and currently is being tested by all the major music labels. Combining technologies that are the subject of patents developed internally, patents acquired from Midbar Tech (1998) Ltd. in November 2002 and patents acquired from TTR Technologies, Inc. in May 2003, we believe that we are well positioned to develop and market unique solutions that meet the needs of the consumer, the artist, the publisher and the music label.
PC Games Technology
Our SafeDisc technology is designed to prevent the copying of CD/DVD-ROM computer software by encrypting executable files, embedding an authenticating digital signature and adding multi-layered anti-hacking software. This is a proprietary software-based copy protection solution that does not require any changes to standard PC or CD/DVD-ROM hardware. Because SafeDisc is designed to operate while the disc is in the CD/DVD-ROM drive, it is ideally suited to PC games and education software. The technology is licensed directly to software publishers, and to mastering and replication facilities that embed our patented digital signature in a CD/DVD-ROM during the manufacturing process. SafeDisc, introduced in September 1998, has been licensed to 122 replicators worldwide, and is estimated to have been used on more than 200 million CD ROMs.
Software Technologies Group
Software and Hardware Manufacturers
We provide a complete electronic license management solution, ranging from core software toolkits that software vendors incorporate into their products to enable flexible licensing, to back office license fulfillment servers, to end-user monitoring applications, and to worldwide professional services teams that help companies follow best practices and integrate the preceding offerings into various back office systems. By incorporating our license management software into their products, manufacturers improve their ability to price efficiently, simplify product-marketing strategies (with offerings such as trial licenses, bundles and add-ons), reduce unpaid usage, and lower costs associated with product development, distribution, and delivery.
In 2003, we announced that our licensing products FLEXlm, GTlicensing and SafeCast would be combined, unified and extended into our new FLEXnet Publisher universal licensing platform, which will support these previous products in a backwards compatible mode. Our FLEXnet Publisher Licensing and Security modules will enable software vendors to offer multiple licensing models and enforce compliance with license terms. Our FLEXnet Publisher Utility Pricing module will provide usage data to software vendors from their participating customers. This capability enables pay-per-use billing and can be used to automatically implement a new set of licensing policies (e.g., metered usage) that are more accurately matched to each customer’s needs. Our FLEXnet Publisher Operations module will provide electronic license creation, distribution, and tracking for software vendors, allowing vendors to ship and track electronic licenses online without direct human intervention. The system can be integrated into back office systems such as those provided by Siebel and Oracle, completely automating the order fulfillment process.
Enterprise End-Users
Our SAMsuite offering 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. In 2003, we developed a web-based software asset management solution called FLEXnet Manager.
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The Macrovision Growth Strategy
Leverage Key Customer Relationships. We currently maintain relationships with customers in various industry and market segments, including:
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Video and music content providers such as the major Hollywood studios and independent movie producers and major record labels; |
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Hardware and software vendors, as well as enterprise organizations that use their products; |
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Content distributors such as the leading cable and satellite television system operators; and |
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Consumer electronics manufacturers of DVD players, CD and DVD drives, personal video recorders (“PVR”), and digital set-top boxes. |
We intend to build our business by capitalizing on these customer relationships and targeting them for delivery of our existing and future rights management and copy protection technologies.
Introduce New Product Applications and Technologies. We intend to develop additional rights management solutions to sell to our extensive customer base. We have committed significant resources to expand our technology base, to enhance our existing products, to introduce additional products and to participate in industry standard-setting efforts and organizations. We intend to pursue opportunities for rights management, copy protection and enabling solutions in the following areas:
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Digital video; |
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Music CDs; |
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Internet downloaded and streamed audio and video files; |
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Internet downloaded software files; |
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Peer-to-peer file sharing; |
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CD-ROM, CD-Rs; |
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DVD-ROM, DVD-Rs; |
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Electronic license management and delivery for enterprise software; |
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Software asset management products for enterprise customers; and |
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Improved authentication, compression, and encryption technologies. |
Expand and Protect Patent Position. We believe that our future success will depend on our ability to continue to introduce proprietary solutions for rights management and copy protection technologies that can be supplemented by enabling features that will incent consumers and users to pay for legitimate video, audio and software products, rather than trying to get them for free in an unauthorized fashion. We have patented many of these proprietary solutions, and they underpin our strong competitive position and financial model. We also have acquired key software rights management and copy protection patents. We use patents to limit the proliferation of devices that circumvent our video 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 DRM and copy protection technologies.
Continue To Make Strategic Acquisitions. We intend to continue to expand our technology portfolio by pursuing licensing arrangements, joint ventures and strategic acquisitions of companies whose technologies or proprietary rights complement our rights management and copy protection technologies.
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We have made a number of acquisitions since 1999. We acquired C-Dilla, Ltd. of the UK in June 1999 in order to enter the application software copy protection and DRM business; in August 2000, we acquired Globetrotter Software, Inc., which facilitated our entry into enterprise electronic license management and software asset management business; in October 2000, we acquired Productivity through Software plc (“PtS”) of the UK, which was a distributor of our enterprise software solutions; in July 2001, we acquired the intellectual property and technology assets of AudioSoft, Inc., and in September 2001, we acquired the intellectual property and technology assets of MediaDNA, Inc., both of which provided us with significant intellectual property in the DRM business; in November 2002, we acquired the assets of Midbar Tech (1998) Ltd., which provided us with significant intellectual property and key personnel skilled in music copy protection and controlled disc burning applications; in May 2003, we acquired certain assets of TTR Technologies, Inc. to further enhance our intellectual property relating to music copy protection; and in August 2003, we acquired intellectual property and other assets, including patents and software that can be used to track and manage content in the peer-to-peer file sharing space.
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 their end-user customers pay them for the use of such content or software. We receive royalties and recurring revenues as follows:
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Video, music and PC games content owners typically pay us a per-unit licensing fee for the right to use our proprietary copy protection technologies for DVDs, videocassettes, music CDs and CD-ROM games; |
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Enterprise software vendors and enterprise end-user customers pay us a fee to license our technology using either time-based licenses or perpetual licenses with annual maintenance fees; |
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Consumer software publishers pay us a per-unit licensing fee to use our technology for CD-ROM copy protection and time-based or perpetual licenses for our DRM technology; |
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Digital set-top box and digital PVR manufacturers license our video copy protection technologies for an up-front fee and a per-unit royalty; |
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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 or VOD services. In addition, we are entitled to transaction-based royalty payments when copy protection for digital PPV or VOD programming is activated by system operators; and |
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DVD hardware manufacturers (DVD consumer electronic player manufacturers and PC DVD drive suppliers) license our technology for an up-front fee and annual license fee. |
Sales and Marketing. We market our rights management and copy protection technologies directly to content owners and independent software vendors in both the video and software markets. We also license our software asset management solutions directly to end-user enterprise customers. We supplement our direct sales efforts with reseller programs and service partnerships among VHS, DVD, and CD duplicator, replicator and authoring organizations, and third party professional services, value added reseller, and systems integrator organizations in our enterprise software business. We also utilize a variety of marketing initiatives, including trade show participation, trade advertisements, industry education and newsletters. As part of our FLEXnet platform, we established alliances with several partner companies to extend the FLEXnet ecosystem to include other third-party services and solutions.
Our primary locations for product development, business strategy, and operations are in our Santa Clara (California) and Woodley (United Kingdom) offices. We have sales and support operations through our U.S. sales force, and through our offices in Maidenhead, Woodley and Cheshire in the United Kingdom; Frankfurt, Germany; Tokyo, Japan; Seoul, Korea; Hong Kong; Taipei, Taiwan; and Tel Aviv, Israel.
Customers
Entertainment Technologies Group
Video Technology
Video Content. Our copy protection technology for videocassettes and DVDs is used by the following leading major motion picture studios and home video suppliers:
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Lions Gate Entertainment Corp. |
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Paramount Pictures |
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Buena Vista Home Video (Disney) |
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Twentieth Century Fox Home Entertainment |
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Columbia TriStar Home Entertainment (Sony Pictures) |
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Universal Studios Home Video (Vivendi) |
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HBO Home Video |
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Warner Brothers Home Video |
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New Line Cinema |
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One customer accounted for more than 10% of our net revenues in 2003 and one customer accounted for more than 10% of our net revenues in 2002. No customer accounted for more than 10% of our net revenues in 2001. The MPAA studios as a group accounted for 36.0%, 42.2% and 33.2% of our total net revenues in 2003, 2002 and 2001, 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.
PPV/VOD System Operators. There are over 20 system operators who have licensed or specified Macrovision’s digital PPV copy protection technology for incorporation into their networks, including:
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British Sky Broadcasting Group (UK) |
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LodgeNet Entertainment Corp. (USA) |
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BS Conditional Access Systems Co., Ltd. (Digital BS Broadcast) (Japan) |
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NTL (UK) |
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DirecTV (North America) |
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Premiere Fernsehen GmBH & Co KG (Germany) |
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EchoStar Communications (USA) |
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Singapore Telecom (Sing Tel) (Singapore) |
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Galaxy Satellite Broadcast (Hong Kong) |
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SkyPerfecTV! (Japan) |
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Korea Digital Broadcast (“KDB”) (Korea) |
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These system operators have paid a one-time license fee to us and have entered into agreements with us pursuant to which we are entitled to transaction-based royalty payments at such time as copy protection for digital PPV or VOD programming is activated. While 12 international system operators have activated our copy protection in their networks, the majority of U.S. systems operators have not yet activated copy protection, even though the technology is included in their network infrastructure. We are in discussions with a number of major studios and system operators to activate VOD copy protection in the U.S.
Consumer Electronics Hardware Manufacturers. We believe that our DVD copy protection technology is universally utilized as the analog-to-analog and analog-to-digital copy protection solution that satisfies the principles established by the DVD licensing and standards group, and has been tested and accepted for compatibility with TV sets by leading consumer electronics companies. As of December 31, 2003, 317 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 PlayStation®2 and Xbox™.
Our PPV/VOD copy protection technology is embedded in more than 117 million digital set-top boxes currently in use worldwide, which we believe represents approximately 90% of all digital set-top boxes. We have licensed our copy protection technology for digital PPV/VOD to 89 set-top box and 22 PVR manufacturers, including:
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Acer |
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Panasonic (MEI) |
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Advanced Digital Broadcast (“ADB”) |
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Philips Electronics |
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Daewoo Electronic Co., Ltd. |
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Pioneer Electronics |
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EchoStar Communications |
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Scientific-Atlanta |
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Hughes Electronics |
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Sony |
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Motorola Broadband |
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THOMSON Multimedia |
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Nokia |
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TiVo |
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Pace Micro Technology |
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We have also authorized 61 semiconductor companies to incorporate our digital PPV/VOD and DVD copy protection technologies into their semiconductor and reference designs. These companies generally pay us a one-time service fee to verify correct implementation of our video 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-
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licensed DVD hardware manufacturers and to Macrovision-licensed digital set-top box and hard drive recorder (sometimes referred to as “digital video recorder”) manufacturers.
Music Technology
CDS-100 and CDS-200 have been utilized on music CDs by all five major music labels (i.e., Universal, Warner, Sony, BMG, and EMI) in Europe and/or Japan, and by Avex, Pony Canyon and others in Japan. The CDS processor, which our customers use to apply our copy protection technologies to their CDs, has been installed in 57 manufacturing plants worldwide, including plants in North America, Europe and Japan. In January 2004, we introduced CDS-300, which is a dual session copy protection DRM solution that provides enhanced features for the PC.
PC Games Technology
Our copy protection technology for consumer software is used by leading software (primarily games) publishers, including the following:
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Activision |
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Hyperion Solutions |
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Apple |
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MathWorks |
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CDV Software Entertainment |
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Mattel |
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Eidos |
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Microsoft |
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Electronic Arts |
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Take 2 Interactive |
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Hasbro (Infogrames) |
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3DO |
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Havas (Vivendi Universal Interactive) |
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Ubisoft Entertainment |
Our consumer software customers have a wide choice of licensed replicators that they can use throughout the world and 122 replicators have been licensed and have installed SafeDisc mastering and quality assurance systems from authorized suppliers of these systems.
Software Technologies Group
Software and Hardware Manufacturers
We believe that FLEXlm, our electronic license management product, is the industry leader. We have licensed our ELM and ELD technologies in a range of market segments to more than 3,000 software and hardware manufacturers, including:
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Adobe |
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Macromedia |
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Autodesk |
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Sybase |
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Cadence Design Systems |
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Synopsys |
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Cisco Systems |
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UGS PLM Solutions |
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Citrix |
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Wind River Systems |
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Intuit |
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Enterprise End-Users
In addition we have licensed software asset management (“SAM”) companion products to over 750 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:
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ABB |
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Lockheed Martin |
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BMW |
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Motorola |
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Eastman Kodak |
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Nokia |
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Ford Motor Company |
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Philips |
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IBM |
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Royal Dutch/Shell Group |
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Technology
Entertainment Technologies Group
Video Technology
Our technology was originally designed to prevent unauthorized copying of VHS and PPV/VOD programming to VCRs without impacting the original playback. We expanded this to inhibit unauthorized DVD-to-VHS copying. Industry groups have adapted our copy protection technology to prevent DVD-to-DVD copying as well. The majority of the recently introduced PVRs, DVD/VCR combo units, DVD recorders and PVR/DVD-R combo units comply with the U.S. Digital Millennium Copyright Act and, as a result, they recognize Macrovision’s proprietary analog copy protection process and disable digital recording onto DVD discs.
Videocassette Copy Protection. 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 copy protection pulses are embedded electronically in the prerecorded content of the videocassettes in the process of videocassette manufacture. 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, 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/VOD Copy Protection. The DVD and digital PPV/VOD 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, and DVD recorders do not make DVD copies when they sense Macrovision copy protection signals at their analog inputs.
Music Technology
In the audio CD market, CDS-100 and CDS-200 first session copy protection technologies were developed to prevent consumer electronic device music files (standard, uncompressed music CD format) from being ripped by PCs. Each of the several CDS-100 and CDS-200 first session copy protection functions (e.g., coding, hiding and timing) is covered by pending patent applications.
In January 2003, Microsoft officially announced its “second session” DRM system for the music industry, called “Windows Media® Data Session Toolkit (“WMDST”).” In April 2003, we announced a non-exclusive joint development agreement with Microsoft to develop a dual session solution for our CDS product. In January 2004, we shipped the CDS-300 product that combines our first session copy protection technology and second session DRM solution using the WMDST with a Macrovision user interface. CDS-300 utilizes an authentication scheme based upon our SafeDisc product, which is covered by a patent and a pending patent application (for disc-based rights authentication). This solution is designed to ensure that consumers can only transfer these second session music files to their personal computer and to Windows Media compatible portable devices if they are in possession of an original copy protected CD.
PC Games Technology
Each CD/DVD-ROM published with the patented SafeDisc technology is premastered with encrypted executable files and contains authenticating instructions and a unique SafeDisc digital signature. The digital signature, which prevents copying by CD recorders or transfer from a CD/DVD-ROM to a hard disc drive, is added to each original disc during the mastering/replication process. SafeDisc is a “unilateral” copy protection solution, which means that all of the copy protection technology resides on the CD/DVD-ROM and nothing has to be added to or changed in the PC. When a user inserts an original SafeDisc-protected disc in a CD/DVD-ROM drive, the authentication software reads the digital signature, allowing the program to be decrypted and run normally. The digital signature and authentication process is transparent to the user. If a consumer or pirate uses a CD recording device or
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professional mastering equipment to duplicate a CD/DVD-ROM and make an unauthorized copy, SafeDisc is designed to inhibit the transfer of the digital signature to the copy. If someone attempts to use such an unauthorized copy, the digital signature cannot be found, decryption will not take place and the copy will not run.
SafeDisc also contains anti-hacking technology to prevent the compromise of its security features. Because of our widespread penetration in the PC games’ market, hackers have targeted and cracked several versions of SafeDisc. For us to continue to be successful in this market, we must continually stay a step ahead of the hacker community. We have released new product versions approximately two to three times per year incorporating new anti-hacking features.
Software Technologies Group
Software and Hardware Manufacturers
Software and hardware vendors integrate FLEXlm and Safecast into their products to monitor or control a customer’s compliance with a product’s license terms. Terms of the license are typically stored in an authenticated license file that resides either on the local computer’s disk or on a network-connected central server. Compliance with those license rights is automatically monitored. The software vendor may choose to block users from running a product if doing so violates or exceeds the license rights, or simply provide notification to the user or system administrator when product use has exceeded the customer’s license rights. This allows 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 or after a specific number of uses). With SafeCast, software vendors can enable users to “activate” previously unlicensed copies of the software over the Internet, or by typing in a series of digits read over the phone. Electronic licensing can also record the use of licensed software into a transaction log, which is authenticated and encrypted so software vendors and customers can use this information as a basis for pay-per-use or other usage-based pricing or licensing.
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. Marketing, sales, support or order administration staff define licensing policies in the human readable text file, without the need for software engineers to make changes in software. Software vendors can include information identifying the 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.
Enterprise End-Users
Macrovision’s SAM software enables larger organizations to more effectively manage their licensed software, by providing interfaces to control licensed servers and set alerts to important licensing events. Moreover, this software can read and interpret the usage transaction logs described in the preceding section, enabling customers to better manage their FLEXenabled software assets and to “bill back” software-related costs to different departments or projects in the company.
Research and Development
Our internal research and development efforts are focused on developing enhancements to existing products, new applications for our current technologies and new technologies related to our various 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 acquired other companies and technologies to supplement our research and development expenditures.
In 2003, 2002 and 2001, our expenses for research and development were $17.2 million, $11.9 million and $9.3 million, respectively.
Intellectual Property Rights
Patents Issued & Pending. We hold 87 U.S. patents and have 74 U.S. patent applications pending. Of the issued or allowed patents, 48 relate to our copy protection technologies, 20 relate to video scrambling, 10 relate to audio scrambling, five relate to electronic license management and four relate to DRM technology (namely content usage control, tracking, and e-transactions). Of the pending patent applications, seven relate to consumer software copy protection and 29 relate to audio copy protection. The last of our
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issued U.S. patents expires in 2019. The last of our core group of analog copy protection patents expires in the year 2017. We also have 652 foreign patents issued and 394 foreign patent applications pending in 40 countries. Of the issued foreign patents, 524 relate to our copy protection technologies, 99 relate to video scrambling, 10 relate to audio scrambling, and 19 relate to electronic license management and DRM.
Circumvention Technology Patents. Included in the patents related to our copy protection technologies are 15 U.S. and 102 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
Entertainment Technologies Group
Video Technology
Our video copy protection technologies are proprietary and have broad U.S. and international patent coverage. We believe that there are currently no significant analog video copy protection competitors. We have the only analog copy protection scheme that has been widely deployed on commercial products that significantly distorts or inhibits copying by VHS VCRs, DVD recorders and hard drive recorders. Currently, our video copy protection technology is embedded in nearly 100% of all DVD players and nearly 90% of digital set-top boxes worldwide. While it is possible that a competitive video copy protection technology could be developed and deployed, we believe it would take years for the competitive technology to be tested and accepted by hardware manufacturers and ultimately to begin to be embedded into the consumer electronic devices. By the time this would happen, it is unlikely any other analog copy protection technology would displace our copy protection infrastructure and our extensive video copy protection “ecosystem.”
Our technology is designed to inhibit or prevent unauthorized consumer copying; it is not designed to prevent professional piracy. We believe that our customers are very concerned with professional piracy of their video, audio and software products. We believe that our customers’ need to address professional piracy presents a certain level of competition to our video copy protection business, to the extent that some content owners may decide to devote more of their resources to fighting professional video piracy instead of using our copy protection to deter unauthorized consumer copying.
In addition, with the increase in online movie and music distribution over the Internet, our video copy protection technologies that protect distribution through packaged media and digital PPV/VOD signals may be viewed by our customers as having reduced value, and other Internet-based digital content protection or DRM technologies may present significant competition to our video copy protection business, such as DRM offerings by Microsoft, RealNetworks and Sony.
Music Technology
We believe that there are a limited number of direct competitors in the audio copy protection and rights management market, including SunnComm, Sony, First4Internet and Settec, with Sony having substantially greater financial and other resources than we have. To date, we believe we have a significant market share of the CDs produced worldwide to which audio CD copy protection has been applied. In 2003, only 140 million music CDs out of a total of more than approximately 2.5 billion music CDs produced included copy protection technology from any supplier, including Macrovision.
In January 2003, Microsoft announced the release of its WMDST with a second session DRM solution that can to be deployed independently of our solutions. The announcement included SunnComm as the first company to integrate a third party music CD copy protection technology with Microsoft’s WMDST. We believe that SunnComm uses technology that is competitive with our CDS-100 and CDS-200 technologies. It is possible that Microsoft may develop or acquire copy protection and rights management solutions that compete with our offerings. We have a non-exclusive agreement with Microsoft to include their Windows Media Player and WMDST in our CDS products.
PC Games Technology
We believe that there are a limited number of competitors in our SafeDisc consumer software copy protection market, including Sony SecuROM (developed and marketed by Sony’s DADC optical disk manufacturing subsidiary), StarForce Technologies, Settec and Smarte Solutions.
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Software Technologies Group
Software Licensing
Our primary competition in the software licensing market currently comes from some of our independent software vendor customers and prospects who develop their own electronic license management solutions or electronic software distribution technology. Other more traditional competitors include electronic licensing technology vendors such as XtreamLok and Softwrap, as well as companies that have historically offered hardware dongle products and supplemented them with software licensing offerings such as Rainbow and Aladdin. Operating system developers such as Microsoft, IBM and Sun already integrate limited license management functionality into their products; potentially, they could expand this functionality, which could pose an increased competitive threat. Similarly, microprocessor suppliers may choose to integrate rights management solutions into their products, and software resellers could also begin to develop their own electronic license management solutions.
Enterprise End-User Software Asset Management
Macrovision provides software asset management solutions to end users for FLEXenabled applications only and is currently the only company authorized to interpret the FLEXlm usage log file. We believe that there are currently no significant competitors in this particular software asset management area. In the larger market of software asset management in general, products such as CA Unicenter and IBM Tivoli offer related and sometimes overlapping functionality.
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