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Macrovision 10-Q 2007 Table of ContentsSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended March 31, 2007 or
For the transition period from to Commission file number: 000-22023
Macrovision Corporation (Exact name of registrant as specified in its charter)
(408) 562-8400 (Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Table of ContentsFORM 10-Q INDEX
Table of Contents
MACROVISION CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands) (Unaudited)
See the accompanying notes to these unaudited condensed consolidated financial statements.
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Table of ContentsMACROVISION CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) (Unaudited)
See the accompanying notes to these unaudited condensed consolidated financial statements.
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Table of ContentsMACROVISION CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
See the accompanying notes to these unaudited condensed consolidated financial statements.
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Table of ContentsMACROVISION CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 – BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared by Macrovision Corporation and its subsidiaries (the “Company”) in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC.”) Certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted in accordance with such rules and regulations. However, the Company believes the disclosures are adequate to make the information not misleading. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, which in the opinion of management are considered necessary to present fairly the results for the periods presented. This quarterly report on Form 10-Q should be read in conjunction with the audited financial statements and notes thereto and other disclosures, including those items disclosed under the caption “Risk Factors” contained in our 2006 Annual Report on Form 10-K. The consolidated results of operations for the interim periods presented are not necessarily indicative of the results expected for the entire year ending December 31, 2007, for any future year, or for any other future interim period. The Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”) effective January 1, 2007. FIN 48 prescribes a new recognition threshold and measurement attribute for the financial statement recognition and measurement of an income tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Upon its adoption of FIN 48, the Company applied the provisions of FIN 48 to all income tax positions. The cumulative effect of applying the provisions of FIN 48 have been reported as an adjustment to the opening balance of Additional Paid-in-Capital in the Condensed Consolidated Balance Sheet as of the beginning of 2007. The Company adopted the provisions of Emerging Issues Task Force, or EITF, Issue No. 06-03, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation),” effective January 1, 2007. EITF No. 06-03 allows companies to choose either the gross basis or net basis of income statement presentation for taxes collected from customers and remitted to governmental authorities and requires companies to disclose such policy. The Company applies the net basis presentation for taxes collected from customers and remitted to governmental authorities. NOTE 2 – EQUITY-BASED COMPENSATION Stock Options Currently, the Company grants options from the 2000 Equity Incentive Plan (“2000 Plan”) and the 1996 Directors Stock Option Plan (the “Directors Plan”). The 2000 Equity Incentive Plan succeeded the 1996 Equity Incentive Plan (“1996 Plan”) in August 2000. Restricted Stock Restricted stock awards are issued from the 2000 Plan and vests annually over four years. Restricted stock awards are considered outstanding at the time of the grant, as the stockholders are entitled to dividends and voting rights. As of March 31, 2007, the number of shares awarded but unreleased was 858,379.
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Table of ContentsAs of March 31, 2007, the Company had 18.6 million shares reserved and 4.7 million shares remained available for issuance under the 2000 Plan and 1996 Plan. The 2000 Plan provides for the grant of stock options, stock appreciation rights, and restricted stock awards by the Company to employees, officers, directors, consultants, independent contractors, and advisers of the Company. The 2000 Plan permits the grant of either incentive or nonqualified stock options at the then current market price. Option vesting periods are generally three years under the 2000 Plan where one-sixth vests in the first year, one-third vests in the second year and one-half vests in the third year. Option grants have contractual terms ranging from five to ten years. As of March 31, 2007, the Company had 1.0 million shares reserved under the Directors Plan and 0.3 million shares remained available for issuance. The Directors Plan provides for the grant of stock options to non-employee directors of the Company. The Directors Plan permits the grant of nonqualified stock options at the then current market price. Option vesting periods are generally one year under the Directors Plan. Option grants have terms ranging from five to ten years. Employee Stock Purchase Plan The Company’s 1996 Employee Stock Purchase Plan (the “ESPP”) allows eligible employee participants to purchase shares of the Company’s common stock at a discount through payroll deductions. The ESPP consists of twenty-four-month offering periods with four six-month purchase periods in each offering period. Employees purchase shares in each purchase period at 85% of the market value of the Company’s common stock at either the beginning of the offering period or the end of the purchase period, whichever price is lower. As of March 31, 2007, the Company had reserved 4.3 million shares of common stock for issuance under the ESPP and 2.4 million shares remained available for future issuance. Valuation and Assumptions The Company uses the Black-Scholes option pricing model to determine the fair value of stock options and employee stock purchase plan shares. The fair value of equity-based payment awards on the date of grant is determined by an option-pricing model using a number of complex and subjective variables. These variables include expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. Estimated volatility of the Company’s common stock for new grants is determined by using a combination of historical volatility and implied volatility in market traded options. The expected term of options granted is determined by calculating the average term from historical stock option exercise experience. The risk-free interest rate used in the option valuation model is from U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. The Company does not anticipate paying any cash dividends in the foreseeable future and therefore uses an expected dividend yield of zero in the option valuation model. In accordance with SFAS 123(R), the Company estimates forfeitures at the time of grant and revises those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company uses historical data to estimate pre-vesting option forfeitures and record equity-based compensation expense only for those awards that are expected to vest. The assumptions used to value equity-based payments are as follows:
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As of March 31, 2007, there was $28.2 million of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested equity-based payments granted to employees. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures and is expected to be recognized over a weighted average period of 2.0 years. The weighted average fair value of options granted during the three months ended March 31, 2007 and 2006 was $8.22 and $6.53, respectively. The weighted average grant date fair value of an employee purchase share right granted during the three months ended March 31, 2007 and 2006 was $7.71 and $7.60, respectively. The total intrinsic value of options exercised during the quarter ended March 31, 2007 was $5.0 million. The intrinsic value is calculated as the difference between the market value on the date of exercise and the exercise price of the shares. NOTE 3 – BUSINESS COMBINATION AND ASSET PURCHASES Mediabolic Inc. In January 2007, the Company acquired Mediabolic Inc. (“Mediabolic”), a privately held company based in San Mateo, California, for $43.3 million of purchase consideration. Mediabolic is a provider of software solutions for connected consumer electronics devices, such as televisions, set-top boxes and digital video recorders. The acquisition of Mediabolic extends the Company’s capabilities in the delivery and enhancement of digital content to a wide variety of connected consumer electronics devices for the digital home. Mediabolic’s results have been included in the Company’s Entertainment Technologies segment. The condensed consolidated financial statements include the results of operations of Mediabolic since January 1, 2007, the effective date of the acquisition.
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Table of ContentsThe following is a summary of the estimated fair values of the tangible assets acquired and liabilities assumed at the date of the acquisition (in thousands):
The following is a summary of goodwill and identifiable intangible assets acquired in the acquisition of Mediabolic (in thousands):
As of March 31, 2007, the amount allocated to goodwill may be further adjusted during the year as a result of changes in deferred tax assets. The weighted average amortization period for amortizable Mediabolic intangible assets is 3.9 years. The amortization schedule for Mediabolic intangibles is as follows (in thousands):
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Table of ContentseMeta Corporation In February 2006, the Company acquired eMeta Corporation (“eMeta”), a privately held company based in New York, for $36.1 million of purchase consideration. eMeta provided software solutions that enable companies to manage and sell digital goods and services online. During 2006, the Company had paid $35.2 million in cash consideration. During the first quarter of 2007, the Company paid the remaining $0.9 million to shareholders, which was included in the original purchase price. NOTE 4 – GOODWILL AND OTHER ACQUIRED INTANGIBLES The Company’s goodwill reported by segment (in thousands) is as follows:
The Company’s intangible assets from acquisitions subject to amortization as of December 31, 2006 and March 31, 2007 are as follows (in thousands):
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Table of ContentsAs of March 31, 2007, the Company’s estimates its amortization expense in future periods to be as follows (in thousands):
NOTE 5 – STRATEGIC INVESTMENTS As of March 31, 2007 and December 31, 2006, the adjusted cost of the Company’s strategic investments totaled $25.4 million and $22.7 million, respectively. The Company’s strategic investments include public and non-public companies. In 2006, the Company invested $5.0 million in a privately-held digital watermarking company for strategic purposes. As of March 31, 2007, the adjusted cost of the Company’s strategic investments consisted of its investment in Digimarc, a publicly traded company, and its investment in the privately-held digital watermarking company. The Company holds investments in other privately held companies, which had no carrying value as of March 31, 2007. The investments in Digimarc and the digital watermarking company have been classified on the balance sheet as “Long-term marketable investment securities” and “Prepaid expenses and other current assets,” respectively. There were no impairment charges related to the Company’s strategic investments during the three months ended March 31, 2007 and 2006. NOTE 6 – RESTRUCTURING AND OTHER CHARGES In January 2007, the Company’s board of directors approved a restructuring program, which included a workforce reduction, a restructuring of certain business functions and an abandonment of certain facilities. The workforce reduction resulted in a charge of $1.3 million. All affected employees were notified of their termination prior to March 31, 2007. The restructuring of certain business functions included the cancellation of certain service contracts and asset losses, resulting in a charge of $0.5 million. The abandonment of certain leased facilities resulted in a charge of $0.4 million. A summary of restructuring activities follows (in thousands):
The Company has accounted for its restructuring charges and accruals in accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” and its asset impairment charges in accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.”
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Table of ContentsNOTE 7 – EARNINGS PER SHARE Basic net earnings per share (“EPS”) is computed using the weighted average number of common shares outstanding during the period. Diluted EPS is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period except for periods of operating loss for which no common share equivalents are included because their effect would be anti-dilutive.
The following weighted average potential common shares were excluded from the computation of diluted net earnings per share as their effect would have been anti-dilutive:
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Table of ContentsNOTE 8 – COMPREHENSIVE INCOME The components of comprehensive income, net of taxes, are as follows (in thousands):
NOTE 9 – RECENT ACCOUNTING PRONOUNCEMENTS In February 2007, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits companies to choose to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS 159 is effective for the company beginning in the first quarter of fiscal year 2008, although earlier adoption is permitted. The company is currently evaluating the impact that SFAS 159 will have on its consolidated financial statements. NOTE 10 – INCOME TAXES The Company recorded income tax expense of $0.9 million and $6.3 million for the three months ended March 31, 2007 and 2006, respectively. The Company calculates income tax expense based upon an annual effective tax rate forecast, including estimates and assumptions that could change during the year. The Company recorded a discrete tax expense of $3.6 million during the first quarter of 2006 to reflect a change in estimate of income tax accrued on an intercompany asset transfer. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible, as well as tax planning strategies. Based on projections of future taxable income over the periods in which the deferred tax assets are deductible and the history of the Company’s profitability, management believes that it is more likely than not that the Company will realize the benefits of these deductible differences, net of valuation allowances as of March 31, 2007. There were no adjustments to the valuation allowance balance in the three months ended March 31, 2007. The Company adopted FIN 48 effective January 1, 2007. As a result of adopting FIN 48, the Company recorded a credit of approximately $16.3 million to additional paid-in-capital as of January 1, 2007. As of the adoption date, the Company had gross tax effected unrecognized tax benefits of $35.6 million which, if recognized, would affect the effective tax rate. Also as of the adoption date, the Company had accrued interest expense related to unrecognized tax benefits of $4.5 million. During the first quarter of 2007 the Company reclassed $40.1 million from current taxes payable to non-current taxes payable. The Company recognized accrued interest related to unrecognized tax benefits in interest expense. Penalties, if incurred, would be recognized as a component of income tax expense.
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Table of ContentsThe Company conducts business globally and, as a result, files U.S. federal, state and foreign income tax returns in various jurisdictions. In the normal course of business, the Company is subject to examination by taxing authorities throughout the world, including such major jurisdictions as Japan, the Netherlands, the United.Kingdom and the U.S. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations for years before 2003. The Company is currently under audit by the Internal Revenue Service for the 2003 and 2004 tax years. NOTE 11 – SEGMENT AND GEOGRAPHIC INFORMATION The Company has two reportable segments: Entertainment Technologies and Software Technologies. Entertainment Technologies’ revenues are derived from licensing various digital content value management products and services to video, music, and PC games content owners. Entertainment Technologies’ products include content protection and rights management solutions for optical discs; digital set top boxes for cable/satellite TV; a variety of PC and consumer electronics video playback and record devices; digital distribution services for games; peer-to-peer networks; and entertainment networking solutions. The Video product group includes content protection and rights management solutions for optical discs and digital set top boxes. The Other product group of Entertainment Technologies includes content protection and rights management solutions for PC and consumer electronics video playback and record devices; digital distribution services for games; peer to peer networks; and entertainment networking solutions. The Software Technologies segment licenses various software products and services to independent software vendors and enterprise IT departments. Software Technologies’ products include the FLEXnet suite of electronic license management, electronic license delivery, and software asset management products; Installer Products; Update Service; Admin Studio; and RightCommerce licensing and access control solutions. Revenue by Significant Product Group:
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Table of ContentsSegment income: Segment income is based on the reportable segment’s revenue less the respective segment’s cost of revenues, selling and marketing expenses and research and development expenses. The following table summarizes operating results for each reportable segment and further reconciled to pretax income:
Information on Revenue by Geographic Areas:
Geographic area information is based upon country of destination for products shipped and country of contract holder for royalties and license fees. NOTE 12 – COMMITMENTS AND CONTINGENCIES Lease Commitments The Company leases its facilities and certain equipment pursuant to noncancelable operating lease agreements expiring through 2017. The Company’s corporate headquarters are located in Santa Clara, California and such leases expire in January 2017. The Company also leases office space, including those located in Illinois, New York, the United Kingdom and Japan, which expire at various dates from 2008 through 2016. The Company has recorded rent expense on a straight-line basis based on contractual lease payments. Allowances from lessors for tenant improvements have been included in the straight-line rent expense for applicable locations. Tenant improvements are capitalized and depreciated over the remaining life of the applicable lease. The Company also leases certain computer software under a capital lease agreement which expires on March 1, 2009. The current and long-term portions of the capital lease have been recorded in “Accrued expenses” and “Other non current liabilities,” respectively, on the condensed consolidated balance sheet as of March 31, 2007. Amortization of assets recorded under the capital lease is included in depreciation expense.
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Table of ContentsFuture minimum lease payments pursuant to these leases as of March 31, 2007 were as follows (in thousands):
Indemnifications In the normal course of business, the Company provides indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of the Company’s products. Historically, costs related to these indemnification provisions have not been significant and the Company is not able to estimate the maximum potential impact of these indemnification provisions on its future results of operations. Restricted Cash and Investments For one of our products, the Company has offered a maximum indemnity of $12.0 million to a collective group of customers under current contracts. Funds totaling $12.0 million have been segregated from the rest of the Company’s cash and investments and are restricted to use for customer claims under such indemnification provisions. Legal Proceedings The Company has not been required to pay a penalty to the Internal Revenue Service (“IRS”) for failing to make disclosures required with respect to any transaction that has been identified by the IRS as abusive or that has a significant tax avoidance purpose. The Company is involved in legal proceedings related to some of its intellectual property rights. USPTO Interference Proceedings Between Macrovision Corporation and Intertrust Technologies A patent interference is declared by the United States Patent and Trademark Office (“USPTO”) when two or more parties claim the same patentable invention. In the United States, the party who can prove earliest inventorship is granted the patent. The Company received notice on September 4, 2003 that the USPTO had declared an interference between our U.S. Patent No. 5,845,281 (“the ‘281 patent”) together with two of our continuation applications, and a patent application from Intertrust Technologies Corporation (“Intertrust”). On or about December 28, 2005, the Board of Patent Appeals (“BPA”) issued its final ruling in the case, holding that the ‘281 patent had priority over the two Intertrust patent applications at issue, but also that the inventor of the ‘281 patent had committed inequitable conduct during the prosecution of that patent. As a result of this decision, the Company’s ‘281 patent was rendered unenforceable.
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Table of ContentsOn December 19, 2003, the Company received notice from the USPTO declaring another interference, this time between two of its patent applications and four of Intertrust’s patents. On or about April 11, 2005, the BPA issued its final ruling, holding that the Intertrust patents had priority over the Company’s two applications at issue. Intertrust and Macrovision filed lawsuits on July 28, 2006 and July 31, 2006, respectively, in the U.S. District Court for the Northern District of California against the other party, seeking to overturn the BPA’s rulings adverse to the parties in the two interference proceedings. The parties are engaged in discovery and motion practice. The Company has a family of international patents and patent applications related to the U.S. cases involved in the interference. The U.S. patent interference affects only U.S. patents and U.S. pending patent applications, not the international cases which have been granted or are proceeding to grant in Europe and Japan. InstallShield Software Corporation Liquidating Trust vs. Macrovision On October 27, 2005, the Company received notice of an arbitration proceeding filed by InstallShield Software Corporation Liquidating Trust (the “Trust.”) The Trust has demanded arbitration of certain disputes between the Trust and Macrovision pursuant to the Asset Purchase Agreement dated June 16, 2004 by and among InstallShield Software Corporation, Macrovision Corporation, Macrovision Europe Limited, and Macrovision International Holding L.P. (the “Agreement”). Under the Agreement, the Company could have been required to make an additional contingent payment of up to $20 million based on post-acquisition revenue performance through June 30, 2005. Based upon the revenue results through June 30, 2005, the Company concluded that no additional payment was required under the terms of the Agreement. The Trust alleges that the post-acquisition revenue performance targets were not reached due to the Company’s conduct in violation of the Agreement, and therefore is seeking the contingent payment in an amount exceeding $15 million. The Company denies these allegations and intends to vigorously defend itself in the arbitration proceeding. The parties are engaged in discovery and no date has yet been set for the hearing. Macrovision vs. Wise Solutions, Inc. and Altiris Inc. On November 21, 2006, the Company filed a lawsuit in the United States District Court for the Northern District of California against Wise Solutions, Inc. and Altiris, Inc., alleging infringement of two of our patents. The patents involved are: U.S. Patent No. 5,671,412 entitled “License Management System for Software Applications” and U.S. Patent No. 5,390,297 entitled “System for Controlling the Number of Concurrent Copies of a Program in a Network Based on the Number of Available Licenses.” The lawsuit further alleges Wise and Altiris tortiously interfered with Macrovision’s economic relationships with its customers and seeks a declaratory judgment from the court that Macrovision does not infringe Wise’s U.S. Patent No. 7,028,019 (“the ‘019 patent”). On January 5, 2007, the defendants counterclaimed, alleging that Macrovision’s products infringe both the ‘019 patent and Altiris’ U.S. Patent No. 7,065,566. The parties entered into a settlement agreement effective April 6, 2007 providing for certain cross-releases. Stock Option Inquiries In addition to the aforementioned intellectual property litigation matters, on June 13, 2006 and June 28, 2006, the Company announced that it had been contacted by the Securities and Exchange Commission (SEC) and had received a subpoena from the U.S. Attorney’s Office, respectively, each requesting information relating to the Company’s stock option practices. By letter dated October 24, 2006, the SEC
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Table of Contentsinformed the Company that its investigation into the matter has been terminated without enforcement action being recommended to the Commission. By letter dated January 11, 2007, the U.S. Attorney’s Office informed the Company that it withdrew its subpoena. The Internal Revenue Service has requested information relating to the Company’s stock option granting practices in connection with its current examination of the Company’s 2003 and 2004 federal tax returns. The Company believes that the findings of this review of stock option practices has no material impact on the financial statements included in this report or on any previously issued financial statements. As of March 31, 2007, for all the abovementioned matters, it was not possible to estimate the liability, if any, in connection with the pending matters. Accordingly, no accruals for these contingencies have been recorded. From time to time, the Company has been involved in other disputes and legal actions arising in the ordinary course of business. In management’s opinion, none of these other disputes and legal actions is expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
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The following commentary should be read in conjunction with the financial statements and related notes contained in our Annual Report on Form 10-K for the year ended December 31, 2006 as filed with the SEC. Overview Macrovision Corporation, a Delaware corporation founded in 1983, enables businesses reliant on the deployment of software or content to protect, enhance, or distribute their offering among digital distribution channels and destination devices. These digital lifecycle management solutions include anti-piracy and content protection technologies and services, digital rights management products and technologies, embedded licensing technologies, usage monitoring for enterprises, access control and billing, and several other related technologies and services from installation to update to back-office entitlement management. We market the FLEXnet licensing platform and the InstallShield suite of software installation, repackaging, and update solutions. We also operate a game network for digital distribution of downloadable PC games, and market our Rights products, which enable the sale and security of digital goods and services, such as text, audio, video, streaming media, games and applications. Our customers consist of entertainment content producers such as motion picture studios, software and PC games publishers, hardware manufacturers, consumer electronic firms, personal computer manufacturers, digital set-top box manufacturers, digital pay-per-view and video-on-demand network operators, publication companies and enterprise information technology organizations. In January 2007, we acquired Mediabolic, a provider of software solutions for connected consumer electronics devices, such as televisions, set-top boxes and digital video recorders. We report our revenues by our two segments: Entertainment Technologies and Software Technologies. Entertainment Technologies’ revenues are derived from licensing various digital content management products and services to video and PC games content owners. Entertainment Technologies’ products include content protection and rights management solutions for optical discs; digital set top boxes for cable/satellite TV; a variety of PC and consumer electronics video playback and record devices; digital distribution services for games; peer-to-peer networks; and entertainment networking solutions. Software Technologies’ revenues are derived from licensing various software products and services to independent software vendors and enterprise IT departments. Software Technologies’ products include the FLEXnet suite of electronic license management, electronic license delivery, and software asset management products; Installer Products; Update Service; Admin Studio; and RightCommerce licensing and access control solutions in our Software Technologies Segment. products.
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Table of ContentsThe following table provides revenue information by segment for the periods indicated (dollars in thousands):
Entertainment Technologies Our Entertainment Technologies generate revenues from the home video divisions of member companies of the MPAA, videocassette duplication and DVD replication companies and a number of “special interest” content owners, such as independent producers of exercise, sports, educational, documentary and corporate video programs. We typically receive per unit royalties based upon the number of copy-protected DVDs that are produced by MPAA studios or other content owners. Our Entertainment Technologies also generate revenues from licensing digital PPV and VOD content protection solutions to satellite and cable system operators and equipment manufacturers that supply cable and satellite industries. Most of our PPV content protection revenues are generated from royalties on digital set top boxes. We also receive one-time and annual license fees from set top box, DVD, and personal video recorder manufacturers. Support costs related to these one-time and annual licensing fee arrangements are not significant. We also receive transaction fees from PPV and VOD systems when they activate our technology to protect specific PPV or VOD programs. In addition, our Entertainment Technologies generate revenues from customers implementing our CD-ROM copy protection technology on PC games and peer to peer anti-piracy services. We are also a provider of secure digital distribution services and the operator of the largest distribution network for downloadable games. In January 2007, we acquired Mediabolic, a provider of software solutions for connected consumer electronics devices, such as televisions, set-top boxes and digital video recorders. The acquisition of Mediabolic extends our capabilities in the delivery and enhancement of digital content to a wide variety of connected consumer electronics devices for the digital home. Mediabolic’s results are reported as part of our Entertainment Technologies segment. Revenues from our Entertainment Technologies increased $6.0 million, or 19% from the first quarter of 2006 to the first quarter of 2007, due primarily to the growth of our hardware licensing products. We actively engage in intellectual property compliance and enforcement activities focused on identifying third parties who have under reported to us the amount of royalties owed under license
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Table of Contentsagreements with us. As a result, from time to time, we may not receive timely replicator reports, and therefore, we may recognize revenues that relate to activities from prior periods. These royalty recoveries may cause revenues to be higher than expected during a particular reporting period and may not occur in subsequent periods. We cannot predict the amount or timing of such revenues. As we sign new contracts and generate more business for our Hawkeye, RipGuard DVD™ and ActiveMARK products, we anticipate that future revenues from our Entertainment Technologies will increase in absolute terms and continue to be a significant part of our revenues, but may vary as a percentage of our total revenues. Software Technologies Our Software Technologies generate revenues from licensing software solutions and providing services related to the support and maintenance of this software. Revenues from our Software Technologies increased $2.2 million or 8% from the first quarter of 2006 to the first quarter of 2007. The increase in our Software Technologies’ revenue is primarily due to the growth of our customer base. We believe that revenues from our Software Technologies will continue to increase in the future in absolute terms, but may vary as a percentage of our total revenues. Seasonality of Business We have experienced significant seasonality in our business, and our consolidated financial condition and results of operations are likely to be affected by seasonality in the future. We have typically experienced our highest revenues in the fourth quarter of each calendar year. We believe that this trend in our Entertainment Technologies business has been principally due to the tendency of certain of our customers to manufacture and release new video and PC games titles during the year-end holiday shopping season, while our operating expenses are incurred more evenly throughout the year. In our Software Technologies business, we have found that typical software and enterprise customers tend to spend up to one-third of their annual capital budgets in the fourth calendar quarter. Costs and Expenses Our cost of revenues for our Entertainment Technologies consists primarily of replicator fees, Hawkeye service costs, ActiveMARK service costs and patent related expense. Fees paid to licensed duplicators and replicators that produceDVDs and CDs for content owners include fees paid to help offset costs of reporting copy protected volumes and costs of equipment used to apply our technology. Hawkeye and ActiveMARK service costs include customer support, hosting, bandwidth and equipment maintenance costs. Our cost of revenues for our Software Technologies includes software product support costs, direct labor and benefit costs of employees’ time spent on billable consulting or training, the cost of producing and shipping CDs containing our software and certain license fees paid to third parties. Cost of revenues also includes amortization of intangibles from acquisitions. Our research and development expenses are comprised primarily of employee compensation and benefits, tooling and supplies and an allocation of overhead and facilities costs. Our selling and marketing expenses are comprised primarily of employee compensation and benefits, travel, advertising and an allocation of overhead and facilities costs. Our general and administrative expenses are comprised primarily of employee compensation and benefits, travel, accounting and tax fees and an allocation of overhead and facilities costs.
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Table of ContentsCritical Accounting Policies and Use of Estimates The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements. These condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, equity-based compensation, valuation of strategic investments, goodwill and intangible assets, impairment of long lived assets and income taxes. Our estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. Other than the critical accounting policy described below, there have been no significant changes in our critical accounting estimates during the three months ended March 31, 2007 as compared to those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006. Income Taxes We account for income taxes using the asset and liability method of SFAS 109, “Accounting for Income Taxes.”. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year and for deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. We account for uncertainty in income taxes using the cumulative probability method under FIN48. Management must make assumptions, judgments and estimates to determine our current provision for income taxes, our deferred tax assets and liabilities and any valuation allowance to be recorded against a deferred tax asset, and for unrecorded tax benefits resulting from uncertain tax positions. Our judgments, assumptions and estimates relative to the current provision take into account current tax laws, our interpretation of current tax laws and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. Changes in tax law or our interpretation of tax laws and the resolution of current and future tax audits could significantly impact the amount provided for income taxes in our consolidated financial statements.
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Table of ContentsResults of Operations The following tables present our condensed consolidated statements of income compared to the prior year periods.
License Revenues. Our license revenues increased $3.4 million, or 8%, from the first quarter of 2006 to the first quarter of 2007 primarily due to $5.6 million increase from the growth in hardware licensing due to strong demand from consumers, especially in international territories, for digital cable and digital satellite operators’ businesses. This was partially offset by a decrease in license revenues from our Software Technologies products. Service Revenues. Our service revenues increased $4.7 million, or 40%, from the first quarter of 2006 to the first quarter of 2007 primarily due to the growth of our core software solutions and a growing customer base.
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Table of ContentsCost of Revenues – License Fees. Cost of revenues from license fees as a percentage of license revenues was comparable to the prior year’s first quarter at 4%. Cost of Revenues – Service Fees. Cost of revenues from service fees as a percentage of service revenues increased from 56% in the first quarter of 2006 to 62% for the first quarter of 2007. Cost of revenues from service fees increased $3.6 million from $6.7 million in the first quarter of 2006 to $10.4 million in the first quarter of 2007. The increases were primarily due to $1.9 million increase in costs related to our digital distribution services and $1.4 million increase in support and service costs related to operations acquired through eMeta. We anticipate our cost of revenues from service fees may increase as we continue to increase activity in our service products and expand our customer base. Cost of Revenues – Amortization of Intangibles from Acquisitions. Cost of revenues from amortization of intangibles increased $0.4 million primarily due to the amortization of intangibles from the acquisition of Mediabolic in January 2007. Research and Development. Research and development expenses increased by $2.4 million, or 19%, from $12.7 million in the first quarter of 2006 to $15.1 million in the first quarter of 2007, primarily due to increased costs related to the acquisitions of Mediabolic and eMeta. Research and development expenses increased as a percentage of net revenues from 22% in the first quarter of 2006 to 23% in the first quarter of 2007. We expect research and development expenses to increase in absolute terms over the prior year period as a result of expected increases in research and development activity to support our new technologies, but decrease as a percentage or net revenues. Selling and Marketing. Selling and marketing expenses increased by $1.8 million, or 11%, from $16.9 million in the first quarter of 2006 to $18.7 million in the first quarter of 2007, primarily due to an increase in costs related to the acquisitions of Mediabolic and eMeta. Selling and marketing expenses, as a percentage of net revenues, decreased from 30% in the first quarter of 2006 to 29% in the first quarter of 2007. We expect selling and marketing expenses to increase in absolute terms and vary as a percentage of total revenues as we continue our efforts to increase our market share and grow our business. General and Administrative. General and administrative expenses increased by $0.9 million, or 11%, from $8.8 million in the first quarter of 2006 to $9.7 million in the first quarter of 2007, primarily due additional headcount to support the overall growth of the business. General and administrative expenses as a percentage of net revenues was consistent with the prior year’s quarter at 15%. We expect our general and administrative expenses to increase in absolute terms and vary as a percentage of total revenues as we continue our efforts to grow our business. Restructuring and other charges. In January 2007, the Company’s board of directors approved a restructuring program, which included a workforce reduction, a restructuring of certain business functions and an abandonment of certain facilities. The workforce reduction resulted in a charge of $1.3 million. All affected employees were notified of their termination prior to March 31, 2007. The restructuring of certain business functions included the cancellation of certain service contracts and asset losses, resulting in a charge of $0.5 million. The abandonment of certain leased facilities resulted in a charge of $0.4 million. Interest and Other Income, Net. Interest and other income increased $0.9 million, or 42%, from $2.0 million in the first quarter of 2006 to $2.9 million in the first quarter of 2007. In August 2006, we issued $240 million in principal amount of 2.625% convertible senior notes due 2011. Proceeds from the convertible senior notes resulted in higher invested balances and an increase in interest income of $2.6 million, partially offset by an increase in interest expense of $2.0 million. Income Taxes. We recorded income tax expense of $6.3 million and $0.9 million for the first quarters of 2006 and 2007, respectively. Income tax expense represents combined federal, foreign and state taxes at effective rates of 72% and 13% for the first quarters of 2006 and 2007, respectively. The change in effective tax rate in 2007 compared to 2006 was primarily due to the difference in tax charges for profits generated by our foreign operations and a discrete tax expense of $3.6 million during the first quarter of 2006 to reflect a change in estimate of income tax accrued on an intercompany asset transfer.
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Table of ContentsLiquidity and Capital Resources We have financed our operations primarily from cash generated by operations, principally our content protection products and our software products. Our operating activities provided net cash of $21.3 and $22.2 million in the first quarters of 2006 and 2007, respectively. Cash provided by operating activities increased $0.9 million from the first quarter of 2006 to the first quarter of 2007, primarily due to an increase in net income, adjusted for non-cash expenses such as depreciation, amortization and equity-based compensation. To a lesser extent, the increase was due to an increase in customer collections, partially offset by an increase in liabilities. The availability of cash generated by our operations in the future could be affected by other business risks including, but not limited to, those factors set forth under the caption “Risk Factors” contained in this Quarterly Report in Item 1A. We used $53.4 million less cash for investing activities in the first quarter of 2007 than in the first quarter of 2006. Although the acquisition of Mediabolic was effective January 1, 2007, we paid $40.2 million in cash consideration during 2006. As a result, cash used during the first quarter of 2007 decreased from the first quarter of 2006, primarily due to the acquisition of eMeta in the first quarter of 2006. We made capital expenditures of $3.5 million and $2.0 million in the first quarter of 2006 and 2007, respectively, primarily for computer software and hardware. Net cash provided by financing activities decreased $2.7 million, from $9.4 million in the first quarter of 2006 to $6.7 million in the first quarter of 2007, primarily due to a decrease in cash proceeds from stock option exercises and employee stock purchases. In May 2002, our Board of Directors authorized a stock repurchase program, which allows us to purchase up to 5.0 million shares of common stock in the open market from time-to-time at prevailing market prices, through block trades or otherwise, or in negotiated transactions off the market, at the discretion of our management. In 2002, we repurchased 3.0 million shares of common stock under this program, which have been recorded as treasury stock and resulted in a reduction of stockholders’ equity. In August 2006, our Board of Directors authorized the purchase of up to $100 million of our common stock from time-to-time (inclusive of the stock repurchase program mentioned above). In connection with our offering of 2.625% Convertible Senior Notes due 2011, our Board authorized the purchase of up to $50 million of our common stock under this new stock repurchase program. In the year ended December 31, 2006, we repurchased approximately 2.3 million shares of common stock for $50.0 million, which was recorded as treasury stock and resulted in a reduction of stockholders’ equity. As of March 31, 2007, treasury stock consisted of 5.3 million shares of common stock that we had repurchased, with a cost basis of approximately $88.4 million. March 31, 2007, we had $165.2 million in cash and cash equivalents, $165.2 million in short-term investments, and $152.9 million in long-term marketable investment securities, which includes $20.4 million in fair market value of our holdings in Digimarc. We anticipate that capital expenditures for the remainder of the year will aggregate approximately $11.0 million in order to support the growth of our business and strengthen our operations infrastructure. We have future minimum lease payments of approximately $67.3 million under operating and capital leases. We believe that the current available funds and cash flows generated from operations will be sufficient to meet our working capital and capital expenditure requirements for the foreseeable future. We may also use cash to acquire or invest in additional businesses or to obtain the rights to use certain technologies in the future. During the first quarter of 2007, we reclassed $40.1 million from current taxes payable to non-current taxes payable. In February 2007, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits companies to choose to measure certain financial instruments
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Table of Contentsand certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS 159 is effective for us beginning in the first quarter of fiscal year 2008, although earlier adoption is permitted. We are currently evaluating the impact that SFAS 159 will have on our consolidated financial statements.
We are exposed to financial market risks, including changes in interest rates, foreign currency exchange rates and security investments. Changes in these factors may cause fluctuations in our earnings and cash flows. We evaluate and manage the exposure to these market risks as follows: Fixed Income Investments. We have an investment portfolio of fixed income securities, including those classified as cash equivalents, short-term investments and long-term marketable investment securities of $392.9 million as of March 31, 2007. Most of these securities are subject to interest rate fluctuations. An increase in interest rates could adversely affect the market value of our fixed income securities. We do not use derivative financial instruments in our investment portfolio to manage interest rate risk. We limit our exposure to interest rate and credit risk, however, by establishing and strictly monitoring clear policies and guidelines for our fixed income portfolios. The primary objective of these policies is to preserve principal while at the same time maximizing yields, without significantly increasing risk. A hypothetical 50 basis point increase in interest rates would result in an approximate $1.3 million decrease (approximately 0.3%) in the fair value of our fixed income available-for-sale securities as March 31, 2007. Yield risk is also reduced by targeting a weighted average maturity of our portfolio at 12 months so that the portfolio’s yield regenerates itself as portions of the portfolio mature. Foreign Currency Exchange Rates. Due to our reliance on international and export sales, we are subject to the risks of fluctuations in currency exchange rates. Because a substantial majority of our international and export revenues, as well as expenses, are typically denominated in U.S. dollars, fluctuations in currency exchange rates could cause our products to become relatively more expensive to customers in a particular country, leading to a reduction in sales or profitability in that country. Many of our subsidiaries operate in their local currency, which mitigates a portion of the exposure related to the respective currency collected. Strategic Investments. We currently hold interests in a number of companies. These investments, at book value totaling $25.4 million and $22.7 million, represented 3.0% and 2.8% of our total assets as of March 31, 2007 and December 31, 2006, respectively. In 2006, we made a $5.0 million investment in a privately-held digital watermarking company for strategic purposes. As of March 31, 2007, the adjusted cost of our strategic investments consisted of our investment in Digimarc, a publicly traded company, and our investment in the privately-held digital watermarking company. In addition, we hold investments in a number of other privately held companies, which have no carrying value as of March 31, 2007. Digimarc is subject to price fluctuations based on the public market. Because there is no active trading market for the securities of privately held companies, our investments in them are illiquid. As such, we may never have an opportunity to realize a return on our investment in these private companies, and we may in the future be required to write off all or part of one or more of these investments. Long-term Debt. The fair market value of the 2.625% convertible senior notes is subject to interest rate market price risk and equity risk due to the convertible feature of the notes and other factors. Generally the fair market value of fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise. The fair market value of the notes will also increase as the market price of our stock rises and decrease as the market price of the stock falls. Interest rate and market value changes affect the fair market value of the notes but do not impact our financial position, cash flows or results of operations.
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Table of ContentsThe notes may be converted, under certain circumstances, based on an initial conversion rate of 35.3571 shares of common stock per $1,000 principal amount of notes (which represents an initial conversion price of approximately $28.28 per share), into an aggregate of 8.5 million shares. Prior to June 15, 2011, holders may convert their notes into cash and our common stock, at the applicable conversion rate, under any of the following circumstances: 1) during any fiscal quarter after the calendar quarter ending September 30, 2006, if the last reported sale price of our common stock for at least 20 trading days during the 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 120% of the applicable conversion price in effect on the last trading day of the immediately preceding fiscal quarter; 2) during the five business-day period after any ten consecutive trading-day period (the “measurement period”) in which the trading price per note for each day of such measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such day; or 3) upon the occurrence of specified corporate transactions, as defined in the indenture. On and after June 15, 2011 until the close of business on the scheduled trading day immediately preceding the maturity date of August 15, 2011, holders may convert their notes into cash and shares of our common stock, if any, at the applicable conversion rate, at any time, regardless of the foregoing circumstances. In addition, in the event of a significant change in our corporate ownership or structure, the holders may require us to repurchase all or any portion of their notes for 100.00% of the principal amount.
Evaluation of Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with participation of management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). In evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report. Changes in Internal Controls over Financial Reporting. During the quarter ended March 31, 2007, there have been no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, these controls.
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Table of ContentsPART II. OTHER INFORMATION
We have not been required to pay a penalty to the Internal Revenue Service (“IRS”) for failing to make disclosures required with respect to any transaction that has been identified by the IRS as abusive or that has a significant tax avoidance purpose. We are involved in legal proceedings related to some of our intellectual property rights. USPTO Interference Proceedings Between Macrovision Corporation and Intertrust Technologies A patent interference is declared by the United States Patent and Trademark Office (“USPTO”) when two or more parties claim the same patentable invention. In the United States, the party who can prove earliest inventorship is granted the patent. We received notice on September 4, 2003 that the USPTO had declared an interference between our U.S. Patent No. 5,845,281 (“the ‘281 patent”) together with two of our continuation applications, and a patent application from Intertrust Technologies Corporation (“Intertrust”). On or about December 28, 2005, the Board of Patent Appeals (“BPA”) issued its final ruling in the case, holding that the ‘281 patent had priority over the two Intertrust patent applications at issue, but also that the inventor of the ‘281 patent had committed inequitable conduct during the prosecution of that patent. As a result of this decision, our ‘281 patent was rendered unenforceable. On December 19, 2003, we received notice from the USPTO declaring another interference, this time between two of its patent applications and four of Intertrust’s patents. On or about April 11, 2005, the BPA issued its final ruling, holding that the Intertrust patents had priority over the two applications at issue. Intertrust and Macrovision filed lawsuits on July 28, 2006 and July 31, 2006, respectively, in the U.S. District Court for the Northern District of California against the other party, seeking to overturn the BPA’s rulings adverse to the parties in the two interference proceedings. The parties are engaged in discovery and motion practice. We have a family of international patents and patent applications related to the U.S. cases involved in the interference. The U.S. patent interference affects only U.S. patents and U.S. pending patent applications, not the international cases which have been granted or are proceeding to grant in Europe and Japan. InstallShield Software Corporation Liquidating Trust vs. Macrovision On October 27, 2005, we received notice of an arbitration proceeding filed by InstallShield Software Corporation Liquidating Trust (the “Trust.”) The Trust has demanded arbitration of certain disputes between the Trust and Macrovision pursuant to the Asset Purchase Agreement dated June 16, 2004 by and among InstallShield Software Corporation, Macrovision Corporation, Macrovision Europe Limited, and Macrovision International Holding L.P. (the “Agreement”). Under the Agreement, we could have been required to make an additional contingent payment of up to $20 million based on post-acquisition revenue performance through June 30, 2005. Based upon the revenue results through June 30, 2005, we concluded that no additional payment was required under the terms of the Agreement. The Trust alleges that the post-acquisition revenue performance targets were not reached due to the our conduct in violation of the Agreement, and therefore is seeking the contingent payment in an amount exceeding $15 million. We deny these allegations and intend to vigorously defend ourselves in the arbitration proceeding. The parties are engaged in discovery and no date has yet been set for the hearing.
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Table of ContentsMacrovision vs. Wise Solutions, Inc. and Altiris Inc. On November 21, 2006, we filed a lawsuit in the United States District Court for the Northern District of California against Wise Solutions, Inc. and Altiris, Inc., alleging infringement of two of our patents. The patents involved are: U.S. Patent No. 5,671,412 entitled “License Management System for Software Applications” and U.S. Patent No. 5,390,297 entitled “System for Controlling the Number of Concurrent Copies of a Program in a Network Based on the Number of Available Licenses.” The lawsuit further alleges Wise and Altiris tortiously interfered with Macrovision’s economic relationships with its customers and seeks a declaratory judgment from the court that Macrovision does not infringe Wise’s U.S. Patent No. 7,028,019 (“the ‘019 patent”). On January 5, 2007, the defendants counterclaimed, alleging that Macrovision’s products infringe both the ‘019 patent and Altiris’ U.S. Patent No. 7,065,566. The parties entered into a settlement agreement effective April 6, 2007 providing for certain cross-releases. Stock Option Inquiries In addition to the aforementioned intellectual property litigation matters, on June 13, 2006 and June 28, 2006, we announced that we had been contacted by the Securities and Exchange Commission (SEC) and had received a subpoena from the U.S. Attorney’s Office, respectively, each requesting information relating to the Company’s stock option practices. By letter dated October 24, 2006, the SEC informed us that its investigation into the matter has been terminated without enforcement action being recommended to the Commission. By letter dated January 11, 2007, the U.S. Attorney’s Office informed us that it withdrew its subpoena. The Internal Revenue Service has requested information relating to our stock option granting practices in connection with its current examination of our 2003 and 2004 federal tax returns. We believe that the findings of this review of stock option practices has no material impact on the financial statements included in this report or on any previously issued financial statements. As of March 31, 2007, for all the abovementioned matters, it was not possible to estimate the liability, if any, in connection with the pending matters. Accordingly, no accruals for these contingencies have been recorded. From time to time, we have been involved in other disputes and legal actions arising in the ordinary course of business. In management’s opinion, none of these other disputes and legal actions is expected to have a material impact on our consolidated financial position, results of operations or cash flows.
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A description of the risk factors associated with our business is included under “Risk Factors” contained in Item 1A. of our 2006 Annual Report on Form 10-K and is incorporated herein by reference. There have been no material changes in our risk factors since the filing of our 2006 Annual Report on Form 10-K.
None.
None.
None.
None.
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Table of ContentsSIGNATURES In accordance with the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Macrovision Corporation Authorized Officer:
Principal Financial Officer and Principal Accounting Officer:
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