<PAGE>
Filed Pursuant to Rule 424(b)(4)
Registration No. 333-84033
6,500,000 Shares
[LOGO OF INTERTRUST]
Common Stock
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Before this offering, there has been no public market for the common stock.
The common stock has been approved for listing on The Nasdaq Stock Market's
National Market under the symbol ITRU.
Of the 6,500,000 shares for sale in this offering, the underwriters have
reserved, at our request, up to 1,300,000 shares for sale at the initial
public offering price to current and potential customers, others with whom we
do business, existing stockholders, employees, and friends of InterTrust. In
addition, the underwriters have an option to purchase a maximum of 975,000
additional shares to cover over-allotments of shares.
Investing in the common stock involves risks. See Risk Factors on page 7.
<TABLE>
<CAPTION>
Proceeds to
Underwriting InterTrust
Price to Discounts and Technologies
Public Commissions Corporation
------------ ------------- ------------
<S> <C> <C> <C>
Per Share.................................. $18.00 $1.26 $16.74
Total...................................... $117,000,000 $8,190,000 $108,810,000
</TABLE>
Delivery of the shares of common stock will be made on or about November 1,
1999.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
Credit Suisse First Boston
J.P. Morgan & Co.
Salomon Smith Barney
SoundView Technology Group
The date of this prospectus is October 26, 1999.
<PAGE>
Narrative Description of Inside Front Cover
In the center of the page is the InterTrust logo.
<PAGE>
Narrative Description of Gate Fold
Heading Bottom Centered InterTrust logo; centered heading at the top of the
page of "Digital Rights Management for Global Electronic Commerce."
There is a large platform with a waffle-like pattern suspended in space. The
platform is labeled "The MetaTrust Utility." In the center of the platform are
two buildings. The building on the left is marked with the symbol "$" in a
circle. The building on the right is marked with the letter "i" in a circle.
Above the buildings is the caption "8. Commerce Services Provider" and text that
reads: "Providers process financial transactions and usage information from
online and offline transactions, and deploy and manage InterRights Points."
From the building on the left, two arrows marked with the symbol "$" in a circle
point to a caption off the bottom of the platform that read "Partners" and to
the InterTrust logo, respectively. To the right of the arrows are the captions
"Payment" and "InterTrust Revenues = percentage of value of all goods and
services sold in system."
Also from the building on the left, an arrow marked with the symbol "$" in a
circle and the letter "i" in a circle points up to a web browser. An identical
arrow points to a human figure next to a computer monitor showing a three-
dimensional cube on its screen. Below is a sphere with three arrows meeting in
its center. Above is the heading "1. Publisher" above text that reads:
"Publishers package content and associated usage rules in a secure DigiBox
Container." Below is the caption "InterRights Point." Next to the arrow is the
caption "9. Payment and Usage Information" above the text "Everyone who is
supposed to get paid, gets paid, and everyone who is entitled to usage
information, gets it."
Above and to the left is a list under the heading "Target Markets." Below the
heading is the following: the symbol for musical notes in a circle to the left
of the caption "Music;" a drawing of a strip of film inside a circle to the left
of the caption "Videos;" a drawing of a video game joystick to the left of the
caption "Games;" a drawing of a computer disk inside a circle to the left of the
caption "Software;" a drawing of a financial chart inside a circle to the left
of the caption "Business/Financial Information;" a drawing of sheets of paper
inside a circle to the left of the caption "Publishing;" a drawing of a
graduate's cap inside a circle to the left of the caption "Education;" a drawing
of a cross inside a circle to the left of the caption "Healthcare;" and a
drawing of two arrows pointing in two different directions inside a circle to
the left of the caption "Enterprise."
From the computer monitor an arrow points to the right. In the middle of the
arrow is a three dimensional cube. Above the cube is the heading "2. DigiBox
Container" and text that reads "The DigiBox container protects the content and
reduces piracy." The arrow points to a sphere with three arrows meeting in its
center. To the right of the sphere is a web browser labeled "WWW." To the right
of the web browser is a compact disk and a floppy disk. Above the grouping is
the heading "3. Distributor" above text that reads "Distributors can add rules
and sell content contained in the DigiBox."
From the floppy disk, an arrow points down and to the right. In the middle of
the arrow is a three dimensional cube. Above the cube is the heading "4. DigiBox
Container" and text that reads "Distributors disseminate content over the
Internet, or on compact discs and DVDs." To the right of the cube is the caption
"5. User" and text that reads "Users see personalized offers, purchase content
online and offline, and use content according to the rules." The arrow points to
a sphere with three arrows meeting in its center. To the left of the sphere is
the caption "InterRights Point." To the right of the sphere is a human figure.
An arrow points from the figure to a group of three human figures. In the middle
of the arrow is a three dimensional cube. Beneath the cube is the caption
"Content and rules." Above the cube is the heading "DigiBox container." Next to
each of the three human figures are spheres with three arrows meeting in their
centers. Below the cube is the caption "6. Superdistribution" and text that
reads "Users can forward the content and rules to other users, and encourage
purchase and redistribution.
From the human figure, an arrow points downward and to the left. In the middle
of the arrow is a three dimensional cube. Beneath the cube is the caption
"DigiBox Container" and text that reads "7. Protects payment and usage
information." The arrow points to a sphere with three arrows meeting in its
center. Above the sphere is the caption "InterRights Point." To the left of the
sphere is the building marked with the letter "i" in a circle.
<PAGE>
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TABLE OF CONTENTS
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Page
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Prospectus Summary....................................................... 4
Risk Factors............................................................. 7
Special Note Regarding Forward-Looking Statements........................ 17
Use of Proceeds.......................................................... 17
Dividend Policy.......................................................... 17
Capitalization........................................................... 18
Dilution................................................................. 20
Selected Consolidated Financial Data..................................... 22
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 23
Business................................................................. 35
</TABLE>
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Page
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Management................................................................. 56
Related-Party Transactions................................................. 68
Principal Stockholders..................................................... 70
Description of Capital Stock............................................... 72
Shares Eligible for Future Sale............................................ 75
Underwriting............................................................... 77
Notice to Canadian Residents............................................... 80
Legal Matters.............................................................. 81
Experts.................................................................... 81
Where You Can Find More Information........................................ 81
Index to Consolidated Financial Statements................................. F-1
</TABLE>
------------
Dealer Prospectus Delivery Obligation
Until November 21, 1999, 25 days after the commencement of this offering,
all dealers that effect transactions in these securities, whether or not
participating in this offering, may be required to deliver a prospectus. This
is in addition to the dealer's obligation to deliver a prospectus when acting
as an underwriter and with respect to unsold allotments or subscriptions.
3
<PAGE>
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding InterTrust and the common stock being sold in this
offering in our consolidated financial statements and notes appearing elsewhere
in this prospectus and our risk factors beginning on page 7.
InterTrust Technologies Corporation
We have developed a general purpose digital rights management, or DRM,
platform to serve as a foundation for providers of digital information,
technology, and commerce services to participate in a global e-commerce system
for digital commerce. We license our DRM platform to partners to build digital
commerce services and applications. These partners intend to offer digital
commerce services and applications that collectively will form a global
commerce system, which we have branded as the MetaTrust Utility. We maintain
the MetaTrust Utility's foundation and will receive as a fee from our partners
a small percentage of the value of goods and services that run through the
system.
DRM technologies protect and manage rights and interests in digital
information. DRM is needed by any industry that distributes information that
can be put into digital form. These types of information include music, videos,
software, games, publications, business information, and images. DRM also
applies to organizations and individuals who want to protect the vast amount of
proprietary and personal information that has been computerized.
Our technology is designed to enable all these industries, organizations,
and individuals, and each of their constituencies, to protect and manage their
rights and interests in digital information. Holders of these rights and
interests can easily associate usage rules with the digital information and
persistently apply these rules throughout the lifecycle of the information.
When these rights and rules are based on a common foundation, they can form the
basis for a global system for digital commerce.
We believe our DRM platform represents a new computing technology that
addresses a key threat to digital commerce--the threat of a user who has been
authorized to receive and decrypt digital information and then seeks to use it
in an unauthorized way. Our DRM platform enables automation of many aspects of
the secure commercial exchange of digital information and is designed to allow
digital commerce to be conducted more efficiently.
We believe our platform provides the following benefits:
. robust security; . multiple content and media types;
. persistent protection and . efficient transaction processing;
management;
. new advertising models; and
. flexible business models;
. personalized marketing.
. superdistribution;
Our current partners include BMG Entertainment Storage Media, Computacenter,
Diamond Multimedia Systems, Matsushita Electric Industrial, Mediascience,
Mitsubishi Corporation, MusicMatch, National Westminster Bank, PublishOne,
Reciprocal, Samsung SDS, and Universal Music Group. We also have alliances with
Adobe Systems, Digital Theater Systems, Fraunhofer-Institut, Harris
Corporation, Portal Software, and Science Application Information Company. Some
4
<PAGE>
of our partners are conducting, or are planning to conduct, commercial trials,
and have announced that their applications and services will be commercially
available in the MetaTrust Utility in 2000.
Our goal is to empower multiple providers of content, technology, and
commerce services to build a global system for digital commerce based on our
DRM platform. The key elements of our strategy are to:
. expand our key strategic partnerships;
. promote widespread deployment of our technology;
. leverage our neutral MetaTrust Utility model; and
. maintain our technology lead.
We were incorporated in Delaware in January 1990. Our principal executive
offices are located at 4750 Patrick Henry Blvd., Santa Clara, California 95054,
and our telephone number is (408) 855-0100.
InterTrust, DigiBox, and our logo are our registered trademarks. MetaTrust,
MetaTrust Utility, InterRights, Powerchord, RightsWallet, and TrustMail are our
trademarks. This prospectus also contains trademarks of other companies.
----------------
Except as otherwise indicated, information in this prospectus is based on
the following assumptions:
. redesignation of our class A voting common stock as common stock upon the
closing of this offering;
. conversion of all outstanding shares of preferred stock and class B non-
voting common stock into shares of common stock upon the closing of this
offering;
. exercise of warrants to purchase 6,692 shares of our common stock
outstanding as of August 31, 1999;
. the filing of our sixth amended and restated certificate of incorporation
in the state of Delaware after completion of this offering; and
. no exercise of the underwriters' over-allotment option.
5
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THE OFFERING
<TABLE>
<C> <S>
Common stock offered by us................. 6,500,000 shares
Common stock to be outstanding after the 37,751,085 shares. This number is
offering.................................. based on the number of shares
outstanding as of June 30, 1999.
It excludes 6,741,411 shares of
common stock issuable upon the
exercise of options outstanding
as of June 30, 1999 at a weighted
average exercise price of $1.91
per share. It also excludes
325,000 shares of common stock
issuable upon the exercise of a
warrant with an exercise price of
$14.00 per share and 85,000
shares of common stock issued in
connection with our purchase and
license of technology. From July
1, 1999 through October 13, 1999,
we issued options to purchase
571,000 shares of common stock at
a weighted average exercise price
of $11.79.
Over-allotment option...................... 975,000 shares
Use of proceeds............................ General corporate purposes,
including working capital. For
more information about our use of
proceeds, please see the use of
proceeds section on page 17.
Dividend policy............................ Currently, we do not anticipate
paying cash dividends.
Nasdaq National Market symbol.............. ITRU
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL DATA
(in thousands, except per share data)
<TABLE>
<CAPTION>
Six Months
Years Ended December 31, Ended June 30,
--------------------------------------------- -----------------
1994 1995 1996 1997 1998 1998 1999
------- ------- ------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Consolidated Statements
of Operations Data:
Total revenues.......... $ 850 $ -- $ 25 $ 1,100 $ 152 $ 50 $ 486
Loss from operations.... (1,549) (3,423) (8,140) (11,938) (19,667) (9,369) (11,613)
Net loss................ (1,588) (3,583) (7,960) (11,709) (19,662) (9,378) (11,411)
Basic and diluted net
loss per share......... $ (0.16) $ (0.35) $ (0.67) $ (0.86) $ (1.41) $ (0.68) $ (0.75)
======= ======= ======= ======== ======== ======= ========
Shares used in computing
basic and diluted net
loss per share......... 9,645 10,223 11,913 13,639 13,966 13,777 15,307
======= ======= ======= ======== ======== ======= ========
Pro forma basic and
diluted net loss per
share.................. $ (0.91) $ (0.43)
======== ========
Shares used in computing
pro forma basic and
diluted net loss per
share.................. 21,688 26,808
======== ========
</TABLE>
<TABLE>
<CAPTION>
June 30, 1999
-----------------------------
Pro Forma
Actual Pro Forma As Adjusted
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<S> <C> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents......................... $15,295 $31,053 $138,713
Working capital................................... 11,970 28,728 136,388
Total assets...................................... 17,020 32,778 140,438
Total stockholders' equity........................ 4,645 21,403 129,063
</TABLE>
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The pro forma column in the consolidated balance sheet data table above
reflects the sale of 1,309,700 shares of series E preferred stock for
approximately $15.7 million in cash and the issuance of 83,333 shares of series
E preferred stock on the conversion of a $1.0 million promissory note in
July 1999, the exercise of warrants to purchase 21,692 shares of common stock
for an aggregate exercise price of $42,000 and the conversion of all
outstanding shares of preferred stock and class B non-voting common stock into
shares of common stock upon completion of this offering.
The pro forma as adjusted column in the consolidated balance sheet data
table above reflects our sale of 6,500,000 shares of common stock in this
offering, at an initial public offering price of $18.00 per share, and after
deducting underwriting discounts and commissions and estimated offering
expenses payable by us.
6
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RISK FACTORS
This offering and an investment in our common stock involve a high degree of
risk. You should carefully consider the following risk factors and the other
information in this prospectus before investing in our common stock. Our
business and results of operations could be seriously harmed by any of the
following risks. The trading price of our common stock could decline due to any
of these risks, and you might lose all or part of your investment.
Risks Related to Our Business
Our business model is new and unproven and we may not succeed in generating
sufficient revenue to sustain or grow our business.
Our business model is new and unproven and may not generate sufficient
revenue for us to be successful. The success of our business depends upon our
ability to generate transaction fees in the form of a percentage of fees
charged by our licensees in commercial transactions. However, our licensees
have not yet used our technology in the commercial distribution of their
products and we have not earned any transaction fees under this business model.
If our technology is commercially released, the volume of products and services
distributed using our technology may be too small to support or grow our
business. While some companies have licensed our technology, other companies
may wish to use other technology based on different business models, including
the payment of a one-time license fee without sharing in ongoing revenues. If
we are unable to generate revenues from transaction fees, our current revenues,
consisting of initial license fees and support fees, will be insufficient to
sustain our business.
Our quarterly operating results are volatile and difficult to predict. If we
fail to meet the expectations of public market analysts or investors, the
market price of our common stock may decrease significantly.
Our operating results have varied from period to period and, in some future
quarter or quarters, will likely fall below the expectations of securities
analysts or investors, causing the market price of our common stock to decline.
Our quarterly operating results may fail to meet these expectations for a
number of reasons, including:
. a quarterly decline in the overall demand for digital goods and services;
. a quarterly decline in the demand for our Commerce software product;
. our failure to quickly reduce costs in the event of unanticipated
declines in revenues in a given period;
. delays in the timing of licensing our Commerce software and services;
. the nature and types of our licensing arrangements;
. the inability of our licensees and their customers to commercialize our
technology, or delays or deferrals in this commercialization; and
. customer budget cycles and changes in these budget cycles.
7
<PAGE>
We have a history of losses, and we expect our operating expenses and losses to
increase significantly.
Our failure to increase our revenues significantly would seriously harm our
business. We have experienced operating losses in each quarterly and annual
period since inception, and we expect to incur significant and increasing
losses in the future. We incurred net losses of $8.0 million in 1996, $11.7
million in 1997, $19.7 million in 1998, and $11.4 million for the six months
ending June 30, 1999. As of June 30, 1999, we had an accumulated deficit of
$56.9 million. We expect to significantly increase our research and
development, sales and marketing, and general and administrative expenses. As a
result of these additional expenses, we must significantly increase our
revenues to become profitable. We expect to incur significant losses for at
least the next several years.
If third parties do not deploy our technology and create a market for digital
commerce, our business will be harmed.
Relationships with leading content, technology, and commerce service
providers are critical to our success. Our business and operating results would
be harmed to the extent our licensees fail, in whole or in part, to:
. deploy our technology;
. develop an infrastructure for the sale and delivery of digital goods and
services;
. generate transaction fees from the sale of digital content and services;
. develop and deploy new applications; and
. promote brand preference for InterTrust products and services and the
MetaTrust Utility.
We need to significantly increase the number of companies that license our
technology to sustain and grow our business.
We will not generate sufficient revenue to grow our business unless we
maintain relationships with existing licensees and significantly increase the
number of companies that license our technology and use it for the sale and
management of digital information and services. We have not yet attracted, and
may not in the future be able to attract, a sufficient number of these
companies. To date, only 13 companies have licensed our software for commercial
use. Our ability to attract new licensees will depend on a variety of factors,
including the following:
. the performance, reliability and security of our products and services;
. the scalability of our products and services--the ability to rapidly
increase deployment size from a limited number of end-users to a very
large number of end-users;
. the cost-effectiveness of our products and services; and
. our ability to market our products and services effectively.
8
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Our ability to attract new licensees will also depend on the performance of
our initial licensees and the overall success of the MetaTrust Utility. Many
potential licensees may resist working with us until our, and our licensees',
applications and services have been successfully introduced into the market and
have achieved market acceptance. We may not be able to attract a critical mass
of licensees that will develop products and establish clearinghouses and other
commerce services, and our licensees may not achieve the widespread deployment
of users we believe is necessary for us to become successful.
In addition, we may not be able to establish relationships with important
potential customers if we have already established relationships with their
competitors. Therefore, it is important that we are perceived as a neutral and
trusted technology and service provider. In addition, we require that products
and services operating within the MetaTrust Utility comply with specifications
administered by us. Potential licensees may be unwilling to be subject to the
control of these specifications.
The long and complex process of licensing our Commerce software could delay the
deployment of our technology and harm our business.
Licensing our Commerce software is a long and complex process. If initial
license fees are delayed or reduced as a result of this process, our future
revenue and operating results could be impaired. Before committing to license
our product, our licensees must generally consider a wide range of issues
including product benefits, installation and infrastructure requirements,
ability to work with existing computer systems, ability to support a large user
base, functionality, security, and reliability. The process of entering into a
licensing agreement with a company typically involves lengthy negotiations. As
a result of our long sales cycle, which in the past has generally ranged from
six months to 18 months, it is difficult for us to predict the quarter in which
a particular prospect might sign a license agreement.
Because our technology must be integrated into the products and services of our
licensees, there will be significant delay between our licensing the software
and our licensees' commercial deployment of their products and services, which
will delay our receipt of transaction fee revenue.
Our success depends upon the deployment of our technology by a potential
licensee in the use and sale of digital content. Our licensees undertake a
lengthy process of integrating our technology into their existing systems or a
new system. Until a licensee deploys our technology, we do not receive
transaction fees from that licensee.
We expect that the period between entering into a licensing arrangement and
the time our licensee commercially deploys applications based on our Commerce
software will be lengthy and will vary, which makes it difficult for us to
predict when revenue will be recognized.
Our Commerce software has only recently been used by our licensees in pilot
programs, making evaluation of our business and prospects difficult.
We began offering the general availability release of our Commerce software
in December 1998, and released version 1.2 in May 1999. Our licensees'
applications and services based on our Commerce software are in development or
have only been released for evaluation in very limited
9
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pilot programs. Our licensees have not yet commercially deployed their
applications or services. It is possible that we or our licensees may uncover
serious technical and other problems resulting in the delay or failure of the
commercial deployment of our licensees' implementation of our Commerce
software, including problems relating to security, the ability to support a
large user base, and interoperability of our software or the combination of our
software with our licensees' software. We may not successfully address any of
these problems and the failure to do so would seriously harm our business and
operating results.
Security breaches of our software and our licensees' software could result in
decreased demand for our technology by our licensees or their customers or in
litigation.
The secure transmission and trusted management of proprietary or
confidential information over the Internet are essential to establishing and
maintaining confidence in our Commerce software and the software and services
developed using our software. Without this confidence, potential or current
licensees may not use our technology and their customers may not trust and use
our licensees' products. Therefore, security concerns and security breaches of
our and our licensees' software could harm our business and operating results.
Advances in computer capabilities, new discoveries, or other developments could
result in a compromise or breach of the security technology, including
cryptography technology, that we and our licensees use to protect customer
digital content and transaction data. Security breaches could damage our
reputation and expose us to a risk of loss or litigation. Our insurance
policies have low coverage limits that may not be adequate to reimburse us for
losses caused by security breaches. We cannot guarantee that our security
measures will prevent security breaches.
Defects in our software and the software of our licensees could delay
deployment of our technology and reduce our revenues.
Defects or errors in current or future products could result in delayed or
failed deployment of our technology, lost revenues, or a delay in or failure to
achieve market acceptance, any of which could seriously harm our business and
operating results. Complex software products like ours often contain errors or
defects, including errors relating to security, particularly when first
introduced or when new versions or enhancements are released. Because this is a
system used for commerce, we believe the standards for reliability and
performance may be very high.
If our licensees' products and services contain errors or defects not
discovered in the process of development and pilot programs, it could seriously
undermine the perceived trust and security needed for a commercial system and
could delay or prevent market acceptance of digital commerce resulting in
serious harm to our business and operating results.
The deployment and use of our products expose us to substantial risks of
product liability claims because our products are expected to be used in
sensitive and valuable digital commerce transactions and because we require our
partners to comply with our specifications. Although our license agreements
typically contain provisions designed to limit our exposure to product
liability claims, it is possible that these limitations of liability provisions
may not be effective as a result of existing or future laws or unfavorable
judicial decisions. A product liability claim brought against us, even if not
successful, would likely be time consuming and costly to defend and could
significantly harm our business and operating results.
10
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If we are unable to continue obtaining third-party software and applications,
we could be forced to change our product offering or find alternative
suppliers, which could delay shipment of our product.
We integrate third-party software with our software. We would be seriously
harmed if the providers from which we license software ceased to deliver and
support reliable products, enhance their current products, or respond to
emerging industry standards. In addition, the third-party software may not
continue to be available to us on commercially reasonable terms or at all. The
loss of, or inability to maintain or obtain this software, could result in
shipment delays or reductions, or could force us to limit the features
available in our current or future product offerings. Either alternative could
seriously harm our business and operating results.
Year 2000 issues could force us to incur significant costs or cause our
customers to delay licensing of our products.
If our systems do not operate properly with date calculations involving the
year 2000 and subsequent dates, we could incur unanticipated expenses to remedy
any problems, which could seriously harm our business and operating results. We
may also experience reduced sales of our software and services as current or
potential customers reduce their budgets for enterprise software due to
increased expenditures on their own year 2000 compliance efforts. To the extent
our Commerce software is embedded with other companies' products that are not
year 2000 compliant, our reputation in the marketplace and use of our
technology by our partners could be harmed, both of which would harm our
business and operating results.
The market for digital rights management will be subject to rapid technological
change and new product introductions and enhancements that we may not be able
to address. We need to develop and introduce new products, technologies, and
services.
The market for digital rights management solutions is fragmented and marked
by rapid technological change, frequent new product introductions and
enhancements, uncertain product life cycles, and changes in customer demands.
To succeed, we must develop and introduce, in response to customer and market
demands, new releases of our Commerce software that offer features and
functionality that we do not currently provide. Any delays in our ability to
develop and release enhanced or new products could seriously harm our business
and operating results. In the past we have experienced delays in new product
releases, and we may experience similar delays in the future.
Our markets are highly competitive and we may not be able to compete
successfully against current or potential competitors, reducing our market
share and revenue growth.
Our markets are new, rapidly evolving, and highly competitive, and we expect
this competition to persist and intensify in the future. Our failure to
maintain and enhance our competitive position could reduce our market share and
cause our revenues to grow more slowly than anticipated or not at all. We
encounter current or potential competition from a number of sources, including:
. providers of secure digital distribution technology like AT&T, IBM,
Microsoft, Liquid Audio, Preview Systems, and Xerox;
. providers of hardware-based content metering and copy protection systems,
including Sony, Wave Systems, and the 4C Entity, comprised of IBM, Intel,
Matsushita, and Toshiba; and
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. operating system manufacturers, including Microsoft or Sun Microsystems,
that may develop or license digital rights management solutions for
inclusion in their operating systems.
Potential competitors may bundle their products or incorporate a digital
rights management component into existing products in a manner that discourages
users from purchasing our products. For example, we expect that future releases
of Microsoft's Windows operating system, which manages the programs on a
computer, will include components addressing digital rights management
functions. Furthermore, new competitors or alliances among competitors may
emerge and rapidly acquire significant market share. Our competitors may be
able to respond more quickly to new or emerging technologies and changes in
customer requirements than we do.
Some of our competitors have longer operating histories and significantly
greater financial, technical, marketing, and other resources than we do. Many
of these companies have more extensive customer bases and broader partner
relationships that they could leverage, including relationships with many of
our current and potential partners. These companies also have significantly
more established customer support and professional services organizations than
we do. In addition, these companies may adopt aggressive pricing policies. For
a more detailed description of our competitive position, including some of our
competitors and competitive products, please see "Business--Competition."
We and our licensees may be found to infringe proprietary rights of others,
resulting in litigation, redesign expenses, or costly licenses.
Digital rights management is an emerging field in which our competitors, may
obtain patents or other proprietary rights that would prevent, or limit or
interfere with, our, or our licensees', ability to make, use, or sell products.
Furthermore, companies in the software market are increasingly bringing suits
alleging infringement of their proprietary rights, particularly patent rights.
We and our licensees could incur substantial costs to defend or settle any
litigation, and intellectual property litigation could force us to do one or
more of the following:
. cease selling, incorporating, or using products or services that
incorporate the infringed intellectual property;
. obtain a license from the holder of the infringed intellectual property
right; or
. redesign products or services to avoid infringement.
Our licensees' products and services may be subject to a claim of patent
infringement independent of any infringement by our software.
In the past, we have received notices alleging potential infringement by us
of the proprietary rights of others. In January 1996, we received a letter from
an attorney representing E-Data Corporation containing an allegation of
infringement of a patent E-Data allegedly owns. We exchanged correspondence
with E-Data's attorneys ending in September 1996. We have not heard from any
representative of E-Data since that time. In November 1997, we received a
letter from representatives of TAU Systems Corporation informing us of two
patents held by TAU Systems. In the letter, the representatives stated their
opinion that our Commerce software contained various elements recited in the
two patents and requested that we discuss licensing the technology of these
patents. We responded to the letter stating that, although we had not
undertaken a detailed review of the patents, we were unaware of any of our
products having one of the elements required by the patent claims. We have not
received any further correspondence from TAU Systems. In May 1999,
12
<PAGE>
we received a letter from representatives of TechSearch LLC offering us a
license to a patent held by TechSearch. We have reviewed the patent and do not
believe that we need to obtain a license to this patent. In the future,
however, we or our licensees could be found to infringe upon the patent rights
of E-Data, TAU Systems, TechSearch, or other companies.
Protection of our intellectual property is limited and efforts to protect our
intellectual property may be inadequate, time consuming, and expensive.
Our success and ability to compete are substantially dependent on our
proprietary technology and trademarks, which we attempt to protect through a
combination of patent, copyright, trade secret, and trademark laws, as well as
confidentiality procedures and contractual provisions. These legal protections
afford only limited protection and may be time consuming and expensive.
Furthermore, despite our efforts, we may be unable to prevent third parties
from infringing upon or misappropriating our intellectual property. Also, our
competitors may independently develop similar, but not infringing, technology,
duplicate our products, or design around our patents or our other intellectual
property.
Our patent applications or trademark registrations may not be approved.
Moreover, even if approved, the resulting patents or trademarks may not provide
us with any competitive advantage or may be challenged by third parties. If
challenged, our patents might not be upheld or their claims could be narrowed.
Any litigation surrounding our rights could force us to divert important
financial and other resources away from our business operations. In addition,
we license our products internationally, and the laws of many countries do not
protect our proprietary rights as well as the laws of the United States.
To successfully license our product and grow our business, we must retain and
attract key personnel; competition for these personnel is intense.
Our success depends largely on the skills, experience, and performance of
the members of our senior management and other key personnel, including our
chairman of the board and chief executive officer, Victor Shear. None of our
senior management or other key personnel must remain employed for any specific
time period. In addition, we recently hired our executive vice chairman and
president and chief operating officer. If we lose one or more of these key
employees, our business and operating results could be significantly harmed. In
addition, our future success will depend largely on our ability to continue
attracting, integrating, and retaining highly skilled personnel. In addition,
competition for qualified sales and marketing personnel is intense. We may not
be able to hire enough qualified individuals in the future or in a timely
manner. New employees require extensive training and typically take at least
four to six months to achieve full productivity.
Failure to appropriately manage our growth and expansion could seriously harm
our business and operating results.
Our historical growth has placed, and any further growth is likely to
continue to place, a significant strain on our resources. Any failure to manage
growth effectively could seriously harm our business and operating results. We
have grown from 87 employees at December 31, 1997 to 144 employees at August
31, 1999. To be successful, we will need to implement additional management
information systems, improve our operating, administrative, financial and
accounting
13
<PAGE>
systems and controls, train new employees, and maintain close coordination
among our executive, engineering, accounting, finance, marketing, and
operations organizations.
Industry-Related Risks
Our revenues may not grow and our stock price may decline if digital music
commerce over the Internet does not develop.
We currently devote a significant portion of our time, resources, and
attention pursuing partnerships and business within the music industry. As a
result, if digital music commerce over the Internet does not develop, our
business and operating results will be significantly harmed. A number of
factors could delay or prevent the development of digital music commerce. These
factors include:
. music content providers' inability to attract significant music artists,
record labels, and recordings to be distributed in their format;
. lack of development and adoption of compression technology to facilitate
digital delivery of music or related information like music videos; and
. lack of development and adoption of consumer devices that are able to
play downloaded digital music.
We may not receive sufficient revenues to be successful and our stock price
will decline if use of the Internet for commercial distribution of digital
content is not widely accepted.
Acceptance and use of the Internet for commercial distribution of digital
content may not continue to develop at recent rates, and a sufficiently broad
base of consumers may not adopt, and continue to use, the Internet and other
online services as a medium for digital commerce. Because our transaction fees
are derived from digital commerce transactions, if digital commerce is not
accepted for any reason, our revenues would not grow sufficiently and our
business and operating results would be significantly harmed.
We depend on the widespread acceptance of commerce in digital information
over the Internet, through DVD, and other means. These methods for distribution
of digital information may not be commercially accepted for a number of
reasons, including:
. failure to develop the necessary infrastructure for communication of
digital information and for payment processing;
. failure to develop or deploy enabling technologies, including compression
or broadband technology necessary for distribution of particular digital
content over the Internet;
. reduced demand for paid digital content due to the widespread
availability of free content online and the ability to use and distribute
this content without restriction; and
. insufficient speed, access, and server reliability, as well as lengthy
download time for content.
If standards for digital rights management are not adopted, confusion among
content providers, distributors, and consumers may depress the level of digital
commerce, which would reduce our revenues.
If standards for digital rights management are not adopted or complied with,
content providers may delay distributing content until they are confident that
the technology by which the content is to be distributed will be commercially
accepted. Standards for the distribution of various digital content might not
develop or might be found to violate antitrust laws or fair use of copyright
policies. In
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<PAGE>
addition, the failure to develop a standard among device manufacturers may
affect the market for digital goods and services. As a result, consumers may
delay purchasing products and services that include our technology if they are
uncertain of commercial acceptance of the standards with which our technology
complies. Consequently, if a standard format for the secure delivery of content
on the Internet is not adopted, or if the standards are not compatible with our
digital rights management technology, our business and operating results would
likely be harmed.
We may face increased governmental regulation and legal uncertainties that
could increase our costs and provide a barrier to doing business.
Exports of software products utilizing encryption technology are generally
restricted by the United States and various foreign governments. Although we
have obtained approval to export our Commerce software, changes in export laws
and regulations may impose restrictions that affect our ability to distribute
products and services internationally, limiting our ability to gain revenue and
grow our business.
It is also possible that Congress or individual states could enact laws
regulating or taxing Internet commerce. In addition, several telecommunications
companies have petitioned the Federal Communications Commission to regulate
Internet service providers in a manner similar to long distance telephone
carriers and to impose access fees on these companies. Access fees, sales taxes
or any other taxes or fees could increase the cost of transmitting data over
the Internet and reduce the number or amount of transactions from which we get
our transaction fees.
Risks Related to this Offering
Our stock price may be particularly volatile and could decline substantially
because of the industry in which we compete.
The stock market in general has recently experienced extreme price and
volume fluctuations. In addition, the market prices of securities of technology
companies, particularly Internet-related companies, have been extremely
volatile, and have experienced fluctuations that have often been unrelated or
disproportionate to the operating performance of these companies. These broad
market fluctuations could adversely affect the market price of our common
stock. In addition, these fluctuations could lead to costly class action
litigation which could significantly harm our business and operating results.
Existing stockholders significantly influence us and could delay or prevent an
acquisition by a third party.
On completion of this offering, our executive officers, directors, their
affiliates, and other 5% stockholders will beneficially own, in the aggregate,
approximately 34.4% of our outstanding common stock, assuming no exercise of
the underwriters' over-allotment option and assuming that one of our existing
stockholders exercises in full its right to buy in this offering. We have
requested that the underwriters reserve up to 1,300,000 shares for sale at the
initial public offering price to current and potential customers, others with
whom we do business, existing stockholders, employees, and friends of
InterTrust. If our executive officers, directors, their affiliates, and other
5% stockholders purchase any of these shares in this offering from the
underwriters, their aggregate percentage ownership will
15
<PAGE>
increase. As a result, these stockholders will be able to significantly
influence all matters requiring stockholder approval, including the election of
directors and approval of significant corporate transactions, which could have
the effect of delaying or preventing a third party from acquiring control over
us. For information regarding the ownership of our outstanding stock by our
executive officers and directors and their affiliates, please see "Principal
Stockholders."
We have implemented anti-takeover provisions that could make it more difficult
to acquire us.
Our sixth amended and restated certificate of incorporation, our amended and
restated bylaws, and Delaware law contain provisions that could make it more
difficult for a third party to acquire us, even if its doing so would be
beneficial to our stockholders. These provisions include:
. authorizing the issuance of shares of undesignated preferred stock
without a vote of stockholders;
. prohibiting stockholder action by written consent; and
. limitations on stockholders' ability to call special stockholder
meetings.
We are also currently considering other anti-takeover measures, including a
stockholders' rights plan.
Substantial sales of our common stock could depress our stock price.
If our stockholders sell substantial amounts of our common stock in the
public market following this offering, the market price of our common stock
could fall. Based on shares outstanding as of August 31, 1999, upon completion
of this offering, we will have outstanding 37,961,011 shares of common stock.
Upon completion of this offering, 7,163,091 shares of common stock, including
the 6,500,000 shares being sold in this offering, will be eligible for sale in
the public market immediately, unless purchased by our affiliates or by some
participants in our directed share program who enter into lock up agreements.
Substantially all of our stockholders will be subject to agreements with the
underwriters or us that restrict their ability to transfer their stock for 180
days from the date of this prospectus. After these agreements expire, an
additional 27,144,146 shares will be eligible for sale in the public market.
As a new investor, you will incur substantial dilution as a result of this
offering and future equity issuances.
The initial public offering price is substantially higher than the book
value per share of our outstanding common stock. As a result, investors
purchasing common stock in this offering will incur immediate substantial
dilution of $14.58 per share. A warrant for up to 311,016 shares of our common
stock can no longer be exercised, and was terminated upon the initial public
offering of our common stock. If the exercisability of this warrant is
challenged and the warrant is found to be exercisable, there could be further
dilution to investors in this offering if the warrant is ultimately exercised.
In addition, we have issued options and a warrant to acquire common stock at
prices significantly below the initial public offering price. To the extent
outstanding options or the warrant are ultimately exercised, there will be
further dilution to investors in this offering. We have in the past and may in
the future issue equity securities to our partners. Any issuances to these
partners may cause further dilution to investors in this offering. If we issue
additional equity securities, stockholders may experience dilution, and the new
equity securities could have rights senior to those of existing holders of our
common stock.
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<PAGE>
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements. These statements relate
to future events or our future business or financial performance. In some
cases, you can identify forward-looking statements by terminology--for
instance, may, will, should, expect, plan, anticipate, believe, estimate,
predict, potential or continue, the negative of these terms, or other
comparable terminology. These statements are only predictions. Actual events or
results may differ materially. In evaluating these statements, you should
specifically consider various factors, including the risks outlined in the risk
factors section. These factors may cause our actual results to differ
materially from any forward-looking statement.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other
person assumes responsibility for the accuracy and completeness of the forward-
looking statements. We are under no duty to update any of the forward-looking
statements after the date of this prospectus to conform these statements to
actual results or to changes in our expectations.
USE OF PROCEEDS
Our net proceeds from the sale of the 6,500,000 shares of common stock we
are offering are estimated to be $107.7 million, at an initial public offering
price of $18.00 per share and after deducting underwriting discounts and
commissions and estimated offering expenses payable by us. If the underwriters'
over-allotment option is exercised in full, we estimate that our net proceeds
will be approximately $124.0 million. We expect to use the net proceeds for
general corporate purposes, including working capital. A portion of the net
proceeds may also be used for the acquisition of businesses, products and
technologies that are complementary to ours. We have no current agreements or
commitments for acquisitions of complementary businesses, products, or
technologies. Pending these uses, we will invest the net proceeds of this
offering in investment grade and interest-bearing securities.
DIVIDEND POLICY
We have not paid any cash dividends since inception and do not currently
intend to pay any cash dividends.
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<PAGE>
CAPITALIZATION
The following table presents the following information:
. our actual capitalization as of June 30, 1999;
. our pro forma capitalization as of June 30, 1999, after giving effect to
the sale of 1,309,700 shares of series E preferred stock for
approximately $15.7 million in cash and the issuance of 83,333 shares of
series E preferred stock on the conversion of a $1.0 million promissory
note in July 1999, the exercise of warrants to purchase 21,692 shares of
common stock, and the conversion of all outstanding shares of preferred
stock and class B non-voting common stock into shares of common stock;
and
. our pro forma as adjusted capitalization as of June 30, 1999, to reflect
our receipt of the estimated net proceeds from our sale of 6,500,000
shares of common stock in this offering, at an initial public offering
price of $18.00 per share and after deducting the underwriting discounts
and commissions and estimated offering expenses payable by us, and the
filing of a new certificate of incorporation after the closing of this
offering.
The number of shares outstanding excludes the following shares:
. 6,741,411 shares of common stock issuable upon the exercise of stock
options outstanding as of June 30, 1999 at a weighted average exercise
price of $1.91 per share;
. 638,124 shares of common stock available for issuance as of June 30, 1999
under our 1995 stock plan;
. 571,000 shares of common stock issuable upon exercise of stock options
granted between July 1, 1999 and October 13, 1999 at a weighted average
exercise price of $11.79 per share;
. 325,000 shares of common stock issuable upon the exercise of a warrant
outstanding as of September 9, 1999 at an exercise price of $14.00 per
share;
. 85,000 shares of common stock issued in connection with our purchase and
license of technology and related assets;
. 1,900,000 shares of common stock available for issuance under our 1999
equity incentive plan;
. 350,000 shares of common stock available for issuance under our 1999
employee stock purchase plan; and
. 350,000 shares of common stock available for issuance under our 1999 non-
employee directors option plan.
We intend to grant options to purchase 1,301,000 shares of common stock to
recently hired employees under our 1999 equity incentive plan at the same time
as this offering. Of these options, options to purchase 351,000 shares of
common stock will be at an exercise price equal to the initial public offering
price of the common stock and the remaining options to purchase 950,000 shares
of common stock, which includes an option to purchase 300,000 shares of common
stock to our new executive vice chairman and an option to purchase 500,000
shares of common stock to our new president and chief operating officer, will
be at an exercise price equal to 85% of the initial public offering price of
the common stock.
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<PAGE>
<TABLE>
<CAPTION>
June 30, 1999
--------------------------------
Pro Forma
Actual Pro Forma As Adjusted
-------- --------- -----------
(in thousands)
<S> <C> <C> <C>
Convertible promissory note.................... $ 1,000 $ -- $ --
-------- -------- --------
Stockholders' equity:
Convertible preferred stock, 20,000,000 shares
authorized, 12,492,410 shares outstanding
actual; 20,000,000 shares authorized, no
shares outstanding pro forma; 10,000,000
shares authorized, no shares outstanding pro
forma as adjusted............................ 12 -- --
Class A voting common stock, 50,000,000 shares
authorized, 15,003,082 shares outstanding
actual; 50,000,000 shares authorized,
31,251,085 shares outstanding pro forma;
120,000,000 shares authorized, 37,751,085
shares outstanding pro forma as adjusted..... 15 31 38
Class B non-voting common stock, 20,000,000
shares authorized, 2,340,868 shares
outstanding actual; 20,000,000 shares
authorized, no shares outstanding pro forma;
no shares authorized, no shares outstanding
pro forma as adjusted........................ 2 -- --
Additional paid-in capital..................... 65,801 82,557 190,210
Deferred stock compensation.................... (4,078) (4,078) (4,078)
Notes receivable from stockholders............. (236) (236) (236)
Accumulated deficit............................ (56,871) (56,871) (56,871)
-------- -------- --------
Total stockholders' equity..................... 4,645 21,403 129,063
-------- -------- --------
Total capitalization.......................... $ 5,645 $ 21,403 $129,063
======== ======== ========
</TABLE>
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<PAGE>
DILUTION
Our pro forma net tangible book value as of June 30, 1999 was $21.4 million,
or approximately $0.68 per share. Net tangible book value per share represents
the amount of stockholders' equity, less intangible assets, divided by
31,251,085 shares of common stock outstanding after giving effect to the
following transactions:
. the sale of 1,309,700 shares of series E preferred stock for
approximately $15.7 million in cash and the issuance of 83,333 shares of
series E preferred stock on the conversion of a $1.0 million promissory
note in July 1999;
. the exercise of warrants to purchase 21,692 shares of common stock; and
. the conversion of all outstanding shares of preferred stock and class B
non-voting common stock into shares of common stock upon completion of
this offering.
Net tangible book value dilution per share to new investors represents the
difference between the initial public offering price and the net tangible book
value per share immediately after completion of this offering. Our net tangible
book value as of June 30, 1999 would have been $129.1 million or $3.42 per
share after giving effect to the sale of shares of our common stock in this
offering less discounts, commissions and estimated expenses. This amount
represents an immediate increase in net tangible book value to existing
stockholders and an immediate dilution in net tangible book value to purchasers
of common stock in the offering, as illustrated in the following table:
<TABLE>
<S> <C> <C>
Initial public offering price per share.......................... $18.00
Pro forma net tangible book value per share as of June 30,
1999.......................................................... $ 0.68
Increase per share attributable to new investors............... 2.74
------
Pro forma net tangible book value per share after the offering... 3.42
------
Dilution per share to new investors.............................. $14.58
======
</TABLE>
The following table presents as of June 30, 1999, on the pro forma basis
described above, the differences between the existing stockholders and the
purchasers of common stock in this offering relating to the number of shares
purchased from us, the total consideration paid to us and the average price per
share paid to us:
<TABLE>
<CAPTION>
Shares Purchased Total Consideration Average
------------------ ------------------- Price Per
Number Percent Amount Percent Share
---------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders.......... 31,251,085 82.8% $77,960,000 40.0% $2.49
New investors ................. 6,500,000 17.2 117,000,000 60.0 $18.00
---------- ----- ----------- -----
Totals....................... 37,751,085 100.0% 194,960,000 100.0%
========== ===== =========== =====
</TABLE>
As of June 30, 1999, there were outstanding options to purchase a total of
6,741,411 shares of common stock at a weighted average exercise price of $1.91
per share. In addition, as of September 9, 1999, there was an outstanding
warrant to purchase 325,000 shares of common stock at an exercise price of
$14.00 per share. Between July 1, 1999 and October 13, 1999, we issued options
to purchase 571,000 shares of common stock at a weighted average exercise price
of $11.79 per
20
<PAGE>
share. To the extent these outstanding options or this warrant are exercised,
there will be further dilution to new investors. We also issued 85,000 shares
of common stock in October 1999 in exchange for technology and related assets
we purchased and licensed. We intend to grant options to purchase
1,301,000 shares of common stock to recently hired employees under our 1999
equity incentive plan at the same time as this offering. Of the options,
options to purchase 351,000 shares of common stock will be at an exercise price
equal to the initial public offering price of the common stock and the
remaining options to purchase 950,000 shares of common stock, which includes an
option to purchase 300,000 shares of common stock to our new executive vice
chairman and an option to purchase 500,000 shares of common stock to our new
president and chief operating officer, will be at an exercise price equal to
85% of the initial public offering price of the common stock.
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<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with, and are qualified by reference to, the consolidated financial
statements and related notes and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" appearing elsewhere in this
prospectus. The consolidated statements of operations data for the years ended
December 31, 1996, 1997 and 1998, and the consolidated balance sheet data at
December 31, 1997 and 1998 are derived from our consolidated financial
statements, which have been audited by Ernst & Young LLP, independent auditors,
and are included elsewhere in this prospectus. The consolidated statements of
operations data for the years ended December 31, 1994 and 1995, and the
consolidated balance sheet data at December 31, 1994, 1995 and 1996 are derived
from our consolidated financial statements not included in this prospectus,
which have been audited by Ernst & Young LLP, independent auditors. The
consolidated statements of operations data for the six months ended June 30,
1998 and 1999 and the consolidated balance sheet data at June 30, 1999 are
derived from unaudited consolidated financial statements included elsewhere in
this prospectus and, in the opinion of our management, include all adjustments,
consisting only of normal recurring adjustments, that are necessary for a fair
presentation of the results of operations for these periods. The historical
results are not necessarily indicative of future results.
<TABLE>
<CAPTION>
Six Months
Years Ended December 31, Ended June 30,
--------------------------------------------- -----------------
1994 1995 1996 1997 1998 1998 1999
------- ------- ------- -------- -------- ------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Consolidated Statements
of Operations Data:
Revenues:
Licenses............... $ 850 $ -- $ -- $ 1,000 $ -- $ -- $ 309
Software support and
training services..... -- -- 25 100 152 50 177
------- ------- ------- -------- -------- ------- --------
Total revenues....... 850 -- 25 1,100 152 50 486
Cost of revenues:
Licenses............... -- -- -- -- -- -- 42
Software support and
training services..... -- -- 5 102 191 84 208
------- ------- ------- -------- -------- ------- --------
Total cost of
revenues............ -- -- 5 102 191 84 250
------- ------- ------- -------- -------- ------- --------
Gross profit (loss)..... 850 -- 20 998 (39) (34) 236
Operating costs and
expenses:
Research and
development........... 1,469 2,620 4,852 8,287 13,041 6,358 7,088
Sales and marketing.... -- -- 1,573 2,717 3,870 1,902 2,449
General and
administrative........ 930 803 1,735 1,932 2,717 1,075 2,117
Amortization of
deferred stock
compensation.......... -- -- -- -- -- -- 195
------- ------- ------- -------- -------- ------- --------
Total operating costs
and expenses........ 2,399 3,423 8,160 12,936 19,628 9,335 11,849
------- ------- ------- -------- -------- ------- --------
Loss from operations.... (1,549) (3,423) (8,140) (11,938) (19,667) (9,369) (11,613)
Interest income
(expense), net......... (39) (160) 180 229 5 (9) 202
------- ------- ------- -------- -------- ------- --------
Net loss................ $(1,588) $(3,583) $(7,960) $(11,709) $(19,662) $(9,378) $(11,411)
======= ======= ======= ======== ======== ======= ========
Basic and diluted net
loss per share......... $ (0.16) $ (0.35) $ (0.67) $ (0.86) $ (1.41) $ (0.68) $ (0.75)
======= ======= ======= ======== ======== ======= ========
Shares used in computing
basic and diluted net
loss per share......... 9,645 10,223 11,913 13,639 13,966 13,777 15,307
======= ======= ======= ======== ======== ======= ========
Pro forma basic and
diluted net loss per
share.................. $ (0.91) $ (0.43)
======== ========
Shares used in computing
pro forma basic and
diluted net loss per
share.................. 21,688 26,808
======== ========
</TABLE>
<TABLE>
<CAPTION>
December 31,
------------------------------------- June 30,
1994 1995 1996 1997 1998 1999
------ ------ ------ ------ ------ --------
Consolidated Balance Sheet
Data: (in thousands)
<S> <C> <C> <C> <C> <C> <C>
Cash and cash equivalents..... $ 9 $ 386 $8,359 $1,884 $5,575 $15,295
Working capital (deficit)..... (1,319) (4,590) 7,561 607 4,939 11,970
Total assets.................. 194 603 9,076 3,111 8,280 17,020
Total stockholders' equity
(deficit).................... (1,148) (4,387) 6,708 (847) (2,014) 4,645
</TABLE>
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<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We have developed a general purpose digital rights management, or DRM,
platform to serve as a foundation for providers of digital information,
technology, and commerce services to participate in a global e-commerce system.
InterTrust was formed and incorporated in January 1990. From inception through
1998, our efforts were principally devoted to research and development, raising
capital, recruiting personnel, and establishing licensing relationships. As a
result, we were considered a development stage enterprise during this period.
We shipped the general availability version of our Commerce software at the end
of December 1998, and some of our partners are conducting or are about to
conduct pilot programs using this software.
We license our DRM platform to companies to build digital commerce services
and applications. Our goal is to license to content, technology, and commerce
services partners to achieve widespread dissemination of our technology, an
expanding consumer base, and broad participation by digital information
providers. We currently derive all of our revenues from initial license fees
and associated software support and training services. Our license agreements
also generally require our partners to pay a transaction fee that is a
percentage of amounts paid by users or charged by our partners in commercial
transactions and services that use our technology, and for sales of products
incorporating our technology. Our license agreements relating to uses of our
technology within enterprises for privately managing proprietary data may
require a per-user fee. Within the next several years, we anticipate that our
revenues will be derived primarily from transaction fees and, to a
significantly lesser extent, from initial license fees and software support and
training services fees. However, we do not expect to receive any transaction
fees in 1999. Any future transaction fees are dependent on the success of our
licensees and their customers in commercially deploying services and
applications.
We are targeting relationships that will establish our DRM platform in
several large markets, including entertainment, business information, and
publishing. To date, a significant part of our licensing efforts has been
focused on adoption of our technology by the music industry as we believe it
will be an early implementer of DRM technology. We believe that, if our general
purpose platform is adopted in the music market, we will be positioned to have
our platform adopted in additional entertainment markets, including games,
audio books, and video, and other markets, including business information and
publications.
We have three basic types of license agreements: commerce service licenses,
business licenses, and applications licenses. These agreements provide
different rights and technology depending on the commercial plans of our
partners. Initial license fees received from these agreements may vary in
amount depending on factors such as partner commitments, scope of the license
as it relates to commercial markets, territory, and term of agreement. Examples
of partner commitments include deploying licensed products within a specified
time frame, exclusively using portions of our software, and using and publicly
promoting us as the partner's preferred digital rights management technology.
We have in the past decided, and may in the future decide, to reduce or
eliminate initial license fees based on these factors. We do not believe that
we can determine the amount of foregone revenue due to reduced or eliminated
license fees with any reliable degree of certainty. Our license fees are
23
<PAGE>
negotiated based on the terms and conditions of each individual agreement and
take into account the scope of the license, the term, and the other commitments
made by our partners that provide strategic value to us. In addition, we have
entered into a limited number of license agreements which have varying license
scopes and terms and which do not provide adequate comparable data to determine
the amount of foregone revenue. In connection with our strategy to promote
widespread deployment of our software, through June 30, 1999, we have on one
occasion received an initial license fee for our Commerce software in the form
of a minority equity position in the licensee. The value of the license fee was
determined based on the estimated fair value of the underlying equity
securities received. In the future, we may enter into other equity payment
arrangements.
Licenses of our Commerce software generally require the payment of an initial
license fee. Initial license revenue, net of any discounts granted, is
recognized upon execution of a license agreement and delivery of our software
if we have no remaining obligations relating to development, upgrades, new
releases, or other future deliverables, if the license fee is fixed or
determinable, and if collection of the fee is probable. Our license agreements
generally include the right to obtain access to upgrades and new releases, on a
when and if available basis, for a specified period. Under these circumstances,
the license payments received, net of any discounts granted, in advance of
revenue recognition are deferred and recognized on a subscription basis over
the period of obligation beginning upon delivery of the licensed product. In
addition, under license agreements where we are obligated to provide a
specified upgrade and do not have vendor specific objective evidence of fair
value of the specified upgrade, all of the license revenue is deferred until
the specified upgrade has been delivered. Upon delivery of the specified
upgrade, license revenue is recognized using the subscription method. We began
recognizing revenue under some license agreements in January 1999, after
shipping the general availability version of our Commerce software at the end
of December 1998. At June 30, 1999, we had approximately $7.7 million of
deferred license revenue that will be recognized in future periods.
In May 1999, we received a license fee in the form of a minority equity
position in a non-public entity in exchange for a seven year technology
license. We received approximately 1.7 million shares of common stock of the
licensee, which we believe represents approximately 10% of the outstanding
shares of the licensee as of June 30, 1999. Because the entity is a recently
formed, privately-held company and we were unable to obtain sufficient evidence
of the fair value of the common stock of the entity, we did not record revenue
or deferred revenue from the license fee. We are obligated to provide
unspecified upgrades and new releases, on a when and if available basis, to the
licensee over a two year period under the agreement for additional fees. We are
not obligated to provide any funding to the licensee for the development of the
licensee's software.
For contracts entered into before 1998, we recognize revenue as the amounts
are earned under the related agreements, provided no significant obligations
exist and the related receivable is determined to be collectible, consistent
with Statement of Position 91-1, Software Revenue Recognition. Our license
revenues in 1994 and 1997 were derived from licenses of pre-commercial versions
of our software.
Our license agreements also require the payment of a transaction fee that is
a percentage of revenues received by our partners from transactions and
services that use our technology and sales of products incorporating our
technology. Transactions involving the use of our technology to conduct the
sale, lease, rental, or licensing of commercial content require the payment of
a transaction fee based on the amounts paid by users or charged by our partners
for selling or distributing the content.
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<PAGE>
Transactions involving the use of our technology for commercial services
generally require the payment of a transaction fee based on the amounts paid by
users or charged by our partners for the services. Transactions involving the
sale, lease, rental, or licensing of products incorporating our technology
generally require the payment of a transaction fee based on the amounts paid by
users or charged by our partners for the product. Our partners are required to
pay all amounts due for transaction fees within specified periods, depending on
the licensing arrangement. Our revenue recognition policy relating to
transaction fees is to recognize the revenue when the amounts due are known,
which will generally be in the quarter after the transaction. Prepaid
transaction fees are recorded as deferred revenue and will be recognized when
the related transactions occur. We have received $1.5 million in prepaid
transaction fees which are included in deferred revenue as of June 30, 1999.
Prepaid transaction fees may generally be offset against a portion of
transaction fee amounts due in any given quarter. To date, we have not
recognized any transaction fees from commercial transactions or services, or
sales of products.
Software support and training services, which typically include the right to
telephone and online support and customer training, are generally provided for
in the license agreements for an agreed-upon amount. Software support and
training service revenue is recognized over the period in which the services
are provided, generally two years. Some of our partners were utilizing pre-
commercial versions of our product in the development of their own solutions
and, as a result, were utilizing our software support and training services
before the shipment of the general availability version of our software.
Through the end of 1998, we were in the development stage and had a limited
number of licensees. Mitsubishi, a stockholder, accounted for 91% of total
revenues in 1997 and 40% of total revenues in the six months ended June 30,
1999. Reciprocal accounted for 100% of total revenues in 1996, 9% in 1997, 66%
in 1998, 100% in the six months ended June 30, 1998, and 24% in the six months
ended June 30, 1999. Bertelsmann accounted for 21% of total revenues in 1998.
Computacenter accounted for 13% of total revenues in the six months ended June
30, 1999. Our success depends on significantly increasing the number of
companies that license our technology and use it for the sale and management of
digital content and services.
In view of the rapidly changing nature of our industry and our new and
unproven business model, we believe that period-to-period comparisons of
revenues and operating results are not necessarily meaningful and should not be
relied upon as indications of future performance. In addition, our business
model is new and unproven and has not succeeded in generating sufficient
revenue to sustain or grow our business. We also operate in an intensely
competitive market for highly qualified technical, sales and marketing, and
management personnel and periodically make salary and other compensation
adjustments to retain and hire employees. We anticipate that our operating
expenses will increase in future quarters. We expect to incur additional losses
for at least the next several years. As a result, we will need to generate
significant additional revenue to achieve and maintain profitability. In
addition, we have limited and delayed insight on consumer trends and sales,
which makes prediction of our future revenues difficult.
Recent Developments
Based on our preliminary analysis, total revenues increased by $108,000,
from $254,000 in the second quarter of 1999 to $362,000 in the third quarter of
1999. Total revenues during the third
25
<PAGE>
quarter were comprised of $186,000 from license revenues and $176,000 from
software support and training service revenues. Increased revenues during the
third quarter resulted from license fees recognized under agreements with new
and existing partners.
Our net loss increased from ($6.2 million) in the second quarter of 1999 to
($8.0 million) in the third quarter of 1999. Higher operating expenses offset
slightly higher revenues in the third quarter. We increased operating expenses
as we continued to expand our organization in all operating areas.
We believe that the unaudited financial information for the third quarter of
1999 contains all adjustments necessary to present fairly the information
discussed above, and that the adjustments made consist only of normal recurring
adjustments.
In October 1999, we purchased audio decoding and rendering technology and
related assets and received a license to video technology from a third party,
in exchange for 85,000 shares of our common stock and $100,000 in cash. The
purchase price, which will be capitalized as an intangible asset, was valued at
approximately $1.3 million. We will amortize the value of the technology
acquired over its estimated useful life, which has not yet been determined.
Results of Operations
Six Months Ended June 30, 1998 and 1999
Revenues
Total revenues increased from approximately $50,000 in the six months ended
June 30, 1998 to approximately $486,000 in the six months ended June 30, 1999.
Software support and training services accounted for 100% of total revenues in
the six months ended June 30, 1998. License fees and software support and
training services accounted for 64% and 36% of total revenues in the six months
ended June 30, 1999.
No license revenue was recognized in the six months ended June 30, 1998, as
the general availability release of our Commerce software was not delivered to
our partners until December 1998. License revenues were approximately $309,000
for the six months ended June 30, 1999, and represent the amortization of
deferred license fees.
Revenue from software support and training services increased from $50,000
in the six months ended June 30, 1998 to approximately $177,000 in the six
months ended June 30, 1999. This increase was due to support and training fees
from additional partner licensing agreements.
Cost of Revenues
Cost of license revenue consists primarily of the costs incurred to
manufacture, package, and distribute our products and related documentation.
Cost of software support and training services consists primarily of the cost
of personnel, travel related expenditures, and training materials. These
expenditures are incurred both onsite at our facilities as well as offsite at
partner locations. Total cost of revenues was approximately $84,000 in the six
months ended June 30, 1998 and approximately $250,000 in the six months ended
June 30, 1999. The period-over-period increase resulted from increased costs
incurred to support our new partners.
26
<PAGE>
No costs were incurred for licenses during the six months ended June 30,
1998, as we did not deliver the general availability release of our Commerce
software to our partners until December 1998. Cost of license revenue was
approximately $42,000 during the six months ended June 30, 1999. Cost of
license revenue is expected to increase from the amortization of purchased
technology and will fluctuate from period to period depending on the number of
new partners, the number of software releases, and the amount of software
documentation provided to our partners during the period.
Cost of software support and training services revenue increased from
approximately $84,000 for the six months ended June 30, 1998 to approximately
$208,000 for the six months ended June 30, 1999. The increase in cost of
software support and training services revenue represents the increase in
support personnel time required to provide technical assistance and training to
a greater number of partners. Software support and training services costs are
expected to increase as we license to new partners and may vary significantly
from period to period depending on the support requirements of our partners.
Research and Development
Research and development expenses consist principally of salaries and
related personnel expenses, consultant fees, and the cost of software used in
product development. Research and development expenses are expensed to
operations as incurred. Research and development spending was approximately
$6.4 million for the six months ended June 30, 1998 and approximately
$7.1 million for the six months ended June 30, 1999. This increase was
primarily attributable to a $742,000 increase in personnel costs and consultant
services associated with both product research and development. This increase
was partially offset by a $213,000 decrease in the cost of software used in
product development. Cost of purchased software used in product development
includes the amortization of purchased software as well as the cost of software
expensed to research and development when the software is determined to have no
alternative future use. We believe that continued investment in research and
development is critical to attaining our strategic product objective and we
expect these expenses to increase significantly in absolute dollars in future
periods.
Sales and Marketing
Sales and marketing expenses consist of salaries and related expenses for
personnel engaged in direct sales, partner development, marketing, field
service support, consultant fees and advertising, promotional material, and
trade show exhibit expenses. Sales and marketing expenses increased from
approximately $1.9 million for the six months ended June 30, 1998 to
$2.4 million for the six months ended June 30, 1999. This increase reflects the
costs associated with increased selling efforts. The increase in these costs is
comprised primarily of $285,000 in increased personnel costs, $121,000 in
increased public relations and other promotional costs, and $75,000 in
increased travel costs. We expect sales and marketing expenses to increase in
absolute dollars due to planned growth of our sales and partner development
organizations, including the establishment of additional offices in domestic
and international locales, and aggressive implementation of advertising and
promotional programs.
General and Administrative
General and administrative expenses consist primarily of salaries and
related expenses for executive, legal, accounting and administrative personnel,
professional service fees, and general corporate expenses. General and
administrative expenses increased from approximately $1.1 million for
27
<PAGE>
the six months ended June 30, 1998 to $2.1 million for the six months ended
June 30, 1999. This increase was primarily attributable to a $631,000 increase
in personnel costs, as a result of increased legal and accounting personnel,
and a $103,000 increase in costs associated with the filing of patent
applications, including the use of outside patent counsel. Expenses associated
with the preparation of new patent applications, patent application processing
fees, and attorneys costs associated with patent applications and maintaining
our patent portfolio totaled $88,000 for the six months ended June 30, 1998,
and $191,000 for the six months ended June 30, 1999. We expect general and
administrative expenses to increase in absolute dollars as we add personnel,
incur additional costs to support continued growth, and implement additional
operating systems necessary to support a public company.
Deferred Stock Compensation
We recorded total deferred stock compensation of approximately $4.3 million
in the six months ended June 30, 1999. This amount represents the difference
between the exercise prices of employee stock options and what were considered
to be the fair values of our common stock on the dates of the grants. We are
amortizing this amount over the vesting periods of the applicable options using
a graded vesting method. We recognized approximately $195,000 of related
compensation expense during the six months ended June 30, 1999. The total
charges to be recognized in future periods from amortization of deferred stock
compensation recorded as of June 30, 1999 are anticipated to be approximately
$1.1 million for the remaining six months of 1999, $1.6 million for 2000,
$835,000 for 2001, $410,000 for 2002, and $110,000 for 2003. These charges will
increase as a result of the issuance of options to purchase 950,000 shares of
our common stock at 85% of the initial public offering price of our common
stock at the same time as this offering.
Interest Income (Expense), Net
Interest income (expense), net, consists primarily of interest earned on
cash and cash equivalents offset by interest expense incurred on convertible
promissory notes. We recognized no interest income in the six months ended June
30, 1998 and approximately $202,000 of interest income in the six months ended
June 30, 1999. The increase in interest income results primarily from increases
in the amount of interest-bearing investments outstanding. We recorded $9,000
in interest expense in the six months ended June 30, 1998 related to
convertible promissory notes that were subsequently converted to preferred
stock. We did not incur interest expense in the six months ended June 30, 1999.
Years Ended December 31, 1996, 1997 and 1998
Revenues
Total revenues were approximately $25,000 in 1996, $1.1 million in 1997, and
$152,000 in 1998. The increase in total revenues in 1997 was primarily related
to $1.0 million of revenue recognized from a limited term license.
Software support and training services accounted for 100% of total revenues
in the 1996, 9% of total revenues in 1997 and 100% of total revenues in 1998.
Software support and training services revenues increased from approximately
$25,000 in 1996, to approximately $100,000 in 1997, and to approximately
$152,000 in 1998. The increase from 1996 to 1997 was attributable to the
recognition of only six months of support and training fees from one partner in
1996 to a full year of fees in
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<PAGE>
1997. The increase from 1997 to 1998 was due to support and training fees from
additional partner licensing agreements.
Cost of Revenues
Total cost of revenues was related entirely to software support and training
services in 1996, 1997, and 1998. Total cost of revenues increased from
approximately $5,000 in 1996, to approximately $102,000 in 1997, and to
approximately $191,000 in 1998. The increase in the cost of software support
and training services revenue represents the increase in support personnel time
required to provide technical assistance and training to a greater number of
our partners.
Research and Development
Research and development expenses increased from approximately $4.9 million
in 1996 to approximately $8.3 million in 1997, and increased 57.4% to
approximately $13.0 million in 1998. These increases were primarily
attributable to increases in personnel costs and consultant services associated
with product research and development of $2.9 million in 1997 and $3.7 million
in 1998.
Sales and Marketing
Sales and marketing expenses increased from approximately $1.6 million in
1996 to approximately $2.7 million in 1997, and increased 42.4% to
approximately $3.9 million in 1998. The increase in 1997 was primarily
attributable to an $898,000 increase in personnel costs and consultant services
associated with increased selling efforts. The increase in 1998 was primarily
attributable to a $408,000 increase in personnel costs and consultant services
associated with increased selling efforts, and a $176,000 increase in public
relations costs and other promotional expenses.
General and Administrative
General and administrative expenses increased from approximately $1.7
million in 1996 to approximately $1.9 million in 1997, and increased 40.6% to
approximately $2.7 million in 1998. These increases were primarily attributable
to increases in legal and accounting personnel that resulted in increases in
personnel costs of $53,000 in 1997 and $371,000 in 1998. Expenses associated
with the preparation of new patent applications, patent application processing
fees, and attorneys costs associated with patent applications and maintaining
our patent portfolio totaled $312,000 for the year ended December 31, 1996,
$334,000 for the year ended December 31, 1997, and $237,000 for the year ended
December 31, 1998.
Interest Income (Expense), Net
Interest income (expense), net, was primarily derived from interest earned
on cash and cash equivalents offset by interest expense incurred on convertible
promissory notes. Net interest income increased from approximately $180,000 in
1996, to approximately $229,000 in 1997, and decreased to approximately $5,000
in 1998. Interest income decreased from approximately $261,000 in 1996, to
approximately $229,000 in 1997, and to approximately $42,000 in 1998. The
change in interest income results primarily from changes in the amount and rate
of interest bearing investments
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<PAGE>
outstanding during each period. We recorded $81,000 of interest expense in 1996
and $37,000 of interest expense in 1998 related to two separate convertible
promissory notes.
Income Taxes
We have incurred net losses since inception for federal and state tax
purposes and have not recognized any tax provision or benefit. As of December
31, 1998, we had approximately $36.2 million of federal and $4.3 million of
state net operating loss carryforwards to offset against future taxable income.
We also had $1.1 million of federal research and development tax credit
carryforwards. The related deferred tax assets have been fully reserved through
June 30, 1999. The federal net operating loss and tax credit carryforwards
expire in years 2007 through 2018, if not used. The state net operating loss
carryforwards expire in years 1999 through 2003, if not used. Utilization of
net operating losses and credits may be subject to a substantial annual
limitation due to the change in ownership provisions of the Internal Revenue
Code of 1986 and similar state provisions. The annual limitation may result in
the expiration of net operating losses and credits before utilization.
Quarterly Results of Operations
The following table contains, for the periods presented, selected data from
our consolidated statements of operations. The data has been derived from our
unaudited consolidated financial statements, and, in the opinion of our
management, include all adjustments, consisting only of normal recurring
adjustments, that are necessary for a fair presentation of the results of
operations for these periods. This unaudited information should be read in
conjunction with the consolidated financial statements and notes included
elsewhere in this prospectus. The operating results in any quarter are not
necessarily indicative of the results that may be expected for any future
period. We have incurred losses in each quarter since inception and expect to
continue to incur losses through at least the next several years.
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------------------
Mar. June Sept. Dec. Mar. June
31, 30, 30, 31, 31, 30,
1998 1998 1998 1998 1999 1999
------- ------- ------- ------- ------- -------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Licenses............... $ -- $ -- $ -- $ -- $ 167 $ 142
Software support and
training services..... 25 25 25 77 65 112
------- ------- ------- ------- ------- -------
Total revenues....... 25 25 25 77 232 254
Cost of revenues:
Licenses............... -- -- -- -- 32 10
Software support and
training services..... 40 44 50 57 87 121
------- ------- ------- ------- ------- -------
Total cost of
revenues............ 40 44 50 57 119 131
------- ------- ------- ------- ------- -------
Gross profit (loss)...... (15) (19) (25) 20 113 123
Operating costs and
expenses:
Research and
development........... 3,215 3,143 3,299 3,384 3,436 3,652
Sales and marketing.... 1,004 898 956 1,012 1,134 1,315
General and
administrative........ 554 521 683 959 759 1,358
Amortization of
deferred stock
compensation.......... -- -- -- -- 27 168
------- ------- ------- ------- ------- -------
Total operating costs
and expenses........ 4,773 4,562 4,938 5,355 5,356 6,493
------- ------- ------- ------- ------- -------
Loss from operations..... (4,788) (4,581) (4,963) (5,335) (5,243) (6,370)
Interest income
(expense), net.......... -- (9) (2) 16 42 160
------- ------- ------- ------- ------- -------
Net loss................. $(4,788) $(4,590) $(4,965) $(5,319) $(5,201) $(6,210)
======= ======= ======= ======= ======= =======
</TABLE>
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We began recognizing revenue on a subscription basis under a number of
license agreements in January 1999, after shipping the general availability
version of our product at the end of December 1998. The increase in software
support and training services revenue beginning in the quarter ended December
31, 1998 was the result of training services associated with new partner
agreements. Software support and training services revenue in the quarter ended
December 31, 1998 also included a one-time support fee related to a limited
term license. Quarter over quarter increases in the cost of software support
and training services reflect the increased effort of engineering personnel to
provide support services to our partners. During the quarter ended June 30,
1998, we reduced the amount of employee travel, limited the amount of hiring,
and reduced the number of consultants to InterTrust with the intention of
managing cash flow. As a result of these efforts, our operating costs and
expenses declined in all departments during the quarter ended June 30, 1998.
Overall increases in research and development spending since the quarter ended
March 31, 1998 are primarily attributable to increased headcount and spending
on software tools used in the development of our products. The decrease in
sales and marketing spending in the quarter ended June 30, 1998 also reflects a
reduction in marketing personnel. Increases in sales and marketing expenses
beginning in the quarter ended September 30, 1998 reflect additional headcount
as well as increased expenses for travel, trade shows, public relations, and
other promotional costs. General and administrative expenses generally
increased quarter over quarter beginning in the quarter ended September 30,
1998, primarily as a result of increased legal and accounting personnel and
costs associated with patent prosecution including filing and translation fees
and the use of outside patent counsel. General and administrative expenses in
the quarter ended December 31, 1998 also included higher than normal charges
for executive recruiting commissions, charges related to the writedown of
abandoned computer equipment, and higher building maintenance expenses.
We anticipate that research and development, sales and marketing, and
general and administrative expenses will increase in absolute dollars as a
result of new hires and related personnel costs. Sales and marketing spending
is expected to increase as a result of our spending on branding, trade shows,
advertising, and promotion. Beginning in the quarter ending December 31, 1999,
we also expect to incur increases in our quarterly operating costs and expenses
of approximately $260,000 as a result of the new facility lease we entered into
in July 1999.
We expect our revenues to vary. If our revenue levels fall below our
expectations, our net loss will increase because only a small portion of our
expenses varies with our revenues. In the future, our operating results may
fall below the expectations of securities analysts and investors. If this
occurs, the trading price of our common stock would likely decline.
Liquidity and Capital Resources
We have funded our cash requirements primarily through private placements of
equity securities. Through June 30, 1999, we had raised approximately $61.2
million through equity financings. In July 1999, we raised approximately $15.7
million through the sale of preferred stock.
Net cash used in operating activities totaled $14.1 million in 1998 and $8.8
million in the six months ended June 30, 1999. The $14.1 million of cash used
in 1998 is primarily attributable to the net loss of $19.7 million and an
increase in accounts receivable of $1.5 million, offset by an increase of $6.1
million in deferred revenue. The use of cash in the six months ended June 30,
1999 was
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primarily attributable to a net loss in the period of $11.4 million offset by a
decrease in accounts receivable of $1.1 million and increases in accounts
payable, accrued liabilities and deferred revenue.
Through June 30, 1999, our investing activities have consisted primarily of
capital expenditures totaling $509,000 in 1998 and $210,000 in the six months
ended June 30, 1999. Capital acquisitions have been principally comprised of
computer equipment and software used to support our product development and
growing employee base. Although to date our requirements for capital
expenditures have been moderate, we anticipate a substantial increase in
capital expenditures and lease commitments consistent with anticipated growth
in operations, infrastructure, and personnel.
Net cash provided by financing activities totaled $18.3 million in 1998 and
$18.8 million in the six months ended June 30, 1999. The proceeds in 1998 were
principally generated from the issuance of preferred stock totaling $14.8
million and the issuance of $3.0 million of convertible promissory notes. In
the six months ended June 30, 1999, proceeds from financing activities were
provided by the issuance of $14.7 million of preferred stock and approximately
$3.1 million from stock option and warrant exercises. During the six months
ended June 30, 1999, we also issued a convertible promissory note in the face
amount of $1.0 million which converted into preferred stock in July 1999.
At June 30, 1999, our principal source of liquidity included $15.3 million
in cash and cash equivalents. We believe that the net proceeds of this
offering, together with our cash and cash equivalents and credit facilities
with our equipment vendors, will be sufficient to meet our working capital
needs for at least the next 12 months. From then on, we may require additional
funds to support our working capital requirements or for other purposes and may
seek to raise additional funds through public or private equity financing or
from other sources. Additional financing may not be available at all or, if
available, may not be obtainable on terms favorable to us. In addition, any
additional financing may be dilutive and new equity securities could have
rights senior to those of existing holders of our common stock. If we need to
raise funds and cannot do so on acceptable terms, we may not be able to respond
to competitive pressures or anticipated requirements or take advantage of
future opportunities.
Impact of Year 2000
Many currently installed computer systems and software products are coded to
accept or recognize only two digit entries in the date code field. These
systems and software products will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, computer
systems and/or software used by many companies and governmental agencies may
need to be upgraded to comply with these year 2000 requirements or risk system
failure or miscalculations causing disruptions of normal business activities.
Our software and associated tools were designed to be year 2000 compliant.
Our year 2000 plan currently in progress will determine whether or not our
products, internal systems, computer hardware and software, and the products of
our critical vendors and suppliers are year 2000 compliant. Our assessment plan
consists of:
. quality assurance testing of our internally developed proprietary
software;
. contacting third-party vendors and licensors of material hardware,
software, and services that are directly or indirectly related to the
delivery of our DRM platform to our partners;
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. contacting vendors of the third-party systems;
. assessing repair or replacement requirements;
. implementing repair or replacement; and
. creating contingency plans if there are year 2000 failures.
Based on product evaluations and quality assurance testing, we believe that
our products are year 2000 compliant. We have contacted our third-party vendors
that supply our core technology infrastructure and obtained statements from
them regarding their compliance with the year 2000 issue. We have also
conducted an inventory of our information technology hardware and software
systems and anticipate that any year 2000 non-compliant hardware or software
will be replaced before January 2000.
Costs
To date, we have spent an immaterial amount on year 2000 compliance issues
but expect to incur an additional $35,000 to $50,000 of expense in connection
with identifying, evaluating, and addressing year 2000 compliance issues. Most
of our expenses have related to, and are expected to continue to relate to, the
operating costs associated with time spent by employees and consultants in the
evaluation process and year 2000 compliance matters generally. These expenses,
if higher than anticipated, could significantly harm our business and operating
results.
Risks
We are not currently aware of any year 2000 compliance problems relating to
our systems that would significantly harm our business and operating results,
without taking into account our efforts to avoid or fix these problems. We
might discover year 2000 compliance problems in our systems that will require
significant upgrading or replacement. In addition, third-party software,
hardware, or services incorporated into our material systems might need to be
fixed or replaced, all of which could be time-consuming and expensive. The
failure on our part to fix or replace our proprietary software or third-party
software, hardware, or services on a timely basis could result in lost
revenues, increased operating costs, the loss of customers, and other business
interruptions, any of which could significantly harm our business and operating
results. Moreover, our failure to address year 2000 compliance adequately could
result in claims of mismanagement, misrepresentation, or breach of contract and
related litigation, which could be costly and time-consuming to defend.
In addition, governmental agencies, utility companies, Internet access
companies, third-party service providers, and others outside of our control
might not be year 2000 compliant. The failure by these entities to be year 2000
compliant could result in a systemic failure beyond our control, for example, a
prolonged Internet, telecommunications, or electrical failure. We believe the
primary business risks, in the event of these failures, would include:
. loss of telecommunication tools to support our partners;
. lost transaction revenues;
. increased operating costs; and
. claims of mismanagement, misrepresentation or breach of contract.
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<PAGE>
Contingency Plan
We have developed our year 2000 contingency plans. The results of our year
2000 testing and the responses received from third-party vendors and service
providers will be taken into account in determining the nature and extent of
our contingency plans.
Recent Accounting Pronouncements
We adopted Statement of Position, or SOP, 97-2, Software Revenue Recognition
and SOP 98-4, Deferral of the Effective Date of a Provision of 97-2, as of
January 1, 1998. SOP 97-2 and SOP 98-4 provide guidance for recognizing revenue
on software transactions and supersede SOP 98-1. The adoption of SOP 97-2 and
SOP 98-4 did not have a material impact on our operating results.
In December 1998, the American Institute of Certified Public Accountants
issued SOP 98-9, Modifications of SOP 97-2, Software Revenue Recognition, With
Respect to Certain Transactions. SOP 98-9 amends SOP 98-4 to extend the
deferral of the application of some passages provided by SOP 98-4 though fiscal
years beginning on or before March 15, 1999. All provisions of SOP 98-9 are
effective for transactions entered into in fiscal years beginning after March
15, 1999. We believe the adoption of SOP 98-9 will not have a material effect
on our operating results or financial condition.
In June 1998, the Financial Accounting Standards Board issued Statement on
Financial Accounting Standards, or SFAS, No. 133, Accounting for Derivative
Instruments and Hedging Activities, which is required to be adopted in years
beginning after June 15, 1999. To date, we have not used derivatives, and
management anticipates that the adoption of SFAS 133 will not have a
significant effect on our operating results or financial position.
Qualitative and Quantitative Disclosures about Market Risks
We develop products in the United States and license our products to
partners in North America, Europe, and Asia. As a result, our financial results
could be affected adversely by various factors, including foreign currency
exchange rates or weak economic conditions in foreign markets. Transaction
revenues from our European and Asian partners will be primarily denominated in
foreign currencies and translated generally on a monthly basis to United States
dollars to determine the amount of fees due to us. As a result, we could be
affected adversely by fluctuations in foreign currency exchange rates.
Our interest income is sensitive to changes in the general level of United
States interest rates, particularly since the majority of our investments are
in short-term instruments. Due to the nature of our short-term investments, we
have concluded that there is no material market risk exposure. Therefore, no
quantitative tabular disclosures are required. At December 31, 1998 and June
30, 1999, our cash and cash equivalents consisted primarily of demand deposits
and money market funds held by a large institution in the United States.
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BUSINESS
Overview
We have developed a general purpose digital rights management, or DRM,
platform to serve as a foundation for providers of digital information,
technology, and commerce services to participate in a global e-commerce system.
We provide our DRM platform as software and tools to licensees, which we call
partners. These partners intend to offer digital commerce services and
applications that collectively will form a global commerce system, which we
have branded as the MetaTrust Utility.
DRM technologies protect and manage the rights and interests in digital
information of artists, authors, producers, publishers, distributors, traders
and brokers, enterprises, governments and other institutions, and consumers.
The Internet and the music industry have dramatized the need for protection and
management of digital information. The very characteristics that make the
Internet ideal for distributing digital information also make it ideal for
pirating. DRM is needed by any industry that distributes information that can
be put into digital form.
Our DRM platform provides a foundation for people and organizations to
define rules for using digital information and building commercial models. Our
technology is designed to protect digital information, apply rules persistently
after information is distributed, and automate many of the commercial
consequences of using the information. Our general purpose DRM platform is
designed to manage a broad range of rights across digital information and media
types.
Our current partners include BMG Entertainment Storage Media, Computacenter,
Diamond Multimedia Systems, Matsushita Electric Industrial, Mediascience,
Mitsubishi Corporation, MusicMatch, National Westminster Bank, PublishOne,
Reciprocal, and Universal Music Group. We also have alliances with Adobe
Systems, Digital Theater Systems, Fraunhofer-Institut, Harris Corporation,
Portal Software, and Science Application Information Company. These partners,
including alliance partners, actively endorse or promote our products and
services through various sales and marketing activities, including press
releases and trade shows. Some of our partners are conducting, or are planning
to conduct, commercial trials, and have announced that their applications and
services will be commercially available in the MetaTrust Utility in 2000.
Industry Background
The Internet has emerged not only as the fastest growing communications
medium in history, but also as one of the most efficient distribution channels
for commerce. According to International Data Corporation, total worldwide
Internet commerce spending was $50.4 billion in 1998 and is estimated to grow
to $1.3 trillion in 2003. International Data Corporation further estimates that
worldwide Internet commerce spending per online buyer will grow from $1,635 in
1998 to $7,216 per year in 2003.
While most Internet commerce to date has involved the delivery of physical
goods like books and compact discs ordered online, the Internet is poised to
become a leading distribution channel for digital goods as well. Today, most
content is in, or can be easily put into, digital form. This content includes
music, videos, games, software, publications, business information, and images.
The Internet can be used to disseminate this digital information efficiently to
broad audiences without geographic boundaries, and can eliminate many of the
traditional costs associated with manufacturing, packaging, and distribution.
The use of the Internet for digital goods is being supported both by the
growing
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number of households and businesses connected to the Internet, and by
electronic devices other than the personal computer, such as set-top boxes,
portable music players, mobile phones, and other hand-held devices, all of
which are becoming connected to the Internet. In addition, downloading digital
content is becoming significantly easier with the emergence and adoption of
broadband technologies including digital subscriber lines and cable modems, and
enhanced compression technologies including MP3 for music and MPEG-4 for video.
The Internet will add to the existing channels for distributing digital goods
on physical media like compact discs and DVDs.
The characteristics that make the Internet ideal for distributing digital
goods also make it ideal for pirating and misusing them. Digital goods, if not
protected and managed, can be easily copied without any degradation in quality,
altered and defaced, and distributed with the touch of a button to a large
number of recipients. These threats are increased by advances in broadband and
compression technologies, wider uses of portable devices, and wider
availability of re-writeable compact disc and DVD devices. As the number of
users connected to the Internet and the amount of digital information
transmitted over the Internet increases, these users and this information
become more vulnerable to parties who wish to interfere with the integrity of
digital information and digital transactions.
Recent events in the music industry provide the most visible example of an
industry facing the problem of protecting and managing its rights related to
digital information. A technology called MP3 that compresses music with near-
compact disc quality has rapidly become recognized as a major threat to the
industry. With readily available MP3-enabled software, music can be copied from
compact discs into computers, compressed to under 10% of its former size,
redistributed, played, and even copied back onto a blank compact disc for
private use or pirated resale. Songs in the MP3 format can be moved from
personal computers to new portable consumer devices and can then be played
through headphones or stereo speakers. Every compact disc published and
distributed is at risk of being copied. Already, many popular titles have been
digitized in MP3 form multiple times across the Internet and a new channel of
direct MP3 distribution is emerging.
Digital rights management is needed across all content industries, including
music, video, games, software, publications, business information, and images,
and by all of the constituencies in these industries. These constituencies,
including artists, authors, producers, publishers, and distributors, are all
concerned about protecting and managing their rights in digital content. All
parties want to get paid. Artists and authors want to protect the integrity of
their works. Consumers want easy transparent access to good content but are
concerned about protecting their privacy. Producers, publishers, and
distributors want to structure and optimally manage their business models.
DRM applies to more than content industries. The Internet is becoming a
principal means for digital interaction among organizations and individuals. A
vast amount of data about organizations and individuals is digitized on
computers, sent over networks, and stored in electronic form. Much of this
information is confidential and proprietary, including trade secrets and supply
chain and product information. Some of this information is also personal in
nature, including financial and medical records. This information is gathered,
stored, and exchanged among many entities, including corporations, governments,
schools, hospitals, and individuals. These organizations and individuals need
to manage their digital rights in the flow of proprietary and personal
information, so that only the appropriate people can use the information. DRM
is also useful for protecting rights as these information flows become more
automated, in trading, brokering, regulatory compliance, and other industries.
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Current computing environments and security techniques are not designed to
provide sufficient protection and management of digital rights. Historically,
computers, networks, and operating systems were designed primarily for
creating, processing, and distributing information. Similarly, security
technologies evolved to protect computers and networks from the outside
environment and to protect information during a point-to-point transmission,
not to protect information and rights once information has been received and
properly accessed by a user. In commercial transactions in current computing
environments, information is generally stored and transactions are processed at
remote mainframes or servers, even when it is less efficient, because the
client and other parts of the environment do not provide adequate protection
and security. As a result, these security technologies either do not consider
an authorized user as a potential threat, or fail to provide sufficient
mechanisms to prevent the improper use of information. With digital commerce,
the threat comes not only from the outside--a hacker trying to break into the
protected computer or decrypt an encrypted transmission. The threat comes also
from the inside--a user may be authorized initially to access digital
information but performs an unauthorized act, such as making or distributing
copies. Moreover, the requirement for centralized transaction processing and
information storage is less efficient, harder to scale, and more constrained in
use than systems that distribute secure processing.
Current techniques for DRM that are built on these centralized security
approaches generally only provide secure digital distribution. For example,
these techniques generally lack the ability to persistently manage digital
information, especially when offline, and essentially allow only a limited
number of inflexible business relationships that are predetermined by the
technology provider. These techniques usually require online interaction, which
increases costs, limits consumer convenience, and makes some business models
uneconomical.
A new computing technology is required to address all of these concerns--one
that, when distributed over a vast array of computers and devices, consistently
protects and manages rights related to digital information and processes,
online and offline, wherever this information and these processes may occur.
Creators, publishers, distributors, service providers, governments and other
institutions, and users must have the ability both to create and associate
rights and rules that persistently apply to digital information and processes,
and to modify the rights and rules, if permitted, even after the information is
distributed. These rights and rules might represent information regarding
ownership, access, payment, promotion, warranty, privacy, and other elements of
commerce in information. When these rights and rules are based on a common
foundation, they can form a basis for an interoperable global system for
digital commerce.
InterTrust Solution
We have developed a general purpose DRM platform to serve as a foundation
for providers of digital information, technology, and commerce services to
participate in a global system for digital commerce. Protected information can
flow from party to party, as it would in normal commerce, and be managed
throughout its lifecycle in compliance with specified rules. Our platform
consists of:
. DRM Software and Technology--We license platform software and tools to
partners that build products and operate commerce services. Our
technology is designed to operate on the personal computers, devices, and
servers in this global system and to provide the capability to package
and publish protected information with rules for use. These rules are
designed to be flexible, and can be applied and changed dynamically,
enabling our partners to develop and
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program their business models easily. The rules are designed to be
persistently enforced wherever the content may travel.
. MetaTrust Utility Services--We maintain and administer the specifications
that are designed to ensure the interoperability, security, and
trustedness of the global digital commerce system being built by our
partners. This utility service enables our DRM platform to offer a
common, neutral basis for publishers, merchants, organizations,
consumers, and other participants to conduct business and exchange
protected information.
Our focus on providing DRM technology and MetaTrust Utility services allows
our partners to develop their own commercial models. They build the
applications and operate the commerce services themselves. A content provider
can establish a relationship with one or more of our partners and have its
content managed consistently as it flows throughout the entire system. As in
traditional commerce, a content provider can select several commerce service
providers and provide users with a choice of payment methods.
Our general purpose DRM platform is designed to have broad capabilities to
address the needs of all parties seeking to distribute and manage digital
goods. We believe our platform provides the following benefits:
. Robust Security--Our highly sophisticated use of multiple layers of
security and tamper-resistance techniques are designed to provide varying
levels of security depending on the commercial value and nature of
digital information consistent with the rights and interests of all
parties.
. Persistent Protection and Management--Our platform is designed to allow
content providers to protect persistently both the information itself and
the rules of use. Persistent protection means that these rules continue
to apply even after the information arrives, online or offline, each time
the information is accessed, and even when it may be forwarded to other
people.
. Flexible Business Models--Our platform is designed to allow content
providers to specify and establish their own commercial models with fully
programmable rules that manage the use of digital information. These
rules can be easily changed, even after content is distributed, for
example to permit promotional offers, to accommodate changing commercial
circumstances, or to automatically present differing offers under
differing circumstances. Our platform is also designed so that these
rules can also adjust themselves dynamically to each consumer's unique
identity characteristics and circumstances of access, for example,
student or senior citizen discounts, membership in affinity groups, or
employment at a specific corporation.
. Superdistribution--We believe content providers can take advantage of
superdistribution-- allowing and encouraging consumers to become
redistributors of content in the system. Superdistribution means that
users of content, if permitted by rules, can forward content to others,
with persistent application of rules and protection of content. Our
platform is designed to enable providers to get paid and users to act
naturally by forwarding content they like to their associates or friends.
If these parties are not already part of the digital commerce system,
they have an incentive to join so that they may use the content.
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. Multiple Content and Media Types--Content providers can use our platform
for multiple content types. Our platform is designed to permit
distributors to employ various means of digital distribution, including
compact discs, DVDs, the Internet, and broadband. Consumers may sign up
to use any one content type, like music, but then can use our client
software for other content or services in the MetaTrust Utility system.
Payment processors can use our technology both for digital goods
transactions and to process payments for physical goods sold
electronically.
. Efficient Transaction Processing--We believe processing partners can take
advantage of significant increases in efficiency, including offline
processing, immediate payment across all participants in the chain of
distribution, and automated application of rules. Our platform is
designed to securely store usage and payment transactions that take place
offline, accumulate them until a minimum threshold is met, for example 30
days or $50, and then automatically forward the stored transactions for
processing. This allows both micropayments and efficient collection of
usage information. In addition, as required by provider-supplied rules,
when processing these transactions, immediate payment can be made
throughout the distribution chain, eliminating multiple parties handling
payment.
. New Advertising Models--Today, advertising on the Internet is largely
limited to viewing banners and other promotional materials on a web page.
With our technology, we believe advertising can be managed and audited
locally on a user's machine every time the user sees the advertisement,
whether the user is on-line or off-line. Our platform is designed to
allow a rule to be applied to a brief product placement, for example, the
appearance of a car within a music video, so that the car company
promotes its products and pays for the promotion each time the car is
viewed. This feature, combined with our ability to operate offline and
securely store and later forward collected data, enables new cost-
effective ways for companies to price content and generate revenue from
advertising.
. Personalized Marketing--Our platform is designed so that marketing
organizations can use many different aspects of our platform to identify
and profile individual consumers and match content, offers, and ads to
specific users or class of users, subject to user consent and privacy
rights. Because our technology is designed to locally process ads and
promotions as easily as digital content, this automated personalization
can occur on the network or offline on the consumer's personal computer.
The MetaTrust Utility
We license our DRM platform as software and tools to partners to build
applications and operate services for electronic commerce. By offering
commercial products and services based on our specifications and MetaTrust
Utility services, our partners can collectively build a global digital commerce
system, which we have branded as the MetaTrust Utility. Our DRM platform is
designed to enable creators, publishers, distributors, service providers,
governments and other institutions, and users to persistently associate rights
and rules with digital information.
The user experience with the MetaTrust Utility will typically begin by
activating our client software, called the InterRights Point, which our
partners will either preinstall or distribute through a variety of means,
including digital download and optical disk distribution. The user will
activate the
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InterRights Point by establishing a relationship with one of our commerce
service partners. Users will provide basic identity and authentication
information in a largely automated process. Once initialized, the InterRights
Point is designed to interact with any of the services and content available in
the system, from any of our partners. The following diagram illustrates the
lifecycle of content commerce in the system.
Commerce Flow Example
Narrative Description of Graphic on p. 40 of Business Section
Graphic titled "Commerce Flow Example." In the upper right hand corner is a box
titled "Key" in which there are four symbols. The first is a sphere with three
arrows pointing to its center labeled "InterRights Point." The second is a cube
labeled "DigiBox container." The third is the symbol "$" labeled "Payment." The
fourth is the letter "i" inside a circle labeled "Usage information."
In the center is a cube labeled "Distributor." Above and to the right is a
picture of a piece of paper titled "Usage Rules." From the cube an arrow with a
cube in the middle points down towards a box labeled "User." Inside the box is
a human form, a sphere with three arrows meeting in its center, and a picture
of a computer monitor with an image, entitled "Agree to Rules," projecting from
the screen.
From the box an arrow with a sphere in the middle points to the right to a
picture of an electronic device entitled "Information Appliance."
From the box an arrow points to the left to a box entitled "Commerce services
provider." In the middle of the arrow is a web brower labeled "www" next to two
compact disks and a floppy disk. Inside the box there are two buildings and a
sphere with three arrows that meet in its center. The building on the left is
marked with the symbol "$" in a circle. The building on the right is marked
with the letter "i" in a circle.
Two arrows, one with the symbol "$" in the middle and one with the letter "i"
in the middle, both in clear cubes, point to a box titled "Publisher." Inside
the box is a human form, a sphere with three arrows meeting in its center and a
computer monitor. Pointing towards the sphere is a picture of a piece of paper
captioned "Usage rules" and a sphere with the caption "Digital information." An
arrow with a cube in the middle points back to the cube in the center of the
graphic.
. Packaging Content--With an application developed by one of our partners
using our DRM technology, system participants can be both creators and
consumers of digital information. Working from a personal computer, in
this example, a user creates digital information and, using an
InterRights Point, associates business rules with the information and
packages the information securely in a DigiBox container.
. Distributing Content--The information is disseminated in DigiBox
containers over networks, on optical disks, or by other means of
delivering digital information. The information can securely travel
through unsecure networks, because the information in a DigiBox container
is itself protected. Distributors, portals, and web sites can, as enabled
by the rules of the publisher, add additional rules for use or modify the
rules--for example, mark up price, make promotional offers, bundle the
content with other content, or establish frequent buyer programs.
Importantly, rules for use can be easily changed, even after content is
distributed.
. Using Content--A user can receive content in a DigiBox container, select
the content and set in motion a secure process. The InterRights Point
compares identity characteristics of the user or machine with the rules
that have been associated with the requested event, for example, listen
or view, and presents the appropriate offers. The event occurs only as
permitted by the
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rules. If the rules permit, protected content can be transferred to other
devices. Our technology, if present, will continue to manage the
information's use.
. Processing Transactions--The InterRights Point can process transactions
involving both payment and usage information, for example, special
surveys or information on interaction with an advertisement. These
transactions could be processed immediately, much like a credit card
event, or deferred, much like running up a tab, or any combination of
immediate and deferred processing, as specified by the rules. The
InterRights Point forwards the transactions in secure DigiBox containers
to our processing partners which ensure that everyone who is supposed to
get paid gets paid, that usage information is made available to agreed
upon parties, and that the privacy of the individual is protected.
Strategy
Our goal is to empower multiple providers of digital information,
technology, and commerce services to build a global system for digital commerce
based on our DRM platform. The key elements of our strategy are:
Expand Key Strategic Partnerships
We are focused on bringing into the MetaTrust Utility an optimal combination
of digital information, technology, and commerce service participants. Through
this focus we intend to create mutually-reinforcing widespread dissemination of
our technology, an expanding consumer base, and ever-broader participation by
information providers. We are targeting relationships that will establish our
DRM initially in several large markets, including entertainment, business
information, and publishing. We intend to leverage early success in any one
market to help encourage adoption and usage in other markets. We encourage
potential participants to enter into relationships with us, as well as with our
partners, in the following key areas:
Content--We intend to continue entering into direct relationships with
premier and emerging publishers, distributors, and packagers of content. We
have established strategic relationships with Universal Music Group and BMG
Entertainment Storage Media. In addition, we will encourage premier content
providers to participate in the MetaTrust Utility through our partners.
Technology--We will continue to target leading technology and device
companies that can build our technology into the infrastructure of several
industries, including computers, consumer electronics, the Internet, and
communications. We have established a strategic relationship with Diamond
Multimedia Systems to build our technology into portable music devices and
software players.
Commerce Services--We are targeting partners with trusted brands and
operations, including Mitsubishi Corporation and National Westminster Bank. We
believe that these partners' reputations, markets, and customer base will
facilitate user acceptance of the MetaTrust Utility.
By having a combination of content, technology, and commerce service
participants in multiple markets in the MetaTrust Utility, we would not depend
on any one partner, any specific commercial model, or any specific vertical
market to succeed.
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Promote Widespread InterRights Point Deployment
We have designed our client technology and our licensing structure to
achieve efficient and rapid deployment. Our technology is designed so that it
can be conveniently activated by consumers. It is also designed so that it can
be flexibly deployed by our partners through a variety of means, including
digital download, optical disk distribution, and pre-installation. We will also
work with our partners to develop business models that promote rapid
deployment, for example, superdistribution which allows users to drive
InterRights Point deployment through redistribution of content.
Leverage the MetaTrust Utility Model
We believe that our neutral utility model is fundamental to achieving
widespread adoption of our DRM platform. We believe partners are more likely to
participate in building a global commerce system if they perceive that the
provider of the foundational technology is unlikely to engage in commercial
models that directly compete with them. We intend to provide technology and
maintain policies needed for an interoperable, secure, and trusted foundation
for all participants in the MetaTrust Utility. Partners can take advantage of
the global interoperability and general purpose nature of this system to build
on the success of our other partners; as more partners and users participate in
the system, participation in the system becomes more efficient and valuable. In
addition, by structuring our compensation as a small share of the value of
goods and services flowing through the system, we align our interests with
those of our partners. From time to time, we may provide special assistance to
new ventures using our technology and may in return take limited equity
positions if we believe it will not compromise our neutrality. In addition, we
have developed and plan to develop further special technology and services to
assist our partners in promoting the use of the MetaTrust Utility in various
vertical markets.
Maintain Technology Lead
We believe we are the leader in DRM technology and intend to continue
advancing the state-of-the-art of DRM. We have attracted a group of computer
scientists in both our engineering team and in STARLab, our electronic commerce
research facility, to focus on a broad range of topics important to advancing
DRM. These include commerce language, streaming media, security, software
tamper resistance, secure processing hardware, and watermarking. We currently
have been issued 11 United States patents, and will continue to develop our
intellectual property in the fields of digital rights management and electronic
commerce.
Strategic Partners and Markets
We license our DRM technology to our partners to build digital commerce
services and applications. In addition, we intend to leverage our partners'
activities as they bring their own partners and customers into the MetaTrust
Utility. While we have received initial license fees from our partners, over
time we anticipate that our revenues will be derived primarily from transaction
fees from our partners' and their customers' commercial deployment of
applications and services.
We currently have four basic types of partnering arrangements: commerce
service licenses, business licenses, applications licenses, and alliance
agreements. These partners actively endorse and promote our products at
marketing events, including trade shows and conferences, as well as through
press releases. A summary of our primary relationships follows.
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Commerce Services
Our commerce service partners have broad rights to process and clear
transactions for the MetaTrust Utility, and to create and deploy applications.
They operate data centers, provide various clearinghouse services, and may
distribute applications or host application services. These partners are
actively focused on establishing relationships with multiple digital content,
enterprise, and government customers. Our current commerce service partners
collectively have the ability to provide services both in the United States and
internationally, with bases of operations in the United States, Europe, and
Asia-Pacific.
Mitsubishi--Japan-based Mitsubishi Corporation is one of the largest trading
companies in the world. Mitsubishi's license to our Commerce software allows it
to create financial and usage clearinghouses, develop software applications,
and act as a deployment manager. Mitsubishi is also one of our stockholders.
NatWest--National Westminster Bank Plc is one of the world's largest banks
and a leading processor of credit card transactions and multi-currency credit
card clearing. NatWest recently announced a digital commerce service called
Magex, which is based on our Commerce software. NatWest's license allows it to
create financial and usage clearinghouses, develop software applications, and
act as a deployment manager.
Reciprocal--Reciprocal, Inc. is a venture-backed company formed in 1996 by
SOFTBANK Services Group to provide DRM solutions and clearinghouse services.
Reciprocal's license with us allows it to create financial and usage
clearinghouses, develop software applications, and act as a deployment manager.
Reciprocal has recently made public announcements concerning its initiatives
based on our DRM technology in various vertical markets including music,
business information, and education information.
Samsung SDS--Samsung SDS, part of the Samsung Group, is Korea's leading
information services company. Samsung SDS's license to our Commerce software
allows it to create financial and usage clearinghouses, develop software, and
act as a deployment manager in Korea, for commercial and enterprise customers.
Business
We have licensed business partners to operate services in one or more
content or application markets. We intend to license additional business
partners, and also believe that many content companies will participate in the
MetaTrust Utility through our partners.
ASPSecure.com--ASPSecure.com Corporation was founded in August 1999 to
develop applications and services based on our DRM technology. ASPSecure.com's
license to our Commerce software allows it to create a usage clearinghouse and
software applications and services for the application service provider, or
ASP, market. We licensed our Commerce software to ASPSecure.com and received an
initial license fee in the form of a minority equity position in ASPSecure.com.
Bertelsmann--BMG Entertainment Storage Media, a unit of Bertelsmann AG, one
of the world's leading media companies with significant interests in all areas
of media, services BMG
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Entertainment music labels and other Bertelsmann companies, including Random
House, Inc. BMG Entertainment Storage Media's license to our Commerce software
enables it to develop applications and services in a wide range of vertical
markets including music, business information, software, and computer games.
PublishOne--PublishOne Inc. was founded in February 1999 to develop digital
publishing applications and services based on our DRM technology. PublishOne's
license to our Commerce software allows it to create a usage clearinghouse and
software applications and services for publishing. PublishOne's initial focus
will be on business information, but it also plans to have future activities in
other content areas, including education. We licensed our Commerce software to
PublishOne and received an initial license fee in the form of a minority equity
position in PublishOne.
Reuters--Reuters is one of the largest news and information groups in the
world. Reuters has announced trials with NatWest and is a strategic business
partner of Reciprocal, both of which are our commerce services partners.
Reuters is one of our stockholders.
Universal--Universal Music Group is the largest of the five major music
labels. Universal's license to our Commerce software allows it to create a
financial and usage clearinghouse, to develop software applications, and act as
a deployment manager, for various entertainment markets. Universal is one of
our stockholders.
Applications
Application partners are licensed to develop applications, embed our
technology into software or devices, or perform hosting integration and other
services for users of our DRM technology.
Computacenter--UK-based Computacenter Plc is one of the largest European
information technology providers. Computacenter's license to our Commerce
software allows it to develop a usage clearinghouse for enterprises and to
develop applications and services for enterprises and commercial customers. We
will also work with Computacenter to establish them as a center of excellence
authorized to provide training, support, system integration, and other
services.
Diamond--Diamond Multimedia Systems, Inc. is a multimedia and hardware
device company. It introduced the Rio, the first commercially available
portable player of music files in the MP3 format, in November 1998. Diamond has
licensed our Commerce application developer's kit and additional InterTrust DRM
technology to use with the Diamond Rio player, and to develop software
applications for distributing music in connection with Diamond's Rioport.com
web site.
Mediascience--Mediascience, Inc. developed and distributes the Sonique MP3
player, which is one of the leading MP3 music players. Mediascience licensed a
music player-related application developer's kit to enable Mediascience to
develop a software music player with DRM capabilities.
MEI--Matsushita Electric Industrial Co., Ltd. is one of the largest consumer
electronics companies in the world. MEI has licensed our Commerce ADK to
develop applications and services for electronic music distribution.
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MusicMatch--MusicMatch, Inc. was the first company to introduce an MP3
jukebox music player, which is still one of the most popular MP3 music players.
Its music portal is among the most popular MP3 music sites. MusicMatch licensed
a music player-related application developer's kit to enable MusicMatch to
develop a software music player with DRM capabilities.
Our Commerce Services, Business and Applications Partners and Potential Markets
Through the end of 1998, we were in the development stage and had a limited
number of licensees. Mitsubishi, a stockholder, accounted for 91% of total
revenues in 1997 and 40% of total revenues in the six months ended June 30,
1999. Reciprocal accounted for 100% of total revenues in 1996, 9% in 1997, 66%
in 1998, 100% in the six months ended June 30, 1998, and 24% in the six months
ended June 30, 1999. Bertelsmann accounted for 21% of total revenues in 1998.
Computacenter accounted for 13% of total revenues in the six months ended June
30, 1999. Our success depends on significantly increasing the number of
companies that license our technology and use it for the sale and management of
digital content and services.
The following table shows the markets in which our partners have indicated
an interest in pursuing products and services using our DRM technology. This
table is based on our partners' current interest, which may change, and there
is no assurance that there will be any deployments by our partners in any of
these markets.
<TABLE>
<CAPTION>
Entertainment: Publishing: Regulated: Enterprise:
Market .music .business information .government .secure document
.video .financial information .healthcare exchange
.audio books .traditional media .education .enterprise
.games .images .telecommunications information portals
Partner .secure email .trading/brokering
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mitsubishi X X X X
- --------------------------------------------------------------------------------------------------
NatWest X X X
- --------------------------------------------------------------------------------------------------
Reciprocal X X X
- --------------------------------------------------------------------------------------------------
Samsung X X X X
- --------------------------------------------------------------------------------------------------
ASPSecure.com X X
- --------------------------------------------------------------------------------------------------
Bertelsmann X X
- --------------------------------------------------------------------------------------------------
PublishOne X
- --------------------------------------------------------------------------------------------------
Reuters X
- --------------------------------------------------------------------------------------------------
Universal X
- --------------------------------------------------------------------------------------------------
Computacenter X X X X
- --------------------------------------------------------------------------------------------------
Diamond X
- --------------------------------------------------------------------------------------------------
Mediascience X
- --------------------------------------------------------------------------------------------------
MEI X
- --------------------------------------------------------------------------------------------------
MusicMatch X
</TABLE>
45
<PAGE>
Alliances
We have entered into several alliance agreements to help us penetrate
various vertical markets. The alliance agreements provide for cooperative
activities regarding product development and targeting specific strategic
business opportunities. To date, we have entered into alliance agreements with
Adobe Systems, Digital Theater Systems Inc., Fraunhofer-Institut fur
Integrierte Schaltungen, Harris Corporation, Portal Software, and Science
Application Information Company.
Products and MetaTrust Utility Services
Our general purpose DRM platform is comprised of both proprietary software
and technology, and the utility services needed for security, interoperability,
and trustedness of the MetaTrust Utility.
Products
Our Commerce software is a general purpose DRM platform and includes systems
software, development tools, and applications for building, deploying, and
managing digital commerce applications. We shipped the general availability
version of our Commerce software at the end of December 1998. Digital
information providers and software companies can use the product to integrate
rights management capabilities into applications that securely manage, control
usage of, and fulfill digital information commerce through digital distribution
channels. Payment processing and Internet infrastructure companies can use the
product to provide various commerce services, including payment clearing, usage
reporting, market analysis and user profiling, advertising, regulatory
compliance, affinity marketing, and automated trading systems.
Our software is designed to be fully scalable and comes in several packages,
depending upon the scope of rights licensed by our partners. The key components
of our Commerce software are:
. InterRights Point--software that processes DigiBox containers, and
manages usage of digital information throughout its lifecycle. It may
function as a client or server, as determined by rules;
. Application Developer's Kit--software and tools for systems integrators,
applications developers, software vendors, and web sites enabling them to
develop end-user applications and services;
. Sample Applications--software and components that assist development of
applications and services;
. RightsWallet Application--client software that manage identities,
memberships, budgets, and transactions;
. Transaction Authority Framework--software and databases for handling
communications with InterRights Points and processing transactions; and
. Deployment Manager Application--software for activating and managing
InterRights Points.
We have an enterprise edition of our Commerce software designed for
enterprises to manage private information, including work flow information. It
provides an information security and policy management system for the
enterprise and selected secure document exchange applications.
46
<PAGE>
We have developed and plan to develop further special technology to assist
our partners in promoting the adoption of our DRM platform in various vertical
markets. For example, we created Powerchord technology, comprised of tool kits
and full-featured demonstration applications, to help appropriate partners
accelerate the adoption of our DRM platform for protected digital music
distribution.
MetaTrust Utility Services
We plan to maintain the specifications and administer the interoperability,
security, and trustedness of the MetaTrust Utility. We do this through our
MetaTrust certification program, which has three essential elements:
. Specifications--Our partners and their products and services must comply
with our specifications. These specifications establish policies that
address technical, procedural, and related matters designed to promote
the security, trustedness, integrity, interoperability, and performance
of products and services in the MetaTrust Utility.
. Certification--We test and certify, or provide the means for testing and
certifying, that products and services of participants in the MetaTrust
Utility comply with our specifications. Certification applies to all
applications that interface with an InterRights Point as well as partner
sites and operations. We expect to provide various procedures designed to
make certification an easy process, including pre-certification of
components.
. Security--Our system addresses numerous areas of security, including
securing digital information after initial use and providing tamper
resistance in the InterRights Point software. We have designed, and plan
to continue to design, countermeasures that we intend to implement if
security is compromised. We also plan on assisting our partners in
cryptographic key management.
Technology
Our DRM platform is based on our proprietary software and technology that we
believe add fundamental new functionality to traditional computing
environments. By using proven security technologies plus this new
functionality, we have created platform software designed to enable computing
environments to perform a broad range of new operating functions relating to
managing, not merely protecting, rights in digital information.
Our DRM platform is general purpose and is
designed to enable digital commerce to operate in
compliance with provider-specified rules through a
network of independent, protected processing
environments, which we have branded as InterRights
Points. Our technology is currently implemented as
software and includes tools, components, sample
applications, documentation and training that allow
our partners and their customers to build digital
commerce applications and services and take
advantage of the reusable, common foundation of the
MetaTrust Utility. The accompanying diagram shows
the primary architectural elements of our platform.
Narrative Description of Graphic on p. 47 of Business Section
Box titled "InterTrust DRM Platform." Below the heading, the caption
"InterRights Point" next to a picture of a sphere with three arrows meeting in
its center; the caption "DigiBox container" next to a picture of a cube; the
caption "Usage rules" next to a picture of a piece of paper; and the caption
"Transaction authority" next to a picture of a building.
47
<PAGE>
. InterRights Point. The core element of our architecture is the
InterRights Point, which operates on personal computers and servers in
the MetaTrust Utility. DRM processing occurs at InterRights Points. Each
InterRights Point acts as a secure virtual machine, a software
application acting as a processing device, that is designed to manage
each party's digital rights remotely. Each InterRights Point creates a
local, secure database that stores the users' rights, identities,
transactions, budgets and keys. We are currently developing different
implementations of the InterRights Point for use in other electronic
devices. In particular, we are developing technology for securely
managing the transfer of digital information to portable electronic
devices like MP3 music players.
. DigiBox Container. Protected information in our system is encrypted and
stored in a format called a DigiBox container. Once in a DigiBox
container, the information can flow across unsecured networks, and only
an InterRights Point can access the information. Our design permits
information in a DigiBox container to remain protected even after a user
has accessed it, providing persistent protection of the information and
continuing control over its use regardless of where the information
travels.
. Usage Rules. Content usage is managed by rules, including price, payment
offer, play, view, print, copy, save, superdistribution, and others. We
offer a variety of tools designed to allow providers to create and change
rules and to associate them with digital information. Rules are protected
in the same way content is protected. Like content, they are stored in
DigiBox containers for distribution. Rules are designed to travel with
the information, or separately, allowing our partners the flexibility to
change any rule, including rights or price, after content has been
delivered. InterRights Points are designed to ensure that applicable
rules are followed every time an information usage event is requested.
. Transaction Authority Framework. InterRights Points connect into our
processing partners' data centers through a communications controller
system called the transaction authority framework. The transaction
authority framework is designed to receive transaction records from
InterRights Points, store the records, and forward them, as specified by
usage rules, for further processing, including payment fulfillment. The
transaction authority framework is also designed to store messages
resulting from this further processing, like payment confirmation, and
when the InterRights Point next connects to the data center, send these
messages to the InterRights Points. The transaction authority framework
includes administrative software, called the deployment manager, that is
designed to activate InterRights Points and manage them after activation,
including fraud detection, revocation, security updates, and back-up
services.
Currently most of our software runs on Windows 95, Windows NT, and Windows
98. Our transaction authority framework runs on Window NT and Solaris operating
system environments. Our software is currently being modified to run on
additional operating systems. These efforts are in the development stage.
Sales and Partner Development
Our sales activities are designed to establish the initial relationships
with potential partners and help them understand the services and applications
that can be developed using our technology. Our partner development
organization helps our partners and their potential customers understand both
48
<PAGE>
the business and the technical benefits of the products, and assists them in
expanding their businesses with our technology. The sales organization will
generally make the initial contact with a potential partner. The organization
assigns a representative that will serve as our primary contact point for
managing the potential relationship throughout the due diligence and business
discussion process. Our sales organization consisted of 11 employees as of
August 31, 1999, five in Sunnyvale, one in Washington D.C., three in London,
England and two in Sydney, Australia.
Our partner development organization provides a single point of coordination
for all interactions with the customers after they become partners. These
personnel are skilled in both business consulting and systems design to
facilitate the successful deployment of our products. The partner development
organization works with our partners on using our DRM as well as on developing
cross-partner and new customer relationships. Our partner development
organization consisted of six employees as of August 31, 1999.
Marketing
We market our products worldwide primarily through our partners in
combination with our own efforts. We conduct a variety of marketing programs
worldwide to educate our target market, create awareness and generate leads for
our MetaTrust Utility. To achieve these goals, we have engaged in marketing
activities including joint partner marketing, print and online advertising
campaigns and trade shows. These programs are targeted at key business unit
executives as well information technology officers. In addition, we conduct
comprehensive public relations programs that include establishing and
maintaining relationships with key trade press, business press, and industry
analysts. We have established consistent branding guidelines for all of our
partners to increase our brand awareness. Our programs are designed to assist
our partners in developing their internal marketing programs and capabilities.
Our marketing organization consisted of nine individuals as of August 31, 1999.
Research and Development; Training and Support
Our research and development organization is divided into product
development, training and support, and STARLab. To date, substantially all
software development costs have been expensed as incurred. Research and
development expenses were $8.3 million in 1997, $13.0 million in 1998, and $7.1
million for the six months ended June 30, 1999.
As of August 31, 1999, our research and development and training and support
organizations were comprised of 99 employees and nine contractors.
Product Development
The product development organization is responsible for designing,
developing, and supporting commercial implementations of our DRM and developing
future enhancements to our software. There are six engineering groups in the
product development organization: core rights technology, appliance technology,
applications and components, security and tamper resistance, product
architecture, and advanced development. These six engineering groups are
supported by quality assurance, product management, documentation, deployment
operations, and developer support. The
49
<PAGE>
quality assurance group implements a process designed to identify software
defects through the entire development cycle, including operational
deployments. The product management group is responsible for all functional and
certification specifications, schedules, and overall project coordination. The
documentation group is responsible for end user, administrator and developer
documentation and support for our products. The deployment operations group is
responsible for MetaTrust Utility operations and management, including
emergency response, fraud detection, key management, and application
certification. Developer support is responsible for technical support to our
partners' engineering staffs.
Training and Support
Our training and support organizations work closely with the partner
development organization to provide partners with the training and support
contemplated under their license. We believe that customer satisfaction is
essential for our long-term success. In general, our license agreements provide
for a limited period of support and training, including onsite visits, and
email and web site support. We plan on providing our partners with a variety of
standard support packages after this initial support period. As our partner
base grows, we intend to increase the size of our support organization.
STARLab
We have attracted a group of computer science experts for STARLab, our
electronic commerce research organization. STARLab projects cover a broad range
of topics necessary for advanced DRM, including watermarking, commerce
language, streaming media, security, and secure processing hardware. The
activities of STARLab are integrated with our important strategic objectives,
including:
. extending our portfolio of intellectual property;
. developing and prototyping new digital rights management technology;
. providing an engineering consulting resource to assist product
development;
. participating in and leading standards efforts; and
. advising governmental, research, and other institutions.
Competition
The market for DRM solutions is new, intensely competitive, and rapidly
evolving. We expect competition to continue to increase both from existing
competitors and new market entrants. The DRM market is new and we are not aware
of any one competitor that has established a dominant position in the market.
However, it is possible that one or more companies could become a dominant,
competitive force in the future. Our primary competition currently comes from
or is anticipated to come from:
. companies offering secure digital distribution systems, including AT&T,
IBM, Liquid Audio, Microsoft, Preview Systems, and Xerox; and
. companies offering hardware-based content metering and copy protection
systems, including Sony, Wave Systems, and the 4C Entity, comprised of
IBM, Intel, Matsushita, and Toshiba.
50
<PAGE>
In addition to these two categories, in the future, operating system
manufacturers like Microsoft or Sun Microsystems may also develop or license
digital rights management solutions for inclusion in their operating systems.
The primary bases of competition for providers of DRM solutions include:
. range of content types and markets, from specific content type to general
purpose, multiple markets;
. flexibility of pricing and other business options, from narrow, fixed
rules to flexible, dynamic rules;
. price of solution, from as high as 30-40% to a nominal percentage of
transaction value;
. range of usage environments, from personal computer-based, online-only to
multiple devices, offline and online;
. choice of service providers, from being tied to a single vendor that also
provides DRM technology and processing services, to being able to choose
among multiple, competing service providers; and
. business model of DRM provider, from vertically-integrated technology
provider to neutral utility model.
We believe that our ability to compete depends on many other factors both
within and beyond our control, including:
. the ease of use, performance, features, and reliability of our solutions
and our partners' applications and services as compared to those of our
competitors;
. the timing and market acceptance of new solutions and enhancements to
existing solutions developed by us, our partners, and our competitors;
. the quality of our partner development and support organization and
similar organizations of our partners; and
. the effectiveness of our sales and marketing efforts, and of similar
efforts of our partners.
We believe that we currently compete favorably with our competitors in these
areas.
Some of our competitors have longer operating histories and significantly
greater financial, technical, marketing, and other resources than we do. Many
of these companies have broader customer relationships that could be leveraged,
including relationships with many of our customers. These companies also have
more established customer support and professional services organizations than
we do.
Intellectual Property
Our success will depend in part on our ability to protect our intellectual
property and other proprietary rights in our software and other technology. To
protect our proprietary rights, we rely on a combination of patent, trademark,
copyright, and trade secret law, and confidentiality and license agreements
with our employees, customers, partners, and others. Despite these protections,
others
51
<PAGE>
might use our intellectual property without our authorization. If this occurs,
a party might copy or obtain and use our products or technology to develop
similar technology. If we are unable to protect our intellectual property
adequately, it could materially affect our financial performance. Moreover,
potential competitors might be able to develop technologies or services similar
to ours without infringing our patents. In addition, if our agreements with
employees, consultants and others who participate in product and service
development activities are breached, we may not have adequate remedies, and our
trade secrets may become known or independently developed by competitors.
Patents
We have devoted substantial time, resources, and capital to protecting our
intellectual property. As of August 31, 1999, we held 11 United States patents
and one European patent. We also have filed 31 additional United States patent
applications, as well as counterpart foreign applications in many instances. We
believe that our issued patents and patent applications cover a broad range of
subjects generally relating to protecting electronic rights and content,
enabling secure electronic transactions, and applying DRM technology in the
digital economy. Expenses associated with the preparation of new patent
applications, patent application processing fees, and attorneys costs
associated with patent applications and maintaining our patent portfolio
totaled $312,000 for the year ended December 31, 1996, $334,000 for the year
ended December 31, 1997, $237,000 for the year ended December 31, 1998, and
$191,000 for the six months ended June 30, 1999.
Any pending or future patent applications may not be granted, existing or
future patents may be challenged, invalidated or circumvented, and the rights
granted under a patent that has issued or any patent that may issue may not
provide competitive advantages to us.
Many of our current and potential competitors dedicate substantial resources
to protection and enforcement of intellectual property rights, especially
patents. If a blocking patent has issued or issues in the future, we would need
either to obtain a license or to design around the patent. We might not be able
to obtain a required license on acceptable terms, if at all, or to design
around the patent.
In part due to the broad range of technologies included in InterTrust
technology, we have not conducted and do not conduct comprehensive patent
searches to determine whether technology that is used in our products infringes
patents held by other third parties. In addition, it is difficult to proceed
with certainty in a rapidly evolving technological environment in which there
may be numerous patent applications pending, many of which are confidential
when filed, relating to similar technologies. In the past, we have received
notices alleging potential infringements by us of the proprietary rights of
others. In January 1996, we received a letter from an attorney representing E-
Data Corporation containing an allegation of infringement of a patent E-Data
allegedly owns. We exchanged correspondence with E-Data's attorneys ending in
September 1996. We have not heard from any representative of E-Data since that
time. In November 1997, we received a letter from representatives of TAU
Systems Corporation informing us of two patents held by TAU Systems. In the
letter, the representatives stated their opinion that our Commerce software
contained various elements recited in the two patents and requested that we
discuss licensing the technology of these patents. We responded to the letter
stating that, although we had not undertaken a detailed review
52
<PAGE>
of the patents, we were unaware of any of our products having one of the
elements required by the patent claims. We have not received any further
correspondence from TAU Systems. In May 1999, we received a letter from
representatives of TechSearch LLC offering us a license to a patent held by
TechSearch. We have reviewed the patent and do not believe that we need to
obtain a license to this patent. In the future, we could be found to infringe
upon the patent rights of E-Data, TAU Systems, TechSearch, or other companies.
Furthermore, companies in the software market are increasingly bringing suits
alleging infringement of their proprietary rights, particularly patent rights.
If we were to discover that our products violate third-party proprietary
rights, we might not be able to obtain licenses to continue offering these
products without substantial reengineering. Efforts to undertake this
reengineering might not be successful, licenses might be unavailable on
commercially reasonable terms, if at all, and litigation might not be avoided
or settled without substantial expense and damage awards.
Other Intellectual Property
We have received United States and selected foreign registrations for our
InterTrust and DigiBox trademarks. We also have pending applications for United
States and foreign registration of several of our trademarks and service marks,
including MetaTrust, the MetaTrust Utility, InterRights, TrustMail, and others.
We do not know if these marks will be approved. In addition, a significant
portion of our marks use the words inter, trust, meta, or digi. We are aware of
other companies that use one or more of these words in their marks, alone or in
combination with other words. We do not expect to be able to prevent all third-
party uses of these words. In addition, the laws of some foreign countries do
not protect our proprietary rights to the same extent as do the laws of the
United States, and effective patent, copyright, trademark, and trade secret
protection may not be available in these jurisdictions. We license our
proprietary rights to third parties, and these licensees may fail to abide by
compliance and quality control guidelines relating to our proprietary rights
may or take actions that would harm our business.
Our partners may rely in part on licenses included within the sealed
packaging of commercial software and licenses on a web site that are entered
into by clicking with a computer mouse on a button denoting assent to the terms
of the license displayed on the web site. These licenses, however, may be or
become unenforceable under the laws of some jurisdictions. As with other
software products, our products are susceptible to unauthorized copying and
uses that may go undetected. Policing unauthorized use is difficult.
Any claims relating to the infringement of third-party proprietary rights,
even if meritless, could result in the expenditure of significant financial and
managerial resources and could result in injunctions preventing us from
distributing particular products and services. These claims could harm our
business. We also rely on technology that we license from third parties,
including software that is integrated with internally developed software and
used in our products and services to perform key functions. Third-party
technology licenses may not continue to be available to us on commercially
reasonable terms. The loss of any of these technologies could harm our
business. Although we generally seek to be indemnified against claims that
technology licensed by us infringes the intellectual property rights of others,
we do not receive indemnification in some cases. In some cases indemnification
is not available for all types of intellectual property and proprietary rights,
and in
53
<PAGE>
other cases the scope of indemnification is limited. Even if we receive broad
indemnification, third-party indemnitors are not always well-capitalized and
may not be able to indemnify us in the event of infringement, resulting in
substantial liability to us. Infringement or invalidity claims may arise from
the incorporation of third-party technology, and our customers may make claims
for indemnification. These claims, even if meritless, could result in the
expenditure of significant financial and managerial resources in addition to
potential product or service redevelopment costs and delays, all of which could
harm our business.
Standards Bodies and Industry Groups
We participate in selected industry groups to promote digital rights
management in the computer, consumer electronics, and entertainment markets.
With this aim in mind, we have most recently been involved with the following
standards bodies and industry groups: Moving Picture Experts Group, Secure
Digital Music Initiative, Open Platform Initiative for Multimedia Access, The
Cross Industry Working Team, and Copy Protection Technical Working Group. We
believe our activities in the Moving Picture Experts Group and the Secure
Digital Music Initiative are of particular importance.
MPEG-4, the standard for multimedia software and devices, includes an
intellectual property management and protection architecture that permits DRM
systems to be used in future MPEG-4 systems, including set-top boxes, DVD
players, and game machines. We played a major role in the definition of the
intellectual property management and protection interface, which is consistent
with our technology. MPEG-4 content developers can use our technology to
incorporate intellectual property management and protection capabilities into
their applications.
The Secure Digital Music Initiative was started by the Recording Industry
Association of America, the International Federation of the Phonographic
Industry, and the Recording Industry Association of Japan shortly after the
first release of the Diamond Rio MP3 music player in an effort to establish a
standard for secure digital delivery and use of recorded music. We have
participated in the Secure Digital Music Initiative from the beginning. We have
been active as one of three vice-chairs of the first working group, which
devised the specifications for secure digital music compliant-portable devices.
Following the approval of the Secure Digital Music Initiative portable devices
specification, we believe our technology will enable the protection and
management of digital audio content on the Internet, personal computers, and
portable devices. We plan to continue participating actively and developing our
technology to be compliant with emerging Secure Digital Music Initiative
specifications.
Employees
At August 31, 1999, we had a total of 144 employees. Of the total, 99 were
in research and development and training and support, 26 were in marketing,
sales and partner development, and business development, and 19 were in
administration and finance. None of our employees is subject to a collective
bargaining agreement, and we believe that our relations with our employees are
good.
Our future operating results depend in significant part on the continued
service of our key technical, sales, and senior management personnel, none of
whom is bound by an employment
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agreement with specified terms. Our future success also depends on our
continuing ability to attract and retain highly qualified technical, sales, and
senior management personnel. Competition for these personnel is intense, and we
may not be able to retain our key technical, sales and senior management
personnel or to attract these personnel in the future. We have experienced
difficulty in recruiting qualified technical, sales, and senior management
personnel, and we expect to experience these difficulties in the future. If we
are unable to hire and retain qualified personnel in the future, this inability
could seriously harm our business.
Facilities
Our principal administrative, sales, marketing, and research and development
facility occupies approximately 66,000 square feet in Santa Clara, California
under a lease that terminates in September 2004. We have also entered into a
three-year lease for a research and development facility occupying
approximately 3,900 square feet in Portland, Oregon. This lease commences
October 1999. InterTrust International, our wholly-owned subsidiary, has an
office located in London, England.
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<PAGE>
MANAGEMENT
Executive Officers and Directors
Our executive officers and directors, and their ages and positions as of
October 25, 1999, are as follows:
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Victor Shear............ 52 Chairman of the Board and Chief Executive Officer
David C. Chance......... 42 Executive Vice Chairman of the Board
Peter van Cuylenburg.... 51 Director, President and Chief Operating Officer
Edmund J. Fish.......... 37 Director, Senior Operating Officer and
Executive Vice President, Corporate Development
Erwin N. Lenowitz....... 49 Vice Chairman of the Board,
Chief Financial Officer and Secretary
David P. Maher.......... 48 Chief Technology Officer
Douglas M. Armati....... 48 Senior Vice President, Strategic Sales and
Partner Development
Ann B. Cowan............ 44 Senior Vice President, TrustNet Products, Services and Operations
Duncan M. Davidson...... 46 Senior Vice President, Business Development
Richard H. Frank........ 57 Senior Vice President, Portable Device Group
B. Nicholas Garnett..... 45 Senior Vice President, Trust Utility of InterTrust International
Joseph W. Jennings...... 45 Senior Vice President, Marketing
Richard A. Landsman..... 47 Senior Vice President, Product Development and Support
David M. Van Wie........ 34 Director and Senior Vice President, Research
Patrick P. Nguyen....... 33 Vice President, Global Alliances
Bruce Fredrickson....... 56 Director
Satish K. Gupta......... 54 Director
</TABLE>
Victor Shear has served as chairman of the board and chief executive officer
of InterTrust since our inception in January 1990. Before founding InterTrust,
Mr. Shear co-founded Personal Library Software, Inc., a text and document
database company, in June 1986. Mr. Shear served as chairman, president and
chief executive officer of Data Scientific Corporation, a software developer of
scientific workstations, from May 1982 to February 1985. Mr. Shear received a
B.A. in sociology from Brandeis University.
David C. Chance joined InterTrust as an officer and board member with the
title executive vice chairman in October 1999. Before joining InterTrust, from
January 1994 to January 1998, Mr. Chance was deputy managing director of BskyB
Group Ltd., a leading United Kingdom pay-television and media company, and
continued to serve as a consultant and non-executive director until August
1999. In addition, Mr. Chance is a non-executive director of Modern Times
Group, the primary pay-television operator in Scandinavia, and Sunderland
football club. Mr. Chance also serves on the board of the New Millenium
Experience Company, responsible for the Millenium Dome project in London. Mr.
Chance received a B.S. in psychology, a B.A. in industrial relations, and an
M.B.A. from the University of North Carolina at Chapel Hill.
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Peter van Cuylenburg joined InterTrust as president, chief operating officer
and a director in October 1999. Before joining InterTrust, Mr. van Cuylenburg
served as president of the DLT & Storage Systems group of Quantum Corporation
from September 1996 to October 1999. Before joining Quantum, he served as
executive vice president at Xerox Corporation from 1993 to 1995, where he was
responsible for Xerox's systems sector. Mr. van Cuylenburg was president and
chief operating officer at NeXT Computer, Inc. from 1992 to 1993. From 1989 to
1992, Mr. van Cuylenburg was chief executive of Mercury Communications, a
subsidiary of Cable & Wireless plc in the United Kingdom. Mr. van Cuylenburg
holds a Diploma in electrical engineering and an honorary doctorate in
technology from Bristol Polytechnic in the United Kingdom.
Edmund J. Fish has served as a director and as senior operating officer and
executive vice president, corporate development of InterTrust since June 1999.
From September 1995 to June 1999, Mr. Fish served as general counsel and vice
president, corporate development of InterTrust. Before joining InterTrust,
Mr. Fish practiced law in the Silicon Valley, Washington D.C. and New York
offices of Weil, Gotshal & Manges, an international law firm, from August 1989
to August 1995. Mr. Fish received a B.S. in biomedical engineering from
Marquette University and a J.D. from Wayne State University.
Erwin N. Lenowitz has served as vice chairman of the board, chief financial
officer and secretary of InterTrust since January 1993. Before joining
InterTrust, Mr. Lenowitz served as vice president of business development and
planning for Sun Microsystems, Inc., an enterprise networking company, from
August 1989 to January 1992 and as controller from May 1984 to July 1989.
Mr. Lenowitz received a B.S. in econometrics from the City College of New York
and an M.B.A. from St. Johns University.
David P. Maher has served as chief technology officer of InterTrust since
June 1999. Before joining InterTrust, Mr. Maher served in various positions at
AT&T from June 1981 to June 1999, including as an AT&T fellow, a Bell Labs
fellow and head of the secure systems research department. At AT&T, Mr. Maher
developed secure wideband transmission systems, cryptographic key management
systems and secure communications devices. In addition, Mr. Maher was chief
architect for AT&T's STU-III secure device, data, and video products for secure
government communications. Mr. Maher has been a consultant for the National
Science Foundation, the National Security Agency, the National Institute of
Standards and Technology, and the Congressional Office of Technology
Assessment, and has taught electrical engineering, mathematics and computer
science at several institutions. Mr. Maher received B.A., M.S. and Ph.D.
degrees in mathematics from Lehigh University.
Douglas M. Armati has served as senior vice president, strategic sales and
partner development of InterTrust since April 1999. From June 1997 to March
1999, Mr. Armati served as vice president, strategic sales and managing
director of the United Kingdom branch of InterTrust International. From
December 1996 to June 1997, Mr. Armati served as an independent consultant to
InterTrust International. From January 1994 to December 1996, Mr. Armati was a
principal at Jackson Brevis Ltd., a British consulting firm, focusing on
electronic commerce and intellectual property rights in digital environments.
Mr. Armati received a B.Comm. from Murdoch University.
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Ann B. Cowan has served as senior vice president, TrustNet products,
services and operations since October 1999 and as vice president, systems
development of InterTrust from September 1996 to October 1999. Before joining
InterTrust, Ms. Cowan served as director of engineering at Silicon Graphics, a
software workstation and server developer, from June 1995 to September 1996.
Before joining Silicon Graphics, from August 1986 to September 1994, Ms. Cowan
held several management positions in research and product development at
Ingres, a relational database company, most recently as director of Ingres
database and connectivity. Ms. Cowan received a B.A. in computer science from
Texas Christian University.
Duncan M. Davidson has served as senior vice president, business development
of InterTrust since July 1997. Before joining InterTrust, Mr. Davidson was
managing partner of Gemini McKenna, an alliance between Gemini Consulting and
Regis-McKenna, Inc., and The McKenna Group, from August 1995 to July 1997. Mr.
Davidson also served as vice president of Gemini Consulting, the management
consulting arm of Cap Gemini, a systems integrator, and its predecessor, The
MAC Group, from April 1989 to August 1995. Mr. Davidson is a founder of Covad
Communications, a telecommunications company providing high speed data
services, and serves on its board of advisors. Mr. Davidson received a Sc.B. in
physics-mathematics from Brown University and a J.D. from the University of
Michigan.
Richard H. Frank is senior vice president, portable device group of
InterTrust and has served in various other capacities, including chief
technology officer, since joining InterTrust in February 1997. Before joining
InterTrust, Mr. Frank was a senior consultant to electronic commerce companies,
including Novell Corporation, a computer-networking company. From March 1991 to
September 1992, Mr. Frank served as vice president of development at Software
Publishing, a software development company, and as chief technology officer
from September 1992 to September 1994. From January 1979 to September 1984, Mr.
Frank served as chief executive officer at Sorcim, a personal computer software
company. Mr. Frank received a B.A. in chemistry from San Francisco State
University.
B. Nicholas Garnett has served as senior vice president, trust utility of
InterTrust International, our subsidiary, since August 1999. Before joining
InterTrust International, from March 1992 to July 1999, Mr. Garnett was the
director general and chief executive officer of the International Federation of
the Phonographic Industry, which was instrumental in establishing the recording
industry's worldwide anti-piracy structure. Mr. Garnett received an M.A. in law
from the University of Cambridge and a D.E.A. in French law from the University
of Bordeaux.
Joseph W. Jennings has served as senior vice president, marketing of
InterTrust since February 1998. Before joining InterTrust, Mr. Jennings served
as a consultant to the venture capital firms of Sigma Partners, Mohr Davidow
Ventures, and InnoCal Ventures from January 1995 to December 1997. From July
1994 to January 1998, Mr. Jennings served as president of GCI Jennings, a
technology marketing communications company. Mr. Jennings received a B.A. in
political science from Whitman College and an M.B.A from the University of
Washington.
Richard A. Landsman is senior vice president, product development and
support of InterTrust and has served in various other positions since joining
InterTrust in July 1997. Before joining InterTrust, from October 1992 to July
1997, Mr. Landsman worked for Borland International, Inc., a provider of
programming and data base tools, where he directed Borland's Java development
tools
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business and managed Borland's C++ class libraries and frameworks team. Before
joining Borland, Mr. Landsman served as a senior manager at Lotus Development,
a productivity applications software company, from January 1983 to October
1992. Mr. Landsman received a B.S. in management and finance from the
University of Massachusetts and an M.S. in computer science from Boston
University.
David M. Van Wie has served as senior vice president, research of InterTrust
since January 1996. From September 1992 to January 1996, Mr. Van Wie served as
our chief technology officer and in August 1995, Mr. Van Wie became a member of
our board of directors. From January 1991 to September 1992, Mr. Van Wie was
president and chief executive officer of CD-ROM Solutions, a technology
integrator for the CD-ROM marketplace. From February 1989 to January 1991,
Mr. Van Wie managed the development of a high-speed information retrieval
system for a subsidiary of Maxwell Communications. Mr. Van Wie attended Pomona
College and the University of Wisconsin.
Patrick P. Nguyen is vice president, global alliances, and has also served
as vice president, corporate development, since joining InterTrust in July
1998. Before joining InterTrust, from February 1993 to June 1998, Mr. Nguyen
worked at the Silicon Valley Office of Weil, Gotshal & Manges, where he was
made a partner in January 1998 and headed the corporate and technology
transaction group. Mr. Nguyen received a B.S. in computer science from the
University of California at Irvine and a J.D. from the University of California
at Los Angeles.
Bruce Fredrickson has served as a director of InterTrust since February
1993. Mr. Fredrickson has also served as president of Tactical Marketing
Ventures LLC, a marketing firm for computer hardware, software, and Internet
service companies, since September 1991. Before his position with Tactical
Marketing Ventures, Mr. Fredrickson served as vice president of marketing for
Ingram Micro, a computer products distributor, from February 1986 to August
1991. Mr. Fredrickson received a B.S. in liberal arts from St. Olaf College and
an M.S. in communications and media from the University of Colorado.
Satish K. Gupta has served as a director of InterTrust since February 1993.
Mr. Gupta has been the president and chief executive officer of Cradle
Technologies, a semiconductor company, since July 1998. From May 1994 to June
1998, Mr. Gupta was vice president of corporate marketing and business
development of Cirrus Logic, a semiconductor company, and from June 1991 to May
1994, he was vice president of strategic marketing and advanced development of
Media Vision, a multi-media peripherals company. Mr. Gupta received a B.E. in
electrical engineering in India from Birla Institute of Technology and Science,
an S.M. in electrical engineering from Massachusetts Institute of Technology,
and an M.S. in engineering and economic systems from Stanford University.
Board Committees
The board of directors has an audit committee and a compensation committee.
Audit Committee. The audit committee of the board of directors has
responsibility for reviewing and monitoring our corporate financial reporting
and external audits, including our internal control functions, the results and
scope of the annual audit and other services provided by our independent
auditors, and our compliance with legal matters that have a significant impact
on our financial reports. The audit committee also consults with management and
our independent auditors before the presentation of financial statements to
stockholders and, as appropriate, initiates inquiries
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into aspects of our financial affairs. In addition, the audit committee has the
responsibility to consider and recommend the appointment of, and to review fee
arrangements with, our independent auditors. The current members of the audit
committee are Messrs. Fredrickson and Gupta.
Compensation Committee. The compensation committee of the board of directors
reviews and makes recommendations to the board regarding all forms of
compensation provided to the executive officers and directors of InterTrust and
our subsidiary including stock compensation and loans. In addition, the
compensation committee reviews and makes recommendations on bonus and stock
compensation arrangements for all of our employees. As part of these
responsibilities the compensation committee also administers or will administer
our 1995 stock plan, 1999 equity incentive plan, and 1999 employee stock
purchase plan. The current members of the compensation committee are Messrs.
Fredrickson and Gupta.
Director Compensation
Messrs. Fredrickson and Gupta have each received options for 80,000 shares
of common stock at an exercise price of $0.625 per share. Upon and following
this offering, non-employee directors will receive automatic option grants
under our 1999 non-employee directors option plan.
Compensation Committee Interlocks and Insider Participation
The compensation committee of the board of directors currently consists of
Messrs. Fredrickson and Gupta. No interlocking relationship exists between any
member of our board of directors or our compensation committee and any member
of the board of directors or compensation committee of any other company, and
no interlocking relationship has existed in the past.
Indemnification
Our sixth amended and restated certificate of incorporation, to be effective
after the closing of this offering, includes a provision that eliminates the
personal liability of our directors and officers for monetary damages for
breach of fiduciary duty as a director or officer, except for liability:
. for any breach of the director's or officer's duty of loyalty to us or
our stockholders;
. for acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law;
. under Section 174 of the Delaware General Corporation Law regarding
unlawful dividends and stock purchases; or
. for any transaction from which the director or officer derived an
improper personal benefit.
Our amended and restated bylaws provide that:
. we must indemnify our directors and officers to the fullest extent
permitted by Delaware law, subject to very limited exceptions;
. we may indemnify our other employees and agents to the same extent that
we indemnify our officers and directors; and
. we must advance expenses, as incurred, to our directors and officers in
connection with a legal proceeding to the fullest extent permitted by
Delaware law, subject to very limited exceptions.
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We have also entered into indemnification agreements with our officers and
directors containing provisions that may require us to indemnify our officers
and directors against liabilities that may arise by reason of their status or
service as directors or officers, other than liabilities arising from willful
misconduct of a culpable nature, to advance their expenses incurred as a result
of any proceeding against them for which they could be indemnified, and to
obtain directors' and officers' insurance if available on reasonable terms.
Executive Compensation
The following table presents information about compensation paid by us in
1998 for services by our chief executive officer and our four other highest-
paid executive officers whose total salary and bonus for the fiscal year
exceeded $100,000:
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Compensation
------------
Awards
------------
Annual
Compensation Securities
------------ Underlying
Name and Principal Position(s) Salary ($) Options (#)
- ------------------------------ ------------ ------------
<S> <C> <C>
Victor Shear......................................... $175,000 --
Chairman of the Board and Chief Executive Officer
Douglas M. Armati.................................... 169,751 --
Senior Vice President, Strategic Sales and Partner
Development
Duncan M. Davidson................................... 220,000 --
Senior Vice President, Business Development
Joseph W. Jennings................................... 167,340 320,000
Senior Vice President, Marketing
Erwin N. Lenowitz.................................... 175,000 --
Vice Chairman of the Board, Chief Financial Officer
and Secretary
</TABLE>
The table below shows each grant of stock options during 1998 to our chief
executive officer and our four other highest-paid executive officers. No stock
appreciation rights were granted to these individuals during 1998.
The percentage of total options granted to employees in the last fiscal year
is based on options to purchase a total of 1,616,000 shares granted to our
employees during 1998.
The exercise price of each option granted is equal to the fair market value
of our common stock as valued by our board of directors on the date of grant.
The exercise price may be paid in cash, in shares of our common stock valued at
fair market value on the exercise date or through a cashless exercise procedure
involving a same-day sale of the purchased shares. We may also finance the
option exercise by lending the option holder sufficient funds to pay the
exercise price for the purchased shares.
The potential realizable value is calculated based on the ten-year term of
the option at the time of grant. Annual stock price appreciation of 5% and 10%
is assumed in keeping with rules
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promulgated by the Securities and Exchange Commission and does not represent
our prediction of our stock price performance. The potential realizable value
at 5% and 10% appreciation is calculated by assuming that the exercise price on
the date of grant appreciates at the indicated rate for the entire term of the
option and that the option is exercised at the exercise price and sold on the
last day of its term at the appreciated price.
Option Grants in Last Fiscal Year
<TABLE>
<CAPTION>
Potential Realizable
Individual Grants Value at Assumed
----------------------------------------------- Annual Rates of
Number of Stock Price
Securities % of Total Appreciation for
Underlying Options Granted Exercise Option Term
Options To Employees Price Expiration ---------------------
Name Granted(#) In Fiscal Year ($/share) Date 5%($) 10%($)
- ---- ---------- --------------- --------- ---------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Victor Shear............ -- -- -- -- -- --
Douglas M. Armati....... -- -- -- -- -- --
Duncan M. Davidson...... -- -- -- -- -- --
Joseph W. Jennings...... 320,000 19.8% $2.50 6/4/08 $ 503,116 $ 1,274,994
Erwin N. Lenowitz....... -- -- -- -- -- --
</TABLE>
In addition to the option listed in the table, stock options were granted in
February 1999 to Mr. Armati under our 1995 stock plan for 80,000 shares at an
exercise price of $3.50 per share. Upon the completion of six months of
service, 12.5% of the option shares will vest. Upon the completion of each of
the next 42 months of service, an additional 1/48th of the option shares become
vested.
The table below presents for our chief executive officer and our four other
highest-paid executive officers any options exercised during 1998 and the value
realized from that exercise. It also presents the number and value of shares
underlying unexercised options that were held by these executive officers as of
December 31, 1998. No stock appreciation rights were exercised by these
executive officers in 1998, and no stock appreciation rights were outstanding
at the end of that year.
Upon the completion of six months of service, 12.5% of the option shares
listed in the table below became vested. Upon the completion of each of the
next 42 months of service, an additional 1/48th of the option shares become
vested. Our board may provide for the options to become immediately
exercisable; in that case, any unvested shares that are purchased by a holder
of an option may be repurchased by us at the original exercise price paid per
share if the option holder ceases service with us before vesting in these
shares.
The figures in the value of unexercised in-the-money options at fiscal year-
end column are based on the fair market value of our common stock at the end of
1998, less the exercise price payable for these shares. The fair market value
for class A voting common stock at the end of 1998 was $3.50 per share. Mr.
Armati and Mr. Jennings have options to purchase class A voting common stock.
The fair market value for class B non-voting common stock at the end of 1998
was $1.75 per share. Mr. Lenowitz has options to purchase class B non-voting
common stock. Mr. Davidson was granted options to purchase 160,000 shares of
class A voting common stock and 160,000 shares of class B non-voting common
stock, of which he has exercised and purchased 56,666 shares in 1998 and
193,334 shares in 1999.
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Fiscal Year-End Option Values
<TABLE>
<CAPTION>
Number of Value Of
Securities Underlying Unexercised
Unexercised Options In-the-Money Options
Shares at FY-End (#) at FY-End ($)
Acquired on Value ------------------------- -------------------------
Name Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
- ---- ------------ ------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Victor Shear............ -- -- -- -- -- --
Douglas M. Armati....... -- -- 76,666 83,334 $153,332 $166,668
Duncan M. Davidson...... 56,666 $ 56,666 56,666 206,668 113,332 310,002
Joseph W. Jennings...... -- -- 66,666 253,334 66,666 253,334
Erwin N. Lenowitz....... -- -- 360,000 -- 405,000 --
</TABLE>
Employee Benefit Plans
1992 Stock Plan and 1995 Stock Plan
Our 1992 stock plan and 1995 stock plan will be terminated immediately
before the closing of this offering, and no additional options will be granted
after the closing of this offering under these plans. However, the termination
of these plans will not affect any options outstanding under these plans, which
will remain outstanding until they are exercised, terminate or expire, in
keeping with the terms of the related stock option agreements.
1999 Equity Incentive Plan
Our board of directors adopted our 1999 equity incentive plan on July 22,
1999. Our stockholders have also approved this plan. We have reserved 1,900,000
shares of our common stock for issuance under the 1999 equity incentive plan.
As of January 1 of each year, starting in 2000, the number of shares reserved
for issuance under our 1999 equity incentive plan will be increased
automatically by 4% of the total number of shares of common stock then
outstanding or, if less, 1,500,000 shares. No options have yet been granted
under the 1999 equity incentive plan.
Under the 1999 equity incentive plan, the persons eligible to receive awards
are:
. employees;
. non-employee members of the board of directors; and
. consultants.
The types of awards that may be made under the 1999 equity incentive plan
are:
. options to purchase shares of common stock;
. stock appreciation rights;
. restricted shares; and
. stock units.
Options may be incentive stock options that qualify for favorable tax
treatment for the option holder under Section 422 of the Internal Revenue Code
of 1986 or nonstatutory stock options not designed to qualify for favorable tax
treatment. With limited restrictions, if shares awarded under the 1999 equity
incentive plan are forfeited, those shares will again become available for new
awards under the 1999 equity incentive plan.
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The compensation committee of our board of directors will administer the
1999 equity incentive plan. The committee has complete discretion to make all
decisions relating to the interpretation and operation of our 1999 equity
incentive plan. The committee has the discretion to determine which eligible
individuals are to receive any award, and to determine the type, amount,
vesting requirements, and other features and conditions of each award.
The exercise price for incentive stock options granted under the 1999 equity
incentive plan must be at least 100% of the fair market value of our common
stock on the option grant date. The exercise price for nonstatutory options
granted under the 1999 equity incentive plan must be at least 85% of the fair
market value of our common stock on the option grant date.
Our 1999 equity incentive plan provides that no participant may receive
options or stock appreciation rights covering more than 500,000 shares in the
same year, except that a newly hired employee may receive options or stock
appreciation rights covering up to 1,000,000 shares in the first year of
employment.
The exercise price may be paid with:
. cash;
. outstanding shares of common stock;
. the cashless exercise method through a designated broker;
. a pledge of shares to a broker; or
. a promissory note.
The purchase price for newly issued restricted shares awarded under the 1999
equity incentive plan may be paid with:
. cash;
. a promissory note; or
. the rendering of past services.
The committee may reprice options and may modify, extend or assume
outstanding options and stock appreciation rights. The committee may accept the
cancellation of outstanding options or stock appreciation rights in return for
the grant of new options or stock appreciation rights. The new option or right
may have the same or a different number of shares and the same or a different
exercise price.
If a change in control of InterTrust occurs, an option or other award under
the 1999 equity incentive plan will become fully exercisable and fully vested
if the option or award is not assumed by the surviving corporation or its
parent or if the surviving corporation or its parent does not substitute
comparable awards for the awards granted under the 1999 equity incentive plan.
A change in control includes:
. a merger or consolidation of InterTrust after which our then-current
stockholders own less than 50% of the surviving corporation;
. a sale of all or substantially all of our assets;
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. a proxy contest that results in replacement of more than one-half of our
directors over a 24-month period; or
. an acquisition of 50% or more of our outstanding stock by a person other
than a person related to InterTrust, including a corporation owned by our
stockholders.
If a merger or other reorganization occurs, the agreement of merger or
reorganization may provide that outstanding options and other awards under the
1999 equity incentive plan shall be assumed by the surviving corporation or its
parent, shall be continued by InterTrust if it is the surviving corporation,
shall have accelerated vesting and then expire early, or shall be cancelled for
a cash payment.
Our board of directors may amend or terminate the 1999 equity incentive plan
at any time. If our board amends the plan, stockholder approval of the
amendment will be sought only if required by applicable law. The 1999 equity
incentive plan will continue in effect indefinitely unless the board terminates
the plan.
1999 Employee Stock Purchase Plan
Our board of directors adopted our 1999 employee stock purchase plan on July
22, 1999. Our stockholders have also approved this plan. We have reserved
350,000 shares of our common stock for issuance under our 1999 employee stock
purchase plan. As of January 1 each year, starting in 2000, the number of
shares reserved for issuance under this plan will be increased automatically by
2% of the total number of shares of common stock then outstanding or, if less,
350,000 shares. Our 1999 employee stock purchase plan is intended to qualify
under Section 423 of the Internal Revenue Code.
Eligible employees may begin participating in the 1999 employee stock
purchase plan at the start of an offering period. Each offering period, other
than the initial offering period, will last 24 months. Two overlapping offering
periods will start on May 1 and November 1 of each calendar year. However, the
first offering period will start on the effective date of this offering and end
on October 31, 2001. Purchases of our common stock will occur on or about April
30 and October 31 of each calendar year during an offering period.
Our compensation committee of our board of directors will administer this
plan. Each of our employees is eligible to participate if he is employed by us
for more than 20 hours per week and for more than five months per year.
Our 1999 employee stock purchase plan permits each eligible employee to
purchase common stock through payroll deductions. Each employee's payroll
deductions may not exceed 15% of cash compensation. The initial period during
which payroll deductions may be contributed will begin on the effective date of
this offering and end on April 30, 2000. Each participant may purchase up to
600 shares on any purchase date.
The price of each share of common stock purchased under our 1999 employee
stock purchase plan will be 85% of the lower of:
. the fair market value per share of our common stock on the date
immediately before the first date of the applicable offering period; or
. the fair market value per share of our common stock on the purchase date.
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In the case of the first offering period, the price per share under the plan
will be 85% of the lower of:
. the price offered to the public in this offering; or
. the fair market value per share of our common stock on the purchase date.
Employees may end their participation in the 1999 employee stock purchase
plan at any time. Participation ends automatically upon termination of
employment with InterTrust.
If a change in control of InterTrust occurs, our 1999 employee stock
purchase plan will end, and shares will be purchased with the payroll
deductions accumulated to date by participating employees, unless this plan is
assumed by the surviving corporation or its parent. Our board of directors may
amend or terminate the 1999 employee stock purchase plan at any time. If our
board of directors increases the number of shares of common stock reserved for
issuance under this plan, it must seek the approval of our stockholders.
1999 Non-Employee Directors Option Plan
Our board of directors adopted our 1999 non-employee directors option plan
on July 22, 1999. Our stockholders have also approved this plan. Only the non-
employee members of our board of directors will be eligible for automatic
option grants under this plan.
We have reserved 350,000 shares of our common stock for issuance under our
1999 non-employee directors option plan. As of January 1 each year, starting in
2000, the number of shares reserved for issuance under our 1999 non-employee
directors option plan will be increased automatically to restore the total
number of shares available under this plan to 350,000 shares. No shares have
yet been issued under our 1999 non-employee directors option plan.
The compensation committee of our board of directors will make any
administrative determinations under our 1999 non-employee directors option
plan. No discretionary decisions will be made by the compensation committee
under this plan.
The exercise price for options granted under our 1999 non-employee directors
option plan may be paid in cash or in outstanding shares of our common stock.
Options may also be exercised on a cashless basis through the same-day sale of
the purchased shares.
Each individual who is a member of our board of directors as a non-employee
director on the effective date of this offering will receive a fully vested
option for 15,000 shares of our common stock on the effective date of this
offering. The exercise price of this option will be the initial price offered
to the public in this offering.
Each individual who first joins our board of directors as a non-employee
director after the effective date of this offering will receive at that time a
fully vested option for 15,000 shares of our common stock. In addition, at each
of our annual stockholders' meetings, beginning in 2000, each non-employee
director who will continue to be a director after that meeting will
automatically be granted at that meeting a fully vested option for 5,000 shares
of our common stock. However, any non-employee director who receives an option
for 15,000 shares under this plan will first become
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eligible to receive the annual option for 5,000 shares at the annual meeting
that occurs during the calendar year following the year in which he received
the option for 15,000 shares.
Our board of directors may amend or modify the 1999 non-employee directors
option plan at any time. The 1999 non-employee directors option plan will
continue in effect indefinitely, unless our board of directors terminates the
plan.
Change of Control Arrangements
Joseph W. Jennings, our senior vice president, marketing, has received
option grants for 320,000 shares that provide that upon a change in control
transaction, the vesting of the option will accelerate and 50% of the then
unvested option shares will become vested. Duncan M. Davidson, our senior vice
president, business development, has received option grants for 320,000 shares
that provide that upon a change in control transaction, the vesting of the
option will accelerate and 100% of the then unvested option shares will become
vested. In addition, two of our other executive officers who are not among our
four highest-paid executive officers during 1998 were also granted options that
provide that upon a change in control transaction, the vesting of the options
will accelerate and 100% of the then unvested option shares will become vested.
If a change in control of InterTrust occurs, an option or other award under
the 1999 equity incentive plan will become fully exercisable and fully vested
if the option or award is not assumed by the surviving corporation or its
parent or if the surviving corporation or its parent does not substitute
comparable awards for the awards granted under the 1999 equity incentive plan.
Under our 1995 stock plan, upon a merger or asset sale, if the options or
stock purchase rights are not assumed by the surviving corporation or its
parent or subsidiary or if the surviving corporation or its parent or
subsidiary does not substitute comparable awards for the options or stock
purchase rights, then the options and stock purchase rights will terminate.
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RELATED-PARTY TRANSACTIONS
Since January 1996, there has not been, nor is there currently proposed, any
transaction or series of similar transactions to which we were or are to be a
party in which the amount involved exceeds $60,000 and in which any director,
executive officer, or holder of more than 5% of our common stock, or an
immediate family member of any of these individuals or entities, had or will
have a direct or indirect interest other than:
. compensation arrangements, which are described where required under
"Management;" and
. the transactions described below.
Series A Preferred Stock Financing. In March 1996, we issued and sold
1,174,168 shares of series A preferred stock to Kistler Associates, one of our
5% stockholders, at a per share purchase price of $2.555.
In June 1996, we issued and sold 97,846 shares of series A preferred stock
to SLF Partners IV, LP at a per share purchase price of $2.555. One of our
executive officers, Patrick P. Nguyen, is a limited partner of SLF Partners IV,
L.P.
Series B Preferred Stock Financing. In December 1997, we issued and sold
233,372 shares of series B preferred stock to Kistler Associates, and in March,
April, and December 1998, we issued and sold an aggregate of 466,744 shares of
series B preferred stock to Kistler Associates, in both cases at a per share
purchase price of $4.285.
In June 1997 and January 1998, we issued and sold an aggregate of 1,165,544
shares of series B preferred stock to Reuters New Media, Inc., an entity
affiliated with Reuters Group PLC, one of our 5% stockholders, at a per share
purchase price of $4.285.
In July and December 1998, we issued and sold an aggregate of 878,632 shares
of series B preferred stock to SLF Partners IV, L.P. at a per share purchase
price of $4.285.
In December 1998, we issued and sold 186,500 shares of series B preferred
stock to Ecomm Ventures I, LLC at a per share purchase price of $4.285. One of
our executive officers, Patrick P. Nguyen, is a director of Ecomm Ventures I,
LLC.
Series C Preferred Stock Financing. In March 1999, we issued and sold 29,645
shares of series C preferred stock to Kistler Associates at a per share
purchase price of $5.89.
Series D Preferred Stock Financing. In April 1999, we issued and sold
235,294 shares of series D preferred stock to Kistler Associates at a per share
purchase price of $8.50.
In April 1999, we issued and sold 479,412 shares of series D preferred stock
to SLF Partners IV, L.P. at a per share purchase price of $8.50.
In April 1999, we issued and sold 25,000 shares of series D preferred stock
to Tactical Marketing Ventures, LLC at a per share purchase price of $8.50.
Bruce Fredrickson, a director of InterTrust, is the president of Tactical
Marketing Ventures, LLC.
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In June 1999, we issued and sold 199,412 shares of series D preferred stock
to Ecomm Ventures II, LLC at a per share purchase price of $8.50. One of our
executive officers, Patrick P. Nguyen, is a director of Ecomm Ventures II, LLC.
Series E Preferred Stock Financing. In July 1999, we issued and sold 233,333
shares of series E preferred stock to Kistler Associates at a per share
purchase price of $12.00.
In July 1999, we issued and sold 416,667 shares of our series E preferred
stock to Blaxmill (Four) Limited, an entity affiliated with Reuters Group PLC,
at a per share purchase price of $12.00.
In July 1999, we issued and sold 50,001 shares of series E preferred stock
to Duncan M. Davidson, one of our executive officers, at a per share purchase
price of $12.00.
Option to Purchase Class B Non-Voting Common Stock. In October 1993, we
granted an option to purchase 160,000 shares of our class B non-voting common
stock to Electronic Ventures, LLC at an exercise price of $0.625. Erwin N.
Lenowitz, an executive officer of InterTrust, is a managing director of
Electronic Ventures, LLC.
Option to Purchase Common Stock. In October 1999, we agreed to grant on
consummation of this offering an option to purchase 300,000 shares of our
common stock at an exercise price equal to 85% of the initial public offering
price to David Chance, one of our executive officers.
Option to Purchase Common Stock. In October 1999, we agreed to grant on
consummation of this offering an option to purchase 500,000 shares of our
common stock at an exercise price equal to 85% of the initial public offering
price to Peter van Cuylenburg, one of our executive officers.
Loan to Executive Officer. In December 1997 and January 1998, we loaned an
aggregate of $62,290 to Edmund J. Fish, one of our directors and an executive
officer, secured by a stock pledge agreement. This note accrues interest at the
rate of 7% per year. The principal balance of this note and accrued interest is
due upon consummation of this offering.
Bonus to Executive Officer. In May 1999, our compensation committee approved
a bonus in the amount of $200,000 to Edmund J. Fish, which was paid in June
1999.
Indemnification. We have entered into an indemnification agreement with each
of our officers and directors. See "Management--Indemnification" for a
description of the indemnification available to our officers and directors
under these agreements.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The table on the next page presents selected information regarding
beneficial ownership of our outstanding common stock as of August 31, 1999, and
as adjusted to reflect the sale of the common stock being sold in this offering
for:
. each of our directors, our chief executive officer and our four other
highest-paid executive officers;
. each other person known by us to own beneficially more than 5% of our
common stock and one of our principal stockholders; and
. all of our directors and executive officers as a group.
Under the rules of the Securities and Exchange Commission, beneficial
ownership includes sole or shared voting or investment power over securities
and includes the shares issuable under stock options that are exercisable
within 60 days of August 31, 1999. Shares issuable under stock options
exercisable within 60 days are considered outstanding for computing the
percentage of the person holding the options but are not considered outstanding
for computing the percentage of any other person. Consequently, the table on
the next page includes information regarding shares issuable under stock
options exercisable within 60 days of August 31, 1999 for the following persons
and in the following amounts:
<TABLE>
<CAPTION>
Name Shares Subject to Options
---- -------------------------
<S> <C>
David M. Van Wie................................... 320,800
Erwin N. Lenowitz.................................. 160,000
Joseph W. Jennings................................. 133,332
Satish K. Gupta.................................... 80,000
Edmund J. Fish..................................... 18,333
Duncan M. Davidson................................. 10,000
Douglas M. Armati.................................. 6,667
</TABLE>
Percentage ownership calculations are based on 31,461,011 shares of common
stock outstanding as of August 31, 1999, as adjusted to reflect the conversion
of all outstanding shares of preferred stock and class B non-voting common
stock into common stock, and the exercise of warrants to purchase 6,692 shares
of common stock upon the closing of this offering. The numbers shown in the
table below assume no exercise by the underwriters of their over-allotment
option to purchase up to 975,000 shares and exclude 85,000 shares of common
stock issued in exchange for technology and related assets we purchased and
licensed in October 1999.
Unless otherwise indicated, the address for each listed stockholder is: c/o
InterTrust Technologies Corporation, 4750 Patrick Henry Blvd., Santa Clara,
California 95054. To our knowledge, except as indicated in the footnotes to
this table and under applicable community property laws, the persons or
entities identified in this table have sole voting and investment power over
all shares of common stock shown as beneficially owned by them.
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<PAGE>
<TABLE>
<CAPTION>
Percent of
Shares Outstanding
--------------------
Number of Shares Before the After the
Name of Beneficial Owner Beneficially Owned Offering Offering
- ------------------------ ------------------ ---------- ---------
<S> <C> <C> <C>
Victor Shear.......................... 7,712,000 24.5% 20.3%
Kistler Associates(1)................- 2,372,556 7.5 6.2
955 5th Avenue, Apt. 6B
New York, NY 10021
Reuters Group PLC(2).................. 1,582,211 5.0 4.2
85 Fleet Street
London EC4P 4AJ
United Kingdom
Entities affiliated with SLF 1,540,779 4.9 4.1
Partners(3).........................-
Attn: Steven L. Fingerhood, General
Partner
301 Mission Street, Suite 350
San Francisco, CA 94105
Erwin N. Lenowitz(4).................. 558,206 1.8 1.5
David M. Van Wie...................... 344,800 1.1 0.9
Duncan M. Davidson(5)................. 300,001 1.0 0.8
Edmund J. Fish(6)..................... 291,052 0.9 0.8
Douglas M. Armati(7).................. 157,720 0.5 0.4
Satish K. Gupta....................... 160,000 0.5 0.4
Bruce Fredrickson(8).................. 137,000 0.4 0.4
Joseph W. Jennings.................... 133,332 0.4 0.4
Executive officers and directors as a
group (17 persons)(9)(10)............ 10,844,685 33.2 27.7
</TABLE>
- --------
(1) Kistler Associates has the right to purchase shares of common stock in this
offering. If it exercises this right in full, it will own approximately
2,563,006 shares, or 6.7% of us.
(2) Represents 1,165,544 shares held of record by Reuters New Media, Inc. and
416,667 shares held of record by Blaxmill (Four) Limited.
(3) Represents 1,455,890 shares held of record by SLF Partners IV, L.P. and
84,889 shares held of record by SLF Partners V, L.P.
(4) Includes an option immediately exercisable for 160,000 shares held by
Electronic Ventures, LLC. Mr. Lenowitz, one of our directors and executive
officers, is a managing director of Electronic Ventures, LLC. Mr. Lenowitz
disclaims beneficial ownership of these shares except to the extent of his
pecuniary interest in Electronic Ventures, LLC. Also includes 13,218 shares
held as custodian for Jeremy Lenowitz and 13,218 shares held as custodian
for Jessica Lenowitz.
(5) Includes 210,001 shares held by the Davidson Family Revocable Trust of
which 76,667 shares are subject to a right of repurchase by us as of August
31, 1999. Mr. Davidson, one of our executive officers, is the trustee of
the Davidson Family Revocable Trust and exercises voting and investment
power over these shares. In connection with a loan to two InterTrust
employees, Mr. Davidson is taking a security interest in 80,624 shares of
common stock.
(6) Includes 3,334 shares subject to a right of repurchase by us as of August
31, 1999.
(7) Includes 56,667 shares subject to a right of repurchase by us as of August
31, 1999.
(8) Includes 25,000 shares held of record by Tactical Marketing Ventures, LLC.
Mr. Fredrickson is the chief executive officer of Tactical Marketing
Ventures, LLC and disclaims beneficial ownership of these shares, except to
the extent of his pecuniary interest arising from his interest in Tactical
Marketing Ventures, LLC.
(9) Includes 1,199,255 shares subject to options that are exercisable within 60
days of August 31, 1999 and the shares described in Notes 4 through 8.
(10) Includes 16,667 shares held by Patrick P. Nguyen, one of our executive
officers, subject to a right of repurchase by us as of August 31, 1999.
Also includes 186,500 shares held by Ecomm Ventures I, LLC and 199,412
shares held by Ecomm Ventures II, LLC. Mr. Nguyen is a director of both
entities. Mr. Nguyen disclaims beneficial ownership of these shares,
except to the extent of his pecuniary interest arising from his interest
in Ecomm Ventures II, LLC. Also includes 3,624 shares held by SLF Partners
IV, LP. Mr. Nguyen is a limited partner of SLF Partners IV, LP.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
General
Upon the consummation of this offering and giving effect to the filing of
our sixth amended and restated certificate of incorporation, we will be
authorized to issue 120,000,000 shares of common stock and 10,000,000 shares of
undesignated preferred stock. The following is a summary description of our
capital stock. Our amended and restated bylaws and our sixth amended and
restated certificate of incorporation, to be effective after the closing of
this offering, provide further information about our capital stock.
Common Stock
As of August 31, 1999, there were 31,461,011 shares of common stock
outstanding, as adjusted to reflect the conversion of all outstanding shares of
preferred stock and class B non-voting common stock into common stock, and the
exercise of warrants to purchase 6,692 shares of common stock, upon the closing
of this offering, that were held of record by approximately 307 stockholders.
There will be 37,961,011 shares of common stock outstanding, assuming no
exercise of the underwriters' over-allotment option and, no exercise after
August 31, 1999 of outstanding options or warrants, and excluding 85,000 shares
of common stock issued in exchange for technology and related assets we
purchased and licensed in October 1999, after giving effect to the sale of the
shares of common stock to the public offered in this prospectus.
The holders of common stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. Subject to preferences that may
be applicable to any outstanding preferred stock, the holders of common stock
are entitled to receive dividends, if any, as may be declared from time to time
by the board of directors out of funds legally available. In the event of our
liquidation, dissolution or winding up, the holders of common stock are
entitled to share ratably in all assets remaining after payment of liabilities,
subject to prior distribution rights of preferred stock, if any, then
outstanding. The common stock has no preemptive or conversion rights or other
subscription rights. There are no redemption or sinking fund provisions
applicable to the common stock. All outstanding shares of common stock are
fully paid and nonassessable, and the shares of common stock to be issued upon
completion of this offering will be fully paid and nonassessable.
Warrants
Immediately following the closing of this offering, there will be an
outstanding warrant to purchase a total of 325,000 shares of common stock at an
exercise price of $14.00 per share. The warrant expires in September 2004.
Preferred Stock
The board of directors has the authority, without action by the
stockholders, to designate and issue the preferred stock in one or more series
and to fix the rights, preferences, privileges, and related restrictions,
including dividend rights, dividend rates, conversion rights, voting rights,
terms of redemption, redemption prices, liquidation preferences, and the number
of shares constituting any series or the designation of the series. The
issuance of preferred stock may have the effect of delaying, deferring, or
preventing a change in control of us without further action by the stockholders
and may adversely affect the voting and other rights of the holders of common
stock. The issuance of
72
<PAGE>
preferred stock with voting and conversion rights may adversely affect the
voting power of the holders of common stock, including the loss of voting
control to others. At present, we have no plans to issue any of our preferred
stock.
Registration Rights
After this offering, the holders of approximately 19,014,401 shares of
common stock will be entitled to rights relating to the registration of these
shares under the Securities Act. Under the terms of the agreement between us
and the holders of these registrable securities, if we propose to register any
of our securities under the Securities Act, either for our own account or for
the account of other security holders exercising registration rights, these
holders are entitled to notice of registration and are entitled to include
their shares of common stock in the registration. Holders of 13,885,443 shares
of the registrable securities are also entitled to specified demand
registration rights under which they may require us to file a registration
statement under the Securities Act at our expense to register their shares of
common stock, and we are required to use our best efforts to effect this
registration. Further, the holders of these demand rights may require us to
file additional registration statements on Form S-3. All of these registration
rights are subject to conditions and limitations, among them the right of the
underwriters of an offering to limit the number of shares included in the
registration and our right not to effect a requested registration within six
months following the initial offering of our securities.
Anti-takeover Effects of Delaware Law, and Provisions of the Sixth Amended and
Restated Certificate of Incorporation and Amended and Restated Bylaws
Selected provisions of Delaware law, and our sixth amended and restated
certificate of incorporation and amended and restated bylaws, effective upon
the closing of this offering, could make more difficult the acquisition of
InterTrust by means of a tender offer or a proxy contest and the removal of
incumbent officers and directors. These provisions, summarized below, are
expected to discourage particular types of coercive takeover practices and
inadequate takeover bids and to encourage persons seeking to acquire control of
InterTrust to negotiate first with us. We believe that the benefits of
increased protection of our potential ability to negotiate with the proponent
of an unfriendly or unsolicited proposal to acquire or restructure InterTrust
outweigh the disadvantages of discouraging these proposals. For example,
negotiation of these proposals could result in an improvement of their terms.
However, these provisions could have the effect of discouraging others from
making tender offers for our shares and, as a consequence, they might also
inhibit fluctuations in the market price of our shares that could result from
actual or rumored takeover attempts.
Delaware Anti-Takeover Law. We are subject to Section 203 of the Delaware
General Corporation Law, an anti-takeover law. Generally, Section 203 of the
Delaware General Corporation Law prohibits a publicly held Delaware corporation
from engaging in a business combination with an interested stockholder for a
period of three years after the date of the transaction in which the person
became an interested stockholder, unless:
. before the date of the business combination, the transaction is approved
by the board of directors of the corporation;
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<PAGE>
. upon consummation of the transaction that resulted in the stockholder's
becoming an interested stockholder, the interested stockholder owns at
least 85% of the outstanding stock; or
. on or after the date of the business combination, the business
combination is approved by the board and by the affirmative vote of at
least 66 2/3% of the outstanding voting stock that is not owned by the
interested stockholder.
A business combination includes a merger, asset sale, or other transaction
resulting in a financial benefit to the stockholder. An interested stockholder
is a person who, together with affiliates and associates, owns, or within three
years did own, 15% or more of the corporation's voting stock. The existence of
this provision would be expected to have an anti-takeover effect when
transactions are not approved in advance by our board of directors, including
discouraging attempts that might result in a premium over the market price for
the shares of common stock held by stockholders.
Stockholder Meetings. Under our amended and restated bylaws, special
meetings of the stockholders can only be called by our board of directors or by
the chairman of the board, the chief executive officer or at the request of
stockholders holding at least 20% of our capital stock.
Requirements for Advance Notification of Stockholder Nominations and
Proposals. Our amended and restated bylaws establish advance notice procedures
regarding stockholder proposals and the nomination of candidates for election
as directors, other than nominations made by or at the direction of our board
of directors or a related committee.
Elimination of Stockholder Action By Written Consent. Our sixth amended and
restated certificate of incorporation eliminates the right of stockholders to
act by written consent without a meeting.
Undesignated Preferred Stock. The authorization of undesignated preferred
stock makes it possible for our board of directors to issue preferred stock
with voting or other rights or preferences that could impede the success of any
attempt to change control of InterTrust. These and other provisions may have
the effect of deferring hostile takeovers or delaying changes in control or
management of InterTrust.
Amendment of Restated Charter. The amendment of any of the above provisions
would require approval by holders of at least 66 2/3% of our outstanding common
stock.
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is Boston EquiServe
L.P.
The Nasdaq National Market Listing
We have approval to list our common stock on The Nasdaq Stock Market's
National Market under the symbol ITRU.
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<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
As of August 31, 1999, we will have 37,961,011 shares of common stock
outstanding upon completion of this offering, assuming no exercise by the
underwriters of their over-allotment option to purchase up to 975,000 shares
and assuming no exercise of options after August 31, 1999. This number also
excludes 85,000 shares of common stock issued in exchange for technology and
related assets we purchased and licensed in October 1999. Of these shares, the
6,500,000 shares sold in this offering will be freely tradable without
restriction or further registration under the Securities Act, except that any
shares held by persons that directly or indirectly control, or are controlled
by, or are under common control with us, may generally only be sold in
compliance with the limitations of Rule 144 of the Securities Act described
below.
Sales of Restricted Shares
The remaining 31,461,011 shares of common stock are treated as restricted
shares under Rule 144 of the Securities Act. The number of shares of common
stock available for sale in the public market is limited by restrictions under
the Securities Act and lock-up agreements under which the holders of the shares
have agreed not to sell or dispose of any of their shares for a period of
180 days after the date of this prospectus without the prior written consent of
Credit Suisse First Boston Corporation. On the date of this prospectus,
7,163,091 shares, including the 6,500,000 shares being sold in this offering,
will be eligible for sale unless purchased by our affiliates or by some
participants in our directed share program who enter into lock up agreements.
Beginning 180 days after the date of this prospectus, or earlier with the
consent of Credit Suisse First Boston Corporation, 27,144,146 restricted shares
will become available for sale in the public market subject to the limitations
of Rule 144 of the Securities Act.
In general, under Rule 144 of the Securities Act as currently in effect,
beginning 90 days after this offering, any person who has beneficially owned
restricted shares for at least one year is entitled to sell within any three-
month period a limited number of shares of common stock. The limit is the
greater of:
. 1% of the then-outstanding shares of our common stock, approximately
379,610 shares after giving effect to this offering; or
. the average weekly trading volume of our common stock on The Nasdaq
National Market during the four calendar weeks preceding this sale.
Sales under Rule 144 of the Securities Act are subject to restrictions
relating to manner of sale, notice and the availability of current public
information about us. A person who is not our affiliate at any time during the
90 days preceding a sale, and who has beneficially owned shares for at least
two years, may sell these shares immediately following this offering without
complying with the volume limitations, manner of sale provisions or notice or
other requirements of Rule 144 of the Securities Act. However, the transfer
agent may require an opinion of counsel that a proposed sale of shares
qualifies under Rule 144 of the Securities Act before effecting a transfer of
these shares.
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<PAGE>
Before this offering, there has been no public market for our common stock
and no predictions can be made of the effect, if any, that the sale or
availability for sale of shares of additional common stock will have on the
market price of our common stock. Nevertheless, sales of substantial amounts of
these shares in the public market, or the perception that these sales could
occur, could cause a reduction in the market price of the common stock and
could impair our future ability to raise capital through an offering of our
equity securities.
Options
As of August 31, 1999, options to purchase a total of 6,882,994 shares of
common stock were outstanding and options to purchase 3,243,100 shares of
common stock were exercisable. Substantially all of the shares subject to
options are subject to lock-up agreements. An additional 372,750 shares of
common stock were available as of August 31, 1999 for future option grants or
direct issuances under the 1995 stock plan. In addition, in July 1998, the
board of directors and a majority of stockholders approved an increase in the
1995 stock plan by an additional 500,000 shares. However, as of the date of
this offering, our 1995 stock plan will terminate and no future options will be
granted under this plan. In addition, in July 1999, 1,900,000 shares were
reserved for issuance under our 1999 equity incentive plan, 350,000 shares were
reserved for issuance under our 1999 employee stock purchase plan and 350,000
shares were reserved for issuance under our 1999 non-employee directors option
plan.
Rule 701 under the Securities Act provides that shares of our common stock
acquired on the exercise of outstanding options may be resold by persons other
than our affiliates, beginning 90 days after the date of this prospectus,
subject only to the manner of sale provisions of Rule 144. Rule 701 also
provides that shares of common stock acquired on the exercise of outstanding
options may be resold by our affiliates, beginning 90 days after the date of
this prospectus, subject to all provisions of Rule 144 except its one-year
minimum holding period.
We intend to file one or more registration statements on Form S-8 under the
Securities Act to register all shares of common stock subject to outstanding
stock options and common stock issued or issuable under our 1999 equity
incentive plan. We expect to file the registration statement covering shares
offered under our 1999 equity incentive plan and the 1999 employee stock
purchase plan and 1999 non-employee directors option plan approximately 30 days
after the closing of this offering. These registration statements are expected
to become effective upon filing. Shares covered by these registration
statements will then be eligible for sale in the public markets, subject to the
lock-up agreements, if applicable.
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<PAGE>
UNDERWRITING
Under the terms and subject to the conditions contained in an underwriting
agreement dated October 26, 1999, we have agreed to sell to the underwriters
named below, for whom Credit Suisse First Boston Corporation, J.P. Morgan
Securities Inc., Salomon Smith Barney Inc., and SoundView Technology Group,
Inc. are acting as representatives, the following respective numbers of shares
of common stock:
<TABLE>
<CAPTION>
Number
Underwriter of Shares
----------- ---------
<S> <C>
Credit Suisse First Boston Corporation............................. 2,850,000
J.P. Morgan Securities Inc. ....................................... 1,140,000
Salomon Smith Barney Inc. ......................................... 1,140,000
SoundView Technology Group, Inc. .................................. 570,000
BancBoston Robertson Stephens Inc.................................. 100,000
Hambrecht & Quist LLC.............................................. 100,000
Invemed Associates LLC............................................. 100,000
Morgan Stanley & Co. Incorporated.................................. 100,000
Rodman & Renshaw, Inc.............................................. 100,000
Charles Schwab & Co., Inc.......................................... 100,000
U.S. Bancorp Piper Jaffray Inc..................................... 100,000
Volpe Brown Whelan & Company, LLC.................................. 100,000
---------
Total............................................................ 6,500,000
=========
</TABLE>
The underwriting agreement provides that the underwriters are obligated to
purchase all the shares of common stock in the offering if any are purchased,
other than those shares covered by the over-allotment option described below.
The underwriting agreement also provides that, if an underwriter defaults, the
purchase commitments of non-defaulting underwriters may be increased or the
offering of common stock may be terminated.
We have granted to the underwriters a 30-day option to purchase on a pro
rata basis up to 975,000 additional shares at the initial public offering price
less the underwriting discounts and commissions. This option may be exercised
only to cover any over-allotments of common stock.
The underwriters propose to offer the shares of common stock initially at
the public offering price on the cover page of this prospectus and to selling
group members at that price less a concession of $0.76 per share. The
underwriters and selling group members may allow a discount of $0.10 per share
on sales to other broker/dealers. After the initial public offering, the public
offering price and concession and discount to broker/dealers may be changed by
the representatives.
The following table summarizes the compensation and estimated expenses we
will pay.
<TABLE>
<CAPTION>
Per Share Total
----------------------------- -----------------------------
Without With Without With
Over-Allotment Over-Allotment Over-Allotment Over-Allotment
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Underwriting discounts
and commissions paid by
us..................... $1.26 $1.26 $8,190,000 $9,418,500
Expenses payable by us.. $0.18 $0.15 $1,150,000 $1,150,000
</TABLE>
The underwriters have informed us that they do not expect discretionary
sales to exceed 5% of the shares of common stock being offered.
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<PAGE>
We, our officers and directors, and substantially all of our stockholders
have agreed that we and they will not offer, sell, contract to sell, announce
our intention to sell, pledge or dispose of, directly or indirectly, or file
with the Securities and Exchange Commission a registration statement under the
Securities Act relating to, any shares of our common stock or securities
convertible into or exchangeable or exercisable for any of our shares of common
stock without the prior consent of Credit Suisse First Boston Corporation for a
period of 180 days after the date of this prospectus, except in our case for
limited exceptions, including issuances resulting from the exercise of employee
options outstanding on the date of this prospectus.
At our request, the underwriters have reserved for sale, at the initial
public offering price, up to 1,300,000 shares of the common stock for current
and potential customers, others with whom we do business, existing
stockholders, employees, and other persons associated with us who have
expressed an interest in purchasing common stock in the offering. The number of
shares available for sale to the general public in the offering will be reduced
to the extent these persons purchase the reserved shares. Any reserved shares
not so purchased will be offered by the underwriters to the general public on
the same terms as the other shares. In addition, of the 1,300,000 shares,
Kistler Associates has the right to purchase up to approximately 190,450 shares
in the offering and an affiliate of Amerindo Investment Advisors has the right
to purchase up to approximately 190,450 shares in the offering.
We have agreed to indemnify the underwriters against liabilities under the
Securities Act, or contribute to payments that the underwriters may be required
to make in that respect.
The common stock has been approved for listing on The Nasdaq Stock Market's
National Market under the symbol ITRU.
Before this offering, there has been no public market for our common stock.
The initial public offering price was determined by negotiation between the
representatives and us. The principal factors considered in determining the
public offering price included:
. the information in this prospectus or available to the underwriters;
. the history and the prospects for the industry in which we will compete;
. the ability of our management;
. the prospects for our future earnings;
. the present state of our development and our current financial condition;
. the general condition of the securities markets at the time of this
offering; and
. the recent market prices of, and the demand for, publicly traded common
stock of generally comparable companies.
The representatives may engage in over-allotment, stabilizing transactions,
syndicate covering transactions, and penalty bids in compliance with Regulation
M under the Exchange Act.
. Over-allotment involves syndicate sales in excess of the offering size,
which creates a syndicate short position.
. Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specified maximum.
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<PAGE>
. Syndicate covering transactions involve purchases of the common stock in
the open market after the distribution has been completed to cover
syndicate short positions.
. Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the common stock originally sold by the
syndicate member is purchased in a syndicate covering transaction to
cover syndicate short positions.
These stabilizing transactions, syndicate covering transactions and penalty
bids may cause the price of the common stock to be higher than it would be in
the absence of these transactions. These transactions may be effected on The
Nasdaq National Market or elsewhere and, if commenced, may be discontinued at
any time.
In July 1999, an affiliate of Credit Suisse First Boston Corporation
purchased 41,666 shares of our series E preferred stock for a total purchase
price of $499,992.
You should rely only on information contained in this document or to which
we have referred you. We have not authorized anyone to provide you with
information that is different. This document may only be used where it is legal
to sell these securities. The information in this document may only be accurate
on the date of this document.
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<PAGE>
NOTICE TO CANADIAN RESIDENTS
Resale Restrictions
The distribution of the common stock in Canada is being made only on a
private placement basis exempt from the requirement that we prepare and file a
prospectus with the securities regulatory authorities in each province where
trades of common stock are effected. As as a result, any resale of the common
stock in Canada must comply with applicable securities laws, which will vary
depending on the relevant jurisdiction, and which may require resales to be
made under available statutory exemptions or under a discretionary exemption
granted by the applicable Canadian securities regulatory authority. Purchasers
are advised to seek legal advice before any resale of the common stock.
Representations of Purchasers
Each purchaser of common stock in Canada who receives a purchase
confirmation will be considered to represent to us and the dealer from which
the purchase confirmation is received:
. that the purchaser is entitled under applicable provincial securities
laws to purchase the common stock without the benefit of a prospectus
qualified under those securities laws;
. that where required by law, the purchaser is purchasing as principal and
not as agent; and
. that the purchaser has reviewed the text above under "Resale
Restrictions."
Rights of Action--Ontario Purchasers
The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
Ontario securities law. As a result, Ontario purchasers must rely on other
remedies that may be available, including common law rights of action for
damages or rescission or rights of action under the civil liability provisions
of the U.S. federal securities laws.
Enforcement of Legal Rights
All of the issuer's directors and officers as well as the experts named
herein may be located outside of Canada and, as a result, it may not be
possible for Canadian purchasers to effect service of process within Canada
upon the issuer or these persons. All or a substantial portion of the assets of
the issuer and these persons may be located outside of Canada and, as a result,
it may not be possible to satisfy a judgment against the issuer or these
persons in Canada or to enforce a judgment obtained in Canadian courts against
the issuer or these persons outside of Canada.
Notice to British Columbia Residents
A purchaser of common stock to whom the Securities Act (British Columbia)
applies is advised that the purchaser is required to file with the British
Columbia Securities Commission a report within ten days of the sale of any
common stock acquired by the purchaser in this offering. The report must be in
the form attached to British Columbia Securities Commission Blanket Order BOR
#95/17, a copy of which may be obtained from us. Only one report must be filed
for common stock acquired on the same date and under the same prospectus
exemption.
Taxation and Eligibility for Investment
Canadian purchasers of common stock should consult their own legal and tax
advisors about the tax consequences of an investment in the common stock in
their particular circumstances and about the eligibility of the common stock
for investment by the purchasers under relevant Canadian legislation.
80
<PAGE>
LEGAL MATTERS
The validity of the common stock being offered will be passed upon for
InterTrust by Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP,
Menlo Park, California and for the underwriters by Fenwick & West LLP, Palo
Alto, California. As of the date of this prospectus, some members and employees
of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP beneficially
owned an aggregate of 17,916 shares of our common stock.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements at December 31, 1997 and 1998, and for each of the three
years in the period ended December 31, 1998, as described in their report. We
have included our financial statements in the prospectus and elsewhere in the
registration statement in reliance on Ernst & Young LLP's report, given on
their authority as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act relating to the common stock
being offered. This prospectus does not contain all of the information
presented in the registration statement and the exhibits to the registration
statement. For further information about InterTrust and the common stock we are
offering, reference is made to the registration statement and the exhibits
filed as a part of the registration statement. Statements contained in this
prospectus concerning the contents of any contract or any other document
referred to summarize only the provisions of these documents that are material
to investors. You should refer to the exhibits to this registration statement
for the complete contents of these contracts and documents. The registration
statement, including the exhibits, may be inspected without charge at the
public reference facilities maintained by the Securities and Exchange
Commission in Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and
copies of all or any part may be obtained from this office after payment of
fees prescribed by the Securities and Exchange Commission. The Securities and
Exchange Commission maintains a world wide web site that contains reports,
proxy and information statements and other information regarding registrants,
including us, that file electronically with the Securities and Exchange
Commission. The address of the site is http://www.sec.gov.
81
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........................... F-2
Consolidated Balance Sheets................................................. F-3
Consolidated Statements of Operations....................................... F-4
Consolidated Statements of Stockholders' Equity (Deficit)................... F-5
Consolidated Statements of Cash Flows....................................... F-6
Notes to Consolidated Financial Statements.................................. F-8
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
InterTrust Technologies Corporation
We have audited the accompanying consolidated balance sheets of InterTrust
Technologies Corporation as of December 31, 1997 and 1998, and the related
consolidated statements of operations, stockholders' equity (deficit), and cash
flows for each of the three years in the period ended December 31, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of InterTrust
Technologies Corporation at December 31, 1997 and 1998, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted
accounting principles.
/s/ Ernst & Young LLP
Palo Alto, California
February 19, 1999,
except for Note 6,
as to which the date is
May 5, 1999
F-2
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
Pro Forma
Stockholders'
December 31, Equity
----------------- June 30, (Deficit) at
1997 1998 1999 June 30, 1999
-------- ------- ----------- -------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents....... $ 1,884 $ 5,575 $ 15,295
Accounts receivable............. 25 1,545 399
Other current assets............ 156 132 304
-------- ------- --------
Total current assets.......... 2,065 7,252 15,998
Property and equipment, net....... 967 938 885
Other assets...................... 79 90 137
-------- ------- --------
$ 3,111 $ 8,280 $ 17,020
======== ======= ========
LIABILITIES AND STOCKHOLDERS'
EQUITY (DEFICIT)
Current liabilities:
Accounts payable................ $ 654 $ 549 $ 899
Accrued compensation............ 387 560 740
Other accrued liabilities....... 417 610 720
Convertible promissory note..... -- -- 1,000
Deferred revenue................ -- 594 669
-------- ------- --------
Total current liabilities..... 1,458 2,313 4,028
Deferred revenue--long-term
portion.......................... 2,500 7,981 8,347
Commitments
Stockholders' equity (deficit):
Convertible preferred stock,
$0.001 par value, issuable in
series; 20,000,000 shares
authorized, 6,300,388,
10,500,387, and 12,492,410
shares issued and outstanding
at December 31, 1997 and 1998
and June 30, 1999,
respectively, and none pro
forma.......................... 6 10 12 $ --
Common stock, $0.001 par value,
issuable in classes; 70,000,000
shares authorized, 13,790,260,
14,670,648, and 17,343,950
shares issued and outstanding
at December 31, 1997 and 1998
and June 30, 1999,
respectively, and 29,919,693
shares issued and outstanding
pro forma...................... 14 15 17 30
Additional paid-in capital...... 24,999 43,697 65,801 66,800
Deferred stock compensation..... -- -- (4,078) (4,078)
Notes receivable from
stockholders................... (68) (276) (236) (236)
Accumulated deficit............. (25,798) (45,460) (56,871) (56,871)
-------- ------- -------- -------
Total stockholders' equity
(deficit).................... (847) (2,014) 4,645 $ 5,645
-------- ------- -------- =======
$ 3,111 $ 8,280 $ 17,020
======== ======= ========
</TABLE>
See accompanying notes.
F-3
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Years Ended Six Months Ended
December 31, June 30,
--------------------------- -----------------
1996 1997 1998 1998 1999
------- -------- -------- ------- --------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Revenues:
Licenses..................... $ -- $ 1,000 $ -- $ -- $ 309
Software support and training
services.................... 25 100 152 50 177
------- -------- -------- ------- --------
Total revenues............. 25 1,100 152 50 486
Cost of revenues:
Licenses..................... -- -- -- -- 42
Software support and training
services.................... 5 102 191 84 208
------- -------- -------- ------- --------
Total cost of revenues..... 5 102 191 84 250
------- -------- -------- ------- --------
Gross profit (loss)............ 20 998 (39) (34) 236
Operating costs and expenses:
Research and development..... 4,852 8,287 13,041 6,358 7,088
Sales and marketing.......... 1,573 2,717 3,870 1,902 2,449
General and administrative... 1,735 1,932 2,717 1,075 2,117
Amortization of deferred
stock compensation.......... -- -- -- -- 195
------- -------- -------- ------- --------
Total operating costs and
expenses.................. 8,160 12,936 19,628 9,335 11,849
------- -------- -------- ------- --------
Loss from operations........... (8,140) (11,938) (19,667) (9,369) (11,613)
Interest income................ 261 229 42 -- 202
Interest expense............... (81) -- (37) (9) --
------- -------- -------- ------- --------
Net loss....................... $(7,960) $(11,709) $(19,662) $(9,378) $(11,411)
======= ======== ======== ======= ========
Basic and diluted net loss per
share......................... $ (0.67) $ (0.86) $ (1.41) $ (0.68) $ (0.75)
======= ======== ======== ======= ========
Shares used in computing basic
and diluted
net loss per share............ 11,913 13,639 13,966 13,777 15,307
======= ======== ======== ======= ========
Pro forma basic and diluted net
loss per share ............... $ (0.91) $ (0.43)
======== ========
Shares used in computing pro
forma basic and diluted
net loss per share............ 21,688 26,808
======== ========
</TABLE>
See accompanying notes.
F-4
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except share amounts)
<TABLE>
<CAPTION>
Convertible Notes Total
Preferred Stock Common Stock Additional Deferred Receivable Stockholders'
----------------- ------------------ Paid-In Stock From Accumulated Equity
Shares Amount Shares Amount Capital Compensation Stockholders Deficit (Deficit)
---------- ------ ---------- ------ ---------- ------------ ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December
31, 1995............ -- $-- 10,454,240 $11 $ 1,732 $ -- $ -- $ (6,129) $(4,386)
Issuance of series
A preferred stock,
net................ 3,966,666 4 -- -- 9,513 -- -- -- 9,517
Issuance of series
B preferred stock,
net................ 1,400,234 1 -- -- 5,618 -- -- -- 5,619
Issuance of class A
common stock upon
exercise of war-
rants.............. -- -- 54,560 -- 41 -- -- -- 41
Conversion of con-
vertible promissory
notes and accrued
interest
into class A common
stock.............. -- -- 2,781,958 3 3,475 -- -- -- 3,478
Issuance of class A
common stock upon
exercise of op-
tions.............. -- -- 207,332 -- 136 -- -- -- 136
Issuance of class B
common stock upon
exercise of op-
tions.............. -- -- 179,700 -- 73 -- -- -- 73
Repurchase of class
A common stock..... -- -- (84,446) -- (53) -- -- -- (53)
Compensation re-
lated to stock op-
tions granted...... -- -- -- -- 244 -- -- -- 244
Net loss........... -- -- -- -- -- -- (7,960) (7,960)
---------- --- ---------- --- ------- ------- ----- -------- -------
Balance at December
31, 1996............ 5,366,900 5 13,593,344 14 20,779 -- -- (14,089) 6,709
Issuance of series
B preferred stock.. 933,488 1 -- -- 3,999 -- -- -- 4,000
Issuance of class A
common stock upon
exercise of war-
rant............... -- -- 16,000 -- 20 -- -- -- 20
Issuance of class A
common stock upon
exercise of op-
tions.............. -- -- 138,916 -- 115 -- (68) -- 47
Issuance of class B
common stock upon
exercise of op-
tion............... -- -- 42,000 -- 37 -- -- -- 37
Compensation re-
lated to stock op-
tion granted....... -- -- -- -- 49 -- -- -- 49
Net loss........... -- -- -- -- -- -- -- (11,709) (11,709)
---------- --- ---------- --- ------- ------- ----- -------- -------
Balance at December
31, 1997............ 6,300,388 6 13,790,260 14 24,999 -- (68) (25,798) (847)
Issuance of series
B preferred stock.. 3,484,144 3 -- -- 14,828 -- -- -- 14,831
Issuance of series
B preferred stock
upon conversion of
convertible note
payable and accrued
interest........... 715,855 1 -- -- 3,066 -- -- -- 3,067
Issuance of class A
common stock upon
exercise of op-
tions.............. -- -- 201,568 -- 228 -- (47) -- 181
Issuance of class B
common stock upon
exercise of op-
tions.............. -- -- 617,332 1 500 -- (319) -- 182
Forgiveness of note
receivable from
stockholder........ -- -- -- -- -- -- 106 -- 106
Issuance of class A
common stock upon
net exercise of op-
tions
and related compen-
sation............. -- -- 28,631 -- 50 -- -- -- 50
Issuance of class A
common stock upon
net exercise of
warrant
and related compen-
sation............. -- -- 32,857 -- 26 -- -- -- 26
Payments on notes
receivable from
stockholders....... -- -- -- -- -- -- 52 -- 52
Net loss........... -- -- -- -- -- -- -- (19,662) (19,662)
---------- --- ---------- --- ------- ------- ----- -------- -------
Balance at December
31, 1998............ 10,500,387 10 14,670,648 15 43,697 -- (276) (45,460) (2,014)
Issuance of series
C preferred stock
(unaudited)........ 850,000 1 -- -- 5,006 -- -- -- 5,007
Issuance of series
D preferred stock
(unaudited)........ 1,142,023 1 -- -- 9,706 -- -- -- 9,707
Issuance of class A
common stock upon
exercise
of options (unau-
dited)............. -- -- 1,560,798 1 2,267 -- -- -- 2,268
Issuance of class B
common stock upon
exercise
of options (unau-
dited)............. -- -- 819,196 1 519 -- -- -- 520
Issuance of class A
common stock upon
exercise
of warrants (unau-
dited)............. -- -- 293,308 -- 333 -- -- -- 333
Deferred stock com-
pensation (unau-
dited)............. -- -- -- -- 4,273 (4,273) -- -- --
Amortization of de-
ferred compensation
(unaudited)........ -- -- -- -- -- 195 -- -- 195
Forgiveness of note
receivable from
stockholders (unau-
dited)............. -- -- -- -- -- -- 40 -- 40
Net loss (unau-
dited)............. -- -- -- -- -- -- -- (11,411) (11,411)
---------- --- ---------- --- ------- ------- ----- -------- -------
Balance at June 30,
1999 (unaudited).... 12,492,410 $12 17,343,950 $17 $65,801 $(4,078) $(236) $(56,871) $ 4,645
========== === ========== === ======= ======= ===== ======== =======
</TABLE>
See accompanying notes.
F-5
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Years Ended Six Months Ended
December 31, June 30,
--------------------------- -----------------
1996 1997 1998 1998 1999
------- -------- -------- ------- --------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Operating activities
Net loss....................... $(7,960) $(11,709) $(19,662) $(9,378) $(11,411)
Adjustments to reconcile net
loss to net cash used in
operating activities:
Depreciation and
amortization................ 119 283 538 211 263
Amortization of deferred
stock compensation and other
stock related compensation
charges..................... 264 99 182 -- 275
Issuance of preferred stock
for accrued interest........ -- -- 37 -- --
Changes in operating assets
and liabilities:
Accounts receivable........ (25) -- (1,520) -- 1,146
Other current assets....... (33) (111) 24 (2) (172)
Accounts payable........... 261 187 (105) 229 350
Accrued compensation....... 172 190 173 101 180
Other accrued liabilities.. (326) 214 193 177 110
Deferred revenue........... 1,500 1,000 6,075 2,000 441
------- -------- -------- ------- --------
Net cash used in operating
activities.................... (6,028) (9,847) (14,065) (6,662) (8,818)
Investing activities
Capital expenditures........... (578) (662) (509) (116) (210)
Other noncurrent assets........ 15 (20) (11) 4 (47)
------- -------- -------- ------- --------
Net cash used in investing
activities.................... (563) (682) (520) (112) (257)
Financing activities
Proceeds from issuance of
convertible
promissory notes.............. -- -- 3,030 3,030 1,000
Repayment of convertible
promissory notes.............. (750) -- -- -- --
Proceeds from issuance of
preferred stock, net.......... 15,136 4,000 14,831 3,900 14,714
Proceeds from issuance of
common stock, net............. 178 54 363 115 3,081
Proceeds from repayment of
notes receivable from
stockholders.................. -- -- 52 -- --
------- -------- -------- ------- --------
Net cash provided by financing
activities.................... 14,564 4,054 18,276 7,045 18,795
------- -------- -------- ------- --------
Net increase (decrease) in cash
and cash equivalents.......... 7,973 (6,475) 3,691 271 9,720
Cash and cash equivalents at
beginning of period........... 386 8,359 1,884 1,884 5,575
------- -------- -------- ------- --------
Cash and cash equivalents at
end of period................. $ 8,359 $ 1,884 $ 5,575 $ 2,155 $ 15,295
======= ======== ======== ======= ========
</TABLE>
See accompanying notes.
F-6
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Six Months
Years Ended Ended June
December 31, 30,
------------------ ------------
1996 1997 1998 1998 1999
------ ---- ------ ---- -------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Supplemental schedule of cash flow information
Interest paid................................. $ 90 $ -- $ -- $ -- $ --
====== ==== ====== ==== =======
Supplemental schedule of noncash financing
activities
Conversion of convertible promissory notes and
accrued interest
into series B convertible preferred stock.... $ -- $ -- $3,067 $ -- $ --
====== ==== ====== ==== =======
Conversion of convertible promissory notes and
accrued interest into
class A common stock......................... $3,477 $ -- $ -- $ -- $ --
====== ==== ====== ==== =======
Increase in deferred stock compensation....... $ -- $ -- $ -- $ -- $(4,273)
====== ==== ====== ==== =======
</TABLE>
See accompanying notes.
F-7
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
1.ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
InterTrust Technologies Corporation (InterTrust) has developed a general-
purpose digital rights management (DRM) platform to serve as a foundation for
providers of digital information, technology, and commerce services to
participate in a global e-commerce system. DRM technologies manage rights and
interests in digital information. InterTrust was formed and incorporated in
January 1990. From inception through December 1998, InterTrust's efforts were
principally devoted to research and development, raising capital, recruiting
personnel, and establishing partner relationships. InterTrust shipped the
general availability version of its Commerce software at the end of fiscal
1998, and is therefore no longer in the development stage.
InterTrust has incurred operating losses to date and had an accumulated
deficit of $56.9 million at June 30, 1999. InterTrust's activities have been
primarily financed through private placements of equity securities. InterTrust
may need to raise additional capital through the issuance of debt or equity
securities. This financing may not be available on terms satisfactory to
InterTrust, if at all.
Principles of Consolidation
The consolidated financial statements include the accounts of InterTrust and
its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
Interim Financial Information
The financial information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited but includes all adjustments, consisting
only of normal recurring adjustments, that InterTrust's management considers
necessary for the fair presentation of its financial position, operating
results, and cash flows for the interim date and periods. Results for the six
months ended June 30, 1999 are not necessarily indicative of results to be
expected for the full fiscal year of 1999 or for any future period.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Revenue Recognition
InterTrust recognizes revenue from license fees, transaction fees, and
software support and training services. License revenue, net of any discounts
granted, is recognized after execution of a
F-8
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
license agreement and delivery of the product, provided there are no remaining
obligations relating to development, upgrades, new releases, or other future
deliverables, and provided that the license fee is fixed or determinable, and
collection of the fee is probable. For contracts entered after January 1, 1998,
InterTrust allocates revenue between the elements of the arrangements,
including the license, software support and training services, and the rights
to unspecified upgrades and new releases based on the vendor specific evidence
of the fair value of each of the elements. If Intertrust does not have vendor
specific objective evidence of the fair value of the undelivered elements,
license revenue is not recognized for the delivered elements. InterTrust's
license agreements generally include the right to obtain access to upgrades and
new releases, on a when and if available basis, for a specified period. Under
these circumstances, the license payments received in advance of revenue
recognition, are deferred and recognized on a subscription basis over the
period of obligation beginning upon delivery of the licensed product. In
addition, under license agreements where Intertrust is obligated to provide
specified upgrades and does not have vendor specific objective evidence of fair
value of the specified upgrade, all of the license revenue is deferred until
the specified upgrade has been delivered. Upon delivery of the specified
upgrade, license revenue is recognized using the subscription method.
InterTrust began recognizing revenue under some license agreements in
January 1999, subsequent to shipment of the general availability version of its
Commerce software at the end of fiscal 1998. Under license agreements with two
preferred stockholders, InterTrust had received a total of $4,000,000 from
nonrefundable license payments as of December 31, 1998.
In May 1999, InterTrust received a license fee in the form of a minority
equity position in a non-public entity in exchange for a seven year technology
license. InterTrust received approximately 1.7 million shares of common stock
of the licensee, which it believes represents approximately 10% of the
outstanding shares of the licensee as of June 30, 1999. Because the entity is a
recently formed, privately held company and we were unable to obtain sufficient
evidence of the fair value of the common stock of the entity, we did not record
revenue or deferred revenue from the license fee. InterTrust is obligated to
provide unspecified upgrades and new releases, on a when and if available
basis, to the licensee over a two year period under the agreement for
additional fees. InterTrust is not obligated to provide any funding to the
licensee for the development of the licensee's software.
For contracts entered into prior to 1998, InterTrust recognizes revenue as
the amounts are earned under the related agreements, provided no significant
obligations exist and the related receivable is deemed collectible, in
accordance with Statement of Position 91-1, "Software Revenue Recognition."
InterTrust's license revenue in 1997 was derived from a license of a pre-
commercial version of its software.
InterTrust's license agreements also require the payment of a percentage
transaction fee based on the fulfillment of a transaction that utilizes its
technology. InterTrust's partners are required to pay all amounts due for
transaction fees within 30 to 90 days after the end of each quarter.
InterTrust's
F-9
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
revenue recognition policy relating to transaction fees is to recognize the
revenue when the amounts due are known, which will generally be in the quarter
subsequent to the transaction. Prepaid transaction fees are recorded as
deferred revenue and will be recognized when the related transactions occur.
InterTrust had received $1,000,000 in prepaid transaction fees from a preferred
stockholder, which is included in deferred revenue as of December 31, 1998 and
June 30, 1999. No transaction revenue has been recognized from commercial
transactions or services as of June 30, 1999.
Software support and training services, which typically include the right to
telephone and online support and customer training, are generally provided for
in the license agreements for an agreed upon amount. Software support and
training service revenue is recognized over the period in which the services
are provided, generally two years. Certain of InterTrust's partners were
utilizing pre-commercial versions of its product in the development of their
own solutions and, as a result, were utilizing InterTrust's software support
and training services prior to the shipment of its commercial release in
December 1998. Costs incurred to provide software support and training services
are included as a component of cost of revenues.
InterTrust adopted Statement of Position 97-2, "Software Revenue
Recognition" (SOP 97-2), and Statement of Position 98-4, "Deferral of the
Effective Date of a Provision of 97-2" (SOP 98-4), as of January 1, 1998.
SOP 97-2 and SOP 98-4 provide guidance for recognizing revenue on software
transactions and supersede SOP 91-1. The adoption of SOP 97-2 and SOP 98-4 did
not have a material impact on InterTrust's operating results.
In December 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-9, "Modifications of SOP 97-2, Software Revenue
Recognition With Respect to Certain Transactions" (SOP 98-9). SOP 98-9 amends
SOP 98-4 to extend the deferral of the application of some passages provided by
SOP 98-4 through fiscal years beginning on or before March 15, 1999. All
provisions of SOP 98-9 are effective for transactions entered into in fiscal
years beginning after March 15, 1999. InterTrust believes the adoption of SOP
98-9 will not have a material effect on its results of operations or financial
condition.
Cash and Cash Equivalents
InterTrust considers all highly liquid instruments with insignificant
interest rate risk and maturities of three months or less to be cash
equivalents. At December 31, 1998 and June 30, 1999, cash equivalents consist
of money market funds.
Concentration of Credit Risk
Financial instruments that potentially subject InterTrust to a concentration
of credit risk consist of cash, cash equivalents, and accounts receivable. Cash
and cash equivalents are deposited with a high-credit quality financial
institution. InterTrust's accounts receivable are primarily derived from
F-10
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
customers located in North America, Europe, and Asia. InterTrust performs
ongoing credit evaluations of its customers but does not require collateral
from its customers. When required, InterTrust maintains allowances for credit
losses, and to date, these losses have been within management's expectations.
One customer, who is also a preferred stockholder, accounted for 91% of
total revenues in 1997 and 40% of total revenues in the six months ended June
30, 1999. A second customer, also a preferred stockholder, accounted for 100%,
9%, and 66% of total revenues in 1996, 1997, and 1998, respectively, and 100%
and 24% of total revenues in the six months ended June 30, 1998 and 1999,
respectively. Two customers accounted for 13% and 21% of total revenues in
1998. One customer accounted for 13% of total revenue for the six months ended
June 30, 1999. One customer accounted for 98% of accounts receivable at
December 31, 1998. Two customers accounted for 63% and 10% of accounts
receivable at June 30, 1999.
Fair Value of Financial Instruments
The carrying amounts of InterTrust's financial instruments, which include
cash and cash equivalents, accounts receivable, current liabilities, and notes
receivable from stockholders, approximate their fair value.
Investment in Non-Public Entity
In May 1999, InterTrust received an approximately 10% equity interest in a
non-public entity as consideration for a license fee. Because the entity is a
recently formed, privately held company and we were unable to obtain sufficient
evidence of the fair value of the common stock of the entity, we did not record
revenue or deferred revenue from the license fee.
Property and Equipment
Property and equipment are stated at cost, and depreciation is computed
using the straight-line method over the estimated useful lives of the assets,
generally three years. Leasehold improvements are amortized using the straight-
line method over the shorter of the estimated useful lives of the assets or the
terms of the leases.
Stock-Based Compensation
InterTrust accounts for stock-based compensation for awards to employees
using the intrinsic value method prescribed in Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," and has adopted the
disclosure only alternative of Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" (FAS 123). InterTrust accounts
for stock-based compensation awards to non-employees using the fair value
method prescribed in FAS 123.
F-11
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
Research and Development
Research and development expenditures are expensed to operations as
incurred. Costs incurred in the development of new software and substantial
enhancements to existing software are expensed as incurred until technological
feasibility of the software has been established, at which time any additional
costs would be capitalized in accordance with Statement of Financial Accounting
Standards No. 86, "Accounting for the Costs of Computer Software to Be Sold,
Leased, or Otherwise Marketed." To date, InterTrust's software development has
been completed concurrently with the establishment of technological feasibility
and, as a result, no research and development costs have been capitalized.
Advertising Expense
InterTrust recognizes advertising expense as incurred. Advertising expense
has been immaterial in all periods since inception.
Comprehensive Loss
InterTrust adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" (FAS 130), as of December 31, 1998. Under FAS
130, InterTrust is required to display comprehensive income (loss) and its
components as part of the financial statements. Other comprehensive income
includes changes in equity that are excluded from net income (loss).
Specifically, FAS 130 requires unrealized holding gains and losses on
available-for-sale securities to be included in accumulated and other
comprehensive income. InterTrust has no material components of other
comprehensive loss and, as a result, the comprehensive loss is the same as the
net loss for all periods presented.
Net Loss Per Share, Pro Forma Net Loss per Share, and Pro Forma Stockholders'
Equity
Basic and diluted net loss per share are presented in conformity with
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (FAS
128), for all periods presented. Basic and diluted net loss per share have been
computed using the weighted average number of shares of common stock
outstanding during the period, less the weighted average number of shares
subject to repurchase.
Pro forma net loss per share has been computed as described above but also
gives effect, under Securities and Exchange Commission guidance, to the
conversion of convertible preferred stock not included above that will
automatically convert upon completion of InterTrust's initial public offering
into common stock (using the as-converted method). If the offering contemplated
by this prospectus is consummated, all of the convertible preferred stock
outstanding as of June 30, 1999 and the outstanding convertible promissory note
will automatically be converted into an aggregate of 12,575,743 shares of
common stock. The number of shares to be issued upon conversion of the
convertible promissory note was calculated using the price of the series E
financing completed in July 1999 (see note 7). Pro forma stockholders' equity
at June 30, 1999, as adjusted for the conversion of the convertible preferred
stock and convertible promissory note, is disclosed on the consolidated balance
sheet.
F-12
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
Historical and pro forma basic and diluted net loss per share are as follows
(in thousands, except per share amounts):
<TABLE>
<CAPTION>
Six Months Ended
Years Ended December 31, June 30,
--------------------------- -----------------
1996 1997 1998 1998 1999
------- -------- -------- ------- --------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Historical:
Net loss...................... $(7,960) $(11,709) $(19,662) $(9,378) $(11,411)
======= ======== ======== ======= ========
Basic and diluted shares:
Weighted average shares of
common stock outstanding.... 11,913 13,681 14,186 13,904 15,609
Less weighted average shares
subject to repurchase....... -- (42) (220) (127) (302)
------- -------- -------- ------- --------
Weighted average shares of
common stock outstanding
used in computing basic and
diluted net per loss share.. 11,913 13,639 13,966 13,777 15,307
======= ======== ======== ======= ========
Basic and diluted net loss
per share................... $ (0.67) $ (0.86) $ (1.41) $ (0.68) $ (0.75)
======= ======== ======== ======= ========
Pro Forma:
Net loss...................... $(19,662) $(11,411)
======== ========
Weighted average shares of
common stock
outstanding used in computing
basic and diluted
net loss per share........... 13,966 15,307
Adjustment to reflect the
assumed conversion of
convertible preferred stock
from the date of issuance.... 7,722 11,501
-------- --------
Weighted average shares used
in computing pro forma basic
and diluted net loss per
share........................ 21,688 26,808
======== ========
Pro forma basic and diluted
net loss per share .......... $ (0.91) $ (0.43)
======== ========
</TABLE>
If InterTrust had reported net income, diluted net income per share would
have included the shares used in the computation of pro forma net loss per
share as well as the treasury stock impact of approximately 6,172,000,
8,637,000, 9,084,000, 9,225,000, and 7,074,000 shares purchasable under
outstanding options and warrants not included above for the years ended
December 31, 1996, 1997, and 1998, and for the six months ended June 30, 1998
and 1999, respectively. The number of common equivalent shares from options and
warrants would be determined on a weighted average basis using the treasury
stock method. The convertible promissory note outstanding at June 30, 1999 was
excluded from the common equivalent share calculation, as it would have been
antidilutive. If InterTrust had reported net income, shares used in computing
diluted net income per share at June 30, 1999 would have included an additional
83,333 shares from the conversion of the convertible promissory note.
Segments
Effective January 1, 1998, InterTrust adopted Statement of Financial
Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and
Related Information" (FAS 131). FAS 131 changes the way companies report
selected segment information in annual financial statements and requires
companies to report selected segment information in interim financial reports
to
F-13
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
stockholders. FAS 131 also establishes standards for related disclosures about
products and services, geographic areas, and major customers. InterTrust
operates solely in one segment, and therefore there is no impact on
InterTrust's financial statements as a result of adopting FAS 131. For the year
ended December 31, 1998, revenue from customers outside the United States was
$52,000 and was derived from customers in Europe. For the six months ended June
30, 1999, customers from Asia and Europe accounted for revenue totaling
approximately $194,000 and $130,000, respectively.
Derivative Instruments and Hedging Activities
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (FAS 133), which is required to be adopted in years
beginning after June 15, 2000. To date, InterTrust has not used derivatives,
and management anticipates that the adoption of FAS 133 will not have a
significant effect on InterTrust's results of operations or financial position.
2.PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and consist of the following (in
thousands):
<TABLE>
<CAPTION>
December 31,
-------------- June 30,
1997 1998 1999
------ ------ -----------
(Unaudited)
<S> <C> <C> <C>
Computer equipment and software..................... $1,271 $1,465 $ 1,665
Furniture and equipment............................. 119 193 203
Leasehold improvements.............................. 56 56 56
------ ------ -------
1,446 1,714 1,924
Accumulated depreciation and amortization........... (479) (776) (1,039)
------ ------ -------
$ 967 $ 938 $ 885
====== ====== =======
</TABLE>
3.COMMITMENTS
InterTrust leases its facilities under agreements expiring in August 1999
(see note 7). Rent under the agreements is expensed to operations on a
straight-line basis over the terms of the leases. Future minimum rental
commitments under operating leases entered into as of December 31, 1998 are
approximately $355,000 in 1999. Rent expense for all operating leases was
approximately $167,000, $258,000, $490,000, and $320,000 in 1996, 1997, 1998,
and the six months ended June 30, 1999, respectively.
F-14
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
4.STOCKHOLDERS' EQUITY (DEFICIT)
Preferred Stock
InterTrust is authorized to issue 20,000,000 shares of convertible preferred
stock, designated in series (see Note 7). A summary of convertible preferred
stock is as follows (in thousands, except share amounts):
<TABLE>
<CAPTION>
Issued and Outstanding Shares Liquidation Preference
-------------------------------- -----------------------
December 31,
Shares -------------------- June 30, December 31, June 30,
Designated 1997 1998 1999 1998 1999
---------- --------- ---------- ----------- ------------ ----------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Series A................ 5,000,000 3,966,666 3,966,666 3,966,666 $10,135 $10,135
Series B................ 6,533,722 2,333,722 6,533,721 6,533,721 27,997 27,997
Series C................ 850,000 -- -- 850,000 -- 5,007
Series D................ 1,294,118 -- -- 1,142,023 -- 9,707
--------- ---------- ---------- ------- -------
6,300,388 10,500,387 12,492,410 $38,132 $52,846
========= ========== ========== ======= =======
</TABLE>
The board of directors has the authority to issue the preferred stock in one
or more series and to fix its rights, preferences, privileges, and
restrictions, including dividend rights, dividend rates, conversion rights,
voting rights, terms of redemption, redemption prices, liquidation preferences,
and the number of shares constituting any series or designation of the series.
In compliance with the series A preferred stock financing, InterTrust is
restricted from authorizing or issuing any other equity securities,
reclassifying any equity securities resulting in preferences or priorities to
those holders of series A preferred stock, declaring or paying a dividend in
excess of 10% of its net income, amending or appealing the certificate of
incorporation so as to affect the voting rights of the series A stockholders,
or increasing or decreasing its total number of authorized shares without the
consent of a majority of the holders of series A preferred stock.
In the event of liquidation, the series A preferred stock has preference
over the series B, C, and D preferred stock and common stock in the amount of
$2.555 per share, plus declared but unpaid dividends. Remaining assets would
then be distributed pro rata based on (i) the number of shares of class A
common stock into which the series A preferred stock converts, (ii) three times
the number of shares of class A common stock into which the series B, C, and D
preferred stock converts, and (iii) the then outstanding shares of common
stock. Series A preferred stockholders are to receive distributions to a
maximum aggregate amount of $7.665 per share. Series B, C, and D preferred
stockholders are to receive distributions until their total distributions equal
the aggregate of their original purchase prices of $4.285, $5.89, and $8.50 per
share, respectively.
Each of the series B, C, and D stockholders will recommence participation in
the distribution of any remaining assets once the common stockholders receive
distributions equal to the original per share purchase price of the applicable
preferred stock. Participation would be pro rata with the common stock
outstanding, assuming a one-for-one conversion of the preferred stock to class
A common stock.
F-15
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
Holders of preferred stock are entitled to one vote for each share of common
stock into which the shares are converted. Each share of series A preferred
stock entitles the holder to receive annual noncumulative dividends in
preference to holders of series B, C, D, and E preferred stock and common
stock, when and if declared by the board of directors. If dividends are
declared on series A preferred stock, the dividends must be declared at an
annual rate of $0.23 per share. After payment of any declared annual dividends,
the preferred stockholders will receive dividends, when and if declared by the
board of directors, on an as-if-converted basis in an amount equal to the
dividends paid to any other holders of outstanding stock. As of June 30, 1999,
no dividends had been declared.
Each share of preferred stock is convertible, at the option of the holder,
into class A common stock, subject to adjustments for antidilution. In
addition, the preferred shares will automatically convert into common stock
upon an underwritten public offering of InterTrust's common stock at not less
than $3.75 per share, that results in aggregate proceeds to InterTrust in
excess of $10,000,000. The holders of preferred stock also have registration
rights. InterTrust has a right of first refusal should any preferred
stockholder desire to sell or transfer its shares. The repurchase price must be
substantially the same price and the repurchase terms must be substantially the
same terms offered to the third party. The right of first refusal terminates
upon an underwritten public offering of InterTrust's common stock.
Common Stock
Authorized common stock has been designated as class A voting common stock
and class B nonvoting common stock. The rights, preferences, privileges, and
restrictions of class A voting common stock and class B nonvoting common stock
are identical in all respects except for voting rights. The class B non-voting
common stock will convert to class A voting common stock upon the consummation
of a public offering of InterTrust's common stock. A summary of common stock is
as follows:
<TABLE>
<CAPTION>
Issued and Outstanding Shares
---------------------------------
December 31,
Shares --------------------- June 30,
Designated 1997 1998 1999
---------- ---------- ---------- -----------
(Unaudited)
<S> <C> <C> <C> <C>
Class A............................ 50,000,000 12,885,920 13,148,976 15,003,082
Class B............................ 20,000,000 904,340 1,521,672 2,340,868
---------- ---------- ----------
13,790,260 14,670,648 17,343,950
========== ========== ==========
</TABLE>
At December 31, 1998, common stock was reserved for issuance as follows:
<TABLE>
<S> <C>
Conversion of preferred stock................................... 10,500,387
Exercise of outstanding stock options........................... 8,457,989
Shares of common stock available for grant under the 1995 stock
option plan.................................................... 101,846
Exercise of warrants............................................ 626,016
----------
19,686,238
==========
</TABLE>
F-16
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
During 1998, InterTrust received a note receivable in the amount of
approximately $319,000 from one of its officers upon his exercise of an option
to purchase 320,000 shares of common stock. As of December 31, 1998,
approximately 214,000 of these shares were subject to repurchase by InterTrust
at the original exercise price. The repurchase right lapses ratably over the
48-month vesting period of the underlying option. The note bears interest at 8%
per annum and is secured by the related stock and general assets of the
officer. The note and related interest are being forgiven over a period of four
years of employment. InterTrust is recording compensation expense as the note
is forgiven.
1995 Stock Option Plan
In October 1995, the board of directors adopted the 1995 stock option plan
(the 1995 option plan) for issuance of class A common stock to eligible
participants. Incentive stock options granted under the 1995 option plan are at
prices not less than the fair values as determined by the board of directors,
while nonstatutory options granted under the plan are at prices not less than
85% of the fair values on the respective dates of the grant. Options expire
after ten years. Options generally vest ratably over a period of no more than
five years.
Non Plan Stock Options
InterTrust's board of directors has granted to eligible participants
nonqualified stock options to purchase shares of class B common stock. The
options generally expire up to six years after the date of grant or earlier if
employment or relationship is terminated. The options generally become
exercisable ratably over a period of no more than four years. The exercisable
options may be exercised in whole or in part but no more frequently than twice
a year and in amounts of no less than 250 shares. There were no options to
purchase shares of class B common stock available for grant at December 31,
1998.
During 1996 and 1997, InterTrust issued options outside of the 1995 option
plan to purchase 160,000 shares of class A common stock at $1.25 per share and
298,332 shares of class A common stock at $1.50 per share, respectively.
F-17
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
Information about stock option activity is summarized as follows:
<TABLE>
<CAPTION>
Shares of Common Stock
------------------------------------ Weighted
1995 Option Plan Average
----------------------- Nonplan Exercise
Available Outstanding Outstanding Price
---------- ----------- ----------- --------
<S> <C> <C> <C> <C>
Balance at December 31, 1995... 2,009,600 490,400 3,306,480 $0.51
Shares authorized............. 880,000 -- -- --
Options granted............... (2,326,000) 2,326,000 160,000 $1.16
Options exercised............. -- (207,332) (179,700) $0.54
Unvested shares repurchased... 84,446 -- -- --
Options canceled.............. 32,000 (32,000) (364,852) $0.35
---------- ---------- ----------
Balance at December 31, 1996... 680,046 2,577,068 2,921,928 $0.81
Shares authorized............. 1,600,000 -- -- --
Options granted............... (2,823,300) 2,823,300 882,332 $1.46
Options exercised............. -- (138,916) (92,000) $0.75
Options canceled.............. 720,044 (720,044) (274,016) $1.02
---------- ---------- ----------
Balance at December 31, 1997... 176,790 4,541,408 3,438,244 $1.08
Shares authorized............. 1,200,000 -- -- --
Options granted............... (1,536,000) 1,536,000 80,000 $2.64
Options exercised............. -- (259,275) (617,332) $0.91
Options canceled.............. 261,056 (261,056) -- $1.45
---------- ---------- ----------
Balance at December 31, 1998... 101,846 5,557,077 2,900,912 $1.39
Shares authorized
(unaudited).................. 1,250,000 -- -- --
Options granted (unaudited)... (933,600) 933,600 22,028 $4.75
Options exercised
(unaudited).................. -- (1,264,548) (1,117,528) $1.17
Options canceled (unaudited).. 219,878 (219,878) (70,252) $2.04
---------- ---------- ----------
Balance at June 30, 1999
(unaudited)................... 638,124 5,006,251 1,735,160 $1.91
========== ========== ==========
Exercisable and vested at
December 31, 1998............. 2,026,979 2,529,244
========== ==========
Exercisable and vested at June
30, 1999 (unaudited).......... 1,527,885 1,675,160
========== ==========
Shares of common stock subject
to repurchase at December 31,
1998.......................... -- 213,334
========== ==========
Shares of common stock subject
to repurchase at
June 30, 1999 (unaudited)..... -- 405,002
========== ==========
</TABLE>
F-18
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
The following table summarizes information about options outstanding under
the 1995 option plan and nonplan options at December 31, 1998:
<TABLE>
<CAPTION>
Options Exercisable
Options Outstanding ---------------------
---------------------------------------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Contractual Exercise Exercise
Prices Shares Life Price Shares Price
------------- --------- ----------- -------- --------- --------
(In years)
<S> <C> <C> <C> <C> <C>
$0.01 - $0.31 698,160 3.13 $0.17 698,160 $0.17
$0.63 - $0.75 2,106,838 5.67 $0.63 1,834,001 $0.63
$1.25 1,016,168 7.70 $1.25 604,393 $1.25
$1.50 2,681,107 8.03 $1.50 1,093,162 $1.50
$2.00 - $2.50 1,637,216 9.24 $2.37 318,551 $2.29
$3.50 318,500 9.73 $3.50 7,956 $3.50
--------- ---------
$0.01-$3.50 8,457,989 7.30 $1.39 4,556,223 $0.97
========= =========
</TABLE>
In July 1996, InterTrust extended the exercise period of some fully vested
options to purchase class B common stock for an additional six-year period. The
difference between the exercise price and what was considered to be the fair
value of the options at that date was approximately $220,000. This amount was
recorded as compensation expense in 1996.
In connection with the acceleration of vesting of some options at the time
of an employee termination, InterTrust recorded a charge of $49,166 in 1997.
Stock-Based Compensation
In connection with the grant of options to employees during the six months
ended June 30, 1999, InterTrust recorded deferred stock compensation of
approximately $4,273,000 for the difference between the exercise prices of
those options at their respective dates of grant and what was considered to be
the fair values for accounting purposes of the shares of common stock subject
to the options. These amounts are included as a reduction of stockholders'
equity and are being amortized on a graded vesting method. The compensation
expense of $195,000 during the six months ended June 30, 1999 relates to
options awarded to employees in all operating expense categories. These amounts
have not been separately allocated between operating expense categories.
Pro forma information regarding net income is required by FAS 123 as if
InterTrust had accounted for its stock-based awards to employees granted
subsequent to December 31, 1994 under the fair value method. The fair value was
estimated at the date of grant using the Black-Scholes option pricing model.
The Black-Scholes model was developed for use in estimating the fair value of
traded options that have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of highly subjective
assumptions, including the expected stock volatility. InterTrust is a nonpublic
company and is permitted to use a near-zero volatility factor in its
assumptions when applying the Black-Scholes model. Since InterTrust's stock-
based awards have
F-19
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
characteristics significantly different from those of traded options and since
changes in the subjective input assumptions can materially affect the fair
value estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its stock-based awards.
The fair value of InterTrust's stock-based awards to employees was estimated
assuming no expected dividend; a risk-free interest rate of 6%, and expected
lives of two years for nonplan options and five years for options granted under
the 1995 option plan.
The weighted-average fair value of options granted during 1996, 1997, and
1998 was $0.40, $0.74, and $1.23 per share, respectively.
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------
1996 1997 1998
------- -------- --------
<S> <C> <C> <C>
Pro forma net loss................................ $(8,269) $(12,645) $(21,115)
======= ======== ========
Pro forma basic and diluted net loss per share.... $ (0.97)
========
</TABLE>
For purposes of pro forma disclosures, the estimated fair value of the above
stock-based awards is amortized to expense over the vesting period of the
award. Because FAS 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until
approximately 1999.
Warrants
As of December 31, 1998, warrants to purchase a total of 306,000 shares of
class A common stock at prices ranging from $0.63 to $2.56 per share were
outstanding. Warrants to purchase 40,000 shares were issued in January 1995 in
connection with convertible notes and were exercised in February 1999. Warrants
to purchase 16,000 shares were issued in May 1995 to a related party in
conjunction with convertible notes, of which 13,308 were exercised in May 1999
with the remaining shares exercisable through May 2000. Warrants to purchase
240,000 shares were issued in April 1996 in conjunction with convertible notes
and were exercised in April 1999. Warrants to purchase 10,000 shares were
issued in November 1996 and were exercised in August 1999.
As of December 31, 1998, warrants to purchase a total of 320,016 shares of
class B non-voting common stock were outstanding. A warrant to purchase 311,016
shares of class B non-voting common stock was issued in August 1996 in
conjunction with a license agreement. This warrant is exercisable beginning in
August 2003 through August 2006 but may be exercised at an earlier date upon
the occurrence of certain events at InterTrust's discretion. This warrant may
be terminated upon the closing of an initial public offering of InterTrust's
common stock. Warrants to purchase 9,000 shares of class B non-voting common
stock at a weighted average exercise price of $1.61 per share were issued in
1998 in connection with professional services. Of this amount, 5,000 shares
were exercised in August 1999 and 4,000 shares are exercisable through the
earlier of the completion of an initial public offering of InterTrust's common
stock or December 2003.
F-20
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
5.INCOME TAXES
The difference between the amount of income tax benefit recorded and the
amount of income tax benefit calculated using the U.S. federal statutory rate
of 34% is primarily due to net operating losses not being benefited. For that
reason, there is no provision for income taxes for the years ended December 31,
1996, 1997, and 1998.
Significant components of InterTrust's deferred tax assets are as follows
(in thousands):
<TABLE>
<CAPTION>
December 31,
----------------
1997 1998
------- -------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards............................. $ 8,100 $12,500
Capitalized research and development......................... 1,100 1,800
Research credit carryforwards................................ 800 1,700
Deferred revenue............................................. 400 1,000
Other........................................................ 600 1,500
------- -------
Gross deferred tax assets..................................... 11,000 18,500
Valuation allowances.......................................... (11,000) (18,500)
------- -------
Net deferred tax assets....................................... $ -- $ --
======= =======
</TABLE>
The Financial Accounting Standards Board's Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes," provides for the recognition
of deferred tax assets if realization of these assets is more likely than not.
Based upon the weight of available evidence, which includes InterTrust's
historical operating performance and the reported cumulative net losses in all
prior years, InterTrust has provided a full valuation allowance against its
gross deferred tax assets.
The valuation allowance increased by approximately $5,100,000 and $7,500,000
during the years ended December 31, 1997 and 1998, respectively. Approximately
$100,000 of the valuation allowance at December 31, 1998 relates to the tax
benefits of stock option deductions that will be credited to additional paid-in
capital when realized.
As of December 31, 1998, InterTrust had federal and state net operating loss
carryforwards of approximately $36,200,000 and $4,300,000, respectively.
InterTrust also had federal research and development tax credit carryforwards
of approximately $1,100,000. The federal net operating loss and tax credit
carryforwards expire in years 2007 through 2018, if not utilized. The state net
operating loss carryforwards expire in years 1999 through 2003, if not
utilized.
Utilization of the net operating loss and tax credit carryforwards may be
subject to a substantial annual limitation due to the change in ownership
provisions of the Internal Revenue Code of 1986, as amended, and similar state
provisions. The annual limitation may result in the expiration of net operating
loss and tax credit carryforwards before utilization.
F-21
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
6.SUBSEQUENT EVENTS
In March, April, and May 1999, InterTrust issued 850,000 shares of series C
preferred stock at a price of $5.89 per share and 1,142,023 shares of series D
preferred stock at a price of $8.50 per share. The series C and D preferred
stock have rights and preferences similar to the previously issued series B
preferred stock.
7.EVENTS SUBSEQUENT TO DATE OF AUDITORS' REPORT (UNAUDITED)
In July 1999, InterTrust's stockholders approved a proposal to increase the
available shares under the 1995 option plan by an additional 500,000 shares.
In April 1999, in connection with executing a licensing arrangement,
InterTrust issued to the licensee, for an aggregate amount of $1,000,000, a
noninterest-bearing convertible promissory note. In July 1999, the note
converted into 83,333 shares of series E preferred stock of InterTrust at a
price of $12.00 per share.
In July 1999, the board of directors and stockholders approved the issuance
of up to 1,400,000 shares of series E preferred stock. During July 1999,
InterTrust issued 1,309,700 shares of the series E preferred stock at a price
of $12.00 per share. The series E preferred stock has similar rights and
preferences as the previously issued series B, C and D preferred stock.
In July 1999, InterTrust entered into a lease agreement for office space to
serve as its corporate headquarters and principal operating facility. The lease
period commences September 1, 1999 and extends for a period of 60 months. The
lease requires monthly rental payments of approximately $121,000 plus variable
operating expenses and is subject to increases of 4% per annum.
In July 1999, the board of directors adopted InterTrust's 1999 equity
incentive plan subject to stockholder approval, to be effective upon completion
of InterTrust's initial public offering of its common stock. This 1999 plan
provides for the grant of incentive stock options, nonstatutory stock options,
restricted stock purchase awards, and stock appreciation rights to eligible
participants. A total of 1,900,000 shares of common stock has been reserved for
issuance under this 1999 plan.
In July 1999, the board of directors adopted InterTrust's 1999 employee
stock purchase plan subject to stockholder approval, to be effective upon
completion of InterTrust's initial public offering of its common stock. A total
of 350,000 shares of common stock has been reserved for issuance under this
purchase plan. Eligible employees may purchase common stock at 85% of the
lesser of the fair market value of InterTrust's common stock on the first day
of the applicable two-year offering period or the last day of the applicable
six-month purchase period.
In July 1999, the board of directors adopted InterTrust's 1999 non-employee
directors option plan, subject to stockholder approval, to be effective upon
completion of InterTrust's initial public
F-22
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INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited)
offering of its common stock. The director's plan provides for the automatic
grant of options to purchase shares of common stock to non-employee directors
of InterTrust. A total of 350,000 shares of common stock has been reserved for
issuance under the director's plan.
In September 1999, InterTrust entered into a financial consulting agreement
with Allen & Company Inc. Concurrently, InterTrust issued a warrant to Allen &
Company for 325,000 shares of common stock at an exercise price of $14.00 per
share. The warrant is exercisable as to 50% of the shares one year after the
date of grant and the balance of such shares two years after the date of grant
or immediately prior to a merger or sale of InterTrust. The warrant expires
five years from the date of grant and is subject to early termination upon the
sale or merger of InterTrust.
In October 1999, InterTrust purchased audio decoding and rendering
technology and related assets, and received a license to video decoding and
rendering technology from a third party, in exchange for 85,000 shares of
InterTrust's common stock and $100,000 in cash. The purchase price, which will
be capitalized as an intangible asset, was valued at approximately $1.3
million. InterTrust will amortize the value of the technology acquired over its
estimated useful life, which has not yet been determined.
From July 1, 1999 through October 13, 1999, InterTrust granted options to
purchase 571,000 shares of common stock under the 1999 equity incentive plan at
a weighted average exercise price of $11.79 per share. InterTrust intends to
grant options to purchase 1,296,500 shares of common stock to recently hired
employees under its 1999 equity incentive plan at the same time as this
offering. Of these options, options to purchase 346,500 shares of common stock
will be at an exercise price equal to the initial public offering price of the
common stock and the remaining options to purchase 950,000 shares of common
stock, which includes an option to purchase 300,000 shares of common stock to
InterTrust's new executive vice chairman and an option to purchase 500,000
shares of common stock to InterTrust's new president and chief operating
officer, will be at an exercise price equal to 85% of the initial public
offering price of the common stock.
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Narrative Description of Inside Back Cover
In the center of the page is the InterTrust logo.
<PAGE>
[LOGO OF INTERTRUST]
