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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[ ] For the quarterly period ended September 30, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number 000-27287
INTERTRUST TECHNOLOGIES CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 52-1672106
(State of incorporation) (IRS Employer Identification No.)
4750 Patrick Henry Dr., Santa Clara, California 95054
(Address of principal executive offices, including ZIP code)
(408) 855-0100
(Registrant's telephone number, including area code)
None
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) Yes X No ___, and (2) has
been subject to such filing requirements for the past 90 days. Yes X No
___ ___.
The number of shares outstanding of the registrant's Common Stock as of
November 10, 2000 was 86,673,137.
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INTERTRUST TECHNOLOGIES CORPORATION
INDEX
<TABLE>
<CAPTION>
Page No.
-------
Part I. Financial Information
<S> <C> <C>
Item 1. Condensed Consolidated Balance Sheets as of September 30, 2000
and December 31, 1999 3
Condensed Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 2000 and 1999 4
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2000 and 1999 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Item 3. Qualitative and Quantitative Disclosure About Market Risk 22
Part II. Other Information
Item 1. Legal Proceedings 23
Item 2. Changes in Securities and Use of Proceeds 23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 23
Signature 26
Exhibit Index 27
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
INTERTRUST TECHNOLOGIES CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------ -----------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................................. $ 142,348 $ 98,286
Short-term investments.................................................... 40,356 42,548
Accounts receivable....................................................... 1,756 2,562
Prepaid distribution costs, net........................................... 460 --
Other current assets...................................................... 3,049 1,182
--------- --------
Total current assets.................................................. 187,969 144,578
Property and equipment, net.................................................. 7,849 3,356
Long-term investments........................................................ 24,290 --
Other assets................................................................. 1,223 137
Goodwill and other intangible assets......................................... 19,866 3,426
--------- --------
$ 241,197 $151,497
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................................... $ 3,118 $ 2,184
Accrued compensation...................................................... 4,407 1,113
Other accrued liabilities................................................. 1,210 1,678
Deferred revenue.......................................................... 5,582 3,052
--------- --------
Total current liabilities............................................. 14,317 8,027
Deferred revenue--long-term portion.......................................... 7,604 10,118
Commitments:
Stockholders' equity:
Common stock.............................................................. 86 79
Additional paid-in capital................................................ 335,040 214,241
Deferred stock compensation............................................... (3,910) (6,600)
Notes receivable from stockholders........................................ (73) (196)
Accumulated other comprehensive loss.................................... (282) (107)
Accumulated deficit....................................................... (111,585) (74,065)
--------- --------
Total stockholders' equity............................................ 219,276 133,352
--------- --------
$ 241,197 $151,497
========= ========
</TABLE>
See accompanying notes.
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INTERTRUST TECHNOLOGIES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
---------------- ---------------
2000 1999 2000 1999
---- ---- ---- ----
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues:
Licenses.................................. $ 1,188 $ 187 $ 2,764 $ 496
Software support and training............. 861 176 2,153 353
Clearinghouse services.................... 48 -- 194 --
-------- ------- -------- --------
Total revenues................................. 2,097 363 5,111 849
Cost of revenues:
Licenses.................................. 133 24 346 66
Software support and training............. 236 126 565 334
Clearinghouse services.................... 934 90 2,291 90
-------- ------- -------- --------
Total cost of revenues......................... 1,303 240 3,202 490
-------- ------- -------- --------
Gross profit................................... 794 123 1,909 359
Operating costs and expenses:
Research and development.................. 6,470 4,587 17,446 11,675
Sales and marketing....................... 4,493 1,732 12,511 4,181
General and administrative................ 2,520 1,521 7,021 3,638
Purchased in-process research and -- -- 6,100 --
development...........................
Amortization of goodwill.................. 923 -- 1,845 --
Amortization of deferred stock 746 625 2,690 820
compensation.......................... -------- ------- -------- --------
Total operating costs and expenses............. 15,152 8,465 47,613 20,314
-------- ------- -------- --------
Loss from operations........................... (14,358) (8,342) (45,704) (19,955)
Interest and other income (expense), net....... 3,306 279 8,184 481
-------- ------- -------- --------
Net loss....................................... $(11,052) $(8,063) $(37,520) $(19,474)
======== ======= ======== ========
Basic and diluted net loss per share.......... $ (0.13) $ (0.23) $ (0.45) $ (0.61)
======== ======= ======== ========
Shares used in computing basic and diluted net
loss per share................................ 85,434 34,411 82,871 31,880
======== ======= ======== ========
</TABLE>
See accompanying notes.
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INTERTRUST TECHNOLOGIES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------
2000 1999
---- ----
(unaudited)
<S> <C> <C>
Operating activities
Net loss...................................................................... $(37,520) $(19,474)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization.............................................. 1,341 395
Amortization of deferred stock compensation and other stock related
compensation charges...................................................... 2,750 920
Amortization of goodwill................................................... 1,845 --
Purchased in-process research and development.............................. 6,100 --
Changes in operating assets and liabilities:
Accounts receivable.................................................... 806 1,000
Prepaid and other current assets....................................... (2,327) (674)
Accounts payable....................................................... 917 1,769
Accrued compensation................................................... 3,294 321
Other accrued liabilities.............................................. (468) 741
Deferred revenue....................................................... 16 465
-------- --------
Net cash used in operating activities.................................... (23,246) (14,537)
Investing activities
Capital expenditures.......................................................... (5,541) (1,880)
Purchases of short-term investments........................................... (38,892) --
Proceeds from sales and maturities of short-term investments.................. 40,856 --
Purchases of long-term investments............................................ (24,237) --
Other noncurrent assets....................................................... (1,232) (96)
-------- --------
Net cash used in investing activities...................................... (29,046) (1,976)
Financing activities
Proceeds from issuance of convertible promissory notes........................ -- 1,000
Proceeds from issuance of preferred stock, net................................ -- 30,411
Proceeds from issuance of common stock, net................................... 96,291 3,526
Proceeds from repayment of notes receivable from stockholders................. 63 --
-------- --------
Net cash provided by financing activities.................................. 96,354 34,937
-------- --------
Net increase in cash and cash equivalents..................................... 44,062 18,424
Cash and cash equivalents at beginning of period.............................. 98,286 5,575
-------- --------
Cash and cash equivalents at end of period.................................... $142,348 $ 23,999
======== ========
Supplemental schedule of noncash financing activities:
Conversion of convertible promissory notes and accrued interest into
convertible preferred stock................................................ $ -- $ 1,039
======== ========
Purchase of Infinite Ink:
======== ========
Issuance of common stock................................................... $ 24,516 $ --
======== ========
Assets acquired............................................................ $ 18 $ --
======== ========
Liabilities assumed........................................................ $ 17 $ --
======== ========
</TABLE>
See accompanying notes.
5
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INTERTRUST TECHNOLOGIES CORPORATION
NOTES TO Condensed CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared by us and reflect all adjustments, consisting only of normal
recurring adjustments, which in the opinion of management are necessary to
present fairly the financial position and the results of operations for the
interim periods. The balance sheet at December 31, 1999 has been derived from
audited financial statements at that date. The financial statements have been
prepared in accordance with the regulations of the Securities and Exchange
Commission, but omit certain information and footnote disclosures necessary to
present the statements in accordance with generally accepted accounting
principles. For further information, refer to the Consolidated Financial
Statements and Notes thereto included in our Annual Report on Form 10K for the
year ended December 31, 1999 filed with the Securities and Exchange Commission
on March 30, 1999 (the "Annual Report"). Results of operations for the three and
nine-month periods ended September 30, 2000 are not necessarily indicative of
operating results for the full year.
Stock Split
On January 27, 2000, our Board of Directors approved a two-for-one stock
split (in the form of a 100% stock dividend) of the company's common stock to
shareholders of record on February 14, 2000. Shares resulting from the split
were distributed by the transfer agent on February 28, 2000. All share and per
share amounts in these consolidated financial statements have been adjusted to
give effect to the stock split.
Net Loss Per Share
Basic and diluted net loss per share is computed using the weighted-average
number of shares of common stock outstanding during the period less shares
subject to repurchase. The following table presents the basic and diluted net
loss per share (in thousands, except per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
<S> <C> <C> <C> <C>
2000 1999 2000 1999
------ ------ ------ ------
(in thousands, except per share data)
Net loss $ (11,052) $ (8,063) $ (37,520) $ (19,474)
========= ========= ========= =========
Basic and diluted:
Weighted-average shares of common stock outstanding 85,718 35,011 83,251 32,482
Less weighted-average shares subject to repurchase (284) (600) (380) (602)
--------- --------- --------- ---------
Weighted-average shares used in computing basic and 85,434 34,411 82,871 31,880
diluted net loss per common share
--------- --------- --------- ---------
Basic and diluted net loss per common share $ (0.13) $ (0.23) $ (0.45) $ (0.61)
========= ========= ========= =========
</TABLE>
We excluded all outstanding convertible preferred stock, warrants, and
stock options from the calculation of diluted net loss per share because all
such securities are antidilutive for all periods presented. The total number of
weighted average shares excluded from the calculations of diluted net loss per
share was 13,230,000 and 13,740,000 for the three months September 30, 2000 and
1999, respectively, and 15,350,000 and 15,126,000 for the nine months ended
September 30, 2000 and 1999, respectively. Warrants and stock options, had they
been dilutive, would have been included in the computation of diluted net loss
per share using the treasury stock method.
6
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Revenue Concentration
Three customers accounted for 20%, 16% and 11% of total revenues in the
third quarter of 2000. Three customers accounted for 27%, 16%, and 16% of total
revenues in the third quarter of 1999. In the nine months of 2000, two customers
accounted for 23% and 22% of total revenues and, in the comparable period of
1999, three customers accounted for 34%, 20% and 15% of total revenues.
International revenues accounted for 49% of total revenues for the first nine
months of 2000 and 66% of the revenues for the comparable period of 1999.
Recent Accounting Pronouncements
In December 1999, the SEC issued Staff Accounting Bulletin No. 101 ("SAB
101"), "Revenue Recognition in Financial Statements". SAB 101 summarizes certain
of the SEC's views in applying generally accepted accounting principles to
revenue recognition in financial statements. We must adopt SAB 101 in the fourth
quarter of fiscal 2000 and are currently evaluating the impact of such adoption,
if any, on the Company's results of operations or financial position.
In March 2000, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 44 (FIN 44), "Accounting for Certain Transactions Involving
Stock Compensation - an interpretation of APB No. 25." FIN 44 clarifies the
application of APB Opinion No. 25 with respect to stock related compensation.
The adoption of FIN 44 on July 1, 2000 did not have a material effect on the
financial postion or results of operations of InterTrust.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which establishes accounting and reporting
standards for derivative instruments, including foreign exchange contracts, and
hedging activities. In June 200, the FASB issued SFAS No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities", which addresses
implementation issues related to SFAS No. 133. SFAS No. 133, as amended, and
SFAS No. 138 are effective for fiscal years beginning after June 15, 2000.
InterTrust will adopt the accounting standards effective January 1, 2001, and is
in the process of analyzing the accounting impact of the standards. At this
time management does not expect that the adoption of SFAS No. 133 and SFAS No.
138 will have a material impact on InterTrust's financial position or results of
operations.
2. PUBLIC STOCK OFFERINGS
In April 2000, we sold 2,645,000 shares of common stock in an underwritten
public offering. The common stock was sold to the public at a purchase price of
$35 per share resulting in net proceeds of approximately $86.5 million, after
underwriting discounts and offering expenses. On May 11, 2000, the underwriters
exercised a part of their over-allotment option to purchase 175,244 additional
shares of common stock from us at an exercise price of $35 per share. Net
proceeds from the exercise of the over-allotment option were approximately $5.8
million after underwriting discounts.
3. INVESTMENTS
In April 2000, we purchased approximately $5 million in preferred stock of
Magex Holdings Limited, a non-public company located in the United Kingdom and
established by National Westminster Bank Plc., for the purpose of digitally
distributing music, video and games via the Internet. The investment represents
less than 5% of the outstanding stock of Magex and will be accounted for on the
cost basis.
In May 2000, we entered into a license agreement with CSTH Holdings, S.A.,
a non-public company located in Luxembourg, in exchange for common stock of the
corporation. We did not recognize revenue from the license agreement as the
company is non-public and there is no liquid market for their stock.
Concurrently, we invested an additional $1 million in a private placement round
that was valued by other third party investors. As a result of these two
transactions, we held approximately 18% of the outstanding shares of CSTH
Holdings at the date of the investment and the investment will be accounted for
on the cost basis.
In June 2000, we invested $500,000 in a private round of financing of Zero
Gravity Technologies Corporation, a licensee of InterTrust. The investment was
valued by other third party investors participating in the
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financing arrangement and will be accounted for on the cost basis. The founder
and chief executive officer is the general partner of one of our stockholders.
In September 2000, we invested $500,000 in a convertible debenture of
Massive Media Group, a non-public company and a licensee of InterTrust. The
note is due at the earlier of one year from the date of issuance or upon the
closing of a private financing round in excess of $10 million. The note carries
an annual interest rate of 10%. We may convert the note at anytime into shares
of the company's common stock in a quantity to be determined by the fair market
value of the stock at the time of conversion. Two of the directors of Massive
Media Group are beneficial owners of our Common Stock.
8
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Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information in this discussion contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Act of 1934, as amended. Such statements are based
upon current expectations that involve risks and uncertainties. Any statements
contained herein that are not statements of historical fact may be deemed to be
forward-looking statements. For example, the words "believes," "anticipates,"
"plans," "expects," "intends" and similar expressions are intended to identify
forward-looking statements. InterTrust's actual results and the timing of
certain events may differ significantly from the results discussed in the
forward-looking statements. Factors that might cause such a discrepancy include,
but are not limited to, those discussed in "Other Factors Affecting Operating
Results, Liquidity and Capital Resources" below, as well as Risk Factors
included in our Registration Statement on Form S-1, as amended, filed with
the Securities and Exchange Commission (File No. 333-32484) on April 6, 2000.
All forward-looking statements in this document are based on information
available to InterTrust as of the date hereof and InterTrust assumes no
obligation to update any such forward-looking statements.
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. The
general availability version of our Commerce software was released to our
partners in December 1998. Most of our partners have conducted or are about to
conduct pilot programs using this software. Some partners began using the
technology on a limited commercial basis in January 2000.
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,
associated software support and training services, and TrustNet clearinghouse
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. Some of our license
agreements relating to uses of our technology within enterprises for privately
managing proprietary data require a per-user fee. We do not expect to recognize
any transaction revenue until the fourth quarter of 2000. Over time, we
anticipate that our revenues will be derived primarily from transaction fees
and, to a significantly lesser extent, from TrustNet clearinghouse services,
initial license fees and software support and training services fees. However,
for the foreseeable future, we expect that our revenues will be primarily
derived from license fees and support services. 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, video, and other markets, including business information and
publications.
We have four basic types of license agreements: commerce service licenses,
business licenses, applications licenses and hardware 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
9
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of agreement. Examples of partner commitments include deploying licensed
products within a specified time frame, exclusively using portions of our
technology, 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 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.
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
license revenue in January 1999, after shipping the general availability version
of our Commerce software at the end of December 1998. At September 30, 2000, we
had approximately $13 million of deferred license revenue that will be
recognized in future periods.
In connection with our strategy to promote widespread deployment of our
software, through September 30, 2000, we have on four occasions received initial
license fees for our Commerce software in the form of minority equity positions
in the licensees. We received approximately 1.7 million shares of common stock
from one licensee, 882,000 shares of common stock from the second licensee,
148,300 shares of common stock from the third licensee, and 579 shares of common
stock from the fourth licensee, which we believe represents approximately 10%,
18%, 5%, and 14% of the outstanding shares of the licensees as of the license
date. Because the entities were recently formed, privately-held companies and we
were unable to obtain sufficient evidence of the fair value of the common stock
of the entities, we did not record revenue or deferred revenue from the license
fees. We are obligated to provide unspecified upgrades and new releases, on a
when and if available basis, to the licensees over a two year period under the
agreements for additional fees. We are not obligated to provide any funding to
the licensees for the development of the licensees' software. In the future, we
may enter into other equity payment arrangements. See Note 3 of Notes to
Condensed Consolidated Financial Statements.
In June 2000, we entered into a core license agreement with America OnLine
(AOL) with license fees of $5 million. Under the agreement, we will also receive
our standard transaction fees that are calculated as a percentage of amounts
paid by users or charged by our partners in commercial transactions and services
that use our technology. Concurrently, we entered into a distribution agreement
whereby AOL committed to distribute our InterRights Point software (technology)
on over 100 million disks, which commenced in October 2000. We agreed to pay AOL
a total of $5.5 million for the distribution program. However, as we are paying
AOL for the distribution program in a concurrent transaction with the software
license transaction and could not establish the fair value of the software
license and distribution program, under current accounting guidance, we did not
give accounting recognition to the non-monetary portion of the transaction.
Therefore, in our financial statements we will not recognize license revenue
under the AOL agreement and will only recognize the $500,000 of expense for the
excess of the distribution costs over the amount of the license fees.
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 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
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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. 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 September 30, 2000. 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 one to 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.
TrustNet clearinghouse revenues represent primarily service fees from our
customers for the use of our TrustNet clearinghouse infrastructure in pilot and
test applications and services. Service revenues generally include consulting
and system integration services provided to the customer to establish an
interface with the TrustNet clearinghouse and monthly service fees to use
TrustNet for the clearing of commercial transactions. Consulting and system
integration fees are recognized as services are performed and monthly service
fees are recognized over the term of the service period.
Through the end of 1998, we were in the development stage and had a limited
number of licensees. In the nine months ended September 30, 2000,
PricewaterhouseCoopers accounted for 23% of total revenues and National Computer
Systems Pte accounted for 22% of total revenues. In the comparable period for
1999, Mitsubishi, a stockholder, accounted for 34% of total revenues, Reciprocal
accounted for 20% of total revenues, and Computacenter accounted for 15% of
total revenues. 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. The market for digital commerce
services and applications has not developed as quickly as anticipated and, as
a result, we might not meet analysts' expectations of our future operating
results. 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.
Results of Operations
Revenues
Total revenues increased to approximately $2,097,000 in the three months
ended September 30, 2000 from approximately $363,000 in the three months ended
September 30, 1999. For the nine months ended September 30, 2000, total revenues
increased to approximately $5,111,000 from approximately $849,000 in the
comparable period of 1999.
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License revenues were approximately $1,188,000 or 57% of total revenues for
the three month period ended September 30, 2000 as compared to $187,000 or 52%
of total revenues in the three month period ended September 30, 1999, and
represent the amortization of deferred license fees. License fees accounted for
54% of total revenues in the nine months ended September 30, 2000 and 58% of
total revenues in the nine months ended September 30, 1999. This increase was
due to license fees from additional partner licensing agreements.
Revenue from software support and training increased to $861,000 in the
three months ended September 30, 2000 from approximately $176,000 in the three
months ended September 30, 1999. Software support and training revenue increased
to approximately $2,153,000 for the nine months ended September 30, 2000 from
approximately $353,000 for the comparable period in 1999. This increase was due
to support and training fees from additional partner licensing agreements.
Software support and training services accounted for 41% and 48% of total
revenues in the three month periods ended September 30, 2000 and 1999,
respectively, and 42% for both the nine month periods ended September 30, 2000
and 1999.
No Trustnet clearinghouse revenue was recognized in the three or nine
months ended September 30, 1999, as the service was not available to our
partners until the end of the third quarter of 1999. Service revenues were
approximately $48,000 and $194,000 for the three and nine month periods ended
September 30, 2000, respectively, and represent consulting and system
integration services and monthly service fees for clearinghouse services.
Clearinghouse fees accounted for 2% of total revenues in the three months ended
September 30, 2000 and 4% of total revenues in the nine months ended September
30, 2000.
Cost of Revenues
Cost of license revenue consists primarily of the costs incurred to
manufacture, package, and distribute our products, related documentation and
purchased technology. Cost of license revenue was approximately $133,000 during
the three months ended September 30, 2000 and approximately $24,000 in the three
months ended September 30, 1999. Cost of license revenue was approximately
$346,000 during the nine months ended September 30, 2000 and approximately
$66,000 in the comparable period in 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 consists primarily of the cost of
personnel, travel related expenditures, and training materials. These
expenditures are incurred both at our facilities as well as at partner
locations. Cost of software support and training revenue increased to
approximately $236,000 for the three months ended September 30, 2000 from
approximately $126,000 for the three months ended September 30, 1999. In the
first nine months of 2000, the cost of software support and training was
approximately $565,000 as compared to approximately $334,000 in the comparable
period for 1999. The increase in cost of software support and training
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.
Cost of clearinghouse services consists primarily of the cost to lease
secure third party web site facilities, related support equipment in order to
provide our partners with a facility to conduct pilot programs, and cost of
personnel to support the site. We established the site during the third quarter
of 1999 and began providing services at the end of the third quarter of 1999.
Clearinghouse service costs incurred to establish and test the site were
approximately $90,000 during the three months ended September 30, 1999. Costs to
operate the site were and $934,000 during the three months ended and September
30, 2000 and $2,291,000 in the nine months ended September 30, 2000.
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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 $6.5
million for the three months ended September 30, 2000 and approximately $ 4.6
million for the three months ended September 30, 1999. In the first nine months
of 2000, research and development spending was approximately $17.4 million as
compared to approximately $11.7 million in the comparable period of 1999. This
increase was primarily attributable to increases in personnel costs and
consultant services associated with both product research and development. 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 to approximately $4.5
million for the three months ended September 30, 2000 from $1.7 million for the
three months ended September 30, 1999. In the first nine months of 2000, sales
and marketing expenses were $12.5 million as compared to $4.2 million in the
comparable period of 1999. The increase in sales and marketing expenses was due
primarily to growth in our sales and marketing organizations, including related
salaries, public relations, promotional costs, and 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 domestic and international offices, and implementation of promotional
programs and co-marketing programs with our partners.
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 to approximately $2.5 million for the three
months ended September 30, 2000 from approximately $1.5 million for the three
months ended September 30, 1999. General and administrative expenses were
approximately $7.0 million for the nine months ended September 30, 2000 and $3.6
million for the comparable period in 1999. These increases were primarily
attributed to increases in our legal and business development personnel and
costs associated with being a public company. 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
information systems necessary to support our growth.
Deferred Stock Compensation
During second half of 1999, we recorded deferred compensation of
approximately $8.3 million, representing the difference between the exercise
price of options granted to employees and the deemed fair value of our common
stock for financial reporting purposes.
Deferred compensation is being amortized over the vesting periods of the
options on a graded vesting method. This compensation expense relates to options
awarded to individuals in all operating expense categories. We recognized
approximately $746,000 of related compensation expense during the three months
ended September 30, 2000 and $625,000 in the comparable period of 1999. We
recognized approximately $2.7 million of related compensation expense during the
nine months ended September 30, 2000 as compared to $820,000 in the nine-month
period ended September 30, 1999. The amortization of deferred compensation will
total approximately $3.5 million for 2000, $1.8 million for 2001, $915,000 for
2002, and $305,000 for 2003.
Purchased In-Process Research and Development and Goodwill Amortization
In March 2000, we acquired Infinite Ink Corporation, a developer of
software solutions for rendering and protecting electronic publishing. Under the
terms of the purchase agreement, we acquired all of the shares of Infinite
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Ink in exchange for 230,462 shares of our common stock with aggregate fair value
of $18.7 million, and assumed stock options exercisable for 68,082 shares of
common stock with an aggregate fair value of $5.8 million. The transaction was
accounted for as a purchase with a total purchase price of $24.5 million. Of
this amount, $6.1 million was expensed in March 2000 as purchased in-process
research and development, $18 million was capitalized as goodwill, and $400,000
was capitalized as the cost of work force in place. The goodwill and work force
are being amortized ratably over their estimated useful lives of five and three
years, respectively. We recognized $922,000 of amortization expense in the three
months ended September 30, 2000 and $1.8 million in the nine months ended
September 30, 2000.
Interest and Other Income (Expense), Net
Interest and other income (expense), net, consists primarily of interest
earned on cash and cash equivalents and immaterial gains and losses from foreign
currency transactions. We recognized approximately $3.3 million of interest
income in the three months ended September 30, 2000 and $279,000 in the three
months ended September 30, 1999. We recognized approximately $8.2 million of
interest income in the nine months ended September 30, 2000 and $481,000 in the
comparable period of 1999. The increase in interest income results primarily
from increases in the amount of interest-bearing investments outstanding.
Liquidity and Capital Resources
As of September 30, 2000 our principal sources of liquidity included
approximately $142.3 million of cash and cash equivalents, $40.4 million in
short-term investments, and $24.3 million in long-term investments. Net cash
used in operating activities totaled $23.2 million in the nine months ended
September 30, 2000. The $23.2 million of cash used in the first nine months of
2000 is primarily attributable to the net loss of $37.5 million and an increase
in prepaid expenses of $2.3 million offset by non-cash charges of $6.1 million
for purchased in-process research and development, $2.8 million of deferred
compensation, $1.8 million of goodwill amortization, and increased accrued
liabilities of $2.8 million. Net cash used in investing activities for the nine
months ended September 30, 2000 of $29.0 million primarily reflects a net
increase of $22.3 million in short- and long-term investments and an investment
of approximately $5.5 million in capital equipment. Net cash provided by
financing activities totaled $96.4 million and represent proceeds of
approximately $92.3 million from our public offering in April 2000, the $4.0
million from the exercise of stock options and issuances under the employee
stock purchase plan in the nine months ended September 30, 2000.
We may also choose to invest in venture capital funds that invest in
companies that may be potential licensees or companies that we believe will
facilitate the deployment of our technology.
We believe that our current cash and cash equivalents will be
sufficient to meet our working capital and capital expenditure requirements for
at least the next 12 months.
Other Factors Affecting Operating Results, Liquidity and Capital Resources
Risk 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 market for digital commerce services and
applications has not developed as quickly as anticipated and, as a result, we
might not meet analysts' expectations of our future operating results. 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.
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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 or failure to license our Commerce software and services to one
or more partners;
. the nature and types of our licensing arrangements;
. expenses related to the issuance of stock to our partners;
. higher than expected operating expenses;
. higher spending on deployment programs;
. non monetary transactions;
. 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.
We are dependent on international sales which subject us to a variety of risks.
We received approximately 49% of our total revenues in the first nine
months of 2000, 71% of our total revenues in 1999, and 34% of our total revenues
in 1998 from sales to customers located outside the United States. Our
international business activities are subject to a variety of risks, including
the adoption and changes of laws, actions by third parties and political and
economic conditions that could restrict or eliminate our ability to do business
in certain jurisdictions. Although we currently transact business in U.S
dollars, if we transact business in foreign currencies in the future, we will
become subject to the risks associated with transacting in foreign currencies,
including potential negative effects of exchange rate fluctuations. To date, we
have not adopted a hedging program to protect from risks associated with foreign
currency fluctuations.
Government regulation and requirements influence our sales internationally.
Current or new government laws and regulations, or the application of existing
laws and regulations including those related to property ownership, content and
taxation, could expose us to significant liabilities, significantly slow our
growth or otherwise seriously harm our business and results of operations.
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 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 derive most of our revenues from the sale of a small number of
licenses. As a result, any delay in the recognition of revenue from a license
would have a material adverse effect on our results of operations for subsequent
accounting periods. We have experienced operating losses in each quarterly and
annual period since inception, and we expect to incur
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significant and increasing losses in the future. We incurred net losses of $11.7
million in 1997, $19.7 million in 1998, $28.6 million in 1999, and $37.5 million
for the nine months ending September 30, 2000. 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 foreseeable future.
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. As of September 30, 2000, only 53 companies have licensed our
software for commercial use. As of September 2000, only four companies have
commercially deployed our technology and that has been in a limited manner. 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
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.
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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 recently released version 1.3 in July 2000. Our licensees'
applications and services based on our Commerce software are in development or
have only been released for evaluation in very limited pilot programs. Some of
our licensees have recently begun commercial deployment of 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.
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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 will 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.
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.
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 Adobe, AT&T,
IBM, Microsoft, Liquid Audio, Preview Systems, and Content Guard;
. providers of hardware-based content metering and copy protection
systems, including Sony 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.
Any acquisitions that we make could disrupt our business and harm our
operating results.
We may acquire or make investments in complementary companies, products or
technologies. In the event of any such investments, acquisitions or joint
ventures we could:
. issue stock that would dilute our current stockholders' percentage
ownership;
. incur debt;
. assume liabilities;
. incur amoritization expenses related to goodwill and other intangible
assets; or
. incur large and immediate write-offs.
These investments, acquisitions or joint ventures also involve
numerous risks, including:
. problems combining the purchased operations, technologies or products
with ours;
. unanticipated costs;
. division of managements' attention from our core business;
. adverse effects on existing business relationships with suppliers and
customers;
. potential loss of key employees, particularly those of the acquired
organizations; and
. reliance to our disadvantage on the judgement and decisions of third
parties and lack of control over the operations of a joint venture
partner.
Any acquisition or joint venture may cause our financial results to
suffer as a result of these risks.
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, 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
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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. If we lose 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. We have recently hired many key personnel, including our president
and our chief financial officer. Our ability to effectively execute our
strategies will depend in part upon our ability to integrate new personnel into
our operations. Further, 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.
Although we provide compensation packages that include stock options, cash
incentives, and other employee benefits, the volatility and current market price
of our stock may make it difficult for us to attract, assimilate, and retain
highly qualified employees.
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 approximately 246 employees
at September 30, 2000. To be successful, we will need to implement additional
management information systems, improve our operating, administrative, financial
and accounting 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, or
develops more slowly than expected, 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.
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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 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. There is uncertainty in the market as to the best way to
offer music digitally. For example, there are a number different software
formats available and it is possible that not all music will play on the same
devices. Consumer acceptance of digital delivery of music depends upon the
ability of the various software formats to work together. 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.
21
<PAGE>
Item 3. Qualitative and Quantitative Disclosures about Market Risk
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, 1999 and
September 30, 2000, our cash and cash equivalents consisted primarily of demand
deposits and money market funds held by two large institutions in the United
States.
22
<PAGE>
PART II. OTHER INFORMATION
INTERTRUST TECHNOLOGIES CORPORATION
Item 1. Legal Proceedings.
None.
Item 2. Changes in Securities and Use of Proceeds.
(a) Modification of Constituent Instruments.
On January 27, 2000, our Board of Directors approved a two-for-one stock
split (in the form of a 100% stock dividend) of the company's common stock to
stockholders of record on February 14, 2000.
(b) Changes in Rights.
None.
(c) Issuances of Securities.
None.
(d) Use of Proceeds
On April 12, 2000 we completed a secondary offering in which we sold
2,645,000 shares of common stock at $35 per share. In addition, we sold 175,244
shares of common stock at $35 per share in connection with the exercise of the
underwriters' over-allotment option. The total aggregate proceeds from these
transactions were $98.7 million. Underwriters' discounts and other related costs
were approximately $6.1 resulting in net proceeds $92.6 million. On November 1,
1999, we completed our initial public offering, in which we sold 13,000,000
shares of common stock at $9 per share. Additionally, we sold 1,950,000 shares
of common stock at $9 per share in connection with the exercise of the
underwriters' over-allotment option. The total aggregate proceeds from these
transactions were $134.6 million. Underwriters' discounts and other related
costs were approximately $11.2 resulting in net proceeds $123.4 million. The net
proceeds were predominantly held in cash, cash equivalents and short-term
investments at September 30, 2000.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
The Annual Meeting of Stockholders of InterTrust Technologies Corporation
was held on September 26, 2000 in Santa Clara, California. Of the total of
86,180,198 shares outstanding as of the record date, 57,528,080 shares (66.75%)
were present or represented by proxy at the meeting. The table below presents
the voting results of election of our Board of Directors:
VOTES FOR VOTES WITHHELD
--------- --------------
Victor Shear 56,729,237 798,843
David C. Chance 56,615,783 912,297
Edmund J. Fish 55,198,423 2,329,657
Bruce Fredrickson 56,308,041 1,220,039
Satish Gupta 56,629,731 898,349
The stockholders also approved the appointment of Ernst & Young LLP as our
independent auditors. The proposal received 57,478,921 affirmative votes, 28,925
negative votes and 20,234 abstentions.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibit
No. Description
--- -----------
3.1 Sixth Amended and Restated Certificate of Incorporation filed
with the Secretary of State of
23
<PAGE>
Exhibit
No. Description
--- -----------
Delaware on November 1, 1999 --incorporated herein by reference
to Exhibit 3.2 to the Registrant's Registration Statement on
Form S-1 (File No. 333-84033).
3.2 Amended and Restated Bylaws of the Registrant.
4.1 Reference is made to Exhibits 3.1 and 3.2.
4.2* Form of Registrant's Common Stock certificate.
4.3* Form of Registration Rights under select Convertible Promissory
Notes.
4.4* Form of Registration Rights under select Class A Common Stock
Purchase Agreements.
4.5* Form of Series A Preferred Stock Registration Rights.
4.6* Form of Series B, C, D and E Preferred Stock Registration
Rights.
4.7* Form of Registration Rights found in a Class B Non-Voting
Common Stock Warrant.
10.1* Form of Indemnification Agreement entered into by the
Registrant with each of its directors and executive officers.
10.2* 1999 Equity Incentive Plan and forms of agreements thereunder
10.3* 1999 Employee Stock Purchase Plan.
10.4* 1999 Non-Employee Directors Option Plan.
10.5 Lease between Mission West Properties, L.P. and the Registrant
dated July 21, 1999 --incorporated herein by reference to
Exhibit 10.11 to the Registrant's Registration Statement on
Form S-1 (File No. 333-84033).
10.6+ Technology Development, Marketing, and License Agreement by and
between the Registrant and National Westminster Bank PLC dated
August 18, 1998 -- incorporated herein by reference to Exhibit
10.12 to the Registrant's Registration Statement on Form S-1
(File No. 333-84033).
10.7+ Technology Development and License Agreement by and between the
Registrant and Universal Music Group, Inc. dated April 13,
1999 -- incorporated herein by reference to Exhibit 10.13 to
the Registrant's Registration Statement on Form S-1 (File No.
333-84033).
10.8+ Technology Development and License Agreement by and between the
Registrant and Upgrade Corporation of America dated August 7,
1996 -- incorporated herein by reference to Exhibit 10.14 to
the Registrant's Registration Statement on Form S-1 (File No.
333-84033).
10.9+ Technology Development and License Agreement by and between the
Registrant and Mitsubishi Corporation dated October 7, 1996 --
incorporated herein by reference to Exhibit 10.15 to the
Registrant's Registration Statement on Form S-1 (File No. 333-
84033).
10.10 Warrant for the purchase of Class A Voting Common Stock made by
the Registrant and held by Allen & Company Incorporated dated
September 7, 1999 -- incorporated herein by reference to
Exhibit 10.16 to the Registrant's Registration Statement on
Form S-1 (File No. 333-84033).
10.11 Amendment to Technology, Development, Marketing and License
Agreement by and between the Registrant and National
Westminster Bank dated August 18, 1998 -- incorporated herein
by reference to Exhibit 10.17 to the Registrant's Registration
Statement on Form S-1 (File No. 333-84033).
10.12 Amendment to Technology Development and License Agreement by
and between the Registrant and Universal Music Group, Inc.
dated April 13, 1999 -- incorporated herein by reference to
Exhibit 10.18 to the Registrant's Registration Statement on
Form S-1 (File No. 333-84033).
10.19** Building Lease Agreement by and between First State Realty of
America, Inc. and the Registrant dated January 24, 2000.
10.20 Employment agreement by and between the Company and David
Ludvigson dated August 4, 2000.
27.1 Financial Data Schedule.
_______________
* Incorporated herein by reference to the exhibit of the same number in the
Registrant's Registration Statement on Form S-1 (File No. 333-84033).
24
<PAGE>
** Incorporated herein by reference to the exhibit of the same number in the
Registrant's Registration Statement on Form S-1 (File No. 333-32484).
+ Confidential treatment requested.
(b) Reports on Form 8-K.
None
25
<PAGE>
INTERTRUST TECHNOLOGIES CORPORATION
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTERTRUST TECHNOLOGIES CORPORATION
By: /s/ Victor Shear
---------------------------------------
Victor Shear
Chairman of the Board and Chief
Executive Officer
(Principal Executive Officer)
Date: November 13, 2000 By: /s/ David Ludvigson
---------------------------------------
David Ludvigson
President
(Interim Principal Financial &
Accounting Officer)
26
<PAGE>
EXHIBIT INDEX
Exhibit
No. Description
--- -----------
3.1 Sixth Amended and Restated Certificate of Incorporation filed
with the Secretary of State of Delaware on November 1, 1999 --
incorporated herein by reference to Exhibit 3.2 to the
Registrant's Registration Statement on Form S-1 (File No. 333-
84033).
3.2 Amended and Restated Bylaws of the Registrant.
4.1 Reference is made to Exhibits 3.1 and 3.2.
4.2* Form of Registrant's Common Stock certificate.
4.3* Form of Registration Rights under select Convertible Promissory
Notes.
4.4* Form of Registration Rights under select Class A Common Stock
Purchase Agreements.
4.5* Form of Series A Preferred Stock Registration Rights.
4.6* Form of Series B, C, D and E Preferred Stock Registration
Rights.
4.7* Form of Registration Rights found in a Class B Non-Voting
Common Stock Warrant.
10.1* Form of Indemnification Agreement entered into by the
Registrant with each of its directors and executive officers.
10.2* 1999 Equity Incentive Plan and forms of agreements thereunder
10.3* 1999 Employee Stock Purchase Plan.
10.4* 1999 Non-Employee Directors Option Plan.
10.5 Lease between Mission West Properties, L.P. and the Registrant
dated July 21, 1999 --incorporated herein by reference to
Exhibit 10.11 to the Registrant's Registration Statement on
Form S-1 (File No. 333-84033).
10.6+ Technology Development, Marketing, and License Agreement by and
between the Registrant and National Westminster Bank PLC dated
August 18, 1998 -- incorporated herein by reference to Exhibit
10.12 to the Registrant's Registration Statement on Form S-1
(File No. 333-84033).
10.7+ Technology Development and License Agreement by and between the
Registrant and Universal Music Group, Inc. dated April 13,
1999 --incorporated herein by reference to Exhibit 10.13 to the
Registrant's Registration Statement on Form S-1 (File No. 333-
84033).
10.8+ Technology Development and License Agreement by and between the
Registrant and Upgrade Corporation of America dated August 7,
1996 -- incorporated herein by reference to Exhibit 10.14 to
the Registrant's Registration Statement on Form S-1 (File No.
333-84033).
10.9+ Technology Development and License Agreement by and between the
Registrant and Mitsubishi Corporation dated October 7, 1996 --
incorporated herein by reference to Exhibit 10.15 to the
Registrant's Registration Statement on Form S-1 (File No. 333-
84033).
10.10 Warrant for the purchase of Class A Voting Common Stock made by
the Registrant and held by Allen & Company Incorporated dated
September 7, 1999 -- incorporated herein by reference to
Exhibit 10.16 to the Registrant's Registration Statement on
Form S-1 (File No. 333-84033).
10.11 Amendment to Technology, Development, Marketing and License
Agreement by and between the Registrant and National
Westminster Bank dated August 18, 1998 -- incorporated herein
by reference to Exhibit 10.17 to the Registrant's Registration
Statement on Form S-1 (File No. 333-84033).
10.12 Amendment to Technology Development and License Agreement by
and between the Registrant and Universal Music Group, Inc.
dated April 13, 1999 -- incorporated herein by reference to
Exhibit 10.18 to the Registrant's Registration Statement on
Form S-1 (File No. 333-84033).
10.19** Building Lease Agreement by and between First State Realty of
America, Inc. and the Registrant dated January 24, 2000.
10.20 Employment agreement by and between the Company and David
Ludvigson dated August 4, 2000.
27.1 Financial Data Schedule.
_______________
* Incorporated herein by reference to the exhibit of the same number in the
Registrant's Registration Statement on Form S-1 (File No. 333-84033).
** Incorporated herein by reference to the exhibit of the same number in the
Registrant's Registration Statement on Form S-1 (File No. 333-32484).
+ Confidential treatment requested.
27
