10-Q 1 d10q.txt FORM 10-Q FOR PERIOD ENDED 3/31/2001 ================================================================================ 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 March 31, 2001 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 May 15, 2001 was 93,887,083. ================================================================================ INTERTRUST TECHNOLOGIES CORPORATION INDEX Page No. ------- Part I. Financial Information 3 Item 1. Condensed Consolidated Balance Sheets as of March 31, 2001 and December 31, 2000 3 Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2001 and 2000 4 Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2001 and 2000 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 Item 3. Qualitative and Quantitative Disclosures About Market Risk 22 Part II. Other Information 23 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 24 Item 6. Exhibits and Reports on Form 8-K 24 Exhibit Index 24 Signature 26 PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements INTERTRUST TECHNOLOGIES CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except per share data)
March 31, December 31, 2001 2000 ---- ---- (unaudited) (Note 1) ASSETS Current assets: Cash and cash equivalents $ 23,513 $ 23,811 Short-term investments 124,625 134,707 Accounts receivable, net of allowance of $1,029 in 2001 and $178 in 2000 3,126 3,928 Other current assets 3,509 2,771 --------- ---------- Total current assets 154,773 165,217 Property and equipment, net 10,950 8,919 Restricted long-term investment 944 944 Long-term investments 26,766 16,783 Goodwill and other intangible assets, net 39,216 29,453 Other assets 5,914 5,557 --------- ---------- $ 238,563 $ 226,873 ========= ========== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable $ 2,089 $ 2,728 Accrued compensation 2,955 2,155 Other accrued liabilities 3,378 1,110 Deferred revenue 4,536 5,915 --------- ---------- Total current liabilities 12,958 11,908 Deferred revenue--long-term portion 7,948 7,617 Other long-term liabilities 2,008 -- --------- ---------- Commitments -- -- Stockholders' equity: Common stock, $0.001 par value, 120,000,000 authorized 93,670,545 and 79,216,996 issued and outstanding at March 31, 2001 and 2000 119 88 Additional paid-in capital 372,635 340,380 Deferred stock compensation (5,873) (3,274) Notes receivable from stockholders (475) (516) Accumulated other comprehensive income 544 376 Accumulated deficit (151,301) (129,706) --------- -------------------- Total stockholders' equity 215,649 207,348 --------- -------------------- $ 238,563 $ 226,873 ========= ====================
See accompanying notes. 3 INTERTRUST TECHNOLOGIES CORPORATION CONSOLIDATED STATEMENT OF OPERATIONS (in thousands, except share and per share amounts) (unaudited)
Three Months Ended March 31, ------------------------------------- 2001 2000 ---- ---- Revenues: Licenses $ 1,387 $ 687 Software support and training 730 660 Services 276 - Hardware 12 - -------- -------- Total revenues 2,405 1,347 Cost of revenues: Licenses 137 103 Software support and training 438 147 Services 1,915 643 Hardware 417 - -------- -------- Total cost of revenues 2,907 893 -------- -------- Gross (loss) profit (502) 454 Operating costs and expenses: Research and development 9,391 5,201 Sales and marketing 7,610 3,657 General and administrative 3,946 2,228 Purchased in-process research and development - 6,100 Amortization of goodwill and other intangible assets 2,193 - Amortization of deferred compensation 723 1,006 -------- -------- Total operating costs and expenses 23,863 18,192 -------- -------- Loss from operations (24,365) (17,738) Interest and other income, net 2,770 2,112 -------- -------- Net loss $(21,595) $(15,626) ======== ======== Basic and diluted net loss per share $ (0.24) $ (0.20) ======== ======== Shares used in computing basic and diluted net loss per share 91,485 78,931 ======== ========
See accompanying notes. 4 INTERTRUST TECHNOLOGIES CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)
Three Months Ended March 31, ------------------------------- 2001 2000 ---- ---- Operating activities Net loss $(21,595) $(15,626) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization of property and equipment 824 380 Amortization of goodwill and other intangible assets 2,331 - Amortization of deferred stock compensation 723 1,026 Compensation expense related to forgiveness of notes receivable from stockholders 41 - Gain from sales of long-term investments (93) - Purchased in-process research and development - 6,100 Changes in operating assets and liabilities Accounts receivable 807 1,322 Other current assets (586) (1,044) Accounts payable (1,019) 286 Accrued compensation 800 (7) Other accrued liabilities (301) 975 Deferred revenue (1,048) (336) -------- -------- Net cash used in operating activities (19,116) (6,924) Investing activities Capital expenditures (1,887) (1,052) Business acquisition, net of cash acquired 53 - Purchases of short-term investments (24,051) (25,270) Sales and maturities of short-term investments 34,300 40,855 Purchases of long-term investments (34,448) (19,591) Sales and maturities of long-term investments 24,559 - Issuance of note receivable (435) - Other noncurrent assets, net (58) (379) -------- -------- Net cash used in investing activities (1,967) (5,437) Financing activities Proceeds from issuance of common stock, net 19,963 876 Proceeds from exercise of stock options and warrants 822 - -------- -------- Net cash provided by financing activities 20,785 876 Net decrease in cash and cash equivalents (298) (11,485) Cash and cash equivalents at beginning of period 23,811 98,286 -------- -------- Cash and cash equivalents at end of period $ 23,513 $ 86,801 ======== ======== Supplemental schedule of noncash investing and financing activities: Purchase of Publish One Issuance of common stock and options $ 11,501 $ - ======== ======== Tangible assets acquired, net of cash received $ 1,529 $ - ======== ======== Goodwill and other intangible assets acquired $ 11,988 $ - ======== ======== Liability assumed $ 5,392 $ - ======== ======== Deferred stock compensation $ 3,323 $ - ======== ======== Purchase of Infinite Ink Issuance of common stock $ - $ 24,516 ======== ======== Assets acquired $ - $ 18 ======== ======== Liabilities assumed $ - $ 17 ======== ========
See accompanying notes. 5 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, 2000 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, 2000 filed with the Securities and Exchange Commission on April 2, 2001 (the "Annual Report"). Results of operations for the three month period ended March 31, 2001 are not necessarily indicative of operating results for the full year. 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):
THREE MONTHS ENDED MARCH 31, --------------------------------------- 2001 2000 ----------------- ---------------- Net loss $(21,595) $(15,626) ================= ================ Basic and diluted: Weighted-average shares of common stock outstanding 91,553 79,468 Less weighted-average shares subject to repurchase (68) (537) ----------------- ---------------- Weighted-average shares used in computing basic and 91,485 78,931 diluted net loss per common share ----------------- ---------------- Basic and diluted net loss per common share $ (0.24) $ (0.21) ================= ================
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 5,116,000 and 15,507,000 for the three months March 31, 2001 and 2000, 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. Revenue Concentration Three customers accounted for 18%, 19% and 9% of total revenues in the first quarter of 2001. Three customers accounted for 28%, 22%, and 20% of total revenues in the first quarter of 2000. International revenues accounted for 54% of total revenues for the first three months of 2001 and 57% of the revenues for the comparable period of 2000. Recent Accounting Pronouncements 6 On January 1, 2001, we adopted 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. Because we currently hold no derivative financial instruments and do not currently engage in hedging activities, the adoption of SFAS 133 did not have a material impact on our financial position or results or operations. 2. BUSINESS COMBINATIONS On January 30, 2001, the Company acquired the remaining 92.1% of the outstanding shares and all of the outstanding options of PublishOne, Inc. ("PublishOne"), a privately-held company that develops online publishing software solutions and distribution services for business information publishers. Prior to the acquisition date, the Company owned approximately 7.9% of PublishOne's outstanding stock. The transaction was accounted for as a purchase and the results of PublishOne's operations have been included in the condensed consolidated financial statements from the date of acquisition. The purchase price was $16.9 million and consisted of 1,130,00 shares of InterTrust common stock at a fair value of $5.31 per share, the assumption of options to purchase 1,155,221 shares of InterTrust common stock at a fair value of $4.84 per share, assumed liabilities of $5.2 million, and acquisition costs of approximately $250,000. Additionally, the agreement includes contingent consideration of 320,000 shares of InterTrust common stock to be issued upon the achievement of certain milestones. As of March 31, 2001, no milestones have been met. The Company allocated PublishOne's purchase price based on the relative fair value of the net tangible and intangible assets acquired. No amount was allocated to in-process research and development. The purchase price was allocated based on an independent valuation to tangible and intangible assets as follows (in thousands): Tangible assets $ 1,581 Purchased technology 1,671 Acquired workforce 1,452 Other intangible assets 610 Deferred compensation 3,323 Goodwill 8,255 ------- $16,892 Goodwill, purchased technology and other intangibles are being amortized on a straight-line basis over four years. The acquired workforce is being amortized on a straight-line basis over two years. The fair value of the unvested common stock subject to restricted stock agreements and the intrinsic value of the unvested options held by PublishOne employees was allocated to deferred stock compensation. The deferred stock compensation will be amortized to compensation expense over the remaining vesting term using a graded method. 7 The following pro forma data summarizes the results of operations for the periods indicated as if PublishOne had been completed as of the beginning of the periods presented. The pro forma data gives effect to actual operating results prior to the acquisition. No effect has been given to cost reductions or operating synergies in this presentation. Prior to the acquisition, PublishOne was a customer of InterTrust. The pro forma amounts exclude revenues and expenses recognized in transactions between PublishOne and InterTrust. These pro forma amounts do not purport to be indicative of the results that would have actually been obtained if the acquisition had occurred as of the beginning of the periods presented or that may be obtained in the future. Pro forma results for the three months ended March 31, 2001 and 2000 are as follows (in thousands, except per share amounts): Three Months Ended ------------------ March 31, --------- 2001 2000 ---- ---- Revenues 2,408 1,322 Net loss $(22,509) $(16,504) Net loss per share - basic and diluted $ (0.25) $ (0.21) 3. SALE OF SECURITIES In January 2001, InterTrust sold 4,000,000 shares of common stock at $5.00 per share to Nokia Finance International B.V, a subsidiary of Nokia Corporation ("Nokia"), for total cash consideration of $20,000,000. In connection with its investment, Nokia agreed to license InterTrust DRM solutions and select InterTrust as its preferred DRM technology. Additionally per agreement, InterTrust has appointed an executive officer of Nokia to the InterTrust Board of Directors. 4. COMPREHENSIVE INCOME Total comprehensive income was $168,000 and $355,000 for the three months ended March 31, 2001 and 2000, respectively. 5. SUBSEQUENT EVENTS On April 30, 2001, we announced plans to reduce our current operating expense levels by approximately 15%. The plan provides for the reduction of about 50 employees and reductions in other discretionary spending. The company will record a restructuring charge in the quarter ending June 30, 2001. On April 26, 2001, we filed a patent infringement complaint against Microsoft Corporation in the United States District Court for the Northern District of California. In the complaint, we have alleged that certain of Microsoft's products infringe our United States Patent No. 6,185,683 and we are seeking an injunction in addition to monetary damages. 8 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. 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. As a result, we were considered a development stage enterprise during this period. The general availability version of our Commerce software was not delivered to our partners until December 1998. Some partners began using the technology on a limited commercial basis in January 2000. We license our DRM platform and software 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 our revenues from initial license fees, associated software support and training services, TrustNet clearinghouse services and professional 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. Within the next several years, we anticipate that a significant portion of our revenues will be derived primarily from transaction fees and from license fees associated with the license of products that we are developing. Any future transaction fees are dependent on the success of our licensees and their customers in commercially deploying services and applications. 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 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. In connection with our strategy to promote widespread use of our technology, through March 31, 2001, we have on four occasions received initial license fees for our Commerce software in the form of minority equity positions in the licensees. Additionally, on five occasions we received initial license fees in the form of convertible promissory notes. In the future, we may enter into other equity payment arrangements. 9 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 custom development deliverable and do not have vendor specific objective evidence of fair value of the specified deliverable, all of the license revenue is deferred until the specified upgrade has been delivered. Upon delivery of the specified deliverable, 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 March 31, 2001, we had approximately $12.5 million of deferred license revenue that will be recognized in future periods. Through March 31, 2001, on four occasions we received license fees in the form of minority equity positions in non-public entities. On five occasions we received license fees in the form of convertible promissory notes from non- public entities in exchange for technology licenses. One of these convertible promissory notes was already converted into 125,000 shares of common stock, which we believe represented approximately 1% of the outstanding shares of the licensee as of the conversion date. Because the entities were recently formed, privately held companies, and InterTrust was unable to obtain sufficient evidence of the fair value of the common stock of the entity or sufficient evidence of the fair value of the convertible promissory notes and collectibility was not probable, InterTrust did not record revenue or deferred revenue from the license fees. InterTrust is obligated to provide unspecified upgrades and new releases, on a when and if available basis, to the licensees over a one to two year period under the agreements for additional fees. InterTrust is not obligated to provide any funding to any licensee for the development of the licensee's 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. 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 March 31, 2001. 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 material 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. TrustNet clearinghouse service 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. 10 Professional services represent fees for consulting services provided to our customers for development and system integration not essential to the functionality of the software licensed. The revenue from these services is recognized as services are performed. PricewaterhouseCoopers, National Computer Systems of Singapore, and Magex accounted for 18%, 19% and 8% of total revenues respectively, for the three months ended March 31, 2001. PricewaterhouseCoopers, National Computer Systems of Singapore, and Bertelsmann accounted for 28%, 22%, and 20% of total revenues, respectively, in the comparable period for 2000. 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 has not succeeded in generating sufficient revenue to sustain 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 substantially increase in future quarters. 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. We expect to incur additional losses for at least the next several years. On January 30, 2001, the Company acquired the remaining 92.1% of the outstanding shares and all of the outstanding options of PublishOne, Inc. ("PublishOne"), a privately-held company that develops online publishing software solutions and distribution services for business information publishers. Prior to the acquisition date, the Company owned approximately 7.9% of PublishOne's outstanding stock. The transaction was accounted for as a purchase and the results of PublishOne's operations have been included in the condensed consolidated financial statements from the date of acquisition. The purchase price was $16.9 million and consisted of 1,130,00 shares of InterTrust common stock at a fair value of $5.31 per share, the assumption of options to purchase 1,155,221 shares of InterTrust common stock at a fair value of $4.84 per share, assumed liabilities of $5.2 million, and acquisition costs of approximately $250,000. Additionally, the agreement includes contingent consideration of 320,000 shares of InterTrust common stock to be issued upon the achievement of certain milestones. As of March 31, 2001, no milestones have been met. The Company allocated PublishOne's purchase price based on the relative fair value of the net tangible and intangible assets acquired. No amount was allocated to in-process research and development. The purchase price was allocated based on an independent valuation to tangible and intangible assets as follows (in thousands): Tangible assets $ 1,581 Purchased technology 1,671 Acquired workforce 1,452 Other intangible assets 610 Deferred compensation 3,323 Goodwill 8,255 ------- $16,892 Goodwill, purchased technology and other intangibles are being amortized on a straight-line basis over four years. The acquired workforce is being amortized on a straight-line basis over two years. The fair value of the unvested common stock subject to restricted stock agreements and the intrinsic value of the unvested options held by employees was allocated to deferred stock compensation. The deferred stock compensation will be amortized to compensation expense over the remaining vesting term using a graded method. Results of Operations 11 Revenues Total revenues increased to approximately $2.4 million in the three months ended March 31, 2001 from approximately $1.3 million in the comparable period of 2000. License revenues were approximately $1.4 million or 58% of total revenues for the three months ended March 31, 2001 as compared to $687,000 or 51% of total revenues in the three months ended March 31, 2000, and represent the amortization of deferred license fees. This increase was due to license fees fromnew licensing agreements. Revenue from software support and training increased to $730,000 in the three months ended March 31, 2001 from approximately $660,000 in the three months ended March 31, 2000. This increase was due to support and training fees from new support agreements. Software support and training services accounted for 30% and 49% of total revenues in the three months ended March 31, 2001 and 2000, respectively. Services revenues were approximately $276,000 for the three months ended March 31, 2001, and no services revenues were recognized in the three months ended March 31, 2000. Services revenues represents monthly service fees for TrustNet clearinghouse services, transaction royalties, consulting and system integration services. Services revenues accounted for 11% of total revenues in the three months ended March 31, 2001. Hardware revenue was approximately $12,000 for the three months ended March 31, 2001. This revenue was the result from chips sold to one customer under the terms of a short-term purchase agreement to provide chips for testing and trial production. No hardware revenue was recognized in the three months ended March 31, 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 $137,000 during the three months ended March 31, 2001 and approximately $103,000 in the three months ended March 31, 2000. Cost of license revenue is expected to 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 $438,000 for the three months ended March 31, 2001 from approximately $147,000 for the three months ended March 31, 2000. The increase in cost of software support and training represents the increase in support personnel required to provide technical assistance and training to a greater number of partners. Software support and training services costs are expected to vary from period to period depending on the support requirements of our partners. Cost of services consists primarily of the outside services, personnel, and equipment to operate our clearinghouse, as well as personnel costs to provide professional services. Costs of services were approximately $1,915,000 during the three months ended March 31, 2001. Cost of services were approximately $643,000 during the three months ended March 31, 2000. This increase is primarily attributable to investment in clearinghouse infrastructure and personnel. Cost of hardware was approximately $417,000 for the three months ended March 31, 2001. These costs are related to the purchase of chips from a third party, customization, transport of the chips. During the three months ended March 31, 2001, the cost includes a reserve for inventory due to cancellation of the supply agreement with our customer. There were no hardware costs for the three months ended March 31, 2000. 12 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 $9.4 million for the three months ended March 31, 2001 and approximately $ 5.2 million for the three months ended March 31, 2000. This increase was primarily attributable to increases in personnel costs, recent business acquisitions, 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 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 $7.6 million for the three months ended March 31, 2001 from $3.7 million for the three months ended March 31, 2000. The increase in sales and marketing expenses was due primarily to an increase in sales and marketing personnel, and to a lesser extent, public relations, promotional costs, and travel costs. We expect sales and marketing expense to vary in future periods based upon the implementation of marketing and promotional programs related to the release of new products. 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 $4.0 million for the three months ended March 31, 2001 from approximately $2.2 million for the three months ended March 31, 2000. The increase was primarily attributed to increases in legal expenses, business development personnel, costs associated with being a public company, and bad debt expense. We expect general and administrative expenses to increase as a result of litigation costs related to a claim of patent infringement we filed against Microsoft in April 2001 (see further discussion in Risk Related to Our Business). Amortization of Goodwill and Other Intangible Assets Amortization of goodwill and other intangible assets was $2.2 million for the three months ended March 31, 2001; there was no amortization of goodwill and other intangible assets for the three months ended March 31, 2000. Amortization of goodwill and intangible assets is related to the business acquisitions in 2000 and 2001. Deferred Stock Compensation Deferred compensation represents the difference between the exercise price of options granted to employees and the deemed fair value of our common stock for financial reporting purposes. Additionally, in conjunction with the acquisition of PublishOne, the fair value of the unvested common stock subject to restricted stock agreements and the intrinsic value of the unvested options held by PublishOne employees was allocated to deferred stock compensation. 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 $723,000 of such compensation expense during the three months ended March 31, 2001 and $ 1 million in the comparable period of 2000. Interest and Other Income, net Interest and other income consists primarily of interest earned on cash and cash equivalents, short and long-term investments. Interest and other income increased to $2.8 million during the three months ended March 31, 2001 from $2.1 million in the comparable period in 2000 due to higher cash and investment balances. Liquidity and Capital Resources 13 Cash, cash equivalents and marketable and restricted investments totaled $175.8 million at March 31, 2001, a decrease of $500,000 from December 2000. The change during the three months ended March 31, 2001 is primarily attributable to $20.0 million of cash generated from the sale of 4.0 million shares to Nokia Finance International B.V., a subsidiary of Nokia Corporation, in January 2001 and from proceeds from the exercise of employee stock options and employee stock purchases, offset by our net loss for the quarter of $21.6 million. Net cash used in operating activities totaled $19.1 million in the three months ended March 31, 2001. The cash used the quarter is primarily attributable to the net loss of $21.6 million, partially offset by various non-cash charges such as depreciation and amortization of $800,000, amortization of goodwill and other intangible assets of $2.3 million, and stock related compensation of $700,000. Net cash used in investing activities totaled $2.0 million in the three months ended March 31, 2001. The cash used in 2000 is primarily attributable to capital expenditures totaling $1.9 million. Capital acquisitions were principally comprised of computer equipment and software used to support our product development and growing employee base. Net cash provided by financing activities was $20.8 million for 2001, due to cash generated from issuing common stock to Nokia Finance International B.V., a susidiary of Nokia Corporation and, to a lesser extant, from the exercise of employee stock options. At March 31, 2001, our principal source of liquidity was $175.8 million in cash and cash equivalents and marketable and restricted investments. We believe that our cash and cash equivalents will be sufficient to meet our working capital needs for at least the next 12 months. In the future, 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. Other Factors Affecting Operating Results, Liquidity and Capital Resources In addition to the other information in this report, the following risk factors should be considered carefully in evaluating our business and us: 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 partly upon our ability to generate transaction fees in the form of a percentage of fees charged by our licensees in commercial transactions. However, some of our licensees have just begun using our technology in the commercial distribution of their products and we have not earned any material transaction fees under this business model. 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, may 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. 14 Our operating results have varied from period to period and, in some future quarter or quarters, may 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: . the inability of our licensees and their customers to commercialize our technology, or delays or deferrals in this commercialization; . the inability of our licensees to pay our license and other fees; . our inability to develop or commercialize our technology to meet our customers' requirements on a timely basis; . a decline in the demand for digital goods and services; . a decline in the demand for our Commerce or Rights/System software products; . 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; . expenses related to the issuance of stock to our partners; . higher than expected operating expenses, including expenses related to the patent infringement litigation we recently initiated against Microsoft; . higher spending on deployment programs; 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 54% of our total revenues in the three months ended March 31, 2001, 45% of our total revenues in 2000 and 61% of our total revenues in 1999 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 we or 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 we or 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 significant and increasing losses in the future. We incurred net losses of $21.6 million for the three months ended March 31, 2001, $55.6 million for the year ended December 31, 2000 and $28.6 million for the year-ended December 31, 1999. We expect to continue to have significant research and development, sales and marketing, and general and 15 administrative expenses. In addition, we expect to incur significant expenses related to the patent litigation we recently initiated against Microsoft. As a result of these 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 March 31, 2001, only 64 companies have licensed our software for commercial use. As of March 31, 2001, approximately 27 companies have been involved in the limited commercial deployment of our technology. 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. 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. Our operating results could be harmed if our licensees or potential licensees suffer from downward economic cycles. Our ability to license our technology depends on the economic strength and budgetary cycles of potential licensees. Many of our licensees are Internet- related and start-up companies that currently face unfavorable market conditions and budgetary pressures. Some of our licensees might default on their payment obligations to us. This may be disruptive to our business and may adversely affect our business, financial condition and results of operations. The long and complex process of licensing our Commerce and other software and hardware products could delay the deployment of our technology and harm our business. Licensing our Commerce and other software and hardware products 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. In addition, in some cases we develop specific software applications for our licensees. We cannot predict if we will deliver these applications in a timely manner or at all. 16 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. The integration often receives re-engineering of these business processes, which may delay the deployment of our technology. 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 and other software and hardware products have 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 1.5 in April 2001. Our and our licensees' applications and services based on our Commerce and other software and hardware products are in development or have only been released for evaluation in very limited commercial launches. It is still 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. 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. In April 2001, we filed a claim against Microsoft Corporation alleging that certain of their technology infringes our United Stated Patent NO. 6,185,683. The claim is in the early stages and while the litigation is pending, significant financial resources and management attention will be diverted for that purpose. There is no assurance that we will be successful in this claim, and an unfavorable result would have a significant adverse affect on our results of operations by reducing the value of our proprietary technology and reducing demand for our products. 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 and other software and hardware and the software and services developed using our software. Without this confidence, potential or current licensees may not 17 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 will be very high. If our or 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 and other products 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. In particular, we are currently increasing our focus on our new Rights/System platform, which we believe is important to meeting our customer and market demands. Delays in our ability to develop and release the Rights/System software could seriously harm our operating results. 18 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, 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 . 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, Microsoft's Windows operating system, which manages the programs on a computer, includes components addressing limited 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 have made acquisitions of and investments in other companies in the past and we may continue to 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 amortization 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 management's 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. 19 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 or 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, 23 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. 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. For example, due to the current volatility of our stock price, many of our employees hold options with exercise prices well above the current fair market value of our stock. 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 353 employees at March 31, 2001. On April 30, 2001, we announced a plan to reduce our workforce by approximately 15% in order to reduce costs and increase efficiency. 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 20 maintain close coordination among our executive, engineering, accounting, finance, marketing, and operations organizations. Our stock price has been volatile in the past and is likely to continue to be volatile. The market price of our common stock has been volatile in the past and is likely to continue to be volatile. In addition, the securities markets in general, and Internet stocks in particular, have experienced significant price volatility and accordingly the trading price of our common stock is likely to be affected by this activity. 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. Stockholders may incur dilution as a result of future equity issuances. We have in the past and may in the future issue equity securities to our partners. 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. Industry-Related Risks 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 21 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. 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, Asia and Australia. 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. 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 investments in marketable securities, we have concluded that there is no material market risk exposure. Therefore, no quantitative tabular disclosures are required. At March 31, 2001 and December 31, 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 PART II. OTHER INFORMATION INTERTRUST TECHNOLOGIES CORPORATION Item 1. Legal Proceedings. On April 26, 2001, we filed a patent infringement complaint against Microsoft Corporation in the United States District Court for the Northern District of California. In the complaint, we have alleged that certain of Microsoft's products infringe our United States Patent No. 6,185,683 and we are seeking an injunction in addition to monetary damages. Item 2. Changes in Securities and Use of Proceeds. (a) Changes in Securities. On January 30, 2001, we issued 1,130,000 shares of common stock in exchange for all of the capital stock of PublishOne, Inc. The transaction was accounted for as a purchase and the fair value of the common stock issued was $6 million. The shares were issued pursuant to an exemption by reason of Section 4(2) of the Securities Act of 1933. These sales were made without general solicitation or advertising. Each purchaser was an accredited investor or a sophisticated investor (either alone or through its representative) with access to all relevant information necessary. These shares have not been registered for resale by us. On February 1, 2001, we issued 4,000,000 shares of common stock to Nokia Finance International B.V. for an aggregate purchase price of $20,000,000. The shares were issued pursuant to an exemption by reason of Regulation S of the Securities Act of 1933. This sale was made without general solicitation or advertising. The purchaser was not a U.S. person within the meaning of Rule 903 of the Securities Act of 1933. These shares have not been registered for resale by us. (b) Use of Proceeds. On April 12, 2000 we completed a public offering in which we sold 2,820,244 shares of common stock at $35 per share pursuant to a Registration Statement on Form S-1 (File No. 333-32484) that was declared effective on April 6, 2000. The total aggregate proceeds from these transactions were $98.7 million. Underwriters' discounts and other related costs were approximately $6.5 million resulting in net proceeds $92.2 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 pursuant to a Registration Statement on Form S-1 (File No. 333-84033) that was declared effective on October 26, 1999. 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 used for working capital and general corporate purposes. Remaining proceeds were predominantly held in cash, cash equivalents and marketable securities at March 31, 2001. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None. 23 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 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. 4.8 Stockholder Rights Agreement, by and between the Registrant and Nokia Finance International B.V., dated January 31, 2001 -- incorporated herein by reference to Exhibit 4.1 to the Registrant's Form 8-K filed February 20, 2001. 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). 24 Exhibit No. Description --- ----------- 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. 10.21**** 2000 Supplemental Option Plan. 10.22**** Full-Recourse Promissory Note dated December 7, 2000 from Bruce Fredrickson to the Company. * 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). *** Incorporated herein by reference to the exhibit of the same number of the Registrant's Form 10-Q for the quarter ended September 30, 2001. **** Incorporated herein by reference to the exhibit of the same number of the Registrant's Form 10-K for the year ended December 31, 2000. + Confidential treatment requested. (b) Reports on Form 8-K. On May 1, 2001, the Company filed a report on Form 8-K in which it disclosed that the Registrant had filed a claim against Microsoft Corporation alleging patent infringement. On February 20, 2001, the Company filed a report on Form 8-K in which it disclosed that the Registrant had sold common stock to Nokia Finance International B.V. for an aggregate purchase price of $20,000,000. 25 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: May 15, 2001 By: /s/ Gregory S. Wood ------------------------------------------------- Gregory S. Wood Chief Financial Officer (Principal Financial and Accounting Officer) 26