-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NYgneVha/ArstZ19kp+hISUxzV1/5K+67Wti2yV/S+yi2MLjkQz32ToiHmS23a77 U4oqXdGkAzUZ3Z0WX6a2yg== /in/edgar/work/20000809/0001021408-00-002436/0001021408-00-002436.txt : 20000921 0001021408-00-002436.hdr.sgml : 20000921 ACCESSION NUMBER: 0001021408-00-002436 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000630 FILED AS OF DATE: 20000809 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERTRUST TECHNOLOGIES CORP CENTRAL INDEX KEY: 0001089717 STANDARD INDUSTRIAL CLASSIFICATION: [7371 ] IRS NUMBER: 521672106 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-27287 FILM NUMBER: 690126 BUSINESS ADDRESS: STREET 1: 4750 PATRICK HENRY BLVD. CITY: SANTA CLARA STATE: CA ZIP: 95054 BUSINESS PHONE: 4088550100 10-Q 1 0001.txt QUARTERLY REPORT FOR PERIOD ENDED 6/30/2000 ================================================================================ - -------------------------------------------------------------------------------- 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 June 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 July 31, 2000 was 85,330,281. - -------------------------------------------------------------------------------- ================================================================================ INTERTRUST TECHNOLOGIES CORPORATION INDEX
Page No. ------- Part I. Financial Information Item 1. Condensed Consolidated Balance Sheets as of June 30, 2000 and December 31, 1999 3 Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2000 and 1999 4 Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 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 21 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
PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements INTERTRUST TECHNOLOGIES CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands)
June 30, December 31, 2000 1999 --------- -------- (unaudited) ASSETS Current assets: Cash and cash equivalents................................................. $ 162,994 $ 98,286 Short-term investments.................................................... 34,236 42,548 Accounts receivable....................................................... 6,002 2,562 Prepaid distribution costs, net........................................... 460 -- Other current assets...................................................... 2,404 1,182 --------- -------- Total current assets.................................................. 206,096 144,578 Property and equipment, net.................................................. 5,189 3,356 Long-term investments........................................................ 21,194 -- Other assets................................................................. 533 137 Goodwill and other intangible assets......................................... 20,843 3,426 --------- -------- $ 253,855 $151,497 ========= ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.......................................................... $ 2,036 $ 2,184 Accrued compensation...................................................... 2,470 1,113 Accrued distribution costs................................................ 5,460 -- Other accrued liabilities................................................. 1,791 1,678 Deferred revenue.......................................................... 4,689 3,052 --------- -------- Total current liabilities............................................. 16,446 8,027 Deferred revenue--long-term portion.......................................... 9,178 10,118 Commitments: Stockholders' equity: Convertible preferred stock............................................... -- -- Common stock.............................................................. 85 79 Additional paid-in capital................................................ 334,064 214,241 Deferred stock compensation............................................... (4,656) (6,600) Notes receivable from stockholders........................................ (93) (196) Accumulated other comprehensive income (loss)............................. (636) (107) Accumulated deficit....................................................... (100,533) (74,065) --------- -------- Total stockholders' equity............................................ 228,231 133,352 --------- -------- $ 253,855 $151,497 ========= ========
See accompanying notes. 3 INTERTRUST TECHNOLOGIES CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts)
Three Months Ended Six Months Ended June 30, June 30, -------------------------- -------------------------- 2000 1999 2000 1999 -------- ------- -------- -------- (unaudited) (unaudited) Revenues: Licenses........................ $ 889 $ 142 $ 1,576 $ 309 Software support and training... 632 112 1,292 177 Clearinghouse services.......... 146 -- 146 -- -------- ------- -------- -------- Total revenues 1,667 254 3,014 486 Cost of revenues: Licenses........................ 110 10 213 42 Software support and training... 182 121 329 208 Clearinghouse services.......... 714 -- 1,357 -- -------- ------- -------- -------- Total cost of revenues............. 1,006 131 1,899 250 -------- ------- -------- -------- Gross profit 661 123 1,115 236 Operating costs and expenses: Research and development........ 5,775 3,652 10,976 7,088 Sales and marketing............. 4,361 1,315 8,018 2,449 General and administrative...... 2,273 1,358 4,501 2,117 Purchased in-process research and development............... -- -- 6,100 -- Amortization of goodwill........ 922 -- 922 -- Amortization of deferred stock compensation.................. 938 168 1,944 195 -------- ------- -------- -------- Total operating costs and expenses. 14,269 6,493 32,461 11,849 -------- ------- -------- -------- Loss from operations............... (13,608) (6,370) (31,346) (11,613) Interest and other income (expense), net.............................. 2,766 160 4,878 202 -------- ------- -------- -------- Net loss. $(10,842) $(6,210) $(26,468) $(11,411) ======== ======= ======== ======== Basic and diluted net loss per share............................ $ (0.13) $ (0.19) $ (0.32) $ (0.37) ======== ======= ======== ======== Shares used in computing basic and diluted net loss per share....... 84,247 31,891 81,589 30,614 ======== ======= ======== ========
See accompanying notes. 4 INTERTRUST TECHNOLOGIES CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Six Months Ended June 30, ------------------------- 2000 1999 --------- --------- (unaudited) Operating activities Net loss...................................................................... $(26,468) $(11,411) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization.............................................. 838 263 Amortization of deferred stock compensation and other stock related compensation charges...................................................... 1,984 275 Amortization of goodwill................................................... 922 -- Purchased in-process research and development.............................. 6,100 -- Changes in operating assets and liabilities: Accounts receivable.................................................... (3,440) 1,146 Prepaid and other current assets....................................... (1,682) (172) Accounts payable....................................................... (165) 350 Accrued compensation................................................... 1,357 180 Other accrued liabilities.............................................. 5,573 110 Deferred revenue....................................................... 697 441 -------- -------- Net cash used in operating activities............................... (14,284) (8,818) Investing activities Capital expenditures.......................................................... (2,427) (210) Purchases of short-term investments........................................... (33,072) -- Proceeds from sales and maturities of short-term investments.................. 40,855 -- Purchases of long-term investments............................................ (21,194) -- Other noncurrent assets....................................................... (546) (47) -------- -------- Net cash used in investing activities............................... (16,384) ( 257) Financing activities Proceeds from issuance of convertible promissory notes........................ -- 1,000 Proceeds from issuance of preferred stock, net................................ -- 14,714 Proceeds from issuance of common stock, net................................... 95,313 3,081 Proceeds from repayment of notes receivable from stockholders................. 63 -- -------- -------- Net cash provided by financing activities........................... 95,376 18,795 -------- -------- Net increase (decrease) in cash and cash equivalents.......................... 64,708 9,720 Cash and cash equivalents at beginning of period.............................. 98,286 5,575 -------- -------- Cash and cash equivalents at end of period.................................... $162,994 $ 15,295 ======== ======== Supplemental schedule of noncash financing activities: 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, 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 six-month periods ended June 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):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------------- ---------------------------- 2000 1999 2000 1999 --------- --------- --------- --------- (in thousands, except per share data) Net loss $(10,842) $(6,210) $(26,468) $(11,411) ========= ========= ========= ========= Basic and diluted: Weighted-average shares of common stock outstanding 84,567 32,537 82,017 31,218 Less weighted-average shares subject to repurchase (320) (646) (428) (604) --------- --------- --------- --------- Weighted-average shares used in computing basic and 84,247 31,891 81,589 30,614 diluted net loss per common share --------- --------- --------- --------- Basic and diluted net loss per common share $ (0.13) $ (0.19) $ (0.32) $ (0.37) ========= ========= ========= =========
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 13,631,000 and 37,599,000 for the three months June 30, 2000 and 1999, respectively, and 15,363,000 and 38,238,000 for the six months ended June 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 Revenue Concentration Two customers accounted for 24% and 22% of total revenues in the second quarter of 2000. Three customers accounted for 38%, 23%, and 13% of total revenues in the second quarter of 1999. In the six months of 2000, three customers accounted for 25%, 23% and 13% of total revenues and, in the comparable period of 1999, three customers accounted for 40%, 24% and 13% of total revenues. International revenues accounted for 51% of total revenues for the first six months of 2000 and 67% 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 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 and is effective July 1, 2000. Management does not expect the adoption of FIN 44 to have a material effect on the financial position or results of operations of InterTrust. 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 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. 4. NON MONETARY TRANSACTION In June 2000, we entered into a commerce services 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 7 InterRights Point software (technology) on over 100 million disks which we currently expect to commence in the fall of 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. 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, as well as Risk Factors included in our Registration Statement on Form S-1, as amended and, 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 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 June 30, 2000, we had approximately $13.9 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 June 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 commerce services 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 we currently expect to commence in the fall of 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 10 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 June 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 two years, one year in recent agreements. 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 six months ended June 30, 2000, PricewaterhouseCoopers accounted for 22% of total revenues and National Computer Systems Pte accounted for 24% of total revenues. In the comparable period for 1999, Mitsubishi, a stockholder, accounted for 40% of total revenues, Reciprocal accounted for 24% of total revenues, and Computacenter accounted for 13% 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. 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 $1,667,000 in the three months ended June 30, 2000 from approximately $254,000 in the three months ended June 30, 1999. For the six months ended June 30, 2000, total revenues increased to approximately $3,014,000 from approximately $486,000 in the comparable period of 1999. 11 License revenues were approximately $889,000 or 53% of total revenues for the three month period ended March 31, 2000 as compared to $142,000 or 56% of total revenues in the three month period ended March 31, 1999, and represent the amortization of deferred license fees. License fees accounted for 52% of total revenues in the six months ended June 30, 2000 and 64% of total revenues in the six months ended June 30, 1999. This increase was due to license fees from additional partner licensing agreements. Revenue from software support and training increased to $632,000 in the three months ended June 30, 2000 from approximately $112,000 in the three months ended March 31, 2000. Software support and training revenue increased to approximately $1,292,000 for the six months ended June 30, 2000 from approximately $177,000 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 38% and 44% of total revenues in the three month periods ended June 30, 2000 and 1999, respectively, and 43% and 36% for the six month periods ended June 30, 2000 and 1999, respectively. No Trustnet clearinghouse revenue was recognized in the three or six months ended June 30, 1999, as the service was not available to our partners until the third quarter of 1999. Service revenues were approximately $146,000 for the three and six month periods ended June 30, 2000, and represent consulting and system integration services and monthly service fees for clearinghouse services. Clearinghouse fees accounted for 9% of total revenues in the three months ended June 30, 2000 and 5% of total revenues in the six months ended June 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 $110,000 during the three months ended June 30, 2000 and approximately $10,000 in the three months ended June 30, 1999. Cost of license revenue was approximately $213,000 during the six months ended June 30, 2000 and approximately $42,000 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 $182,000 for the three months ended March 31, 2000 from approximately $121,000 for the three months ended June 30, 1999. In the first six months of 2000, the cost of software support and training was approximately $329,000 as compared to approximately $208,000 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 began providing these services in the third quarter of 1999. Clearinghouse service costs incurred to establish and test the site were approximately $714,000 during the three months ended June 30, 2000 and $1,357,000 in the six months ended June 30, 2000. 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 $5.8 million for the three months ended June 30, 2000 and approximately $3.7 million for the three months ended June 30, 1999. In the first six months of 2000, research and development spending was approximately $11.0 million as compared to 12 approximately $7.1 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 $4.4 million for the three months ended June 30, 2000 from $1.3 million for the three months ended June 30, 1999. In the first six months of 2000, sales and marketing expenses were $8.0 million as compared to $2.4 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 and other 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 advertising and promotional programs. General and Administrative General and administrative expenses consist primarily of salaries and related expenses for executive, legal, accounting and administrative personnel, professional service fees, and general corporate expenses. General and administrative expenses increased to approximately $2.3 million for the three months ended June 30, 2000 from approximately $1.4 million for the three months ended June 30, 1999. General and administrative expenses were approximately $4.5 million for the six months ended June 30, 2000 and $2.1 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 operating 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 $938,000 of related compensation expense during the three months ended June 30, 2000 and $168,000 in the comparable period of 1999. We recognized approximately $1.9 million of related compensation expense during the six months ended June 30, 2000 as compared to $195,000 in the six-month period ended June 30, 1999. The amortization of deferred compensation will approximate $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 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 68,052 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 and six months ended June 30, 2000. 13 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 $2.8 million of interest income in the three months ended June 30, 2000 and $160,000 in the three months ended June 30, 1999. We recognized approximately $4.9 million of interest income in the six months ended June 30, 2000 and $202,000 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 June 30, 2000 our principal sources of liquidity included approximately $163.0 million of cash and cash equivalents, $34.2 million in short-term investments, and $14.7 million in long-term investments. Net cash used in operating activities totaled $14.3 million in the six months ended June 30, 2000. The $14.3 million of cash used in the first six months of 2000 is primarily attributable to the net loss of $26.5 million and an increase in accounts receivable of $3.4 million offset by non-cash charges of $6.1 million for purchased in-process research and development and $2.0 million of deferred compensation, and $922,000 of goodwill amortization, and increased accrued liabilities of $6.9 million. Net cash used in investing activities for the six months ended June 30, 2000 of $16.4 million primarily reflects a net increase of $13.4 million in short- and long-term investments and an investment of approximately $2.4 million in capital equipment. Net cash provided by financing activities totaled $95.4 million and represent proceeds of approximately $92.3 from our public offering in April 2000, the $3.0 million from the exercise of stock options and issuances under the employee stock purchase plan in the six months ended June 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 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 success of our business depends upon our ability to generate transaction fees in the form of a percentage of fees charged by our licensees in commercial transactions. However, our licensees have not yet used our technology in the commercial distribution of their products and we have not earned any transaction fees under this business model. If our technology is commercially released, the volume of products and services distributed using our technology may be too small to support or grow our business. While some companies have licensed our technology, other companies may wish to use other technology based on different business models, including the payment of a one- time license fee without sharing in ongoing revenues. If we are unable to generate revenues from transaction fees, our current revenues, consisting of initial license fees and support fees, will be insufficient to sustain our business. Our quarterly operating results are volatile and difficult to predict. If we fail to meet the expectations of public market analysts or investors, the market price of our common stock may decrease significantly. Our operating results have varied from period to period and, in some future quarter or quarters, will likely fall below the expectations of securities analysts or investors, causing the market price of our common stock to decline. 14 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 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 51% of our total revenues in the first six 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. 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 $11.7 million in 1997, $19.7 million in 1998, $28.6 million in 1999, and $26.5 million for the six months ending June 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. If third parties do not deploy our technology and create a market for digital commerce, our business will be harmed. 15 Relationships with leading content, technology, and commerce service providers are critical to our success. Our business and operating results would be harmed to the extent our licensees fail, in whole or in part, to: . deploy our technology; . develop an infrastructure for the sale and delivery of digital goods and services; . generate transaction fees from the sale of digital content and services; . develop and deploy new applications; and . promote brand preference for InterTrust products and services and the MetaTrust Utility. We need to significantly increase the number of companies that license our technology to sustain and grow our business. We will not generate sufficient revenue to grow our business unless we maintain relationships with existing licensees and significantly increase the number of companies that license our technology and use it for the sale and management of digital information and services. We have not yet attracted, and may not in the future be able to attract, a sufficient number of these companies. As of July 31, 2000, only 39 companies have licensed our software for commercial use. As of July 2000, only one company has commercially deployed our technology and that has been done in a limited number. 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. 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 16 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. 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 17 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 . 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 18 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. 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 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 19 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. Our Chief Financial Officer, Erwin N. Lenowitz, resigned for personal reasons as of May 30, 2000. If we are unable to fill this function, our business could be harmed. In addition, competition for qualified sales and marketing personnel is intense. We may not be able to hire enough qualified individuals in the future or in a timely manner. New employees require extensive training and typically take at least four to six months to achieve full productivity. 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 225 employees at June 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. 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 20 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. 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 21 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 June 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 PART II. OTHER INFORMATION INTERTRUST TECHNOLOGIES CORPORATION Item 1. Legal Proceedings. None. Item 2. Changes in Securities and Use of Proceeds. (a) Changes in Securities 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. During the quarter ended March 31, 2000, we issued 230,462 shares of common stock in exchange for all of the capital stock of Infinite Ink Corporation. The transaction was accounted for a purchase at a value of $28.1 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. (b) 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 July 31, 2000. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None. 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
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 -- incorporated herein by reference to Exhibit 3.4 to the Registrant's Registration Statement on Form S-1 (File No. 333-84033). 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. 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 ** 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 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: August 9, 2000 By: /s/ David M. Lund ---------------------------------------- David M. Lund Vice President of Finance (Principal Financial and Accounting Officer) 26 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 -- incorporated herein by reference to Exhibit 3.4 to the Registrant's Registration Statement on Form S-1 (File No. 333-84033). 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. 27.1 Financial Data Schedule.
__________ 27 * 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. 28 EX-27.1 2 0002.txt FINANCIAL DATA SCHEDULE
5 3-MOS DEC-31-2000 APR-01-2000 JUN-30-2000 162,994 34,236 6,002 0 0 206,096 7,176 (1,987) 253,855 16,446 0 0 0 334,149 (105,918) 253,855 889 1,667 1,006 14,269 0 0 (2,766) (10,842) 0 0 0 0 0 (10,842) (0.13) (0.13)
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