American Green Inc (ERBB)

[triton]

Form 10-K for MACROVISION CORP (EXCERPTS)
Music Technology

In November 2002, we acquired the assets and operations of Midbar Tech (1998) Ltd. ("Midbar"), a leading supplier of copy protection solutions for the music industry, for approximately $17.8 million in cash and related acquisition costs. In addition, we have agreed to additional contingent consideration up to $8.0 million based on a percentage of revenues from sales of our music technology products through December 31, 2004. In connection with the purchase, we recorded goodwill of $6.9 million and identifiable intangibles of $4.9 million in 2002. In 2003, we recorded additional goodwill of approximately $1.2 million, which represents contingent consideration payments we are required to make to Midbar shareholders, as noted above, based on sales of our music technology products through December 31, 2003.

In connection with the acquisition of Midbar, we recorded a charge of $6.0 million for in-process research and development ("IPRD") in the fourth quarter of 2002. At the acquisition date, Midbar's major in-process project was the development of CDS-300, BurnProtect, and BurnShield. This technology had not yet reached technological feasibility. The technological feasibility of the in-process products is established when the enterprise has completed all planning, designing, coding and testing activities that are necessary to establish that the product can be produced to meet its design specifications. We obtained an independent appraiser's valuation to determine the amounts allocated to purchased technology and in-process research and development. The valuation analysis utilized the Income Approach based on discounted future cash flows. This approach took into consideration earnings remaining after deducting from cash flows related to the in-process technology the market rates of return on contributory assets including assembled workforce, customer accounts and existing technology. The adjusted cash flows were then discounted to present value at appropriate rates determined by analysis of the risks associated with each of the identified intangible assets. The weighted average discount rate used for IPRD was approximately 35%. The resulting net cash flows to which the discount rate was applied are based on management's estimates of revenues, operating expenses, and income taxes from such acquired technology.

In May 2003, we acquired the patents and other assets of TTR for $5.1 million in cash and the surrender of 1,880,937 shares of TTR common stock that we originally purchased in January 2000. We recorded a realized gain of $395,000 for the excess of the market value of such TTR stock on the closing date of the acquisition over the adjusted cost basis of such stock. Our copy protection products in this area are used by customers for copy protection, authentication, and rights management for music CDs.

Revenues from our music technology products were 3.6% and 0.4% of our net revenues in 2003 and 2002, respectively. Currently, substantially all of our music technology revenue is from international territories. Additional product features, currently under development, may be required for the product to be accepted in the United States. We believe that revenues from our music technology products will increase in absolute terms and as a percentage of our total revenues as more customers adopt our technology.

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Royalty Revenues

Royalty revenue from the replication of videocassettes, DVDs, and CDs is recognized when realized or realizable and earned. We rely on royalty reports from our customers and third parties as our basis for revenue recognition. In our DVD, videocassette, and PC games product lines, we have established significant experience with certain customers to reasonably estimate current period volume for purposes of making an accurate revenue accrual. Accordingly, royalty revenue from these customers is recognized as earned. Revenue from our PPV and music technology products is recognized only as reported, due to the timing of receipt of reports in PPV, and the embryonic stage and volume volatility of the market for our music technology products. Advanced royalty fees attributable to minimum copy quantities or shared revenues are deferred until earned. In the case of agreements with minimum guaranteed royalty payments with no specified volume, revenue is recognized on a straight-line basis over the life of the agreement.

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Net Revenues. Our net revenues for 2003 increased 25.5% to $128.3 million from $102.3 million in 2002. This increase is primarily driven by increased revenues in the video technology, ESLM and music technology product lines. Video's DVD copy protection revenues increased $17.4 million or 37.9% to $63.4 million in 2003 from $46.0 million in 2002, due to the continued strong growth of the DVD format and continued high penetration among Hollywood studio customers. This increase in DVD revenues was partially offset by continuing decreases in videocassette copy protection revenues. Our DVD copy protection revenues in 2002 were also reduced by a $2.3 million refund resulting from a customer's self-reporting errors detected in 2002, which revenue was previously recognized upon cash receipt. During 2003, the increase in DVD copy protection revenues included approximately $917,000 in revenue as a partial resolution of this customer reporting claim. Revenues from videocassette copy protection decreased $1.7 million or 22.2% to $5.9 million in 2003 from $7.6 million in 2002, reflecting the continuing trend of Hollywood studios to discontinue copy protecting or more selectively copy protect their VHS releases. Digital PPV copy protection revenues increased $942,000 or 8.6% to $11.9 million in 2003 from $11.0 million in 2002, due to slightly increased demand for digital set-top boxes and hard drive recorders and an increase in usage fees. The increase in our music technology revenue is from products resulting from our acquisition of Midbar assets in November 2002 and from the increased market acceptance of our CDS-100 and CDS-200 products by the music labels. Revenues from ESLM increased $6. 9 million or 25.5% to $33.7 million in 2003 from $26.9 million in 2002, primarily due to an increase in licensing and maintenance volume. Revenues from our PC games technology product line decreased $2.3 million or 29.7% to $5.4 million in 2003 from $7.7 million in 2002 due to decreasing volumes and per unit pricing received from a number of customers. Revenues from CSLM increased $749,000 or 30.3% due to the increased market acceptance of our CSLM technology by major software vendors.

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In August 2003, we acquired intellectual property and other assets, including patents and software that can be used to track and manage content in the peer-to-peer file sharing space. We paid $720,000 in cash, $80,000 of acquisition costs and an additional payment of $80,000 will be due on the first anniversary of the closing date for a total purchase price of $880,000. In addition, we have agreed to a maximum payment of $140,000 if certain milestones are achieved by May 28, 2004. The purchase price was allocated to in-process research and development, core technology and employment agreements. The in-process research and development of $624,000 was expensed in 2003, and the balance of the purchase price has been allocated among the other intangible assets and is being amortized on a straight-line basis over two to six years based on the expected useful lives of the intangibles. Research and Development. Research and development expenses increased by $5.3 million or 44.9% to $17.2 million in 2003 from $11.9 million in 2002. The increase is primarily due to increased research and development activities for our video technology, music technology and ESLM product lines. Research and development expenses increased as a percentage of net revenues to 13.4% in 2003 from 11.6% in 2002. We expect research and development expenses to increase in absolute terms and as a percentage of revenues over the prior year periods as a result of expected increases in research and development activity as we develop new technologies in our entertainment and software technologies groups.

Selling and Marketing. Selling and marketing expenses increased by $6.3 million or 30.3% to $27.0 million in 2003 from $20.7 million in 2002. This increase was primarily due to increased business development activities for our enterprise licensing and music technology product lines and increased commission costs associated with higher revenue levels. Selling and marketing expenses increased as a percentage of net revenues to 21.0% in 2003 from 20.3% in 2002. Selling and marketing expenses are expected to increase in absolute terms as we continue to expand our efforts in selling and marketing our ESLM, music technology, PC Games and other digital rights management products. We expect our selling and marketing expenses to increase in absolute terms and as a percentage of revenues over the prior year periods as we continue to invest in additional sales personnel for our ESLM products.

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Net Revenues. Our net revenues for 2002 increased 3.5% to $102.3 million in 2002 from $98.8 million in 2001. This moderate increase is primarily driven by increased revenues in the video technology and ESLM product lines. Video's DVD copy protection revenues increased $8.4 million or 22.3% to $46.0 million in 2002 from $37.6 million in 2001, due to the continued strong growth of the DVD format and continued high penetration among Hollywood studio customers. This increase in DVD revenues was substantially offset by continuing decreases in videocassette and PPV copy protection revenues. Revenues from videocassette copy protection decreased $3.9 million or 33.9% to $7.6 million in 2002 from $11.5 million in 2001, reflecting the trend of Hollywood studios to discontinue copy protecting or more selectively copy protect their VHS releases. Digital PPV copy protection revenues decreased $2.2 million or 16.9% to $11.0 million in 2002 from $13.2 million in 2001 due to the continuing slow demand for digital set-top boxes. Revenues from ESLM increased $1.3 million or 4.9% to $26.9 million in 2002 from $25.6 million in 2001 primarily due to increased market penetration despite the difficult economic environment for enterprise software. Increases in CSLM and music technology product lines were offset by the decrease in PC Games Technology and Other revenue. Our DVD copy protection revenues in 2002 were also reduced by a $2.3 million refund resulting from a customer's self-reporting errors detected in 2002. Revenue from this customer was previously recognized only upon cash receipt.

License Revenues. Our license revenues for 2002 increased modestly by 2.5% compared to 2001 primarily due to increases in our revenues derived by our Entertainment Technologies Group in the DVD copy protection area. This was offset by decreases in our



copy protection revenues for videocassettes and PPV solutions. We also had an increase in license revenues from our music technology product line, which started in 2002.

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Our operating results have fluctuated in the past, and are expected to continue to fluctuate in the future, on an annual and quarterly basis as a result of a number of factors. Such factors include the timing of release of popular titles on videocassettes or DVDs or by digital PPV transmission, the timing of release of popular computer games on CD-ROM, the timing of a small number of our electronic license management high-value perpetual licenses during any period, the degree of acceptance of our copy protection technologies by major motion picture studios and computer game publishers, the mix of products sold and technologies licensed, any change in product or license pricing, the seasonality of revenues, changes in our operating expenses, personnel changes, the development of our direct and indirect distribution channels, foreign currency exchange rates and general economic conditions. We may choose to reduce royalties and fees or increase spending in response to competition or new technologies or elect to pursue new market opportunities. Because a high percentage of our operating expenses are fixed, a small variation in the timing of recognition of revenues can cause significant variations in operating results from period to period.

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