10-K 1 d10k.htm FORM 10-K FOR PERIOD ENDED 12/31/2001 Prepared by R.R. Donnelley Financial -- Form 10-K for period ended 12/31/2001
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 

 
FORM 10-K
 
x
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2001
 
OR
 
¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
 
For the transition period from _______________ to _______________
 
Commission file number 000-27287
 

 
INTERTRUST TECHNOLOGIES CORPORATION
(Exact name of registrant as specified in its charter)
 
Delaware
(State of incorporation)
  
52-1672106
(IRS Employer Identification No.)
 
4750 Patrick Henry Blvd., Santa Clara, California 95054
(Address of principal executive offices, including ZIP code)
 
(408) 855-0100
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
 
None
 
Securities registered pursuant to Section 12(g) of the Act:
 
Common Stock, $0.001
 

 
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), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨
 
The aggregate market value of voting common stock held by non-affiliates of the registrant as of March 15, 2002 was approximately $83 million. Shares of common stock held by each officer and director have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
 
As of March 15, 2002, 96,079,250 shares of the registrant’s common stock were outstanding.
 


INTERTRUST TECHNOLOGIES CORPORATION
 
FORM 10-K
 
DECEMBER 31, 2001
 
TABLE OF CONTENTS
 
Item

         
Page No.

    
PART I
      
1.
       
1
2.
       
20
3.
       
21
4.
       
22
    
PART II
      
5.
       
23
6.
       
25
7.
       
26
7A.
       
41
8.
       
42
9.
       
42
    
PART III
      
10.
       
43
11.
       
48
12.
       
54
13.
       
56
    
PART IV
      
14.
       
58
         
60


PART I
 
ITEM 1.    BUSINESS
 
All statements in this discussion that are not historical are forward–looking statements within the meaning of Section 21E of the Securities Exchange Act, including statements regarding InterTrust’s “expectations”, “beliefs”, “hopes”, “intentions”, “strategies” or the like. Such statements are based on management’s current expectations and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward–looking statements. InterTrust cautions investors that there can be no assurance that actual results or business conditions will not differ materially from those projected or suggested in such forward–looking statements as a result of various factors, including, but not limited to, the risk factors discussed in this Annual Report on Form 10-K. InterTrust expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward–looking statements contained herein to reflect any change in InterTrust’s expectations with regard thereto or any change in events, conditions, or circumstances on which any such statements are based.
 
Overview
 
Since our founding in 1990, we have invented and defined technologies for Digital Rights Management, or DRM, including various trusted computing technologies that enable secure management of digital processes and information. Leveraging these inventions, we developed the Rights|System software family, targeted to providers of digital information, technology, and commerce services. Rights|System is a scalable multi-device, multi-platform DRM solution, and is designed to protect digital information, apply rules persistently after information is distributed, and automate many of the commercial consequences of using the information. Rights|System is designed to manage a broad range of rights across a variety of digital information, media, and device types.
 
We also have a strategic intellectual property group that is dedicated to research, invention protection, patent licensing, and the monetization of our inventions. We believe that our inventions and issued patents to date represent substantial advances in computer science useful to DRM, computing security, and the reliability of computing platforms.
 
Industry Background
 
According to International Data Corporation’s Internet Commerce Market Model (ICMM) version 7.3, total worldwide Internet commerce spending increased 73% between 2000 and 2001—reaching $615 billion—and will continue to grow at a healthy rate through 2005, topping $4.6 trillion. IDC further estimates that worldwide Internet commerce spending per online buyer will grow from $3,402 in 2000 to $11,726 per year in 2005. That same year, IDC projects nearly half of all Internet users will also purchase goods and services over the Internet.
 
While most Internet commerce to date has involved the delivery of physical goods like books and compact discs ordered online, the Internet is poised to become a leading distribution channel for digital goods as well. Today, most content is in, or can be easily put into, digital form. This content includes music, videos, software, games, publications, business information, and images. The Internet can be used to disseminate this digital information efficiently to broad audiences without geographic boundaries, and can eliminate many of the traditional costs associated with manufacturing, packaging, and distribution. The use of the Internet for digital goods is being supported both by the growing number of households and businesses connected to the Internet, and by electronic devices other than the personal computer, such as set-top boxes, portable music players, mobile phones, and other hand-held devices, all of which are becoming connected to the Internet. In addition, downloading digital content is becoming easier with the emergence and adoption of broadband technologies including digital subscriber lines and cable modems, and enhanced compression technologies including MP3 for music and MPEG-4 for video. The Internet will add to the existing channels for distributing digital goods on physical media like compact discs and DVDs.

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Digital rights management can be deployed across all content industries, including music, video, software, games, publications, business information, and images, and by many of the constituencies in these industries. Many constituencies, including artists, authors, producers, publishers, and distributors, are concerned about protecting and managing their rights in digital content. Consumers want easy transparent access to good content but are concerned about protecting their privacy. Producers, publishers, and distributors want to structure and optimally manage their business models.
 
DRM applies to more than content industries. The Internet is becoming a means for digital interaction among organizations and individuals. Data about organizations and individuals is digitized on computers, sent over networks, and stored in electronic form. This information can be confidential and proprietary, including trade secrets and supply chain and product information. This information can also be personal in nature, including financial and medical records. This information is gathered, stored, and exchanged among many entities, including corporations, governments, schools, hospitals, and individuals. These organizations and individuals can manage their rights in the flow of proprietary and personal information, so that only the appropriate people can use the information. DRM is also useful for protecting rights as information flows become more automated in trading, brokering, regulatory compliance, and other industries.
 
DRM is also important to the emerging field of trusted computing. Trusted computing technologies enable software to run reliably and safely on different devices and operating systems. These technologies rely on many of the same security components that DRM uses to manage information content, and can apply policies and rules to software applications, devices and platform operating systems, and related digital information. The ability to apply rules to software to help ensure reliable execution and a dependable user experience appears to be important to initiatives such as Microsoft’s .NET.
 
Current computing environments and security techniques may not be designed to provide sufficient protection and management of digital rights. Historically, computers, networks, and operating systems were designed primarily for creating, processing, and distributing information. Similarly, security technologies evolved to protect computers and networks from the outside environment and to protect information during a point-to-point transmission. In commercial transactions in many current computing environments, information is generally stored and transactions are processed at remote mainframes or servers, even when it is less efficient, because the client and other parts of the environment do not provide adequate protection and security. As a result, these security technologies do not normally treat an authorized user as a potential threat. With digital commerce, the threat comes not only from the outside—a hacker trying to break into the protected computer or decrypt an encrypted transmission—but also from the inside—a user may be authorized to access digital information or provide software executables, but then performs an unauthorized act, of making or distributing copies, or supplying unreliable or malicious software. The absence of technologies that help secure reliable fulfillment of rights and policies when they are processing on “foreign” computing environments is an impediment to the development of distributed digital commerce.
 
A new set of technologies is required to address all of these concerns—one that, when distributed over a vast array of computers and devices, consistently protects and manages rights related to digital information and processes, wherever this information and these processes may occur. Commercial value chain members and enterprises must have the ability both to create and associate rights and rules that persistently apply to digital information and processes, and to modify the rights and rules, if permitted, even after the information is distributed. These rights and rules might represent information regarding ownership, access, usage and distribution limitations, payment, promotion, warranty, privacy, e-commerce process automation, taxes and other government regulations,and any other factors related to digital relationships and policies.
 
InterTrust Solution
 
We have developed a general-purpose DRM solution to serve as a foundation for providers of digital information, technology, and commerce services. Our solution consists of our Rights|System product, intellectual property, and MetaTrust Utility services.
 

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The Rights|System Product
 
Rights|System is our second generation DRM platform. It is designed to have broad capabilities to address the needs of parties seeking to distribute and manage digital goods. We designed Rights|System to meet the requirements of media, service and technology providers seeking to integrate DRM into their electronic commerce services. Rights|System includes many features in our first generation Commerce product and is designed to better meet the demands of the DRM market. Specifically, Rights|System has three basic component sets: packaging tools for content authors, server components for service providers, and client technology for the consumer device. Rights|System is designed to implement a range of DRM functions, including persistent protection of digital information of all types, and support for simple to complex business models. Rights|System provides the following benefits:
 
 
 
Multiple Client Types:    Because consumers use content on multiple devices and software applications, we designed Rights|System with a client architecture that runs on multiple platforms and operating systems including PCs, mobile phones and communicators, set top boxes and consumer electronic devices. Service providers and network operators can support these multiple client types with a single server architecture.
 
 
 
Enhanced Usability:    Rights|System is designed to operate seamlessly within the media/commerce experience through its support of popular media players and integration into standard internet e-commerce infrastructure.
 
 
 
Persistent Protection and Management:    Rights|System is designed to persistently protect both the information itself and the rules of use. Persistent protection means that these rules continue to apply even after the information arrives, online or offline, each time the information is accessed, and even when it may be forwarded to other people.
 
 
 
Robust Security:    Our sophisticated use of multiple layers of security and tamper-resistance techniques is designed to provide varying levels of security depending on the commercial value and nature of digital information, consistent with the rights and interests of many parties.
 
 
 
Flexible Business Models:    Rights|System is designed to allow content providers to specify and establish their own commercial models with rules that manage the use of digital information. Rights|System supports standard business models including purchase, time based pay-per-play (rental), and subscription as well as “superdistribution”.
 
 
 
Multiple Content and Media Types:    We designed Rights|System to permit distributors and service providers to employ various means of digital distribution, including portable media (CD, DVDs, flash memory) and transport options including the Internet, and all forms of broadband (Satellite, DSL, cable, broadband wireless). Rights|System also supports a multiple media standards for both streaming and download for audio, video, images and text, including mp3, AAC, MPEG-4, and PDF.
 
Our Rights|System product consists of the following elements:
 
 
 
Rights/System Packagers—The Right|System Packager products enable content owners, distributors, and service providers to create digital products from content, and package the products for distribution. Rights|System Packagers encrypt the content, and then create a Rights|Pack digital file that contains the business rules that manage the use of the content. Our packager products support processing for a variety of audio, text and video media types using both download and streaming distribution.
 
 
 
Rights/System Servers—The Rights|System Server products establish and maintain the secure infrastructure for the system and authorize and deliver rights to the users of the system. We currently offer three server products: the Authorization Generator, the Content Rights Server, and the System Operations Server.
 
 
 
Rights/System Clients—The Rights|System Client products enable consumers to access and use transparently protected content on a variety of devices, including PCs, mobile phones and

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communicators, set-top boxes, and music players. The clients, enforce the business rules that are associated with the content. We currently offer four Rights|System client products: Rights|Desktop, Rights|TV, Rights|Mobile, and Rights|PD.
 
 
 
Rights/System Toolkits—The Rights|System Toolkit products enables independent software vendors and other developers to quickly integrate our DRM technology in to their products. We currently offer four Toolkit products: Rights|Audio SDK, Rights|Video SDK, Rights|Desktop SDK, and the Packager SDK.
 
The following diagram illustrates the lifecycle of content commerce using Rights|System.
 
LOGO
 
 
1.
 
Packaging Content—With Rights|System Packager, the content owner selects a piece of content for distribution and encrypts the content using the packager into a secure container called a DigiFile. The packager is then used to associate business rules with the content, which are delivered in a secure Rights|Pack file. The information is disseminated in DigiFile over networks, on optical disks, or by other means of delivering digital information to the retailer’s or distributor’s content distribution system. The information can securely travel through unsecure networks, because the information in a DigiFile container is itself protected. Simultaneously, the Rights|Pack containing the business rules are sent to the Content Rights Server. Because the content and the rules travel separately, content distribution and rights delivery can be centralized or distributed to meet our customers’ needs.
 
 
2.
 
Selecting and Purchasing Content—A user can receive content in a DigiFile container and decide to pay for it, or decide to purchase content on a web site. Payment processing is performed using the retailer’s existing payment systems, including credit card processing systems and subscriber billing systems.
 
 
3.
 
Authorization and Delivery of Rights—After payment has been approved, our Authorization Generator issues an authorization to the Rights|System client software that is associated with the software used by the consumer to access the content. When the authorization is received, a secure process is set in motion. The Rights|System client software automatically retrieves the content from the content

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distribution system if the user does not already have the content. Simultaneously, the client software retrieves the Rights|Pack from the Content Rights Server. When both the protected content and its associated Rights|Pack have been retrieved, the user can access the content as permitted by the rules. If the rules permit, protected content can be transferred to other devices or users. Our technology, if present, will continue to manage the information’s use.
 
We announced our Rights|System product in July 2001 and it was commercially available in November 2001. In March 2002, we completed our first license relating to our complete Rights|System Product suite, and a number of small licenses related to our Rights|System Client products have been completed. Our goal is to license our Rights|System products to customers in multiple vertical markets.
 
We also offer two types of professional services to accelerate our partners’ deployment of DRM solutions. Where partners require the development of specific software or hardware applications, we provide such services. We also provide consulting services to help our partners integrate our Rights|System Product into their commerce solutions.
 
Rights|System is a product suite that requires integration into end-to-end systems for distribution of media. It is aimed at providing the necessary tools to build end-to-end protection and management for consumer distribution of media. In order to facilitate the building of complete systems, we have formed the Rights|Alliance Partner Program through which we enter marketing alliances with other technology providers who deliver complimentary components of an end-to-end system. Our Rights|Alliance partners include Sun Microsystems, Skystream, Portal Software, nCube, Seachange, Pace and Envivio.
 
Before developing the Rights|System product, we developed a platform we called the Commerce software. We shipped the general availability version of our Commerce software at the end of December 1998. In July 2001, we announced our Rights|System product and said we would continue to support the Commerce product for a limited period of time.
 
Intellectual Property Business
 
We have devoted substantial time, resources, and capital to protecting our intellectual property. We currently hold twenty-three United States patents, one European patent, four Australian patents and one German patent. We also have filed over 40 additional United States patent applications, as well as counterpart foreign applications in many instances. In all, we have nearly 90 patent applications pending worldwide. We believe that our issued patents and patent applications cover a broad range of subjects generally relating to protecting electronic rights and content, enabling secure electronic transactions, applying DRM and component security technologies in the digital economy, trusted computing, and next generation computing platforms. We believe our inventions represent substantial advances in computer science useful to DRM, computing security, and the reliability of computing platforms.
 
InterTrust has an organized intellectual property group. This group is comprised of technologists, patent litigators, patent prosecutors, and intellectual property business specialists, dedicated to the development, strategic licensing, and monetization of our e-commerce inventions. We are actively seeking to monetize our intellectual property assets through various means including patent licensing to companies that choose to build their own DRM infrastructure. In addition, we will diligently pursue legal action if necessary to enforce our intellectual property rights as discussed in the Patents section.
 
The MetaTrust Utility
 
Historically, our MetaTrust Utility group has maintained the specifications and administered the interoperability, security, and trustedness of the products and services using our Commerce Product. While we are no longer actively licensing our Commerce Product and our partners are winding down activities relating to the Commerce Product, we believe there may be important role for the MetaTrust Utility.

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We believe that there may be a significant need to have a neutral entity such as the MetaTrust Utility to administrator basic trust elements of future commerce and trusted computing systems. We believe that a basic trust administrator would perform important functions relating to maintaining certain specifications for both trusted software interoperability and hardware tamper resistance, certifying that software and hardware meets interoperability and security specifications, and aiding in root key and labeling management. The MetaTrust Utility has technical, business, and legal expertise in providing certification, key management, and related services.
 
Sales, Marketing and Business Development
 
Our sales and business development activities are designed to establish relationships with potential partners and customers and help them understand how to use our technology. We help our customers and their potential customers understand both the business and the technical benefits of our products, and assist them in attempting to expand their businesses with our technology. Our sales, marketing and business development organization consisted of 23 employees as of December 31, 2001. Sales and marketing expenses were $18.6 million in 2001, $18.5 million in 2000, and $6.9 million in 1999. Subsequent to December 31, 2001, this organization was reduced to 15 employees.
 
Research and Development
 
Our research and development organization is divided into product development, professional services, training and support, and STARLab. To date, substantially all software development costs have been expensed as incurred. Research and development expenses were $34.9 million in 2001, $24.5 million in 2000, and $16.5 million in 1999. As of December 31, 2001, our research and development, professional services, training and support, and STARLab organizations were comprised of 128 employees. Subsequent to December 31, 2001, these organizations were reduced to 69 employees.
 
Product Development
 
The product development organization is responsible for designing, developing, and supporting commercial implementations of our product and developing future enhancements to our software. Engineering in the product development organization is focused on the core Rights|System platform and certain specific application areas, such as set-top video and mobile communications. Engineering is supported by quality assurance, product management, and documentation. The quality assurance group implements a process designed to identify software defects through the entire development cycle, including operational deployments. The product management group is responsible for all functional and certification specifications, schedules, and overall project coordination. The documentation group is responsible for end user, administrator, and developer documentation and support for our products. Developer support is responsible for technical support to our partners’ engineering staffs.
 
Professional Services, Training and Support
 
Our professional services, training and support organizations work closely with the business development organization to provide customers with the training and support contemplated under their licenses. We believe that customer satisfaction is essential for our long-term success. In general, we plan on providing limited support and training, with our Rights/System licenses. Our professional services personnel are skilled in both business consulting and systems design to facilitate the successful deployment of our products. They work with our partners on using our DRM technology as well as on developing cross-partner and new customer relationships.
 

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STARLab
 
We have attracted a small group of computer science experts for STARLab, our electronic commerce research organization. STARLab projects cover a broad range of topics necessary for advanced DRM. The activities of STARLab are integrated with our important strategic objectives, including:
 
 
 
extending our portfolio of intellectual property
 
 
 
developing and prototyping new digital rights management technology
 
 
 
supporting our patent litigation team with technical analysis
 
 
 
providing an engineering consulting resource to assist product development
 
Competition
 
The market for DRM solutions is new, intensely competitive, and rapidly evolving. Our primary competition currently comes from or is anticipated to come from:
 
 
 
Dominant platform providers providing DRM features:    Companies such as Microsoft and RealNetworks offer DRM functionality as part of their overall platform value proposition. Customers who buy these platforms may choose to work with the built in DRM features.
 
 
 
Conditional access technology providers:    In digital television, security providers providing access control technology including NDS, Nagra Vision and Canal+ Technologies may develop DRM capabilities.
 
 
 
Component providers with secure digital distribution technology, including IBM, Lockstream, and Sealed Media.
 
 
 
Companies offering hardware-based content metering and copy protection systems, including Sony and the 4C Entity, comprised of IBM, Intel, Matsushita, and Toshiba. We believe that Sony is continuing its development of its MagicGate DRM technology and this technology may be adopted by a number of important technology companies.
 
In addition to these categories, other operating system or middleware developers such as Sun Microsystems, OpenTV or Symbian may also develop or license digital rights management solutions for inclusion in their operating systems. It is also possible that Adobe Systems may enlarge its DRM efforts in conjunction with a partner other than us, including IBM.
 
The primary bases of competition for providers of DRM solutions include:
 
 
 
range of content types and markets, from specific content type to general purpose, multiple markets;
 
 
 
flexibility of pricing and other business options, from narrow, fixed rules to flexible, dynamic rules;
 
 
 
price of solution, from as high as 30-40% to a nominal percentage of transaction value;
 
 
 
range of usage environments, from personal computer-based, online-only to multiple devices, offline and online;
 
 
 
choice of service providers, from being tied to a single vendor that also provides DRM technology and processing services, to being able to choose among multiple, competing service providers; and
 
 
 
business model of DRM provider, from vertically-integrated technology provider to neutral utility model.
 
In addition, we believe that our ability to compete depends on many other factors both within and beyond our control, including:
 
 
 
the ease of use, performance, features, and reliability of our solutions and our partners’ applications and services as compared to those of our competitors;

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the timing and market acceptance of new solutions and enhancements to existing solutions developed by us, our partners, and our competitors;
 
 
 
the quality of our partner development and support organization and similar organizations of our partners; and
 
 
 
the effectiveness of our sales and marketing efforts, and of similar efforts of our partners.
 
Some of our competitors have longer operating histories and significantly greater financial, technical, marketing, and other resources than we do. Many of these companies have broader customer relationships that could be leveraged, including relationships with many of our customers. These companies also have more established customer support and professional services organizations than we do.
 
Intellectual Property
 
Our success depends, in part, on our ability to protect our intellectual property and other proprietary rights in our software and other technology. To protect our proprietary rights, we rely on a combination of patent, trademark, copyright, and trade secret law, and confidentiality and license agreements with our employees, customers, partners, and others. Despite these protections, others might use our intellectual property without our authorization. If this occurs, a party might copy or obtain and use our products or technology to develop similar technology. If we are unable to protect our intellectual property adequately, it could materially affect our financial performance.
 
Furthermore, potential competitors and potential IP licensing customers may be able to develop technologies or services similar to ours without infringing our patents. In addition, if our agreements with employees, consultants and others who participate in product and service development activities are breached, we may not have adequate remedies, and our trade secrets may become known or independently developed by competitors.
 
Patents
 
We have devoted substantial time, resources, and capital to protecting our intellectual property. We currently hold twenty-three United States patents, one European patent, four Australian patents and one German patent. We currently have filed nearly 90 United States and foreign patent applications. We believe that our issued patents and patent applications cover a broad range of subjects generally relating to protecting electronic rights and content, enabling secure electronic transactions, and applying DRM and component security technologies in the digital economy, trusted computing, and next generation computing platforms. Expenses associated with the preparation of new patent applications, patent application processing fees, and attorneys costs associated with patent applications and maintaining our patent portfolio totaled $278,000 for the year ended December 31, 2001, $262,000 for the year ended December 31, 2000, and $244,000 for the year ended December 31, 1999.
 
Any pending or future patent applications may not be granted, existing or future patents may be challenged, invalidated or circumvented, and the rights granted under a patent that has issued or any patent that may issue may not provide competitive advantages to us.
 
Many of our current and potential competitors dedicate substantial resources to protection and enforcement of intellectual property rights, especially patents. If a blocking patent has issued or issues in the future, we would need either to obtain a license or to design around the patent or cease the applicable product or services activity. We might not be able to obtain a required license on acceptable terms, if at all, or to design around the patent.
 
We have not conducted and do not conduct comprehensive patent searches to determine whether technology that is used in our products infringes patents held by other third parties. In addition, it is difficult to proceed with

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certainty in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which are confidential when filed, relating to similar technologies. In the past, we have received notices alleging potential infringements by us of the proprietary rights of others. In January 1996, we received a letter from an attorney representing E-Data Corporation containing an allegation of infringement of a patent E-Data allegedly owns. We exchanged correspondence with E-Data’s attorneys ending in September 1996. We have not heard from any representative of E-Data since that time. In November 1997, we received a letter from representatives of TAU Systems Corporation informing us of two patents held by TAU Systems. In the letter, the representatives stated their opinion that our Commerce software contained various elements recited in the two patents and requested that we discuss licensing the technology of these patents. We responded to the letter stating that, although we had not undertaken a detailed review of the patents, we were unaware of any of our products having all of the elements required by the patent claims. TAU Systems has made no further allegations regarding our software, but representatives of TAU Systems have recently contacted us regarding a sale or exclusive license of TAU System’s patents. In May 1999, we received a letter from representatives of TechSearch LLC offering us a license to a patent held by TechSearch. We have reviewed the patent and do not believe that we need to obtain a license to this patent. In the future, we could be found to infringe upon the patent rights of E-Data, TAU Systems, TechSearch, or other companies. Furthermore, companies in the software market are increasingly bringing suits alleging infringement of their proprietary rights, particularly patent rights. If we were to discover that our products violate third-party proprietary rights, we might not be able to obtain licenses to continue offering these products without substantial reengineering. Efforts to undertake this reengineering might not be successful, licenses might be unavailable on commercially reasonable terms, if at all, and litigation might not be avoided or settled without substantial expense and damage awards.
 
On April 26, 2001, we filed a lawsuit against Microsoft Corporation in the United States District Court for the Northern District of California alleging that certain Microsoft technology infringes our United Stated Patent No. 6,185,683. Through subsequent procedural motions and an additional complaint, the lawsuit has been expanded to include the following additional seven (7) InterTrust United States patents: United States Patent No. 6,253,193, United States Patent No. 5,920,861, United States Patent No. 5,940,504, United States Patent No. 5,892,900, United States Patent No. 5,982,891, United States Patent No. 5,917,912 and United States Patent No. 6,157,721. On September 17, 2001, Microsoft filed an answer denying all the allegations asserted in our original complaint. In addition, the answer included a counterclaim asserting that InterTrust infringes United States Patent No. 6,049,671 and United States Patent No. 6,256,668. These two Microsoft patents relate to the downloading of software.
 
The legal proceedings are in the early stages and while the litigation is pending, significant financial resources and management attention will be diverted for this purpose. Discovery has started in the case and the parties have exchanged initial document production and infringement contentions. On November 1, 2001 Microsoft filed a Motion for Partial Summary Judgment of Non-Infringement of United States Patent No. 5,940,504. By order, the motion for Partial Summary Judgment was denied on February 8, 2002 without prejudice and Microsoft has subsequently filed a Renewed Motion for Partial Summary Judgment on February 22, 2002.
 
There is no assurance that we will be successful in this lawsuit against Microsoft, and an unfavorable overall result would likely have a significant adverse affect on our results of operations by reducing the value of our intellectual property assets as well as reducing the demand for any related products being marketed by the Company.
 
Other Intellectual Property
 
We have received United States and selected foreign registrations for our InterTrust, DigiBox, MetaTrust, and The MetaTrust Utility trademarks. We also have pending applications for United States and foreign registration of several of our trademarks and service marks, including Rights|System, Rights|PD, Trustkey, Rightskey, Rights|Desktop, Rights|Toolkit, Rights|Audio, Rights|Video, RightsLocker, RightsPackager and others. We do not know if these marks will be approved. In addition, a significant portion of our marks use the

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words inter, trust, meta, rights or digi. We are aware of other companies that use one or more of these words in their marks, alone or in combination with other words. We do not expect to be able to prevent all third-party uses of these words. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States, and effective patent, copyright, trademark, and trade secret protection may not be available in these jurisdictions. We license our proprietary rights to third parties, and these licensees may fail to abide by compliance and quality control guidelines relating to our proprietary rights or may take actions that would harm our business.
 
Our partners may rely in part on licenses included within the sealed packaging of commercial software and licenses on a web site that are entered into by clicking with a computer mouse on a button denoting assent to the terms of the license displayed on the web site. These licenses, however, may be or become unenforceable under the laws of some jurisdictions. As with other software products, our products are susceptible to unauthorized copying and uses that may go undetected. Policing unauthorized use is difficult.
 
Any claims relating to the infringement of third-party proprietary rights, even if meritless, could result in the expenditure of significant financial and managerial resources and could result in injunctions preventing us from distributing particular products and services. These claims could harm our business. We also rely on technology that we license from third parties, including software that is integrated with internally developed software and used in our products and services to perform key functions. Third-party technology licenses may not continue to be available to us on commercially reasonable terms. The loss of any of these technologies could harm our business. Although we generally seek to be indemnified against claims that technology licensed by us infringes the intellectual property rights of others, we do not receive indemnification in some cases. In some cases indemnification is not available for all types of intellectual property and proprietary rights, and in other cases the scope of indemnification is limited. Even if we receive broad indemnification, third-party indemnitors are not always well-capitalized and may not be able to indemnify us in the event of infringement, resulting in substantial liability to us. Infringement or invalidity claims may arise from the incorporation of third-party technology, and our customers may make claims for indemnification. These claims, even if meritless, could result in the expenditure of significant financial and managerial resources in addition to potential product or service redevelopment costs and delays, all of which could harm our business.
 
Employees
 
At December 31, 2001, we had a total of 188 employees. Of the total, 128 were in research and development, STARLab, professional services and training and support, 23 were in marketing, sales and business development, and 37 were in administration and finance. None of our employees is subject to a collective bargaining agreement, and we believe that our relations with our employees are good. On January 31, 2002, we announced that we would reduce our work force by approximately 45%, or 83 employees. In addition, on March 27, 2002, David Lockwood, Executive Vice Chairman and President, was also appointed Chief Executive Officer.
 
Our future operating results depend in significant part on the continued service of our key technical, sales, and senior management personnel, none of whom is bound by an employment agreement with specified terms. Our future success also depends on our continuing ability to attract and retain highly qualified technical, sales, and senior management personnel. Competition for these personnel is intense, and we may not be able to retain our key technical, sales and senior management personnel or to attract these personnel in the future. In the past, we have experienced difficulty in recruiting qualified technical, sales, and senior management personnel, and we may experience these difficulties in the future. If we are unable to hire and retain qualified personnel in the future, this inability could seriously harm our business.

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RISK FACTORS
 
In addition to the other information in this report, the following risk factors should be considered carefully in evaluating our business and us:
 
Risk Related to Our Business
 
Our business model is new, in transition, and unproven and we may not succeed in generating sufficient revenue to sustain or grow our business.
 
Our business model is unproven and evolving and may not generate sufficient revenue for us to be successful. The market for digital commerce products, services and applications has not developed as quickly as anticipated and, as a result, we might not meet analysts’ expectations of our future operating results. With the announcement of our Rights|System software platform in July 2001, we do not expect any material future revenue from our existing Commerce software licensees. Because we are no longer licensing our Commerce software, the success of our business depends largely upon our ability to license our new Rights|System product suite and to license our patents and other intellectual property. We have completed only one license of our complete Rights|System product line and a small number of Rights|System component licenses, and future revenue is uncertain. We have not completed any patent licenses independent of licensing our technology or products. Whether we will succeed in licensing our patents and, if so, what revenue will result from these licenses is uncertain. The volume of products and services distributed using our technology and DRM technology in general has been and may continue to be too small to support our business.
 
Our future revenue and prospects depend on market acceptance of our Rights|System software products. We do not expect to recognize any material revenue in the future from our existing Commerce product.
 
Our future revenue and prospects depend on market acceptance and continued enhancements of the Rights|System products that we announced in July 2001. We have completed only one license of our complete Rights|System product line and a small number of Rights|System component licenses. Our Rights|System products have not been commercially deployed by any of our customers. Therefore, it is difficult to predict both the amount of revenue we will generate and when we will be able to recognize revenue from these products. In addition, the Rights|System products may not meet the requirements of the market and we may not be able to license the Rights|System products under desirable terms and conditions. Failure to complete or license the Rights|System products will negatively impact our future revenue.
 
Our Commerce software product has been responsible for generating the most significant portion of our revenue since it was generally released in December 1998. In connection with the introduction of our Rights|System product, we have stopped developing and selling the Commerce product and anticipate that we will stop supporting the product during 2002. As a result, we do not expect to realize any material future revenue from new Commerce product licenses.
 
Our future revenue is significantly dependent on our ability to license our patents.
 
Our future revenue depends significantly on our ability to license our patents. The volume of products and services distributed using DRM and trusted component technology has been and may continue to be too small, which may affect our ability to license our patents. We have not completed any licenses of our patents independent of technology or product licenses, making it difficult to predict whether we will succeed in completing any patent licenses, and if we are successful, both the amount of revenue we will generate and when we will be able to recognize revenue from these licenses. In addition, the validity of our patents may be challenged by third parties. If challenged, our patents might not be upheld or their claims could be narrowed, or we may receive adverse rulings in litigation, which could negatively impact our ability to, and terms under which we could, license our patents.

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Our quarterly operating results are volatile and difficult to predict. If we fail to meet the expectations of public market analysts or investors, the market price of our common stock may decrease significantly.
 
Our operating results have varied from period to period and, in some future quarter or quarters, will likely fall below the expectations of securities analysts, or investors, causing the market price of our common stock to decline. Our quarterly operating results may fail to meet these expectations for a number of reasons, including:
 
 
 
a lack of demand for, or slow customer adoption of, our Rights|System software products;
 
 
 
a lack of demand for licenses to our patents;
 
 
 
the inability of licensees of our Rights|System product to develop complete commercial systems our technology, or delays or deferrals in this commercialization;
 
 
 
the inability of our licensees to pay our license and other fees;
 
 
 
our inability to make enhancements or changes to our product to meet our customers’ requirements on a timely basis;
 
 
 
our inability to effectively enforce or otherwise protect our patent assets or adverse rulings in litigation relating to our patents;
 
 
 
a decline in the demand for digital goods and services or trusted computing infrastructure;
 
 
 
our failure to quickly reduce costs in the event of unanticipated declines in revenues in a given period;
 
 
 
restucturing costs;
 
 
 
higher than expected operating expenses, including expenses related to the patent infringement litigation we initiated against Microsoft or additional or higher than expected operating expenses resulting from patent infringement litigation we initiated against one or more other companies;
 
 
 
customer budget cycles and changes in these budget cycles, including the reduction of spending due to macroeconomic conditions; and
 
 
 
impairment charges recorded to reduce goodwill and other intangible assets associated with our acquisitions to their estimated fair values.
 
We have a history of losses and our operating losses and expenses may increase significantly.
 
Our failure to increase revenues significantly would seriously harm our business. We no longer license our Commerce software and our revenues have decreased in each of the last four quarters. We intend to derive most of our revenues from the sale of Rights|System product licenses and from patent licenses. To date, revenues from Rights|System products have been minimal and we have not licensed our patents independent of technology licenses. We have experienced operating losses in each quarterly and annual period since inception, and we expect to incur significant losses in the future. We incurred net losses of $115.5 million for the year ended December 31, 2001, $55.6 million for the year ended December 31, 2000 and $28.6 million for the year-ended December 31, 1999. We expect to continue to have significant research and development, sales and marketing, and general and administrative expenses. In addition, we expect to incur significant expenses related to the patent litigation we initiated against Microsoft. As a result of these expenses, we must significantly increase our revenues to become profitable. We expect to incur significant losses for at least the foreseeable future.
 
We need to significantly increase the number of companies that license our product and/or our intellectual property to sustain and grow our business.
 
We may not generate sufficient revenue to grow our business unless we license our Rights|System product suite and/or intellectual property to a significant number of new partners and customers.

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At December 31, 2001 we had not yet attracted, and may not in the future be able to attract, a sufficient number of these companies. As of December 31, 2001, no companies had licensed our complete Rights|System product and only seven companies had licensed certain Rights|System components for commercial use. As of December 31, 2001, there has been limited commercial deployment of certain Rights|System components. Our ability to attract new Rights|System licensees will depend on a variety of factors, including the following:
 
 
 
the performance, reliability, functionality, and security of our Rights|System products and services;
 
 
 
the scalability of our Rights|System 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;
 
 
 
competition, particularly from Microsoft;
 
 
 
the growth in demand for DRM products;
 
 
 
the cost-effectiveness of our Rights|System products and services; and
 
 
 
our ability to market our Rights|System products and services effectively.
 
As of December 31, 2001, no companies had licensed our patents independent of technology or product licenses. Our ability to license our patents will depend on a variety of factors including the following:
 
 
 
third party deployment of products and services incorporating DRM or other trusted computing technology;
 
 
 
our ability to describe our patents effectively;
 
 
 
the outcome of our litigation against Microsoft and any other litigation or other proceeding that could affect our intellectual property; and
 
 
 
the outcome of our on-going patent prosecution efforts as well as our ability to continue filing for additional patents.
 
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 which we attempt to protect through a combination of patent, copyright, trade secret, and trademark laws, as well as confidentiality procedures and contractual provisions. These legal protections afford only limited protection and may be time consuming and expensive. Furthermore, despite our efforts, we may be unable to prevent third parties from infringing upon or misappropriating our intellectual property. Also, our competitors may independently develop similar, but not infringing, technology, duplicate our products, or design around our patents or our other intellectual property.
 
Our patent applications or trademark registrations may not be approved. Moreover, even if approved, the resulting patents or trademarks may not provide us with any competitive advantage or may be challenged by third parties. If challenged, our patents might not be upheld or their claims could be narrowed. Any litigation surrounding our rights could force us to divert important financial and other resources away from our business operations. In addition, we license our products internationally, and the laws of many countries do not protect our proprietary rights as well as the laws of the United States.
 
On April 26, 2001, we filed a lawsuit against Microsoft Corporation in the United States District Court for the Northern District of California alleging that certain Microsoft technology infringes our United Stated Patent No. 6,185,683. Through subsequent procedural motions and an additional complaint, the lawsuit has been expanded to include the following additional seven InterTrust United States patents: United States Patent No. 6,253,193, United States Patent No. 5,920,861, United States Patent No. 5,940,504, United States Patent No. 5,892,900, United States Patent No. 5,982,891, United States Patent No. 5,917,912 and United States Patent

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No. 6,157,721. On September 17, 2001, Microsoft filed an answer denying all the allegations asserted in our original complaint. In addition, the answer included a counterclaim asserting that InterTrust infringes United States Patent No. 6,049,671 and United States Patent No. 6,256,668. These two Microsoft patents relate to the downloading of software.
 
The legal proceedings are in the early stages and while the litigation is pending, significant financial resources and management attention will be diverted for this purpose. Discovery has started in the case and the parties have exchanged initial document production and infringement contentions. On November 1, 2001 Microsoft filed a Motion for Partial Summary Judgment of Non-Infringement of United States Patent No. 5,940,504. By order, the motion for Partial Summary Judgment was denied on February 8, 2002 without prejudice and Microsoft has subsequently filed a Renewed Motion for Partial Summary Judgment on February 22, 2002.
 
There is no assurance that we will be successful in this lawsuit against Microsoft, and an overall unfavorable result would have a significant adverse affect on our results of operations by reducing the value of our proprietary technology and patent assets and reducing demand for our products and licenses to our patents.
 
Our operating results have been and may continue to be harmed if our licensees or potential licensees suffer from downward economic cycles.
 
Our ability to license our product or intellectual property depends on the economic strength and budgetary cycles of potential licensees. Our licensees may currently or in the future face unfavorable market conditions and budgetary pressures. In the past, some of our licensees have defaulted on their payment obligations to us and others might default in the future. This may be disruptive to our business and may adversely affect our business, financial condition and results of operations.
 
The long and complex process of licensing our products could delay the deployment of our technology and harm our business.
 
As Rights|System is a new DRM platform and product suite, the process of licensing Rights|System products may be long and complex. Initial license fees could be delayed or reduced as a result of this process, and our future revenue and operating results could be impaired. Before committing to license our products, our licensees will 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, reliability, and price. The process of entering into a licensing agreement with a customer has historically involved lengthy negotiations, and we do not know the length of the sales cycle relating to our new Rights|System products. As a result it is difficult for us to predict the quarter in which a particular prospective customer might sign a license agreement. In addition, in some cases we may develop specific software applications for our licensees. We cannot predict if we will deliver these applications in a timely manner or at all.
 
We are dependent on international sales which subject us to a variety of risks.
 
We received approximately 50% of our total revenues in the year ended December 31, 2001, 45% of our total revenues in 2000 and 61% of our total revenues in 1999 from sales to customers located outside the United States. Our international business activities are subject to a variety of risks, including the adoption and changes of laws, actions by third parties and political and economic conditions that could restrict or eliminate our ability to do business in certain jurisdictions. Although we currently transact business in U.S dollars, if we transact business in foreign currencies in the future, we will become subject to the risks associated with transacting in foreign currencies, including potential negative effects of exchange rate fluctuations. To date, we have not adopted a hedging program to protect from risks associated with foreign currency fluctuations.

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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, slow our growth or otherwise seriously harm our business and results of operations.
 
Because our technology must be integrated into the products and services of our licensees, there could be significant delay between licensing and our licensees’ commercial deployment of products and services, which in part could delay our ability to recognize revenue from our licenses.
 
Our success depends upon the deployment of our product by a potential licensee in the use and sale of digital content. Our licensees may undertake a lengthy process of integrating our product into their existing systems or a new system. The integration often requires re-engineering of a licensee’s business processes, which may delay the deployment of our product. Depending on the terms of the product license, we may not be able to recognize revenue until a licensee deploys our product commercially,
 
We expect that the period between entering into a licensing arrangement and the time our licensee commercially deploys applications based on our software could be lengthy and will vary, which may make it difficult for us to predict when revenue will be recognized.
 
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.
 
We do not expect our Commerce licensees to continue commercial development of products and services based on the Commerce platform, however, it is possible that we or our licensees may uncover serious technical and other problems with existing commercial deployments, including problems relating to security, the ability to support a large user base, and interoperability of our Commerce software or the combination of our Commerce software with our licensees’ software. Our new Rights|System product has not been commercially deployed by any customers. As we continue to develop the Rights|System products it is possible that we or one of our partners or customers may uncover serious technical and other problems with those products. We may not successfully address any of these problems and the failure or delay to do so would seriously harm our business and operating results.
 
If our or our licensees’ products and services contain errors or defects not discovered in the process of development and pilot programs, it could seriously undermine the perceived trust and security needed for a commercial system and could delay or prevent market acceptance of digital commerce resulting in serious harm to our business and operating results.
 
The deployment and use of our products expose us to substantial risks of product liability claims because our products are expected to be used in sensitive and valuable digital commerce transactions, and because we require our partners to comply with our specifications. Although our license agreements typically contain provisions designed to limit our exposure to product liability claims, it is possible that these limitations of liability provisions may not be effective as a result of existing or future laws or unfavorable judicial decisions. A product liability claim brought against us, even if not successful, would likely be time consuming and costly to defend and could significantly harm our business and operating results.

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If we are unable to continue obtaining third-party software and applications, we could be forced to change our product offering or find alternative suppliers, which could delay shipment of our product.
 
We integrate third-party software with our software. We would be seriously harmed if the providers from which we license software ceased to deliver and support reliable products, enhance their current products, or respond to emerging industry standards. In addition, the third-party software may not continue to be available to us on commercially reasonable terms or at all. The loss of, or inability to maintain or obtain this software, could result in shipment delays or reductions, or could force us to limit the features available in our current or future product offerings. Either alternative could seriously harm our business and operating results.
 
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 software and other products that offer features and functionality that we do not currently provide. Any delays in our ability to develop and release enhanced or new products could seriously harm our business and operating results. In the past we have experienced delays in new product releases, and we may experience similar delays in the future.
 
In particular, a large portion of our resources is focused on our new Rights|System platform, which we believe is important to meeting our customer and market demands. Delays in our ability to enhance and release the Rights|System software could seriously harm our operating results.
 
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. Competition, particularly from Microsoft, is very strong, and we expect this competition to persist and intensify in the future. Our failure to build our competitive position will cause our revenues to grow more slowly than anticipated or not at all, and we may be unable to build sufficient market share. We encounter current or potential competition from a number of sources, including:
 
 
 
Dominant platform providers providing DRM features:    Companies such as Microsoft and RealNetworks offer DRM functionality as part of their overall platform value proposition. Customers who buy these platforms may choose to work with the built in DRM features.
 
 
 
Conditional access technology providers:    In digital television, security providers providing access control technology including NDS, Nagra Vision and Canal+ Technologies may develop DRM capabilities.
 
 
 
Component providers with secure digital distribution technology, including IBM, Lockstream, and Sealed Media.
 
 
 
Companies offering hardware-based content metering and copy protection systems, including Sony and the 4C Entity, comprised of IBM, Intel, Matsushita, and Toshiba. We believe that Sony is continuing its development of its MagicGate DRM technology and this technology may be adopted by a number of important technology companies.
 
Potential competitors may bundle their products or incorporate a digital rights management component into existing products in a manner that discourages users from purchasing our products. For example, Microsoft’s Windows operating system, which manages the programs on a computer, includes components addressing digital

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rights management functions. Furthermore, new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements than we do.
 
Some of our competitors have longer operating histories and significantly greater financial, technical, marketing, and other resources than we do. Many of these companies have more extensive customer bases and broader partner relationships that they could leverage, including relationships with many of our current and potential partners. These companies also have significantly more established customer support and professional services organizations than we do. In addition, these companies may adopt aggressive pricing policies.
 
Any acquisitions that we make could disrupt our business and harm our operating results.
 
We have made acquisitions of and investments in other companies in the past, and we may continue to acquire or make investments in complementary companies, products or technologies. In the event of any such investments, acquisitions or joint ventures, we could:
 
 
 
issue stock that would dilute our current stockholders’ percentage ownership;
 
 
 
incur debt;
 
 
 
assume liabilities; or
 
 
 
incur large and immediate write-offs. For example, in 2001 we incurred an $10.0 million charge for the impairment of goodwill and other intangible assets derived from the acquisition of PublishOne, Inc.
 
These investments, acquisitions or joint ventures also involve numerous risks, including:
 
 
 
problems combining the purchased operations, technologies or products with ours;
 
 
 
unanticipated costs;
 
 
 
diversion of management’s attention from our core business;
 
 
 
adverse effects on existing business relationships with suppliers and customers;
 
 
 
potential loss of key employees, particularly those of the acquired organizations; and
 
 
 
reliance to our disadvantage on the judgment and decisions of third parties and lack of control over the operations of a joint venture partner.
 
Any acquisition or joint venture may cause our financial results to suffer as a result of these risks.
 
We and our licensees may be found to infringe proprietary rights of others, resulting in litigation, redesign expenses, or costly licenses.
 
Digital rights management is an emerging field in which our competitors may obtain patents or other proprietary rights that would prevent, or limit or interfere with, our, or our licensees’, ability to make, use, or sell products. Furthermore, companies in the software market are increasingly bringing suits alleging infringement of their proprietary rights, particularly patent rights. We and our licensees could incur substantial costs to defend or settle any litigation, and intellectual property litigation could force us to do one or more of the following:
 
 
 
cease selling, incorporating, or using products or services that incorporate the infringed intellectual property;
 
 
 
obtain a license from the holder of the infringed intellectual property right;
 
 
 
redesign products or services to avoid infringement; or
 
 
 
cross-license our patents with the party alleging infringement.

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Our or our licensees’ products and services may be subject to a claim of patent infringement independent of any infringement by our software.
 
In the past, we have received notices alleging potential infringement by us of the proprietary rights of others. In January 1996, we received a letter from an attorney representing E-Data Corporation containing an allegation of infringement of a patent E-Data allegedly owns. We exchanged correspondence with E-Data’s attorneys ending in September 1996. We have not heard from any representative of E-Data since that time. In November 1997, we received a letter from representatives of TAU Systems Corporation informing us of two patents held by TAU Systems. In the letter, the representatives stated their opinion that our Commerce software contained various elements recited in the two patents and requested that we discuss licensing the technology of these patents. We responded to the letter stating that, although we had not undertaken a detailed review of the patents, we were unaware of any of our products having one of the elements required by the patent claims. TAU Systems has made no further allegations regarding our software, but representatives of TAU Systems have recently contacted us regarding a sale or exclusive license of TAU System’s patents. In May 1999, we received a letter from representatives of TechSearch LLC offering us a license to a patent held by TechSearch. We have reviewed the patent and do not believe that we need to obtain a license to this patent. In the future, however, we or our licensees could be found to infringe upon the patent rights of E-Data, TAU Systems, TechSearch, or other companies.
 
To successfully license our product and our intellectual property 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. 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. Further, competition for qualified sales and marketing personnel is intense. We may not be able to hire enough qualified individuals in the future or in a timely manner. New employees require extensive training and typically take at least four to six months to achieve full productivity. Although we provide compensation packages that include stock options, cash incentives, and other employee benefits, the volatility and current market price of our stock may make it difficult for us to attract, assimilate, and retain highly qualified employees. For example, due to the current volatility of our stock price, some of our employees hold options with exercise prices well above the current fair market value of our stock.
 
Failure to appropriately manage the size of our organization could seriously harm our business and operating results.
 
Any failure to manage the size of our organization effectively could seriously harm our business and operating results. On January 31, 2002, we announced plans to reduce our workforce by approximately 45% in order to reduce costs and increase efficiency. Prior to this announcement, our headcount had been reduced from a high of 358 in February 2001 to approximately 188 as of December 31, 2001. These reductions in our workforce may negatively affect moral and result in qualified employees leaving InterTrust. 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.
 
Our stock price has been volatile in the past and is likely to continue to be volatile.
 
The market price of our common stock has been volatile in the past and is likely to continue to be volatile. In addition, the securities markets in general, and Internet stocks in particular, have experienced significant price volatility, and accordingly the trading price of our common stock is likely to be affected by this activity.

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We are subject to securities class action litigation which may harm our business and results of operations.
 
In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We are a party to the securities class action litigation described in Part II, Item 1—“Legal Proceedings” of this Report on Form 10-K for the year ended December 31, 2001. The defense of such litigation may increase our expenses and divert our management’s attention and resources, and an adverse outcome in this litigation could seriously harm our business and results of operations. In addition, we may in the future be the target of other securities class action or similar litigation.
 
We have implemented anti-takeover provisions that could make it more difficult to acquire us.
 
Our sixth amended and restated certificate of incorporation, our amended and restated bylaws, and Delaware law contain provisions that could make it more difficult for a third party to acquire us, even if its doing so would be beneficial to our stockholders. These provisions include:
 
 
 
authorizing the issuance of shares of undesignated preferred stock without a vote of stockholders;
 
 
 
prohibiting stockholder action by written consent; and
 
 
 
limitations on stockholders’ ability to call special stockholder meetings.
 
In addition, we have implemented a stockholders’ rights plan. Under the plan, rights were distributed as a dividend at the rate of one right for each share of InterTrust common stock held by stockholders of record as of the close of business on June 28, 2001. The plan is designed to protect stockholders in the event of an unsolicited attempt to acquire InterTrust and could make it more difficult for a third party to acquire us, even if its doing so would be beneficial to our stockholders.
 
Stockholders may incur dilution as a result of future equity issuances.
 
We have in the past and may in the future issue equity securities to our licensees and customers. If we issue additional equity securities, stockholders may experience dilution, and the new equity securities could have rights senior to those of existing holders of our common stock.
 
Stockholders may also experience dilution due to stock options or other securities granted to employees for compensation.
 
Industry-Related Risks
 
We have not received and may not in the future 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 digital commerce will drive demand for our product and demand for licensing our patents, 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 wireless and cable networks, 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;

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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 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 2.    PROPERTIES
 
On December 31, 2001, our principal administrative, sales, marketing, and research and development facilities occupied approximately 65,000 square feet in Santa Clara, California under one lease that terminates in September 2004. We lease office space for research and development facilities in Portland, Oregon under a lease that terminates in August 2005 occupying approximately 9,000 square feet. We also lease office space for research and development facilities in Princeton, New Jersey under a lease that terminates in April 2006 occupying approximately 3,500 square feet. Additionally, we lease the following space, which we no longer occupy due to the organizational restructuring that occurred during the three months ending December 31, 2001: 8,413 square feet in San Francisco, California, 8,555 square feet in Portland, Oregon, 58,000 square feet in Santa Clara, California, and 6,174 square feet in Princeton, New Jersey which terminate in March 2005, September 2005, August 2004, and April 2006, respectively. Furthermore, we lease 9400 square feet in Billerica, Massachusetts, which we occupied on December 31, 2001, but will vacate by June 30, 2002 pursuant to the restructuring program initiated in the three months ended December 31, 2001. The lease terminates in July 2005. InterTrust International, our wholly-owned subsidiary, has an office located in London, England.

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ITEM 3.    LEGAL PROCEEDINGS
 
On April 26, 2001, we filed a lawsuit against Microsoft Corporation in the United States District Court for the Northern District of California alleging that certain Microsoft technology infringes our United Stated Patent No. 6,185,683. Through subsequent procedural motions and an additional complaint, the lawsuit has been expanded to include the following additional seven InterTrust United States patents: United States Patent No. 6,253,193, United States Patent No. 5,920,861, United States Patent No. 5,940,504, United States Patent No. 5,892,900, United States Patent No. 5,982,891, United States Patent No. 5,917,912 and United States Patent No. 6,157,721.On September 17, 2001, Microsoft filed an answer denying all the allegations asserted in our original complaint. In addition, the answer included a counterclaim asserting that InterTrust infringes United States Patent No. 6,049,671 and United States Patent No. 6,256,668. These two Microsoft patents relate to the downloading of software and we do not believe that these patents are significant to our business.
 
The legal proceedings are in the early stages and while the litigation is pending, significant financial resources and management attention will be diverted for this purpose. Discovery has started in the case and the parties have exchanged initial document production and infringement contentions. On November 1, 2001 Microsoft filed a Motion for Partial Summary Judgment of Non-Infringement of United States Patent No. 5,940,504. By order, the motion for Partial Summary Judgment was denied on February 8, 2002 without prejudice and Microsoft has subsequently filed a Renewed Motion for Partial Summary Judgment on February 22, 2002.
 
There is no assurance that we will be successful in this lawsuit against Microsoft, and an unfavorable result would have a significant adverse affect on our results of operations by reducing the value of our proprietary technology and reducing demand for our products.
 
Between May 17, 2001 and June 7, 2001, ten complaints were filed in the United States District Court for the Southern District of New York naming InterTrust, certain of its current and former directors ad officers, and the members of the underwriting syndicate involved in InterTrust’s initial public offering and/or secondary public offering as defendants in multiple class action lawsuits. The lawsuits seek unspecified monetary damages and certification of a plaintiff class consisting of all persons who acquired shares of InterTrust between October 26, 1999 through May 16, 2001. The complaints allege, among other things, that InterTrust and the other defendants named in the complaints violated the federal securities laws by issuing and selling InterTrust common stock in our initial public offering in October 1999 and our secondary public offering in April 2000 without disclosing to investors that certain of the underwriters in the offering allegedly solicited and received excessive and undisclosed commissions from certain investors. There is no assurance that we will be successful in the defense of this lawsuit, and an unfavorable result could have a significant adverse affect on our financial position, results of operations, and cash flows.
 
On December 17, 2001, Equiserve Limited Partnership sued InterTrust in the United States District Court for the Southern District of New York, thus bringing InterTrust (as a third-party defendant) into a pending case between plaintiff Fabrizio Caffarelli et al. and defendants Citibank, N.A. and Equiserve. In the original case, the Caffarelli plaintiffs are seeking approximately $13 million in damages arising out of Citibank’s and Equiserve’s alleged two month delay in removing the restrictive legends from the Caffarelli plaintiff’s stock certificates. In the new case, Equiserve has alleged that InterTrust negligently failed to timely deliver an opinion of counsel letter to Equiserve that was necessary for Equiserve to remove the restrictive legends from the Caffarelli Plaintiff’s stock certificates. As a result, Equiserve has alleged that, to the extent Equiserve is held liable for any damages to the Caffarelli plaintiffs in the original case, InterTrust is liable to Equiserve for such damages. InterTrust has reviewed copies of the complaints and has conducted a preliminary factual analysis. Based on this review and analysis, InterTrust presently believes that there was no delay on InterTrust’s part in rendering the opinion of counsel letters. Accordingly, the Company believes that the allegations against it are wholly without merit and intends to defend the case vigorously. There is no assurance that we will be successful in the defense of this lawsuit, and an unfavorable result could have a significant adverse affect on our financial position, results of operations, and cash flows.

21


 
ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
The 2001 Annual Meeting of Stockholders was held on November 27, 2001. The stockholders elected Victor Shear, David Lockwood, Edmund J. Fish, David C. Chance, Bruce Fredrickson, Satish K. Gupta, Patrick S. Jones and Timo Ruikka to the Board of Directors to serve as on the Board of Directors until the 2002 Annual Meeting of Stockholders or until their successors are elected and qualified. The stockholders were also asked to vote to ratify the appointment of Ernst & Young LLP as the Company’s independent auditors for the fiscal year ending December 31, 2001. 77,327,912 votes were cast in favor of the appointment, 162,421 votes were cast against the appointment and 30,000 votes were cast to abstain.

22


 
PART II
 
ITEM 5.
 
MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
Our common stock is traded on the Nasdaq National Market under the symbol ITRU. The following table sets forth, for the periods indicated, the low and high bid prices per share for our common stock as reported by the Nasdaq National Market.
 
    
Low

  
High

Fiscal 2000
             
First Fiscal Quarter
  
$
44.63
  
$
97.47
Second Fiscal Quarter
  
$
15.63
  
$
49.88
Third Fiscal Quarter
  
$
11.81
  
$
22.94
Fourth Fiscal Quarter
  
$
3.38
  
$
11.00
Fiscal 2001
             
First Fiscal Quarter
  
$
2.83
  
$
7.63
Second Fiscal Quarter
  
$
1.04
  
$
4.44
Third Fiscal Quarter
  
$
0.66
  
$
1.41
Fourth Fiscal Quarter
  
$
0.98
  
$
1.53
 
As of December 31, 2001, there were approximately 578 holders of record of our common stock.
 
No dividends have been paid on our common stock. We currently intend to retain all future earnings, if any, for use in our business and do not anticipate paying any cash dividends on our common stock in the foreseeable future.
 
Recent Sales of Unregistered Securities
 
During the quarter ended March 31, 2001, we issued 1,130,000 shares of common stock to the stockholders of PublishOne, Inc. for the purchase of all of the outstanding securities of PublishOne, Inc. We also assumed options to purchase 1,155,221 shares of InterTrust common stock at a fair value of $4.84 per share, per the merger agreement.            
 
During the quarter ended March 31, 2001, we sold 4,000,000 shares of common stock at $5.00 per share to Nokia Finance International B.V., a subsidiary of Nokia Corporation (“Nokia”), for total cash consideration of $20,000,000. Additionally, per the stock acquisition agreement, we have appointed an executive officer of Nokia to our Board of Directors.
 
During the quarter ended September 30, 2001, we issued 500,000 shares of common stock to the stockholders of ZeroGravity Technologies Corporation in addition to $510,000 in cash for the purchase of all of the outstanding securities of ZeroGravity Technologies Corporation. In addition, we assumed outstanding Zero Gravity employee stock options equivalent to approximately 60,000 shares of our common stock at a fair value of $0.98 per share.
 
The above 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.

23


 
Use of Proceeds
 
On April 12, 2000 we completed a public offering in which we sold 2,645,000 shares of common stock at $35 per share pursuant to a Registration Statement on Form S-1 (File No. 333-32484) that was declared effective on April 6, 2000. 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 $6.4 million resulting in net proceeds $92.3 million.
 
On November 1, 1999, we completed our initial public offering, in which we sold 13,000,000 shares of common stock at $9 per share pursuant to a Registration Statement on Form S-1 (File No. 333-84033) that was declared effective on October 26, 1999. Additionally, we sold 1,950,000 shares of common stock at $9 per share in connection with the exercise of the underwriters’ over-allotment option. The total aggregate proceeds from these transactions were $134.6 million. Underwriters’ discounts and other related costs were approximately $11.2 million resulting in net proceeds $123.4 million.
 
The net proceeds were used for working capital and general corporate purposes. The remaining proceeds were predominantly held in cash, cash equivalents and marketable securities at December 31, 2001.

24


 
ITEM 6.    SELECTED FINANCIAL DATA
 
The following selected consolidated financial data should be read in conjunction with, and are qualified by reference to, the consolidated financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere in this Form 10-K. The consolidated statements of operations data for the years ended December 31, 2001, 2000 and 1999, and the consolidated balance sheet data at December 31, 2001 and 2000 are derived from our audited consolidated financial statements included in this Form 10-K. The consolidated statements of operations data for the years ended December 31, 1998 and 1997, and the consolidated balance sheet data at December 31, 1999, 1998 and 1997 are derived from our audited consolidated financial statements not included in this Form 10-K. The historical results are not necessarily indicative of future results.
 
    
Year Ended December 31,

 
    
2001

    
2000

    
1999

    
1998

    
1997

 
    
(in thousands, except per share data)
 
Consolidated Statement of Operations Data:
                                            
Revenues:
                                            
Licenses
  
$
6,079
 
  
$
4,150
 
  
$
778
 
  
$
—  
 
  
$
1,000
 
Software support and training
  
 
1,361
 
  
 
3,149
 
  
 
613
 
  
 
152
 
  
 
100
 
Services
  
 
973
 
  
 
244
 
  
 
150
 
  
 
—  
 
  
 
—  
 
Hardware
  
 
12
 
  
 
445
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
    


  


  


  


  


Total revenues
  
 
8,425
 
  
 
7,988
 
  
 
1,541
 
  
 
152
 
  
 
1,100
 
Cost of revenues:
                                            
Licenses
  
 
430
 
  
 
436
 
  
 
141
 
  
 
—  
 
  
 
—  
 
Software support and training
  
 
1,245
 
  
 
910
 
  
 
470
 
  
 
191
 
  
 
102
 
Services
  
 
5,624
 
  
 
3,670
 
  
 
436
 
  
 
—  
 
  
 
—  
 
Hardware
  
 
840
 
  
 
445
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
    


  


  


  


  


Total cost of revenues
  
 
8,139
 
  
 
5,461
 
  
 
1,047
 
  
 
191
 
  
 
102
 
    


  


  


  


  


Gross profit (loss)
  
 
286
 
  
 
2,527
 
  
 
494
 
  
 
(39
)
  
 
998
 
Operating costs and expenses:
                                            
Research and development
  
 
34,864
 
  
 
24,475
 
  
 
16,472
 
  
 
13,041
 
  
 
8,287
 
Sales and marketing
  
 
18,551
 
  
 
18,539
 
  
 
6,886
 
  
 
3,870
 
  
 
2,717
 
General and administrative
  
 
17,090
 
  
 
9,890
 
  
 
5,588
 
  
 
2,717
 
  
 
1,932
 
Purchased in-process research and development
  
 
567
 
  
 
6,100
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
Amortization of goodwill and other intangibles
  
 
5,389
 
  
 
3,004
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
Amortization of deferred compensation
  
 
2,273
 
  
 
3,326
 
  
 
1,704
 
  
 
—  
 
  
 
—  
 
Impairment of goodwill and other intangible assets
  
 
31,908
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
Restructuring and other
  
 
11,236
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
    


  


  


  


  


Total operating costs and expenses
  
 
121,878
 
  
 
65,334
 
  
 
30,650
 
  
 
19,628
 
  
 
12,936
 
    


  


  


  


  


Loss from operations
  
 
(121,592
)
  
 
(62,807
)
  
 
(30,156
)
  
 
(19,667
)
  
 
(11,938
)
Interest and other income, net
  
 
9,380
 
  
 
10,867
 
  
 
1,876
 
  
 
5
 
  
 
229
 
Loss on debt and equity investments
  
 
(3,246
)
  
 
(3,699
)
  
 
—  
 
  
 
—  
 
  
 
—  
 
Provision for foreign income taxes
  
 
—  
 
  
 
(2
)
  
 
(325
)
  
 
—  
 
  
 
—  
 
    


  


  


  


  


Net loss
  
$
(115,458
)
  
$
(55,641
)
  
$
(28,605
)
  
$
(19,662
)
  
$
(11,709
)
    


  


  


  


  


Basic and diluted net loss per share
  
$
(1.24
)
  
$
(0.66
)
  
$
(0.71
)
  
$
(0.70
)
  
$
(0.43
)
    


  


  


  


  


Shares used in computing the net loss per share
  
 
93,021
 
  
 
84,016
 
  
 
40,426
 
  
 
27,932
 
  
 
27,278
 
    


  


  


  


  


    
December 31,

 
    
2001

    
2000

    
1999

    
1998

    
1997

 
    
(in thousands)
 
Consolidated Balance Sheet Data:
                                            
Cash and cash equivalents and short term investments
  
$
126,701
 
  
$
158,518
 
  
$
140,834
 
  
$
5,575
 
  
$
1,884
 
Working capital
  
 
117,391
 
  
 
153,309
 
  
 
136,551
 
  
 
4,939
 
  
 
607
 
Total assets
  
 
144,593
 
  
 
226,873
 
  
 
151,497
 
  
 
8,280
 
  
 
3,111
 
Total stockholders’ equity (deficit)
  
 
124,611
 
  
 
207,348
 
  
 
133,352
 
  
 
(2,014
)
  
 
(847
)

25


 
ITEM 7.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following commentary should be read in conjunction with the financial statements and related notes contained elsewhere in this Form 10-K. The discussion contains forward-looking statements that involve risks and uncertainties. These statements relate to future events or our future financial performance. In many cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “intend” or “continue,” or the negative of such terms and other comparable terminology. These statements are only predictions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including, but not limited to, those set forth under “Risk Factors” and elsewhere in this Form 10-K.
 
Overview
 
Since our founding in 1990, we have invented and defined technologies for Digital Rights Management, or DRM, including various trusted computing technologies that enable secure management of digital processes and information. InterTrust was formed and incorporated in January 1990. From inception through 1998, our efforts were principally devoted to research and development, raising capital, recruiting personnel, and establishing licensing relationships. As a result, we were considered a development stage enterprise during this period. The general availability version of our Commerce software, our first generation DRM product, was delivered to our partners in December 1998, and some partners began using the technology on a limited commercial basis in January 2000. We are currently transitioning from our Commerce software product to our second generation DRM product, Rights|System. Rights|System is a scaleable multi-device, multi-platform DRM solution, and is designed to protect digital information, apply rules persistently after information is distributed, and automate many of the commercial consequences of using the information. Rights|System is designed to manage a broad range of rights across a variety of digital information, media, and device types. In addition, we have a patent portfolio of 23 issued and nearly 90 patents pending worldwide relating to protecting electronic rights and content, enabling secure electronic transactions, applying DRM and component security technologies in the digital economy, trusted computing, and next generation computing platforms. We plan on licensing, as appropriate, our patent rights to customers who wish to build or operate their own DRM infrastructure.
 
Critical Accounting Policies and Estimates
 
Our discussion and analysis of our financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, impairment of long-lived assets and contingencies. We base our estimates on historical experience and on various other market specific assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
 
We believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements:
 
Revenue Recognition
 
Most of our sales are generated from complex arrangements, which require significant revenue recognition judgments particularly in the areas of the delivery of specific functionality and collectibility. The assessment of collectibility is particularly critical in determining whether or not revenue should be recognized in the current market environment.

26


We recognize revenue in accordance with Statement of Position 97-2, Software Revenue Recognition, as amended by Statements of Position 98-9, Modifications of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions. We recognize revenue from license fees, clearinghouse services, development services, transaction fees, software support and training services, and the sale of chips containing its DRM. License revenue, net of any discounts granted, is recognized after execution of a license agreement and delivery of the product, provided there are no remaining obligations relating to development, upgrades, new releases, or other future deliverables, and provided that the license fee is fixed or determinable, and collection of the fee is probable. We allocate revenue between the elements of the arrangements, including the license, software support and training services, and the rights to unspecified upgrades and new releases based on the vendor specific evidence of the fair value of each of the elements. If we do not have vendor specific objective evidence of the fair value of the undelivered elements, license revenue is deferred for the delivered elements. 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 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 specified upgrades and does not have vendor specific objective evidence of fair value of the specified upgrade, all of the license revenue is deferred until the specified upgrade has been delivered. Upon delivery of the specified upgrade, license revenue is recognized using the subscription method.
 
When a license agreement is terminated pursuant to the original terms of the agreement, we will recognize the entire deferred revenue balance as of the date of termination. For other contract terminations, the remaining deferred revenue balance is recorded as other income.
 
Revenue Sources From Prior Years
 
We currently derive substantially all our revenues from license fees for transactions entered into in past quarters that are related to our Commerce software, associated software support and training services, and professional services. In addition, our existing Commerce software license agreements generally required 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. To date, we have not derived any transaction fees associated with the license of our Commerce software. While we will continue to provide support for our Commerce software licensees, we have announced that we will be making no future enhancements to the Commerce software. As a result, we believe that existing partners will transition to our Rights|System product and we expect that our Commerce licensees will choose to not commercially deploy the Commerce software. Therefore, we do not expect that any transaction fees will be generated from the use of the Commerce software. We had $6.1 million in license revenue in 2001, of which $5.7 million represents the amortization of deferred revenue from previous years.
 
Licenses of our Commerce software generally required 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 Commerce license agreements generally included the right to obtain access to upgrades and new releases of Commerce software, 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 with delivery of the licensed product. In addition, under license agreements where we are obligated to provide a specified custom development deliverable and do not have vendor specific objective evidence of fair value of the specified deliverable, all of the license revenue is deferred until the specified upgrade has been delivered. Upon delivery of the specified deliverable, license revenue is recognized using the subscription method. We began recognizing revenue under some license

27


agreements in January 1999, after shipping the general availability version of our Commerce software at the end of December 1998. At December 31, 2001, we had approximately $7.4 million of deferred license revenue.
 
Our Commerce license agreements also required the payment of a transaction fee that is a percentage of revenues received by our partners from transactions and services that use our technology and sales of products incorporating our Commerce technology. To date, we have not recognized any material transaction fees from commercial transactions or services, or sales of products using our Commerce software.
 
Software support and training services, which typically include the right to telephone and online support and customer training, are generally provided for in the Commerce software license agreements for an agreed-upon amount. Software support and training service revenue is recognized over the period in which the services are provided. Because we are not currently providing support for our Commerce software we do not expect to recognize significant future support fees in connection with our Commerce software licenses entered into in past quarters.
 
TrustNet clearinghouse service revenues represent service fees for the use of our TrustNet clearinghouse infrastructure to pilot and test applications and services using our Commerce software. Service revenues 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, system integration fees, and monthly service fees are recognized over the term of the service period. We do not expect material TrustNet clearinghouse service revenues in the future.
 
Professional services represent fees for consulting services provided to our customers for development and system integration not essential to the functionality of the software licensed. The revenue from these services is recognized as the service obligations related to each agreement are fulfilled.
 
PricewaterhouseCoopers, National Computer Systems of Singapore and National Westminster Bank accounted for 19%, 18% and 10% of total revenues respectively, in 2001. National Computer Systems of Singapore, PricewaterhouseCoopers, and Bertelsmann accounted for 20%, 17%, and 8% of total revenues, respectively, in 2000.
 
Future Revenue Sources
 
In July 2001, we announced the development of Rights|System, our next generation DRM platform for content protection and management. Rights|System is a scaleable multi-device, multi-platform DRM solution, and is designed to protect digital information, apply rules persistently after information is distributed, and automate many of the commercial consequences of using the information. Rights|System is designed to manage a broad range of rights across a variety of digital information, media, and device types.
 
Rights|System has three basic component sets: packaging tools for content authors, server components for service providers, and client technology for the consumer device. Rights|System is designed to implement a range of DRM functions, including persistent protection of digital information of all types, and support for simple to complex business models. Using a single server architecture, Rights|System is designed to allow service providers to deliver secure content to a broad range of devices including personal computers, set top boxes, video recorders, mobile phones and communicators and consumer electronics devices.
 
While we have only recently announced the Rights|System product suite, several Rights|System components of the now completed product suite have previously been licensed to customers.
 
The Rights|System product suite was made available for shipment to customers during the three months ended December 31, 2001, however, we completed the first license of the entire product suite in the first quarter of 2002 and cannot predict the market response to and success of the Rights|System products. Our business development and sales efforts are focused on licensing the three basic components of the product suite under

28


terms that would require the payment of annual license fees for each component and an annual support contract that is a percentage of the listed annual license fee. The most material license revenue may come from the licensing of server components, which are currently being offered on a per central processing unit or CPU. The initial product release has two server components, the rights fulfillment server and the retail services server. Customers will be able to license an initial number of CPU licenses suitable for their anticipated service capacity requirements and then can purchase additional CPU licenses as their demand increases. We also offer professional services to our customers and partners to aid in implementation and integration of our Rights|System products into their environments. Rights|System licenses may require the payment of transaction fees, relating to the sale, lease, rental, or licensing of commercial content using the Rights|System products. Currently, the TrustNet clearinghouse does not support Rights|System customers and we will not derive any revenue from Rights|System-related TrustNet clearinghouse services.
 
In addition to our recent announcements concerning Rights|System, on October 31, 2001, we announced that we were commencing the licensing of our patent portfolio relating generally to protecting electronic rights and content, enabling secure electronic transactions, applying DRM and component security technologies in the digital economy, trusted computing, and next generation computing platforms. While we are currently engaged in discussions concerning licensing our patents, to date, we have not completed any patent license agreements and cannot predict if, when and under what terms licensing may occur.
 
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. As we are transitioning to our Rights|System product, we cannot make any predictions as to the demand for this product. Our business model has not succeeded in generating sufficient revenue to sustain our business. We also operate in an intensely competitive market for highly qualified technical, sales and marketing, and management personnel and periodically make salary and other compensation adjustments to retain and hire employees. As a result, we will need to generate significant additional revenue to achieve and maintain profitability. In addition, current economic conditions and limited visibility into customer demand makes prediction of our future revenues difficult. We expect to incur additional losses for at least the next several years.
 
Estimating Allowance for Doubtful Accounts.
 
We assess collectibility of accounts receivable for each of our customers at the onset of our relationship with that customer. This analysis includes a review of the credit worthiness of the customer, and a review of the customer’s financial statements, if available. For customers where collectibility is not reasonably assured, we defer revenue until cash is collected. Management analyzes accounts receivable and also analyzes historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in customer payment terms, and changes in customer demand when evaluating the adequacy of the allowance for doubtful accounts in any accounting period. Material differences may result in the amount and timing of revenue and or expenses for any period if management made different judgments or utilized different estimates. Because a number of licensees discontinued operations subsequent to licensing our software during the year-ended December 31, 2001, the Company recorded $1.8 million of bad debt expense compared to $198,000 during the year-ended December 31, 2000.
 
Impairment of Long-Lived Assets
 
We periodically review long-lived assets, certain identifiable intangible assets and goodwill related to these assets for impairment in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 121, “Accounting for the Impairment of Long-lived Assets and For Long-lived Assets to be Disposed Of.” Effective January 1, 2002, we adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long Lived Assets.” The statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supercedes SFAS No. 121. We do not expect the adoption of SFAS No. 144 to have a material impact on our financial position or results of operations.

29


 
For assets to be held and used, including acquired intangible assets, we initiate our review whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. Recoverability of an asset is measured by comparison of its carrying amount to the expected future undiscounted cash flows (without interest charges) that the asset is expected to generate. Any impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair market value. Significant management judgment is required in the forecasting of future operating results which are used in the preparation of projected discounted cash flows to determine fair value and should different conditions prevail, material write downs of net intangible assets and/or goodwill could occur.
 
It is reasonably possible that the estimates of anticipated future gross revenue, the remaining estimated economic life of the products and technologies, or both, could differ from those used to assess the recoverability of these costs and result in a write-down of the carrying amount or a shortened life of acquired intangibles in the future.
 
In 2002, the Financial Accounting Standards Board issued SFAS No. 142, “Goodwill and Other Intangible Assets” became effective and as a result, we will cease to amortize approximately $2.1 million of goodwill. In lieu of amortization, we are required to perform an initial impairment review of goodwill in 2002 and at least an annual impairment review thereafter. We expect to complete our initial review during the second quarter of 2002.
 
Acquisitions
 
On January 30, 2001, we acquired the remaining 92.1% of the outstanding shares and all of the outstanding stock options of PublishOne Inc. (“PublishOne”), a privately held company that develops online publishing software solutions and distribution services for business information publishers. Prior to the acquisition date, we owned approximately 7.9% of PublishOne’s outstanding stock. The transaction was accounted for as a purchase and the results of PublishOne’s operations have been included in the condensed consolidated financial statements from the date of acquisition. The purchase price was $16.9 million and consisted of 1,130,000 shares of InterTrust common stock at a fair value of $5.31 per share totaling $6.0 million, the assumption of stock options to purchase 1,155,221 shares of InterTrust common stock at a fair value of $4.84 per share totaling $5.6 million, assumed liabilities of $5.2 million including a lease obligation of $3.1 million in excess facilities, net of expected sublease income, and acquisition costs of approximately $250,000. The Company has paid $1.5 million against the acquired lease obligation during 2001 and has a liability for the remaining exposure of $2.6 million at December 31, 2001. The InterTrust options issued in connection with the assumption of the PublishOne option plan were valued using the Black-Scholes option pricing model assuming a volatility of 1.6, expected life of 4 years, risk-free interest rate of 6%, expected dividend yield of 0% and stock price of $5.31. Additionally, the agreement includes contingent consideration of 320,000 shares of InterTrust common stock to be issued upon the achievement of certain milestones. As of December 31, 2001 no milestones have been met and we do not expect these milestones to be met.
 
We allocated PublishOne’s purchase price based on the relative fair value of the net tangible and intangible assets acquired. We allocated $3.3 million to deferred compensation based upon the intrinsic value of unvested stock options at the date of acquisition. No amount was allocated to in-process research and development. The purchase price was allocated based on an independent valuation to tangible and intangible assets as follows (in thousands):
 
Tangible Assets
  
$
1,581
Purchased Technology
  
 
1,671
Acquired Workforce
  
 
1,452
Other Intangible Assets
  
 
610
Deferred Compensation
  
 
3,323
Goodwill
  
 
8,255
    

    
$
16,892
    

30


 
Goodwill, purchased technology and other intangible assets were originally being amortized on a straight-line basis over four years. The acquired workforce was originally being amortized on a straight-line basis over two years. See further discussion in “Impairment of Goodwill and Other Intangible Assets” below.
 
The fair value of the unvested common stock subject to restricted stock agreements and the intrinsic value of the unvested options held by employees was allocated to deferred stock compensation. The deferred stock compensation is being amortized to compensation expense over the remaining vesting term using a graded method. Due to terminations during the year ended 2001 InterTrust reversed $2.6 million in Deferred Compensation against Additional Paid in Capital. The amount reversed was based on the remaining balance in Deferred Compensation related to each employee at the date of termination.
 
On August 8, 2001, we acquired the remaining 81.1% of Zero Gravity Technologies Corporation (“Zero Gravity”), a developer of a policy-based secure email product. Prior to the acquisition date, we owned approximately 18.9% of Zero Gravity’s outstanding stock. The transaction was accounted for as a purchase and the results of Zero Gravity’s operations have been included in the consolidated financial statements from the date of acquisition. InterTrust paid $510,000 (net of cash received), issued 500,000 shares of InterTrust common stock at a fair value of $0.98 per share totaling $490,000, assumed liabilities of $198,000, and paid $2,000 in acquisition costs to acquire all of the shares of Zero Gravity that we did not already own. In addition, InterTrust assumed outstanding Zero Gravity employee stock options equivalent to approximately 60,000 shares of InterTrust common stock at a fair value of $0.98 per share totaling $59,000. The InterTrust options issued in connection with the assumption of the Zero Gravity options were valued using the Black-Scholes option pricing model assuming a volatility of 2.2, expected life of 9.3 years, risk-free interest rate of 6%, expected dividend yield of 0% and stock price of $0.98. The purchase price of $1,509,000 was allocated based on an internally prepared valuation as follows (in thousands):
 
Tangible Assets
  
$
111
In-Process Research and Development
  
 
567
Goodwill
  
 
831
    

    
$
1,509
    

 
Because this acquisition occurred subsequent to the issuance of SFAS No. 142, “Accounting for the Impairment of Long-lived Assets and For Long-lived Assets to be Disposed Of,” goodwill is considered to have an indefinite life and is not being amortized, and will be reviewed for impairment on an annual basis, or more frequently if impairment indicators arise.
 
Stock Option Exchange Program
 
On May 24, 2001, we announced a voluntary stock option exchange program for our employees. Under the program, our employees were given the opportunity to cancel outstanding stock options previously granted to them in exchange for an equal number of new options to be granted at a future date at least six months and a day from the cancellation date, which was June 22, 2001. We granted 2,229,214 stock options related to the program on January 2, 2002, and the exercise price was $1.22, which was equal to the fair market value of InterTrust’s common stock on that date. Such new options have terms and conditions that are substantially the same as those of the canceled options. The exchange program did not result in any additional compensation charges or variable plan accounting. Members of our board of directors, our officers and our senior executives were not eligible to participate in this program.

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Results of Operations
 
Years Ended December 31, 2001 and 2000
 
Revenues
 
Total revenues increased to $8.4 million in 2001 from $8.0 million in 2000. License fees, software support and training services, services revenue, and revenue from the sales of chips containing our technology accounted for 72%, 16%, 12%, and less than 1% of total revenues in 2001 and 52%, 39%, 3%, and 6% of total revenues in 2000. License revenues increased to $6.1 million in 2001 from $4.1 million in 2000, and represents the amortization of new and deferred license fees. This increase was primarily due to the recognition of deferred revenue totaling $5.7 million from agreements signed in prior years. In addition, we recognized $759,000 of revenue during 2001 relating to license agreements terminated during 2001. The amount recognized represents the remaining deferred revenue balances relating to terminated license agreements as of the dates of termination. The majority of this related to a licensee that declared bankruptcy during 2001, which triggered an automatic termination under the terms of the license agreement.
 
We entered into seven new product license agreements in 2001 for which we recognized revenue . However, no significant new license agreements were entered into during the quarters ended September 30, 2001 and December 31, 2001 due to the transition to our new software platform, Rights|System.
 
Revenues from software support and training services decreased to $1.4 million in 2001 from $3.1 million in 2000. This decrease was due to the expiration of a number of partner support agreements and the inability of many of our smaller licensees to pay amounts due under support agreements due to economic conditions in 2001. Although we anticipate deriving support revenue in the future from our Rights|System product licenses we do not expect to derive any support revenue from the license of any Rights|System products earlier than the second quarter of 2002.
 
Services revenue increased to $1.0 million in 2001 from $244,000 in 2000. Services revenue represents monthly service fees for TrustNet clearinghouse services, consulting and system integration services. The increase in services revenue was due to a greater number of consulting services performed in 2001. We may be offering consulting services in the future relating to the Rights|System product.
 
Revenue from the sale of chips containing our software totaled $12,000 in 2001 and $445,000 in 2000. This revenue was the result of chips sold to one customer under the terms of a short-term purchase agreement to provide chips for testing and trial production. We do not expect to derive any significant revenue from hardware sales in future periods.
 
Cost of Revenues
 
Cost of license revenue consists primarily of the costs incurred to manufacture, package, and distribute our products, related documentation and the amortization of purchased technology. Cost of license revenue was $430,000 in 2001 and $436,000 in 2000. Cost of license revenue is expected to fluctuate from period to period depending on the number of new partners, the number of software releases, and the amount of software documentation provided to our partners during the period.
 
Cost of software support and training revenue consists primarily of the cost of personnel, travel related expenditures, and training materials. Cost of software support and training revenue increased to $1.2 million in 2001 as compared to $910,000 in 2000. The increase in cost of software support and training represents the increase in support personnel required to provide technical assistance and training to our partners. Software support and training services costs are expected to fluctuate from period to period depending on the support requirements of our partners.

32


 
Cost of service revenue consists primarily of outside services, personnel, and equipment to operate our clearinghouse, as well as personnel costs to provide professional and consulting services. Costs of service revenue was $5.6 million in 2001 and $3.7 million in 2000. These increases are primarily attributable to investment in clearinghouse infrastructure, personnel and the costs of performing consulting engagements.
 
Cost of hardware revenue increased to $840,000 in 2001 from $445,000 in 2000. These costs are related to the purchase of chips from a third party, and the customization and transport of the chips. The costs in 2001 include a reserve for inventory in the amount of $823,000 due to cancellation of the supply agreement with one customer.
 
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 increased to $34.9 million in 2001 from $24.5 million in 2000. This increase was primarily attributable to a $6.8 million increase in personnel costs associated with both product research and development, primarily on Rights|System development, and a $1.8 million increase in facilities and related expenses, such as rent and utilities. We anticipate research and development expenses will decrease significantly in the future due to reductions in our workforce.
 
Sales and Marketing
 
Sales and marketing expenses consist of salaries and related expenses for personnel engaged in direct sales, partner development and marketing, public relations, and other marketing expenses. Sales and marketing expenses were $18.6 million in 2001 and $18.5 million in 2000. Sales and marketing expenses were flat in 2001 as compared to 2000, as increases to facilities and related costs and insurance expenses were offset by decreases in advertising, deployment programs and other marketing activities. We anticipate sales and marketing expenses will decrease significantly in the future due to the workforce reductions.
 
General and Administrative
 
General and administrative expenses consist primarily of salaries and related expenses for executive, legal, accounting and administrative personnel, outside professional service fees, and general corporate expenses. General and administrative expenses increased to $17.1 million in 2001 from $10.0 million in 2000. The increase was primarily attributed to a $2.0 million increase in personnel costs due to additional executive, legal and accounting personnel, a $2.4 million increase in legal expenses related to litigation activities, a $1.6 million increase in bad debt expense due to the inability of many of our smaller licensees to pay amounts due under support agreements because of the economic conditions in 2001 and, to a lesser extent, increases in insurance, and professional expenses. We expect general and administrative expenses to continue to increase as a result of litigation costs related to a claim of patent infringement we filed against Microsoft in April 2001.
 
Purchased In-Process Research and Development
 
In August 2001, we recorded $567,000 of purchased in-process research and development related to our acquisition of Zero Gravity Corporation. In March 2000, we recorded $6.1 million of acquired in-process research and development related to our acquisition of Infinite Ink Corporation. These acquisitions were accounted for under the purchase method of accounting in accordance with SFAS 141 “Business Combinations” and Accounting Principles Board Opinion No. 16 (“APB 16”).
 
The purchased in-process research and development relating to the Infinite Ink acquisition consisted of three projects to combine digital rights management with software system that would allow users to securely purchase and view published content on their personal computers. The projects in development were approximately 60%

33


complete at the time of acquisition and, following the acquisition, have been incorporated into our Commerce product. Revenues and operating profit attributable to the in-process research and development were estimated over a three-year projection period. The resulting projected cash flows were discounted to their present value using a discount rate of 30%, which was calculated based on the weighted average cost of capital, adjusted for the technology risk associated with the purchased in-process research and development. The technology risk was considered to be significant due to the rapid pace of technological change in the software industry.
 
The purchased in-process research and development relating to the Zero Gravity acquisition, specifically the secure email application, was 70% complete on the acquisition date. As of December 31, 2001, this technology remained 70% complete. The application was based on InterTrust’s Commerce product, and we chose to discontinue engineering activities aimed at transferring Zero Gravity’s application to the Rights|System platform. We do no expect to expend any resources on this activity in the future. Revenues and operating profit attributable to the in-process research and development were estimated over a four-year projection period. The resulting projected cash flows were discounted to their present value using a discount rate of 30%, which was calculated based on the weighted average cost of capital, adjusted for the technology risk associated with the purchased in-process research and development. The technology risk was considered to be significant due to the rapid pace of technological change in the software industry.
 
Amortization of Goodwill and Other Intangible Assets
 
Amortization of goodwill and other intangible assets was $5.4 million in 2001 as compared to $3.0 million in 2000. Amortization of goodwill and intangible assets is related to business acquisitions in 2000 and 2001 and the amortization of capitalized patent costs. The increase is due to higher goodwill and other intangible assets balances than in prior year related to business acquisitions.
 
Amortization of Deferred Compensation
 
Deferred compensation represents the difference between the exercise price of options granted to employees prior to our initial public offering in 1999 and the deemed fair value of our common stock for financial reporting purposes. Additionally, in conjunction with the acquisition of PublishOne, the fair value of the unvested common stock subject to lapsing rights of repurchase, and the intrinsic value of the unvested options held by PublishOne employees was allocated to deferred stock compensation. Deferred compensation is being amortized over the vesting periods of the options on a graded vesting method. This compensation expense relates to options awarded to individuals in all operating expense categories. During 2001 we recorded a reduction to the deferred compensation balance of $3.6 million due to employee terminations. We recognized approximately $2.3 million of related compensation expense in 2001 as compared to $3.3 million in 2000.
 
Impairment of Goodwill and Other Intangible Assets
 
During the second quarter of 2001, we identified indicators of possible impairment of our long-lived assets, principally goodwill and other acquired intangible assets. Such indicators included the slower than expected development of the Digital Rights Management (DRM) market, aggressive marketing efforts by our principal competitors, an overall decline in industry valuations and growth rates, and a strategy shift from the Company’s existing Commerce product platform to our new Rights|System product platform.
 
We determined that we had three categories of long-lived assets with attributable and identifiable cash flows: Commerce and related technology, Rights|System technology, and PublishOne services. Commerce and related technology long-lived assets include goodwill and other intangible assets recorded in connection with the Company’s acquisitions of Infinite Ink in March 2000 and PassEdge in December 2000. Rights|System technology assets primarily consist of property and equipment, patents and acquired workforce. PublishOne services assets consist of goodwill and other intangible assets goodwill recorded in connection with the Company’s acquisition of PublishOne in January 2001.

34


 
With the assistance of independent valuation experts, we performed asset impairment tests for each of the three identified asset categories. The tests were performed by comparing the expected undiscounted cash flows for a five-year period, plus a terminal value for future cash flows to the total carrying amount of goodwill, other intangible assets and property and equipment for each asset category. The assumptions supporting the estimated cash flows, and an estimated terminal value, reflect our best estimates. Based on the results of these tests, we determined that the carrying amounts of the Commerce and related technology and PublishOne services long-lived assets were impaired.
 
With the assistance of independent valuation experts, we determined the fair value of the long-lived assets for the impaired asset categories. Fair value was determined using the discounted cash flow method, using a discount rate of 18% and an estimated residual value. The discount rate was based upon the weighted average cost of capital for the Company and comparable companies. A write-down of goodwill and intangible assets totaling $31.1 million was recorded during the second quarter of 2001, reflecting the amount by which the carrying amount of the assets exceed their respective fair values. The write-down consisted of $20.9 million for goodwill and $10.2 million for other acquired intangible assets.
 
During the fourth quarter of 2001, we identified indicators of possible impairment of our workforce-in-place intangible assets related to the Infinite Ink, PassEdge, and PublishOne acquisitions. The workforce-in-place balances were originally valued at the time of each acquisition based on the costs necessary to recruit and train employees retained during the merger. These assets are amortized based on the estimated contribution period of the employees. As many of the employees assumed in connection with the three acquisitions were no longer employed by InterTrust as of December 31, 2001, we recorded an impairment charge during the fourth quarter of 2001 of $822,000 out of $1.6 million of the workforce-in-place intangible asset.
 
We did not record any charges in 2000 for the impairment of goodwill and other intangible assets.
 
Effective January 1, 2002, in accordance with the provisions of SFAS 142, we will no longer amortize the remaining balance of goodwill totaling approximately $2.1 million, but we will review it for impairment annually (or more frequently if impairment indicators arise).
 
Restructuring and Other
 
During the year ended December 31, 2001, we recorded restructuring and Other charges totaling $11.2 million comprising $9.1 million in restructuring costs associated with the reductions in our workforce, and a $2.1 million impairment charge relating to long-lived assets to be disposed or abandoned. In the future, discretionary expenses may decrease as a result of the reductions in our workforce. We estimate the total annual savings from workforce, facilities, and other cost reductions in 2001 and the first quarter of 2002 at approximately $50 to $55 million.
 
On April 30, 2001, our board of directors formally adopted a program to reduce our worldwide workforce. The reduction resulted in the decrease of 43 regular employees across all business functions, operating units, and geographic regions. The worldwide workforce reductions were substantially completed in the second quarter of 2001. During the second quarter of 2001, we recorded a restructuring charge of approximately $1.2 million relating primarily to severance and fringe benefits. All amounts had been paid by December 31, 2001.
 
On August 2, 2001, we further reduced our worldwide workforce. The reduction resulted in the decrease of 33 regular employees across all business functions, operating units, and geographic regions. All 33 terminated employees left InterTrust, and all cash payments were made by December 31, 2001. During the third quarter of 2001, we recorded a restructuring charge of approximately $540,000 relating primarily to severance and fringe benefits.
 
On October 29, 2001, our board of directors again approved a plan to reduce our worldwide workforce. The reduction resulted in the decrease of 103 regular employees across all business functions, operating units, and geographic regions. All employees were notified of the reductions prior to December 31, 2001. Of the 103

35


terminated employees, 98 had left by December 31, 2001 and the remaining 5 employees left at different dates during January 2002. During the fourth quarter of 2001, we recorded a restructuring charge of approximately $2.4 million relating to severance and fringe benefits.
 
The October 29, 2001 plan included vacating 5 facilities, in whole or in part, 4 of which have been vacated by December 31, 2001. The remaining facility will be vacated no later that June 30, 2002. We will not use these vacated spaces in the future for any reason, and we expect to continue to make monthly payments on these properties through March 2006. We recorded a restructuring charge for excess facilities of $5.0 million in the quarter ended December 31, 2001, which represents the remaining lease obligation, net of assumed sub-lease income. In March 2002 we paid $2.4 million to terminate the lease of one of our Santa Clara facilities. This amount was included in the restructuring accrual at December 31, 2001.
 
Due to the employee terminations and the vacated facilities, we also identified excess assets that have no future alternative use. These excess assets are computer equipment, furniture and fixtures, and leasehold improvements related to the vacated facilities. Any excess assets that are not included in sublease contracts will be sold in secondary markets or scrapped. We recorded a non-recurring charge for excess or impaired assets of $2.1 million in the quarter ended December 31, 2001.
 
On January 31, 2002, we announced we would further reduce our workforce by approximately 45%, or 83 employees and vacate one facility. We will record a charge of approximately $2.5 million related to the reduction in force and the closure of one facility in the first quarter of 2002.
 
Interest and Other Income, Net
 
Interest and other income consists primarily of interest earned on cash, cash equivalents and short and long-term investments. Interest and other income decreased to $9.4 million in 2001 from $10.9 million in 2000. The decrease in interest income is due to lower cash and investment balances in 2001 as compared to 2000. This decrease in interest income is offset by a $750,000 in cancellation fees recorded as other income in connection with the termination of the Nokia license agreement in the fourth quarter of 2001.
 
Loss on Debt and Equity Investments
 
Investments in privately held companies primarily consist of equity and debt securities in which we own less than a 20% interest. We invest in entities based upon the size of the market opportunity, the entity’s product or service’s ability to meet market demands, the barriers to entry that are established by the entity’s product or service offering, the long-term defensibility of product leadership in a defined marketplace, the previous experience of the management team and its ability to execute on its business plan, and the financial projections of the prospect. Additionally, we also consider the strategic importance of the entity’s technology in furthering the adoption of digital rights management technologies.
 
We do not have the ability to exercise significant influence over any of the companies in which we invest and accordingly account for such investments using the cost method. These investments are assessed for impairment periodically through review of operations and indications of continued viability, such as subsequent rounds of financing. As a result of the deterioration of financial markets and the corresponding effect on private company valuations and financing prospects, during the second quarter of 2001, we recorded $3.0 million in losses reflect other than temporary declines in the value of investments in privately held companies. The remaining carrying amount in privately held companies of $250,000 was further written down to zero during the three months ended December 31, 2001. As a result we carry no value related to investments in privately held companies in the consolidated balance sheet. We have not participated in subsequent financings for any of the companies in which we have invested, and we are not obligated or committed in any way to participate in any future financings of any of our investments.

36


 
Provision for Income Taxes
 
From inception through December 31, 2001, we incurred net losses for federal and state tax purposes and have not recognized any tax provision or benefit.
 
Years Ended December 31, 2000 and 1999
 
Revenues
 
Total revenues increased to $8.0 million in 2000 from $1.5 million in 1999. License fees, software support and training services, TrustNet clearinghouse services, and revenue from the sales of chips containing our technology accounted for 52%, 39%, 3%, and 6% of total revenues in 2000 and 50%, 40%, 10%, and none of total revenues in 1999.
 
License revenues increased to $4.2 million in 2000 from $778,000 in 1999, and represent the amortization of new and deferred license fees.
 
Revenues from software support and training services increased to $3.1 million in 2000 from $613,000 in 1999. This increase was due to support and training fees from additional partner licensing agreements.
 
TrustNet clearinghouse services revenues increased to $244,000 in 2000 from $150,000 in 1999 due to the addition of new customers.
 
Revenue from the sale of chips containing our software totaled $445,000 in 2000 and none in 1999. This revenue results from chips sold to one customer, who is also a licensee, under the terms of a short-term purchase agreement to provide chips for testing and trial production.
 
Cost of Revenues
 
Cost of license revenues consists primarily of the costs incurred to manufacture, package, and distribute our products and related documentation and the amortization of purchased technology. Cost of software support and training services consists primarily of the cost of personnel, travel-related expenditures, and training materials. These expenditures are incurred both onsite at our facilities as well as off-site at partner locations. Cost of TrustNet clearinghouse services includes the cost of personnel, computer hardware, and support of the off-site service center. Costs related to the sale of chips containing our software are related to the purchase price, production, and transport of chips. Total cost of revenues was $5.5 million in 2000 and $1.0 million in 1999. The period-over-period increase resulted from increased costs incurred to support our new partners build our TrustNet and the purchase of chips in 2000. Cost of license revenues increased to $436,000 in 2000 from $141,000 in 1999 due to additional licensing agreements. Cost of license revenues is expected to increase from the amortization of purchased technology and will fluctuate from period to period depending on the number of new partners, the number of software releases, and the amount of software documentation provided to our partners during the period.
 
Cost of software support and training services revenues increased to $910,000 in 2000 from $470,000 in 1999. The increase in cost of software support and training services revenues represents the increase in support personnel time required to provide technical assistance and training to a greater number of partners.
 
TrustNet clearinghouse costs increased to $3.7 million in 2000 from $436,000 in 1999. TrustNet clearinghouse costs reflect the cost of personnel, hardware expenses, and the cost of off-site service centers.
 
Costs related to the sale of chips totaled $445,000 in 2000 and none in 1999. These costs are related to the purchase of chips from a third party, customization, and transport of the chips.

37


 
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 $24.5 million in 2000 and $16.5 million in 1999. This increase was primarily attributable to a $5.3 million increase in personnel costs and consultant services associated with product research and development and a $1.3 million increase in facilities related expenses, such as rent and utilities.
 
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 $18.5 million in 2000 from $6.9 million in 1999. This increase reflects the costs associated with increased selling and promotional efforts. The increase in these costs is comprised primarily of $5.0 million in increased personnel costs, $4.0 million in increased public relations and other promotional costs, $870,000 in increased facilities related expenses, and $693,000 in increased travel costs.
 
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 $9.9 million in 2000 from $5.6 million in 1999. This increase was primarily attributable to a $1.5 million increase in personnel costs, as a result of increased executive, legal and accounting personnel, a $474,000 increase in building and facilities expenses, $610,000 in insurance expenses, and $501,000 in expenses related to being a public company for a full year.
 
Purchased In-Process Research and Development
 
In March 2000, we recorded $6.1 million of acquired in-process research and development related to our acquisition of Infinite Ink Corporation. The acquisition was accounted for under the purchase method of accounting in accordance with APB 16. This expense is a non-recurring charge.
 
Amortization of Goodwill and Other Intangible Assets
 
Amortization of goodwill and other intangibles increased to $3.0 million in 2000 from none in 1999. The increase of amortization of goodwill and purchased intangibles was due to the additional amortization related to the acquisition of Infinite Ink Corporation and the purchase of technology and other assets from PassEdge Corporation. See Note 2 of Notes to Consolidated Financial Statements.
 
Deferred Stock Compensation
 
We are amortizing deferred stock compensation of $8.3 million, recorded prior to January 1, 2000, over the vesting periods of the applicable options using a graded vesting method. This amount represents the difference between the exercise prices of employee stock options and what were considered to be the fair values of our common stock on the dates of the grants. We recognized $3.3 million and $1.7 million of related compensation expense in 2000 and 1999.
 
Interest Income (Expense), Net
 
Interest income (expense), net, consists primarily of interest earned on cash and cash equivalents and marketable securities. We recognized approximately $10.9 million of interest income in 2000 and $1.9 million in

38


1999. The increase in interest income is primarily attributable to the increase in our average investment balance from the proceeds of our public offering in April 2000. We had no interest expense in 2000 nor in 1999.
 
Loss on Debt and Equity Investments
 
In April through June 2000, we made investments of $6.5 million in equity securities in certain private technology companies. Investments in privately-held companies primarily consist of equity and debt securities in which we own less than a 20% interest. We do not have the ability to exercise significant influence over any of these companies and accordingly account for such investments using the cost method. These investments are assessed for impairment periodically through review of operations and indications of continued viability, such as subsequent rounds of financing. During 2000, we recorded $3.0 million in losses as a result of other than temporary declines in the value of investments in privately held companies. Furthermore, in September and October 2000, we made two loans totaling $699,000 to a privately held technology company. In December 2000, we reserved for the entire balance of the notes receivable due to the uncertainty of collection, based on the deterioration of the financial condition of the company.
 
Income Taxes
 
We have incurred net losses since inception for the federal and state tax purposes and have not recognized a domestic tax provision or benefit. In 2000, we recorded a tax provision of $2,000 related to foreign withholding taxes on two license agreements for which we may receive a tax benefit in the future. As of December 31, 2000, we had approximately $89.0 million of federal and approximately $15.5 million of state net operating loss carryforwards to offset against future taxable income. We also had approximately $2.2 million and $1.8 million of federal and state research and development tax credit carryforwards, respectively. The related deferred tax assets have been fully reserved through December 31, 2000. The federal net operating loss and tax credit carryforwards expire in years 2007 through 2020, if not used. The state net operating losses and credits expire in years 2001 through 2010, if not used. Utilization of net operating losses and credits may be subject to a substantial annual limitation due to the change in ownership provisions of the Internal Revenue Code of 1986 and similar state provisions. The annual limitation may result in the expiration of net operating losses and credits before utilization.

39


 
Quarterly Results of Operations (unaudited)
 
The following table contains, for the periods presented, selected data from our consolidated statements of operations. The data has been derived from our unaudited consolidated financial statements, and, in the opinion of our management, includes all adjustments, consisting only of normal recurring adjustments, that are necessary for a fair presentation of the results of operations for these periods. This unaudited information should be read in conjunction with the consolidated financial statements and notes included elsewhere in this Form 10-K. The operating results in any quarter are not necessarily indicative of the results that may be expected for any future period. We have incurred losses in each quarter since inception and expect to continue to incur losses through at least the next several years.
 
   
Three Months Ended

 
   
Dec. 31,
2001

   
Sept. 30,
2001

   
June 30,
2001

   
Mar. 31,
2001

   
Dec. 31,
2000

   
Sept. 30,
2000

   
June 30,
2000

   
Mar. 31,
2000

 
   
(in thousands, except per share data)
 
Consolidated Statement of Operations Data:
                                                               
Revenues:
                                                               
Licenses
 
$
1,588
 
 
$
1,542
 
 
$
1,562
 
 
$
1,387
 
 
$
1,386
 
 
$
1,188
 
 
$
889
 
 
$
687
 
Software support and training
 
 
18
 
 
 
185
 
 
 
428
 
 
 
730
 
 
 
996
 
 
 
861
 
 
 
632
 
 
 
660
 
Services
 
 
253
 
 
 
205
 
 
 
239
 
 
 
276
 
 
 
50
 
 
 
48
 
 
 
146
 
 
 
—  
 
Hardware
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
12
 
 
 
445
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
   


 


 


 


 


 


 


 


Total revenues
 
 
1,859
 
 
 
1,932
 
 
 
2,229
 
 
 
2,405
 
 
 
2,877
 
 
 
2,097
 
 
 
1,667
 
 
 
1,347
 
Cost of revenues:
                                                               
Licenses
 
 
91
 
 
 
112
 
 
 
90
 
 
 
137
 
 
 
90
 
 
 
133
 
 
 
110
 
 
 
103
 
Software support and training
 
 
171
 
 
 
161
 
 
 
475
 
 
 
438
 
 
 
345
 
 
 
236
 
 
 
182
 
 
 
147
 
Services
 
 
1,191
 
 
 
954
 
 
 
1,564
 
 
 
1,915
 
 
 
1,379
 
 
 
934
 
 
 
714
 
 
 
643
 
Hardware
 
 
—  
 
 
 
—  
 
 
 
423
 
 
 
417
 
 
 
445
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
   


 


 


 


 


 


 


 


Total cost of revenues
 
 
1,453
 
 
 
1,227
 
 
 
2,552
 
 
 
2,907
 
 
 
2,259
 
 
 
1,303
 
 
 
1,006
 
 
 
893
 
   


 


 


 


 


 


 


 


Gross profit (loss)
 
 
406
 
 
 
705
 
 
 
(323
)
 
 
(502
)
 
 
618
 
 
 
794
 
 
 
661
 
 
 
454
 
Operating costs and expenses:
                                                               
Research and development
 
 
6,683
 
 
 
9,786
 
 
 
9,004
 
 
 
9,391
 
 
 
7,029
 
 
 
6,470
 
 
 
5,775
 
 
 
5,201
 
Sales and marketing
 
 
1,942
 
 
 
3,552
 
 
 
5,447
 
 
 
7,610
 
 
 
6,028
 
 
 
4,493
 
 
 
4,361
 
 
 
3,657
 
General and administrative
 
 
4,560
 
 
 
4,055
 
 
 
4,529
 
 
 
3,946
 
 
 
2,869
 
 
 
2,520
 
 
 
2,273
 
 
 
2,228
 
Purchased in-process research and development
 
 
—  
 
 
 
567
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
6,100
 
Amortization of goodwill and other
intangibles
 
 
574
 
 
 
259
 
 
 
2,363
 
 
 
2,193
 
 
 
1,159
 
 
 
923
 
 
 
922
 
 
 
—  
 
Amortization of deferred compensation
 
 
315
 
 
 
843
 
 
 
392
 
 
 
723
 
 
 
636
 
 
 
746
 
 
 
938
 
 
 
1,006
 
Impairment of long-lived assets
 
 
822
 
 
 
—  
 
 
 
31,086
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
Restructuring and other
 
 
9,526
 
 
 
540
 
 
 
1,170
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
   


 


 


 


 


 


 


 


Total operating costs and expenses
 
 
24,422
 
 
 
19,602
 
 
 
53,991
 
 
 
23,863
 
 
 
17,721
 
 
 
15,152
 
 
 
14,269
 
 
 
18,192
 
   


 


 


 


 


 


 


 


Loss from operations
 
 
(24,016
)
 
 
(18,897
)
 
 
(54,314
)
 
 
(24,365
)
 
 
(17,103
)
 
 
(14,358
)
 
 
(13,608
)
 
 
(17,738
)
Interest and other income, net
 
 
2,529
 
 
 
1,966
 
 
 
2,115
 
 
 
2,770
 
 
 
2,683
 
 
 
3,306
 
 
 
2,766
 
 
 
2,112
 
Loss from debt and equity investments
 
 
(250
)
 
 
—  
 
 
 
(2,996
)
 
 
—  
 
 
 
(3,699
)
 
 
—  
 
 
 
—  
 
 
 
—  
 
Provision for foreign income taxes
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
(2
)
 
 
—  
 
 
 
—  
 
 
 
—  
 
   


 


 


 


 


 


 


 


Net loss
 
$
(21,737
)
 
$
(16,931
)
 
$
(55,195
)
 
$
(21,595
)
 
$
(18,121
)
 
$
(11,052
)
 
$
(10,842
)
 
$
(15,626
)
   


 


 


 


 


 


 


 


Basic and diluted net loss per share
 
$
(0.23
)
 
$
(0.18
)
 
$
(0.59
)
 
$
(0.24
)
 
$
(0.21
)
 
$
(0.13
)
 
$
(0.13
)
 
$
(0.20
)
   


 


 


 


 


 


 


 


Shares used in computing the net loss per share
 
 
94,537
 
 
 
93,981
 
 
 
93,442
 
 
 
91,485
 
 
 
86,759
 
 
 
85,434
 
 
 
84,247
 
 
 
78,931
 
   


 


 


 


 


 


 


 


 
Liquidity and Capital Resources
 
Cash, cash equivalents and marketable securities totaled $126.7 million at December 31, 2001, a decrease of $48.6 million from December 31, 2000. The change in 2001 is primarily attributable to the net loss of $115.5 million offset by non-cash charges of $54.5 million, and $20.0 million of cash generated from the sale of 4.0 million shares of our common stock to Nokia Finance International B.V., a subsidiary of Nokia Corporation, in January 2001.

40


 
Net cash used in operating activities totaled $66.0 million in 2001. The cash used in 2001 is primarily attributable to the net loss of $115.5 million, partially offset by various non-cash charges such as impairment of long-lived assets of $31.9 million, $7.3 million of non-cash restructuring and other charges, amortization of goodwill and other intangible assets of $5.7 million, depreciation and amortization of $3.8 million, loss on debt and equity investments of $3.2 million, and stock related compensation of $2.3 million.
 
Net cash provided by investing activities totaled $77.3 million in 2001. The cash generated in the period is primarily attributable to sales of marketable investments offset by purchases of $82.0 million offset by capital expenditures totaling $4.1 million principally comprised of computer equipment and software used to support our product development.
 
Net cash provided by financing activities was $21.5 million in 2001, due to cash generated from issuing common stock to Nokia Corporation and, to a lesser extent, from the exercise of employee stock options.
 
At December 31, 2001, our principal source of liquidity was $126.7 million in cash and cash equivalents and marketable securities. We believe that our cash and cash equivalents will be sufficient to meet our working capital needs for at least the next 12 months. In the future, we may require additional funds to support our working capital requirements or for other purposes and may seek to raise additional funds through public or private equity financing or from other sources. Additional financing may not be available at all or, if available, may not be obtainable on terms favorable to us. In addition, any additional financing may be dilutive and new equity securities could have rights senior to those of existing holders of our common stock. If we need to raise funds and cannot do so on acceptable terms, we may not be able to respond to competitive pressures, meet anticipated capital requirements, or take advantage of future business opportunities.
 
We do not have any “special purpose entities” that are unconsolidated in our financial statements. We have contractual obligations in the form of capital and operating leases. See further discussion in the notes to the audited financial statements.
 
The following summarizes our contractual payment obligations and commitments:
 
    
Payment Obligations by Year (in thousands)

    
2002

  
2003

  
2004

  
2005

  
2006

  
There- after

  
Total

Operating leases
  
$
6,311
  
$
5,533
  
$
3,515
  
$
863
  
$
34
  
$
 —  
  
$
16,256
Capital leases
  
 
181
  
 
1
  
 
—  
  
 
—  
  
 
—  
  
 
—  
  
 
182
    

  

  

  

  

  

  

    
$
6,492
  
$
5,534
  
$
3,515
  
$
863
  
$
34
  
$
 —  
  
$
16,438
    

  

  

  

  

  

  

 
At December 31, 2001, we have recorded $4.9 million in accrued restructuring costs related to operating leases included in the table above. During March 2002, InterTrust paid $2.4 million to terminate the lease of one of our Santa Clara facilities. At December 31, 2001 our remaining commitment relating to this lease was $4.5 million and the lease extended through October 2004.
 
ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
 
We develop products in the United States and license our products to partners in North America, Europe, Asia, and Australia. As a result, our financial results could be affected adversely by various factors, including foreign currency exchange rates or weak economic conditions in foreign markets.
 
Our interest income is sensitive to changes in the general level of United States interest rates, particularly since the majority of our investments are in short-term instruments. Due to the nature of our investments in

41


marketable securities, we have concluded that there is no material market risk exposure. Therefore, no quantitative tabular disclosures are required. At December 31, 2001 and December 31, 2000, our cash and cash equivalents consisted primarily of demand deposits and money market funds held by two large institutions in the United States.
 
ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
The financial statements and supplementary data required by this Item 8 are listed in Item 14(a)(1) and begin at page F-1 of this Report.
 
ITEM 9.
 
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
Not applicable.

42


 
PART III
 
ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
Our executive officers and directors, and their ages and positions as of March 31, 2001, are as follows:
 
Name

  
Age

  
Position

Victor Shear
  
54
  
Chairman of the Board
David Lockwood
  
42
  
Executive Vice Chairman of the Board, Chief Executive Officer and President
David C. Chance
  
45
  
Director
Edmund J. Fish
  
39
  
Director, Executive Vice President and President, MetaTrust Utility
Greg Wood
  
43
  
Chief Financial Officer
Mark Ashida
  
43
  
Chief Operating Officer
David P. Maher
  
51
  
Chief Technology Officer
Patrick P. Nguyen
  
35
  
Senior Vice President, Corporate Development
Mark Scadina
  
32
  
Vice President and General Counsel
Talal Shamoon
  
38
  
Executive Vice President, Business Development
Satish K. Gupta
  
57
  
Director
Timo Ruikka
  
45
  
Director
Patrick S. Jones
  
57
  
Director
Robert R. Walker
  
51
  
Director
Lester Hochberg
  
64
  
Director
 
Victor Shear has served as chairman of the board of InterTrust since our inception in January 1990 and until March 2002 served as our chief executive officer. Before founding InterTrust, Mr. Shear co-founded Personal Library Software, Inc., a text and document database company, in June 1986. Mr. Shear served as chairman, president and chief executive officer of Data Scientific Corporation, a software developer of scientific workstations company, from May 1982 to February 1985. Mr. Shear received a B.A. in sociology from Brandeis University.
 
David Lockwood has served as chief executive officer and president since March 2002. Mr. Lockwood has served as president of Intertrust since November 2001 and as executive vice chairman since September 2001. Mr. Lockwood served as a director of InterTrust since October 2000. Before joining InterTrust, Mr. Lockwood served as a managing partner of Reuters Greenhouse Fund, a venture capital firm, from February 2000 to September 2001 . Prior to joining Reuters Greenhouse Fund, Mr. Lockwood spent 10 years at Goldman, Sachs & Co., most recently as a managing director. Mr. Lockwood also serves on the boards of directors of Forbes.com. Mr. Lockwood received a B.A. in history from Miami University and a M.B.A. in Finance from the University of Chicago.
 
David C. Chance has served as a director since October 1999, and also served as executive vice chairman from October 1999 to September 2001. Before joining InterTrust, from January 1994 to January 1998, Mr. Chance was deputy managing director of BskyB Group Ltd., a leading United Kingdom pay-television and media company, and continued to serve as a consultant and non-executive director until August 1999. In addition, Mr. Chance is a non-executive director of Modern Times Group, the primary pay-television operator in Scandinavia, and Sunderland football club. Mr. Chance also serves on the board of the New Millenium Experience Company, responsible for the Millenium Dome project in London. Mr. Chance received a B.S. in psychology, a B.A. in industrial relations, and a M.B.A. from the University of North Carolina at Chapel Hill.
 
Edmund J. Fish has served as a director, executive vice president, and president, MetaTrust Utility, of InterTrust since December 2000. From January 2000 to December 2000, Mr. Fish served as executive vice president and chief business officer of InterTrust. From June 1999 to January 2000, Mr. Fish served as senior

43


operating officer and executive vice president, corporate development of InterTrust. From September 1995 to June 1999, Mr. Fish served as general counsel and vice president, corporate development of InterTrust. Before joining InterTrust, Mr. Fish practiced law in the Silicon Valley, Washington D.C. and New York offices of Weil, Gotshal & Manges, an international law firm, from August 1989 to August 1995. Mr. Fish received a B.S. in biomedical engineering from Marquette University and a J.D. from Wayne State University.
 
Greg Wood has served as chief financial officer of InterTrust since November 2000. Prior to joining InterTrust, Mr. Wood served as chief financial officer of Network Computing Devices, a computer networking company, from August 1999 to November 2000. Mr. Wood also served as executive vice president and chief financial officer, from December 1998 to July 1999, and as chief financial officer, from July 1997 to November 1998, of Sutmyn Storage Corporation, a data storage company. Prior to joining Sutmyn, Mr. Wood served as senior vice president, finance and managing director, from April 1996 to June 1997, and as vice president and treasurer, from January 1990 to March 1996, of Memorex Telex NV, a supplier of computer networking products and services. Mr. Wood received a B.B.A. in accounting from the University of San Diego and a J.D. from the University of San Francisco. Mr. Wood is a certified public accountant.
 
Mark Ashida has served as Chief Operating Officer of InterTrust since April 2001. From February 2001 to April 2001, Mr. Ashida served as executive vice president solutions of InterTrust. From December 2000 to February 2001, Mr. Ashida served as senior vice president solutions for InterTrust. Prior to joining InterTrust, Mr. Ashida served as chief executive officer of PassEdge, a DRM for video company, from December 1999 to December 2000. Mr. Ashida also served as general manager of PassEdge for Intel Corporation, a computer chips company, from March 1999 to December 1999. From January 1991 through March 1999, Mr. Ashida was an independent consultant/interim CEO. Mr. Ashida received a B.A. in Math and Economics from Pomona College and a M.B.A. from Harvard Business School.
 
David P. Maher has served as chief technology officer of InterTrust since June 1999. Prior to joining InterTrust, Mr. Maher served in various positions at AT&T from June 1981 to June 1999, including as an AT&T fellow, a Bell Labs fellow and head of the secure systems research department. At AT&T, Mr. Maher developed secure wideband transmission systems, cryptographic key management systems and secure communications devices. In addition, Mr. Maher was chief architect for AT&T’s STU-III secure device, data, and video products for secure government communications. Mr. Maher has been a consultant for the National Science Foundation, the National Security Agency, the National Institute of Standards and Technology, and the Congressional Office of Technology Assessment, and has taught electrical engineering, mathematics and computer science at several institutions. Mr. Maher received B.A., M.S. and Ph.D. degrees in mathematics from Lehigh University.
 
Patrick P. Nguyen is senior vice president, corporate development, and has also served as vice president, global alliances, since joining InterTrust in July 1998. Prior to joining InterTrust, from February 1993 to June 1998, Mr. Nguyen worked at the Silicon Valley Office of Weil, Gotshal & Manges, where he was made a partner in January 1998 and headed the corporate and technology transaction group. Mr. Nguyen received a B.S. in computer science from the University of California at Irvine and a J.D. from the University of California at Los Angeles.
 
Mark Scadina has served as vice president and general counsel of InterTrust since February 2000 . From March 1999 to February 2000, Mr. Scadina served as Director, corporate development and legal at InterTrust. From September 1994 to March 1999 Mr. Scadina practiced law in the Silicon Valley office of Pennie & Edmonds. Mr. Scadina received a B.S. in computer engineering from Santa Clara University and a J.D. from the University of California, Berkeley School of Law (Boult Hall).
 
Talal Shamoon has served as executive vice president, business development since March 2001, and senior vice president, media of InterTrust since February 2000 to March 2001. From June 1999 to February 2000, Dr. Shamoon served as our vice president, corporate development and technology initiatives. From June 1997 to June 1999, Dr. Shamoon served as a member of the research staff of STARLab. Prior to joining InterTrust, from October 1994

44


to June 1997, Dr. Shamoon worked for NEC Research Institute, an advanced research facility of NEC focused on computer science and physics, where he focused on multimedia security, signal processing and data compression. Dr. Shamoon received B.S., M. Eng and Ph.D degrees in electrical engineering from Cornell University.
 
Satish K. Gupta has served as a director of InterTrust since February 1993. Mr. Gupta has been the president and chief executive officer of Cradle Technologies, a semiconductor company, since July 1998. From May 1994 to June 1998, Mr. Gupta was vice president of corporate marketing and business development of Cirrus Logic, a semiconductor company, and from June 1991 to May 1994, he was vice president of strategic marketing and advanced development of Media Vision, a multi-media peripherals company. Mr. Gupta received a B.E. in electrical engineering in India from Birla Institute of Technology and Science, an M.S. in electrical engineering from Massachusetts Institute of Technology, and a M.S. in engineering and economic systems from Stanford University.
 
Timo Ruikka has served as a director of InterTrust since March 2001. Mr. Ruikka has been a vice president of external affairs of Nokia Inc., an electronics and communications network equipment company and a subsidiary of Nokia Corporation, since April 1999. From January 1988 to March 1999, Mr. Ruikka served as a senior vice president of Nokia Corporation. Mr. Ruikka has a degree from Turku University in Finland. Mr. Ruikka was nominated by Nokia Corporation to serve as a director of InterTrust in connection with an investment by Nokia Finance International B.V. in InterTrust.
 
Patrick S. Jones has served as director of InterTrust since July 2001. Mr. Jones was senior vice president and chief financial officer of GEMPLUS SA, the largest manufacturer of “smart cards” and SIM cards for mobile phones, from June 1998 to March 2001. Prior to joining GEMPLUS SA, Mr. Jones served as vice president and corporate controller of Intel Corporation, the largest semiconductor manufacturing company, from June 1992 to June 1998. Mr. Jones also serves as chairman of the board of Dione Plc (U.K.) and serves as director of Genesys SA (France) and QRS Corporation. Mr. Jones received a B.A. in International Economics from the University of Illinois and a M.B.A. in finance from St. Louis University.
 
Robert R. Walker has served as director of InterTrust since January 2002. Mr. Walker was executive vice president and chief financial officer of Agilent Technologies, an electronic equipment manufacturing company, from March 1999 to December 2001. Prior to joining Agilent Technologies, Mr. Walker held positions of vice president, chief information officer and group controller at Hewlett-Packard Company, an electronic equipment manufacturing company, from June 1975 to February 1999. Mr. Walker is also a director of Financial Executives International. Mr. Walker received a B.S. in Electrical Engineering and a M.B.A. in finance from Cornell University.
 
Lester Hochberg has served as director of InterTrust since January 2002. Mr. Hochberg has served as director and president of Ramp;R Capital Partners, an investment company, since June 1998 and as director and president of Bercap Corporation, a financial advisory company, since 1985. Mr. Hochberg was Chairman of Gibson’s, a retail store, from February 1992 to September 1998. Mr. Hochberg received a B.S. in economics from Brooklyn College and a J.D. from Harvard Law School.
 
Board of Directors Meetings and Committees
 
During the fiscal year ended December 31, 2001, the Board of Directors held fifteen (15) meetings and acted by written consent in lieu of a meeting on no occasions. For the fiscal year, each of the directors during the term of their tenure attended or participated in at least 75% of the aggregate of (i) the total number of meetings or actions by written consent of the Board of Directors and (ii) the total number of meetings held by all committees of the Board of Directors on which each such director served. The Board of Directors has two standing committees: the Audit Committee and the Compensation Committee.
 
The Audit Committee was created on July 22, 1999 and became effective on the effective date of the Company’s initial public offering of its securities, October 26, 1999. The Audit Committee reviews, acts on and reports to the Board of Directors with respect to various auditing and accounting matters, including the selection

45


of the Company’s independent auditors, the scope of the annual audits, fees to be paid to the Company’s independent auditors, the performance of the Company’s independent auditors and the accounting practices of the Company. The members of the Audit Committee are Messrs. Gupta, Jones, and Walker. Mr. Walker was added to the Audit Committee in January 2002. During the fiscal year ended December 31, 2001, the Audit Committee of the Board of Directors held four meetings.
 
The Compensation Committee was created on July 22, 1999 and became effective on the effective date of the Company’s initial public offering of its securities, October 26, 1999. The Compensation Committee reviews the performance of the executive officers of the Company, establishes compensation programs for the officers, and reviews the compensation programs for other key employees, including salary and cash bonus levels and option grants under the 1995 Stock Plan, 1999 Equity Incentive Plan and 1999 Employee Stock Purchase Plan. The members of the Compensation Committee are Messrs. Gupta and Jones. Mr. Jones joined the Compensation Committee in January 2002 following the resignation of another non-employee director. During the fiscal year ended December 31, 2001, the Compensation Committee of the Board of Directors held fourteen meetings.
 
Compensation of Directors
 
Except for grants of stock options, directors of the Company generally do not receive compensation for services provided as a director. The Company also does not pay compensation for committee participation or special assignments of the Board of Directors.
 
Non-employee directors are eligible to receive options under the Company’s 1999 Non-Employee Directors Option Plan (“Directors Plan”). Each individual who first joins the Company’s Board of Directors as a non-employee director after the effective date of the Company’s initial public offering will receive at that time a fully vested option for 30,000 shares of the Company’s common stock. In addition, at each of the Company’s annual stockholders’ meetings, beginning in 2000, each non-employee director who will continue to be a director after that meeting will automatically be granted at that meeting a fully vested option for 10,000 shares of the Company’s common stock. However, any non-employee director who receives an option for 30,000 shares under this Directors Plan will first become eligible to receive the annual option for 10,000 shares at the annual meeting that occurs during the calendar year following the year in which he received the option for 30,000 shares.
 
Non-employee directors are also eligible to receive options and be issued shares of common stock under the Company’s 1999 Equity Incentive Plan. Directors who are also employees of the Company are eligible to receive options and be issued shares of common stock under the Company’s 1999 Equity Incentive Plan and are also eligible to participate in the Company’s 1999 Employee Stock Purchase Plan.
 
Mr. Gupta, one of the Company’s non-employee directors, received an option for 160,000 shares of common stock at an exercise price of $0.3125 per share in February 1994. Mr. Gupta and Mr. Fredrickson, another of the Company’s non-employee directors, received an option for 30,000 shares of common stock at an exercise price per share of $7.00 in October 1999. In March 2000, the Company granted an option to purchase 40,000 shares of common stock at an exercise price of $82.50 per share to each of Messrs. Fredrickson and Gupta and in April 2000, the Company granted an option to purchase 20,000 shares of common stock at an exercise price of $29.13 per share to each of Messrs. Fredrickson and Gupta. In May 2001, the Company granted an option to purchase 40,000 shares of common stock at an exercise price of $2.10 per share; in June 2001, the Company granted an option to purchase 25,000 shares of common stock at an exercise price of $1.10 per share; and in November 2001, the Company granted an option to purchase 10,000 shares of common stock at an exercise price of $1.07 per share to each of Messrs. Fredrickson and Gupta. In March 2001 the Company granted an option to purchase 30,000 shares of common stock at an exercise price of $3.75 per share to Mr. Ruikka, another of the Company’s non-employee directors. In June 2001 the Company granted an option to purchase 30,000 shares of common stock at an exercise price of $1.10 per share, and in July 2001 the Company granted an option to purchase 10,000 shares of common stock at an exercise price of $1.23 per share to Mr. Jones, another of the Company’s non-employee director.

46


 
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
 
The members of the Board of Directors, the executive officers of the Company and persons who hold more than ten percent (10%) of the Company’s outstanding common stock are subject to the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934, as amended, which require them to file reports with respect to their ownership of the Company’s common stock and their transactions in such common stock. Based upon (i) the copies of Section 16(a) reports that the Company received from such persons for their 2001 fiscal year transactions in the common stock and their common stock holdings and (ii) the written representations received from one or more of such persons regarding their Section 16(a) reports for the 2001 fiscal year, the Company believes that all reporting requirements under Section 16(a) for such fiscal year were met in a timely manner by its executive officers, Board members and greater than ten percent (10%) stockholders, except that (i) Bruce Fredricksen, a former Director, filed a Form 4 in March 2002 disclosing eight transactions that took place in May 2001 and February 2001, (ii) David Lockwood filed a Form 4 in March 2002 disclosing two transactions that took place in November 2001 and September 2001, (iii) David Maher filed an amended Form 3 in March 2002 disclosing one transaction that took place in October 1999, (iv) Patrick Nguyen filed a Form 4 in March 2002 disclosing 1 transaction that took place in February 2001, and (v) Talal Shamoon filed an amended Form 3 in March 2002 disclosing one transaction that took place in October 1999.1

47


 
ITEM 11.    EXECUTIVE COMPENSATION AND RELATED INFORMATION
 
Compensation of Executive Officers
 
The following table presents information about compensation paid by the Company in 2001 for services by Victor Shear, the Company’s chief executive officer at December 31, 2001, the Company’s four other highest-paid executive officers who were officers as of the end of fiscal year 2001, and one officer who ceased employment during the year (collectively the “Named Executive Officers”) whose total salary and bonus for the fiscal year exceeded $100,000:
 
Summary Compensation Table
 
    
Year

  
Annual Compensation

    
Long-Term
Compensation
Awards

  
All Other Compen-
sation($)

 
Name and Principal Position

     
Salary ($)

    
Bonus ($)

  
Other Annual
Compensation ($)

    
Number of Securities Underlying Options (#)

  
Victor Shear
Chairman of the Board and Chief Executive Officer
  
2001
2000
1999
  
$
 
 
280,000
249,375
175,000
 
 
 
         
$
 
 
63,404
59,530
38,528
(1)
(2)
(3)
  
 
 
 
—  
—  
—  
  
 
 
 
—  
—  
—  
 
 
 
Edmund J. Fish
Director, Executive Vice
President and President of the MetaTrust Utility
  
2001
2000
1999
  
 
 
 

240,000
222,500
180,000
 
 
 
  
    $
 
200,000
  
 
 
 
—  
—  
—  
 
 
 
  
$
 
 
300,000
125,000
—  
  
 
 
 
—  
—  
—  
 
 
 
Greg Wood
Chief Financial Officer
  
2001
2000
1999
  
 
 
 
240,000
35,455
—  
 
(4)
 
         
 
 
 
—  
—  
—  
 
 
 
  
 
 
 
75,000
360,000
—  
  
 
 
 
—  
—  
—  
 
 
 
Mark Ashida
Chief Operating Officer
  
2001
2000
1999
  
 
 
 
258,750
13,636
—  
 
(5)
 
         
 
 
 
—  
—  
—  
 
 
 
  
 
 
 
350,000
300,000
—  
  
 
 
 
—  
—  
—  
 
 
 
Patrick Nguyen
Senior Vice President, Corporate Development
  
2001
2000
1999
  
 
 
 
233,600
183,650
162,400
 
 
 
         
 
 
 
—  
—  
—  
 
 
 
  
 
 
 
200,000
80,000
40,000
  
 
 
 
—  
—  
—  
 
 
 
David Ludvigson (6)
Former President
  
2001
2000
1999
  
 
 
 
250,352
110,349
—  
 
 
 
  
 
50,000
  
 
 
 
—  
—  
—  
 
 
 
  
 
 
 
400,000
1,000,000
—  
  
$
 
 
75,249
—  
—  
(7)
 
 

(1)
 
Represents $50,689 in rental and related payments, and $12,715 in leased car payments.
 
(2)
 
Represents $47,895 in rental payments and $11,635 in leased car payments.
 
(3)
 
Represents $24,568 in rental payments and $13,960 in leased car payments.
 
(4)
 
Mr. Wood commenced employment with the Company in November 2000.
 
(5)
 
Mr. Ashida commenced employment with the Company in December 2000.
 
(6)
 
Mr. Ludvigson commenced employment with the Company in August 2000 and resigned his position as President in October 2001.
 
(7)
 
Represents forgiveness of loan in the principal amount of $70,000 and interest of $5,249. $61,383 was forgiven as a severance benefit, and $13,866 under the terms of the original employee loan agreement.

48


 
Option Grants in Last Fiscal Year
 
The following table contains information concerning the stock option grants made to each of the Named Executive Officers for 2001. No stock appreciation rights were granted to these individuals during such year.
 
    
Individual Grants (1)

    
Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Option Term ($)(4)

Name

  
Number of
Securities
Underlying
Options
Granted (#)

      
% of Total
Options
Granted to
Employees
in Fiscal
Year(2)

    
Exercise Price per
Share
($/sh) (3)

  
Expiration
Date

    
5%

  
10%

Victor Shear
  
—  
 
    
—  
 
  
 
—  
  
—  
 
  
—  
  
—  
Edmund J. Fish
  
125,000
175,000
(5)
(5)
    
1.4
2.0
%
 
  
$
 
3.75
1.10
  
3/5/11
6/21/11
 
 
  
294,794
121,062
  
747,067
306,795
Greg Wood
  
75,000
(5)
    
0.8
 
  
 
1.10
  
6/21/11
 
  
51,884
  
131,483
Mark Ashida
  
150,000
200,000
(5)
(5)
    
1.7
2.3
 
 
  
 
 
3.29
1.10
  
5/1/11
6/21/11
 
 
  
310,359
138,356
  
786,512
350,623
Patrick Nguyen
  
100,000
100,000
(5)
(5)
    
1.1
1.1
 
 
  
 
 
3.75
1.10
  
3/5/11
9/11/11
 
 
  
235,835
69,178
  
597,653
175,312
David Ludvigson
  
200,000
200,000
(5)
 
    
2.3
2.3
 
 
  
 
 
3.75
1.10
  
3/5/11
6/21/11
(6)
(7)
  
471,671
138,356
  
1,195,307
350,623

(1)
 
The plan administrator has the discretionary authority to re-price the options through the cancellation of those options and the grant of replacement options with an exercise price based on the fair market value of the option shares on the re-grant date. The options have a maximum term of 10 years measured from the option grant date, subject to earlier termination in the event of the optionee’s cessation of service with the Company. Under each of the options, the option shares will vest upon acquisition of the Company by merger or asset sale, unless the acquiring entity or its parent corporation assumes the outstanding options or substitutes comparable.
 
(2)
 
Based on a total of 8,819,149 option shares granted to the Company’s employees and directors during 2001.
 
(3)
 
The exercise price was equal to the fair market value of the Company’s Common Stock, based on the closing price of the Common Stock on the Nasdaq Stock Market, on the date of grant. The exercise price may be paid in cash, in shares of the Company’s Common Stock valued at fair market value on the exercise date or through a cashless exercise procedure involving a same-day sale of the purchased shares or through a margin loan procedure involving a loan secured by the purchased shares with the proceeds of the loan used to pay the Company the exercise price for the purchased shares. The Company may also finance the option exercise by lending the optionee sufficient funds to pay the exercise price for the purchased shares, together with any federal and state income tax liability incurred by the optionee in connection with such exercise.
 
(4)
 
The potential realizable value is calculated based on the ten-year term of the option at the time of grant. Stock price appreciation of 5% and 10% is assumed according to rules promulgated by the Securities and Exchange Commission and does not represent the Company’s prediction of the Company’s stock price performance. The potential realizable value at 5% and 10% appreciation is calculated by assuming that the exercise price on the date of grant appreciates at the indicated rate for the entire term of the option and that the option is exercised at the exercise price and sold on the last day of its term at the appreciated price.
 
(5)
 
The option becomes exercisable in a series of equal monthly installment over a period of 48 months from the vesting commencement date.
 
(6)
 
The option terminated on October 31, 2001.
 
(7)
 
The option terminates on October 31, 2002, based on the terms of the Severance and Release Agreement dated October 31, 2001. The options became fully vested and exercisable on October 31, 2001 based on the terms of the Severance and Release Agreement dated October 31, 2001.

49


 
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values
 
The table below presents for the Company’s Named Executive Officers the number and value of shares underlying unexercised options that were held by these Named Executive Officers as of December 31, 2001. No options or stock appreciation rights were exercised by these Named Executive Officers in 2001, and no stock appreciation rights were outstanding at the end of that year.
 
The figures in the value of unexercised in-the-money options at fiscal year-end column are based on the fair market value of the Company’s common stock at the end of 2001, less the exercise price payable for these shares. The fair market value for the Company’s common stock at the end of 2001 was $1.23 per share.
 
    
Number of Securities
Underlying Unexercised
Options at Fiscal Year-End

  
Value of Unexercised
In-the-Money Options
at Fiscal Year-End

Name

  
Exercisable

  
Unexercisable

  
Exercisable

  
Unexercisable

Victor Shear
  
—  
  
—  
  
 
—  
  
 
—  
Edmund J. Fish
  
251,459
  
343,543
  
$
63,002
  
$
19,906
Greg Wood
  
106,875
  
328,125
  
 
1,219
  
 
8,531
Mark Ashida
  
121,875
  
528,125
  
 
3,250
  
 
22,750
Patrick Nguyen
  
314,999
  
298,335
  
 
37,113
  
 
24,288
David Ludvigson
  
520,831
  
—  
  
 
26,000
  
 
—  
 
Employment Contracts, Termination of Employment and Change-in-Control Arrangements
 
Messrs. Wood and Ashida have employment agreements with the Company that provide the following severance benefits: if each such Named Executive Officer is terminated by the Company for reasons other than certain misconduct, in consideration for compliance with the Company’s confidentiality agreement and a release of claims against the Company, each such officer will receive a cash severance payment equal to three months of base salary and an additional six months of vesting acceleration with respect to his initial option grant from the Company. In addition, if each such Named Executive Officer is terminated by the Company for reasons other than cause in connection with an extraordinary corporate transaction, such Named Executive Officer will receive additional vesting acceleration with respect to his initial option grant from the Company, as if he provided 48 months of service with the Company.
 
David Ludvigson, the Company’s former President, signed a Severance and Release Agreement dated October 31, 2001 (the “Severance Agreement”) with the Company. In consideration for Mr. Ludvigson’s agreement to comply with certain terms of his employment agreement with the Company and the Company’s confidentiality and invention agreement and his release of all claims against the Company, the Severance Agreement provided for the following severance benefits: (a) 100% vesting acceleration of his option to purchase 200,000 shares of the Company’s common stock granted on June 22, 2001 at an exercise price per share of $1.10; (b) extension of the term of this option to October 31, 2002; and (c) forgiveness of the remaining balance due under a promissory note in the amount of $61,383, executed by Mr. Ludvigson on August 14, 2000.
 
Upon a corporate transaction of the Company, 100% of the then unvested shares of the Company’s common stock subject to the following options granted to certain Named Executive Officers will become vested: (a) June 22, 2001 options granted to Mr. Fish for 175,000 shares of the Company’s common stock, Mr. Wood for 75,000 shares of the Company’s common stock and Mr. Ashida for 200,000 shares of the Company’s common stock; (b) September 12, 2001 options granted to Mr. Nguyen for 100,000 shares of the Company’s common stock; (c) January 15, 2002 options granted to Messrs. Fish, Wood, Ashida and Nguyen, each for 300,000 shares of the Company’s common stock. In addition, Mr. Nguyen received option grants for 240,000 shares of the Company’s common stock in connection with his initial employment with the Company, and such option grants provide that upon a change in control transaction, 100% of the then unvested shares of the Company’s common stock subject to such option grants will become vested.

50


 
If a change in control of the Company occurs, an option or other award under the 1999 Equity Incentive Plan will become fully exercisable and fully vested if the option or award is not assumed by the surviving corporation or its parent or if the surviving corporation or its parent does not substitute comparable awards for the awards granted under the 1999 Equity Incentive Plan.
 
Under the Company’s 1995 Stock Plan, upon a merger or asset sale, if the options or stock purchase rights are not assumed by the surviving corporation or its parent or subsidiary or if the surviving corporation or its parent or subsidiary does not substitute comparable awards for the options or stock purchase rights, then the options and stock purchase rights will terminate.
 
COMPENSATION COMMITTEE REPORT
 
The Compensation Committee of the Company’s Board of Directors (the “Compensation Committee” or the “Committee”) was formed on July 22, 1999. The charter for the Committee provides that it has the exclusive authority to establish the level of base salary payable to the chief executive officer (“CEO”) and certain other executive officers of the Company and to administer the Company’s 1999 Equity Incentive Plan and 1999 Employee Stock Purchase Plan. In addition, the Committee has the responsibility for approving the individual bonus programs to be in effect for the CEO and certain other executive officers and key employees each fiscal year.
 
For the 2001 fiscal year, the process utilized by the Compensation Committee in determining executive officer compensation levels was based on a number of factors, including reference to similar positions in other high-technology companies. In the case of the key executive officers, the Compensation Committee also reviewed the inputs from the CEO. In these cases, the final decisions regarding compensation were made independently by the committee.
 
General Compensation Policy.    The Compensation Committee’s fundamental policy is to offer the Company’s executive officers competitive compensation opportunities based upon overall Company performance, their individual contribution to the financial success of the Company and their personal performance. It is the Compensation Committee’s objective to have a substantial portion of each officer’s compensation contingent upon the Company’s performance, as well as upon his or her own level of performance. Accordingly, each executive officer’s compensation package consists of: (i) base salary, (ii) discretionary cash bonus and (iii) long-term stock-based incentive awards.
 
Base Salary.    The base salary for each executive officer is set on the basis of general market levels and personal performance. Each individual’s base pay is positioned relative to the total compensation package, including cash incentives and long-term incentives.
 
Annual Cash Bonuses.    Each executive officer is eligible for a cash bonus at the discretion of the Compensation Committee. The Compensation Committee considers performance targets established at the start of the fiscal year and personal objectives established for each executive. Actual bonuses paid reflect an individual’s accomplishment of both corporate and functional objectives.
 
Long-Term Incentive Compensation.    During fiscal 2001, the Compensation Committee, in its discretion, made option grants to the Company’s Named Executive Officers and certain executive officers as performance bonuses and for retention purposes. The Compensation Committee also made initial option grants to David Lockwood in connection with his employment commencement in September 2001 and subsequent assumption of the President position in November 2001. Mr. Lockwood was also announced as chief executive officer in March 2002. Generally, a significant grant is made in the year that an officer commences employment. Thereafter, option grants may be made at varying times and in varying amounts in the discretion of the Compensation Committee. Generally, the size of each grant is set at a level that the Compensation Committee

51


deems appropriate to create a meaningful opportunity for stock ownership based upon the individual’s position with the Company, the individual’s potential for future responsibility and promotion, the individual’s performance in the recent period and the number of unvested options held by the individual at the time of the new grant. The relative weight given to each of these factors will vary from individual to individual at the Compensation Committee’s discretion.
 
Each grant allows the officer to acquire shares of the Company’s common stock at a fixed price per share (the market price on the grant date) over a specified period of time. The option vests in periodic installments over a two to four year period, contingent upon the executive officer’s continued employment with the Company. The vesting schedule and the number of shares granted are established to ensure a meaningful incentive in each year following the year of grant. Accordingly, the option will provide a return to the executive officer only if he or she remains in the Company’s employ, and then only if the market price of the Company’s common stock appreciates over the option term.
 
CEO Compensation.    The annual base salary for Mr. Shear, the Company’s Chief Executive Officer until March 2002, was not increased by the Compensation Committee during fiscal 2001, and Mr. Shear was not granted any options or given any bonus during fiscal 2001.
 
Tax Limitation.    Under the Federal tax laws, a publicly held company such as the Company will not be allowed a federal income tax deduction for compensation paid to certain executive officers to the extent that compensation exceeds $1 million per officer in any year. To qualify for an exemption from the $1 million deduction limitation, the stockholders were asked to approve a limitation under the Company’s 1999 Equity Incentive Plan on the maximum number of shares of common stock for which any one participant may be granted stock options per fiscal year. Because this limitation was adopted, any compensation deemed paid to an executive officer when he exercises an outstanding option under the 1999 Equity Incentive Plan with an exercise price equal to the fair market value of the option shares on the grant date will qualify as performance-based compensation that will not be subject to the $1 million limitation. Since it is not expected that the cash compensation to be paid to the Company’s executive officers for the 2001 fiscal year will exceed the $1 million limit per officer, the Compensation Committee will defer any decision on whether to limit the dollar amount of all other compensation payable to the Company’s executive officers to the $1 million cap.
 
Compensation Committee
 
Satish K. Gupta
Patrick S. Jones
 
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
 
The Compensation Committee of the Company’s Board of Directors was created on July 22, 1999 and became effective on the date of the Company’s initial public offering of its securities, October 26, 1999. The members of the Compensation Committee are Messrs. Gupta and Jones. Neither of these individuals was at any time during 2001, or at any other time, an officer or employee of the Company. No executive officer of the Company serves as a member of the board of directors or compensation committee of any unrelated entity that has one or more executive officers serving as a member of the Company’s Board of Directors or Compensation Committee.

52


 
STOCK PERFORMANCE GRAPH
 
The graph set forth below compares the cumulative total stockholder return on the Company’s common stock between October 27, 1999 (the date the Company’s common stock commenced public trading) and December 31, 2001 with the cumulative total return of (i) the CRSP Total Return Index for the Nasdaq Stock Market (U.S. Companies) (the “Nasdaq Stock Market-U.S. Index”) and (ii) the J.P. Morgan H&Q Internet 100 Index (the “Internet Index”) over the same period. This graph assumes the investment of $100.00 on October 27, 1999, in the Company’s common stock, the Nasdaq Stock Market-U.S. Index and the Internet Index and assumes the reinvestment of dividends, if any.
 
The comparisons shown in the graph below are based upon historical data. The Company cautions that the stock price performance shown in the graph below is not indicative of, nor intended to forecast, the potential future performance of the Company’s common stock.
 
Comparison of Cumulative Total Return Among InterTrust Technologies Corporation,  the Nasdaq Stock Market-U.S. Index and the J.P. Morgan H&Q Internet 100 Index
 
 
 
LOGO
 
The Company effected its initial public offering of common stock on October 26, 1999 at a price of $9.00 per share. The graph above, however, commences with the closing price of $27.188 per share on October 27, 1999—the date the Company’s common stock commenced public trading.
 
Notwithstanding anything to the contrary set forth in any of the Company’s previous or future filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, that might incorporate this Report on Form 10-K or future filings made by the Company under those statutes, the Compensation Committee Report and Stock Performance Graph shall not be deemed filed with the Securities and Exchange Commission and shall not be deemed incorporated by reference into any of those prior filings or into any future filings made by the Company under those statutes.

53


 
ITEM 12.
 
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
The following table sets forth, as of March 15, 2002, certain information with respect to shares beneficially owned by (i) each person who is known by the Company to be the beneficial owner of more than five percent of the Company’s outstanding shares of common stock, (ii) each of the Company’s directors and the executive officers named in the Summary Compensation Table and (iii) all current directors and executive officers as a group. Beneficial ownership has been determined in accordance with Rule 13d-3 under the Exchange Act. Under this rule, certain shares may be deemed to be beneficially owned by more than one person (if, for example, persons share the power to vote or the power to dispose of the shares). In addition, shares are deemed to be beneficially owned by a person if the person has the right to acquire shares (for example, upon exercise of an option or warrant) within sixty (60) days of the date as of which the information is provided. In computing the percentage ownership of any person, the amount of shares is deemed to include the amount of shares beneficially owned by such person (and only such person) by reason of such acquisition rights. As a result, the percentage of outstanding shares of any person as shown in the following table does not necessarily reflect the person’s actual voting power at any particular date.
 
    
Shares Beneficially
Owned(1)(2)

 
Name of Beneficial Owner

  
Number of
Shares

    
Percentage
of Total

 
Victor Shear
  
15,103,096
    
15.7
%
David Lockwood (3)
  
4,603,149
    
4.8
%
Edmund J. Fish (4)
  
700,050
    
*
 
David C. Chance (5)
  
550,787
    
*
 
David Ludvigson (6)
  
542,024
    
*
 
Patrick Nguyen (7)
  
460,864
    
*
 
Satish K. Gupta (8)
  
440,000
    
*
 
Lester Hochberg (9)
  
422,609
    
*
 
Mark Ashida (10)
  
240,723
    
*
 
Greg Wood (11)
  
165,625
    
*
 
Patrick S. Jones (12)
  
50,000
    
*
 
Robert R. Walker (13)
  
30,000
    
*
 
Timo Ruikka (14)
  
30,000
    
*
 
All current directors and executive officers as a group (15 persons) (15)
  
23,436,035
    
23.7
%

    *
 
Less than 1%
 
  (1)
 
Percentage ownership is based on 96,079,250 shares of common stock outstanding on March 15, 2002.
 
  (2)
 
Shares of common stock subject to options currently exercisable or exercisable within 60 days of March 15, 2002 are deemed outstanding for purposes of computing the percentage ownership of the person holding such options but are not deemed outstanding for computing the percentage ownership of any other person. Except pursuant to applicable community property laws or as indicated in the footnotes to this table, each stockholder identified in the table possesses sole voting and investment power with respect to all shares of common stock shown as beneficially owned by such stockholder. Unless otherwise indicated, the address of each of the individuals listed in the table is c/o InterTrust Technologies Corporation, 4750 Patrick Henry Drive, Santa Clara, CA 95054.
 
  (3)
 
Includes 411,249 shares subject to options that are exercisable within 60 days of March 15, 2002.
 
  (4)
 
Includes 297,812 shares subject to options that are exercisable within 60 days of March 15, 2002.
 
  (5)
 
Includes 550,787 shares subject to options that are exercisable within 60 days of March 15, 2002.
 
  (6)
 
Includes 520,824 shares subject to options that are exercisable within 60 days of March 15, 2002.
 
  (7)
 
Includes 395,829 shares subject to options that are exercisable within 60 days of March 15, 2002.

54


 
  (8)
 
Includes 285,000 shares subject to options that are exercisable within 60 days of March 15, 2002.
 
  (9)
 
Includes 39,121 shares subject to options that are exercisable within 60 days of March 15, 2002, and 189,044 shares, which are held directly by LHZG Ventures, LLC. Mr. Hochberg is a manager of LHZG Ventures, LLC, and may be deemed to have shared voting or dispositive power over these shares. Mr. Hochberg expressly disclaims any beneficial ownership of the shares held by LHZG Ventures, LLC except as to any pecuniary interest therein.
 
(10)
 
Includes 185,415 shares subject to options that are exercisable within 60 days of March 15, 2002.
 
(11)
 
Includes 150,625 shares subject to options that are exercisable within 60 days of March 15, 2002.
 
(12)
 
Includes 40,000 shares subject to options that are exercisable within 60 days of March 15, 2002.
 
(13)
 
Includes 30,000 shares subject to options that are exercisable within 60 days of March 15, 2002.
 
(14)
 
Includes 30,000 shares subject to options that are exercisable within 60 days of March 15, 2002.
 
(15)
 
Includes 2,985,020 shares subject to options that are exercisable within 60 days of March 15, 2002.

55


 
ITEM 13.    RELATED PARTY TRANSACTIONS
 
Since January 1, 2001, there has not been, nor is there currently proposed, any transaction or series of similar transactions to which the Company or any of its subsidiaries was or is to be a party in which the amount involved exceeded or will exceed $60,000 and in which any director, executive officer, holder of more than 5% of the common stock of the Company or any member of the immediate family of any of the foregoing persons had or will have a direct or indirect material interest other than (i) compensation agreements and other arrangements, which are described where required in Employment Contracts and Change in Control Arrangements and (ii) the transactions described below.
 
Options to Purchase Common Stock.    In March 2001, we granted an option to purchase 100,000 shares of our common stock to Talal Shamoon, one of our executive officers, an option to purchase 80,000 shares of our common stock to Mark Scadina, one of our executive officers, an option to purchase 100,000 shares of our common stock to Patrick Nguyen, one of our executive officers, an option to purchase 65,000 shares of our common stock to David Maher, one of our executive officers, an option to purchase 125,000 shares of our common stock to Edmund Fish, one of our executive officers and one of our directors, and an option to purchase 200,000 shares of our common stock to David Ludvigson, a former executive officer, each at an exercise price of $3.75 per share. In May 2001, we granted an option to purchase 150,000 shares of our common stock to Mark Ashida, one of our executive officers, at an exercise price of $3.29 per share. In June 2001, we granted an option to purchase 75,000 shares of our common stock to Greg Wood, one of our executive officers, an option to purchase 150,000 shares of our common stock to Mr. Shamoon, an option to purchase 200,000 shares to Mr. Ludvigson, an option to purchase 175,000 shares of our common stock to Mr. Fish, an option to purchase 200,000 shares of our common stock to Mr. Ashida, and an option to purchase 100,000 shares of our common stock to Mr. Nguyen each at an exercise price of $1.10 per share. In September 2001, we granted an option to purchase 1,500,000 shares of our common stock to David Lockwood, one of our executive officers and one of our directors, at an exercise price of $1.07 per share. In November 2001, we granted an option to purchase 1,500,000 shares of our common stock to Mr. Lockwood at an exercise price of $1.18 per share. In January 2002, we granted an option to purchase 300,000 shares of our common stock to Mr. Shamoon, an option to purchase 275,000 shares of our common stock to Mr. Scadina, an option to purchase 300,000 shares of our common stock to Mr. Nguyen, an option to purchase 300,000 shares of our common stock to Mr. Maher, an option to purchase 300,000 shares of our common stock to Mr. Fish, an option to purchase 300,000 shares of our common stock to Mr. Wood, an option to purchase 400,000 shares of our common stock to Mr. Lockwood, and an option to purchase 300,000 shares of our common stock to Mr. Ashida at an exercise price of $1.22 per share. In March 2002, we granted an option to purchase 50,000 shares of our common stock to David Chance , one of our directors at an exercise price of $1.26 per share.
 
Forgiveness of Loan of Executive Officer.    In August 2000, our Compensation Committee agreed to assume a $70,000 loan of David Ludvigson, one of our executive officers. The loan was forgiven as follows: $12,000 in principal plus interest earned of $1,866 on January 1, 2001 according to the original loan document; and $58,000 in principal plus $3,383 in interest on October 31, 2001 as a provision of the Severance and Release agreement.
 
Loans to Directors and Officers.    During 2001 we made two loans to Mark Ashida, one of our executive officers, totaling $200,000. The first loan is a full-recourse, unsecured promissory note for $100,000 accruing interest at 7%, and is forgivable at $50,000 in January 2002 and $8,333 per month beginning in February 2002 as long as the officer is employed with the company. This note contains a provision that forgiveness will accelerate upon acquisition of the Company by another entity. The second note is a full-recourse unsecured promissory note for $100,000 accruing interest at 7%, and is forgivable at $50,000 on October 9, 2002 and on October 9, 2003 as long as the officer is employed with the company. This note also contains a provision that forgiveness will accelerate upon acquisition of the Company by another entity.
 
In July 2001 we made a loan to Edmund Fish, another one of our executive officers. The loan is a full-recourse, unsecured promissory note for $100,000 accruing interest at 7%. The entire principal and accrued interest is due on July 30, 2004.

56


 
In December 2000, we loaned $100,000 to Bruce Fredrickson, a former non-employee director. The loans in in the form of a full-recourse note which accrues interest at the rate of 6.10% per year and was due in December 2001.
 
In September 2001, the Company entered into an employment agreement with David Lockwood to serve as Executive Vice Chairman. The agreement provides for a base salary of $200,000 per year. In connection with his employment in September 2001, Mr. Lockwood received an option to acquire 1,500,000 shares at an exercise price of $1.07 per share. In the event of a change of control of the company, vesting will accelerate on 50% of such then unvested shares, unless consideration to the Company exceeds $5.00 per share in which case 100% of the then unvested options will vest. Upon assumption of the additional role of President, in November 2001, Mr. Lockwood received an option to acquire an additional 1,100,000 shares at an exercise price of $1.18 per share. The November 2001 options will vest 100% in the event of a change of control.
 
In January 2001, we sold 4,000,000 shares of common stock at $5.00 per share, fair market value, to Nokia Finance International B.V., a subsidiary of Nokia Corporation (“Nokia”), for total cash consideration of $20 million. In connection with its investment, Nokia agreed to license our DRM solutions and selected us as its preferred DRM technology. Additionally, per the agreement, we have appointed an executive officer of Nokia to our board of directors. During the fourth quarter of 2001 the two parties agreed to terminate the license, and we recognized $750,000 in cancellation fees as other income.
 
The Company’s Certificate of Incorporation limits the liability of its directors for monetary damages arising from a breach of their fiduciary duty as directors, except to the extent otherwise required by the Delaware General Corporation Law. Such limitation of liability does not affect the availability of equitable remedies such as injunctive relief or rescission.
 
The Company’s Bylaws provide that the Company shall indemnify its directors and officers to the fullest extent permitted by Delaware law, including in circumstances in which indemnification is otherwise discretionary under Delaware law. The Company has also entered into indemnification agreements with its officers and directors containing provisions that may require the Company, among other things, to indemnify such officers and directors against certain liabilities that may arise by reason of their status or service as directors or officers and to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified.

57


 
PART IV
 
ITEM 14.
 
EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
 
(a)(1)  Financial Statements—See Index to Financial Statements and Financial Statement Schedule at page F-1 of this Form 10-K.
 
(a)(2)  Financial Statement Schedule—Schedules have been omitted because the information required to be set forth therein is not applicable or is readily available in the financial statements or notes thereto.
 
(a)(3)  Exhibits:
 
Exhibit No.

  
Description

  3.1
  
Sixth Amended and Restated Certificate of Incorporation filed with the Secretary of State of Delaware on November 1, 1999—incorporated herein by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1 (File No. 333-84033).
  3.2***
  
Amended and Restated Bylaws of the Registrant.
  4.1
  
Reference is made to Exhibits 3.1 and 3.2.
  4.2*
  
Form of Registrant’s Common Stock certificate.
  4.3*
  
Form of Registration Rights under select Convertible Promissory Notes.
  4.4*
  
Form of Registration Rights under select Class A Common Stock Purchase Agreements.
  4.5*
  
Form of Series A Preferred Stock Registration Rights.
  4.6*
  
Form of Series B, C, D and E Preferred Stock Registration Rights.
  4.7*
  
Form of Registration Rights found in a Class B Non-Voting Common Stock Warrant.
  4.8
  
Stockholder Rights Agreement, by and between the Registrant and Nokia Finance International, B.V., dated January 31, 2000—incorporated herein by reference to Exhibit 4.1 to the Registrant’s Form 8-K filed February 20, 2001.
  4.9
  
Rights Agreement dated June 8, 2001—incorporated herein by reference to Exhibit 4.1 to the Registrant’s Form 8-K filed June 27, 2001.
10.1*
  
Form of Indemnification Agreement entered into by the Registrant with each of its directors and executive officers.
10.2*
  
1999 Equity Incentive Plan and forms of agreements thereunder.
10.3*
  
1999 Employee Stock Purchase Plan.
10.4*
  
1999 Non-Employee Directors Option Plan.
10.5
  
Lease between Mission West Properties, L.P. and the Registrant dated July 21, 1999— incorporated herein by reference to Exhibit 10.11 to the Registrant’s Registration Statement on Form S-1 (File No. 333-84033).
10.6+
  
Technology Development, Marketing, and License Agreement by and between the Registrant and National Westminster Bank PLC dated August 18, 1998—incorporated herein by reference to Exhibit 10.12 to the Registrant’s Registration Statement on Form S-1 (File No. 333-84033).
10.7+
  
Technology Development and License Agreement by and between the Registrant and Universal Music Group, Inc. dated April 13, 1999—incorporated herein by reference to Exhibit 10.13 to the Registrant’s Registration Statement on Form S-1 (File No. 333-84033).
10.8+
  
Technology Development and License Agreement by and between the Registrant and Upgrade Corporation of America dated August 7, 1996—incorporated herein by reference to Exhibit 10.14 to the Registrant’s Registration Statement on Form S-1 (File No. 333-84033).
10.9+
  
Technology Development and License Agreement by and between the Registrant and Mitsubishi Corporation dated October 7, 1996—incorporated herein by reference to Exhibit 10.15 to the Registrant’s Registration Statement on Form S-1 (File No. 333-84033).
10.10
  
Warrant for the purchase of Class A Voting Common Stock made by the Registrant and held by Allen & Company Incorporated, dated September 7, 1999—incorporated herein by reference to Exhibit 10.16 to the Registrant’s Registration Statement on Form S-1 (File No. 333-84033).

58


Exhibit No.

  
Description

10.11
  
Amendment to Technology, Development, Marketing and License Agreement by and between the Registrant and National Westminster Bank dated August 18, 1998—incorporated herein by reference to Exhibit 10.17 to the Registrant’s Registration Statement on Form S-1 (File No. 333-84033).
10.12
  
Amendment to Technology Development and License Agreement by and between the Registrant and Universal Music Group, Inc. dated April 13, 1999—incorporated herein by reference to Exhibit 10.18 to the Registrant’s Registration Statement on Form S-1 (File No. 333-84033).
10.19**
  
Building Lease Agreement by and between First State Realty of America, Inc. and the Registrant dated January 24, 2000.
10.20***
  
Employment Agreement by and between the Company and David Ludvigson dated August 4, 2000.
10.21****
  
2000 Supplemental Option Plan.
10.22****
  
Full-Recourse Promissory Note dated December 7, 2000 from Bruce Fredrickson to the Company.
10.23
  
Acceleration of Stock Option Vesting Agreement by and between the Company and David Lockwood dated September 25, 2001—Incorporated herein by reference to Exhibit 10.23 to the Registrant’s Form 10-Q filed November 14, 2001.
10.24
  
Employment Agreement by and between the Company and David Lockwood dated
September 25, 2001.
23.1
  
Consent of Ernst & Young LLP, Independent Auditors.
24.1
  
Power of Attorney (See page 60).

    *
 
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 Form S-1 (File No. 333-32484).
***
 
Incorporated herein by reference to the exhibit of the same number in the Registrant’s Form 10-Q for the quarter ended September 30, 2000.
****
 
Incorporated herein by reference to the exhibit of the same number in the Registrant’s Form 10-K for the year ended December 31, 2000.
    †
 
Confidential treatment requested.
 
 
(b)
 
Reports on Form 8-K
 
None.
 
 
(c)
 
Exhibits
 
See (a)(3) above.
 
 
(d)
 
Financial Statement Schedule
 
See (a)(2) above.

59


 
SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
April 1, 2002
INTERTRUST TECHNOLOGIES CORPORATION (Registrant)
By:
 
/S/    DAVID LOCKWOOD        

   
David Lockwood
Executive Vice Chairman of the Board,
Chief Executive Officer and President
 
POWER OF ATTORNEY
 
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints David Lockwood and Edmund J. Fish, or either of them, each with the power of substitution, his attorney-in-fact, to sign any amendments to this Form 10-K (including post-effective amendments), and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
Signature

  
Title

 
Date

/s/    VICTOR SHEAR        

Victor Shear
  
Chairman of the Board
 
April 1, 2002
/s/    DAVID LOCKWOOD        

David Lockwood
  
Executive Vice Chairman
of the Board, Chief Executive Officer and President (Principal Executive Officer)
 
April 1, 2002
/s/    EDMUND J. FISH        

Edmund J. Fish
  
Director and President
MetaTrust Utility
 
April 1, 2002
/s/    GREG S. WOOD        

Greg S. Wood
  
Chief Financial Officer
 
April 1, 2002
/s/    SATISH K. GUPTA        

Satish K. Gupta
  
Director
 
April 1, 2002

60


Signature

  
Title

 
Date

/s/    DAVID C. CHANCE        

David C. Chance
  
Director
 
April 1, 2002
/s/    PATRICK S. JONES        

Patrick S. Jones
  
Director
 
April 1, 2002
/s/    LESTER HOCHBERG        

Lester Hochberg
  
Director
 
April 1, 2002
/s/    ROBERT WALKER        

Robert Walker
  
Director
 
April 1, 2002
/s/    TIMO RUIKKA        

Timo Ruikka
  
Director
 
April 1, 2002

61


 
INTERTRUST TECHNOLOGIES CORPORATION
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 

F-1


 
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors and Stockholders
InterTrust Technologies Corporation
 
We have audited the accompanying consolidated balance sheets of InterTrust Technologies Corporation as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2001. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
 
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of InterTrust Technologies Corporation at December 31, 2001 and 2000, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
 
 
/s/  
  ERNST & YOUNG LLP
 
San Francisco, California
January 29, 2002, except for Note 14,
as to which the date is March 22, 2002.

F-2


 
INTERTRUST TECHNOLOGIES CORPORATION
 
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
 
    
December 31,

 
    
2001

    
2000

 
ASSETS
                 
Current assets:
                 
Cash and cash equivalents
  
$
56,643
 
  
$
23,811
 
Short-term investments
  
 
70,058
 
  
 
134,707
 
Accounts receivable, net of allowance of $186 in 2001 and $178 in 2000
  
 
353
 
  
 
3,928
 
Other current assets
  
 
1,702
 
  
 
2,771
 
    


  


Total current assets
  
 
128,756
 
  
 
165,217
 
Property and equipment, net
  
 
8,071
 
  
 
8,919
 
Restricted long-term investment
  
 
945
 
  
 
944
 
Long-term investments
  
 
—  
 
  
 
16,783
 
Goodwill and other intangible assets, net
  
 
4,849
 
  
 
29,453
 
Other assets
  
 
1,972
 
  
 
5,557
 
    


  


    
$
144,593
 
  
$
226,873
 
    


  


LIABILITIES AND STOCKHOLDERS’ EQUITY
                 
Current liabilities:
                 
Accounts payable
  
$
783
 
  
$
2,728
 
Accrued compensation
  
 
1,556
 
  
 
2,155
 
Accrued professional fees
  
 
1,355
 
  
 
418
 
Accrued restructuring costs—current portion
  
 
2,259
 
  
 
—  
 
Other accrued liabilities
  
 
3,797
 
  
 
692
 
Deferred revenue
  
 
1,615
 
  
 
5,915
 
    


  


Total current liabilities
  
 
11,365
 
  
 
11,908
 
Deferred revenue—long-term portion
  
 
5,779
 
  
 
7,617
 
Accrued restructuring costs—long-term portion
  
 
2,838
 
  
 
—  
 
    


  


    
 
19,982
 
  
 
19,525
 
Commitments and contingencies
                 
Stockholders’ equity:
                 
Common stock, $0.001 par value, 120,000,000 authorized 95,289,605 and 87,776,991 issued and outstanding at December 31, 2001 and 2000
  
 
95
 
  
 
88
 
Additional paid-in capital
  
 
370,118
 
  
 
340,380
 
Deferred stock compensation
  
 
(846
)
  
 
(3,274
)
Notes receivable from stockholders
  
 
—  
 
  
 
(516
)
Accumulated other comprehensive income
  
 
408
 
  
 
376
 
Accumulated deficit
  
 
(245,164
)
  
 
(129,706
)
    


  


Total stockholders’ equity
  
 
124,611
 
  
 
207,348
 
    


  


    
$
144,593
 
  
$
226,873
 
    


  


 
See accompanying notes.

F-3


 
INTERTRUST TECHNOLOGIES CORPORATION
 
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except share and per share amounts)
 
    
Year Ended December 31,

 
    
2001

    
2000

    
1999

 
Revenues:
                          
Licenses
  
$
6,079
 
  
$
4,150
 
  
$
778
 
Software support and training
  
 
1,361
 
  
 
3,149
 
  
 
613
 
Services
  
 
973
 
  
 
244
 
  
 
150
 
Hardware
  
 
12
 
  
 
445
 
  
 
—  
 
    


  


  


Total revenues
  
 
8,425
 
  
 
7,988
 
  
 
1,541
 
Cost of revenues:
                          
Licenses
  
 
430
 
  
 
436
 
  
 
141
 
Software support and training (exclusive of amortization of deferred compensation of $22, $36 and $32 for the year ended December 31, 2001, 2000 and 1999, respectively)
  
 
1,245
 
  
 
910
 
  
 
470
 
Services
  
 
5,624
 
  
 
3,670
 
  
 
436
 
Hardware
  
 
840
 
  
 
445
 
  
 
—  
 
    


  


  


Total cost of revenues
  
 
8,139
 
  
 
5,461
 
  
 
1,047
 
    


  


  


Gross profit
  
 
286
 
  
 
2,527
 
  
 
494
 
Operating costs and expenses:
                          
Research and development (exclusive of amortization of deferred compensation of $576, $849 and $664 for the year ended December 31, 2001, 2000 and 1999, respectively)
  
 
34,864
 
  
 
24,475
 
  
 
16,472
 
Sales and marketing (exclusive of amortization of deferred compensation of $681, $592 and $366 for the year ended December 31, 2001, 2000 and 1999, respectively)
  
 
18,551
 
  
 
18,539
 
  
 
6,886
 
General and administrative (exclusive of amortization of deferred compensation of $994, $1,849 and $642 for the year ended December 31, 2001, 2000 and 1999, respectively)
  
 
17,090
 
  
 
9,890
 
  
 
5,588
 
Purchased in-process research and development
  
 
567
 
  
 
6,100
 
  
 
—  
 
Amortization of goodwill and other intangible assets
  
 
5,389
 
  
 
3,004
 
  
 
—  
 
Amortization of deferred compensation
  
 
2,273
 
  
 
3,326
 
  
 
1,704
 
Impairment of goodwill and other intangible assets
  
 
31,908
 
  
 
—  
 
  
 
—  
 
Restructuring and other
  
 
11,236
 
  
 
—  
 
  
 
—  
 
    


  


  


Total operating costs and expenses
  
 
121,878
 
  
 
65,334
 
  
 
30,650
 
    


  


  


Loss from operations
  
 
(121,592
)
  
 
(62,807
)
  
 
(30,156
)
Interest and other income, net
  
 
9,380
 
  
 
10,867
 
  
 
1,876
 
Loss on debt and equity investments
  
 
(3,246
)
  
 
(3,699
)
  
 
—  
 
Provision for foreign income taxes
  
 
—  
 
  
 
(2
)
  
 
(325
)
    


  


  


Net loss
  
$
(115,458
)
  
$
(55,641
)
  
$
(28,605
)
    


  


  


Basic and diluted net loss per share
  
$
(1.24
)
  
$
(0.66
)
  
$
(0.71
)
    


  


  


Shares used in computing basic and diluted net lossper share
  
 
93,021
 
  
 
84,016
 
  
 
40,426
 
    


  


  


 
 
See accompanying notes.

F-4


 
INTERTRUST TECHNOLOGIES CORPORATION
 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(in thousands, except share amounts)
 
   
Convertible Preferred Stock

   
Common Stock

 
Additional
Paid-In
Capital

   
Deferred Stock
Compen-
sation

    
Notes Receivable
Stockholders

   
Accum-
ulated Other Income
(Loss)

   
Accum-
ulated
Deficit

   
Total Compre-
hensive
Income (Loss)

   
Total
Stock-
holders’
Equity

 
 
Shares

    
Amount

   
Shares

    
Amount

              
Balance at December 31, 1998
 
21,000,774
 
  
$
21
 
 
29,341,296
 
  
$
29
 
$
43,672
 
 
$
—  
 
  
$
(276
)
 
$
—  
 
 
$
(45,460
)
 
$
—  
 
 
$
(2,014
)
Issuance of series C preferred stock
 
1,700,000
 
  
 
2
 
 
—  
 
  
 
—  
 
 
5,005
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
         
 
5,007
 
Issuance of series D preferred stock
 
2,284,046
 
  
 
2
 
 
—  
 
  
 
—  
 
 
9,705
 
                                          
 
9,707
 
Issuance of series E preferred stock
 
2,619,400
 
  
 
3
 
 
—  
 
  
 
—  
 
 
15,688
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
         
 
15,691
 
Issuance of series E preferred stock upon conversion of note payable
 
166,666
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
1,000
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
         
 
1,000
 
Issuance of common stock upon exercise of options
 
—  
 
  
 
—  
 
 
6,354,814
 
  
 
6
 
 
3,893
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
3,899
 
Issuance of common stock upon exercise of warrants
 
—  
 
  
 
—  
 
 
630,000
 
  
 
1
 
 
374
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
375
 
Conversion of preferred stock to common stock upon completion of initial public offering
 
(27,770,886
)
  
 
(28
)
 
27,770,886
 
  
 
28
 
 
—  
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
Issuance of common stock in public offering, net of issuance costs of $11,123
 
—  
 
  
 
—  
 
 
14,950,000
 
  
 
15
 
 
123,412
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
123,427
 
Issuance of common stock for asset acquisition
 
—  
 
  
 
—  
 
 
170,000
 
  
 
—  
 
 
1,190
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
1,190
 
Issuance of patent for patent acquisition
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
1,919
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
1,919
 
Compensation related to issuance of common stock warrant
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
79
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
79
 
Deferred stock compensation
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
8,304
 
 
 
(8,304
)
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
Amortization of deferred compensation
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
—  
 
 
 
1,704
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
1,704
 
Forgiveness of note receivable from stockholders
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
—  
 
 
 
—  
 
  
 
80
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
80
 
Unrealized loss on short-term investments
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
—  
 
 
 
—  
 
  
 
—  
 
 
 
(107
)
 
 
—  
 
 
 
(107
)
 
 
(107
)
Net loss
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
—  
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
(28,605
)
 
 
(28,605
)
 
 
(28,605
)
   

  


 

  

 


 


  


 


 


 


 


Total comprehensive loss
                                                                      
 
(28,712
)
       
Balance at December 31, 1999
 
—  
 
  
 
—  
 
 
79,216,996
 
  
 
79
 
 
214,241
 
 
 
(6,600
)
  
 
(196
)
 
 
(107
)
 
 
(74,065
)
         
 
133,352
 
Issuance of common stock for business combination and asset acquisitions
 
—  
 
  
 
—  
 
 
1,105,180
 
  
 
1
 
 
27,850
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
27,851
 
Issuance of common stock in public offering, net of issuance cost of $6,488
 
—  
 
  
 
—  
 
 
2,820,244
 
  
 
3
 
 
92,232
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
92,235
 
Issuance of common stock upon exercise of options and warrants
 
—  
 
  
 
—  
 
 
4,326,578
 
  
 
5
 
 
3,695
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
3,700
 
Issuance of common stock upon employee stock purchases
 
—  
 
  
 
—  
 
 
307,993
 
  
 
—  
 
 
2,362
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
2,362
 
Note receivable from stockholder
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
—  
 
 
 
—  
 
  
 
(500
)
                 
 
—  
 
 
 
(500
)
Amortization of deferred stock compensation
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
—  
 
 
 
3,326
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
3,326
 
Forgiveness and repayment of notes receivable from stockholders
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
—  
 
 
 
—  
 
  
 
180
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
180
 
Unrealized holding gain on investments
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
—  
 
 
 
—  
 
  
 
—  
 
 
 
483
 
 
 
—  
 
 
 
483
 
 
 
483
 
Net loss
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
—  
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
(55,641
)
 
 
(55,641
)
 
 
(55,641
)
   

  


 

  

 


 


  


 


 


 


 


Total comprehensive loss
                                                                      
 
(55,158
)
       
Balance at December 31, 2000
 
—  
 
  
 
—  
 
 
87,776,991
 
  
 
88
 
 
340,380
 
 
 
(3,274
)
  
 
(516
)
 
 
376
 
 
 
(129,706
)
         
 
207,348
 
Issuance of common stock
 
—  
 
  
 
—  
 
 
4,000,000
 
  
 
4
 
 
19,996
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
20,000
 
Issuance of common stock and stock options assumed for business combination
 
—  
 
  
 
—  
 
 
1,950,000
 
  
 
2
 
 
12,048
 
 
 
(3,322
)
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
8,728
 
Issuance of common stock upon exercise of options and warrants
 
—  
 
  
 
—  
 
 
1,330,711
 
  
 
1
 
 
1,086
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
1,087
 
Issuance of common stock under employee stock purchase plan
 
—  
 
  
 
—  
 
 
197,943
 
  
 
—  
 
 
442
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
442
 
Issuance of common stock for services
 
—  
 
  
 
—  
 
 
116,373
 
  
 
—  
 
 
160
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
160
 
Deferred stock compensation due to issuance of restricted stock
 
—  
 
  
 
—  
 
 
160,000
 
  
 
—  
 
 
143
 
 
 
(143
)
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
Reversal of deferred compensation due to employee termination
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
(3,620
)
 
 
3,620
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
Reversal of notes receivable from stockholders related to stock options not exercised
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
(500
)
 
 
—  
 
  
 
516
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
16
 
Amortization of deferred stock compensation
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
—  
 
 
 
2,273
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
2,273
 
Repurchase of common stock
 
—  
 
  
 
—  
 
 
(242,413
)
  
 
—  
 
 
(17
)
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
—  
 
 
 
(17
)
Unrealized holding gain on investments
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
—  
 
 
 
—  
 
  
 
—  
 
 
 
32
 
 
 
—  
 
 
 
32
 
 
 
32
 
Net loss
 
—  
 
  
 
—  
 
 
—  
 
  
 
—  
 
 
—  
 
 
 
—  
 
  
 
—  
 
 
 
—  
 
 
 
(115,458
)
 
 
(115,458
)
 
 
(115,458
)
   

  


 

  

 


 


  


 


 


 


 


Total comprehensive loss
                                                                      
$
(115,426
)
       
Balance at December 31, 2001
 
—  
 
  
$
—  
 
 
95,289,605
 
  
$
95
 
$
370,118
 
 
$
(846
)
  
$
—  
 
 
$
408
 
 
$
(245,164
)
         
$
124,611
 
   

  


 

  

 


 


  


 


 


 


 


 
See accompanying notes.

F-5


 
INTERTRUST TECHNOLOGIES CORPORATION
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
    
Year Ended December 31,

 
    
2001

    
2000

    
1999

 
Operating activities
                          
Net loss
  
$
(115,458
)
  
$
(55,641
)
  
$
(28,605
)
Adjustments to reconcile net loss to net cash used in operating activities:
                          
Issuance of common stock for services
  
 
160
 
  
 
—  
 
  
 
—  
 
Depreciation and amortization of property and equipment
  
 
3,822
 
  
 
1,694
 
  
 
660
 
Amortization of goodwill and other intangible assets
  
 
5,747
 
  
 
3,492
 
  
 
—  
 
Amortization of deferred stock compensation
  
 
2,273
 
  
 
3,326
 
  
 
1,863
 
Compensation expense related to the reversal of notes receivable from stockholders
  
 
16
 
  
 
118
 
  
 
—  
 
Impairment of goodwill and other intangible assets
  
 
31,908
 
           
 
—  
 
Gain from sales of long-term investments
  
 
(531
)
           
 
—  
 
Purchased in-process research and development
  
 
567
 
  
 
6,100
 
  
 
—  
 
Loss on debt and equity investments
  
 
3,246
 
  
 
3,699
 
  
 
—  
 
Non-cash restructuring and other charges
  
 
7,258
 
  
 
—  
 
  
 
—  
 
Changes in operating assets and liabilities:
                          
Accounts receivable
  
 
3,580
 
  
 
(1,366
)
  
 
(1,017
)
Other current assets
  
 
1,227
 
  
 
(1,589
)
  
 
(1,040
)
Accounts payable
  
 
(2,389
)
  
 
509
 
  
 
1,635
 
Accrued compensation
  
 
(599
)
  
 
1,042
 
  
 
553
 
Accrued professional fees
  
 
937
 
  
 
52
 
  
 
140
 
Other accrued liabilities
  
 
(1,607
)
  
 
(620
)
  
 
788
 
Deferred revenue
  
 
(6,138
)
  
 
362
 
  
 
4,595
 
    


  


  


Net cash used in operating activities
  
 
(65,981
)
  
 
(38,822
)
  
 
(20,428
)
Investing activities
                          
Capital expenditures
  
 
(4,084
)
  
 
(7,158
)
  
 
(3,017
)
Proceeds from sale of equipment
  
 
20
 
  
 
—  
 
  
 
—  
 
Business acquisition, net of cash aquired
  
 
(457
)
  
 
—  
 
  
 
—  
 
Purchases of short-term investments
  
 
(96,668
)
  
 
(140,503
)
  
 
(42,655
)
Sales and maturities of short-term investments
  
 
161,349
 
  
 
48,704
 
  
 
—  
 
Purchases of long-term investments
  
 
(34,448
)
  
 
(16,660
)
  
 
—  
 
Sales and maturities of long-term investments
  
 
51,762
 
  
 
—  
 
  
 
—  
 
Purchase of restricted investments
  
 
—  
 
  
 
(944
)
  
 
—  
 
Purchased technology
  
 
—  
 
  
 
(7,800
)
  
 
—  
 
Other noncurrent assets, net
  
 
(173
)
  
 
(9,151
)
  
 
(295
)
    


  


  


Net cash provided by (used in) investing activities
  
 
77,301
 
  
 
(133,512
)
  
 
(45,967
)
Financing activities
                          
Proceeds from issuance of convertible promissory notes
  
 
—  
 
  
 
—  
 
  
 
1,000
 
Proceeds from issuance of preferred stock, net
  
 
—  
 
  
 
—  
 
  
 
30,405
 
Proceeds from issuance of common stock, net
  
 
20,000
 
  
 
92,235
 
  
 
123,427
 
Proceeds from exercise of stock options and warrants
  
 
1,087
 
  
 
3,700
 
  
 
4,274
 
Proceeds from purchases under employee stock purchase plan
  
 
442
 
  
 
2,362
 
  
 
—  
 
Repurchase of common stock
  
 
(17
)
  
 
—  
 
  
 
—  
 
Notes receivable from stockholders, net
  
 
—  
 
  
 
(438
)
  
 
—  
 
    


  


  


Net cash provided by financing activities
  
 
21,512
 
  
 
97,859
 
  
 
159,106
 
Net increase (decrease) in cash and cash equivalents
  
 
32,832
 
  
 
(74,475
)
  
 
92,711
 
Cash and cash equivalents at beginning of year
  
 
23,811
 
  
 
98,286
 
  
 
5,575
 
    


  


  


Cash and cash equivalents at end of year
  
$
56,643
 
  
$
23,811
 
  
$
98,286
 
    


  


  


F-6


 
INTERTRUST TECHNOLOGIES CORPORATION
 
CONSOLIDATED STATEMENTS OF CASH FLOWS—(Continued)
(in thousands)
 
    
Years Ended December 31,

    
2001

  
2000

  
1999

Supplemental schedule of noncash investing and financing activities:
                    
Business acquisitions:
                    
Issuance of common stock and options
  
$
12,050
  
$
24,516
  
$
    

  

  

Tangible assets acquired, net of cash received
  
$
1,640
  
$
  
$
    

  

  

Goodwill and other intangible assets acquired
  
$
12,819
  
$
18,433
  
$
    

  

  

Liabilities assumed
  
$
5,373
  
$
17
  
$
    

  

  

Deferred stock compensation
  
$
3,323
  
$
  
$
    

  

  

Technology asset acquisition:
                    
Common stock issued in exchange for assets
  
$
  
$
3,335
  
$
1,190
    

  

  

Other assets received in exchange
  
$
  
$
3,353
  
$
10
    

  

  

Other liabilities assumed in exchange
  
$
  
$
18
  
$
140
    

  

  

Patent acquired in exchange for stock option
  
$
  
$
  
$
1,919
    

  

  

Increase in deferred stock compensation
  
$
  
$
  
$
8,304
    

  

  

Conversion of convertible promissory notes and accrued interest into convertible preferred stock
  
$
  
$
  
$
1,000
    

  

  

 
 
See accompanying notes.

F-7


INTERTRUST TECHNOLOGIES CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
December 31, 2001
 
1.    ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Description of Business
 
Since InterTrust’s founding in 1990, InterTrust has invented and defined technologies for Digital Rights Management, or DRM, including various trusted computing technologies that enable secure management of digital processes and information. Inter