Macrovision Corporation (MVSN)
Q3 2000
Investor/Analyst Conference Call Script
Moderator: John Ryan
October 30, 2000
2:00 p.m. PST
Global Crossings
Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Macrovision third quarter earnings release conference call. At this time all participants are in a listen only mode. Later we will conduct a question and answer session. At that time, if you have a question, you will need to press the one followed by the four on your telephone. As a reminder, this conference is being recorded, Monday, October 30, 2000. I would now like to turn the conference over to Mr. John Ryan, CEO of Macrovision. Please go ahead Mr. Ryan.
John Ryan Chairman/CEO: Welcome, ladies and gentlemen, to Macrovision's 3rd quarter 2000 conference call. I am here today with Bill Krepick, our President and COO, and Ian Halifax, our CFO.
We are pleased to report our consolidated earnings results for the first quarter following the merger of GLOBEtrotter Software and Macrovision. Certainly the closing of the GLOBEtrotter acquisition on August 31st was the highlight of the quarter.
As stated in our Q3 Earnings Press Release earlier today, we had another record quarter in revenues and earnings. Business continues to be very strong in our core growth areas of DVD and digital pay-per-view copy protection. We are also delighted to report that our new GLOBEtrotter division achieved an all-time record quarter in both revenues and earnings. Our combined software-based rights management and CD-ROM copy protection businesses accounted for 38% of our total revenues in Q3.
Ian and Bill will give you more details about our financial and operating performance for the quarter. Let me now turn the microphone over to Ian.
Ian Halifax VP and CFO: Thank you, John.
Before I discuss the Company's Q3 2000 operating results released earlier today, I would like to remind you that all statements made during our conference call, that are not statements of historical fact, constitute "forward-looking statements" and are made pursuant to the Safe-Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results could vary materially from those contained in the forward-looking statements. Factors that could cause actual results to differ materially from those in the forward-looking statements are described in our Forms 10K and 10Q, other periodic filings with the SEC, and our press releases.
This is the first quarterly earnings conference call since SEC Regulation FD became effective and we would like to take a moment to outline our disclosure policy. In general, there will be no change from our prior communications policy, which bears repeating--we do not disclose material non-public information to anyone--investors or market analysts. We will continue to use press releases, public reports and now webcasts as the vehicles to communicate with the investment community. We will answer questions only in public forums, other than questions relating to purely historical and factual publicly available information. We will provide limited guidance publicly as to the future ranges of our revenue and earnings outlook. Those projections will speak as of the date made, and will generally be given during our quarterly earnings' conference calls. We intend to stay within the guidelines established by the SEC.
The following financial information and the financial statements released earlier today reflect the inclusion of the operations of Ç-Dilla Ltd., which Macrovision acquired in June of 1999, as well as GLOBEtrotter Software, Inc which was acquired on August 31, 2000. The GLOBEtrotter transaction is accounted for using the "pooling of interests" method. Hence, Macrovision has presented pro-forma reconciliation income statements to show earnings before goodwill amortization, in-process research and development write-off, non-cash deferred compensation expense and one-time, acquisition-related costs in order to reflect both the historical and the on-going operations of the combined companies, as well as net income.
As stated in our earnings release, consolidated net revenues for the third quarter of 2000 increased to a record $20,446,000 or 48% from $13,824,000 in the third quarter of 1999. Overall, revenues in the Video Copy Protection group, which includes copy protection for DVD, videocassettes, and digital pay-per-view, increased 63% to $12,501,000 in the third quarter of 2000 from $7,673,000 in the third quarter of 1999. DVD revenue was $5,669,000 in the third quarter of 2000 compared to $2,032,000 in 1999, an increase of 179%. This phenomenal growth in DVD copy protection revenue reflects both the extraordinary growth of DVD software in the market and a robust quarter for DVD hardware licenses from Asian manufacturers. Third quarter Copy Protection revenues from videocassettes were $2,603,000 in 2000 compared to $3,374,000 in 1999, a 23% drop, reflecting the continuing trend for Hollywood studios to invest more proportionally in copy protecting their DVD titles compared to VHS releases. Digital Pay-Per-View copy protection revenue was $4,229,000 in the third quarter of 2000 compared to $2,267,000 in 1999 reflecting an 87% increase. Revenue from the Company's Computer Software Copy Protection group was $1,769,000 during the third quarter of 2000, compared to $1,442,000 in 1999, an increase of 23%. Revenue from the Company's GLOBEtrotter business was $6,076,000 in the third quarter of 2000, compared to $4,460,000 in 1999, an increase of 36%. Revenues in the Video Scrambling group were $100,000.
Gross margin for the third quarter of 2000 was 93%, compared with 90% in the third quarter of 1999, primarily resulting from an increased proportion of revenues from our higher-margin DVD and digital pay-per-view businesses.
Pro forma operating income (before goodwill amortization, deferred compensation expense and one-time acquisition-related expenses), pro forma earnings and net income all set new third quarter records for the Company. Pro forma operating income was $10,842,000 or 85% higher than the third quarter of 1999, which was $5,865,000. Pro forma earnings for the third quarter of 2000 was a record $8,907,000 or 90% higher than the third quarter of 1999, which was $4,694,000. Net income for the third quarter of 2000 was $4,803,000.
Our operating margins showed continued strength. Pro forma operating income was 53% of revenue in Q3 2000 up from 42% in Q3 1999.
Pro forma diluted earnings per share (before goodwill amortization, deferred compensation expense and one-time acquisition-related expenses) for the third quarter of 2000 was 17 cents, compared to 10 cents (adjusted for the August 1999 and March 2000 2-for-1 stock splits) in the third quarter of 1999. This represents an increase of 70%. Diluted net earnings per share after goodwill amortization, deferred compensation expense and one-time acquisition-related expenses for the third quarter of 2000 was 9 cents.
Interest and other income was $3,127,000 for the quarter reflecting the impact of investing the proceeds from our January follow-on offering.
The total of the Company's cash and cash equivalents, short-term investments and long-term marketable investment securities balance as of September 30, 2000 was $227,621,000. This includes the proceeds from our follow-on offering in January and the market value of our investments in Digimarc and TTR.
The accounts receivable balance as of September 30, 2000 was $14,855.000. DSO (days' sales outstanding) was 65 days at the end of the third quarter. Deferred revenue was $9,526,000 at the end of the third quarter.
Analyst estimates for the fourth quarter show revenues in the range of $21m-$24m and pro forma EPS (before goodwill amortization, deferred compensation expense and one-time acquisition-related expenses) in the range of 16c-18c. These ranges are consistent with our targeted year-on-year revenue growth (in the 45%-50% range) and our intent to grow pro forma earnings at a rate higher than that for revenue growth. We remain comfortable with these estimates and believe our business will continue its strong momentum into 2001. We do not intend to separate out our various product line revenues in our guidance because of inherent quarter -to-quarter variability in the different business lines.
Now, let me turn the microphone over to Bill who will discuss the significant highlights of the quarter, as well as the trends in our various businesses and markets.
Bill Krepick President/COO: Thanks, Ian.
Our core businesses in video copy protection and computer software copy protection continue to do well, thanks to sustained market growth in those respective business segments. Sales of DVD hardware and DVD video software continue to set a torrid pace for the year and most industry forecasts show continued strong growth into 2001 and 2002. In North America, the Consumer Electronics Association (CEA) reported that 2.6 million DVD players were sold to dealers in Q3 '00 compared with 1.2 million in Q3 '99 representing a 116% year-over-year increase. Almost 11.6 million DVD players have been sold to dealers in North America since the product's launch in March 1997. Adams Media Research predicts that by 2005, 53% of U.S. homes will have a DVD player, and 61% of video rentals, and 74% of video sales will be DVD format. Screen Digest reported that by the end of 2003, 47 million homes in Europe (almost 30%) will have some form of DVD player hooked to their TV set compared with approximately five million at the end of 2000.
DVD video software continues to show explosive growth also. IRMA (International Recording Media Association) and Understanding & Solutions (UK market researcher) both predict that worldwide DVD video shipments will almost double between 2000 and 2001, and grow a further 60%-70% in 2002 when approximately 900 million units will be shipped. As we have reported in the past, our copy protection technology has been used on approximately 75% of all DVD videos to date. We have observed that when companies release catalog video product on DVD, e.g., titles which have been released in the past on other video formats or on TV, they may forego copy protection because they feel the program has been in the market for so long. We are seeing that as the major motion picture studios are joined in the DVD business by smaller independents and by special interest video producers, our overall penetration rate is beginning to decline, though our penetration of major Hollywood studio DVDs remains well above 75%. In spite of this phenomenon, we believe that a good barometer for growth in our DVD business will be growth in the overall DVD video software market.
A highlight of the quarter was our negotiation of a 5-year, 100% DVD and selected VHS titles' copy protection contract with Paramount Home Video. This is the third 5-year contract with a major motion picture studio that we have signed in the past 10 months, with the others being Universal and Disney. We believe it shows the confidence that the studios have in the future viability and value of our video copy protection technologies.
During the quarter we continued to see positive results from our aggressive DVD manufacturer licensing audit and enforcement program in Asia. Our DVD hardware licensee base has grown to 166 manufacturers, an increase of 29% from the same period in 1999. We receive modest annual license fees from these manufacturers. We have expanded our base of authorized authoring facilities and replicators from 170 in Q3 1999 to 296 this year, an increase of 74%. This simply means that the infrastructure is in place to make it easier for DVD video producers and distributors to be able to copy protect their DVDs throughout the world.
Our digital pay-per-view copy protection business continued strong throughout the world with the majority of our $4.2 million revenues coming from set top box royalties. With the announcement that our technology had been selected as a standard by the digital broadcast satellite system in Japan, we believe that we will see significant revenues from Japan over the next several years as the digital service is rolled out to millions of existing analog subscribers. We continue to be optimistic about our digital PPV business, as the cable and satellite operators around the world aggressively push to convert their installed base from analog to digital services, and as more and more system operators market hardware and services upgrades to their subscriber base with personal video recorders, and Internet appliances, most of which include Macrovision's copy protection features. Our future growth is very much tied to market growth and the upgrade success in set top boxes, since we have penetrated approximately 90% of the digital set top boxes.
On the PPV copy protection activation front, we are pleased to report that NTL and Telewest, the two largest UK cable companies, have joined BSkyB in activating copy protection for pay-per-view movies. We believe that NTL and Telewest have about 600,000 digital subscribers compared with 4.5 million for BSkyB.
In the software business segment, our newly acquired GLOBEtrotter electronic licensing management, or ELM business, contributed $6.1 million in revenue for the quarter. IDC, the internationally known computer software market research organization, has predicted that more than 50% of all software will be distributed or controlled electronically by the year 2002, up from approximately 25 % in 1999. By 2008 IDC predicts that virtually all software will be distributed electronically. We believe that GLOBEtrotter's products are well positioned to take advantage of this trend in software distribution. During 2000 GLOBEtrotter has been transitioning their licensing strategy from perpetual licenses to annual (or subscription-based) licenses, which allows for greater predictability of future revenues. At the same time, GLOBEtrotter has benefited from increases in its average license fee, as a larger number of major corporations are signing up for multi-platform, multinational licenses. Our primary objective for GLOBEtrotter during the coming year will be to beef up the sales force and implement a more aggressive outbound sales and marketing program in order to achieve our annual growth goals. As a first step in this strategy, we acquired the GLOBEtrotter sales and service operation from PtS, GLOBEtrotter's exclusive European distributor. We have already placed a Macrovision executive as Managing Director of this operation. .
Our computer software copy protection business generated Q3 revenues of $1.8 million, which was 23% higher than Q3 '99 revenues. Growth in PC Games' copy protection has been a little below our expectations due to a number of factors including consolidation and financial pressures within the industry on companies such as Mattel, Eidos, and others; fewer Q3 releases than expected; and concern by the publishers over SAFEDISC hack sites. We expect a more robust fourth quarter in our SAFEDISC business. On September 11th, we released our 2nd generation digital signature which will afford our PC games customers more anti-hack protection for their upcoming 4th quarter holiday title releases. During the quarter we installed our SAFEDISC signature technology in our 100th replicator, which we believe is important because it gives our customers unparalleled flexibility and choice in selecting replication vendors throughout the world. We also signed our first SAFEDISC HD application software customer, Lernout and Hauspie, to protect their speech recognition software in the Asian markets.
We signed two new SAFECAST DRM customers during the quarter: Element 5 in Germany, and GamePlay in the UK. Element 5 is a leading provider of ESD (electronic software distribution) for software publishers similar to Digital River. Element 5 selected SAFECAST because of the combination of high security and robust copy protection. GamePlay will be using SAFECAST in its "try and buy" programs, as well as secure on-line delivery of PC games. Both of these companies can be considered leading edge companies in the ESD space. We believe that SAFECAST may be a bit ahead of the market at this time as bandwidth to consumers' homes to support software downloads, although growing rapidly, is not yet widespread. Although SAFECAST revenues are not likely to be material for the next several quarters, we believe that SAFECAST has great promise for the future as the architecture can be applied to either computer software, or audio, or video, and we intend to continue to invest for the future and focus a substantial part of our R&D and marketing efforts on this exciting product line.
During the quarter we distributed a copy-protected audio CD as an alpha test to 1,000 U.S. consumers and are awaiting the analysis of the playback quality results from our contract market research firm. We designed the test CD with four different versions of SAFEAUDIO copy protection to allow us to pick the optimal solution for clear playback. If we find that we have achieved our compatibility goal, our next step will be to pursue beta testing with one or more major music labels. The ultimate acid test for acceptance of our technology will be the record labels' findings in their own trial releases.
In the digital watermarking area, we are teamed with Digimarc and Philips as the Millennium group and are vying for selection as the industry standard digital copy protection solution using digital watermarks. We continue to discuss our solution and our implementation plans with the studios and other industry participants, but risks of patent infringement lawsuits still remain a sticky issue for studios and hardware companies. Our plan is to continue with the development and release of the Millennium watermarking solution and search for a way to minimize or eliminate the patent risks for users. Philips has announced that their next generation DVD +RW recorders will deploy the Millennium watermark detectors.
Watermarks can also carry data that can be utilized for other rights management applications in addition to copy control and playback control. We believe that these other rights management applications of watermarking will become increasingly important in the future and that it is in the Company's best interests to have an ownership position in this vital technology. We believe that our Millennium partner Digimarc has the dominant worldwide intellectual property position in watermarking technology. Consequently during the quarter, we expanded our equity investment in Digimarc from approximately 7% to 12.5%, and received a board seat.
This concludes our presentation, and we'll be happy to answer any questions that you have.
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Operator: Ladies and gentlemen, we will now begin the question and answer session. If you do have a question, please press the one followed by the four on your telephone. You will hear a three-tone prompt acknowledging your request. If your question has been answered and you would like to withdraw your polling request, you may do so by pressing the one followed by the three. If you are using a speakerphone, please pick up your handset before entering your request. One moment, please, for the first question.
Gene Munster with US Bancorp Piper Jaffrey, please go ahead with your question.
Gene Munster: Hi guys. You talked a little bit about GLOBEtrotter and obviously have had a great quarter and going forward you're pretty optimistic. Could you give us a little bit more specific in terms of the growth rate we should be expecting in a business like that? Second, in terms of the profitability going forward?
B. Krepick: Yes, I think what we have announced on the GLOBEtrotter business is that their business model is very similar to ours, in terms of profitability. I think that's one of the reasons why you saw the quarter results that we had.
In terms of specific growth rates for the GLOBEtrotter business, I think I can only refer you to the IDC report, which currently has some outstanding kinds of growth rates associated with the conversion to electronic licensing management. As Ian mentioned at the beginning of the call, we're a little hesitant to get into specifically forecasted growth rates for specific business areas. We would rather, at this time, say that our overall business, we're targeting, is in the 45% to 50% range, and we would like to leave it at that.
G. Munster: Is it safe to say that seeing your gross margins were 93% that the possibility of that business has been in line with the possibility of your other businesses?
B. Krepick: Yes, very much so.
G. Munster: And, in terms of guidance for next year, I'm kind of on and off there, but did you reiterate your $100 million kind of revenue guidance for next year?
I. Halifax: Gene, this is Ian. We did not talk about FY '01 at all during the conference call. We are just about kicking off our FY '01 business planning process. It would be premature, at this point, to be giving guidance on FY '01 in the conference call. We remain comfortable with the analysts' estimates that we see out there for FY'01, at present.
G. Munster: Ok. Finally, I know you guys want to keep everybody pretty conservative on this, but in terms of the audio trials, any sort of feedback? I know you guys had a number of CDs that went out for Beta testing. Any feedback on how that's going?
B. Krepick: Well, we're very close, Gene, to starting to get some of the preliminary results, and I think that, no matter what we get, we are still hopeful that we can go to one or more of the major music labels and have them participate in their own trial. I think the way that people want to ultimately decide on both the effectiveness and the playability of this technology, is to actually put it out in the field with real customers. So, we hope within the next 30 days or so to enter into some kind of trial agreement with one of the major music labels on that.
G. Munster: So, we could start to see some revenues by mid-next year?
B. Krepick: Well, again, as you say, we've been very conservative on this. I don't think we want to talk about revenues until we get through this next level kind of beta tests with one of the music labels.
G. Munster: Ok. All right, well, I'll turn it over for now. Thank you.
B. Krepick: Ok, thanks Gene.
Operator: Your next question is from Rob Stone, with SG Cowan. Please go ahead.
Rob Stone: Congratulations, gentlemen, on a busy quarter. Bill, if I remember correctly, you specifically commented on the run rate of per-session revenues, in the pay-per-view segment, last time. I recognize that you don't probably want to get in the habit of breaking that out precisely every quarter, but was that still a meaningful portion of pay-per-view this time? Did it go up or down, sequentially?
B. Krepick: I think it was pretty much in line with what we had reported last quarter.
R. Stone: Ok.
B. Krepick: I did mention that we had two additional system operators in the UK that had actually activated copy protection during the quarter. I think if you look at their subscriber base, they're still small compared with BSkyB. I think BSkyB is up in the 4.5 million range for subscribers, and I think both NTL and our other customer over there, Tele-West, are probably in the 600,000 subscriber range.
R. Stone: Ok, so that's a small incremental expansion in the base.
You mentioned a number of hack sites, with respect to the CD-ROM copy protection software. Do you have, or do you plan to seek, any legal remedies against those operations?
B. Krepick: Not only do we plan, we've already been involved in a pretty aggressive effort, both ourselves as well as with some of our customers as well as with the trade industry organizations. We have utilized the DMCA, which is the Digital Millennium Copyright Act, to go after these guys, because circumvention devices or technologies are illegal under that.
So, we've had a pretty much all out effort deployed at them, and we have been successful in closing some sites down. As you're aware, they do tend to pop back up, but they certainly know that they have pressure from us as well as from some of the major games publishers, and we intend to continue with that program.
R. Stone: But, if I understood your comments correctly, you've upped the ante with the next generation of the software?
B. Krepick: Yes. From a technology standpoint, by changing the signature, we basically have put these guys back to square one, where they've got to try and figure out what we've done. The first generation signature that we had, basically, lasted for about 18 months. We're not going to stand here today and claim that it's going to take them another 18 months to try and hack it, but we think we do have a significant amount of breathing room. The intent was for sure to support our publishers during the up coming Christmas season for some of their major titles. And, in fact, I think some of the titles in Q3 had fewer releases, I think, than many in the industry expected.
But, as I mentioned in my prior comments, we do expect a robust Q4 for our copy protection business for games.
R. Stone: Ok. A question for Ian on the topic of guidance. Would you be willing to comment on operating expense trends, Q3 to Q4, in absolute dollars?
I. Halifax: At this point, probably not, Rob. I just refer you to the percentages in the overall operating model from the third quarter. On that, we would hope to squeeze a little extra out of that model, in the fourth quarter.
R. Stone: But, is it reasonable to expect that expenses would go up some, sequentially, as you further-for instance, you've taken on the UK operation that was a distributor for GLOBEtrotter, so that ought to add some incremental dollars, correct?
I. Halifax: That's correct, Rob. I think it's fair to say that we are short on resources, both in engineering and sales functions, both in the US and in the UK, and we are intending to beef up our sales and marketing efforts in the GLOBEtrotter business. So, yes, there will be an incremental tendency of the company, to support those efforts.
R. Stone: Ok, last question, Ian, with respect to the deferred revenue account, if you could just walk us through the-I assume this is related to contracts for GLOBEtrotter. But, I'll let you give the explanation for what's in there and how it flows in and out.
I. Halifax: Typically, what's in the approximate $9.5 million number, it's deferred revenue from agreements from which we have to recognize revenue over a 12 month period. It's a combination of both Macrovision and GLOBEtrotter revenue.
R. Stone: Ok, and was that up or down sequentially, vs. the prior quarter?
I. Halifax: Sequentially, up by around $400,000.
R. Stone: Thanks very much.
Operator: Your next question is from Todd Baker from Chase H&Q. Please go ahead.
Tom Dingus: Hi, actually it's Tom Dingus in for Todd Baker. Can you guys talk a little bit about, your customer mix change from what it had traditionally always been, because so much of your revenue had some from the video side, with bringing on GLOBEtrotter and its suite of customers. Have you seen any change in the kind of major customers that they might have that are creeping up there as a higher percentage of revenue, maybe pushing on some of the major studios who had always been your top customers?
B. Krepick: Yes, Tom I think GLOBEtrotter certainly has some customers that are in the million dollar plus category. As I mentioned before, in my other remarks, they definitely have had a trend in their business where they're getting a number of larger deals that are coming in. Historically, you can typically count these deals on one hand on a quarterly basis.
But, certainly that trend is growing. If your comment was directed at whether there's an element of risk because we have a concentrated business among a small customer set, I think not only with GLOBEtrotter, but over time, we have been spreading that risk and we may have only one 10% customer going forward.
So, clearly, by getting into these other businesses, we've spread any kind of risk of having one or two major customers that dominate our business.
T. Dingus: Ok, and then, can you talk a little bit more about the DVD to DVD protection program that you've got out there, that you've kind of pre-empted from others. And what kind of traction and what the initial response, from the studios has been to that technology? And also, to that effect, what have you been hearing from the copy protection technical working group, as far as one or the other becoming the actual standard?
B. Krepick: Yes it's still, as I mentioned in my remarks, a difficult situation, because although we believe that we do have dominant patents in this area, if you put yourself in the position of a studio, and if you're being asked by our group, the Millennium group, to sign up for X number of dollars or X number of years, one of your first questions is going to be, well, what kind of indemnification are you going to give me to protect against somebody who comes after me for patent infringements?
We've put together what we felt was a fairly generous indemnification clause in our contracts. We have presented the studios with Millennium contracts. At the end of the day, it really comes down to a studio saying, "You know, if I'm going to put out a major title, which might have any where from two to three million DVDs and if I'm going to put that out on the market, the studio believes that there is some kind of identifiable risk where the other group, the Galaxy consortium, could come after them and say, "We're going to go after you guys with an injunction to try to prevent you from shipping the product."
And so the studio, when they look at that potential risk, they come back to us and they say, "Would you guys provide us with indemnification for 3 million units times $20 a unit, or $60 million?" And we say at that point, no, we don't think we're going to go to that limit; and so it kind of throws it all back into pretty much the old IP (Intellectual Property) stalemate, and what we're trying to do is simultaneously going forward with our technology and also figure out if there is a way to solve that problem.
Clearly, the implications are that it's still-politically, a dicey situation. There may need to be a compromise between the two groups and, this has been discussed with the studios and discussed amongst ourselves, and that's pretty much where we are. So, all I can say is that we're going ahead full bore.
We've actually changed our technology. We've enhanced it. We've demonstrated to everybody, and provided specifications, what we've done. We're close to building the encoders, which are the watermark embedding devices. And, we're going to continue to push forward in that way, while at the same time trying to be sensitive to our customers and trying to see if we can come up with a solution.
T. Dingus: Ok, and then just one last housekeeping item, which is the Lernout & Hauspie deal. That only covers their technology in the Asia markets. Is that correct, is it the SAFEDISC HD licensing that they've got?
B. Krepick: Yes, they wanted to go forward. They felt that was the most vulnerable market place they had. And so, they wanted to get started and see how things went in that market place.
T. Dingus: Ok, thank you very much.
Operator: Ladies and gentlemen, if there are any additional questions at this time, please press the one followed by the four on your telephone.
Gentlemen, I'm showing no further questions at this time. Please continue with your closing remarks.
J. Ryan: Thank you very much, ladies and gentlemen for your interest in our company. We look forward to reporting on our year-end earnings, some time in the late February '01 time frame.
Operator: Ladies and gentlemen, that does conclude your conference call for today. You may all disconnect, and thank you for participating.
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