SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001.
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 000-32373
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Roxio, Inc.
(Exact name of Registrant as specified in its charter)
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Delaware 77-0551214
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
461 South Milpitas Boulevard, Milpitas, California 95035
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (408) 635-7694
---------------
Indicate by check mark whether the Registrant 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 has been subject to such filing requirements
for the past 90 days. Yes [X] No [_]
As of November 6, 2001, there were 16,864,257 shares of the Registrant's
Common Stock outstanding, par value $0.001.
1
ROXIO, INC.
TABLE OF CONTENTS
Page
PART I. Financial Information Number
--------------------- ------
Item 1 Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of September 30, 2001
and March 31, 2001 ......................................................... 3
Condensed Consolidated Statements of Operations for the three and six
month periods ended September 30, 2001 and 2000 ........................... 4
Condensed Consolidated Statements of Cash Flows for the six month
periods ended September 30, 2001 and 2000 .................................. 5
Notes to Condensed Consolidated Financial Statements ....................... 6
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations ........................................ 12
Item 3 Quantitative and Qualitative Disclosures about Market Risk ................. 28
PART II. Other Information
-----------------
Item 1 Legal Proceedings .......................................................... 29
Item 2 Changes in Securities and Use of Proceeds .................................. 29
Item 3 Defaults Upon Senior Securities ............................................ 29
Item 4 Submission of Matters to a Vote of Security Holders ........................ 29
Item 5 Other Information .......................................................... 29
Item 6 Exhibits and Reports on Form 8-K ........................................... 29
Signatures ............................................................................... 30
2
PART I. Financial Information
ITEM 1. FINANCIAL STATEMENTS
ROXIO, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data, unaudited)
September 30, March 31,
2001 2001
------------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 50,655 $ --
Accounts receivable, net of allowance for doubtful accounts of
$935 and $155, respectively 27,490 31,525
Inventories 471 1,211
Prepaid expenses and other current assets 3,027 2,354
Deferred income taxes 3,482 3,133
------------- ---------
Total current assets 85,125 38,223
Property and equipment, net 2,142 1,426
Goodwill, net 16,255 16,255
Other intangibles, net 7,345 10,268
Other assets 339 --
------------- ---------
Total assets $ 111,206 $ 66,172
============= =========
LIABILITIES AND OWNER'S NET INVESTMENT /
STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 16,568 $ 7,721
Income taxes payable 2,174 9,508
Accrued liabilities 8,539 6,075
Current portion of capital lease obligation 125 --
------------- ---------
Total current liabilities 27,406 23,304
Long term liabilities:
Long term capital lease obligation 269 --
Deferred income taxes 1,689 2,251
------------- ---------
Total liabilities 29,364 25,555
------------- ---------
Owner's net investment / stockholders' equity:
Common stock, $0.001 par value; 100,000 shares
authorized; 16,838 and 16,500 issued and outstanding 17 17
Additional paid-in capital 92,752 16
Deferred stock-based compensation (9,437) --
Accumulated other comprehensive income 220 402
Accumulated deficit (1,710) --
Owner's net investment -- 40,182
------------- ---------
Total owner's net investment / stockholders' equity 81,842 40,617
------------- ---------
Total liabilities and owner's net investment / stockholders' equity $ 111,206 $ 66,172
============= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
ROXIO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data, unaudited)
Three Months Six Months
Ended September 30, Ended September 30,
2001 2000 2001 2000
-------- -------- -------- --------
Net revenues $ 30,508 $ 29,482 $ 67,463 $ 58,072
Cost of revenues (excludes stock-based compensation
charges of $14, $0, $75 and $0, respectively) 5,261 6,351 12,902 12,352
-------- -------- -------- --------
Gross profit 25,247 23,131 54,561 45,720
-------- -------- -------- --------
Operating expenses:
Research and development (excludes stock-based
compensation charges of $208, $648,
$1,099 and $1,296, respectively) 5,078 4,448 11,195 9,381
Sales and marketing (excludes stock-based
compensation charges of $938, $0,
$2,175 and $0, respectively) 12,125 8,414 21,639 14,869
General and administrative (excludes stock-based
compensation charges of $394, $0,
$1,715 and $0, respectively) 5,263 2,931 8,468 5,573
Amortization of intangible assets 1,495 3,860 2,864 7,720
Stock-based compensation charges 1,554 648 5,046 1,296
-------- -------- -------- --------
Total operating expenses 25,515 20,301 49,212 38,839
-------- -------- -------- --------
Income (loss) from operations (268) 2,830 5,349 6,881
Other income 414 -- 715 --
-------- -------- -------- --------
Income before provision for income taxes 146 2,830 6,064 6,881
Provision for income taxes (1,154) (938) (4,694) (2,561)
-------- -------- -------- --------
Net income (loss) $ (1,008) $ 1,892 $ 1,370 $ 4,320
======== ======== ======== ========
Basic and diluted net income (loss) per share $ (0.06) $ 0.11 $ 0.08 $ 0.26
======== ======== ======== ========
Weighted average shares used in computing basic and
diluted net income (loss) per share
Basic 16,793 16,500 16,708 16,500
======== ======== ======== ========
Diluted 16,793 16,500 17,146 16,500
======== ======== ======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
ROXIO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
Six Months
Ended September 30,
2001 2000
---------- ----------
Cash flows from operating activities:
Net income $ 1,370 $ 4,320
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,356 8,254
Stock-based compensation charges 5,046 1,296
Provision for doubtful accounts 780 82
Deferred income taxes (911) (656)
Change in operating assets and liabilities:
Accounts receivable 5,947 (6,385)
Inventories 727 (107)
Prepaid expenses and other assets (1,025) (750)
Accounts payable (987) 1,024
Income taxes payable 4,197 8
Accrued liabilities 2,423 (1,763)
---------- ----------
Net cash provided by operating activities 20,923 5,323
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment (668) (437)
Purchases of other intangible assets (95) (1,177)
---------- ----------
Net cash used in investing activities (763) (1,614)
---------- ----------
Cash flows from financing activities:
Net cash transfers from (to) Adaptec 27,446 (3,709)
Proceeds from issuance of common stock 2,000 -
Proceeds from exercise of stock options 937 -
---------- ----------
Net cash provided by (used in) financing activities 30,383 (3,709)
---------- ----------
Effect of exchange rate changes on cash 112 -
Change in cash and cash equivalents 50,655 -
Cash and cash equivalents at beginning of period - -
---------- ----------
Cash and cash equivalents at end of period $ 50,655 $ -
========== ==========
Supplemental cash flow disclosure:
Cash paid during the period:
Income taxes $ 318 $ -
========== ==========
Noncash investing and financing activities:
Capital lease obligation in connection with acquisition
of equipment $ 403 $ -
========== ==========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
ROXIO, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) Basis of Presentation
The unaudited condensed consolidated financial statements have been
prepared by Roxio, Inc., a Delaware corporation ("Roxio"), pursuant to the rules
and regulations of the Securities and Exchange Commission ("SEC"). Certain
information and footnote disclosures normally included in consolidated financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations. However,
Roxio believes that the disclosures are adequate to make the information
presented not misleading. The condensed consolidated financial statements
reflect all adjustments (which include only normal, recurring adjustments) that
are, in the opinion of management, necessary to state fairly the results for the
periods presented. The results for such periods are not necessarily indicative
of the results to be expected for the full year. These condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and the notes included in Roxio's annual report on Form
10-K for the year ended March 31, 2001.
Prior to legal separation on May 5, 2001, Roxio conducted its business as
an operating segment of Adaptec, Inc. ("Adaptec"). Roxio's consolidated
financial statements have been carved out of the consolidated financial
statements of Adaptec using the historical results of operations of the Adaptec
software operating segment and historical bases of the assets and liabilities of
Adaptec that Roxio comprises. Certain software products directly related to
Adaptec's hardware products, which were historically reflected in Adaptec's
software segment (SPG) results of operations in Adaptec's segment reporting,
were retained by Adaptec after legal separation. As such, the revenues and
associated costs of sales and operating expenses related to these products have
not been included in Roxio's financial statements. Accordingly, the results
reported herein do not reflect the software operating segment disclosures
previously reported under Statement of Financial Accounting Standard ("SFAS")
No. 131, "Disclosures about Segments of an Enterprise and Related Information,"
within the Adaptec annual reports. Prior to legal separation, the consolidated
financial statements also included allocations to Roxio of certain shared
expenses, including centralized legal, accounting, finance, manufacturing, real
estate, information technology, distribution, customer services, sales,
marketing, engineering and other Adaptec corporate services and infrastructure
costs. The expense allocations have been determined on a basis that Adaptec and
Roxio considered to be a reasonable reflection of the utilization of the
services provided to Roxio or the benefit received by Roxio. Such allocations
and charges are based on a percentage of total corporate costs for the services
provided, based on factors such as headcount, revenue, gross asset value or the
specific level of activity directly related to such costs.
Roxio's fiscal quarters end on a Friday and are 13 weeks in length. For
presentation purposes, Roxio has indicated its first and second quarters of
fiscal 2002 as having ended on June 30, 2001 and September 30, 2001 whereas in
fact, Roxio's first and second quarters of fiscal 2002 ended on June 29, 2001
and September 28, 2001, respectively. The results of operations for the three
and six months ended September 30, 2001 are not necessarily indicative of the
results to be expected for the entire year. Unless otherwise stated, all years
and dates refer to our fiscal year and fiscal quarters.
The balance sheet as of March 31, 2001 has been derived from audited
financial statements but does not include all disclosures required by generally
accepted accounting principles. Such disclosures are contained in Roxio's annual
report on Form 10-K for the year ended March 31, 2001.
The preparation of condensed consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the condensed consolidated financial statements and the reported amounts of
revenues and expenses during the reporting periods. Actual results could differ
from those estimates.
(2) Completion of Separation from Adaptec
On June 8, 2000, Adaptec announced a plan to create a separate company
comprised of substantially all of its software segment, subsequently named
Roxio, Inc.
Adaptec and Roxio entered into a Master Separation and Distribution
Agreement (the "Separation Agreement") under which Adaptec contributed at legal
separation (the "Separation Date") $33.2 million in cash, which included
6
$3.2 million in cash held by Roxio's overseas subsidiaries to fund working
capital as a stand-alone entity. Additionally, with the exception of
approximately $11.5 million in income taxes payable, Adaptec transferred to
Roxio, on the Separation Date, substantially all of the assets and liabilities
that appeared on Roxio's consolidated balance sheet. Also on the Separation
Date, Roxio recorded a receivable of $2.7 million and a payable of $9.6 million
with Adaptec, which were previously included in owner's net investment.
On April 12, 2001, the board of directors of Adaptec approved the
distribution of all of the outstanding shares of Roxio's common stock to the
record holders of Adaptec common stock on April 30, 2001, with the exception of
190,941 shares that Adaptec continues to hold for issuance upon the exercise of
an outstanding warrant to purchase Adaptec common stock. In the distribution,
each holder of Adaptec common stock received as a dividend 0.1646 of a share of
Roxio's common stock for every one share of Adaptec common stock held on April
30, 2001, which was the record date for determining the holders of Adaptec stock
entitled to receive the dividend. Roxio's separation from Adaptec was completed
on May 5, 2001 and the distribution of Roxio's common stock by Adaptec to its
stockholders was completed on May 11, 2001.
(3) Goodwill and Other Intangible Assets
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which Roxio
adopted effective April 1, 2001 and the implementation resulted in Roxio ceasing
to amortize goodwill effective April 1, 2001. The following summary reflects the
condensed consolidated results of operations as if SFAS 142 had been adopted at
the beginning of the periods presented (in thousands, except net income (loss)
per share amounts):
Three Months Six Months
Ended September 30, Ended September 30,
2001 2000 2001 2000
-------- ------- ------- -------
Reported net income (loss):
Reported net income (loss) $ (1,008) $ 1,892 $ 1,370 $ 4,320
Effect of goodwill amortization - 2,427 - 4,917
-------- ------- ------- -------
Adjusted net income (loss) $ (1,008) $ 4,319 $ 1,370 $ 9,237
======== ======= ======= =======
Basic and diluted net income (loss) per share:
Reported basic and diluted net income (loss) per share $ (0.06) $ 0.11 $ 0.08 $ 0.26
Effect of goodwill amortization - 0.15 - 0.30
-------- ------- ------- -------
Adjusted basic and diluted net income (loss) per share $ (0.06) $ 0.26 $ 0.08 $ 0.56
======== ======= ======= =======
The gross carrying amounts and accumulated amortization of intangible
assets, are as follows for the periods presented (in thousands):
September 30, 2001 March 31, 2001
--------------------------- ---------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
-------- ------------ -------- ------------
Amortized intangible assets
Patents $ 5,260 $ 2,717 $ 5,260 $ 1,841
Covenant not to compete 6,010 4,122 6,010 3,278
Purchased technology 3,258 2,416 3,258 1,873
OEM relationships 1,186 890 1,186 692
Trade name 1,479 986 1,479 740
Others 1,823 540 1,728 229
------- ------- ------- -------
$19,016 $11,671 $18,921 $ 8,653
======= ======= ======= =======
Goodwill $29,125 $12,870 $29,125 $12,870
======= ======= ======= =======
7
Roxio constitutes of one reporting unit, as defined by SFAS 142. As
Roxio's market capitalization from the distribution date up to September 30,
2001 has been above the net book value, Roxio has determined that its goodwill
has not been impaired.
The estimated future amortization expense for intangible assets as of
March 31, 2002, 2003 and 2004 are as follows (in thousands):
2002 $ 6,350
2003 $ 3,815
2004 $ 355
-----------
$ 10,520
===========
(4) Net Income (Loss) Per Share
Basic net income (loss) per share is computed using the weighted-average
number of common shares outstanding during the period. Diluted net income (loss)
per share is computed using the weighted-average number of common and dilutive
common equivalent shares outstanding during the period. Dilutive common
equivalent shares consist of a warrant issued in connection with a strategic
relationship agreement with Virgin Holding Inc. ("Virgin"), an indirect
subsidiary of EMI Group plc, and common stock issuable upon exercise of stock
options using the treasury stock method.
The following is a reconciliation of the shares used in the computation of
basic and diluted net income (loss) per share (in thousands):
Three Months Six Months
Ended September 30, Ended September 30,
2001 2000 2001 2000
------ ------ ------ ------
Basic net income (loss) per share - weighted-average
number of common shares outstanding 16,793 16,500 16,708 16,500
Effect of dilutive common equivalent shares:
Stock options outstanding - - 421 -
Warrant issued in relation to the
Virgin agreement - - 17 -
------ ------ ------ ------
Diluted net income (loss) per share - weighted-average
number of common shares outstanding 16,793 16,500 17,146 16,500
====== ====== ====== ======
(5) Other Comprehensive Income (Loss)
SFAS No. 130, "Reporting Comprehensive Income," requires the disclosure of
comprehensive income to reflect changes in equity that result from transactions
and economic events from non-owner sources. Accumulated other comprehensive
income (loss) for the periods presented represents foreign currency translation
items associated with Roxio's Japanese and European operations. No tax effect
has been provided on the foreign currency translation items for any period
shown, as the undistributed earnings of Roxio's foreign investments will
continue to be reinvested.
The components of comprehensive income (loss), net of tax, are as follows
(in thousands):
Three Months Six Months
Ended September 30, Ended September 30,
2001 2000 2001 2000
------- ------- ------- -------
Net income (loss) $(1,008) $ 1,892 $ 1,370 $ 4,320
Cumulative translation adjustment (132) (118) (182) (69)
------- ------- ------- -------
Total comprehensive income (loss) $(1,140) $ 1,774 $ 1,188 $ 4,251
======= ======= ======= =======
8
(6) Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133 ("SFAS 133"), "Accounting for
Derivative Instruments and Hedging Activities." SFAS 133 establishes accounting
and reporting standards for derivative instruments and for hedging activities
and requires recognition of all derivatives as assets or liabilities and
measurements of those instruments at fair value. In June 1999, the FASB issued
SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities--Deferral of the Effective Date of FASB Statement No. 133," which
deferred the required date of adoption of SFAS 133 for one year, to fiscal years
beginning after June 15, 2000. In June 2000, the FASB issued SFAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging
Activities--an Amendment of FASB Statement No. 133," which amends the accounting
and reporting standards for certain derivative instruments and certain hedging
activities. Roxio adopted these statements in its first quarter of fiscal 2002
and the adoption has not had a material effect on Roxio's financial position or
results of operations to date.
In July 2001, the FASB issued SFAS No. 141 ("SFAS 141"), "Business
Combinations." SFAS 141 requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. Roxio adopted the standard on July 1, 2001 and the
adoption of SFAS 141 has not had a significant impact on its financial
statements to date.
In July 2001, the FASB issued SFAS No. 142 ("SFAS 142"), "Goodwill and
Other Intangible Assets", which is required for fiscal years beginning after
December 15, 2001 and can be early-adopted for fiscal years beginning after
March 15, 2001. SFAS 142 requires, among other things, the discontinuance of
goodwill amortization. In addition, the standard includes provisions upon
adoption for the reclassification of certain existing recognized intangibles as
goodwill, reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill and
the testing for impairment of existing goodwill and other intangibles. Roxio
implemented SFAS 142 effective April 1, 2001 and the implementation resulted in
Roxio ceasing to amortize goodwill effective April 1, 2001. The implementation
also resulted in the reclassification of $1.1 million of certain intangible
assets related to acquired work force to goodwill on Roxio's balance sheet.
In October 2001, the FASB issued SFAS No. 144 ("SFAS 144"), "Accounting for
the Impairment or Disposal of Long-lived Assets." The objective of SFAS 144 is
to address significant issues relating to the implementation of SFAS No. 121
("SFAS 121"), "Accounting for the Impairment of Long-lived assets to be Disposed
of," and to develop a single accounting model, based on the framework
established by SFAS 121, for long-lived assets to be disposed of by sale,
whether previously held and used or newly acquired. Although SFAS 144 supercedes
SFAS 121, it retains some fundamental provisions of SFAS 121. SFAS 144 is
effective for financial statements issued for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years. Roxio expects
that the initial application of SFAS 144 will not have a material impact on its
financial statements.
(7) Settlement of Litigation
On February 13, 2001, several former stockholders of Incat Systems Software
USA, Inc. filed a lawsuit against Adaptec in the Superior Court of California in
the County of Santa Clara. The lawsuit stems from Adaptec's alleged failure to
pay these former stockholders all of the amounts due to them based on an
earn-out agreed to in connection with the acquisition of Incat. We have been
asked to defend and indemnify Adaptec in such lawsuit pursuant to the terms of
an agreement between us. The lawsuit requests a judgment against Adaptec for
actual, compensatory and punitive damages, including interest, court costs, each
in amounts to be proven, and reasonable attorneys' fees incurred. We believe the
lawsuit is without merit and intend to vigorously defend our interests.
On May 10, 2001, Gracenote, Inc. filed a lawsuit against us in U.S.
District Court for the Northern District of California. In the complaint,
Gracenote seeks unspecified damages and injunctive and other relief based upon
claims including patent and trademark infringement and breach of contract. The
lawsuit stems from the use of Gracenote's music recognition service in version 4
of our Easy CD Creator and Toast CD-burning software and our use of a competing
music recognition service, Freedb.org. We believe that we have meritorious
defenses to each of the claims alleged by Gracenote and we intend to defend
ourselves vigorously. In addition, we have filed a number of counterclaims
against Gracenote seeking unspecified damages, injunctive relief and other
relief based upon claims including breach of contract, antitrust violations and
tortious interference with business relationships.
9
We are a party to litigation matters and claims which are normal in the
course of our operations, and, while the results of such litigation and claims
cannot be predicted with certainty, we believe that the final outcome of such
matters will not have a material adverse impact on our business, financial
position or results of operations.
(8) Capital Stock
On May 17, 2001, Roxio entered into a strategic relationship with Virgin
to, among other things, develop technology solutions relating to CD-recording
technology. As part of the agreement, Virgin will provide strategic guidance and
advice to Roxio for a one-year period. Simultaneously with the execution of the
agreement, Virgin purchased 235,294 of Roxio's common stock at a price of $8.50
per share. Virgin also received a warrant to purchase 117,647 shares of Roxio's
common stock at a price equal to $8.50 per share. The warrant becomes
exercisable by 25% each quarter following the initial agreement. In the first
quarter of fiscal 2002, approximately $1.1 million in deferred stock-based
compensation was recorded for the common stock issued. In relation to the common
stock and warrant, approximately $257,000 and $494,000, respectively, of
amortization expense was recorded and is included in stock-based compensation
charges in the consolidated statement of operations for the second quarter of
fiscal 2002, and approximately $447,000 and $725,000, respectively, was recorded
for the first half of fiscal 2002.
(9) Segment and Geographic Information
Segment information
Roxio has organized and managed its operations in a single operating
segment which designs, develops and markets application software.
Geographic information
The following table presents net revenues by country and is attributed to
countries based on location of the selling entity:
Three Months Six Months
Ended September 30, Ended September 30,
2001 2000 2001 2000
------- -------- -------- --------
(in thousands)
United States $25,246 $19,963 $52,496 $38,711
Singapore -- 3,854 2,084 9,203
Netherlands 4,022 -- 8,202 --
Japan -- 3,233 2,813 7,139
Other countries 1,240 2,432 1,868 3,019
------- ------- ------- -------
$30,508 $29,482 $67,463 $58,072
======= ======= ======= =======
Prior to our separation from Adaptec, some of our Japanese and European
sales were made through Adaptec's office in Singapore. These customers are now
serviced by Roxio's sales offices in the United States.
The following table presents net tangible long term assets by country based
on the location of the assets:
September 30, March 31,
2001 2001
------ -------
(in thousands)
United States $1,831 $1,123
Germany 399 294
Other countries 251 9
------ ------
$2,481 $1,426
====== ======
Significant customers
One customer constitutes 25% and 29% of gross revenues for the second
quarter and first half of fiscal 2002, respectively, compared to 25% and 24% for
the comparable periods in the prior year.
10
(10) Cash and Cash Equivalents
Prior to legal separation, Adaptec managed cash and cash equivalents on a
centralized basis. Cash receipts associated with Roxio's business have been
transferred to Adaptec and Adaptec has funded Roxio's disbursements. All changes
in cash and cash equivalents were included in owner's net investment for all
periods presented. Following legal separation, cash and cash equivalents are
stated at cost, which approximates fair value. We include in cash equivalents
all highly liquid investments that mature within three months of their purchase
date. Cash equivalents consist primarily of high-grade commercial paper, money
market funds and debt instruments.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In addition to the other information in this report, certain statements in
the following Management's Discussion and Analysis of Financial Condition and
Results of Operation ("MD&A") are forward-looking statements. When used in this
report, the words "expects," "anticipates," "estimates," and similar expressions
are intended to identify forward-looking statements. Such statements are subject
to risks and uncertainties that could cause actual results to differ materially
from those projected. Certain of these risks and uncertainties are set forth in
this Report on Form 10-Q under " Risks Relating to Our Business," "Risks
Relating to Separating Roxio from Adaptec" and "Risks Related to the Securities
Markets and Ownership of Our Common Stock." The following discussion should be
read in conjunction with the Condensed Consolidated Financial Statements and
notes thereto included elsewhere in this report.
Overview
Separation from Adaptec
We are a leading provider of digital media software solutions which allow
individuals to personalize and store music, photos, video and data onto
recordable CDs. We were incorporated in August 2000 as a wholly-owned subsidiary
of Adaptec, Inc. ("Adaptec") to conduct substantially all of the business of its
software products group. Upon legal separation from Adaptec in May 2001, with
the exception of approximately $11.5 million in income taxes payable, Adaptec
transferred to Roxio, Inc. ("Roxio") substantially all of the assets and
liabilities that appear on Roxio's consolidated balance sheet, as well as $33.2
million in cash, which included $3.2 million in cash held by our overseas
subsidiaries. Also on the Separation Date, Roxio recorded a receivable of $2.7
million and a payable of $9.6 million with Adaptec, which were previously
included in owner's net investment.
We have entered into agreements with Adaptec under which Adaptec provides
services to us during a transition period after the distribution. The agreements
provide for transitional services and support in the areas of information
technology systems, supply chain, buildings and facilities, marketing and
communications, finance and accounting. The transition period is not intended to
exceed 12 months following legal separation. Specified charges for transition
services are generally cost plus 5% and, for products purchased from Adaptec,
cost plus 10%. Although the fees provided for in the agreements are intended to
represent the fair market value of these services, we cannot assure you that
these fees necessarily reflect the costs of obtaining the services from
unrelated third parties or of our providing these services internally. However,
we believe that purchasing these services from Adaptec provides an efficient
means of obtaining these services during the transition period. We do not
believe that these arrangements with Adaptec will materially alter our financial
position or results of operations during the transition period.
We must also negotiate new or revised agreements with various third parties
as a separate, stand-alone entity. We cannot assure you that the terms we will
be able to negotiate will be as favorable as those that we enjoyed as part of
Adaptec. In addition, as part of Adaptec, we benefited from various economies of
scale including shared global administrative functions, facilities and product
distribution. We expect that our costs will increase as a result of the loss or
renegotiation of these agreements, although the amount of the cost increase has
not been determined at this time.
Our Business
Historically, we have derived most of our revenues through sales of our
CD-recording software products to original equipment manufacturers ("OEMs"),
which consist of PC manufacturers, CD-recordable drive manufacturers and
integrators, and to distributors. Generally, OEMs bundle the standard version of
our software together with their products pursuant to licensing agreements with
us. Distributors resell stand-alone deluxe versions of our products to retailers
of computer software products. Sales to OEMs for the second quarter and first
half of fiscal 2002 represented 52% and 46% of our net revenues, respectively,
compared to 58% and 55% for the second quarter and first half of fiscal 2001.
Sales to distributors and direct sales to end users through our web site and
(800) number collectively for the second quarter and first half of fiscal 2002
represented 48% and 54% of our net revenues, respectively, compared to 42% and
45% for the second quarter and first half of fiscal 2001.
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Although sales to our distributors and direct sales to end users
represented 48% and 54% of our net revenues during the second quarter and for
the first half of fiscal 2002, the number of units sold to our distributors and
end users represented less than 10% of the total number of units sold. In the
future, we anticipate that CD-recording technology revenues from our standard
products to OEMs will decline as a percentage of total net revenues, as a result
of highly competitive pricing pressures in the PC industry. We anticipate that
licensing fees for new features and technologies as well as increased revenues
from sales of our deluxe products will represent an increasingly larger
percentage of total net revenues in future periods. International sales, defined
as sales from our international subsidiaries, accounted for approximately 17%
and 22% of our net revenues for the second quarter and first half of fiscal
2002, respectively, compared to 32% and 33% for the second quarter and first
half of fiscal 2001. One customer constitutes 29% and 31% of net revenues for
the second quarter and first half of fiscal 2001and 2002, respectively.
Net revenues include revenues from licensing and sales of our software,
reduced by estimated product returns and pricing adjustments. We recognize
licensing revenues from OEMs based on reported product shipments by OEMs,
provided all fees are fixed or determinable, evidence of an arrangement exists
and collection is reasonably assured. We recognize revenues from sales to
distributors upon shipment by us or receipt of the products by the distributor,
depending on the shipping terms, provided all fees are fixed or determinable,
evidence of an arrangement exists and collection is reasonably assured. We
provide for estimated product returns and pricing adjustments in the period in
which the revenue is recognized. Our distributor agreements generally provide
distributors with stock rotation and price protection rights as well as the
right to return discontinued products. We recognize revenues from direct product
sales to end users upon shipment by us.
Gross margin is the percentage of profit from net revenues after deducting
cost of revenues, which includes the physical goods shipped, third party
licensed intellectual property, freight, warranty, end user technical support,
scrap and manufacturing variances. Our gross margin from OEM revenues is
generally significantly higher than our gross margin from distributor revenues
primarily due to lower product and support costs. For sales of our products
through OEMs, these OEMs are responsible for the first level of product support
and we only provide a second level of support to the OEM. We expect gross margin
to fluctuate on a quarterly basis based on the relative mix of OEM and
distributor revenues. Additionally, over time, our overall gross margin may
decline somewhat as the relative percentage of net revenues derived from
distributor sales increases and if we are unable to offset margin reductions
through less expensive distribution, packaging and support costs.
We classify operating expenses as research and development, sales and
marketing and general and administrative. Each category includes related
expenses for salaries, employee benefits, incentive compensation, travel,
telephone, communications, rent and allocated facilities and professional fees.
Our sales and marketing expenses include additional expenditures specific to the
marketing group, such as public relations and advertising, trade shows, and
marketing collateral materials, and expenditures specific to the sales group,
such as commissions. To date, all software product development costs have been
expensed as incurred. We expect our operating expenses to continue to increase
following our separation from Adaptec as we develop an infrastructure to support
our level of business activity, build a corporate brand identity separate from
Adaptec and promote our products, add personnel and create incentive programs
with our distribution partners.
In July 1999, we acquired CeQuadrat GmbH, or CeQuadrat, a German-based
software company providing CD- recording software products primarily in Germany.
The acquisition provided us with enhanced product development and engineering
expertise, as well as a greater European customer base. In March 2000, we
acquired Wild File, Inc., or Wild File, the developer of our GoBack system
recovery software. These acquisitions were accounted for as purchases and the
results of operations are included in our financial statements from the dates of
these acquisitions. Goodwill and other intangibles consist primarily of
capitalized costs incurred through the acquisitions of Wild File and CeQuadrat.
Until our current quarter ended September 30, 2001, these capitalized costs were
amortized over their estimated useful lives of three years. We adopted SFAS No.
142, "Goodwill and Other Intangible Assets" effective April 1, 2001, and as such
no longer amortize goodwill and acquired workforce intangibles, which are now
classified as goodwill in the balance sheet in accordance with SFAS No. 142. We
periodically review the unamortized balance to determine if the costs are
realizable and may in the future make adjustments to the carrying balance or
amortization period based upon these reviews.
Stock-based compensation charges relate to the amortization of costs
associated with the assumption of restricted stock from the Wild File
acquisition, stock and warrants issued to Virgin Holding Inc., an indirect
subsidiary of EMI Group plc. ("Virgin"), stock options issued to employees, and
the commitment of Roxio stock options to Adaptec employees who became Roxio
employees as described in the paragraphs below.
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Roxio 2000 Stock Option Plan
On December 20, 2000, a commitment was made to issue employees of Adaptec,
who were projected to become and who subsequently became employees of Roxio at
the date of legal separation, options to purchase 1.15 million shares of Roxio
common stock with an exercise price of $8.50 per share. Prior to legal
separation, approximately 400,000 additional options had been committed to be
issued. Due to the binding nature of the commitment, the date of the commitment
to grant the options was assumed to be the date of grant. The options will vest
25% on the one-year anniversary of the later of September 21, 2000 or the
applicable employee's hire date and 6.25% each quarter thereafter until fully
vested. As the grants of these options constituted grants to non-employees,
prior to the establishment of a measurement date the options were valued using
the Black-Scholes valuation model with the following assumptions: expected life
of 10 years, risk-free interest rate of 5%, volatility of 63% and dividend yield
of 0%. The estimated fair value of the underlying common stock on the date of
legal separation was $12.12 per share. The estimated fair value of the options
granted was $9.72 and the aggregate fair value of $14.6 million was recognized
over the service period, estimated to be 3.75 years. Approximately $2.4 million
and approximately $832,000 were recorded and were included in stock-based
compensation expense for the year ended March 31, 2001 and the quarter ended
June 30, 2001 related to the period before legal separation, respectively.
On the date of legal separation, a final measurement date was established
at which time certain employees of Adaptec became employees of Roxio and 1.5
million options were granted to these employees under the Roxio 2000 stock
option plan. Pursuant to Financial Accounting Standards Board ("FASB")
Interpretation No. 44 "Accounting for Certain Transactions involving Stock
Compensation", at the date of change in status from non-employees to employees,
the accounting basis for the options changed and the compensation associated
with these options was re-measured and fixed using the intrinsic value at that
date as prescribed by Accounting Principles Board Opinion No. 25. In the first
quarter, approximately $5.2 million in deferred stock-based compensation has
been recorded for these options. During the quarter ended June 30, 2001, Roxio
issued approximately 1.8 million stock options in addition to the options
discussed above, and recorded approximately $6.6 million in deferred stock-based
compensation. These options have vesting schedules that differ based on the
individual employee's contribution to Roxio. Approximately $803,000 and $3.0
million of amortization expense was recorded and is included in stock-based
compensation charges on the consolidated statement of operations for the second
quarter and first half of fiscal 2002. The remaining amortization expense will
be recognized over the remaining service period of up to 4 years. All stock
options issued after the first quarter of fiscal 2002 have been issued with an
exercise price at or above the fair market value of the common stock at the
grant date.
Issuance of Common Stock and Warrant
On May 17, 2001, Roxio entered into a strategic relationship with Virgin
to, among other things, develop technology solutions relating to CD-recording
technology. As part of the agreement, Virgin will provide strategic guidance and
advice to Roxio for a one-year period. Simultaneously with the execution of the
agreement, Virgin purchased 235,294 of Roxio's common stock at a price of $8.50
per share. Virgin also received a warrant to purchase 117,647 shares of Roxio
common stock at a price equal to $8.50 per share. The warrant becomes
exercisable by 25% each quarter following the initial agreement. In the first
quarter, approximately $1.1 million in deferred stock-based compensation was
recorded for the common stock issued. In relation to the common stock,
approximately $257,000 and $447,000 of amortization expense was recorded and is
included in stock-based compensation charges on the consolidated statement of
operations for the second quarter and first half of fiscal 2002, respectively.
In relation to the warrant, approximately $494,000 and $725,000 of amortization
expense was recorded and is included in stock-based compensation charges on the
consolidated statement of operations for second quarter and first half of fiscal
2002, respectively.
Basis of Presentation
Prior to legal separation on May 5, 2001, we conducted our business as an
operating segment of Adaptec. Our consolidated financial statements have been
carved out of the consolidated financial statements of Adaptec using the
historical results of operations of the Adaptec software operating segment and
historical bases of the assets and liabilities of Adaptec that our company
comprises. Certain software products directly related to Adaptec's hardware
products, which were historically reflected in our results of operations in
Adaptec's segment reporting, were retained by Adaptec after legal separation. As
such, the revenues and associated costs of sales and operating expenses related
to these products have not been included in our financial statements.
Accordingly, the results reported herein do not reflect the software operating
segment disclosures previously reported under Statement of Financial Accounting
Standard ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and
Related Information," within the Adaptec annual reports. Prior to legal
separation, the consolidated financial statements also included
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allocations to us of certain shared expenses, including centralized legal,
accounting, finance, manufacturing, real estate, information technology,
distribution, customer services, sales, marketing, engineering and other Adaptec
corporate services and infrastructure costs. The expense allocations have been
determined on a basis that Adaptec and we considered to be a reasonable
reflection of the utilization of the services provided to us or the benefit
received by us. Such allocations and charges are based on a percentage of total
corporate costs for the services provided, based on factors such as headcount,
revenue, gross asset value or the specific level of activity directly related to
such costs.
The financial information presented in this quarterly report is not
necessarily indicative of our financial position, results of operations or cash
flows in the future nor is certain of the financial information necessarily
indicative of what our financial position, results of operations or cash flows
would have been had we been a separate, stand-alone entity for the periods
presented.
Results of Operations
Comparison of Three and Six Month Periods Ended September 30, 2001 and 2000.
Net Revenues
Net revenues increased 3% to $30.5 million in the second quarter of fiscal
2002 from $29.4 million for the comparable quarter in the prior year. Net
revenues increased 16% to $67.4 million in the first half of fiscal 2002 from
$58.0 million for the comparable period in the prior year. The growth in net
revenue resulted primarily from continued distributor sales of our Easy CD
creator 5.0 product which was released in the fourth quarter of fiscal 2001.
Distributor and retail revenues accounted for $14.7 million or 48% of net
revenues in the quarter ended September 30, 2001 as compared to $12.2 million or
42% of net revenues for the comparable quarter in the prior year. Distributor
revenues accounted for $36.6 million or 54% of net revenues in the first half of
fiscal 2002 as compared to $25.9 million or 45% for the comparable period in the
prior year. OEM revenues for the second quarter and first half of fiscal 2002
accounted for $15.8 million or 52%, and $30.9 million or 46% of net revenues,
respectively, compared to $17.2 million or 58%, and $32.2 million or 55% for the
second quarter and first half of fiscal 2001.
Gross Margin
Gross margin was 83% and 81% of net revenues for the second quarter and
first half of fiscal 2002, respectively, compared to 78% and 79% for the
comparable periods of fiscal 2001, respectively. This increase is mainly due to
a reduction in the cost of technical support services partially offset by a
slight increase in production costs as a result of our separation from Adaptec.
Operating Expenses
Research and Development. Research and development expenses increased 14%
to $5.1 million in the quarter September 30, 2001 from $4.4 million for the
comparable quarter in the prior year. Research and development expenses
increased 19% to $11.2 million in the first half of fiscal 2002 from $9.4
million for the comparable period in fiscal 2001. This increase was driven by
additional personnel and consultants to support increased product development
efforts for both CD and DVD recordable software products. We expect that
research and development expenses will increase in absolute dollars for the
foreseeable future as we intend to continue to invest in product development.
Sales and Marketing. Sales and marketing expenses increased 44% to $12.1
million in the quarter ended September 30, 2001 from $8.4 million for the
comparable quarter in the prior year. Sales and marketing expenses increased 46%
to $21.6 million in the first half of fiscal 2002 from $14.9 million for the
comparable period in the prior year. This increase primarily resulted from
increased staffing associated with expanding our marketing team to pursue
revenue generating opportunities and increased advertising and promotion
expenses related to building our product brands. We expect that sales and
marketing expenses will increase in absolute dollars for the foreseeable future
as we intend to invest in marketing and advertising focused on building the
corporate identity and brand of Roxio, and to continue our current efforts to
build our product brands.
General and Administrative. General and administrative expenses increased
80% to $5.3 million in the quarter ended September 30, 2001 from $2.9 million
for the comparable quarter in the prior year. General and
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administrative expenses increased 52% to $8.5 million in the first half of
fiscal 2002 from $5.6 million for the comparable period in the prior year. This
increase resulted primarily from payroll and other related costs associated with
establishing a senior management team and dedicated human resources, information
technology and finance support for us to operate as a stand-alone entity and
additional costs related to the ongoing operation of Wild File in Minnesota. The
increase in the first half of fiscal 2002 was partially offset by a decrease to
general and administrative expense as a result of the $2.0 million in cash
received in connection with the settlement of the Prassi litigation.
Amortization of Goodwill and Other Intangibles. Amortization of goodwill
and other intangibles decreased 61% to $1.5 million in the quarter ended
September 30, 2001 from $3.9 million for the comparable quarter in the prior
year. Amortization of goodwill and other intangibles decreased 63% to $2.9
million in the first half of fiscal 2002 from $7.7 million for the comparable
period in the prior year. This decrease was due to the early adoption of SFAS
No. 142, "Goodwill and Other Intangible Assets", which resulted in the cessation
of goodwill amortization expense effective April 1, 2001. Amortization of
goodwill and other intangibles consist of amortization expense of goodwill and
other intangibles acquired as part of the purchase of Wildfile and CeQuadrat.
Stock-Based Compensation Charges. Stock-based compensation charges
increased 140% to $1.6 million in the quarter ended September 30, 2001 from
$648,000 for the comparable quarter in the prior year. Stock-based compensation
charges increased 289% to $5.0 million in the first half of fiscal 2002 from
$1.3 million for the comparable period in the prior year. For the second quarter
and the first half of fiscal 2002, we amortized $1.6 million and $5.0 million,
respectively, in non-cash charges primarily associated with employee stock
options and the common stock and warrant issued as part of our agreement with
Virgin. For the comparable periods in the prior year, we amortized $648,000 and
$1.3 million in non-cash charges related to the assumption of restricted stock
as part of the Wild File acquisition.
Provision for Income Taxes. Income taxes are accounted for in accordance
with Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes," which requires recognition of deferred tax liabilities and assets for
the expected future tax consequences of events that have been included in the
financial statements or tax returns. Under this method, deferred tax liabilities
and assets are determined based on the temporary difference between the
financial statement and tax bases of assets and liabilities using enacted tax
rates in effect for the year in which the differences are expected to reverse.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amounts expected to be realized. Income tax expense is the tax
payable and the change during the period in deferred tax assets and liabilities.
Our operating results historically have been included in Adaptec's
consolidated United States federal and state income tax returns. The provision
for income taxes in our financial statements has been determined on a separate
return basis. Our effective income tax rates were 77% and 37% for the six months
of fiscal 2002 and 2001, respectively. The increase in the effective tax rate
was due to higher stock-based compensation charges for the first half of fiscal
2002. Prior to our separation from Adaptec, Roxio benefited from an advantageous
tax rate system in Singapore, which resulted in a lower effective tax rate for
the first half of fiscal 2001. We are subject to tax in jurisdictions in which
we operate around the world. Our future effective tax rate will be impacted by
our organizational structure and the geographic distribution of our worldwide
revenue and profitability. As a result of these factors, our effective tax rate
may be higher in the future than it has been in the past.
Liquidity and Capital Resources
Prior to legal separation, Adaptec managed cash on a centralized basis.
Adaptec collected cash receipts associated with our business and provided us
funding to cover our disbursements. Accordingly, we reported no cash or cash
equivalents prior to legal separation on May 4, 2001. As of September 30, 2001,
we reported cash and cash equivalents of $50.7 million. As of September 30, 2001
and March 31, 2001, we reported working capital of $57.8 and $14.9 million,
respectively.
During the six months ended September 30, 2001, we generated approximately
$20.9 million in cash flow from operating activities as compared to the same
period in the prior year when we generated approximately $5.3 million. Operating
cash flows increased during the first half of fiscal 2002 as compared with the
same period in the prior year as a result of decreases in accounts receivable,
decreases in inventory, increases in non-cash charges for depreciation and
amortization and amortization of deferred stock-based compensation, and
increases in income taxes payable, and accrued liabilities. These increases in
cash were partially offset by uses of cash resulting from an increase in
deferred income taxes and a decrease in prepaid and other assets, and from
decreased levels of net income from operations.
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Net cash used in investing activities was approximately $760,000 and $1.6
million for the six months ended September 30, 2001 and 2000, respectively. The
net cash used in investing activities in the quarters ended September 30, 2001
and 2000 consisted of capital expenditures.
During the six months ended September 30, 2001, we generated approximately
$30.4 million in financing activities as compared to cash used of $3.7 million
in the same period of fiscal 2001. With the exception of $2.0 million generated
from the issuance of common stock and $937,000 generated from the exercise of
stock options in the first half of fiscal 2002, net cash generated from
financing activities relates to net cash received from or transferred to
Adaptec. For the same period in the prior year, all net cash used in financing
activities represented returns of capital to Adaptec. Any other cash receipts or
disbursements from/to Adaptec relate to operating activities and are classified
as such in the cash flow statement and the discussion above.
On May 5, 2001, the date of legal separation, Adaptec contributed $33.2
million in cash to us, which included $3.2 million in cash held by our overseas
subsidiaries. The contribution is non-reciprocal and we will not repay any of
this amount. We intend to use these proceeds for working capital. We believe
that cash from this contribution and from our future operating results will
provide sufficient capital to fund our operations for the next 12 months.
However, we may seek additional equity or debt financing. In addition, any
material acquisition of complementary businesses, products or technologies or
material joint venture could require us to obtain additional equity or debt
financing. We cannot assure you that such additional financing would be
available on acceptable terms, if at all. If additional funds are raised through
the issuance of equity securities, dilution to existing stockholders may result.
If sufficient funds are not available, we may not be able to introduce new
products or compete effectively in any of our markets, either of which could
materially harm our business, financial condition and results of operations.
Generally, payment terms from our customers do not exceed 45 days, while
our liabilities with vendors are due from zero to 30 days following the invoice
date. Generally, payments of receivables by our customers to us are not
contingent upon resale and we have not experienced payment delays due to product
disputes.
Although we have historically generated positive cash flow from operations,
we cannot assure you that we will be able to do so in the future. If we are
unable to generate positive cash flow from operations, we may be required to
obtain additional financing from other sources.
We have never held derivative financial instruments, nor had debt
outstanding at any time. Accordingly, we have not been exposed to near-term
adverse changes in interest rates or other market prices. We may, however,
experience such adverse changes if we incur debt or hold derivative financial
instruments in the future.
Risks Relating to Our Business
Fluctuations in our quarterly operating results may cause our stock price
to decline.
Our quarterly operating results may fluctuate from quarter to quarter. We
cannot reliably predict future revenue and margin trends, and such trends may
cause us to adjust our operations. Other factors that could affect our quarterly
operating results include:
. timing of new product introductions and our ability to transition
between product versions;
. product returns upon the introduction of new product versions and
pricing adjustments for our distributors;
. seasonal fluctuations in sales;
. anticipated declines in selling prices of our products to original
equipment manufacturers and potential declines in selling prices to
other parties as a result of highly competitive pressures;
. changes in the relative portion of our revenues represented by our
various products and customers;
. adverse changes in the level of economic activity in the United States
or other major economies in which we do business, or in industries,
such as PC manufacturing, on which we are particularly dependent;
. foreign currency exchange rate fluctuations;
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. expenses related to possible acquisitions of other businesses;
. changes in the timing of product orders due to unexpected delays in
the introduction of our customers' products, due to lifecycles of our
customers' products ending earlier than expected or due to market
acceptance of our customers' products;
. the impacts of acts of war and terrorism on the U.S. economy and
other major economies; and
. timely and accurate reporting to us by our original equipment
manufacturer customers of units shipped.
Our CD- recording software accounts for the majority of our revenue. If
demand for this software falls, our sales could be significantly reduced and our
operating results may suffer.
Historically, nearly all of our operating revenue has come from sales of
our CD-recording software. Any factors adversely affecting the pricing of,
demand for or market acceptance of our CD-recording software products, such as
competition or technological change, would materially adversely affect our
business and operating results. In particular, sales of our Easy CD Creator
software have accounted for a significant portion of our revenue. We expect that
this product will continue to account for a majority of our software license
revenue for the foreseeable future. Our future operating results depend on the
continued market acceptance of our CD-recording software, including future
enhancements. Competition, technological change or other factors could decrease
demand for these products or make these products obsolete.
If new technologies or formats replace the CD as the preferred method of
consumers to store digital content, such as DVD or portable MP3 players, sales
of our current CD-recording products could be seriously harmed. Additionally, if
new consumer appliance technologies replace the PC as the preferred means of
personalizing and managing digital content, our business could be seriously
harmed.
We expect our future success will heavily depend on the sale of upgrades to
our CD-recording software products. If we fail to sell upgrades to such products
effectively, our revenue may not increase and may decline.
Historically, we have derived a significant portion of our revenue from
sales of our CD-recording software products to original equipment manufacturers
of PCs and CD recorders. Recently, because of competition in the PC industry and
the diminishing margins PC manufacturers have been experiencing, we have reduced
the prices we charge PC manufacturers to include our software in their product
offerings. If this trend continues as anticipated, we expect that revenues
derived from the sale of our CD-recording software products to PC manufacturers
in total and as a percentage of net revenue will decline. As such, our future
success will depend in part on our ability to sell software upgrades. Although
we are developing marketing strategies to increase our sales of software
upgrades, we cannot assure you that any marketing strategies we develop will be
successful in increasing our upgrade rate or that users will not be content with
the version of our software that is included in their PC or CD recorder
purchase.
To grow our business, we must develop new and enhanced products and lead in
the commercialization of new technology.
We sell our products in a market that is characterized by rapid
technological changes, frequent new product and service introductions and
evolving industry standards. Without the timely introduction of new products,
services and enhancements, our existing products and services will likely become
technologically obsolete.
Our operations could be significantly disrupted if we fail to integrate the
members of our management team, many of whom have been recently hired or may be
hired in the near future.
We recently hired key management personnel. These individuals were added to
fill newly-created positions as a result of our separation from Adaptec. These
individuals and the other members of our management have not previously worked
together and are in the process of integrating as a management team. We cannot
assure you that our new management team will work together effectively or
successfully pursue our business objectives.
If our products do not interoperate effectively with the drives of our
customers and consumers, our revenues will suffer.
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We must design our CD-recording software products to interoperate
effectively with a variety of hardware and software products, including CD
recorders, PCs and operating system software. We depend on significant
cooperation with manufacturers of these products to achieve our design
objectives and to produce products that interoperate successfully.
If we fail to establish, maintain or expand our strategic relationships for
the integration of our software with the services of third parties, the growth
of our business may cease or decline.
In order to expand our business, we must generate, maintain and strengthen
strategic relationships with third parties. To date, we have established
relationships with Microsoft and RealNetworks, through which they integrate our
software into their services. We have also entered into a strategic relationship
with Virgin to, among other things, develop technology solutions relating to
CD-recording technology. We may also need to establish additional strategic
relationships in the future. If these parties do not provide sufficient,
high-quality service or integrate and support our software correctly, or if we
are unable to enter into successful new strategic relationships, our revenues
and growth may be harmed. We cannot assure you that the time and effort spent on
developing or maintaining strategic relationships will produce significant
benefits to us.
In addition, Microsoft, RealNetworks or any future strategic partners may
offer products of other companies, including products that compete directly with
our products. For example, Microsoft has included system recovery related
functionality in its Windows Me operating system. Additionally, Microsoft has
included CD-recording software in its Windows XP operating system and Apple has
included CD-recording software for its operating system. Although we have
entered into an agreement to provide Microsoft with CD-recording software with
limited functionality, we cannot assure you that Microsoft will include our
CD-recording software in any future releases, that they will not include
CD-recording software from one of our competitors or that they will not develop
their own CD-recording software.
A significant portion of our revenue currently comes from one distributor,
and any decrease in revenue from this or other distributors could harm our
operating results.
For the six months ended September 30, 2001, and the year ended March 31,
2001, approximately 29% and 31%, respectively, of our gross revenue came from
Ingram Micro. We expect that a significant portion of our revenues will continue
to depend on sales of our products to a small number of distributors. Any
downturn in the business of our distributors could seriously harm our revenues
and operating results.
We are substantially dependent on our relationships with original equipment
manufacturers, and our failure to maintain or expand these relationships could
cause demand for our products to decline.
Historically, we have derived a majority of our revenue from sales of our
products to original equipment manufacturers, such as PC and drive manufacturers
and integrators. These original equipment manufacturers typically purchase and
include the standard version of our Easy CD Creator software with PCs and CD
recorders. As a result, these relationships also serve an important role in
distributing Easy CD Creator to the end user and positioning the market for
upgrades to Easy CD Creator 5 Platinum. If our competitors offer these original
equipment manufacturers more favorable terms or if our competitors are able to
take advantage of their existing relationships with these original equipment
manufacturers, then these original equipment manufacturers may decline to
include our software with their PCs and CD recorders. Hewlett-Packard recently
informed us that they will be bundling one of our competitor's CD-recording
software across their PCs and CD recorders and that our solution will likely be
phased out by January 2002. The loss of any of our relationships with original
equipment manufacturers, including Hewlett-Packard, could harm our operating
results.
Because sales to PC manufacturers provide a significant means of
distributing our software to end users, and because sales to PC manufacturers
account for a significant portion of our revenue, a downturn or competitive
pricing pressures in the PC industry could cause our revenue to decline.
The PC industry is highly competitive, and we expect this competition to
increase significantly. In particular, we expect pricing pressures in the PC
market to continue. To the extent that PC manufacturers are pressured through
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competition to reduce the prices of their PCs, they may be less likely to
purchase our products on terms as favorable as we have negotiated with our
current PC manufacturer customers, if at all. In addition, if the demand for PCs
decreases, our sales to PC manufacturers will likely decline. If we are unable
to sell our products to PC manufacturers in the amount and on the terms that we
have negotiated with our current PC manufacturer customers, our revenue may
decline.
We rely on distributors and retailers to sell our products, and disruptions
to these channels would adversely affect our ability to generate revenue from
the sale of our products.
Because we sell a significant portion of our products to distributors, we
are subject to many risks related to distributors' businesses, including risks
related to their inventory levels. Our distributors maintain significant levels
of our products in their inventories. If they attempt to reduce their levels of
inventory or if they do not maintain sufficient levels to meet customer demand,
our sales could be negatively impacted. If we reduce the prices of our products
to our distributors, we may have to compensate them for the difference between
the higher price they paid to buy their inventory and the new lower prices. In
addition, we are exposed to the risk of product returns from distributors,
either through their exercise of contractual return rights or as a result of our
strategic interest in assisting them in balancing inventories.
Our distributors, and the retailers who sell our software to the public,
also sell products offered by our competitors. If our competitors offer our
distributors or retailers more favorable terms, those distributors or retailers
may de-emphasize or decline to carry our products. In the future, we may not be
able to retain or attract a sufficient number of qualified distributors or
retailers. Further, distributors or retailers may not recommend, or continue to
recommend, our products.
If we are unable to compete effectively with existing or new competitors,
including if these competitors offer original equipment manufacturers better
terms than we do, we could experience price reductions, fewer customer orders,
reduced margins or loss of market share.
We compete in providing solutions for moving, managing and protecting
digital content. The markets for providing products and services offering these
solutions are highly competitive, and we expect competition to increase in the
future. Key competitors for sales of our CD/DVD-recording software include
Ahead, Applix, BHA, DataBecker, Oak Technology, Prassi, Sonic Foundry, Sonic
Solutions, Pinnacle Systems and Veritas. Microsoft has included system recovery
related functionality in its recently introduced Windows Me and Windows XP
operating systems. While so far this has not had a negative impact on sales, we
cannot assure you that this will not have a negative impact on future sales of
our GoBack software. Additionally, Microsoft has included CD-recording software
in its Windows XP operating system and Apple has CD-recording software for its
operating system.
If we are unable to devote resources equivalent to those of our
competitors, we could experience a loss of market share and reduced revenues.
Some of our competitors or potential competitors have significantly greater
financial, technical and marketing resources than we do. These competitors may
be able to respond more rapidly than we can to new or emerging technologies or
changes in customer requirements and may be able to leverage their customer
bases and adopt aggressive pricing policies to gain market share. They may also
devote greater resources to the development, promotion and sale of their
products than we do. In addition, some of our competitors or potential
competitors have existing relationships with PC and CD-recordable drive
manufacturers, integrators or retailers which currently carry our products. If
our competitors are able to exploit these existing relationships to expand into
our product areas, our business could be harmed.
Digital content providers may claim that our CD-recording software
contributes to copyright infringement, and we could incur significant expenses
or be prevented from selling our CD-recording software.
Recently, copyright owners have filed lawsuits against services such as
Napster and KaZaA, alleging copyright infringement based on unauthorized
distribution of their copyrighted works over the Internet. We believe that our
software does not pose a threat of copyright infringement because there are
legitimate, non-infringing uses for our software. However, we cannot assure you
that a lawsuit will not be filed against us by third parties attempting to
protect their rights with respect to music, video or other digital content. Such
a lawsuit could be costly and time-consuming to defend and could result in
significant damages or injunctions against the development and sales of our
products.
20
To the extent that consumers are no longer able to obtain free digital
content over the Internet, sales of our software may decline.
We believe that our CD-recording software has been successful in part
because consumers want to personalize, store and access digital content. If
digital content providers are successful in obtaining injunctions against web
sites, such as Napster, which facilitate the free distribution of digital
content, there may be less digital content on the Internet which consumers can
obtain at no cost. To the extent that less free digital content is available on
the Internet, demand for our CD-recording software may be harmed.
If the installed base of CD recorders does not grow as expected, sales of
our CD-recording software may decline.
Sales of our CD-recording software and related services depend in large
part on the continued growth of the installed base of CD recorders. While this
installed base is rapidly expanding, we cannot assure you that this growth will
continue as expected. Consumers may choose to purchase new PCs that do not
include CD recorders, or existing PC owners may not purchase CD recorders as a
stand-alone product in the numbers that are expected if an alternative
technology emerges or if the demand for moving, managing and storing digital
content is less than expected. Growth in the installed base of CD recorders may
also be limited due to shortages in components required to manufacture CD
recorders or other supply constraints. Additionally, as the market for CD
recorders matures, we believe OEMs will encounter strong competition and may
discontinue their participation in the market thereby potentially disrupting the
supply of products.
If we fail to release our products as scheduled, it would adversely affect
our revenue and the growth of our business.
We may fail to introduce or deliver new product offerings, or new versions
of existing products, on a timely basis or at all. In fiscal 1999, Easy CD
Creator 4.0 was not ready for release on its scheduled release date. We believe
this delay resulted in a loss of revenues for fiscal 1999. If new versions of
existing products or potential new products are delayed, we could experience a
delay or loss of revenues and customer dissatisfaction. Customers may delay
purchases of Easy CD Creator or other products in anticipation of future
releases. If customers defer material orders of Easy CD Creator or other
products in anticipation of new releases or new product introductions, our
business would be seriously harmed.
If we fail to manage expansion effectively, we may not be able to
successfully manage our business, which could cause us to fail to meet our
customer demand or to attract new customers, which would adversely affect our
revenue.
Our ability to successfully offer our products and implement our business
plan in a rapidly evolving market requires an effective planning and management
process. We plan to continue to increase the scope of our operations
domestically and internationally. In addition, we plan to continue to hire a
significant number of employees this year, including several key management
positions. This anticipated growth in future operations will place a significant
strain on our management resources.
In the future we will need to develop and continue to improve our financial
and managerial controls, reporting systems and procedures. In addition, we will
need to continue to expand, train and manage our work force worldwide.
We may need to make additional future acquisitions to remain competitive.
The process of identifying, acquiring and integrating future acquisitions may
constrain valuable management resources, and our failure to effectively
integrate future acquisitions may result in the loss of key employees and the
dilution of stockholder value and have an adverse effect on our operating
results.
We have completed several acquisitions and expect to continue to pursue
strategic acquisitions in the future. If we identify an appropriate acquisition
candidate, we may not be able to negotiate the terms of the acquisition
successfully, finance the acquisition or integrate the acquired business,
products, technologies or employees into our existing business and operations.
Completing and integrating any potential future acquisitions could cause
significant diversions of management time and resources. Financing for future
acquisitions may not be available on favorable terms, or at all. If we acquire
businesses, new products or technologies in the future, we may be required to
amortize significant amounts of intangible assets. If we consummate one or more
significant future acquisitions in which the
21
consideration consists of stock or other securities, our existing stockholders'
ownership could be significantly diluted. If we were to proceed with one or more
significant future acquisitions in which the consideration included cash, we
could be required to use a substantial portion of our available cash. As of
September 30, 2001, we had an aggregate of $22.3 million of goodwill and other
intangible assets, related to prior acquisitions. We adopted SFAS No. 142,
"Goodwill and Other Intangible Assets" effective April 1, 2001, and as such no
longer amortize goodwill and acquired workforce intangibles, which are now
classified as goodwill in the balance sheet in accordance with SFAS No. 142. We
periodically review the unamortized balance to determine if the costs are
realizable and may in the future make adjustments to the carrying balance or
amortization period based upon these reviews. The amortization of the remaining
other intangible assets are expected to result in additional charges to
operations through the quarter ending March 31, 2003.
We could be subject to potential product liability claims and third party
liability claims related to users' reliance on our GoBack system recovery
software.
Our GoBack system recovery software may be heavily relied upon to protect
important work product, data and other content against human error and computer
viruses. Any errors, defects or other performance problems could result in
financial or other damages to our customers. Although our license agreements
generally contain provisions designed to limit our exposure to product liability
claims, existing or future laws or unfavorable judicial decisions could negate
such limitation of liability provisions. Product liability litigation, even if
it not successful, would likely be time consuming and costly to defend.
A significant portion of our revenue is derived from international sales.
Economic, political, regulatory and other risks associated with international
sales and operations could have an adverse effect on our revenue.
Because we sell our products worldwide, our business is subject to risks
associated with doing business internationally. Based on the selling entity,
international sales accounted for approximately 22% and 34% of our net revenues
for the six months ended September 30, 2001 and the year ended March 31, 2001,
respectively. We anticipate that revenue from international operations will
represent an increasing portion of net total revenue. Accordingly, our future
revenue could decrease based on a variety of factors, including:
. changes in foreign currency exchange rates;
. seasonal fluctuations in sales;
. changes in a specific country's or region's political or economic
condition, particularly in emerging markets;
. unexpected changes in foreign laws and regulatory requirements;
. trade protection measures and import or export licensing requirements;
. potentially adverse tax consequences;
. longer accounts receivable collection cycles;
. difficulty in managing widespread sales and manufacturing operations;
and
. less effective protection of intellectual property.
We could suffer significant litigation expenses, incur substantial damages,
be required to pay substantial license fees or be prevented from selling certain
products.
Any litigation, with or without merit, could be time-consuming, divert
management's attention and resources, prevent product shipment, cause delays or
require us to enter into royalty or licensing agreements, any of which could
harm our business. For example, in May 2001, we were sued by Gracenote, Inc. for
breach of contract and patent and trademark infringements. Similarly, Adaptec
was sued by the former principal shareholders of Incat Systems Software USA,
Inc. in February 2001 for breach of contract and we may be asked to defend and
indemnify Adaptec in such lawsuit pursuant to the terms of an agreement between
Adaptec and us. While we believe that we have strong defenses to Gracenote's and
Incat's claims, extended litigation will be costly and could harm our business.
Patent litigation in particular has complex technical issues and inherent
uncertainties. Parties making
22
claims against us could secure substantial damages, as well as injunctive or
other equitable relief which could effectively block our ability to license our
products in the United States or abroad. Such a judgment could seriously harm
our business.
Third parties may claim that we are infringing their intellectual property
rights, and we may be found to infringe those intellectual property rights. We
cannot assure you that other third parties will not claim infringement by us
with respect to our products and associated technology. While we do not believe
that any of our products infringe the proprietary rights of third parties, we
acquired all of our assets "as is" from Adaptec, and we may be unaware of
intellectual property rights of others that may cover some of our technology.
Claims of intellectual property infringement might require us to enter into
costly royalty or license agreements. In the event that we are unable to obtain
royalty or license agreements on terms acceptable to us or if we are subject to
significant damages or injunctions against the development and sale of our
products, our business would be harmed. In addition, we have received opposition
to our registration of DirectCD as our trademark. We cannot assure you that we
will be able to register DirectCD as our trademark or that we will receive a
license to continue using the name DirectCD in the event that our trademark
registration efforts are unsuccessful.
Third parties may infringe our intellectual property, and we may need to
expend significant resources enforcing our rights or suffer competitive injury.
Our success depends in large part on our proprietary technology. We rely on
a combination of patents, copyrights, trademarks, trade secrets, confidentiality
and licensing arrangements to establish and protect our proprietary rights. We
have filed over 70 patent applications in the past six years, covering general
CD recording, audio transformations, improving data utilization and methods for
saving and recording data. Twelve patents have been issued to us.
Our pending patent and trademark registration applications may not be
allowed or competitors may challenge the validity or scope of these
registrations. Even if patents are issued and maintained, these patents may not
be of adequate scope to benefit us or may be held invalid and unenforceable
against third parties.
We have in the past expended and may be required in the future to expend
significant resources to protect our intellectual property rights. We may not be
able to detect infringement and may lose competitive position in the market
before we do so. In addition, competitors may design around our technology or
develop competing technologies. Intellectual property rights may also be
unavailable or limited in some foreign countries.
Despite our efforts to protect our proprietary rights, existing laws,
contractual provisions and remedies afford only limited protection. In addition,
effective copyright and trade secret protections may be unavailable or limited
in some foreign countries. Attempts may be made to copy or reverse engineer
aspects of our product or to obtain and use information that we regard as
proprietary. Accordingly, we cannot assure you that we will be able to protect
our proprietary rights against unauthorized third-party copying or use. Use by
others of our proprietary rights could materially harm our business.
Furthermore, policing the unauthorized use of our products is difficult, and
expensive litigation may be necessary in the future to enforce our intellectual
property rights.
Our software could be susceptible to errors or defects that could result in
lost revenues, liability or delayed or limited market acceptance.
Complex software products often contain errors or defects, particularly
when first introduced or when new versions or enhancements are released. We have
in the past discovered, and may in the future discover, software errors in our
new releases after their introduction. Despite internal testing and testing by
current and potential clients, our current and future products may contain
serious defects or errors. Any such defects or errors would likely result in
lost revenues, liability or a delay in market acceptance of these products.
The technology labor market is generally competitive, and, to grow our
business, we must be able to hire and retain sufficient qualified technical,
sales, marketing and administrative personnel in this market.
Our future success depends in part on our ability to attract and retain
engineering, sales, marketing, finance and customer support personnel. Our
separation from Adaptec has required us to hire many additional employees to
perform operational functions which were previously performed by Adaptec
employees. If we fail to retain and hire a sufficient number of these employees,
we will not be able to maintain and expand our business. Competition for
qualified personnel in technology is intense, and our principal operations are
in the Silicon Valley region of
23
Northern California where labor markets are competitive. We believe we have
benefited from Adaptec's name and reputation as an employer in the past. To the
extent we do not obtain similar recognition, our ability to attract and retain
personnel could be harmed. In addition, some employees of Adaptec who worked in
our businesses in the past may have chosen to remain with Adaptec. We cannot
assure you that we will be able to hire and retain a sufficient number of
qualified personnel to meet our business objectives.
We may encounter computer problems or a natural disaster at our
headquarters, which could cause us to lose revenue and customers.
Viruses or bugs introduced into our product development, quality assurance,
production and shipping, customer support or financial and administrative
software systems could cause us to lose data, expose us to time and expense in
identifying and resolving the problem or delay product shipments. Furthermore,
our headquarters are located in a single location in Milpitas, California. We
could be particularly vulnerable in a natural disaster, such as an earthquake.
Any of these events could cause us to lose customers or damage our reputation,
which would decrease our revenues.
We rely on a continuous power supply to conduct our operations, and
California's current energy crisis could disrupt our operations and increase our
expenses.
California has recently been in an energy crisis that could disrupt our
operations and increase our expenses. In the event of an acute power shortage,
California has on some occasions implemented, and may in the future continue to
implement, rolling blackouts throughout California. We currently do not have
backup generators or alternate sources of power in the event of a blackout, and
our current insurance does not provide coverage for any damages we or our
customers may suffer as a result of any interruption in our power supply. If
blackouts interrupt our power supply, we would be temporarily unable to continue
operations at our facilities. Any such interruption in our ability to continue
operations at our facilities could damage our reputation, harm our ability to
retain existing customers and to obtain new customers, and could result in lost
revenue.
If we repatriate cash from our foreign subsidiaries, we will incur
additional income taxes that could negatively impact our results of operations
and financial position.
A portion of our cash and cash equivalents will be held by one or more of
our foreign subsidiaries. If we need additional cash to acquire assets or
technology, or to support our operations in the United States, we may be
required to repatriate some of our cash from these foreign subsidiaries to the
United States. We are likely to incur additional income taxes from the
repatriation, which could negatively affect our results of operations and
financial position.
Risks Relating to Separating Roxio from Adaptec
We are operating with a new brand, which may cause our product sales to
suffer until our new brand receives widespread recognition.
In connection with our separation from Adaptec, we changed the brand name
and some of the trademarks and trade names under which we conduct our business.
We believe that sales of our products have benefited from the use of the
"Adaptec" brand. Our current customers, suppliers and partners may react
negatively to the separation. In addition, the loss of the "Adaptec" brand may
hinder our ability to establish new relationships.
We currently use Adaptec's operational and administrative infrastructure,
and our ability to satisfy our customers and operate our business will suffer if
we do not develop our own infrastructure quickly and cost-effectively.
We currently use Adaptec's systems, processes and personnel to support our
operations, including systems to manage inventory, order processing, shipping,
accounting, payroll and internal computing operations. Many of these systems and
processes are proprietary to Adaptec and are very complex. These systems and
processes have been modified, and are in the process of being further modified,
to enable us to separately track items related to our business. These
modifications, however, may result in unexpected system failures or the loss or
corruption of data.
We are in the process of creating our own systems and processes to replace
Adaptec's systems and processes. We may not be successful in implementing these
systems or processes and transitioning data from Adaptec's systems to ours.
24
Any failure or significant downtime in Adaptec's or our own information
systems could prevent us from taking customer orders, shipping products or
billing customers. In addition, Adaptec's and our information systems and
processes require the services of employees with extensive knowledge of these
information systems and processes and the business environment in which we
operate. In order to successfully implement and operate our systems and
processes, we must be able to attract and retain a significant number of highly
skilled employees. We cannot assure you that we will be able to attract and
retain the highly skilled personnel required to implement, maintain, and operate
our information systems and processes.
We may be required to indemnify Adaptec for tax liabilities it may incur in
connection with its distribution of our common stock.
We have entered into a tax sharing agreement with Adaptec in which we have
agreed to indemnify Adaptec for certain taxes and similar obligations that it
could incur if the distribution does not qualify for tax-free treatment due to
any of the following events:
. the acquisition of a controlling interest in our stock after the
distribution;
. our failure to continue our business after the distribution;
. a repurchase of our stock; or
. other acts or omissions by us.
Internal Revenue Service regulations provide that if another entity
acquires a controlling interest in our stock within two years of the
distribution, a presumption will arise that the acquisition was made in
connection with the distribution, causing the distribution to become taxable.
This presumption may deter other companies from acquiring us for two years after
the distribution. We may be held jointly and severally liable for tax
liabilities we incurred as a result of our operations prior to our separation
from Adaptec, and we cannot assure you that we will be able to recover from
Adaptec any losses we may suffer. If we take any action or fail to take any
action that would cause Adaptec's distribution of our common stock to be taxable
to Adaptec, our financial condition could be seriously harmed.
Because we separated our business from that of Adaptec, our historical
financial information may not be representative of our results as a company
separate from Adaptec.
Our consolidated financial statements have been carved out from the
consolidated financial statements of Adaptec using the historical operating
results and historical bases of the assets and liabilities of the Adaptec
business that we comprised. Accordingly, the historical financial information we
have included in this annual report does not necessarily reflect what our
financial position, operating results and cash flows would have been had we been
a separate, stand-alone entity during the periods presented. Adaptec did not
account for us, and we were not operated, as a separate, stand-alone entity for
the periods presented. Our costs and expenses include allocations from Adaptec
for centralized corporate services and infrastructure costs, including:
. legal;
. accounting;
. finance;
. manufacturing;
. real estate;
. information technology;
. distribution;
. customer service;
25
. sales;
. marketing; and
. engineering.
These allocations have been determined on bases that Adaptec and we
consider to be reasonable reflections of the utilization of services provided to
or the benefit received by us. The historical financial information is not
necessarily indicative of what our operating results, financial position and
cash flows will be in the future. We have not made adjustments to our historical
financial information to reflect many significant changes that will occur in our
cost structure, funding and operations as a result of our separation from
Adaptec, including increased costs associated with reduced economies of scale,
increased marketing expenses related to building a company brand identity
separate from Adaptec and increased costs associated with being a
publicly-traded, stand-alone company.
We will not be able to rely on Adaptec to fund our future capital
requirements, and financing from other sources may not be available on favorable
terms or at all.
In the past, our capital requirements have been satisfied by Adaptec.
However, following our separation, Adaptec no longer provides funds to finance
our working capital or other cash requirements.
We believe our capital requirements will vary greatly from quarter to
quarter, depending on, among other things, capital expenditures, fluctuations in
our operating results, financing activities, acquisitions and investments and
inventory and receivables management. We believe that our future cash flow from
operations, together with the cash contributed to us by Adaptec upon separation
and the cash held by our foreign subsidiaries, will be sufficient to satisfy our
working capital, capital expenditure and product development requirements for
the foreseeable future. However, we may require or choose to obtain additional
debt or equity financing in order to finance acquisitions or other investments
in our business. Future equity financings would be dilutive to the existing
holders of our common stock. Future debt financings could involve restrictive
covenants. We may not be able to obtain financing with favorable interest rates
or at all.
We may have potential business conflicts of interest with Adaptec with
respect to our past and ongoing relationships, and we may not resolve these
conflicts on terms favorable to us.
Conflicts of interest may arise between Adaptec and us in a number of areas
relating to our past and ongoing relationships, including:
. labor, tax, employee benefit, indemnification and other matters arising
from our separation from Adaptec;
. intellectual property matters;
. employee retention and recruiting;
. the nature, quality and pricing of transitional services Adaptec has
agreed to provide us; and
. business opportunities that may be attractive to both Adaptec and us.
Nothing restricts Adaptec from competing with us.
If the transitional services being provided to us by Adaptec are not
sufficient to meet our needs, or if we are not able to replace these services
after our agreements with Adaptec expire, we will be unable to manage critical
operational functions of our business.
Adaptec has agreed to provide transitional services to us, including
services related to:
. information technology systems;
. supply chain;
26
. product order administration;
. buildings and facilities; and
. finance and accounting.
These services may not be provided at the same level as when we were part
of Adaptec, and we may not be able to obtain the same benefits. Other than the
lease for our corporate headquarters, these transitional service and leasing
arrangements generally have a term of one year following the separation. After
the expiration of these various arrangements, we may not be able to replace the
transitional services or enter into appropriate leases in a timely manner or on
terms and conditions, including cost, as favorable as those we receive from
Adaptec.
These agreements were made in the context of a parent-subsidiary
relationship and were negotiated in the overall context of our separation from
Adaptec. The prices charged to us under these agreements may be lower than the
prices that we may be required to pay third parties for similar services or the
costs of similar services if we undertake them ourselves.
Risks Related to the Securities Markets and Ownership of Our Common Stock
We cannot assure you that our stock price will not decline.
The market price of our common stock could be subject to significant
fluctuations. Among the factors that could affect our stock price are:
. quarterly variations in our operating results;
. changes in revenue or earnings estimates or publication of research
reports by analysts;
. failure to meet analysts' revenues or earnings estimates;
. speculation in the press or investment community;
. strategic actions by us or our competitors, such as acquisitions or
restructurings;
. actions by institutional stockholders;
. general market conditions; and
. domestic and international economic factors unrelated to our
performance, such as the effects of the September 11, 2001 terrorist
attacks on the United States.
The stock markets in general, and the markets for technology stocks in
particular, have experienced extreme volatility that has often been unrelated to
the operating performance of particular companies. These broad market
fluctuations may adversely affect the trading price of our common stock. In
particular, we cannot assure you that you will be able to resell your shares at
any particular price, or at all.
Provisions in our agreements, charter documents, stockholder rights plan
and Delaware law may delay or prevent acquisition of us, which could decrease
the value of your shares.
Our certificate of incorporation and bylaws and Delaware law contain
provisions that could make it more difficult for a third party to acquire us
without the consent of our board of directors. These provisions include a
classified board of directors and limitations on actions by our stockholders by
written consent. In addition, our board of directors has the right to issue
preferred stock without stockholder approval, which could be used to dilute the
stock ownership of a potential hostile acquirer. Delaware law also imposes some
restrictions on mergers and other business combinations between us and any
holder of 15% or more of our outstanding common stock. In addition, we have
adopted a stockholder rights plan that makes it more difficult for a third party
to acquire us without the approval of our board of directors. Although we
believe these provisions provide for an opportunity to receive a higher bid by
requiring potential acquirers to negotiate with our board of directors, these
provisions apply even if the offer may be considered beneficial by some
stockholders.
27
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We develop our software in the United States and Europe and sell it in
North America, Europe, the Pacific Rim and Asia. As a result, our financial
results could be affected by factors such as changes in foreign currency
exchange rates or weak economic conditions in foreign markets. For our foreign
divisions whose functional currency is the local currency, we translate assets
and liabilities to U.S. dollars using period-end exchange rates and translate
revenues and expenses using average exchange rates during the period. Exchange
gains and losses arising from translation of foreign entity financial statements
are included as a component of other comprehensive income.
For foreign divisions whose functional currency is the U.S. dollar, certain
assets and liabilities are re-measured at the period end or historical rates as
appropriate. Revenues and expenses are re-measured at the average rate during
the period. Currency translation gains and losses are recognized in current
operations and have not been material to our operating results in the periods
presented.
We sell our products primarily to original equipment manufacturers and
distributors throughout the world. Sales to customers and cash and cash
equivalents are primarily denominated in U.S. dollars and, as a result, we do
not believe that our foreign currency risk is significant. Cash and cash
equivalents are predominantly denominated in U.S. dollars.
We do not currently hold any derivative instruments and do not engage in
hedging activities. Also, we do not currently hold any variable interest rate
debt or lines of credit. Financial instruments that potentially subject us to
significant concentrations of credit risk consist principally of trade accounts
receivable and accounts payable.
28
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On February 13, 2001, several former stockholders of Incat Systems Software
USA, Inc. filed a lawsuit against Adaptec in the Superior Court of California in
the County of Santa Clara. The lawsuit stems from Adaptec's alleged failure to
pay these former stockholders all of the amounts due to them based on an
earn-out agreed to in connection with the acquisition of Incat. We have been
asked to defend and indemnify Adaptec in such lawsuit pursuant to the terms of
an agreement between us. The lawsuit requests a judgment against Adaptec for
actual, compensatory and punitive damages, including interest, court costs, each
in amounts to be proven, and reasonable attorneys' fees incurred. We believe the
lawsuit is without merit and intend to vigorously defend our interests.
On May 10, 2001, Gracenote, Inc. filed a lawsuit against us in U.S.
District Court for the Northern District of California. In the complaint,
Gracenote seeks unspecified damages and injunctive and other relief based upon
claims including patent and trademark infringement and breach of contract. The
lawsuit stems from the use of Gracenote's music recognition service in version 4
of our Easy CD Creator and Toast CD-burning software and our use of a competing
music recognition service, Freedb.org. We believe that we have meritorious
defenses to each of the claims alleged by Gracenote and we intend to defend
ourselves vigorously. In addition, we have filed a number of counterclaims
against Gracenote seeking unspecified damages, injunctive relief and other
relief based upon claims including breach of contract, antitrust violations and
tortious interference with business relationships.
We are a party to litigation matters and claims which are normal in the
course of our operations, and, while the results of such litigation and claims
cannot be predicted with certainty, we believe that the final outcome of such
matters will not have a material adverse impact on our business, financial
position or results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The 2001 Annual Meeting of Stockholders of Roxio, Inc. was held on
September 20, 2001. At the meeting, Roxio's stockholders approved the
re-election of W. Christopher Gorog as a director of Roxio for a three-year term
ending at Roxio's 2004 Annual Meeting and until his successor is elected and
qualified. The number of votes cast for Mr. Gorog at the 2001 Annual Meeting was
13,559,216 and the number of votes abstained was 682,239.
ITEM 5. OTHER INFORMATION. None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits -
See attached exhibit list for exhibits filed as part of this
quarterly report.
(b) Reports on Form 8-K
There were no reports on form 8-K filed during the three-month period
ended September 30, 2001.
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
ROXIO, INC.
(Registrant)
Date: November 14, 2001
By: /s/ Wm. CHRISTOPHER GOROG
---------------------------------------
Wm. Christopher Gorog
Chief Executive Officer, President and
Director (Principal Executive Officer)
By: /s/ R. ELLIOT CARPENTER
---------------------------------------
R. Elliot Carpenter
Chief Financial Officer
(Principal Financial and Accounting
Officer)
30
ROXIO, INC.
INDEX TO EXHIBITS
Exhibit
Number Description of Exhibit
- ----------- -------------------------------------------------------------------
2.1 First Amended and Restated Master Separation and Distribution
Agreement effective as of February 28, 2001 between Adaptec and the
Registrant (1)
2.2 General Assignment and Assumption Agreement dated May 5, 2001
between Adaptec and the Registrant (1)
2.3 Indemnification and Insurance Matters Agreement dated May 5, 2001
between Adaptec and the Registrant (1)
2.4 Master Patent Ownership and License Agreement effective as of May
5, 2001 between Adaptec and the Registrant (1)
2.5 Master Technology Ownership and License Agreement effective as of
May 5, 2001 between Adaptec and the Registrant (1)
2.6 Master Confidential Disclosure Agreement effective as of May 5,
2001 between Adaptec and the Registrant (1)
2.7 Master Transitional Services Agreement effective as of May 5, 2001
between Adaptec and the Registrant (1)
2.8 Employee Matters Agreement dated May 5, 2001 between Adaptec and
the Registrant (1)
2.9 Tax Sharing Agreement dated May 5, 2001 between Adaptec and the
Registrant (1)
2.10 Real Estate Matters Agreement dated May 5, 2001 between Adaptec and
the Registrant (1)
2.11 Manufacturing Agreement effective as of May 5, 2001 between Adaptec
and the Registrant (1)
2.12 International Transfer of Assets Agreement dated May 5, 2001
between Adaptec Mfg(S) Pte Ltd. and Roxio CI Ltd. (1)
2.13 Letter Agreement dated May 5, 2001 between Adaptec and the
Registrant (1)
2.14 Amendment to the Tax Sharing Agreement dated July 19, 2000 between
Adaptec and the Registrant (4)
3.1 Amended and Restated Certificate of Incorporation of the Registrant
(1)
3.2 Amended and Restated Bylaws of the Registrant (1)
3.3 Certificate of Designation of Rights, Preferences and Privileges of
Series A Participating Preferred Stock of Roxio, Inc. (2)
4.1 Form of Common Stock certificate of the Registrant (1)
4.2 Warrant to Purchase Common Stock dated May 17, 2001 between the
Registrant and Virgin Holdings, Inc. (3)
4.3 Registration Rights Agreement dated May 17, 2001 between the
Registrant and Virgin Holdings, Inc. (3)
4.4 Preferred Stock Rights Agreement, dated as of May 18, 2001, between
Registrant and Mellon Investor Services, LLC, including the
Certificate of Designation, the form of Rights Certificate and the
Summary of Rights attached thereto as Exhibits A, B, and C,
respectively (2)
10.1 Employment Agreement dated July 24, 2001 between R. Elliot
Carpenter and the Registrant (4)
10.2 Employment Agreement dated September 24, 2001 between Wm.
Christopher Gorog and the Registrant
- -----------------
(1) Incorporated by reference to the Registrant's Form 10 Registration
Statement (No. 000-32373) as filed with the Securities and Exchange
Commission on May 15, 2001.
(2) Incorporated by reference to the Registrant's Registration
Statement on Form 8-A as filed with the Securities and Exchange
Commission on June 5, 2001.
(3) Incorporated by reference to the Registrant's Annual Report on Form
10-K as filed with the Securities and Exchange Commission on June
29, 2001.
(4) Incorporated by reference to the Registrant's Quarterly Report on
Form 10-Q as filed with the Securities and Exchange Commission on
August 14, 2001.
31