10-Q 1 d10q.txt FORM 10-Q -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------- Form 10-Q [X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001 OR [_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number 000-27287 ----------------- INTERTRUST TECHNOLOGIES CORPORATION (Exact name of registrant as specified in its charter) Delaware 52-1672106 (State of incorporation) (IRS Employer Identification No.) 4750 Patrick Henry Drive, Santa Clara, California 95054 (Address of principal executive offices, including ZIP code) (408) 855-0100 (Registrant's telephone number, including area code) None (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) Yes X No , and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_]. The number of shares outstanding of the Registrant's Common Stock as of October 31, 2001 was 95,046,956. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- INTERTRUST TECHNOLOGIES CORPORATION INDEX

2 PART I FINANCIAL INFORMATION Item 1. Consolidated Financial Statements INTERTRUST TECHNOLOGIES CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except per share data)

See accompanying notes. 3 INTERTRUST TECHNOLOGIES CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except share and per share amounts) (unaudited)

See accompanying notes. 4 INTERTRUST TECHNOLOGIES CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)

5 INTERTRUST TECHNOLOGIES CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS PART I. FINANCIAL INFORMATION 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared by us and reflect all adjustments, consisting only of normal recurring adjustments, $540,000 and $1,170,000 adjustments for restructuring charges in the quarters ending September 30 and June 30, 2001, respectively and a $31.1 million adjustment for the impairment of long-lived assets in the quarter ended June 30, 2001, which in the opinion of management are necessary to present fairly the financial position and the results of operations for the interim periods. The balance sheet at December 31, 2000 has been derived from audited financial statements at that date. The financial statements have been prepared in accordance with the regulations of the Securities and Exchange Commission, but omit certain information and footnote disclosures necessary to present the statements in accordance with generally accepted accounting principles. For further information, refer to the Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10K for the year ended December 31, 2000 filed with the Securities and Exchange Commission on April 2, 2001 (the "Annual Report"). Results of operations for the three and nine month periods ended September 30, 2001 are not necessarily indicative of operating results for the full year. Net Loss Per Share Basic and diluted net loss per share is computed using the weighted-average number of shares of common stock outstanding during the period less shares subject to repurchase. The following table presents the basic and diluted net loss per share (in thousands, except per share amounts):

We excluded all outstanding warrants and stock options from the calculation of diluted net loss per share because all such securities are antidilutive for all periods presented. The total number of weighted average shares excluded from the calculations of diluted net loss per share was 8,025,000 and 13,230,000 for the three months ended September 30, 2001 and 2000, respectively, and 7,944,000 and 15,350,000 for the nine months ended September 30, 2001 and 2000, respectively. Warrants and stock options, had they been dilutive, would have been included in the computation of diluted net loss per share using the treasury stock method. Revenue Concentration Three customers accounted for 21%, 20% and 17% of total revenues in the three months ended September 30, 2001 compared to 20%, 16%, and 11% of total revenues in the comparable period of 2000; and three customers accounted for 36%, 25% and 13% of total revenues for the nine months ended September 20, 2001 compared to 35%, 28%, and 11% in the comparable period of 2000. International revenues were 62% and 56% of total revenues for the three months ended September 30, 2001 and 2000, respectively, and 49% and 44% for the nine months ended September 30, 2001 and 2000, respectively. 6 Goodwill and Other Intangible Assets Intangible assets are primarily comprised of goodwill, purchased technology and patent rights, assets related to acquired workforce in place, and capitalized patent application costs related to internally developed technology. These assets are amortized using the straight-line method over the estimated useful lives of the assets, generally two to 17 years. During the second quarter of 2001, our management identified indicators of possible impairment of our long-lived assets, principally goodwill and other acquired intangible assets. Such indicators included the slower than expected development of the Digital Rights Management (DRM) market, aggressive marketing efforts by our principal competitors, an overall decline in industry valuations and growth rates, and a strategy shift from our existing Commerce product platform to the new Rights|System product platform. We determined that we had three categories of long-lived assets with attributable and identifiable cash flows: Commerce and related technology, Rights|System technology, and PublishOne services. Commerce and related technology long-lived assets include goodwill and other intangible assets recorded in connection with our acquisitions of Infinite Ink in March 2000 and PassEdge in December 2000. Rights|System technology assets primarily consist of property and equipment, patents and acquired workforce. PublishOne services assets consist of goodwill and other intangible assets recorded in connection with our acquisition of PublishOne in January 2001. With the assistance of independent valuation experts, we performed asset impairment tests for each of the three identified asset categories. The tests were performed by comparing the expected undiscounted cash flows for a five-year period, plus a terminal value for future cash flows after the five-year period, to the total carrying amount of goodwill, other intangible assets and property and equipment for each asset category. The assumptions supporting the estimated cash flows, and an estimated terminal value, reflect management's best estimates. Based on the results of these tests, we determined that the carrying amounts of the Commerce and related technology and PublishOne services long-lived assets were impaired. With the assistance of independent valuation experts, we determined the fair value of the long-lived assets for the impaired asset categories. Fair value was determined using the discounted cash flow method, using a discount rate of 18% and an estimated residual value. The discount rate was based upon the weighted average cost of capital for InterTrust and comparable companies. A write-down of goodwill and intangible assets totaling $31.1 million was recorded during the second quarter of 2001, reflecting the amount by which the carrying amount of the assets exceed their respective fair values. The write-down consisted of $20.9 million for goodwill and $10.2 million for other acquired intangible assets. Investments in Privately-held Companies Investments in privately-held companies primarily consist of equity and debt securities in which InterTrust owns less than a 20% interest. InterTrust invests in entities based upon factors that include the size of the market opportunity and the barriers to entering that market, the strength of the entity's products, services, and intellectual property, the previous experience of the management team and its ability to execute on its business plan, and the financial projections of the prospect. Additionally, InterTrust also considers the strategic importance of the entity's technology in furthering the adoption of DRM technologies. InterTrust does not have the ability to exercise significant influence over any of the companies in which it invests and accordingly accounts for such investments using the cost method. These investments are assessed for impairment periodically through review of operations and indications of continued viability, such as subsequent rounds of financing. As a result of the deterioration of financial markets and the corresponding effect on private company valuations and financing prospects during the second quarter of 2001, we recorded $3.0 million in losses as a result of other than temporary declines in the value of investments in privately held companies. 7 The remaining investment in privately-held companies of $250,000 at September 30, 2001 is included in other assets in the consolidated balance sheet. InterTrust has not participated in subsequent financings for any of the companies in which it is invested, and it is not obligated or committed in any way to participate in any future financings of any of its investments. Recent Accounting Pronouncements On January 1, 2001, we adopted SFAS No. 133, ''Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments, including foreign exchange contracts, and hedging activities. In June 2001, the FASB issued SFAS No. 138, ''Accounting for Certain Derivative Instruments and Certain Hedging Activities," which addresses implementation issues related to SFAS No. 133. SFAS No. 133, as amended, and SFAS No. 138 are effective for fiscal years beginning after June 15, 2000. Because we currently hold no derivative financial instruments and do not currently engage in hedging activities, the adoption of SFAS 133 did not have a material impact on our financial position or results of operations. In July 2001 the FASB issued SFAS No. 141 "Business Combinations" and SFAS No. 142 "Goodwill and Other Intangible Assets." SFAS No. 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting, and broadens the criteria for recording intangible assets separate from goodwill. Recorded goodwill and intangibles will be evaluated against this new criteria and may result in certain intangibles being subsumed into goodwill, or alternatively, amounts initially recorded as goodwill may be separately identified and recognized apart from goodwill. SFAS No. 142 requires the use of a nonamortization approach to account for purchased goodwill and certain intangibles. Under a nonamortization approach, goodwill and certain intangibles will not be amortized into results of operations, but instead would be reviewed for impairment and written down and charged to results of operations only in the periods in which the recorded value of goodwill and certain intangibles is more than its fair value. The provisions of each statement which apply to goodwill and intangible assets acquired prior to June 30, 2001 will be adopted by us on January 1, 2002. We expect the adoption of these accounting standards may result in certain of our intangibles being subsumed into goodwill and will have the impact of reducing our amortization of goodwill and other intangible assets commencing January 1, 2002; however, impairment reviews may result in future periodic write-downs. In August, 2001, the FASB issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS 144 supercedes SFAS 121, "Accounting for the Impairment of Long Lived Assets and Long-Lived Assets to be Disposed of" and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business. SFAS 144 establishes a single accounting model for assets to be disposed of by sale whether previously held and used or newly acquired. SFAS No. 144 retains the provisions of APB No. 30 for presentation of discontinued operations in the income statement, but broadens the presentation to include a component of an entity. SFAS 144 is effective for fiscal years beginning after December 15, 2001 and the interim periods within. We do not believe that the adoption of SFAS 144 will have a material impact on our financial position or results of operations. 2. BUSINESS COMBINATIONS On January 30, 2001, we acquired the remaining 92.1% of the outstanding shares and all of the outstanding options of PublishOne Inc. (PublishOne), a privately-held company that develops online publishing software solutions and distribution services for business information publishers. Prior to the acquisition date, we owned approximately 7.9% of PublishOne's outstanding stock. The transaction was accounted for as a purchase and the results of PublishOne's operations have been included in the condensed consolidated financial statements from 8 the date of acquisition. The purchase price was $16.9 million and consisted of 1,130,000 shares of InterTrust common stock at a fair value of $5.31 per share, the assumption of options to purchase 1,155,221 shares of InterTrust common stock at a fair value of $4.84 per share, assumed liabilities of $5.2 million, and acquisition costs of approximately $250,000. The InterTrust options issued in connection with the assumption of the PublishOne options were valued using the Black-Scholes option pricing model assuming a volatility of 1.6, expected life of 4 years, risk-free interest rate of 7%, expected dividend yield of 0% and stock price of $5.31. Additionally, the agreement includes contingent consideration of 320,000 shares of InterTrust common stock to be issued upon the achievement of certain milestones. As of September 30, 2001, no milestones have been met. We allocated PublishOne's purchase price based on the relative fair value of the net tangible and intangible assets acquired. No amount was allocated to in-process research and development. The purchase price was allocated based on an independent valuation to tangible and intangible assets as follows (in thousands): Tangible Assets........ $ 1,581 Purchased Technology... 1,671 Acquired Workforce..... 1,452 Other Intangible assets 610 Deferred Compensation.. 3,323 Goodwill............... 8,255 ------- $16,892 =======

Goodwill, purchased technology and other intangible assets are being amortized on a straight-line basis over four years. The acquired workforce is being amortized on a straight-line basis over two years. The fair value of the unvested common stock subject to restricted stock agreements and the intrinsic value of the unvested options held by employees was allocated to deferred stock compensation. The deferred stock compensation will be amortized to compensation expense over the remaining vesting term using a graded method. On August 8, 2001, we acquired the remaining 81.1% of Zero Gravity Technologies Corporation, a developer of a policy based secure email product. Prior to the acquisition date, we owned approximately 18.9% of Zero Gravity's outstanding stock. The transaction was accounted for as a purchase and the results of Zero Gravity's operations have been included in the condensed consolidated financial statements from the date of acquisition. InterTrust paid $510,000 (net of cash received), issued 500,000 shares of InterTrust common stock at a fair value of $0.98, assumed liabilities of $198,000, and paid $2,000 in acquisition costs to acquire all of the shares of Zero Gravity that we did not already own. In addition, InterTrust assumed outstanding Zero Gravity employee stock options equivalent to approximately 60,000 shares of InterTrust common stock at a fair value of $0.98 per share. The InterTrust options issued in connection with the assumption of the Zero Gravity options were valued using the Black-Scholes option pricing model assuming a volatility of 2.2, expected life of 9.3 years, risk-free interest rate of 6%, expected dividend yield of 0% and stock price of $0.98. Total acquisition price was $1,509,000 and was allocated as follows: 38% to in-process research and development, 30% to acquired workforce and 25% to goodwill. The purchase price of $1,509,000 was allocated based on an internal valuation as follows (in thousands): Tangible Assets.................... $ 111 In-Process Research and Development 567 Goodwill........................... 831 ------ $1,509 ======

9 Goodwill and other intangible assets will be accounted for in accordance with the provisions of FASB Statement No. 142, Goodwill and Other Intangible Assets. These assets will not be amortized but will be reviewed annually (or more frequently if impairment indicators arise) for impairment. The following pro forma data summarizes the results of operations for the periods indicated as if the PublishOne and Zero Gravity acquisitions had been completed as of the beginning of the periods presented. The pro forma data gives effect to actual operating results prior to the acquisition. No effect has been given to cost reductions or operating synergies in this presentation. Prior to their acquisition, PublishOne and Zero Gravity were customers of InterTrust. The pro forma amounts exclude revenues and expenses recognized in transactions between PublishOne, Zero Gravity and InterTrust. These pro forma amounts do not purport to be indicative of the results that would have actually been obtained if the acquisition had occurred as of the beginning of the periods presented or that may be obtained in the future. Pro forma results for the three and nine months ended September 30, 2001 and 2000 are as follows (in thousands, except per share amounts):

3. SALE OF SECURITIES On January 31, 2001, InterTrust sold 4,000,000 shares of common stock at $5.00 per share to Nokia Corporation (Nokia) for total cash consideration of $20,000,000. The fair market value of the stock on that day was $4.6875 per share. We accounted for the difference of $0.3125 per share as additional paid-in capital. In connection with its investment, Nokia agreed to license InterTrust DRM solutions and select InterTrust as its preferred DRM technology. Additionally, per an agreement, InterTrust has appointed an executive officer of Nokia to the InterTrust board of directors. 4. RESTRUCTURING COSTS On April 30, 2001, we announced and formally adopted a program to reduce our worldwide workforce. The reduction resulted in the decrease of 43 regular employees across all business functions, operating units, and geographic regions. The worldwide workforce reductions were substantially completed in the second quarter of 2001. Of the 43 terminated employees, 41 had left InterTrust by June 30, 2001 and the remaining 2 employees left at different dates during September 2001. We recorded a non-recurring charge of approximately $1.2 million relating primarily to severance and fringe benefits which is included in non-recurring charges in the statement of operations. On August 2, 2001, we further reduced our worldwide workforce. The reduction resulted in the decrease of 33 regular employees across all business functions, operating units, and geographic regions. All 33 terminated employees left InterTrust, and all cash payments were made by September 30, 2001. We recorded a non-recurring charge of approximately $540,000 relating to severance and fringe benefits, and the charge is included in non-recurring charges in the statement of operations. All severance payments we made during the three months ended September 30, 2001. A summary of workforce reduction costs during the nine months ended September 30, 2001 is outlined as follows:

10 5. COMPREHENSIVE INCOME Total other comprehensive income (loss) was $175,000 and $354,000 for the three months ended September 30, 2001 and 2000, respectively and $612,000 and $(175,000) for the nine months ended September 30, 2001 and 2000, respectively. 6. STOCK OPTION EXCHANGE PROGRAM On May 24, 2001, we announced a voluntary stock option exchange program for our employees. Under the program, our employees were given the opportunity to cancel outstanding stock options previously granted to them in exchange for an equal number of new options to be granted at a future date which will be at least six months and a day from the cancellation date of June 22, 2001. Options to purchase 2,763,497 shares were returned and cancelled. The exercise price of these new options will be equal to the fair market value of InterTrust's common stock on the date of grant, which is expected to be not earlier than December 23, 2001 or later than January 31, 2002. Such new options will have terms and conditions that are substantially the same as those of the canceled options. The exchange program is not expected to result in any additional compensation charges or variable plan accounting. Members of the our board of directors, our officers and our senior executives were not eligible to participate in this program. 7. SHAREHOLDER RIGHTS PLAN On June 8, 2001, our board of directors approved a stockholders' rights plan. Under the plan, rights were distributed as a dividend at the rate of one preferred share purchase right for each share of InterTrust common stock held by stockholders of record as of the close of business on June 28, 2001. Each preferred share purchase right entitles the registered holder to purchase from InterTrust one one-thousandth of a share of Series A Junior Participating Preferred Stock, par value $.001 per share, at a price of $20.00 per one one-thousandth, subject to adjustment. The description and terms of the rights are set forth in a Rights Agreement dated as of June 8, 2001, as the same may be amended from time to time, between InterTrust and Fleet National Bank, as Rights Agent, filed as Exhibit 4.1 to our Form 8-K filed June 27, 2001. 8. LEGAL PROCEEDINGS Between May 17, 2001 and July 3, 2001, complaints were filed in the United States District Court for the Southern District of New York naming InterTrust, certain of its current and former directors and the members of the underwriting syndicate involved in InterTrust's initial public offering and/or secondary public offering as defendants in multiple class action lawsuits. The lawsuits seek unspecified monetary damages and certification of a plaintiff class consisting of all persons who acquired shares of InterTrust between October 26, 1999 and May 16, 2001. The complaints allege, among other things, that InterTrust and the individual defendants named in the complaints violated the federal securities laws by issuing and selling InterTrust common stock in its initial public offering in October 1999 and its secondary public offering in April 2000 without disclosing to investors that certain of the underwriters in the offering allegedly solicited and received excessive and undisclosed commissions from certain investors. We believe that the claims against us are without merit and intend to defend against the complaints vigorously. In addition, Microsoft filed a claim which asserted infringement of two patents relating to the downloading of software, which we do not believe are significant to our business. 9. SUBSEQUENT EVENTS On October 31, 2001, we announced that we would reduce our workforce by approximately 103 employees and would consolidate certain business facilities. We will record a charge related to the reduction in force and closure of facilities in the three months ending December 31, 2001. 11 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information in this discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, the words "believes," "anticipates," "plans," "expects," "intends" and similar expressions are intended to identify forward-looking statements. InterTrust's actual results and the timing of certain events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a discrepancy include, but are not limited to, those discussed in "Other Factors Affecting Operating Results, Liquidity and Capital Resources" below. All forward-looking statements in this document are based on information available to InterTrust as of the date hereof and InterTrust assumes no obligation to update any such forward-looking statements. Overview We have developed a general purpose digital rights management, or DRM, platform to serve as a foundation for providers of digital information, technology, and commerce services to participate in a global e-commerce system. InterTrust was formed and incorporated in January 1990. From inception through 1998, our efforts were principally devoted to research and development, raising capital, recruiting personnel, and establishing licensing relationships. As a result, we were considered a development stage enterprise during this period. The general availability version of our Commerce software, our first generation DRM product, was delivered to our partners in December 1998, and some partners began using the technology on a limited commercial basis in January 2000. We are currently transitioning to our second generation DRM product, Rights|System, a product designed to be platform-independent, componetized, efficient and scalable for content, service and technology providers who are seeking to deliver high-volume, retail-based subscription services for music, video, and documents. The Rights|System product is designed to allow service providers to deliver governed content to a very broad range of devices and operating system platforms, including personal computers, set top boxes, video recorders, mobile communicators, and consumer electronics components such as game stations and portable devices. We have targeted Rights|System to be generally available to customers before the end of 2001. In addition, we have an extensive patent portfolio of 22 issued and approximately 90 patents pending worldwide relating to DRM, watermarking, and distributed trust management. We plan on licensing, as appropriate, our patent rights to customers who wish to build or operate their own DRM solutions, content distribution system, or other system that uses trust management technologies. Discussion of Revenue Sources From Prior Quarters We license our DRM platform and software to companies to build digital commerce services and applications. We intend to license to content, technology, and commerce services partners to achieve widespread dissemination of our technology, an expanding consumer base, and broad participation by digital information providers. We currently derive substantially all our revenues from license fees for transactions entered into in past quarters that are related to our Commerce software, associated software support and training services, and professional services. In addition, our existing Commerce software license agreements generally required our partners to pay a transaction fee that is a percentage of amounts paid by users or charged by our partners in commercial transactions and services that use our technology, and for sales of products incorporating our technology. To date, we have not derived any transaction fees associated with the license of our Commerce software. While we will continue to support our Commerce software licensees, we have announced that we will be making no future enhancements to the Commerce software. As a result, we believe that existing partners will transition to our Rights|System product and we expect that our Commerce licensees will choose to not commercially deploy the Commerce software. Therefore, we do not expect that any transaction fees will be 12 generated from the use of the Commerce software. Whether our Commerce licensees transition to our Rights|System product will depend on the outcome of ongoing negotiations. The Commerce software license agreements entered into in past quarters provide different rights and technology depending on the commercial plans of our partners. Initial license fees received from these agreements varied in amount depending on factors such as partner commitments, scope of the license as it relates to commercial markets, territory, and term of agreement. Examples of partner commitments include deploying licensed products within a specified time frame, exclusively using portions of our technology, and using and publicly promoting us as the partner's preferred digital rights management technology. We have in the past decided, and may in the future decide, to reduce or eliminate initial license fees based on these factors. We do not believe that we can determine the amount of foregone revenue due to reduced or eliminated license fees with any reliable degree of certainty. Our Commerce software license fees were negotiated based on the terms and conditions of each individual agreement and take into account the scope of the license, the term, and the other commitments made by our partners that provide strategic value to us. In addition, we have entered into a limited number of license agreements which have varying license scopes and terms and which do not provide adequate comparable data to determine the amount of foregone revenue. InterTrust is obligated to provide unspecified upgrades and new releases with respect to Commerce software, on a when and if available basis, to the licensees over a one to two year period under the agreements for additional fees. InterTrust is not obligated to provide any funding to any licensee for the development of the licensee's software. In the future, we may enter into other equity payment arrangements. Licenses of our Commerce software generally required the payment of an initial license fee. Initial license revenue, net of any discounts granted, is recognized upon execution of a license agreement and delivery of our software if we have no remaining obligations relating to development, upgrades, new releases, or other future deliverables, if the license fee is fixed or determinable, and if collection of the fee is probable. Our Commerce license agreements generally included the right to obtain access to upgrades and new releases of Commerce software, on a when and if available basis, for a specified period. Under these circumstances, the license payments received, net of any discounts granted, in advance of revenue recognition are deferred and recognized on a subscription basis over the period of obligation beginning with delivery of the licensed product. In addition, under license agreements where we are obligated to provide a specified custom development deliverable and do not have vendor specific objective evidence of fair value of the specified deliverable, all of the license revenue is deferred until the specified upgrade has been delivered. Upon delivery of the specified deliverable, license revenue is recognized using the subscription method. We began recognizing revenue under some license agreements in January 1999, after shipping the general availability version of our Commerce software at the end of December 1998. At September 30, 2001, we had approximately $10.1 million of deferred license revenue. Our Commerce license agreements also required the payment of a transaction fee that is a percentage of revenues received by our partners from transactions and services that use our technology and sales of products incorporating our Commerce technology. Transactions involving the use of our Commerce technology to conduct the sale, lease, rental, or licensing of commercial content required the payment of a transaction fee based on the amounts paid by users or charged by our partners for selling or distributing the content. Transactions involving the use of our technology for commercial services generally required the payment of a transaction fee based on the amounts paid by users or charged by our partners for the services. Transactions involving the sale, lease, rental, or licensing of products incorporating our Commerce technology generally required the payment of a transaction fee based on the amounts paid by users or charged by our partners for the product. Our partners are required to pay all amounts due for transaction fees within specified periods, depending on the licensing arrangement. Our revenue recognition policy relating to transaction fees is to recognize the revenue when the amounts due are known, which will generally be in the quarter after the transaction. Prepaid transaction fees are recorded as deferred revenue and will be recognized when the related transactions occur. We have received $1.5 million in prepaid transaction fees, which are included in deferred revenue as of September 30, 2001. Prepaid transaction fees may generally be offset against a portion of transaction fee amounts due in any given quarter. To date, we have not recognized any material transaction fees from commercial transactions or services, or sales of products using our Commerce software. 13 Software support and training services, which typically include the right to telephone and online support and customer training, are generally provided for in the Commerce software license agreements for an agreed-upon amount. Software support and training service revenue is recognized over the period in which the services are provided. Because we are not currently providing support for our Commerce software we do not expect to recognize significant future support fees in connection with our Commerce software licenses entered into in past quarters. TrustNet clearinghouse service revenues represent service fees for the use of our TrustNet clearinghouse infrastructure to pilot and test applications and services using our Commerce software. Service revenues include consulting and system integration services provided to the customer to establish an interface with the TrustNet clearinghouse and monthly service fees to use TrustNet for the clearing of commercial transactions. Consulting, system integration fees, and monthly service fees are recognized over the term of the service period. Professional services represent fees for consulting services provided to our customers for development and system integration not essential to the functionality of the software licensed. The revenue from these services is recognized as services are performed. National Computer Systems of Singapore, PricewaterhouseCoopers and Nippon Telegraph and Telephone accounted for 21%, 20% and 17% of total revenues respectively, in the three months ended September 30, 2001. National Computer Systems of Singapore, PricewaterhouseCoopers, and Nippon Telegraph and Telephone accounted for 22%, 23%, and 0% of total revenues, respectively, in the comparable period for 2000. Our success depends on significantly increasing the number of companies that license our technology and use it for the sale and management of digital content and services. In view of the rapidly changing nature of our industry and our new and unproven business model, we believe that period-to-period comparisons of revenues and operating results are not necessarily meaningful and should not be relied upon as indications of future performance. As we are transitioning to our Rights|System product, we cannot make any predictions as to the demand for this product. Our business model has not succeeded in generating sufficient revenue to sustain our business. We also operate in an intensely competitive market for highly qualified technical, sales and marketing, and management personnel and periodically make salary and other compensation adjustments to retain and hire employees. As a result, we will need to generate significant additional revenue to achieve and maintain profitability. In addition, current economic conditions and limited visibility into customer demand makes prediction of our future revenues difficult. We expect to incur additional losses for at least the next several years. Discussion of Future Revenue Sources In July 2001, we announced the development of Rights|System, our next generation DRM platform for content protection and management. The new platform is designed to be a lightweight, flexible, multi-platform environment that easily integrates with existing systems. It is also designed to provide the enterprise and business information sector with a platform to automate policies and protect documents beyond simple secure delivery and firewalls. The Rights|System product suite consists of three components: packagers, rights servers and clients. We believe we have optimized Rights|System for content, service and technology providers seeking to deliver high-volume retail-based and subscription services for music, video and documents. Rights|System is designed to be efficient, scalable, and delivers transparent content management and protection. Using a single server architecture, Rights|System is designed to allow service providers to deliver secure content to a broad range of devices including personal computers, set top boxes, video recorders, mobile communicators and consumer electronics devices such as game stations and portable devices. In turn, consumers should be able to easily access any type of content with any device. While we have only recently announced the Rights|System product suite, several Rights|System components have previously been licensed to customers. 14 licenses of the new product suite, which is expected to be available for shipment to customers during the three months ended December 31, 2001. We have not completed any licenses and cannot predict the market response to and success of the Rights/System products. Our business development and sales efforts are focused on licensing the three basic components of the product suite under terms that would require the payment of annual license fees for each component and an annual support contract that is a percentage of the listed annual license fee. The most material license revenue may come from the licensing of server components, which are currently being offered on a per central processing unit or CPU, basis. The initial product release will have two server components, the rights fulfillment server and the retail services server. Customers will be able to license an initial number of CPU licenses suitable for their anticipated service capacity requirements and then can purchase additional CPU licenses as their demand increases. We also offer professional services to our customers and partners to aid in implementation and integration of our Rights|System products into their environments. We also expect that the Rights|System licenses may require the payment of transaction fees, relating to the sale, lease, rental, or licensing of commercial content using the Rights|System products. Currently, the TrustNet clearinghouse does not support Rights|System customers and we do not currently expect to derive any revenue from Rights|System-related TrustNet clearinghouse services. In addition to our recent announcements concerning Rights|System, on October 31, 2001, we announced that we are commencing the licensing our patent portfolio of 22 issued and approximately 90 patents pending in the field of DRM, watermarking, and distributed trust management to third parties. While we are currently engaged in discussions concerning licensing our patents, to date, we have not completed any patent license agreements and cannot predict if, when and under what terms licensing may occur. Acquisitions On January 30, 2001, we acquired the remaining 92.1% of the outstanding shares and all of the outstanding options of PublishOne Inc. ("PublishOne"), a privately-held company that develops online publishing software solutions and distribution services for business information publishers. Prior to the acquisition date, we owned approximately 7.9% of PublishOne's outstanding stock. The transaction was accounted for as a purchase and the results of PublishOne's operations have been included in the condensed consolidated financial statements from the date of acquisition. The purchase price was $16.9 million and consisted of 1,130,000 shares of InterTrust common stock at a fair value of $5.31 per share, the assumption of options to purchase 1,155,221 shares of InterTrust common stock at a fair value of $4.84 per share, assumed liabilities of $5.2 million, and acquisition costs of approximately $250,000. The InterTrust options issued in connection with the assumption of the PublishOne options were valued using the Black-Scholes option pricing model assuming a volatility of 1.6, expected life of 4 years, risk-free interest rate of 7%, expected dividend yield of 0% and stock price of $5.31. Additionally, the agreement includes contingent consideration of 320,000 shares of InterTrust common stock to be issued upon the achievement of certain milestones. As of September 30, 2001, no milestones have been met. We allocated PublishOne's purchase price based on the relative fair value of the net tangible and intangible assets acquired. No amount was allocated to in-process research and development. The purchase price was allocated based on an independent valuation to tangible and intangible assets as follows (in thousands): Tangible Assets........ $ 1,581 Purchased Technology... 1,671 Acquired Workforce..... 1,452 Other Intangible Assets 610 Deferred Compensation.. 3,323 Goodwill............... 8,255 ------- $16,892 =======

Goodwill, purchased technology and other intangibles are being amortized on a straight-line basis over four years. The acquired workforce is being amortized on a straight-line basis over two years. 15 The fair value of the unvested common stock subject to restricted stock agreements and the intrinsic value of the unvested options held by employees was allocated to deferred stock compensation. The deferred stock compensation will be amortized to compensation expense over the remaining vesting term using a graded method. On August 8, 2001, we acquired the remaining 81.1% of Zero Gravity Technologies Corporation ("Zero Gravity"), a developer of a policy-based secure email product. Prior to the acquisition date, we owned approximately 18.9% of Zero Gravity's outstanding stock. The transaction was accounted for as a purchase and the results of Zero Gravity's operations have been included in the condensed consolidated financial statements from the date of acquisition. InterTrust paid $510,000 (net of cash received), issued 500,000 new shares of InterTrust common stock at a fair value of $0.98, assumed liabilities of $198,000, and paid $2,000 in acquisition costs to acquire all of the shares of Zero Gravity that we did not already own. In addition, InterTrust assumed outstanding Zero Gravity employee stock options equivalent to approximately 60,000 shares of InterTrust common stock at a fair value of $0.98 per share. The InterTrust options issued in connection with the assumption of the Zero Gravity options were valued using the Black-Scholes option pricing model assuming a volatility of 2.2, expected life of 9.3 years, risk-free interest rate of 6%, expected dividend yield of 0% and stock price of $0.98. The purchase price of $1,509,000 was allocated based on an internal valuation as follows (in thousands): Tangible Assets.................... $ 111 In-Process Research and Development 567 Goodwill........................... 831 ------ $1,509 ======

Stock Option Exchange Program On May 24, 2001, we announced a voluntary stock option exchange program for our employees. Under the program, our employees were given the opportunity to cancel outstanding stock options previously granted to them in exchange for an equal number of new options to be granted at a future date which will be at least six months and a day from the cancellation date, which was June 22, 2001. The exercise price of these new options will be equal to the fair market value of InterTrust's common stock on the date of grant, which is not expected to be later than January 31, 2002. Such new options will have terms and conditions that are substantially the same as those of the canceled options. The exchange program is not expected to result in any additional compensation charges or variable plan accounting. Members of our board of directors, our officers and our senior executives were not eligible to participate in this program. Results of Operations Total revenues decreased to approximately $1.9 million in the three months ended September 30, 2001 from approximately $2.1 million in the comparable period of 2000. For the nine months ended September 30, 2001, total revenues increased to approximately $6.6 million from approximately $5.1 million in the comparable period of 2000. License revenues were approximately $1.5 million, or 80% of total revenues, for the three months ended September 30, 2001, as compared to $1.2 million or 57% of total revenues in the three months ended September 30, 2000, and primarily represent the amortization of deferred license fees. For the nine months ended September 30, 2001, license revenue increased to $4.5 million or 69% of total revenues, from $2.8 million, or 54% of total revenues, in the same nine month period in 2000. These increases were due to the growth in the number of licensing agreements over the prior year. No significant new license agreements were entered into during the quarter ended September 30, 2001 due to the transition to our new software platform, Rights|System. Revenue from software support and training decreased to $185,000 in the three months ended September 30, 2001 from approximately $861,000 in the three months ended September 30, 2000 and decreased to 16 approximately $1.3 million for the nine months ended September 30, 2001 from approximately $2.2 million for the comparable period in 2000. These decreases were due to the expiration of a number of partner support agreements in the three months ended September 30, 2001 and the inability of many of our smaller licensees to pay amounts due under support agreements due to current economic conditions. As the majority of our support revenue relates to the Commerce Products, the transition to Rights|System has also negatively impacted support revenue. Software support and training services accounted for 10% and 41% of total revenues in the three month periods ended September 30, 2001 and 2000, respectively, and 21% and 43% for the nine month periods ended September 30, 2001 and 2000, respectively. We anticipate deriving support revenue in the future from our Rights|System product licenses. Services revenue increased to approximately $205,000 for the three months ended September 30, 2001 from $48,000 in the three months ended September 30, 2000 and increased to approximately $720,000 for the nine months ended September 30, 2001 from approximately $194,000 for the comparable period in 2000. Services revenue represents monthly service fees for TrustNet clearinghouse services, transaction royalties, consulting and system integration services. The increase in services revenue was due to a greater number of consulting services performed during the nine months ended September 30, 2001. Services revenue accounted for 11% and 3% of total revenues in the three months ended September 30, 2001 and 2000, respectively, and accounted for 11% and 4% of total revenues in the nine months ended September 30, 2001 and 2000, respectively. We anticipate deriving service revenue in the future relating to the Rights|System product. There was no hardware revenue for the three months ended September 30, 2001. Hardware revenue recognized in the nine months ended September 30, 2001 was $12,000. This revenue was the result of chips sold to one customer under the terms of a short-term purchase agreement to provide chips for testing and trial production. No hardware revenue was recognized in the comparable periods in 2000. We do not expect to derive any significant revenue from hardware sales in future periods. Cost of Revenues Cost of license revenue consists primarily of the costs incurred to manufacture, package, and distribute our products, related documentation and the amortization of purchased technology. Cost of license revenue was approximately $112,000 during the three months ended September 30, 2001 and approximately $133,000 in the three months ended September 30, 2000. Cost of license revenue was approximately $339,000 during the nine months ended September 30, 2001 and approximately $346,000 in the comparable period in 2000. Cost of license revenue is expected to fluctuate from period to period depending on the number of new partners, the number of software releases, and the amount of software documentation provided to our partners during the period. Cost of software support and training consists primarily of the cost of personnel, travel related expenditures, and training materials. Cost of software support and training revenue decreased to approximately $161,000 for the three months ended September 30, 2001 from approximately $236,000 for the three months ended September 30, 2000. In the first nine months of 2001, the cost of software support and training was approximately $1.1 million as compared to approximately $565,000 in the comparable period for 2000. The increase in cost of software support and training for the nine months ended September 30, 2001 represents the increase in support personnel required to provide technical assistance and training to our partners. Software support and training services costs are expected to fluctuate from period to period depending on the support requirements of our partners. Cost of services consists primarily of the outside services, personnel, and equipment to operate our clearinghouse, as well as personnel costs to provide professional and consulting services. Costs of services were approximately $954,000 during the three months ended September 30, 2001 and approximately $934,000 during the three months ended September 30, 2000. Cost of services was approximately $4.4 million during the nine months ended September 30, 2001 and approximately $2.3 million in the comparable period in 2000. These increases are primarily attributable to investment in clearinghouse infrastructure, personnel and the costs of performing consulting engagements. 17 Cost of hardware was zero for the three months ended September 30, 2001. The cost of hardware for the nine months ended September 30, 2001 was approximately $840,000. These costs are related to the purchase of chips from a third party, and the customization and transport of the chips. The costs include a reserve for inventory in the amount of $823,000 due to cancellation of the supply agreement with our customer. There were no hardware costs for the comparable periods in 2000. Research and Development Research and development expenses consist principally of salaries and related personnel expenses, consultant fees, and the cost of software used in product development. Research and development expenses are expensed to operations as incurred. Research and development spending was approximately $9.8 million for the three months ended September 30, 2001 and approximately $6.5 million for the three months ended September 30, 2000. In the first nine months of 2001, research and development spending was approximately $28.2 million as compared to approximately $17.5 million in the comparable period of 2000. These increases were primarily attributable to increases in personnel costs, recent business acquisitions, and consultant services associated with both product research and development. We anticipate research and development expenses will decrease significantly in the future due to the workforce reductions. Sales and Marketing Sales and marketing expenses consist of salaries and related expenses for personnel engaged in direct sales, partner development and marketing, public relations, and other marketing expenses. Sales and marketing expenses decreased to approximately $3.6 million for the three months ended September 30, 2001 from $4.5 million for the three months ended September 30, 2000 due to compensation cost reductions related to our headcount reductions in April 2001 and August 2001. In the first nine months of 2001, sales and marketing expenses were approximately $16.6 million as compared to approximately $12.5 million in the comparable period of 2000. Increases in sales and marketing expenses were due primarily to an increase in sales and marketing personnel, consulting expenses, and to a lesser extent, public relations, promotional costs, and travel costs. We expect sales and marketing expense to vary in future periods based upon the implementation of marketing and promotional programs related to the release of new products. We anticipate sales and marketing expenses will decrease significantly in the future due to the workforce reductions. General and Administrative General and administrative expenses consist primarily of salaries and related expenses for executive, legal, accounting and administrative personnel, professional service fees, and general corporate expenses. General and administrative expenses increased to approximately $4.1 million for the three months ended September 30, 2001 from approximately $2.5 million for the three months ended September 30, 2000. General and administrative expenses were approximately $12.5 million for the nine months ended September 30, 2001 and $7.0 million for the comparable period in 2000. The increase was primarily attributed to increases in legal expenses, consulting expenses, insurance expenses, and bad debt expense. We expect general and administrative expenses to continue to increase as a result of litigation costs related to a claim of patent infringement we filed against Microsoft in April 2001. See further discussion in Other Factors Affecting Operating Results, Liquidity, and Capital Resources. Amortization of Goodwill and Other Intangible Assets Amortization of goodwill and other intangible assets was $259,000 for the three months ended September 30, 2001 and $923,000 for the three months ended September 30, 2000. We recognized approximately $4.8 million of amortization expense during the nine months ended September 30, 2001 as compared to $1.8 million in the nine months ended September 30, 2000. Amortization of goodwill and intangible assets is related to business acquisitions in 2000 and 2001 and the amortization of capitalized patent costs. See further discussion in subsection Impairment of Goodwill and Other Intangible Assets. 18 Deferred Stock Compensation Deferred compensation represents the difference between the exercise price of options granted to employees and the deemed fair value of our common stock for financial reporting purposes. Additionally, in conjunction with the acquisition of PublishOne, the fair value of the unvested common stock subject to restricted stock agreements, and the intrinsic value of the unvested options held by PublishOne employees was allocated to deferred stock compensation. Deferred compensation is being amortized over the vesting periods of the options on a graded vesting method. This compensation expense relates to options awarded to individuals in all operating expense categories. In the quarters ended September 30, 2001 and June 30, 2001 we recorded an adjustment to the deferred compensation balance in order to reflect a reduction in deferred compensation associated with employees who have left InterTrust. These adjustments resulted in decreases in deferred compensation of $88,000 and $481,000, respectively. We recognized approximately $843,000 of deferred compensation expense during the three months ended September 30, 2001 and $746,000 in the comparable period of 2000. We recognized approximately $2.0 million of related compensation expense during the nine months ended September 30, 2001 as compared to $2.7 million in the nine months ended September 30, 2000. Restructuring Costs On April 30, 2001, we announced and formally adopted a program to reduce our worldwide workforce. The reduction resulted in the decrease of 43 regular employees across all business functions, operating units, and geographic regions. The worldwide workforce reductions were substantially completed in the second quarter of 2001. We recorded a non-recurring charge of approximately $1.2 million relating primarily to severance and fringe benefits. On August 2, 2001, we further reduced our worldwide workforce. The reduction resulted in the decrease of 33 regular employees across all business functions, operating units, and geographic regions. All 33 terminated employees left InterTrust, and all cash payments were made by September 30, 2001. We recorded a non-recurring charge of approximately $540,000 relating to severance and fringe benefits, and the charge is included in non-recurring charges in the statement of operations. See Note 7 to the Condensed Consolidated Financial Statements for further information. On October 31, 2001, we announced that we would reduce our workforce by approximately 103 employees and would consolidate certain business facilities. We will record a charge related to the reduction in force and closure of facilities in the three months ending December 31, 2001. Due to these reductions, we will save approximately $23.0 million annually in salary related expenses. In addition, we are consolidating facilities, and there will be further savings due to the reduction in workforce and fewer facilities. Such additional savings have not been quantified at this time. Interest and Other Income, net Interest and other income consists primarily of interest earned on cash and cash equivalents, and short and long-term investments. Interest and other income decreased to $2.0 million during the three months ended September 30, 2001 from $3.3 million in the comparable period in 2000. We recognized approximately $3.9 million of interest and other income in the nine months ended September 30, 2001 and $8.2 million in the comparable period of 2000. The decrease in interest income is due to lower cash and investment balances in the current period. Impairment of Investments in Privately-held Companies Investments in privately-held companies primarily consist of equity and debt securities in which we own less than a 20% interest. We invest in entities based upon the size of the market opportunity, the entity's product 19 or service's ability to meet market demands, the barriers to entry that are established by the entity's product or service offering, the long-term defensibility of product leadership in a defined marketplace, the previous experience of the management team and its ability to execute on its business plan, and the financial projections of the prospect. Additionally, we also consider the strategic importance of the entity's technology in furthering the adoption of digital rights management technologies. We do not have the ability to exercise significant influence over any of the companies in which we invest and accordingly account for such investments using the cost method. These investments are assessed for impairment periodically through review of operations and indications of continued viability, such as subsequent rounds of financing. As a result of the deterioration of financial markets and the corresponding effect on private company valuations and financing prospects, during the second quarter of 2001, we recorded $3.0 million in losses as a result of other than temporary declines in the value of investments in privately held companies. The remaining investment in privately-held companies of $250,000 at September 30, 2001 is included in other assets in the consolidated balance sheet. We have not participated in subsequent financings for any of the companies in which we are invested, and we are not obligated or committed in any way to participate in any future financings of any of our investments. Impairment of Goodwill and Purchased Intangible Assets As part of our review of our second quarter financial results, we performed an impairment assessment of identifiable intangible assets and goodwill recorded in connection with various acquisitions, with the assistance of third party valuation experts. The assessment was performed primarily due to the significant decline in our stock price, the net book value of assets significantly exceeding their market capitalization, and the overall decline in industry growth rates, which indicate that this trend may continue for an indefinite period. As a result, we recorded a $31.1 million impairment charge in the second quarter of 2001 to reduce goodwill and other intangible assets associated with three acquisitions and their estimated fair values. The estimates of fair value were based upon the discounted estimated cash flows for the succeeding three years using a discount rate of 18% and an estimated terminal value. The assumptions supporting the estimated cash flows, including the discount rate and an estimated terminal value, reflect management's best estimates. The discount rate was based upon the weighted average cost of capital for comparable companies. The remaining goodwill and other intangible assets will be amortized using the straight-line method using a three year amortization rate thru December 31, 2001, resulting in an aggregate quarterly charge of $348,000 for the three months ending December 31, 2001. On January 1, 2002 we will no longer amortize the remaining goodwill, but we will review it for impairment annually (or more frequently if impairment indicators arise), in accordance with the provisions of FASB Statement No. 142, Goodwill and Other Intangible Assets. Liquidity and Capital Resources Cash, cash equivalents and marketable and restricted investments totaled $142.6 million at September 30, 2001, a decrease of $33.6 million from December 31, 2000. The change during the nine months ended September 30, 2001 is primarily attributable to $20.0 million of cash generated from the sale of 4.0 million shares of our common stock to Nokia Finance International B.V., a subsidiary of Nokia Corporation, in January 2001 and from proceeds from the exercise of employee stock options and employee stock purchases, offset by our net loss for the nine months ended September 30, 2001 of $93.7 million. Net cash used in operating activities totaled $51.1 million in the nine months ended September 30, 2001. The cash used in the period is primarily attributable to the net loss of $93.7 million, partially offset by various non-cash charges such as depreciation and amortization of $2.9 million, amortization of goodwill and other intangible assets of $5.2 million, stock related compensation of $1.8 million, impairment of long-lived assets of $31.1 million, and loss on equity investments of $3.0 million. 20 Net cash provided by investing activities totaled $26.0 million in the nine months ended September 30, 2001. The cash generated in the period is primarily attributable to net investment activity of $30.8 million offset by capital expenditures totaling $4.2 million principally comprised of computer equipment and software used to support our product development. Net cash provided by financing activities was $21.5 million in the nine months ended September 30, 2001, due to cash generated from issuing common stock to Nokia Corporation and, to a lesser extent, from the exercise of employee stock options. At September 30, 2001, our principal source of liquidity was $142.6 million in cash and cash equivalents and marketable and restricted investments. We believe that our cash and cash equivalents will be sufficient to meet our working capital needs for at least the next 12 months. In the future, we may require additional funds to support our working capital requirements or for other purposes and may seek to raise additional funds through public or private equity financing or from other sources. Additional financing may not be available at all or, if available, may not be obtainable on terms favorable to us. In addition, any additional financing may be dilutive and new equity securities could have rights senior to those of existing holders of our common stock. If we need to raise funds and cannot do so on acceptable terms, we may not be able to respond to competitive pressures, meet anticipated capital requirements, or take advantage of future business opportunities. Other Factors Affecting Operating Results, Liquidity and Capital Resources In addition to the other information in this report, the following risk factors should be considered carefully in evaluating our business and us: Risks Related to Our Business Our business model is new, in transition, and unproven and we may not succeed in generating sufficient revenue to sustain or grow our business. Our business model is new and unproven and may not generate sufficient revenue for us to be successful. The market for digital commerce services and applications has not developed as quickly as anticipated and, as a result, we might not meet analysts' expectations of our future operating results. The success of our business now depends largely upon our ability to develop and license our new Rights|System product suite and our patents. Because we have not yet completed any Rights|System product or patent licenses, we may not generate sufficient revenue to support and grow our business. The volume of products and services distributed using our technology has been and may continue to be too small to support or grow our business. The success of our business in the past has depended partly upon our ability to generate license and support fees, and transaction fees in the form of a percentage of fees charged by our licensees in commercial transactions using our Commerce software. With the announcement of our Rights|System software platform in July 2001, we announced that we would continue to support the Commerce products, but we would make no further enhancements to such products. As a result, licensees of our Commerce products may choose not to continue using our Commerce products and we do not expect any material future revenue from existing Commerce software licensees. Our future revenue is significantly dependent on market acceptance of Rights|System software products. Our future revenue depends significantly on market acceptance and continued enhancements of the Rights|System products that we announced in July 2001. We have not completed any licenses of the Rights|System products, making it difficult to predict both the amount of revenue we will generate and when we will be able to recognize revenue from these products. In addition, the Rights|System products may not meet the requirements of the market and we may not be able to license the Rights|System products under desirable terms and conditions. Failure to complete or license the Rights|System products may negatively impact our future revenue. 21 Our future revenue is significantly dependent on our ability to license our patents. Our future revenue depends significantly on our ability to license our patents. We have not completed any licenses of our patents, making it difficult to predict both the amount of revenue we will generate and when we will be able to recognize revenue from these licenses. In addition, the validity of our patents may be challenged by third parties. If challenged, our patents might not be upheld or their claims could be narrowed which could negatively impact our ability to, and terms under which we could, license our patents. Our quarterly operating results are volatile and difficult to predict. If we fail to meet the expectations of public market analysts or investors, the market price of our common stock may decrease significantly. Our operating results have varied from period to period and, in some future quarter or quarters, will likely fall below the expectations of securities analysts or investors, causing the market price of our common stock to decline. Our quarterly operating results may fail to meet these expectations for a number of reasons, including: . a lack of demand for, or slow customer adoption of, our Rights|System software products; . a lack of demand for licenses to our patent portfolio; . the inability of our existing licensees and their customers to commercialize our technology, or delays or deferrals in this commercialization; . the inability of our licensees to pay our license and other fees; . our inability to develop or commercialize our technology to meet our customers' requirements on a timely basis; . a decline in the demand for digital goods and services; . our failure to quickly reduce costs in the event of unanticipated declines in revenues in a given period; . expenses related to the issuance of stock to our partners; . higher than expected operating expenses, including expenses related to the patent infringement litigation we initiated against Microsoft; . customer budget cycles and changes in these budget cycles; and . impairment charges recorded to reduce goodwill and other intangible assets associated with our acquisitions to their estimated fair values. If we or third parties do not deploy our technology patent inventions and create a market for digital commerce, our business will be harmed. Relationships with leading content, technology, and commerce service providers are critical to our success. Our business and operating results would be harmed to the extent we or our licensees fail, in whole or in part, to: . deploy our technology or employ our patented inventions; . develop an infrastructure for the sale and delivery of digital goods and services; . generate transaction fees from the sale of digital content and services; . develop and deploy new applications; and . promote brand preference for InterTrust products. We have a history of losses and we expect our operating losses and expenses to increase significantly. Our failure to increase our revenues significantly would seriously harm our business. We derive most of our revenues from the sale of a small number of licenses. As a result, any delay in the recognition of revenue from a 22 license would have a material adverse effect on our results of operations for subsequent accounting periods. We have experienced operating losses in each quarterly and annual period since inception, and we expect to incur significant and increasing losses in the future. We incurred net losses of $93.7 million for the nine months ended September 30, 2001, $55.6 million for the year ended December 31, 2000 and $28.6 million for the year-ended December 31, 1999. We expect to continue to have significant research and development, sales and marketing, and general and administrative expenses. In addition, we expect to incur significant expenses related to the patent litigation we initiated against Microsoft. As a result of these expenses, we must significantly increase our revenues to become profitable. We expect to incur significant losses for at least the foreseeable future. We need to significantly increase the number of companies that license our technology and/or our intellectual property to sustain and grow our business. We may not generate sufficient product revenue to grow our business unless we maintain relationships with existing Commerce software licensees by transitioning them to our Rights|System product suite and begin licensing our Rights|System product suite to a significant number of new partners and customers. We have not yet attracted, and may not in the future be able to attract, a sufficient number of these companies. As of September 30, 2001, only 62 companies have licensed our Commerce software and certain Rights|System components for commercial use. As of September 30, 2001, approximately eight companies have been involved in the limited commercial deployment of our Commerce software and certain Rights|System components. Our ability to attract new licensees will depend on a variety of factors, including the following: . the performance, reliability and security of our Rights|System products and services; . the scalability of our Rights|System products and services--the ability to rapidly increase deployment size from a limited number of end-users to a very large number of end-users; . the cost-effectiveness of our Rights|System products and services; and . our ability to market our Rights|System products and services effectively. Our ability to attract new product licensees will also depend on the performance of our initial licensees. Many potential licensees may resist working with us until our and our initial licensees' applications and services have been successfully introduced into the market and have achieved market acceptance. We may not be able to attract a critical mass of licensees that will develop products and services, and our licensees may not achieve the widespread deployment of users we believe is necessary for a commercially successful product line. In addition, we may not be able to establish relationships with important potential customers if we have already established relationships with their competitors. Therefore, it is important that we are perceived as a neutral and trusted technology and service provider. Our operating results have been and may continue to be harmed if our licensees or potential licensees suffer from downward economic cycles. Our ability to license our technology depends on the economic strength and budgetary cycles of potential licensees. Many of our licensees are Internet-related and start-up companies that currently face unfavorable market conditions and budgetary pressures. Recently, some of our licensees have defaulted on their payment obligations to us and others might default in the future. This may be disruptive to our business and may adversely affect our business, financial condition and results of operations. The long and complex process of licensing our software and hardware products could delay the deployment of our technology and harm our business. As Rights|System is a newly announced DRM platform and product suite, the process of licensing our Rights|System products may be long and complex, initial license fees could be delayed or reduced as a result of 23 this process, and our future revenue and operating results could be impaired. Before committing to license our products, our licensees must generally consider a wide range of issues including product benefits, installation and infrastructure requirements, ability to work with existing computer systems, ability to support a large user base, functionality, security, and reliability. The process of entering into a licensing agreement with a company has typically involved lengthy negotiations, but we do not know the length of the sales cycle relating to our new products as we have not completed any Rights|System licenses. As a result it is difficult for us to predict the quarter in which a particular prospect might sign a license agreement. In addition, in some cases we develop specific software applications for our licensees. We cannot predict if we will deliver these applications in a timely manner or at all. We are dependent on international sales which subject us to a variety of risks. We received approximately 56% of our total revenues in the nine months ended September 30, 2001, 51% of our total revenues in 2000 and 67% of our total revenues in 1999 from sales to customers located outside the United States. Our international business activities are subject to a variety of risks, including the adoption and changes of laws, actions by third parties and political and economic conditions that could restrict or eliminate our ability to do business in certain jurisdictions. Although we currently transact business in U.S dollars, if we transact business in foreign currencies in the future, we will become subject to the risks associated with transacting in foreign currencies, including potential negative effects of exchange rate fluctuations. To date, we have not adopted a hedging program to protect from risks associated with foreign currency fluctuations. Government regulation and requirements influence our sales internationally. Current or new government laws and regulations, or the application of existing laws and regulations including those related to property ownership, content and taxation, could expose us to significant liabilities, significantly slow our growth or otherwise seriously harm our business and results of operations. Because our technology must be integrated into the products and services of our licensees, there could be significant delay between our licensing the software and our licensees' commercial deployment of their products and services, which in part will delay our receipt of transaction fee revenue. Our success depends upon the deployment of our technology by a potential licensee in the use and sale of digital content. Our licensees may undertake a lengthy process of integrating our technology into their existing systems or a new system. The integration often requires re-engineering of these business processes, which may delay the deployment of our technology. Until a licensee deploys our technology, we do not receive transaction fees from that licensee. We expect that the period between entering into a licensing arrangement and the time our licensee commercially deploys applications based on our software could be lengthy and will vary, which makes it difficult for us to predict when transaction revenue will be recognized. Our Commerce product has only recently been used by our licensees in limited commercial deployment, and our Rights|System product has not been released. Therefore, evaluation of our business and prospects is difficult. We began offering the general availability release of our Commerce software in December 1998, and released version 1.5 in April 2001. Our and our licensees' applications and services based on our Commerce and other software and hardware products are in development or have only been released for evaluation in very limited commercial launches. It is still possible that we or our licensees may uncover serious technical and other problems resulting in the delay or failure of the commercial deployment of our licensees' implementation of our Commerce software, including problems relating to security, the ability to support a large user base, and interoperability of our software or the combination of our software with our licensees' software. Our new Rights|System product has not been released to any customers. As we continue to develop the Rights|System 24 products it is possible that we or one of our partners or customers may uncover serious technical and other problems with those products. We may not successfully address any of these problems and the failure to do so would seriously harm our business and operating results. Protection of our intellectual property is limited and efforts to protect our intellectual property may be inadequate, time consuming, and expensive. Our success and ability to compete are substantially dependent on our proprietary technology and trademarks, which we attempt to protect through a combination of patent, copyright, trade secret, and trademark laws, as well as confidentiality procedures and contractual provisions. These legal protections afford only limited protection and may be time consuming and expensive. Furthermore, despite our efforts, we may be unable to prevent third parties from infringing upon or misappropriating our intellectual property. Also, our competitors may independently develop similar, but not infringing, technology, duplicate our products, or design around our patents or our other intellectual property. Our patent applications or trademark registrations may not be approved. Moreover, even if approved, the resulting patents or trademarks may not provide us with any competitive advantage or may be challenged by third parties. If challenged, our patents might not be upheld or their claims could be narrowed. Any litigation surrounding our rights could force us to divert important financial and other resources away from our business operations. In addition, we license our products internationally, and the laws of many countries do not protect our proprietary rights as well as the laws of the United States. In April 2001, we filed a lawsuit against Microsoft Corporation alleging that certain of their technology infringes our United Stated Patent No. 6,185,683. We have subsequently amended our claim to also allege infringement by Microsoft Corporation of our United States Patent No. 6,253,193, United States Patent No. 5,920,861, United States Patent No. 5,940,504, United States Patent No. 5,892,900, United States Patent No. 5,982,891, and United States Patent No. 5,917,912. The claim is in the early stages and while the litigation is pending, significant financial resources and management attention will be diverted for that purpose. Microsoft has filed an answer which denied all the allegations as to the previously filed patents, and which asserted infringement of two patents relating to the downloading of software, which we do not believe are significant to our business. Discovery has started in the case and the parties have exchanged initial document production and infringement contentions. There is no assurance that we will be successful in this lawsuit, and an unfavorable result would have a significant adverse affect on our results of operations by reducing the value of our proprietary technology and reducing demand for our products. Security breaches of our software and our licensees' software could result in decreased demand for our technology by our licensees or their customers or in litigation. The secure transmission and trusted management of proprietary or confidential information over the Internet are essential to establishing and maintaining confidence in our Commerce and Rights|System products, and other software and hardware, and the software and services developed using our software. Without this confidence, potential or current licensees may not use our technology and their customers may not trust and use our licensees' products. Therefore, security concerns and security breaches of our and our licensees' software could harm our business and operating results. Advances in computer capabilities, new discoveries, or other developments could result in a compromise or breach of the security technology, including cryptography technology, that we and our licensees use to protect customer digital content and transaction data. Security breaches could damage our reputation and expose us to a risk of loss or litigation. Our insurance policies have low coverage limits that may not be adequate to reimburse us for losses caused by security breaches. We cannot guarantee that our security measures will prevent security breaches. 25 Defects in our software and the software of our licensees could delay deployment of our technology and reduce our revenues. Defects or errors in current or future products could result in delayed or failed deployment of our technology, lost revenues, or a delay in or failure to achieve market acceptance, any of which could seriously harm our business and operating results. Complex software products like ours often contain errors or defects, including errors relating to security, particularly when first introduced or when new versions or enhancements are released. Because this is a system used for commerce, we believe the standards for reliability and performance will be very high. If our or our licensees' products and services contain errors or defects not discovered in the process of development and pilot programs, it could seriously undermine the perceived trust and security needed for a commercial system and could delay or prevent market acceptance of digital commerce resulting in serious harm to our business and operating results. The deployment and use of our products expose us to substantial risks of product liability claims because our products are expected to be used in sensitive and valuable digital commerce transactions and because we require our partners to comply with our specifications. Although our license agreements typically contain provisions designed to limit our exposure to product liability claims, it is possible that these limitations of liability provisions may not be effective as a result of existing or future laws or unfavorable judicial decisions. A product liability claim brought against us, even if not successful, would likely be time consuming and costly to defend and could significantly harm our business and operating results. If we are unable to continue obtaining third-party software and applications, we could be forced to change our product offering or find alternative suppliers, which could delay shipment of our product. We integrate third-party software with our software. We would be seriously harmed if the providers from which we license software ceased to deliver and support reliable products, enhance their current products, or respond to emerging industry standards. In addition, the third-party software may not continue to be available to us on commercially reasonable terms or at all. The loss of, or inability to maintain or obtain this software, could result in shipment delays or reductions, or could force us to limit the features available in our current or future product offerings. Either alternative could seriously harm our business and operating results. The market for digital rights management will be subject to rapid technological change and new product introductions and enhancements that we may not be able to address. We need to develop and introduce new products, technologies, and services. The market for digital rights management solutions is fragmented and marked by rapid technological change, frequent new product introductions and enhancements, uncertain product life cycles, and changes in customer demands. To succeed, we must develop and introduce, in response to customer and market demands, new releases of our software and other products that offer features and functionality that we do not currently provide. Any delays in our ability to develop and release enhanced or new products could seriously harm our business and operating results. In the past we have experienced delays in new product releases, and we may experience similar delays in the future. In particular, a large portion of our resources is focused on our new Rights|System platform, which we believe is important to meeting our customer and market demands. Delays in our ability to enhance and release the Rights|System software could seriously harm our operating results. 26 Our markets are highly competitive and we may not be able to compete successfully against current or potential competitors, reducing our market share and revenue growth. Our markets are new, rapidly evolving, and highly competitive, and we expect this competition to persist and intensify in the future. Our failure to maintain and enhance our competitive position could reduce our market share and cause our revenues to grow more slowly than anticipated or not at all. We encounter current or potential competition from a number of sources, including: . providers of secure digital distribution technology like Adobe, IBM, Microsoft, and Real Networks; . providers of hardware-based content metering and copy protection systems, including Sony and the 4C Entity, comprised of IBM, Intel, Matsushita, and Toshiba; and . operating system manufacturers, including Microsoft or Sun Microsystems, that may develop or license digital rights management solutions for inclusion in their operating systems. Potential competitors may bundle their products or incorporate a digital rights management component into existing products in a manner that discourages users from purchasing our products. For example, Microsoft's Windows operating system, which manages the programs on a computer, includes components addressing digital rights management functions. Furthermore, new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements than we do. Some of our competitors have longer operating histories and significantly greater financial, technical, marketing, and other resources than we do. Many of these companies have more extensive customer bases and broader partner relationships that they could leverage, including relationships with many of our current and potential partners. These companies also have significantly more established customer support and professional services organizations than we do. In addition, these companies may adopt aggressive pricing policies. Any acquisitions that we make could disrupt our business and harm our operating results. We have made acquisitions of and investments in other companies in the past, and we may continue to acquire or make investments in complementary companies, products or technologies. In the event of any such investments, acquisitions or joint ventures, we could: . issue stock that would dilute our current stockholders' percentage ownership; . incur debt; . assume liabilities; or . incur large and immediate write-offs. These investments, acquisitions or joint ventures also involve numerous risks, including: . problems combining the purchased operations, technologies or products with ours; . unanticipated costs; . division of management's attention from our core business; . adverse effects on existing business relationships with suppliers and customers; . potential loss of key employees, particularly those of the acquired organizations; and . reliance to our disadvantage on the judgment and decisions of third parties and lack of control over the operations of a joint venture partner. Any acquisition or joint venture may cause our financial results to suffer as a result of these risks. 27 We and our licensees may be found to infringe proprietary rights of others, resulting in litigation, redesign expenses, or costly licenses. Digital rights management is an emerging field in which our competitors may obtain patents or other proprietary rights that would prevent, or limit or interfere with, our, or our licensees', ability to make, use, or sell products. Furthermore, companies in the software market are increasingly bringing suits alleging infringement of their proprietary rights, particularly patent rights. We and our licensees could incur substantial costs to defend or settle any litigation, and intellectual property litigation could force us to do one or more of the following: . cease selling, incorporating, or using products or services that incorporate the infringed intellectual property; . obtain a license from the holder of the infringed intellectual property right; or . redesign products or services to avoid infringement. Our or our licensees' products and services may be subject to a claim of patent infringement independent of any infringement by our software. In the past, we have received notices alleging potential infringement by us of the proprietary rights of others. In January 1996, we received a letter from an attorney representing E-Data Corporation containing an allegation of infringement of a patent E-Data allegedly owns. We exchanged correspondence with E-Data's attorneys ending in September 1996. We have not heard from any representative of E-Data since that time. In November 1997, we received a letter from representatives of TAU Systems Corporation informing us of two patents held by TAU Systems. In the letter, the representatives stated their opinion that our Commerce software contained various elements recited in the two patents and requested that we discuss licensing the technology of these patents. We responded to the letter stating that, although we had not undertaken a detailed review of the patents, we were unaware of any of our products having one of the elements required by the patent claims. We have not received any further correspondence from TAU Systems. In May 1999, we received a letter from representatives of TechSearch LLC offering us a license to a patent held by TechSearch. We have reviewed the patent and do not believe that we need to obtain a license to this patent. In the future, however, we or our licensees could be found to infringe upon the patent rights of E-Data, TAU Systems, TechSearch, or other companies. To successfully license our product and grow our business, we must retain and attract key personnel; competition for these personnel is intense. Our success depends largely on the skills, experience, and performance of the members of our senior management and other key personnel, including our chairman of the board and chief executive officer, Victor Shear. None of our senior management or other key personnel must remain employed for any specific time period. If we lose key employees, our business and operating results could be significantly harmed. In addition, our future success will depend largely on our ability to continue attracting, integrating, and retaining highly skilled personnel. Further, competition for qualified sales and marketing personnel is intense. We may not be able to hire enough qualified individuals in the future or in a timely manner. New employees require extensive training and typically take at least four to six months to achieve full productivity. Although we provide compensation packages that include stock options, cash incentives, and other employee benefits, the volatility and current market price of our stock may make it difficult for us to attract, assimilate, and retain highly qualified employees. For example, due to the current volatility of our stock price, many of our employees hold options with exercise prices well above the current fair market value of our stock. Failure to appropriately manage our growth could seriously harm our business and operating results. Our historical growth has placed, and any further growth is likely to continue to place, a significant strain on our resources. Any failure to manage growth effectively could seriously harm our business and operating results. We have grown from 87 employees at December 31, 1997 to approximately 282 employees at September 30, 28 2001. On October 30, 2001, we announced plans to reduce our workforce by approximately 40% in order to reduce costs and increase efficiency. Our headcount has been reduced from a high of 358 in February 2001 to approximately 282 as of September 30, 2001. These reductions in our workforce may negatively affect moral and result in qualified employees leaving InterTrust. To be successful, we will need to implement additional management information systems, improve our operating, administrative, financial and accounting systems and controls, train new employees, and maintain close coordination among our executive, engineering, accounting, finance, marketing, and operations organizations. Our stock price has been volatile in the past and is likely to continue to be volatile. The market price of our common stock has been volatile in the past and is likely to continue to be volatile. In addition, the securities markets in general, and Internet stocks in particular, have experienced significant price volatility, and accordingly the trading price of our common stock is likely to be affected by this activity. We are subject to securities class action litigation which may harm our business and results of operations. In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We are a party to the securities class action litigation described in Part II, Item 1--"Legal Proceedings" of our Report on Form 10-Q for the quarter ended September 30, 2001. The defense of such litigation may increase our expenses and divert our management's attention and resources, and an adverse outcome in this litigation could seriously harm our business and results of operations. In addition, we may in the future be the target of other securities class action or similar litigation. We have implemented anti-takeover provisions that could make it more difficult to acquire us. Our sixth amended and restated certificate of incorporation, our amended and restated bylaws, and Delaware law contain provisions that could make it more difficult for a third party to acquire us, even if its doing so would be beneficial to our stockholders. These provisions include: . authorizing the issuance of shares of undesignated preferred stock without a vote of stockholders; . prohibiting stockholder action by written consent; and . limitations on stockholders' ability to call special stockholder meetings. In addition, on June 8, 2001, our board of directors approved a stockholders' rights plan. Under the plan, rights were distributed as a dividend at the rate of one right for each share of InterTrust common stock held by stockholders of record as of the close of business on June 28, 2001. The plan is designed to protect stockholders in the event of an unsolicited attempt to acquire InterTrust and could make it more difficult for a third party to acquire us, even if its doing so would be beneficial to our stockholders. Stockholders may incur dilution as a result of future equity issuances. We have in the past and may in the future issue equity securities to our partners. If we issue additional equity securities, stockholders may experience dilution, and the new equity securities could have rights senior to those of existing holders of our common stock. Industry-Related Risks We may not receive sufficient revenues to be successful and our stock price will decline if use of the Internet for commercial distribution of digital content is not widely accepted. Acceptance and use of the Internet for commercial distribution of digital content may not continue to develop at recent rates, and a sufficiently broad base of consumers may not adopt, and continue to use, the 29 Internet and other online services as a medium for digital commerce. Because our transaction fees are derived from digital commerce transactions, if digital commerce is not accepted for any reason, our revenues would not grow sufficiently and our business and operating results would be significantly harmed. We depend on the widespread acceptance of commerce in digital information over the Internet, through wireless and cable networks, and other means. These methods for distribution of digital information may not be commercially accepted for a number of reasons, including: . failure to develop the necessary infrastructure for communication of digital information and for payment processing; . failure to develop or deploy enabling technologies, including compression or broadband technology necessary for distribution of particular digital content over the Internet; . reduced demand for paid digital content due to the widespread availability of free content online and the ability to use and distribute this content without restriction; and . insufficient speed, access, and server reliability, as well as lengthy download time for content. If standards for digital rights management are not adopted, confusion among content providers, distributors, and consumers may depress the level of digital commerce, which would reduce our revenues. If standards for digital rights management are not adopted or complied with, content providers may delay distributing content until they are confident that the technology by which the content is to be distributed will be commercially accepted. Standards for the distribution of various digital content might not develop or might be found to violate antitrust laws or fair use of copyright policies. In addition, the failure to develop a standard among device manufacturers may affect the market for digital goods and services. As a result, consumers may delay purchasing products and services that include our technology if they are uncertain of commercial acceptance of the standards with which our technology complies. There is uncertainty in the market as to the best way to offer music digitally. For example, there are a number different software formats available and it is possible that not all music will play on the same devices. Consumer acceptance of digital delivery of music depends upon the ability of the various software formats to work together. Consequently, if a standard format for the secure delivery of content on the Internet is not adopted, or if the standards are not compatible with our digital rights management technology, our business and operating results would likely be harmed. We may face increased governmental regulation and legal uncertainties that could increase our costs and provide a barrier to doing business. Exports of software products utilizing encryption technology are generally restricted by the United States and various foreign governments. Although we have obtained approval to export our Commerce software, changes in export laws and regulations may impose restrictions that affect our ability to distribute products and services internationally, limiting our ability to gain revenue and grow our business. It is also possible that Congress or individual states could enact laws regulating or taxing Internet commerce. In addition, several telecommunications companies have petitioned the Federal Communications Commission to regulate Internet service providers in a manner similar to long distance telephone carriers and to impose access fees on these companies. Access fees, sales taxes or any other taxes or fees could increase the cost of transmitting data over the Internet and reduce the number or amount of transactions from which we get our transaction fees. Item 3. Qualitative and Quantitative Disclosures about Market Risk We develop products in the United States and intend to license our products to partners throughout the world. As a result, our financial results could be affected adversely by various factors, including foreign currency exchange rates or weak economic conditions in foreign markets. 30 Our interest income is sensitive to changes in the general level of United States interest rates, particularly since the majority of our investments are in short-term instruments. Due to the nature of our investments in marketable securities, we have concluded that there is no material market risk exposure. Therefore, no quantitative tabular disclosures are required. At September 30, 2001 and December 31, 2000, our cash and cash equivalents consisted primarily of demand deposits and money market funds held by two large institutions in the United States. 31 PART II. OTHER INFORMATION Item 1. Legal Proceedings. On April 26, 2001, we filed a patent infringement complaint against Microsoft Corporation in the United States District Court for the Northern District of California. In the complaint, we have alleged that certain of Microsoft's products infringe our United States Patent No. 6,185,683 and we are seeking an injunction in addition to monetary damages. We have subsequently amended our complaint to also allege infringement by Microsoft Corporation of our United States Patent No. 6,253,193, United States Patent No. 5,920,861, United States Patent No. 5,940,504, United States Patent No. 5, 892,900, United States Patent No. 5,982,891, and United States Patent No. 5, 917, 912. Microsoft filed an answer which denied all the allegations as to the previously filed patents, and which asserted infringement of two patents relating to the downloading of software, which we do not believe are significant to our business. Discovery has started in the case and the parties have exchanged initial document production and infringement contentions. Between May 17, 2001 and June 7, 2001, ten complaints were filed in the United States District Court for the Southern District of New York naming InterTrust, certain of its current and former directors and officers, and the members of the underwriting syndicate involved in InterTrust's initial public offering and/or secondary public offering as defendants in multiple class action lawsuits. The lawsuits seek unspecified monetary damages and certification of a plaintiff class consisting of all persons who acquired shares of InterTrust between October 26, 1999 through May 16, 2001. The complaints allege, among other things, that InterTrust and the other defendants named in the complaints violated the federal securities laws by issuing and selling InterTrust common stock in our initial public offering in October 1999 and our secondary public offering in April 2000 without disclosing to investors that certain of the underwriters in the offering allegedly solicited and received excessive and undisclosed commissions from certain investors. Item 2. Changes in Securities and Use of Proceeds. (a) Changes in Securities. None. (b) Use of Proceeds. On April 12, 2000 we completed a public offering in which we sold 2,820,244 shares of common stock at $35 per share pursuant to a Registration Statement on Form S-1 (File No. 333-32484) that was declared effective on April 6, 2000. The total aggregate proceeds from these transactions were $98.7 million. Underwriters' discounts and other related costs were approximately $6.5 million resulting in net proceeds of $92.2 million. On November 1, 1999, we completed our initial public offering in which we sold 13,000,000 shares of common stock at $9 per share pursuant to a Registration Statement on Form S-1 (File No. 333-84033) that was declared effective on October 26, 1999. Additionally, we sold 1,950,000 shares of common stock at $9 per share in connection with the exercise of the underwriters' over-allotment option. The total aggregate proceeds from these transactions were $134.6 million. Underwriters' discounts and other related costs were approximately $11.2 resulting in net proceeds of $123.4 million. The net proceeds were used for working capital and general corporate purposes. Remaining proceeds were predominantly held in cash, cash equivalents and marketable securities at September 30, 2001. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None. 32 Item 5. Other Information. None. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits.

* Incorporated herein by reference to the exhibit of the same number in the Registrant's Registration Statement on Form S-1 (File No. 333-84033). ** Incorporated herein by reference to the exhibit of the same number in the Registrant's Registration Statement on Form S-1 (File No. 333-32484). ***Incorporated herein by reference to the exhibit of the same number of the Registrant's Form 10-Q for the quarter ended September 30, 2001. ****Incorporated herein by reference to the exhibit of the same number of the Registrant's Form 10-K for the year ended December 31, 2000. + Confidential treatment requested. (b) Reports on Form 8-K. On July 26, 2001, the Company filed a report on Form 8-K in which it disclosed that the Company appointed Patrick S. Jones to its Board of Directors. 34 INTERTRUST TECHNOLOGIES CORPORATION SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. INTERTRUST TECHNOLOGIES CORPORATION /S/ VICTOR SHEAR By: _________________________________ Victor Shear Chairman of the Board and Chief Executive Officer (Principal Executive Officer) /S/ DAVID LOCKWOOD By: _________________________________ David Lockwood Executive Vice Chairman and President /S/ GREGORY S. WOOD By: _________________________________ Gregory S. Wood Chief Financial Officer (Principal Financial and Accounting Officer) Date: November 14, 2001 35

INTERTRUST TECHNOLOGIES CORP 10-Q