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FORM 10-KSB
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
/X/ ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
/ / TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
COMMISSION FILE NO. 000-22023
MACROVISION CORPORATION
(Name of small business issuer in its charter)
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DELAWARE 77-0156161
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
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1341 ORLEANS DRIVE
SUNNYVALE, CALIFORNIA 94089
(Address of principal executive offices) (Zip code)
(408) 743-8600
(Registrant's telephone number including area code)
NOT APPLICABLE
(Former name, former address, and former fiscal year, if changed since last
report)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE EXCHANGE ACT: NONE.
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE EXCHANGE ACT: COMMON
STOCK, $0.001 PAR VALUE.
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes _X_ No ___
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B contained in this form, and no disclosure will be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. _X_
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Check whether the registrant has filed all documents and reports required to
be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934
subsequent to the distribution of securities under a plan confirmed by a court.
Yes ___ No ___
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Transitional Small Business Disclosure Format (check one):
Yes ___ No ___
State the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
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Outstanding as of March 20,
Title 1998
Common Stock 7,271,866
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The Registrant's revenues for the fiscal year ended December 31, 1997
totaled $20,340,076.
As of March 20, 1998, the aggregate market value of the voting stock held by
non-affiliates of the Registrant (assuming for this purpose that only directors
and officers of the Registrant are affiliates of the Registrant), based on the
average of the closing bid and asked prices on that date, was approximately
$116,071,000.
Documents incorporated by reference: Certain exhibits hereto have been
specifically incorporated by reference herein in Item 13 under Part III hereof.
Registrant's definitive Proxy Statement which will be filed with the Securities
and Exchange Commission in connection with Registrant's annual meeting of
stockholders to be held on May 20, 1998 is incorporated by reference to Part III
of the Report.
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MACROVISION CORPORATION
FORM 10-KSB
INDEX
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PART I
ITEM 1. Description of Business..................................................... 3
ITEM 2. Description of Facilities................................................... 28
ITEM 3. Legal Proceedings........................................................... 29
ITEM 4. Submission of Matters to a Vote of Security Holders......................... 29
PART II
ITEM 5. Market for Common Equity and Related Stockholder Matters.................... 29
ITEM 6. Management's Discussion and Analysis of Financial Conditions and Results of
Operations................................................................ 30
ITEM 7. Consolidated Financial Statements........................................... 36
ITEM 8. Changes In and Disagreements with Accountants on Accounting and Financial
Disclosures............................................................... 36
PART III
ITEM 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
with Section 16(a) of the Exchange Act.................................... 36
ITEM 10. Executive Compensation...................................................... 36
ITEM 11. Security Ownership of Certain Beneficial Owners and Management.............. 36
ITEM 12. Certain Relationships and Related Transactions.............................. 36
ITEM 13. Exhibits, Lists and Reports on Form 8-K..................................... 36
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THIS ANNUAL REPORT ON FORM 10-KSB FOR MACROVISION CORPORATION ("MACROVISION"
OR THE "COMPANY" CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE
RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE
ANY SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN THE
SECTIONS ENTITLED "BUSINESS--FACTORS AFFECTING OPERATING RESULTS AND MARKET
PRICE OF STOCK" AND "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS."
PART I
ITEM 1. DESCRIPTION OF BUSINESS
CORPORATE OVERVIEW
The Company was incorporated in California in January 1983. It operated as a
corporation until 1985 and as a limited partnership from 1985 until its
incorporation as Macrovision Corporation in 1987. The Company reincorporated in
Delaware in February 1997. As used in this Form 10-KSB, references to the
"Company" and "Macrovision" refer to Macrovision Corporation, its predecessors
and its consolidated subsidiaries. The Company's principal executive offices are
located at 1341 Orleans Drive, Sunnyvale, California 94089. The Company's
telephone number is (408) 743-8600.
Macrovision-Registered Trademark-, PhaseKrypt-Registered Trademark- and
Protecting Your Image-Registered Trademark- are registered trademarks of the
Company. CineGuard-TM-, Colorstripe-TM-, StarShaker-TM-, VES-TM- and VES-TM-TM-
are trademarks of the Company. All other trademarks or trade names referred to
in this Report are the property of their respective owners.
The Company's Board of Directors approved a 1 for 1.8 reverse stock split of
common and preferred stock, $.001 par value per share which became effective
February 26, 1997. The accompanying consolidated financial statements have been
restated to give effect to the reverse stock split.
On March 12, 1997, the Company consummated an initial public offering ("IPO"
or the "Offering") of 2,350,000 shares of its Common Stock at a price of $9.00
per share, of which 1,434,016 shares were issued and sold by the Company and
915,984 shares were sold by selling stockholders of the Company. The net
proceeds to the Company from the Offering, after underwriting discounts and
commissions and other expenses of the Offering, were approximately $10.4
million. The Company did not receive any proceeds from the sale of shares sold
by the selling stockholders. On April 16, 1997, the Underwriters exercised their
option pursuant to the offering and purchased an additional 330,000 shares of
Common Stock at a price of $9.00 per share. The net proceeds to the Company from
the Option, after underwriting discounts and commissions and other expenses of
the Offering, were approximately $2.7 million.
BUSINESS
The Company designs, develops and markets video security technologies and
products that provide copy protection and video scrambling for motion pictures
and other proprietary video materials that are stored on videocassettes, digital
versatile discs or digital video discs ("DVDs") or other media or are
transmitted by means of cable, satellite or microwave transmission. The
Company's two primary technologies, copy protection and video scrambling, are
distinct in their application, but can be complementary in their ability to
protect copyright holders' video programming.
The Company's copy protection technologies enable consumers to view
programming stored on prerecorded videocassettes and DVDs or transmitted as
digital Pay-Per-View ("PPV") programs via cable and satellite, but deter
unauthorized consumer copying of such programming. The Company believes that
approximately one-third of all commercial videocassettes produced worldwide
during 1997 were copy protected, and that substantially all of those copy
protected videocassettes incorporated the Company's technology. All of the
Motion Picture Association of America ("MPAA") studios, including Disney, Fox
and Universal, have used the Company's copy protection technology to protect
some or all of their
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videocassettes in one or more countries around the world. The Company believes
that its video copy protection technologies are accepted as the DE FACTO
standard for consumer copy protection. The Company has developed an enhanced
version of its videocassette copy protection technology for the DVD format and
for digital PPV networks.
The Company's video scrambling technologies are used by cable and satellite
television system operators in connection with cable delivered subscription
television ("Pay TV") and analog PPV programming, as well as by businesses,
governments and other organizations to provide for the secure transmission of
video signals. Another application of the Company's video scrambling technology
is the Company's CineGuard program, a theatrical exhibition alternative in which
motion pictures are recorded in a scrambled state on Super VHS videocassettes
and distributed primarily to small theaters in rural towns in international
markets.
INDUSTRY BACKGROUND
Motion picture studios generally release major motion pictures to various
venues (E.G., theaters, hotels/airlines or home video) in a series of "release
windows" in order to maximize revenues from each venue. These release windows in
the United States by venue and annual revenue in 1997, as estimated by
entertainment media analyst Paul Kagan Associates, Inc. ("Paul Kagan") are
Theatrical Box Office (month 0 to month 4 ) $3.1 billion; Home Video (month 4 to
over month 15) $4.9 billion; Pay-Per-View (month 6 to month 8) $279 million and
Subscription TV (month 8 to month 11) $1.4 billion.
In the past few years, home video has surpassed the theatrical box office as
the largest source of revenues for the motion picture industry. With production
costs continually growing, studio profitability has become increasingly
dependent on the development of new venues, such as home video and digital PPV.
Theatrical box office release in foreign countries generally follows theatrical
box office release in the United States by at least four months. In foreign
countries, PPV releases generally follow home video release in a particular
foreign country by approximately six months followed by PayTV six months later.
COPY PROTECTION
Copyright holders wish to maximize the economic value from each feature film
or other video program over its copyright life, currently 75 years. When
consumers make copies of motion pictures, whether from hotel, airline, home
video or PPV releases, independent studies show that studios and video retailers
lose video sales and rental revenues. Paul Kagan estimates that 34.8 million
households in the United States (approximately 43% of all households with VCRs)
owned two or more videocassette recorders in December 1997, and thus were
capable of making unauthorized copies of prerecorded videocassettes. Based on a
1996 Macrovision-sponsored national survey, the Company estimates that consumer
video piracy costs the industry approximately $370 million in annual lost
revenues. To protect their revenues in the home video and subsequent release
venues, many studios are attempting to prevent unauthorized copies of motion
pictures from entering the marketplace. Other copyright holders, such as
independent video producers, governments, businesses and institutions, also
benefit from preventing unauthorized copying of special interest, educational
and other prerecorded video programming.
Emerging trends in the PPV market are also increasing the need for effective
copy protection technologies. PPV television, which enables consumers to view
motion pictures and other programming in their homes via their existing cable or
satellite television systems for an additional fee for each viewing, has
generated to date only a small fraction of the revenues generated by home video.
However, motion picture studios typically receive revenue each time a consumer
views a motion picture on PPV, which results in higher profit margins than home
video, for example, where the studios generate revenues only from the one-time
sale of videocassettes except for a some revenue sharing activities. Analog
cable television systems provide few PPV channels, which limits the number of
available motion pictures and the frequency of viewing times. In addition, the
studios, in an effort to protect their home video revenues, typically
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release a motion picture on PPV one to three months after it is released on
videocassette. Digital PPV, however, provides consumers with the benefits of
more channels, a greater variety of motion pictures and more frequent motion
picture viewing times. However, viewers can copy PPV motion pictures in their
homes with a single VCR. When the transmission is digital, copy quality is
better than that of copies made from videocassettes or analog cable television.
It is not economically feasible to retrofit the analog cable television systems
currently in place in the United States with copy protection technology. As a
result, the opportunity to introduce effective copy protection for PPV is
expected to grow only to the extent that digital PPV replaces existing analog
PPV systems.
DVD hardware and media became commercially available in the United States in
1997 as approximately 300,000 DVD players have been shipped by manufacturers as
of December 31, 1997. The introduction of DVDs presents serious concerns to the
studios. Without effective copy protection, any one of the approximately 425
million VCRs throughout the world, when combined with a DVD player, can make
unlimited videocassette copies of a non-copy protected DVD that are nearly equal
in quality to a professionally prerecorded videocassette. Because of their
superior picture quality, lower manufacturing cost, relative ease of use and
smaller size, DVDs are expected to supplant videocassettes over time as the
preferred home video distribution medium. As a result, the need for reliable
copy protection is expected to become more important as DVDs become more readily
available.
VIDEO SCRAMBLING
Cable and satellite television system operators require secure video
scrambling technology to prevent unauthorized viewing of PPV and Pay TV
programming. Unauthorized or "pirate" descramblers for existing analog PPV and
Pay TV scrambling systems are readily available to consumers at low cost,
allowing them to view programming without paying the system operator. Based on a
1992 survey of cable television system operators, the National Cable Television
Association's Office of Cable Signal Theft reported that unauthorized viewing of
cable television premium channels and PPV translated into an estimated $4.7
billion per year in potentially lost revenues to system operators and motion
picture studios. However, the substantial installed base of analog set-top
decoders makes the cost of providing a new, more secure analog scrambling system
in the United States prohibitive.
Although system operators in the United States and Western Europe are
upgrading their networks with digital compression, analog cable and microwave
Pay TV systems continue to be built, particularly in developing countries,
because analog systems are far less expensive to build than digital systems and
these emerging markets do not require the range of programming and channel
capacity that digital compression provides. Industry publications have projected
that the market for addressable analog Pay TV decoders will be approximately $2
billion annually by the year 2000. MPAA studios are increasingly requiring
international cable operators to install effective and secure scrambling systems
as a precondition to receiving their motion pictures. International system
operators now offer premium and PPV channels that require new addressable analog
systems that provide security against signal theft, are cost effective, can
support a variety of program tiers and can be authorized remotely by the system
operator.
THE MACROVISION SOLUTION
Macrovision offers copy protection and video scrambling technologies and
products that address the video security needs of motion picture studios and
other copyright holders, program distributors, cable and satellite Pay TV and
PPV system operators, governments, businesses and equipment manufacturers.
COPY PROTECTION
The Company's copy protection technologies allow consumers to view
programming stored on prerecorded videocassettes or DVDs or transmitted as
digital PPV programs via cable or satellite, but
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deter unauthorized consumer copying of such programming. Videocassettes are
encoded with the Company's copy protection process as they are manufactured. In
digital PPV and DVD applications, the Company's copy protection is activated by
a copy protection signal generator circuit embedded within the cable or
satellite digital set-top decoder or the DVD player.
VIDEO SCRAMBLING
The Company's video scrambling technologies prevent unauthorized viewing of
video programming unless the viewer has paid for, or otherwise has been granted,
the right to view such programming. The video signals are scrambled using a
combination of analog video scrambling and digital encryption. This provides a
high level of security against signal theft while maintaining low decoder cost.
For cable television applications of the Company's PhaseKrypt technology, the
cost of decoding the scrambled picture is minimized by using a secure analog
technology that partially relies on the electronics of the television set to
make the image viewable. The Company has also developed products implementing
other video scrambling technologies that serve growing niche markets, such as
law enforcement and private networks.
THE MACROVISION STRATEGY
The Company is dedicated to providing advanced video security technologies
and products to its customers. The Company intends to maintain and enhance its
position as a leading provider of these technologies and products by focusing on
the following key strategies:
PURSUE ROYALTY-BASED LICENSING MODEL. The Company is pursuing a
royalty-based licensing model that results in a high margin,
transaction-oriented business with recurring revenues. As the sole provider of
copy protection for prerecorded videocassettes to the MPAA studios, the Company
typically licenses its technology pursuant to volume-based pricing schedules.
Royalties and other fees are currently paid by copyright holders, commercial
duplicators, hardware manufacturers and program distributors. The Company
intends whenever feasible to continue to license its technologies to third
parties for volume or transaction-based royalties and fees.
LEVERAGE KEY CUSTOMER RELATIONSHIPS. Over the past ten years, the Company
has developed strong relationships with its customers, including the major
Hollywood studios and key members of the video duplication industry, as well as
the cable and satellite television system operators and the equipment
manufacturers that serve these customers. The Company attempts to develop
strategic relationships with its customers, to broaden the use of existing
applications for its technologies and to enhance the security of its customers'
video properties.
INCREASE MARKET PENETRATION OF COPY PROTECTION BUSINESS. The Company
estimates that it has penetrated approximately one-third of the worldwide
videocassette copy protection market, which leaves a large potential
opportunity, even as digital PPV and DVDs begin to displace analog
videocassettes. The Company licenses its technology to DVD hardware
manufacturers and provides favorable terms to the DVD manufacturers who ensure
that their new VCRs respond to copy protected video signals. The Company intends
to make its copy protection technology available and affordable to all video
copyright holders in all prerecorded packaged media and digital PPV venues and
seeks to have its technology specified by all PPV system operators, digital
set-top decoder manufacturers and DVD hardware manufacturers.
DEVELOP NEW PRODUCT APPLICATIONS AND TECHNOLOGIES. The Company intends to
continue to expand the applications for its copy protection and video scrambling
technologies as they apply to current as well as new markets. The Company
intends to expand its technological base, either through internal development or
potential acquisitions. The Company has recently concluded two separate Joint
Marketing and Development Agreements with Digimarc Corp., (Portland, OR) in
August 1997 and C-Dilla, Ltd. (Woodley, UK)
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in February 1998 to develop products aimed at digital-to-digital copy protection
for DVDs and CD-ROM copy protection. (See section on Investments)
PROTECT PATENT POSITION. The Company believes that its future success will
depend, in part, on the continued protection of its proprietary technologies.
The Company has obtained patents to protect its copy protection and video
scrambling technologies and intends to continue to pursue patent protection
aggressively. The Company has invested substantial resources in developing and
obtaining patents covering a number of processes and devices that unauthorized
parties could use to circumvent the Company's consumer copy protection
technologies. The Company uses these patents to limit the proliferation of such
devices and has initiated a number of actions relating to infringement of these
patents. The Company intends to continue to protect and defend its patented
technologies aggressively through both further technological innovation and
legal action.
MACROVISION'S BUSINESS, LICENSED TECHNOLOGIES AND PRODUCTS
The Company's technologies are either licensed or sold, depending upon the
particular application or product. For videocassette copy protection, copyright
holders and licensed duplicators typically pay the Company a per unit licensing
fee for the right to apply the Company's technology. In addition, copyright
holders typically pay the Company a per unit license fee to apply copy
protection to DVDs. For digital PPV, cable and satellite television system
operators pay the Company a one-time license fee for the right to incorporate
the Company's copy protection technology into their networks and have entered
into agreements with the Company pursuant to which the Company is entitled to
transaction-based royalty payments at such time as copy protection for digital
PPV programming is activated. Set-top decoder manufacturers also license the
Company's copy protection and video scrambling technologies for an up-front fee
and a per unit hardware royalty. In addition, semiconductor manufacturers pay
the Company a small one-time service fee for the right to embed the Company's
copy protection technologies in integrated circuits for set-top decoders. For
the DVD market, the Company offers licenses to consumer electronics and personal
computer manufacturers and for rights owners follows a business model using
media-based royalties similar to that for its videocassette copy protection
business. The Company also sells a line of products based on its various video
scrambling technologies for applications in television broadcasting and niche
markets such as law enforcement and private networks.
COPY PROTECTION
The Company's copy protection technologies are designed to allow motion
picture studios and other copyright holders to protect their copyrighted and
proprietary video material from unauthorized consumer copying. The Company's
copy protection technologies for videocassettes and DVDs generally are priced as
low as a few pennies per unit, depending upon such factors as the term of the
contract and the annual volume commitment made by the copyright holder. The
Company believes that copyright holders justify the decision to pay for the
Company's technology through a combination of increased videocassette sales,
increased revenues from downstream venues, stronger relationships with retailers
and a favorable return on investment compared to equivalent advertising
expenditures.
The Company's copy protection technology is "applied" electronically to
videocassettes at the time of duplication at over 230 commercial duplication
facilities in 34 countries. Company-owned copy protection equipment is installed
and maintained by the Company in each duplication facility. The Company licenses
commercial duplicators to act as distributors and sales agents in return for a
share of the copy protection fees duplicators receive from their customers. In
cases in which the rights owner licenses the technology directly from the
Company, the Company pays service fees to the commercial duplicators. The
Company's copy protection technology has been applied to more than 2 billion
videocassettes worldwide since 1985, and was applied to more than 400 million
videocassettes in 1997. All MPAA studios use the Company's copy protection
technologies to protect some or all of their videocassettes in one or more
countries around the world. In 1997 and 1996, three of these studios applied the
Company's technology to a majority of all
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videocassettes they produced. In addition, the Company believes that more than
1,500 corporate, educational and special interest copyright holders have
contracted with the Company's licensed duplicators to apply the Company's copy
protection process to their videocassettes.
The Company has developed an enhanced version of its videocassette copy
protection technology for the DVD format and for the digital PPV networks that
are being developed and deployed by direct broadcast satellite and cable
television operators. This enhanced copy protection technology is "applied" by
an integrated circuit that is embedded within the DVD player or digital set-top
decoder and that can later be activated by copy protection control codes in the
video program or PPV network access control system. Upon activation, the
embedded integrated circuit generates the Company's copy protection signal and
applies it to the program material at the analog output port of the DVD player
or digital set-top decoder. This copy protection signal inhibits consumers from
using a DVD player or a digital set-top decoder to make commercial quality
videocassette copies of the DVD or PPV program.
The Company has licensed its copy protection technology for digital PPV to
40 set-top decoder manufacturers and thirteen digital PPV system operators. As
of December 31, 1997, four digital PPV program providers in Japan have activated
copy protection for digital PPV programming. The Company's copy protection
technology is embedded in approximately seven million digital set-top decoders
currently in use in the United States, Japan, Europe and a number of countries
in Latin America, for which the Company has received license fees and royalties
from the digital set-top decoder manufacturers.
In October 1996, a multi-industry technical working group comprised of major
motion picture studios, consumer electronics manufacturers and personal computer
hardware and software companies adopted a set of copy protection principles that
established prerequisites for commercial availability of DVD hardware and media.
The Company believes that its copy protection technology is currently the only
digital-to-analog copy protection solution that satisfies these principles. To
date, 76 companies that manufacture DVD-video players and DVD-Rom drives have
signed agreements with the Company to incorporate the Company's DVD copy
protection technology in their hardware.
Consumers routinely make videocassette copies of premium cable television
and free television broadcasts. The Company does not license its technology for
use in deterring consumer copying of such programming.
Copy protection products represented 85.6% and 87.5% of the Company's net
revenues in 1997 and 1996, respectively.
VIDEO SCRAMBLING
The Company's video scrambling technologies are used to prevent unauthorized
viewing of video content during transmission from one location to another
location(s). These technologies are used in PPV, Pay TV, business television,
private networks, broadcast television and government, military and law
enforcement markets.
The Company's PhaseKrypt video scrambling technology is a relatively secure,
easy to use, low cost alternative to other widely used analog scrambling
systems. PhaseKrypt is intended for use in Pay TV and PPV applications in
developing cable television markets such as South America, South Korea, Taiwan,
the People's Republic of China and the Philippines. Analog set-top decoder
manufacturers either license PhaseKrypt for an up-front fee and a per unit
hardware royalty or purchase encoder hardware and decoder components from the
Company. Cable television operators purchase PhaseKrypt-enabled set-top decoders
and encoder hardware from Macrovision licensees for installation in their
systems.
The Company's video encryption system ("VES") technology is incorporated
into a variety of professional and near-professional broadcast quality
scrambling products that the Company sells rather than licenses. One of the VES
systems is a professional, broadcast-quality video scrambling system that is
available in NTSC and PAL versions. Primary applications include broadcast
television distribution to
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network affiliate stations and retransmission facilities, programming delivery
to cable television head-ends, programming contribution circuits and backhauls.
The Company has also developed two miniaturized DC-powered scrambling systems
that are used primarily for covert law enforcement, military surveillance and
broadcast television news gathering applications. A miniaturized multiplexer
product is also available that combines two video signals for transmission over
single channel video links.
Video scrambling products represented 13.5% and 12.1% of the Company's net
revenues in 1997 and 1996, respectively.
CINEGUARD
CineGuard utilizes the Company's PhaseKrypt video scrambling technology to
distribute motion pictures on Super VHS videocassettes primarily to small
theaters in rural towns in international markets. The Company's PhaseKrypt
technology allows motion pictures to be recorded on videocassettes in a
scrambled state and descrambled by the Company's decoder integrated into the
video projector located at the CineGuard theater. This deters unauthorized
parties from copying the motion picture from the videocassette. As a result,
studios would be able to distribute motion pictures to small theaters
concurrently with their release to major film exhibitors at a cost of
approximately $40 per videocassette compared to approximately $1,500 for a film
print. In 1997, the Company discontinued its CineGuard operations in Poland,
Ireland and South Africa due to lack of demand from local exhibitors. The
Company has an existing Master Licensee in the Philippines and will continue to
license CineGuard to interested parties. Neither the revenues nor the costs for
CineGuard are expected to have a material impact on the business or financial
condition of the Company in 1998.
CUSTOMERS
The Company's packaged media copy protection technology for videocassettes
and DVDs is used by the following major motion picture studios and home video
suppliers and by the following commercial videocassette duplicators, each of
which accounted for at least $75,000 of the Company's net revenues during 1997:
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HOME VIDEO SUPPLIERS COMMERCIAL VIDEOCASSETTE DUPLICATORS
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BMG Entertainment Allied Digital Technologies
Buena Vista Home Video, Inc. (Disney) Vaughn Communications, Inc.
Columbia House
Columbia TriStar Home Video (Sony Pictures
Entertainment)
HBO Home Video
New Line Home Video
Paramount Pictures
Twentieth Century Fox Home Entertainment, Inc.
Universal Studios Home Video
Warner Home Video
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For 1997, one customer accounted for 11% of the total revenues and revenues
from the three largest customers represented 26% of the Company's net revenues.
During 1996, revenues from the Company's three largest customers represented 37%
of the Company's net revenues and each accounted for more than 10% of the
Company's net revenues. The Company expects that revenues from a limited number
of customers will continue to account for a substantial portion of the Company's
net revenues for the foreseeable future.
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The Company also licenses its videocassette copy protection technology to
special interest customers that include independent video producers and
corporations. Licensed commercial duplicators act as distributors of the
Company's videocassette copy protection technology to special interest
customers. Revenues from special interest customers accounted for approximately
12.1% and 17.2% of the Company's revenues in 1997 and 1996 , respectively.
The Company has licensed its digital PPV copy protection technology for
incorporation into the networks of 13 system operators. These system operators
have paid a one-time license fee to the Company and have entered into agreements
with the Company pursuant to which the Company is entitled to transaction-based
royalty payments at such time as copy protection for digital PPV programming is
activated. Another 13 system operators require Macrovision-capable set-top
decoders in their networks or have signed agreements with the Company to test
its digital PPV copy protection technology on a limited basis.
The Company has licensed its copy protection technology to 40 digital
set-top decoder manufacturers. The Company generally receives an up-front fee
and a per unit royalty from each digital set-top decoder manufacturer that
licenses its technology. The Company has also authorized 40 companies to
incorporate the Company's technology in their semiconductor designs. These
companies generally pay a small one-time service fee for limited rights to
include the Company's copy protection technology in digital-to-analog
application specific integrated circuits ("ASICs") that are embedded in digital
set-top decoders and DVD players. They are authorized to sell the
Macrovision-capable ASICs to Macrovision-licensed DVD hardware manufacturers and
to Macrovision-licensed digital set-top decoder manufacturers.
The Company's customers for video scrambling Pay TV components and licenses
are cable television system hardware manufacturers that sell their products to
cable operators in developing markets. These customers purchase encoder hardware
and decoder components from the Company or pay the Company a volume-based
royalty for encoder and decoder components when they manufacture such components
under license from the Company. The following is a representative list of the
Company's video scrambling customers, each of which accounted for at least
$25,000 of the Company's net revenues during 1997:
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VES CUSTOMERS PAY TV COMPONENTS AND LICENSES
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Government of Israel Eastern Electronics Co., Ltd. (Taiwan)
Integrated Telecommunications Systems (Canada) Efforts Development International, Ltd. (Hong Kong)
News Sports Microwave, Inc. Microelectronics Technology, Inc. (Taiwan)
SIM Security and Electronic (Germany) Pacific Satellite International, Ltd. (Hong Kong)
Skehan Televideo Service Inc. Tae Kwang Industrial (South Korea)
Wood & Douglas LTD (United Kingdom) Taihan Electric Wire Co., Ltd. (South Korea)
</TABLE>
SALES, MARKETING AND CUSTOMER SUPPORT
The Company markets its videocassette copy protection and digital PPV and
DVD copy protection technologies directly to the MPAA studios and certain major
independent rights owners and video producers. The Company also provides ongoing
technical support to the three major duplicators that manufacture most of the
videocassettes for the MPAA studios. The Company supplements its direct sales
efforts with a variety of marketing initiatives, including trade show
participation, trade advertisements, industry education and newsletters. The
Company provides technical support to its licensed duplicators, including
hardware installation assistance and quality control. In addition, the Company
supports licensed duplicator sales personnel by providing sales training and
sales incentive programs and literature and by participating in trade shows.
The Company markets its video scrambling technologies through a combination
of direct sales, distributors, sales representatives and licensing in the United
States and internationally. The Company has a total of 18 distributors, sales
representatives and licensees serving 29 countries that sell products based
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on the Company's video scrambling technologies. VES scrambling products are sold
directly or through distributors to end users. The Company licenses its
PhaseKrypt technology and sells encoder hardware and decoder components directly
to manufacturers of cable television set-top decoders. Technical support is
provided from the Company's Sunnyvale headquarters.
The Company markets its copy protection technologies internationally from
its Sunnyvale headquarters, through its subsidiaries in Japan and the United
Kingdom and through exclusive licensing arrangements with third parties in
Egypt, Hungary and South Korea. International and export sales together
represented 46.5% and 37.9% of net revenues in 1997 and 1996, respectively. The
increase in 1997 reflects the increased international opportunities for the
Company's Pay TV video scrambling business, the emergence of the PPV business,
and sales efforts from our subsidiaries . The Company expects that international
and export sales will continue to represent a substantial portion of its net
revenues for the foreseeable future. Due to its reliance on international and
export sales, the Company is subject to the risks of conducting business
internationally.
TECHNOLOGY
COPY PROTECTION
Effective copy protection systems are difficult to develop because of the
need to address the dual requirements of playability and effectiveness.
Consumers must be able to view the copy protected content using a consumer VCR
and a television set without the need for any intervening devices, while, at the
same time, the quality of an unauthorized copy must be reduced to such an extent
that it loses its entertainment value. The extent to which the entertainment
value is reduced varies, depending on the VCR model and the VCR and television
combination that plays the unauthorized copy. To prevent VCRs from making good
copies, the copy protected video must differ in some manner from the standard
video signal because, by design, all VCRs will make good copies from standard
video signals. Television sets are designed to play standard or near-standard
video signals. As a result, there is a risk that making a video signal
non-standard in order to prevent copying will decrease playability by causing
some television sets to generate impaired or distorted pictures. In the tradeoff
between effectiveness and playability, designers of copy protection systems must
favor playability while maintaining effectiveness.
The Company's videocassette copy protection technology involves the patented
technique of inserting a series of electronic pulses in the vertical blanking
interval ("VBI") of a standard video signal. The VBI is the blank space between
the video fields on television sets that are refreshed at a rate of 60 fields
per second. The copy protection pulses are embedded electronically in the
prerecorded content of the videocassettes in the process of videocassette
manufacturing. The electronic pulses are not visible in the television picture.
The pulses are intended to affect the automatic gain control ("AGC") circuit in
the recording system of most VHS videocassette recorders, but not to affect a
similar circuit in the television set. Therefore, when the consumer plays a copy
protected prerecorded videocassette, the picture is clean and crisp, but when
the consumer plays an unauthorized consumer-made copy of that same
videocassette, the picture typically has substantially reduced entertainment
value. The Company's copy protection technology is effective against most
consumer copying, but generally does not deter professional pirates who use
professional duplication and video processing equipment. In the event that the
major motion picture studios or other rights holders determine that the
inability of the Company's technology to deter professional piracy renders the
Company's technology less useful, demand for the Company's copy protection
products could decline, which would have a material adverse effect on the
Company's business, financial condition and results of operations.
The DVD and digital PPV versions of the Company's copy protection
technologies employ both the electronic pulses used in videocassettes and a
second patented copy protection process called Colorstripe. Colorstripe affects
the color playback circuit of a VCR causing colored horizontal stripes to appear
in the picture of an unauthorized copy. The combination of the two processes
provides a higher level of
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effectiveness than that provided by either process alone. In addition,
Colorstripe is more effective against circumvention by currently available
professional duplication equipment. Copy protection is implemented in DVD and
digital PPV applications by embedding a copy protection signal generator
integrated circuit within the DVD player or digital set-top decoder. The
integrated circuit is activated by copy protection control codes, which are
integrated into the DVD media or the PPV transmission. Once the integrated
circuit is activated, it adds the copy protection signal to the analog output of
the DVD player or digital set-top decoder. As with videocassette copy
protection, consumers are able to see a clear picture on their television sets,
but generally cannot make a usable videocassette copy on a VCR.
VIDEO SCRAMBLING
The Company's PhaseKrypt technology utilizes a combination of digital
encryption techniques and analog video scrambling to scramble video signals. The
resulting scrambled picture oscillates at random rates, which makes it almost
impossible to watch. Because the encoding or scrambling technique is digitally
controlled, the level of security against signal theft can be increased by
increasing the number of bits that are used in the encryption algorithm. The
Company's technology uses the largest number of bits currently allowable by U.S.
law for export products. The scrambled picture is decoded using the secure
PhaseKrypt analog technology that partially relies on the electronics of the
television set to make the image viewable. The combination of the digital
encoding process, which provides security, and the analog decoding technology,
which is inexpensive, makes PhaseKrypt a cost-effective solution for
analog-based cable television set-top decoders in developing countries.
PhaseKrypt video scrambling is often accompanied by one of Macrovision's
patented audio scrambling technologies.
RESEARCH AND DEVELOPMENT
The Company's research and development efforts are focused on developing
enhancements to existing products, new applications for the Company's current
technologies and new patentable technologies related to the video security
market. The Company's core technological competencies are in video engineering,
which involves the generation and modification of electronic signals in both
digital and analog form and the transformation of such signals between digital
and analog forms, and in ASIC design. Such technologies are primarily hardware
based. The Company also has expertise in developing software security codes,
which are used to restrict access to encoding and decoding devices.
For its copy protection technologies, the Company supports the efforts of
television, VCR and DVD hardware manufacturers to design hardware that is
compatible with the Company's technologies. The Company also assists
semiconductor manufacturers in incorporating the Company's copy protection
technologies into digital video-based ASICs for digital to analog converters.
The Company regularly tests the effectiveness and transparency of its copy
protection technologies on representative samples of consumer televisions and
VCRs to determine whether modifications or enhancements may be necessary.
A new program was started in 1997 to develop in collaboration with Digimarc
Corporation ("Digimarc"), a video watermarking system solution for copy
protection associated with the DVD platform and other digital distribution
media. In September 1997, the Company entered into an agreement with Digimarc to
develop a digital video watermarking solution to address the digital-to-digital
copying issues associated with the next generation DVD recording devices.
Digital watermarks embedded in movies and other video material act as an
invisible identity providing basic copyright identification information as well
as various rules to either allow or disallow playback, viewing, and copying onto
another digital device. The new technology will be based upon the Company's
patented play control technology and Digimarc's patented watermarking
technology, which is very robust and can survive numerous transformations (e.g.,
from digital to analog and back to digital, or from one video format to
another). The digital watermarks are designed to be imperceptible to the viewer,
but can be read easily by special purpose decoders that can be built into
software or silicon chipsets. This jointly developed technology is intended to
have the
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capability to protect motion pictures and other video content from
indiscriminate copying on future digital recording devices.
For its video scrambling technologies, the Company's primary focus is the
development of enhancements to its PhaseKrypt-based Pay TV encoder and decoder
products. The Company works closely with its customers to identify problems in
the video security market and to develop products and technologies that address
those problems. Development projects completed in 1997 included: a video
multiplexor to complement one of the VES products to enable customers to monitor
multiple video channels simultaneously; enhancements to the PhaseKrypt Pay TV
encoder, which, for a given cable television operator, will increase the number
of addressable set-top decoders as well as the number of individually
addressable scrambled channels; and modifications to the DVD and digital PPV
copy protection specifications for the PAL video format.
As of December 31, 1997, the Company's research and development staff
consisted of 11 engineers and four technicians. The Company believes that its
ability to attract, train and retain qualified development personnel is
essential to the success of its development programs. The market for such
personnel is highly competitive, and the Company's development activities could
be adversely affected if the Company were unsuccessful in attracting, training
and retaining skilled engineering personnel. In 1997 and 1996, the Company's
expenses for research and development were $2.2 million and $2.5 million,
respectively.
The video security industry in which the Company competes, and in which its
technologies and products are utilized, is characterized by rapid technological
change, frequent product introductions and enhancements, changes in customer
demands and evolving industry standards. The emergence of new industry standards
and the introduction of new technologies or products embodying new technologies
can render existing technologies or products obsolete and unmarketable. The
Company's future success will depend in large part on its ability to enhance its
current technologies and products in a timely, cost-effective manner and to
develop or acquire new technologies and products that meet changing market
conditions, which include emerging industry standards, changing customer
demands, new competitive product offerings and changing technology. Any failure
by the Company to anticipate or to respond adequately to changing market
conditions, or any significant delays in technology or product development or
introduction, could cause customers to delay or decide against licensing or
purchasing the Company's technologies or products and would have a material
adverse effect on the Company's business, financial condition and results of
operations.
INTELLECTUAL PROPERTY RIGHTS
The Company holds 35 United States patents and has 33 United States patent
applications pending, of which five are allowed. Of the issued United States
patents, 21 relate to the Company's copy protection technologies, 10 relate to
video scrambling and 4 relate to audio scrambling. The Company's issued United
States patents expire between June 2000 and March 2015. The Company also has 114
foreign patents and 180 foreign patent applications pending in 40 countries. Of
the issued foreign patents, 68 relate to the Company's copy protection
technologies, 45 relate to video scrambling and 1 relates to audio scrambling.
Included in the patents related to the Company's copy protection technologies
are eight United States and 21 foreign patents covering a number of processes
and devices that unauthorized parties could use to circumvent the Company's copy
protection technologies. The Company uses these patents to limit the
proliferation of devices intended to circumvent the Company's copy protection
technologies.
The Company's success is heavily dependent upon its proprietary
technologies. The Company relies primarily on a combination of patent,
trademark, copyright and trade secret laws, nondisclosure and other contractual
provisions, and technical measures to protect its intellectual property rights.
There can be no assurance that any patent, trademark or copyright owned by the
Company will not be challenged and invalidated or circumvented, that patents
will issue from any of the Company's pending or future patent applications or
that any claims in issued patents or pending patent applications will be of
sufficient scope
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or strength or be issued in all countries where the Company's products can be
sold or its technologies can be licensed to provide meaningful protection or any
commercial advantage to the Company. There can be no assurance that the
expiration of any of the Company's patents will not have a material adverse
effect on the Company's business, financial condition and results of operations.
Further, there can be no assurance that others will not develop technologies
that are similar or superior to the Company's technologies, duplicate the
Company's technologies or design around the patents owned by the Company.
Effective intellectual property protection may be unavailable or limited in
certain foreign countries. Despite the Company's efforts to protect its
proprietary rights, unauthorized parties may attempt to copy or otherwise use
aspects of the Company's processes and devices that the Company regards as
proprietary. Policing unauthorized use of the Company's proprietary information
is difficult, and there can be no assurance that the steps taken by the Company
will prevent misappropriation of its technologies. In the event that the
Company's intellectual property protection is insufficient to protect the
Company's intellectual property rights, the Company could face increased
competition in the market for its products and technologies, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
From time to time, the Company may receive claims from third parties that
the Company's technologies and products infringe the intellectual property
rights of such third parties. Any such claims, with or without merit, could be
time consuming to defend, result in costly litigation, cause product shipment
delays or require the Company to cease utilizing the infringing technology
unless it can enter into royalty or licensing agreements. Such royalty or
licensing agreements might not be available on terms acceptable to the Company,
or at all. In the event of an adverse ruling in any such litigation, the Company
might be required to pay substantial damages, discontinue the use and sale of
infringing products, expend significant resources to develop non-infringing
technology or obtain licenses to infringed technology. The failure of the
Company to develop or license a substitute technology could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company has been notified that a Japanese company has filed an
invalidation claim against one of Macrovision's anti-copy patents in Japan. The
Company and its Japanese patent counsel believe this claim is without merit and
will aggressively contest the claim in the Japanese Patent Office. In the event
of an adverse ruling on such claim, the Company may incur legal competition from
clones of its own copy protection technology in Japan and a corresponding
decline in demand for such technology from the Company, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company has initiated a number of patent infringement disputes against
manufacturers and distributors of devices intended to circumvent the Company's
copy protection technologies. The company has one lawsuit of this type pending
to require the defendants to discontinue the sale of devices that circumvent the
Company's copy protection technologies and infringe one or more of the company's
circumvention patents. There can be no assurance that any such litigation will
be successful. Such litigation could result in substantial costs and diversion
of resources and could have a material adverse effect on the Company's business,
financial condition and results of operations, whether or not such litigation is
determined adversely to the Company. In the event of an adverse ruling in any
such litigation, the Company may suffer from the legal availability of such a
circumvention device, which could result in the increased proliferation of
devices that defeat the Company's copy protection technology and a decline in
demand for the Company's technologies.
COMPETITION
COPY PROTECTION
The Company believes that it has had no significant videocassette copy
protection competitor for the last five years other than companies that have
occasionally developed hardware based on the Company's
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technology in foreign countries where the Company does not have patents issued.
The Company's copy protection technologies are proprietary and have broad
international patent coverage. As a result, none of the Company's competitors
has been successful in the past. It is possible, however, that a competitive
copy protection technology could be developed in the future. For example, the
Company's customers could attempt to promote competition by supporting the
development of alternative copy protection technologies or solutions, including
solutions that deter professional duplication. Increased competition would be
likely to result in price reductions and loss of market share, either of which
could materially adversely affect the Company's business, financial condition
and results of operations.
The Company and Digimarc have submitted their digital media copyright
protection solution (which is under development as described in "Research and
Development" above) in response to a call for proposals from the Copy Protection
Technical Working Group (CPTWG). The Company and Digimarc are competing with at
least six other companies who have submitted similar proposals to the CPTWG.
Certain of these companies have substantially greater name recognition and
significantly greater financial, technical, marketing and other resources than
the Company and Digimarc. There can be no assurance that the Company and
Digimarc will be able to compete successfully in presenting their proposal to
the CPTWG. The company which has its solution accepted by the CPTWG will have a
significant advantage in licensing its technology to video rights owners
worldwide and to work cooperatively with consumer electronics manufacturers, PC
platform companies, and their suppliers to implement the decoder technology
which will make digital-to-digital copy protection a reality. If the solution
being developed by the Company and Digimarc is not the accepted solution, the
Company and Digimarc will be at a competitive disadvantage in marketing their
solution.
VIDEO SCRAMBLING
The market for video scrambling products and technologies is highly
competitive. The Company, as a recent entrant into these markets, competes
directly or through licensed manufacturers with many companies, including
Scientific-Atlanta, Inc., General Instrument Corporation, Pace Microelectronics,
Zenith Electronics Corporation and Toshiba Corporation. These companies have
substantially greater name recognition, larger installed customer bases and
market share and significantly greater financial, technical, marketing and other
resources than the Company and its licensees, many of which are manufacturing
and selling addressable set-top decoders for the first time. There can be no
assurance that the Company and its licensees will be able to compete
successfully in the video scrambling systems markets, that the Company will be
able to make technological advances necessary to improve or even maintain its
competitive position or that the Company's products will achieve market
acceptance. In addition, there can be no assurance that technological changes or
development efforts by the Company's competitors will not render the Company's
video scrambling products obsolete or uncompetitive. The Company believes that
the principal competitive factors affecting these markets include the level of
security provided, price, quality, product reputation, customer service and
support, the effectiveness of sales and marketing efforts and company
reputation. There can be no assurance that the Company can compete successfully
against current and potential competitors, especially against those with
significantly greater financial, marketing, service, support, technical and
other resources.
MANUFACTURING
The Company's manufacturing strategy is to license its technologies to third
parties that manufacture products incorporating those technologies. The Company
generates royalty revenues from these licenses, generally in the form of an
up-front fee and a per unit royalty. For example, licensees of the Company's
PhaseKrypt technology can either manufacture PhaseKrypt decoder components or
purchase such components from the Company.
The Company's manufacturing operations are limited to low volume products
that require significant quality control efforts by the Company, such as the VES
products, PhaseKrypt encoders and videocassette
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copy protection processors used by commercial videocassette duplicators. These
manufacturing operations consist primarily of component procurement, final
assembly and test, and quality control of subassemblies and systems. The Company
generally uses domestic independent contractors to manufacture and assemble
printed circuit boards, which enables the Company to configure the hardware and
software in combinations to meet a wide variety of customer requirements. The
Company installs its software into electronically programmable read-only memory
to maintain quality control and security. The Company utilizes "burn-in"
procedures, functional and system integration testing and comprehensive
inspections to assure quality and reliability of its products.
The Company depends upon third-party manufacturers and suppliers for
components, subassemblies and printed circuit boards used in its VES products,
PhaseKrypt encoders, PhaseKrypt decoder components and videocassette copy
protection processors. The Company's product designs are proprietary but
generally incorporate industry-standard hardware components that are obtainable
from multiple sources. The Company's ability to deliver its products in a timely
manner depends upon the availability of quality components and subassemblies
used in these products and, in part, on the ability of subcontractors to
manufacture, assemble and deliver certain items in a timely and satisfactory
manner.
The Company obtains certain electronic components and subassemblies from a
single source or a limited number of sources. For example, one company is
currently the Company's sole source of integrated circuits for the Company's
PhaseKrypt decoders. The reliance on third-party manufacturers and sole or
limited suppliers involves a number of risks, including a potential inability to
obtain an adequate supply of required components, subassemblies and printed
circuit boards and reduced control over pricing, quality and timely delivery of
components, subassemblies and printed circuit boards. A significant interruption
in the delivery of any such items or any other circumstance that would require
the Company to seek alternative sources of supply could result in the inability
of the Company to deliver certain of its products on a timely basis, which in
turn could result in a deterioration of the Company's customer relationships and
have a material adverse effect on the Company's business, financial condition
and results of operations.
LEGISLATIVE AND TECHNOLOGY INITIATIVES
The Company has been an active participant in a DVD Copy Protection
Technical Working Group that in 1996 adopted a set of copy protection principles
that established prerequisites for commercial availability of DVD hardware and
media. The Company believes that adoption of these principles will result in
worldwide copy protection standards for DVD players and media. The Technical
Working Group is comprised of representatives from the following associations
and their respective member companies: MPAA, Consumer Electronics Manufacturers
Association, Information Technology Industries Council, Business Software
Alliance, Recording Industry Association of America, Home Recording Rights
Coalition, Interactive Multimedia Association and DVD Manufacturers Consortium.
The Company believes that its copy protection technology is currently the only
digital-to-analog copy protection solution that satisfies these principles. The
Technical Working Group has recommended that copyright legislation be drafted
and enacted throughout the world that would support the technical design
principles and would also outlaw copy protection circumvention devices. Such
legislation, if introduced and enacted into law, would assist the Company in
controlling proliferation of circumvention devices. However, there can be no
assurance that such legislation will be introduced in the United States Congress
or the legislature of any other country, or if it is introduced, that it will
ever be enacted or that all DVD and PC manufacturers will follow industry design
principles and applicable technology-based copy protection schemes.
As noted above under "Competition", Macrovision and Digimarc has submitted
their digital media copyright protection solution in response to a call for
proposals from the CPTWG. The new technology will be based upon the Company's
patented play control technology and Digimarc's patented watermarking
technology, which is very robust and can survive numerous transformations (e.g.,
from digital to analog and back to digital, or from one video format to
another). This jointly developed technology is intended to have the capability
to protect motion pictures and other video content from indiscriminate copying
on
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future digital recording devices. Macrovision and Digimarc are competing with at
least six other companies who have submitted similar proposals to the CPTWG.
INVESTMENTS
COMMAND AUDIO CORPORATION
In October 1995, Command Audio Corporation ("CAC") was incorporated as a
wholly-owned subsidiary of the Company to commercialize a distinct and new
audio-on-demand technology. In June 1996, the Board of Directors of the Company
approved the discontinuation of the Company's involvement in CAC. In August
1996, the Company divested itself of all but 19.8% of the outstanding stock of
CAC. CAC is developing an audio-on-demand system consisting of a program center
that provides continuously updated news and information on a subscription basis
and a hand-held portable receiver that stores the information. The system allows
consumers to control the timing and content of the program playback. CAC has
entered into an agreement with a major consumer electronics manufacturer for
branding, distribution and manufacturing the hand-held receivers. It has also
acquired brand-name content from a variety of respected sources. CAC is on
schedule to begin beta trials in late summer 1998 and is aiming to introduce the
service in two cities in September 1998. The Company has no plans to increase
its ownership above the 19.8% minority position, but does have a right of first
refusal to acquire additional stock to maintain its 19.8% ownership if and when
CAC offers additional stock, subject to certain exceptions. During 1997, the
Company maintained its ownership in CAC of 19.8% with the additional cash
investment of $1,980,000 in connection with various rounds of external
third-party financing obtained by CAC. Additionally, the Company assigned to CAC
all rights in certain technology and released its reversion rights in technology
that the Company had previously assigned to CAC. In consideration of such
assignment and release, CAC agreed to pay to the Company royalties equal to 2.0%
of CAC's gross revenues for 12 years, beginning when CAC has operating revenues
from certain sources or, at the election of the Company, at any time prior
thereto.
DIGIMARC CORPORATION
In December 1997, the Company invested $1,500,000 in Digimarc in exchange
for shares of Digimarc's preferred stock representing 6.8% ownership. Digimarc
is a private company which was founded in 1995 and headquartered in Portland,
Oregon. Its products include proprietary digital watermarking technology used in
information embedding, enabling image identification, copyright protection and
facilitating electronic commerce. Digimarc's family of products include:
PictureMarc(tm) digital watermarking software; MarcCentre(tm) online locator
service; MarcSpider(tm), the first service that searches the Web for digitally
watermarked images; and BatchMarc Pro(tm), batch watermarking software.
C-DILLA LTD.
On February 17, 1998, Macrovision acquired 247,500 shares (approximately
19.8%) of the common stock of C-Dilla, Ltd., a UK company ("C-Dilla") for a
purchase price of L2,121,212 (approximately $3,500,000). C-Dilla is a private
company founded in 1991 and headquartered in Woodley, England. C-Dilla is a
recognized leader in rights management software for high value-added information
and software publishers.
On February 17, 1998, the Company also entered into a Software Marketing
Licence and Development Agreement, (the "Agreement") under which it has
obtained, for an initial five-year term, the world-wide exclusive license to
market in the consumer multimedia software market C-Dilla's proprietary copy
protection technology for CD-ROM and internet-delivered software products. Under
the Agreement, the Company paid L606,060 (approximately $1,000,000) in up-front
license fees subject to offset against future royalties and will pay royalty
payments to C-Dilla of between 30% to 45% of revenues from sales of software
products incorporating C-Dilla's technology. In the event that the Company fails
to reach
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minimum royalty levels of $2,000,000 in year three of the Agreement, $5,000,000
in year four, and $10,000,000 in year five, the license becomes a non-exclusive
license for the term of the Agreement. Additionally, in connection with
C-Dilla's granting of licenses for certain of its products outside of the
markets for which the Company has been granted rights under the Agreement,
C-Dilla will pay to the Company royalties of between 7.5% to 30% of revenues
from such licenses. The Company has the option to extend the initial term of the
Agreement for an additional five year period upon payment of an option fee of
$1,000,000 and an additional license fee of $5,000,000 which fee may be paid
through future increased royalty payments. Under the terms of the Agreement, the
Company and C-Dilla also agreed to develop jointly certain other proprietary
copy protection technologies for CD-ROM, DVD-ROM and other digital delivery
methods.
EMPLOYEES
As of December 31, 1997, the Company had 82 employees, including 8 in
manufacturing, 15 in research, engineering and development, 26 in sales and
marketing plus 8 in technical support and 25 in general and administrative
capacities. Twelve of these employees are based outside of the United States.
None of the Company's employees is covered by a collective bargaining agreement
or is represented by a labor union with respect to employment by the Company.
The Company has not experienced any organized work stoppages and considers its
relations with its employees to be good.
The Company's future performance is highly dependent upon the continued
service of members of the Company's senior management and other key research and
development and sales and marketing personnel. The Company believes that its
future success will also depend upon its continuing ability to identify,
attract, train and retain other highly skilled managerial, technical, sales and
marketing personnel. Hiring for such personnel is competitive, and there can be
no assurance that the Company will be able to retain its key employees or
attract, assimilate or retain the qualified personnel necessary for the
development of its business.
RISK FACTORS
FLUCTUATIONS IN FUTURE OPERATING RESULTS; SEASONALITY
The Company's operating results have fluctuated in the past, and are
expected to continue to fluctuate in the future, on an annual and quarterly
basis as a result of a number of factors. Such factors include, but are not
limited to, the timing of release of popular motion pictures on videocassettes
or DVDs or by digital PPV transmission, the degree of acceptance of the
Company's copy protection technologies by major motion picture studios, the mix
of products sold and technologies licensed, any change in product or license
pricing, the seasonality of revenues, changes in the Company's operating
expenses, personnel changes, the development of the Company's direct and
indirect distribution channels, foreign currency exchange rates and general
economic conditions. The Company may choose to reduce prices or increase
spending in response to competition or new technologies or elect to pursue new
market opportunities. If new competitors, technological advances in the industry
or by existing or new competitors or other competitive factors require the
Company to invest significantly greater resources in research and development or
marketing efforts, the Company's future operating results may be adversely
affected. Because a high percentage of the Company's operating expenses is
fixed, a small variation in the timing of recognition of revenues can cause
significant variations in operating results from period to period.
The Company has experienced significant seasonality in its business, and the
Company's financial condition and results of operations are likely to be
affected by seasonality in the future. The Company has typically experienced its
highest revenues in the fourth quarter of each calendar year followed by lower
revenues and operating income in the first quarter, and at times in subsequent
quarters, of the next year. The Company believes that this trend has been
principally due to the tendency of certain of the Company's customers to release
their more popular motion pictures on videocassettes during the Christmas
shopping season. In addition, revenues have tended to be lower in the summer
months, particularly in Europe.
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Based upon the factors enumerated above, the Company believes that its
quarterly and annual revenues, expenses and operating results could vary
significantly in the future and that period-to-period comparisons should not be
relied upon as indications of future performance. There can be no assurance that
the Company will be able to grow in future periods or that it will be able to
sustain its level of net revenues or its rate of revenue growth on a quarterly
or annual basis. It is likely that, in some future quarter, the Company's
operating results will be below the expectations of stock market analysts and
investors. In such event, the price of the Company's Common Stock could be
materially adversely affected.
DEPENDENCE ON VIDEOCASSETTE COPY PROTECTION TECHNOLOGY AND ADVOCACY BY MAJOR
MOTION PICTURE STUDIOS
The Company currently derives a substantial majority of its net revenues and
operating income from fees for the application of its patented video copy
protection technology to prerecorded videocassettes of motion pictures and other
copyrighted materials that are sold or rented to consumers. Such fees
represented 62.0% and 75.4% of the Company's net revenues during 1997 and 1996,
respectively. The Company expects these fees to account for a majority of the
Company's net revenues and operating income at least through 1998. This portion
of the Company's business has not grown significantly in recent years, and there
can be no assurance that revenues from such fees will grow significantly or at
all. Any future growth in revenues from such fees will depend on the use of the
Company's copy protection technology on a larger number of videocassettes. In
order to increase or maintain its market penetration, the Company must continue
to persuade rights owners that the cost of licensing the technology is
outweighed by the increase in revenues that the rights owners and retailers
would achieve as a result of using copy protection, such as revenues from
additional sales of the copy protected material and/or subsequent revenues from
other venues. In this regard, the Company's copy protection technologies are
intended to deter consumer copying and are not effective against professional
duplication and video processing equipment.
In the event that the major motion picture studios or other customers of the
Company's copy protection technology were to determine that the benefits of
using the Company's technology did not justify the cost of licensing the
technology, demand for the Company's technology would decline. Any factor that
results in a decline in demand for the Company's copy protection technology,
including a change of copy protection policy by the major motion picture studios
or a decline in sales of prerecorded videocassettes that are encoded with the
Company's copy protection technology, would have a material adverse effect on
the Company's business, financial condition and results of operations. Moreover,
the ability of the Company to expand its markets to include additional home
entertainment venues such as digital PPV and DVDs will depend in large part on
the support of the major motion picture studios in advocating the incorporation
of copy protection into the hardware and network infrastructure required to
distribute such video programming. In the event that the motion picture industry
withdraws its support for the Company's copy protection technologies or
otherwise determines not to copy protect a significant portion of prerecorded
video on videocassettes or DVD or digital PPV programs, the Company's business,
financial condition and results of operations would be materially adversely
affected.
DEPENDENCE ON KEY CUSTOMERS
The Company's customer base is highly concentrated among a limited number of
customers, primarily due to the fact that the MPAA studios dominate the motion
picture industry. Historically, the Company has derived a substantial majority
of its net revenues from relatively few customers. Most of the Company's
videocassette and DVD copy protection customers license the Company's technology
on an annual contract basis or simply title-by-title and month-by-month. There
can be no assurance that the Company's current customers will continue to use
the Company's technology at current or increased levels, if at all, or that the
Company will be able to obtain new customers. The loss of, or any significant
reduction in
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revenues from, a key customer would have a material adverse effect on the
Company's business, financial condition and results of operations.
EVOLVING MARKET FOR DVD, DIGITAL PPV, AND CD-ROM COPY PROTECTION
The Company's future growth and operating results will depend to a large
extent on the successful introduction, marketing and commercial viability of
DVDs and digital PPV programming that utilize the Company's copy protection
technologies. A number of factors will affect the Company's ability to derive
revenues from DVD and digital PPV copy protection. These factors include the
cost and effectiveness of the Company's copy protection technology in its
various applications, the development of alternative technologies or standards
for DVD copy protection, the ability of the Company to obtain commitments from
the motion picture studios to require copy protection on DVD media and digital
PPV transmissions and the relative ease of copying, as well as the quality of
the copies of, unprotected video materials distributed in new digital formats.
Because of their early stages of development, demand for and market acceptance
of DVD and digital PPV, as well as demand for associated copy protection, are
subject to a high level of uncertainty. Much of the DVD and digital PPV
technology and infrastructure is unproven, and it is difficult to predict with
any assurance whether, or to what extent, these evolving markets will grow. In
this regard, the Company's future growth would be adversely affected if DVD
players and digital PPV set-top decoders that do not include the Company's copy
protection components achieve market acceptance.
While the Company's copy protection capability is embedded in approximately
seven million digital set-top decoders manufactured by certain of the leading
set-top decoder manufacturers, only four programmers on one direct broadcast
satellite network in Japan have activated copy protection for digital PPV
programming. These four programmers distribute adult PPV programming and the
Japanese government has required that all such programming be copy protected.
There can be no assurance that any of the MPAA studios will require copy
protection for any of their PPV motion pictures or that PPV system operators
will activate such copy protection in other digital PPV networks outside of
Japan. Moreover, consumers may react negatively to copy protected PPV
programming because, to date, they have routinely copied for later viewing
analog cable and satellite-delivered subscription television ("Pay TV") and PPV
programs, as well as free broadcast programming. In addition, there can be no
assurance that certain television sets or combinations of VCRs and television
sets will not exhibit impaired pictures while displaying a copy protected DVD or
digital PPV program. If there is consumer dissatisfaction that cannot be
managed, or if there are technical compatibility problems, the Company's
business, financial condition and results of operations would be materially
adversely affected. If the market for DVD or digital PPV copy protection fails
to develop or develops more slowly than expected, or if the Company's solution
does not achieve or sustain market acceptance, the Company's business, financial
condition and results of operations would be materially adversely affected.
The Company, through its agreements with Digimarc and others, is attempting
to expand its copy protection business into the next generation DVD machines.
There can be no assurance that such DVD machines will be developed or, if
developed, will achieve market acceptance. Furthermore, there can be no
assurance that the Company's digital video watermarking solution will be
selected as the standard by the CPTWG or that there will be adequate demand for
the use of the Company's digital-to-digital copy protection technology in
connection with such DVD machines to justify its development and support
expense.
In the CD-ROM computer software market, the Company expects to enter a new
market that is as yet unproven. There can be no assurance that there will be
adequate demand for the Company's CD-ROM copy protection products to justify its
development and support expense. The Company knows of various potential
competitors currently at various phases of technological development.
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DEPENDENCE ON PROPRIETARY TECHNOLOGY
The Company's success is heavily dependent upon its proprietary
technologies. The Company relies primarily on a combination of patent,
trademark, copyright and trade secret laws, nondisclosure and other contractual
provisions, and technical measures to protect its intellectual property rights.
The Company holds 35 United States patents and has 33 United States patent
applications pending, of which five are allowed. In addition, the Company has
113 foreign patents and 180 foreign patent applications pending. There can be no
assurance that any patent, trademark or copyright owned by the Company will not
be challenged and invalidated or circumvented, that patents will issue from any
of the Company's pending or future patent applications or that any claims in
issued patents or pending patent applications will be of sufficient scope or
strength or be issued in all countries where the Company's products can be sold
or its technologies can be licensed to provide meaningful protection or any
commercial advantage to the Company. There can be no assurance that the
expiration of any of the Company's patents will not have a material adverse
effect on the Company's business, financial condition and results of operations.
Further, there can be no assurance that others will not develop technologies
that are similar or superior to the Company's technologies, duplicate the
Company's technologies or design around the patents owned by the Company.
Effective intellectual property protection may be unavailable or limited in
certain foreign countries. Despite the Company's efforts to protect its
proprietary rights, unauthorized parties may attempt to copy or otherwise use
aspects of the Company's processes and devices that the Company regards as
proprietary. Policing unauthorized use of the Company's proprietary information
is difficult, and there can be no assurance that the steps taken by the Company
will prevent misappropriation of its technologies. In the event that the
Company's intellectual property protection is insufficient to protect the
Company's intellectual property rights, the Company could face increased
competition in the market for its products and technologies, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
From time to time, the Company may receive claims from third parties that
the Company's technologies and products infringe the intellectual property
rights of such third parties. Any such claims, with or without merit, could be
time consuming to defend, result in costly litigation, cause product shipment
delays or require the Company to cease utilizing the infringing technology
unless it can enter into royalty or licensing agreements. Such royalty or
licensing agreements might not be available on terms acceptable to the Company,
or at all, which could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company has been notified
that a Japanese company has filed an invalidation claim against one of
Macrovision's anti-copy patents in Japan. The Company and its Japanese patent
counsel believe this claim is without merit and will aggressively contest the
claim in the Japanese Patent Office.
The Company has eight United States and 21 foreign patents covering a number
of processes and devices that unauthorized parties could use to circumvent the
Company's copy protection technologies. The Company uses these patents to limit
the proliferation of devices intended to circumvent the Company's copy
protection technologies. The Company has initiated a number of patent
infringement disputes against manufacturers and distributors of such devices.
The Company has one lawsuit of this type pending to require the defendants to
discontinue the sale of devices that circumvent the Company's copy protection
technologies and infringe one or more of the company's circumvention patents. In
the event of an adverse ruling in this litigation or in any similar litigation,
the Company may suffer from the legal availability of such a circumvention
device or obtain rights to the offending devices. Legislation is before the
Congress of the United States and certain foreign legislative bodies to make
such circumvention devices illegal. The Company is aggressively pursuing a
successful result in these legislative bodies to make such circumvention devices
illegal irrespective of any patent position held by the Company.
Additional litigation may be necessary in the future to limit the sale of
defeat technologies, to enforce the Company's patents and other intellectual
property rights, to protect the Company's trade secrets, to determine the
validity and scope of the proprietary rights of others or to defend against
claims of
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infringement or invalidity. There can be no assurance that any such litigation
will be successful. Such litigation could result in substantial costs and
diversion of resources and could have a material adverse effect on the Company's
business, financial condition and results of operations, whether or not such
litigation is determined adversely to the Company. In the event of an adverse
ruling in any such litigation, the Company may be required to pay substantial
damages, discontinue the use and sale of infringing products, expend significant
resources to develop non-infringing technology or obtain licenses to infringed
technology. The failure of the Company to develop or license a substitute
technology could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, such an adverse
ruling could result in the increased proliferation of devices that defeat the
Company's copy protection technology, which could result in a decline in demand
for the Company's technologies.
RAPID TECHNOLOGICAL CHANGE
The video security industry in which the Company competes, and in which its
technologies and products are utilized, is characterized by rapid technological
change, frequent product introductions and enhancements, changes in customer
demands and evolving industry standards. The emergence of new industry standards
and the introduction of new technologies or products embodying new technologies
can render existing technologies or products obsolete and unmarketable. For
example, new industry standards for VCRs or television sets could adversely
affect the effectiveness or transparency of the Company's copy protection
technology. The Company's videocassette copy protection technology exploits the
automatic gain control ("AGC") circuit in VHS VCRs. While most VCR manufacturers
use a standard AGC circuit that responds to the Company's copy protection
process, there can be no assurance that VCR manufacturers will not use
alternative AGC circuits that do not respond to the Company's copy protection
technology, thereby lessening the effectiveness of the Company's consumer copy
protection solution over time as new VCRs are sold into the market. Moreover,
there can be no assurance that television manufacturers will continue to design
television sets that are transparent to the Company's copy protection
technologies when they display original, copy protected videocassettes, DVDs and
digital PPV programming.
The Company is attempting to expand its copy protection business into the
next generation DVD machines and is competing with a host of companies, many of
whom have far greater resources than Macrovision or its partners. There can be
no assurance that the Company's digital video watermarking solution will be
selected as the standard by the CPTWG. In addition, the IEEE 1394 transmission
protocol has been proposed as another solution to digital-to-digital copy
protection. The Company believes that the IEEE 1394 technology is complimentary
to digital video watermarking, but there can be no assurance that the CPTWG
would not adopt IEEE 1394 as the primary digital -to-digital copy protection
technology.
In the CD-ROM computer software market, the Company expects to enter a
rapidly developing new market with a copy protection technology that is as yet
unproven. The Company knows of several competitors at various stages of
technological development. There can be no assurance that the Company's
technology will be accepted under emerging industry standards or will meet, and
continue to meet, the changing demands of software providers.
The success of the Company's PhaseKrypt video scrambling technology will
depend upon the growth of analog cable Pay TV networks in the Pacific Rim, South
America and other developing countries and the ability of the Company's
licensees to sell into those markets. The development of lower cost digital
video scrambling systems could result in a transition from analog to digital
scrambling systems in the developing cable Pay TV markets and a reduction in
demand for the Company's PhaseKrypt video scrambling technology.
The Company's future success will depend in large part on its ability to
enhance its current technologies and products in a timely, cost-effective manner
and to develop new technologies and products that meet changing market
conditions, which include emerging industry standards, changing customer
demands, new competitive product offerings and changing technology. There can be
no assurance that the
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Company will be successful in developing and marketing, on a timely and
cost-effective basis or at all, fully functional and integrated product
enhancements or new technologies or products that respond to technological
change, updates or enhancements to other consumer electronics products, changes
in customer requirements or evolving industry standards; that the Company will
not experience difficulties that delay or prevent the successful development,
introduction and license or sale of such enhancements, technologies or products;
or that any such enhancements, technologies or products will adequately meet the
requirements of the marketplace and achieve market acceptance. Any failure by
the Company to anticipate or to respond adequately to changing market
conditions, or any significant delays in technology or product development or
introduction, could cause customers to delay or decide against licensing or
purchasing the Company's technologies or products and would have a material
adverse effect on the Company's business, financial condition and results of
operations.
RISKS OF DEFEAT TECHNOLOGIES
Attempts by third parties to defeat the Company's copy protection
technologies have been and are expected to be a persistent problem. To
anticipate such attempts, the Company has developed and patented a number of
processes and devices in the videocassette field that could be used by
unauthorized parties to circumvent its copy protection technologies. The Company
has then attempted to use these patents as barriers to the manufacture and sale
of such devices by others. The Company has no such patents in the DVD or CD-ROM
fields. Notwithstanding the Company's patent position, a number of devices have
been available, and currently are available, that defeat copy protection.
Moreover, the Company's copy protection technologies are not effective against
professional duplication and video processing equipment. There can be no
assurance that third parties will not be able to develop defeat technologies
that do not infringe the Company's patents or that the Company will be able to
obtain patents on defeat technologies developed in the future. A number of
factors could cause copyright holders to choose not to use the Company's copy
protection technology, including a perception that the inability of the
Company's technology to deter professional pirates renders the Company's
technology less useful, the interference with the legitimate consumer use of the
original copyrighted product, the commercial availability of products that
defeat the Company's copy protection technology, or any significant reduction in
the effectiveness of the Company's copy protection technology in deterring
consumer copying. Any reduction in demand for the Company's products could have
a material adverse effect on the Company's business, financial condition and
results of operations.
DEPENDENCE ON SUPPLIERS AND THIRD-PARTY MANUFACTURERS
The Company depends upon third-party manufacturers and suppliers for
components, subassemblies and printed circuit boards used in its VES products,
PhaseKrypt encoders, PhaseKrypt decoder components and videocassette copy
protection processors. The Company's product designs are proprietary but
generally incorporate industry-standard hardware components that are obtainable
from multiple sources. The Company's ability to deliver its products in a timely
manner depends upon the availability of quality components and subassemblies
used in these products and, in part, on the ability of subcontractors to
manufacture, assemble and deliver certain items in a timely and satisfactory
manner. The Company obtains certain electronic components and subassemblies from
a single source or a limited number of sources. For example, one such company is
currently the Company's sole source of integrated circuits for the Company's
PhaseKrypt decoders and another is currently the sole source of integrated
decoders for CineGuard video projectors. The reliance on third-party
manufacturers and sole or limited suppliers involves a number of risks,
including a potential inability to obtain an adequate supply of required
components, subassemblies and printed circuit boards and reduced control over
pricing, quality and timely delivery of components, subassemblies and printed
circuit boards. A significant interruption in the delivery of any such items or
any other circumstance that would require the Company to seek alternative
sources of supply could result in the inability of the Company to deliver
certain of its products on a timely basis, which in
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turn could result in a deterioration of the Company's customer relationships and
have a material adverse effect on the Company's business, financial condition
and results of operations.
NEED TO ESTABLISH AND MAINTAIN LICENSING RELATIONSHIPS
The Company's future success will depend in part upon its ability to
establish and maintain licensing relationships with companies in related
business fields, including videocassette duplicators, international distributors
of videocassettes, DVD authoring houses and replicators, semiconductor and
equipment manufacturers, operators of digital PPV systems, consumer electronics
hardware manufacturers and video cinema exhibitors. The Company believes that
these current and future relationships can allow the Company greater access to
manufacturing, sales and distribution resources. However, the amount and timing
of resources to be devoted to these activities by such other companies are not
within the Company's control. There can be no assurance that the Company will be
able to maintain its existing relationships or enter into beneficial
relationships in the future, that other parties will perform their obligations
as expected or that the Company's reliance on others for the development,
manufacturing and distribution of its technologies and products will not result
in unforeseen problems. Substantially all of the Company's license agreements
are non-exclusive, and therefore such licensees are free to enter into similar
agreements with third parties, including the Company's current or potential
competitors. There can be no assurance that the Company's licensees will not
develop or pursue alternative technologies either on their own or in
collaboration with others, including the Company's competitors, as a means of
developing or marketing products targeted by the collaborative programs and by
the Company's products. The failure of any of the Company's current or future
collaboration efforts could have a material adverse effect on the Company's
ability to introduce new products or applications and therefore could have a
material adverse effect on the Company's business, financial condition and
results of operations.
COMPETITION
The Company believes that it has had no significant videocassette copy
protection competitor for the last five years other than companies that have
occasionally developed hardware based on the Company's technology in foreign
countries where the Company does not have patents issued. It is possible,
however, that a competitive copy protection technology could be developed in the
future. For example, the Company's customers could attempt to promote
competition by supporting the development of alternative copy protection
technologies or solutions, including solutions that deter professional
duplication. Increased competition would be likely to result in price reductions
and loss of market share, either of which could materially adversely affect the
Company's business, financial condition and results of operations.
The market for video scrambling products is highly competitive. The Company,
as a recent entrant into these markets, competes directly or through licensed
manufacturers with many companies, including Scientific-Atlanta, Inc., General
Instrument Corporation, Leitch Technology International, Inc., Zenith
Electronics Corporation and Toshiba Corporation. These companies have
substantially greater name recognition, larger installed customer bases and
market share and significantly greater financial, technical, marketing and other
resources than the Company and its licensees, many of which are manufacturing
and selling addressable set-top decoders for the first time. There can be no
assurance that the Company and its licensees will be able to compete
successfully in the video scrambling systems markets, that the Company will be
able to make technological advances necessary to improve or even maintain its
competitive position or that the Company's products will achieve market
acceptance. In addition, there can be no assurance that technological changes or
development efforts by the Company's competitors will not render the Company's
video scrambling products obsolete or uncompetitive.
The Company and Digimarc have submitted a digital media copyright protection
solution in response to a call for proposals from the CPTWG. The Company and
Digimarc are competing with at least six other companies who have submitted
similar proposals to the CPTWG. Certain of these companies have
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substantially greater name recognition and significantly greater financial,
technical, marketing and other resources than the Company and Digimarc. There
can be no assurance that the proposal by Company and Digimarc will be accepted
by the CPTWG, or even if accepted by the CPTWG will be implemented by consumer
electronics manufacturers, PC platform companies, or their suppliers for
digital-to-digital copy protection. If the solution being developed by the
Company and Digimarc is not the CPTWG's accepted solution, the Company and
Digimarc will be at a competitive disadvantage in marketing their solution.
RISKS ASSOCIATED WITH INTERNATIONAL AND EXPORT SALES
In 1997 and 1996, international and export sales together represented 46.5%
and 37.9%, respectively, of the Company's net revenues. The Company expects that
such sales will continue to represent a substantial portion of its net revenues
for the foreseeable future. The Company's future growth will depend to a large
extent on worldwide deployment of addressable analog cable television systems,
as well as digital PPV programming and DVDs and the use of copy protection in
these media. To the extent that foreign governments impose restrictions on
importation of programming, technology or components from the United States, the
requirement for copy protection and video scrambling in these markets would
diminish. Any limitation on the growth of these markets or the Company's ability
to sell its products or license its technologies into these markets would have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, the laws of certain foreign countries may
not protect the Company's intellectual property rights to the same extent as do
the laws of the United States, which increases the risk of unauthorized use of
the Company's technologies and the ready availability or use of defeat
technologies. Such laws also may not be conducive to copyright protection of
video materials and digital media, which reduces the need for the Company's copy
protection and video scrambling technologies.
Due to its reliance on international and export sales, the Company is
subject to the risks of conducting business internationally, including foreign
government regulation and general geopolitical risks such as political and
economic instability, potential hostilities and changes in diplomatic and trade
relationships. International and export sales are subject to other risks, such
as changes in, or imposition of, regulatory requirements, decision making
control to use the Company's products by studio headquarters operations, tariffs
or taxes and other trade barriers and restrictions, foreign government
regulations, fluctuations in currency exchange rates, interpretations or
enforceability of local patent or other intellectual property laws, longer
payment cycles, difficulty in collecting accounts receivable, potentially
adverse tax consequences, the burdens of complying with a variety of foreign
laws, difficulty in staffing and managing foreign operations and political and
economic instability. For example, under the United States Export Administration
Act of 1979, as amended, and regulations promulgated thereunder, encryption
algorithms such as those used in the Company's video scrambling technologies are
classified as munitions and subject to stringent export controls. Any changes to
the statute or the regulations with respect to export of encryption technologies
could require the Company to redesign its products or technologies or prevent
the Company from selling its products and licensing its technologies
internationally. While international and export sales are typically denominated
in United States dollars, fluctuations in currency exchange rates could cause
the Company's products to become relatively more expensive to customers in a
particular country, leading to a reduction in sales or profitability in that
country. There can be no assurance that the Company's future results of
operations will not be materially adversely affected by currency fluctuations.
There can be no assurance that foreign markets will continue to develop or that
the Company will receive additional orders to supply its products for use in
foreign transmission systems. The Company's business and operating results could
be materially adversely affected if foreign markets do not continue to develop,
or if the Company does not receive additional orders to supply its technologies
or products for use in foreign prerecorded video, PPV and Pay TV networks and
other applications requiring the Company's video security solutions.
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MANAGEMENT OF GROWTH
The growth of the Company's business has placed, and is expected to continue
to place, significant demands on the Company's personnel, management and other
resources. The Company's future results of operations will depend in part on the
ability of its officers and other key employees to continue to implement and
expand its operational, customer support and financial control systems and to
expand, train and manage its employee base. In order to manage its future
growth, if any, successfully, the Company will be required to hire additional
personnel and to augment its existing financial and management systems or to
implement new such systems. There can be no assurance that management will be
able to augment or to implement such systems efficiently or on a timely basis,
and the failure to do so could have a material adverse effect on the Company's
business, financial condition or results of operations. There can be no
assurance that the Company will be able to manage any future expansion
successfully, and any inability to do so would have a material adverse effect on
the Company's business, financial condition or results of operations.
DEPENDENCE ON KEY PERSONNEL
Because of the specialized nature of the Company's business, the Company's
future performance is highly dependent upon the continued service of members of
the Company's senior management and other key research and development and sales
and marketing personnel. The loss of any of such persons could have a material
adverse effect on the Company's business, financial condition and results of
operations. The Company does not have employment contracts for a fixed term with
any of its employees in the United States. The Company believes that its future
success will depend upon its continuing ability to identify, attract, train and
retain other highly skilled managerial, technical, sales and marketing
personnel. Hiring for such personnel is competitive. There can be no assurance
that the Company will be able to continue to attract, assimilate and retain the
qualified personnel necessary for the development of its business. The failure
to recruit additional key personnel in a timely manner, or the failure to retain
new or current personnel, would have a material adverse effect on the Company's
business, financial condition and results of operations.
TRANSACTIONS WITH COMPANY AFFILIATES
The Company is a party to a number of transactions with affiliated entities.
Victor Company of Japan, Limited ("JVC"), the parent of a principal stockholder
of the Company, licenses and utilizes various technologies of the Company
pursuant to several agreements. Matsushita Electric Industrial Co., Ltd., which
owns approximately 52% of JVC, also is a party to various agreements with the
Company. In addition, the Company has certain agreements with a former
subsidiary, Command Audio Corp., in which it currently has a 19.8% interest.
LITIGATION RISK
SWYT LITIGATION
In October 1995, Joseph Swyt, a former officer and director of the Company,
filed suit against the Company in the Superior Court of the State of California
alleging monetary damages suffered as a result of alleged fraud,
misrepresentation and other malfeasance in connection with the Company's grant
of stock options to him. Mr. Swyt maintains that the Company induced him to
accept employment by falsely representing to him that the options granted to him
eventually would have substantial value. Between August 1990 and December 1993,
the Company granted to him options to purchase approximately 200,000 shares with
per-share exercise prices of $2.25 or $2.70. Substantially all of these options
expired unexercised within three months following his departure from the Company
in June 1995. In December 1996, the court ordered this matter to binding
arbitration in accordance with a written agreement between Mr. Swyt and the
Company. The arbitration agreement contains limitations on the types of damages
available to him
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and expressly precludes punitive damages. Mr. Swyt filed his claim in
arbitration for this matter with the American Arbitration Association in June
1997 and the arbitration is proceeding. The Company believes that the case is
without merit and intends to contest it vigorously. In the opinion of counsel,
it is not possible to determine with precision the probable outcome or the
amount of liability, if any, under this lawsuit. However, a decision against the
Company could have a material adverse effect on the Company's business,
financial condition and results of operations.
PATENT LITIGATION
The Company has been notified that a Japanese company has filed an
invalidation claim against one of Macrovision's anti-copy patents in Japan. The
Company and its Japanese patent counsel believe this claim is without merit and
will aggressively contest the claim in the Japanese Patent Office. From time to
time, the Company may receive claims from third parties that the Company's
technologies and products infringe the intellectual property rights of such
third parties. Any such claims, with or without merit, could be time consuming
to defend, result in costly litigation, cause product shipment delays or require
the Company to cease utilizing the infringing technology unless it can enter
into royalty or licensing agreements. Such royalty or licensing agreements might
not be available on terms acceptable to the Company, or at all, which could have
a material adverse effect on the Company's business, financial condition and
results of operations.
The Company has initiated one patent infringement lawsuit to require the
defendants to discontinue the sale of devices that circumvent the Company's copy
protection technologies and infringe one or more of the Company's circumvention
patents. In the event of an adverse ruling of this litigation, the Company may
suffer from the legal availability of such a circumvention device or obtain
rights to the offending devices. Legislation is before the Congress of the
United States and certain foreign legislative bodies to make such circumvention
devices illegal.
EFFECT OF ANTI-TAKEOVER PROVISIONS
The Company's Board of Directors has the authority to issue up to 5,000,000
shares of Preferred Stock and to determine the price, rights, preferences,
privileges and restrictions, including voting rights, of those shares without
any further vote or action by the stockholders. The rights of the holders of
Common Stock will be subject to, and may be adversely affected by, the rights of
the holders of any Preferred Stock that may be issued in the future. The
issuance of Preferred Stock may delay, defer or prevent a change in control of
the Company. The Company has no present plans to issue shares of Preferred
Stock; however, in the future the Company has the option to consider the
adoption of a stockholder rights plan in order to protect the Company's
stockholders from coercive or abusive takeover tactics and to afford the
Company's Board of Directors more negotiating leverage in dealing with potential
acquirors. Additionally, the Company's charter documents contain a provision
eliminating the ability of the Company's stockholders to take action by written
consent. This provision is designed to reduce the vulnerability of the Company
to an unsolicited acquisition proposal, to maintain independent ownership and
control of the Company's copy protection technologies and to render the use of
stockholder written consent unavailable as a tactic in a proxy fight. However,
such provision could have the effect of discouraging others from making tender
offers for the Company's shares, thereby inhibiting increases in the market
price of the Company's shares that could result from actual or rumored takeover
attempts. Such provision also may have the effect of preventing changes in the
management of the Company. Further, the Company's Bylaws limit the ability of
stockholders of the Company to raise matters at a meeting of stockholders
without giving advance notice thereof. In addition, Section 203 of the Delaware
General Corporation Law, to which the Company is subject, restricts certain
business combinations with any "interested stockholder" as defined by such
statute. The statute may delay, defer or prevent a change in control of the
Company.
Pursuant to the terms of a Copy Protection Technology Agreement (the
"Technology Agreement") between the Company and Victor Company of Japan, Limited
("JVC"), the Company has agreed to
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<PAGE>
continue to license its copy protection technologies to third parties in the
event of the acquisition of the Company by a party other than JVC. Further, the
Company has granted to JVC the right to sublicense the Company's copy protection
technologies in the event that the Company fails to make its copy protection
technologies generally available for licensing to third parties following an
acquisition of the Company. The Technology Agreement could have the effect of
making the Company less attractive to third parties as an acquisition candidate.
POTENTIAL VOLATILITY OF STOCK PRICE
The market price of the Company's Common Stock is likely to be highly
volatile and could be significantly affected by factors such as actual or
anticipated fluctuations in the Company's operating results, announcements of
technical innovations, new products or new contracts by the Company, its
competitors or their customers, governmental regulatory action, developments
with respect to patents or proprietary rights, changes in financial estimates by
securities analysts, general market conditions and other factors, certain of
which could be unrelated to, or outside the control of, the Company. In
addition, announcements by the MPAA or its members, satellite television
operators, cable television operators, government agencies or others regarding
motion picture distribution, business combinations or other developments could
cause the market price of the Company's Common Stock to fluctuate substantially.
The stock market has from time to time experienced significant price and volume
fluctuations that have particularly affected the market prices for the common
stocks of technology companies and that often have been unrelated or
disproportionate to the operating performance of such companies. Further, the
trading prices of many technology companies' stocks are at or near historical
highs and reflect price/earnings ratios substantially above historical levels.
There can be no assurance that these trading prices and price/earnings ratios
will be sustained. In the past, following periods of volatility in the market
price of a company's securities, securities class action litigation often has
been initiated against such company. There can be no assurance that such
litigation will not occur in the future with respect to the Company. Such
litigation, if instituted, could result in substantial costs and a diversion of
management's attention and resources, which could have a material adverse effect
on the Company's business, financial condition and results of operations. Any
settlement or adverse determination in such litigation could also subject the
Company to significant liability, which could have a material adverse effect on
the Company's business, financial condition and results of operations. These
market price fluctuations, as well as general economic, political and market
conditions such as recessions or international currency fluctuations, may
adversely affect the market price of the Common Stock.
DIVIDEND POLICY
The Company currently anticipates that it will retain all future earnings
for use in its business and does not anticipate that it will pay any in the
foreseeable future. The payment of any future dividends will be at the
discretion of the Company's Board of Directors and will depend upon, among other
things, future earnings, operations, capital requirements and the general
financial condition of the Company, general business conditions and contractual
restrictions on payment of dividends, if any.
ITEM 2. DESCRIPTION OF FACILITIES
The Company's principal operations are located in a 43,960 square foot
building in Sunnyvale, California. The Company's lease for this building expires
on June 30, 2002. The Company also leases space for sales, marketing and
technical support operations near London, England and in Tokyo, Japan. The
Company believes that its existing facilities are adequate to meet its current
needs.
28
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
SWYT LITIGATION
In October 1995, Joseph Swyt, a former officer and director of the Company,
filed suit against the Company in the Superior Court of the State of California
alleging monetary damages suffered as a result of alleged fraud,
misrepresentation and other malfeasance in connection with the Company's grant
of stock options to him. Mr. Swyt maintains that the Company induced him to
accept employment by falsely representing to him that the options granted to him
eventually would have substantial value. Between August 1990 and December 1993,
the Company granted to him options to purchase approximately 200,000 shares with
per-share exercise prices of $2.25 or $2.70. Substantially all of these options
expired unexercised within three months following his departure from the Company
in June 1995. In December 1996, the court ordered this matter to binding
arbitration in accordance with a written agreement between Mr. Swyt and the
Company. The arbitration agreement contains limitations on the types of damages
available to him and expressly precludes punitive damages. Mr. Swyt filed his
claim in arbitration for this matter with the American Arbitration Association
in June 1997 and the arbitration is proceeding. The Company believes that the
case is without merit and intends to contest it vigorously. In the opinion of
counsel, it is not possible to determine with precision the probable outcome or
the amount of liability, if any, under this lawsuit. However, a decision against
the Company could have a material adverse effect on the Company's business,
financial condition and results of operations.
PATENT LITIGATION
The Company has been notified that a Japanese company has filed an
invalidation claim against one of Macrovision's anti-copy patents in Japan. The
Company and its Japanese patent counsel believe this claim is without merit and
will be aggressively contested by the Company in the Japanese Patent Office.
From time to time, the Company may received claims from third parties that the
Company's technologies and products infringe the intellectual property rights of
such third parties, and the Company may receive similar claims in the future.
Any such claims, with or without merit, could be time consuming to defend,
result in costly litigation, cause product shipment delays or require the
Company to cease utilizing the infringing technology unless it can enter into
royalty or licensing agreements. Such royalty or licensing agreements might not
be available on terms acceptable to the Company, or at all, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company has initiated one lawsuit to require the defendants to
discontinue the sale of devices that circumvent the Company's copy protection
technologies and infringe one or more of the company's circumvention patents. In
the event of an adverse ruling of this litigation, the Company may suffer from
the legal availability of such a circumvention device or obtain rights to the
offending devices. Legislation is before the Congress of the United States and
certain foreign legislative bodies to make such circumvention devices illegal.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the Company's fiscal year ended December 31, 1997.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
In connection with the IPO, the Company applied for and was granted
inclusion of its securities for quotation on the NASDAQ National Market
("Nasdaq"). Consequently, the Common Stock commenced on quotation on NASDAQ,
commencing March 17, 1997, under the symbol "MVSN."
29
<PAGE>
The following table sets forth, for the periods indicated, the reported high
and low bid and asked price quotations for the Common Stock for the period from
March 17, 1997 (when the Company's securities commenced quotation on NASDAQ)
through December 31, 1997 (the end of the Company's most recent fiscal year).
These quotations reflect prices between dealers and do not include retail
mark-ups, mark-downs or commissions and may not necessarily represent actual
transactions.
COMMON STOCK
<TABLE>
<CAPTION>
PERIOD OF QUOTATION HIGH LOW
- ------------------------------------------------------------------------ --------- ---------
<S> <C> <C>
1st Quarter 1997 (Commencing March 17, 1997)............................ $ 9.000 $ 8.000
2nd Quarter 1997........................................................ $ 14.750 $ 8.250
3rd Quarter 1997........................................................ $ 18.125 $ 12.750
4th Quarter 1997........................................................ $ 17.125 $ 12.750
</TABLE>
As of March 20, 1998, there were 123 holders of record of Common Stock based
upon information furnished by Boston EquiServe, Boston, MA, the transfer agent
for the Company's securities. The Company believes, based upon security
positions listings, that there are more than 600 beneficial owners of the Common
Stock. The closing price of the Company's securities as reported on NASDAQ on
March 20, 1998 was $19.00 per share of Common Stock. As of March 20, 1998 there
were 7,271,866 shares of Common Stock outstanding.
The Company does not anticipate paying any cash dividends on its Common
Stock in the foreseeable future. The Company intends to retain all earnings for
use in the Company's business operations and in the expansion of its business.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION IN THE SECTION "MANAGEMENTS'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS" CONTAINS TREND
ANALYSIS AND OTHER FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A
OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934, AS AMENDED. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF RISK FACTORS,
INCLUDING, WITHOUT LIMITATION, THOSE SET FORTH ABOVE IN THE SECTION "RISK
FACTORS".
OVERVIEW
Macrovision was founded in 1983 to develop video security solutions for
major motion picture studios and independent video producers. Since that time,
the Company has derived most of its revenues and operating income from licensing
its video copy protection technologies. The Company expects such license fees to
account for a majority of the Company's net revenues and operating income at
least through 1998. The Company's videocassette copy protection customers have
included the home video divisions of the seven members of the MPAA. The Company
also has a variety of special interest videocassette copy protection customers,
including more than 125 videocassette duplication companies and a number of
rights holders, such as independent producers of exercise, sports and
educational videocassettes. The Company typically receives license fees for
videocassette copy protection based upon the number of copy protected
videocassettes that are produced by MPAA studios or other rights holders.
License fees from MPAA studios represented a majority of such fees in 1997 and
1996.
In 1993, the Company began licensing its digital PPV video copy protection
technologies to satellite and cable television system operators and to the
equipment manufacturers that supply the satellite and cable television
industries. These manufacturers include in their digital set-top decoders
integrated circuits incorporating the Company's copy protection technologies
that can be activated to apply video copy protection to digital PPV
transmissions. The Company's digital PPV copy protection revenues have been
derived from up-front license fees, hardware royalties and limited PPV
programming royalties. Digital
30
<PAGE>
PPV up-front license fees, hardware royalties and PPV programming royalties
increased to 18.2% of the Company's net revenues in 1997 from 12.2% in 1996. The
Company's agreements with digital PPV system operators entitle the Company to
transaction-based royalty payments at such time as copy protection for digital
PPV programming is activated.
In 1994, the Company began licensing and selling its PhaseKrypt video
scrambling technology to manufacturers of analog set-top decoders for sale to
cable television system operators in developing cable television markets. The
Company also sells other analog scrambling systems to television broadcasters
for securing incoming contribution circuits to network control centers and
outbound rebroadcast circuits to affiliate and regional stations. Finally, the
Company sells specialized analog video scrambling systems in the government,
military and law enforcement markets, primarily for covert surveillance
applications. Video scrambling revenues increased to 13.5% of the Company's net
revenues in 1997 from 12.1% in 1996. Gross margins on sales of the Company's
video scrambling products have been significantly lower than on its licenses of
copy protection or video scrambling technologies because of the hardware product
costs associated with a more traditional manufacturing environment. The Company
expects this to continue for the foreseeable future.
In 1995, the Company introduced PhaseKrypt video scrambling technology for
use in motion picture theaters using large-screen video projectors and scrambled
Super VHS videocassettes as a complement to film projectors and 35mm film
prints. CineGuard, the Company's theatrical exhibition alternative, is intended
for small theaters in rural towns in international markets where the population
is not large enough to support traditional film theaters or where exhibitors
must wait long periods of time to receive film prints of first-run motion
pictures. In 1997, the Company discontinued its CineGuard operations in Poland,
Ireland and South Africa due to lack of demand from local exhibitors. The
Company has an existing Master Licensee in the Philippines and will continue to
license CineGuard to interested parties. Revenues from CineGuard theaters have
been insignificant to date and are expected to remain insignificant in the
future.
In October 1995, Command Audio Corporation ("CAC") was incorporated as a
wholly-owned subsidiary of the Company to commercialize a distinct and new
audio-on-demand technology that the Company's founder developed during 1994 and
1995. This technology does not involve copy protection or video scrambling, but
rather stores digitally broadcast audio programs so that a user can listen to
these programs at his or her convenience. For example, a traveler can listen to
content that was actually broadcast earlier. During 1996, the Company recognized
that its technological, sales and marketing core competencies would not be
sufficient to develop the CAC technology fully or to exploit the market
opportunities for it. In June 1996, the Board of Directors of the Company
approved the discontinuation of the Company's involvement in CAC. The decision
to spin off CAC was primarily caused by the fact that the Company lacked the
financial resources to pursue both its core business of copy protection and
video scrambling and the CAC business. The Company felt that the CAC business
would require significant additional investment to exploit the technology
commercially, including setting up manufacturing alliances and distribution
arrangements. Although the Company decided that its resources should be focused
on its core business, it recognized the significant opportunities for the CAC
business. In August 1996, the Company divested itself of all but 19.8% of its
ownership in CAC. As a result, the financial results of CAC have been treated as
discontinued operations.
In 1997, the Company derived its first revenues from royalties and hardware
license fees associated with DVDs. The initial customers implementing the DVD
copy protection, from which the royalties have been derived, have been members
of the MPAA. The Company expects revenues from DVD media copy protection to
increase in 1998 as DVD players are accepted into the market place. Revenues
from DVD royalties in 1997 were not significant.
The Company's cost of revenues consists primarily of manufacturing costs
associated with the Company's video scrambling product revenues, service fees
paid to licensed duplicators that apply the
31
<PAGE>
Company's videocassette copy protection whenever rights owners license the
technology directly from the Company, and costs associated with equipment used
in applying the copy protection process at the licensed duplicators. Also
included in cost of revenues are patent amortization costs and legal costs
associated with the Company's efforts to prevent the sale of devices that
attempt to circumvent the Company's video copy protection technologies. The
Company's research and development expenses are comprised primarily of employee
compensation and benefits, consulting fees, tooling and supplies and an
allocation of facilities costs. The Company's selling, general and
administrative expenses are comprised primarily of employee compensation and
benefits, consulting and recruiting fees, travel, advertising, professional fees
and an allocation of facilities costs.
The Company has experienced significant seasonality in its business, and the
Company's financial condition and results of operations are likely to be
affected by seasonality in the future. The Company has typically experienced its
highest revenues in the fourth quarter of each calendar year followed by lower
revenues and operating income in the first quarter, and at times in subsequent
quarters, of the next year. The Company believes that this trend has been
principally due to the tendency of certain of the Company's customers to release
their more popular motion pictures on videocassettes during the Christmas
shopping season. In addition, revenues have tended to be lower in the summer
months, particularly in Europe.
RESULTS OF OPERATIONS
The following table sets forth selected consolidated statement of income
data expressed as a percentage of net revenues for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Net revenues..................................................................................... 100.0% 100.0%
Costs and expenses:
Cost of revenues............................................................................... 11.9 15.1
Research and development....................................................................... 11.1 14.8
Selling and marketing.......................................................................... 28.3 29.8
General and administrative..................................................................... 20.4 20.9
--------- ---------
Total costs and expenses..................................................................... 71.7 80.6
--------- ---------
Operating income from continuing operations.................................................. 28.3 19.4
Interest and other income (expense), net......................................................... 2.4 (1.5)
--------- ---------
Income from continuing operations before income taxes........................................ 30.7 17.9
Provision for income taxes....................................................................... 11.9 7.2
--------- ---------
Net income from continuing operations........................................................ 18.8 10.7
Loss from discontinued operations................................................................ -- (4.8)
--------- ---------
Net income................................................................................... 18.8% 5.9%
--------- ---------
--------- ---------
</TABLE>
The following information provides revenue information by general product
lines for the periods indicated (dollars in thousands):
<TABLE>
<CAPTION>
FOR PERIOD ENDING DECEMBER 31,
-------------------------------------------------------
1997 % 1996 % % CHANGE
--------- --------- --------- --------- -----------
<S> <C> <C> <C> <C> <C>
Copy Protection Group.......................................... $ 17,412 85.6 $ 14,953 87.5 16.4%
Video Scrambling Group......................................... 2,739 13.5 2,068 12.1 32.4%
Other.......................................................... 189 .9 59 .4 220.3%
--------- --------- --------- ---------
Total.......................................................... $ 20,340 100.0 $ 17,080 100.0 19.1%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
32
<PAGE>
NET REVENUES. The Company's net revenues increased 19.1% from $17.1 million
in 1996 to $20.3 million in 1997. The Company's copy protection revenues
comprise of videocassettes and DVD copy protection and digital PPV.
Videocassette and DVD copy protection revenues increased $823,000 or 6.4% from
$12,877,000 to $13,700,000 in 1997 compared to 1996 principally due to copy
protection royalty revenue from replication of DVDs and license fees from PC and
DVD Rom manufacturers. In addition, digital PPV, saw revenues for 1997 of
$3,712,000, reflecting an increase of $1.6 million or 78.8% from 1996 as a
result of increased shipments of set-top decoders from licensed manufacturers.
The Company's video scrambling revenues increased $671,000 or 32.4% from 1996 to
1997. Video scrambling in made up of VES products and components and licensing
which use the PhaseKrypt technology. VES product revenue decreased $441,000 or
36.8% from $1,197,000 in 1996 to $756,000 in 1997 as a result of a decline in
orders from various government law enforcement agencies. Components and
licensing revenue from PhaseKrypt related royalties and hardware and chip sales
to licensed cable TV equipment manufacturers in 1997 was $2.0 million, a $1.1
million or 127.8% increase over 1996. The increase in this area was due
primarily to the Company's licensee's sale of addressable set-top converters
into Brazil, which included royalties from our PhaseKrypt TM scrambling
technology. Due primarily to the growth in the Company's digital PPV copy
protection and video scrambling businesses, videocassette copy protection
revenues from the MPAA studios in the United States declined as a percentage of
net revenues, representing 27.3% and 33.4% of the Company's net revenues for
1997 and 1996, respectively.
In 1997 and 1996, the Company's international and export revenues totaled
$9.5 million and $6.5 million, respectively, representing 46.5% and 37.9%,
respectively, of the Company's net revenues during those periods. International
and export revenues grew primarily as a result of increased usage of
videocassette copy protection technology by the MPAA studios in international
markets, overseas shipments of copy protection enabled digital PPV set-top
decoders from manufacturers and increased growth in PhaseKrypt component sales
and licensing fees from new geographic areas. The Company expects that
international and export revenues will continue to represent a significant
portion of its net revenues and that the Company's future growth will depend to
a large extent on continued increases in international and export opportunities.
COST OF REVENUES. Cost of revenues as a percentage of net revenues was
11.9% in 1997 and 15.1% in 1996 . The variations in cost of revenues as a
percentage of net revenues were primarily due to changes in revenue mix between
product sales, which have a relatively high cost of revenues, and licensing
revenues, which have a relatively low cost of revenues. In the event that
revenues from video scrambling products increase as a percentage of net
revenues, cost of revenues as a percentage of net revenues will increase. In
addition, service fee rates for duplicators were reduced, but were offset by
increased patent related expenses and processor equipment costs. See Note 1 of
Notes to Consolidated Financial Statements.
RESEARCH AND DEVELOPMENT. Research and development expenses were $2.2
million and $2.5 million, which represented 11.1% and 14.8% of net revenues, in
1997 and 1996, respectively. The decrease from 1996 to 1997 was principally due
to a decrease in consulting fees and project supplies associated with the
completion of hardware development of VES products and the Company's Colorstripe
technology for use in DVD and digital PPV applications in 1996. One of the major
projects started by the Company in 1997 was the joint development effort with
Digimarc to develop a video watermarking solution for DVD and other digital
video platforms. The Company believes that research and development expenses
will increase in dollar amount in the future, but may decline as a percentage of
net revenues. There can be no assurance, however, that net revenues will grow as
a percentage more rapidly than research and development expenses as a
percentage.
SELLING AND MARKETING. Selling and marketing expenses were $5.8 million and
$5.1 million, which represented 28.3% and 29.8% of net revenues, in 1997 and
1996, respectively. The increases from 1996 to 1997 were primarily a result of
the hiring of additional employees for PPV and international business
development, increased compensation and benefits, and external consulting costs
associated with digital
33
<PAGE>
PPV and international marketing. The Company believes that the dollar amount of
selling and marketing expenses will increase in the future as the Company incurs
the additional costs related to new business development. There can be no
assurance, however, that net revenues will grow as a percentage more rapidly
than selling and marketing expenses as a percentage.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were $4.1
million and $3.6 million, representing 20.4% and 20.9% of net revenues, in 1997
and 1996, respectively. The increase in 1997 compared to 1996 was primarily
related to the additional administrative expenses required in managing a public
company compared to a private company, increased compensation and benefits,
legal fees associated with the Company's arbitration proceeding with a prior
employee and an increase in bad debt expense. The Company believes that the
dollar amount of general and administrative expenses will increase in the future
as the Company evaluates new business opportunities and completes its first full
year as a public company. There can be no assurance, however that net revenues
will grow as a percentage more rapidly than general and administrative expenses
as a percentage.
INTEREST AND OTHER INCOME (EXPENSE), NET. Interest and other income
(expense), net, consists primarily of interest expense on a convertible note and
capitalized equipment leases, net of interest income. Interest and other expense
was $35,000 and $327,000 in 1997 and 1996, respectively. The decrease in
interest expense from 1996 to 1997 was principally attributable to the
conversion of a $3.0 million convertible note into Preferred Stock in July 1996
and subsequently into common stock upon completion of the IPO. Interest income
was $513,000 and $67,000 in 1997 and 1996, respectively. The increase in 1997
compared to 1996 was a result of interest earned from cash and cash equivalents,
short term investments and long-term marketable investment securities primarily
from the proceeds received from the IPO. See Notes 2 and 3 of Notes to
Consolidated Financial Statements.
PROVISION FOR INCOME TAXES. The Company's effective rate of taxation on
continuing operations was 38.7% and 40.0% in 1997 and 1996, respectively. The
provision for income taxes consists primarily of federal income taxes, state
taxes and international taxes withheld on foreign revenue. The decrease in such
rate from 1996 to 1997 was primarily due to an increase in tax credits and an
increase in tax exempt interest. See Note 6 of Notes to Consolidated Financial
Statements.
LOSS FROM DISCONTINUED OPERATIONS. The loss from discontinued operations
was $827,000 in 1996, net of income tax benefit. Information related to
discontinued operations is as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1996
-----------------
<S> <C>
Costs and expenses............................................................................. $ (1,081)
-------
Operating loss............................................................................... (1,081)
Other income, net.............................................................................. 5
-------
Loss before income taxes..................................................................... (1,076)
Income tax benefit, net........................................................................ 249
-------
Net loss..................................................................................... $ (827)
-------
-------
</TABLE>
The costs and expenses in the above table represent the administration and
development costs of CAC, which was incorporated as a wholly-owned subsidiary of
the Company in October 1995, to commercialize a distinct and new audio-on-demand
technology. In connection with the incorporation of CAC, the Company contributed
to CAC the patents that related to the CAC technology. The underlying technology
of CAC is distinct from the copy protection and video scrambling technologies
that underlie the Company's core business. The employees of CAC have been
exclusively involved in the CAC operation since they were hired. None of these
employees was involved in the technology development underlying the Company's
core business or any other aspect of the Company's business. From its inception
until
34
<PAGE>
separation, CAC generated no revenues and concentrated exclusively on research
and development activities. In the third quarter of 1996, the Company divested
itself of all but 19.8% of its ownership in CAC. See Note 4 of Notes to
Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital improved to $15,266,000 from $2,225,000, an
increase of 586%, primarily from proceeds generated from the IPO. The net
proceeds to the Company, after underwriting discounts and commissions and other
expenses of the Offering, were approximately $13,234,000. In addition, the
Company has financed its operations primarily from cash generated by continuing
operations. The Company's operating activities from continuing operations
provided net cash of $2.4 million and $2.9 million in 1997 and 1996,
respectively. In 1997, net cash was provided by net income, increases in
deferred revenue and income taxes, partially offset by decreases in accounts
payable and accrued expenses and increases in accounts receivable and prepaids.
In 1996, net cash was provided primarily by net income, increases in accounts
payable, accrued liabilities and deferred revenue, partially offset by increases
in accounts receivable and inventories.
The Company made capital expenditures of $571,000 and $476,000 in 1997 and
1996, respectively. The Company also paid $332,000 and $343,000, respectively,
related to patents and other intangibles during those periods. In addition, the
Company paid cash dividends on its Series A Preferred Stock of $156,000 and
$401,000 in 1997 and 1996, respectively. Upon the closing of the IPO, all shares
of Series A Preferred Stock automatically converted into Common Stock, and the
Company is no longer be required to pay cash dividends with respect to such
stock.
Since the completion of the IPO, the Company has actively worked to increase
the Company's revenues, profits and growth rate, both by effectively managing
its existing business opportunities and by pursuing new opportunities. In
December 1997, the Company invested $1.5 million in exchange for shares of
Digimarc Corporation's preferred stock, reflecting a 6.8% interest in Digimarc.
In addition to the investment, the two companies are developing a digital video
watermarking solution to control illicit copying of DVDs and other digital
media. The Company has maintained its 19.8% ownership in CAC by investing $2.0
million in connection with a round of external third-party financing obtained by
CAC.
The Company believes that the net proceeds from the IPO, together with its
existing cash and cash equivalents and cash provided by operating activities,
will be sufficient to meet its working capital and capital expenditure
requirements for at least the next 12 months. At December 31, 1997, the Company
had $1.3 million in cash and cash equivalents, $11.2 million in short-term
investments and $1.8 million in long-term marketable investment securities. The
Company anticipates that capital expenditures for 1998 will aggregate
approximately $400,000. In the future, the Company may elect to purchase
additional stock in CAC to maintain its 19.8% equity ownership in CAC.
To the extent that the Company experiences growth in the future, the Company
anticipates that its operating and investing activities may use cash.
Consequently, any such growth may require the Company to obtain additional
equity or debt financing. There can be no assurance that any necessary
additional financing will be available to the Company on commercially reasonable
terms, if at all. Management intends to invest the Company's excess cash in
short-term and long-term, interest bearing, investment grade securities. In
February 1998, the Company made a cash investment of approximately $3,500,000
for common stock of C-Dilla, Ltd. and paid to C-Dilla another $1,000,000 in
up-front license fees subject to offset against future royalties. (See
Investments) Although there are no other present understandings, commitments or
agreements with respect to any acquisition of other businesses, products or
technologies, from time to time in the ordinary course of business, the Company
evaluates potential acquisitions of businesses, products or technologies that
are complementary to those of the Company and may in the future use a portion of
the Company's cash to acquire or invest in complementary businesses or products
or obtain the right to use complementary technologies.
35
<PAGE>
YEAR 2000 ISSUES
The Year 2000 problem is the result of computer programs being written using
two digits rather than four to define the applicable year. The Company's plan
for the Year 2000 problem entails the research and testing of its computer
systems. The plan calls for the compliance verification with external vendors
supplying the Company software, the testing of in house engineering and
manufacturing software tools and testing software in the Company's products for
the Year 2000. To date, the Company has not encountered any material Year 2000
issues concerning its respective computer programs. The Company plans to
complete its Year 2000 research and testing by the end of 1999. All costs
associated with carrying out the Company's plan for the Year 2000 problem are
being expensed as incurred. The costs associated with the Year 2000 problem are
not expected to have a material adverse effect on the Company's business,
financial condition and results of operations.
ITEM 7. CONSOLIDATED FINANCIAL STATEMENTS
The response to this item is submitted in a separate section of this report
beginning on F-1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES.
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
The information required by this item is incorporated by reference from the
infomation under the caption "Election of Directors," with respect to Directors,
and under the caption "Management," with respect to Executive Officers,
contained in the Company's definitive Proxy Statement which will be filed with
the Commission in connection with the solicitation of proxies for the Company's
1998 Annual Meeting of Stockholders (the "Proxy Statement").
ITEM 10. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
information under the caption "Executive Compensation" to be contained in the
Proxy Statement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the
information under the caption "Security Ownership of Certain Beneficial Owners
and Management" to be contained in the Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
information under the caption "Certain Transactions" to be contained in the
Proxy Statement.
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K
(a) Financial Statements and Schedules
The financial statements listed on the index to financial statements on page
F-1 are filed as part of this Form 10-KSB.
36
<PAGE>
(b) Reports on Form 8-K
During the fiscal quarter ended December 31, 1997, the Company filed no
Current Reports on Form 8-K.
(c) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
- ----------- --------------------------------------------------------------------------------------------------------
<S> <C>
2.01 Form of Merger Agreement by and between Macrovision Corporation, a Delaware Corporation, and Macrovision
Corporation, a California corporation.*
3.01 Certificate of Incorporation of Macrovision Corporation.*
3.02 Amended and Restated Certificate of Incorporation of Macrovision Corporation.
3.03 Bylaws of Macrovision Corporation.*
3.04 Amended and Restated Bylaws of Macrovision Corporation.*
3.05 Certificate of Amendment of Certificate of Incorporation of Macrovision Corporation.
10.01 Stock Option Plan and related documents of Macrovision Corporation.*
10.02 Macrovision Corporation's 1996 Equity Incentive Plan and related documents.*
10.03 Macrovision Corporation's 1996 Directors Stock Option Plan and related documents.*
10.04 Macrovision Corporation's 1996 Employee Stock Purchase Plan and related documents.*
10.05 Macrovision Corporation's Executive Incentive Plan.*
10.06 Employment Agreement dated as of June 5, 1996, between Macrovision Corporation and Victor A. Viegas.*
10.07 Restricted Stock Purchase Agreement dated as of June 7, 1996, between Macrovision Corporation and Victor
A. Viegas and related documents, including Promissory Note and Stock Pledge Agreement.*
10.08 Form of Indemnification Agreement to be entered into by Macrovision Corporation with each of its
directors and executive officers.*
10.09 Recapitalization and Stock Purchase Agreement dated as of July 31, 1996, between Macrovision Corporation
and Command Audio Corporation.*
10.10 Restricted Stock Acquisition Agreement dated as of July 31, 1996, between Macrovision Corporation and
Command Audio Corporation, and First Amendment dated as of November 29, 1996.*
10.11 Technology Transfer and Royalty Agreement dated as of July 31, 1996, between Macrovision Corporation and
Command Audio Corporation, and First Amendment dated as of November 29, 1996.*
10.12 Letter dated December 6, 1996 from Macrovision Corporation to Command Audio Corporation.*
10.13 License Agreement dated September 26, 1995, among Macrovision Corporation, Victor Technobrain Co., Ltd.
And Video Culture Institute, Inc., Amendment Number One dated June 30, 1996 and Amendment Number Two
dated September 30, 1996.*
10.14 Duplicator Agreement dated as of June 1, 1988, by and between and Victor Company of Japan, Limited.*
10.15 Technology Application Agreement dated November 29, 1988, by and between Macrovision Corporation and
Victor Company of Japan, Limited.*
10.16 Agreement dated July 15, 1994, by and between Macrovision Corporation and Victor Company of Japan,
Limited.*
10.17 Copy Protection Technology Agreement dated as of January 7, 1997, between Macrovision Corporation and
Victor Company of Japan, Limited.*
10.18 Waiver Agreement dated as of January 6, 1997, between Macrovision Corporation and Pacific Media
Development, Inc.*
</TABLE>
37
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
- ----------- --------------------------------------------------------------------------------------------------------
<S> <C>
10.19 Stock and Convertible Note Purchase Agreement dated as of May 24, 1991, among Macrovision Corporation, a
trustee for Pacific Media Development, Inc. and A. Victor Farrow and Carol Ann Farrow as Trustees of
the Farrow Family Trust U/T/D December 18, 1990.*
10.20 Lease Agreement dated April 21, 1995, by and between Macrovision Corporation and Caribbean Geneva
Investors.*
10.21 Standard Sublease dated September 21, 1995, by and between Macrovision Corporation and Deutsch
Technology Research, together with Lease Agreement dated May 26, 1992, by and between Macrovision
Corporation and Crossroads Investment Group.*
10.22 Letter Agreement dated January 14, 1997 by and between Macrovision Corporation and Buena Vista Home
Video.*/**
10.23 Technical Consulting Agreement dated as of July 1, 1996 by and between Macrovision Corporation and
Victor Technobrain Co., Ltd.*
10.24 Second Amendment to Restricted Stock Acquisition Agreement dated as of January 29, 1997 by and between
Macrovision Corporation and Command Audio Corporation.*
10.25 Letter dated February 10, 1997 from Macrovision Corporation to Command Audio Corporation.*
10.26 Promissory Note dated January 7, 1997 executed by Command Audio Corporation.*
10.27 Digital Versatile Disc Player/Digital Video Cassette Recorder License Agreement for Anticopy Technology
dated as of February 18, 1997 by and between Macrovision Corporation and Victor Company of Japan,
Limited.*
16.01 Letter regarding change in certifying accountant.*
21.01 List of subsidiaries.*
23.01 Consent of Independent Auditors
27.01 1997 Financial Data Schedule.
27.02 1996 Financial Data Schedule.
</TABLE>
- ------------------------
* Previously filed.
** Confidential treatment has been granted with respect to certain portions of
these Exhibits. Such portions have been omitted from this filing and have
been filed separately with the Securities and Exchange Commission.
38
<PAGE>
SIGNATURES
In accordance with Section 13 or 15 (d) of the Exchange Act, the Registrant
caused this Report to be signed on its behalf by the undersigned thereunto duly
authorized on this 24th day of March, 1998.
MACROVISION CORPORATION
By: /s/ WILLIAM A. KREPICK
-----------------------------------
William A. Krepick
President and Chief Operating
Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the Registrant, and in the capacities and on
the date indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------------ -------------------------------------------- -----------------
<S> <C> <C>
/s/ JOHN O. RYAN Chairman of the Board of Directors, Chief
- -------------------------------------- Executive Officer and Secretary March 30, 1998
John O. Ryan
/s/ WILLIAM A. KREPICK
- -------------------------------------- President and Chief Operating Officer March 30, 1998
William A. Krepick
/s/ VICTOR A. VIEGAS Vice President, Finance and Administration
- -------------------------------------- and Chief Financial Officer March 30, 1998
Victor A. Viegas
/s/ RICHARD S. MATUSZAK Vice-President, Special Interest Copy
- -------------------------------------- Protection and Director March 30, 1998
Richard S. Matuszak
/s/ DONNA BIRKS
- -------------------------------------- Director March 30, 1998
Donna Birks
/s/ WILLIAM N. STIRLEN
- -------------------------------------- Director March 30, 1998
William N. Stirlen
/s/ TOM WERTHEIMER
- -------------------------------------- Director March 30, 1998
Tom Wertheimer
</TABLE>
39
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Independent Auditors' Report............................................................................... F-2
Consolidated Balance Sheets................................................................................ F-3
Consolidated Statements of Income.......................................................................... F-4
Consolidated Statements of Stockholder's Equity............................................................ F-5
Consolidated Statements of Cash Flows...................................................................... F-6
Notes to Consolidated Financial Statements................................................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF KPMG PEAT MARWICK LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Macrovision Corporation and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Macrovision
Corporation and subsidiaries (the Company) as of December 31, 1997 and 1996, and
the related consolidated statements of income, stockholders' equity, and cash
flows for the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Macrovision
Corporation and subsidiaries as of December 31, 1997 and 1996, and the results
of their operations and their cash flows for the years then ended in conformity
with generally accepted accounting principles.
/s/ KPMG PEAT MARWICK LLP
Mountain View, California
February 6, 1998
F-2
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................................................... $ 1,314 $ 2,409
Short-term investments...................................................................... 11,241 --
Accounts receivable, net of allowance for doubtful accounts of $684 and $267 as of December
31, 1997 and 1996, respectively........................................................... 5,240 3,376
Inventories................................................................................. 433 550
Receivable from related party............................................................... 279 --
Deferred tax assets......................................................................... 1,336 929
Prepaid expenses and other current assets................................................... 430 186
--------- ---------
Total current assets...................................................................... 20,273 7,450
Property and equipment, net................................................................... 1,722 2,017
Patents and other intangibles, net of accumulated amortization of $796 and $401 as of December
31, 1997 and 1996, respectively............................................................. 1,098 1,161
Receivable from related party................................................................. -- 329
Long-term marketable investment securities.................................................... 1,763 --
Other assets.................................................................................. 4,000 996
--------- ---------
$ 28,856 $ 11,953
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................................ $ 919 $ 1,318
Accrued expenses............................................................................ 2,190 2,468
Deferred revenue............................................................................ 944 749
Income taxes payable........................................................................ 846 585
Current portion of capital lease obligations................................................ 108 105
--------- ---------
Total current liabilities................................................................. 5,007 5,225
Capital lease obligations, net of current portion............................................. 188 296
Deferred tax liabilities...................................................................... 84 360
--------- ---------
5,279 5,881
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, 5,000,000 shares authorized; none and 1,376,432 shares
issued and outstanding as of December 31, 1997 and 1996, respectively..................... -- 1
Common stock, $.001 par value; 50,000,000 and 100,000,000 shares authorized as of December
31, 1997 and 1996, respectively; 7,215,195 and 3,951,759 shares issued and outstanding as
of December 31, 1997 and 1996, respectively............................................... 7 4
Additional paid-in capital.................................................................. 23,277 9,530
Stockholder notes receivable................................................................ (131) (157)
Deferred stock compensation................................................................. (96) (240)
Cumulative translation adjustments.......................................................... (218) (135)
Unrealized gain on investments.............................................................. 4 --
Retained earnings (accumulated deficit)..................................................... 734 (2,931)
--------- ---------
Total stockholders' equity................................................................ 23,577 6,072
--------- ---------
$ 28,856 $ 11,953
--------- ---------
--------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
----------------------
1997 1996
---------- ----------
<S> <C> <C>
Net revenues............................................................................ $20,340 $17,080
---------- ----------
Costs and expenses:
Cost of revenues...................................................................... 2,422 2,579
Research and development.............................................................. 2,248 2,527
Selling and marketing................................................................. 5,765 5,090
General and administrative............................................................ 4,149 3,566
---------- ----------
Total costs and expenses............................................................ 14,584 13,762
---------- ----------
Operating income from continuing operations............................................. 5,756 3,318
Interest and other income (expense), net................................................ 478 (260)
---------- ----------
Income from continuing operations before income taxes............................... 6,234 3,058
Income taxes............................................................................ 2,413 1,223
---------- ----------
Income from continuing operations................................................... 3,821 1,835
Discontinued operations:
Loss from operations of CAC business, net of income tax benefit of $204............... -- (663)
Provision for operating losses during holding period, net of income tax benefit of
$45................................................................................. -- (164)
---------- ----------
Net income.............................................................................. $ 3,821 $ 1,008
---------- ----------
---------- ----------
Computation of basic and diluted earnings per share:
Income from continuing operations..................................................... $ 3,821 $ 1,835
Preferred stock dividends............................................................. (156) (587)
---------- ----------
Adjusted income from continuing operations............................................ 3,665 1,248
Discontinued operations............................................................... -- (827)
---------- ----------
Earnings applicable to common stock................................................... $ 3,665 $ 421
---------- ----------
---------- ----------
Basic earnings (loss) per share:
Continuing operations................................................................. $ .57 $ .33
Discontinued operations............................................................... -- (.22)
---------- ----------
Net income.......................................................................... $ .57 $ .11
---------- ----------
---------- ----------
Shares used in computing basic earnings per share....................................... 6,476,000 3,787,000
---------- ----------
---------- ----------
Diluted earnings (loss) per share:
Continuing operations................................................................. $ .53 $ .29
Discontinued operations............................................................... -- (.19)
---------- ----------
Net income.......................................................................... $ .53 $ .10
---------- ----------
---------- ----------
Shares used in computing diluted earnings per share..................................... 6,960,000 4,280,000
---------- ----------
---------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
MACROVISION CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL STOCKHOLDER
---------------------- ---------------------- PAID-IN NOTES DEFERRED STOCK
SHARES AMOUNT SHARES AMOUNT CAPITAL RECEIVABLE COMPENSATION
--------- ----------- --------- ----------- ----------- ------------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances as of December 31, 1995....... 833,333 $ 1 3,632,719 $ 4 $ 5,058 $ -- $ --
Issuance of common stock upon
exercise of options................ -- -- 66,263 -- 171 -- --
Issuance of common stock in exchange
for stockholder note receivable.... -- -- 58,333 -- 157 (157) --
Issuance of common stock in
connection with recapitalization of
Command Audio Corporation.......... -- -- 194,444 -- 875 -- --
Conversion of note into 543,099
shares of Series A preferred
stock.............................. 543,099 -- -- -- 3,038 -- --
Cash dividends of $.405 per share
paid on 833,333 shares of preferred
stock, $.117 per share paid on
543,099 shares of preferred stock,
and $.135 per share declared on
1,376,432 shares of preferred
stock.............................. -- -- -- -- -- -- --
Deferred stock compensation related
to stock option grants............. -- -- -- -- 231 -- (231)
Spin-off of Command Audio
Corporation, including deferred
stock compensation................. -- -- -- -- -- -- (189)
Amortization of deferred stock
compensation....................... -- -- -- -- -- -- 180
Translation adjustment............... -- -- -- -- -- -- --
Net income........................... -- -- -- -- -- -- --
--------- --- --------- --- ----------- ----- -----
Balances as of December 31, 1996....... 1,376,432 1 3,951,759 4 9,530 (157) (240)
Conversion of preferred stock to
common stock....................... (1,376,432) (1) 1,376,432 1 -- -- --
Issuance of common stock in initial
public offering, net of issuance
costs of $1,531.................... -- -- 1,764,016 2 13,232 -- --
Issuance of common stock upon
exercise of options................ -- -- 111,342 -- 288 -- --
Issuance of common stock under stock
purchase plan...................... -- -- 11,646 -- 89 -- --
Cash dividends of $.075 per share
paid on 1,376,432 shares of
preferred stock.................... -- -- -- -- -- -- --
Payment on stockholder note
receivable......................... -- -- -- -- -- 26 --
Amortization of deferred stock
compensation....................... -- -- -- -- -- -- 144
Tax benefit associated with stock
plans.............................. -- -- -- -- 138 -- --
Translation adjustment............... -- -- -- -- -- -- --
Unrealized gain on investments....... -- -- -- -- -- -- --
Net income........................... -- -- -- -- -- -- --
--------- --- --------- --- ----------- ----- -----
Balances as of December 31, 1997....... -- $ -- 7,215,195 $ 7 $ 23,277 $ (131) $ (96)
--------- --- --------- --- ----------- ----- -----
--------- --- --------- --- ----------- ----- -----
<CAPTION>
(ACCUMULATED
CUMULATIVE DEFICIT) TOTAL
TRANSLATION UNREALIZED GAIN RETAINED STOCKHOLDERS'
ADJUSTMENT ON INVESTMENTS EARNINGS EQUITY
------------- --------------- ------------- -------------
<S> <C> <C> <C> <C>
Balances as of December 31, 1995....... $ (118) -- $ (2,099) $ 2,846
Issuance of common stock upon
exercise of options................ -- -- -- 171
Issuance of common stock in exchange
for stockholder note receivable.... -- -- -- --
Issuance of common stock in
connection with recapitalization of
Command Audio Corporation.......... -- -- -- 875
Conversion of note into 543,099
shares of Series A preferred
stock.............................. -- -- -- 3,038
Cash dividends of $.405 per share
paid on 833,333 shares of preferred
stock, $.117 per share paid on
543,099 shares of preferred stock,
and $.135 per share declared on
1,376,432 shares of preferred
stock.............................. -- -- (587) (587)
Deferred stock compensation related
to stock option grants............. -- -- -- --
Spin-off of Command Audio
Corporation, including deferred
stock compensation................. -- -- (1,253) (1,442)
Amortization of deferred stock
compensation....................... -- -- -- 180
Translation adjustment............... (17) -- (17)
Net income........................... -- -- 1,008 1,008
----- --- ------------- -------------
Balances as of December 31, 1996....... (135) -- (2,931) 6,072
Conversion of preferred stock to
common stock....................... -- -- -- --
Issuance of common stock in initial
public offering, net of issuance
costs of $1,531.................... -- -- -- 13,234
Issuance of common stock upon
exercise of options................ -- -- -- 288
Issuance of common stock under stock
purchase plan...................... -- -- -- 89
Cash dividends of $.075 per share
paid on 1,376,432 shares of
preferred stock.................... -- -- (156) (156)
Payment on stockholder note
receivable......................... -- -- -- 26
Amortization of deferred stock
compensation....................... -- -- -- 144
Tax benefit associated with stock
plans.............................. -- -- -- 138
Translation adjustment............... (83) -- (83)
Unrealized gain on investments....... -- 4 -- 4
Net income........................... -- -- 3,821 3,821
----- --- ------------- -------------
Balances as of December 31, 1997....... $ (218) $ 4 $ 734 $ 23,577
----- --- ------------- -------------
----- --- ------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
---------------------
1997 1996
---------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income................................................................................ $ 3,821 $ 1,008
Adjustments to reconcile net income to net cash provided by continuing operations:
Depreciation and amortization............................................................. 1,156 1,002
Deferred income taxes..................................................................... (683) (451)
Amortization of deferred stock compensation............................................... 144 180
Loss on disposal of fixed assets.......................................................... 105 --
Tax benefit from employee stock option plan............................................... 138 --
Change in provision for accounts and notes receivable..................................... 467 13
Discontinued operations................................................................... -- 827
Changes in operating assets and liabilities:
Accounts receivable, inventories, and other current assets.............................. (2,408) (590)
Accounts payable, accrued liabilities, deferred revenue, and income taxes payable....... (221) 916
Other................................................................................... (83) (17)
---------- ---------
Net cash provided by continuing operations............................................ 2,436 2,888
Net cash used in discontinued operations.............................................. -- (1,227)
---------- ---------
Net cash provided by operating activities............................................. 2,436 1,661
---------- ---------
Cash flows from investing activities:
Purchases of long-term marketable investment securities................................... (1,763) --
Purchases of short-term investments....................................................... (51,737) --
Sales or maturities of short-term investments............................................. 40,500 1,200
Acquisition of property and equipment..................................................... (571) (476)
Payments for patents and other intangibles................................................ (332) (343)
Receivable from related party............................................................. -- (329)
Investment in Command Audio Corporation and Digimarc Corporation.......................... (3,480) --
Other, net................................................................................ (67) (4)
---------- ---------
Net cash (used in) provided by investing activities................................... (17,450) 48
---------- ---------
Cash flows from financing activities:
Payments on capital lease obligations..................................................... (105) (117)
Payments on long-term debt................................................................ -- (696)
Proceeds from issuance of common stock upon exercise of options........................... 288 171
Proceeds from issuance of common stock under employee stock purchase plan................. 89 --
Payment of stockholder note receivable.................................................... 26 --
Proceeds from sale of common stock, net of issuance costs and payments of deferred
offering costs.......................................................................... 13,777 (543)
Cash dividends............................................................................ (156) (401)
---------- ---------
Net cash (used in) provided by financing activities................................... 13,919 (1,586)
---------- ---------
Net (decrease) increase in cash and cash equivalents........................................ (1,095) 123
Cash and cash equivalents at beginning of year.............................................. 2,409 2,286
---------- ---------
Cash and cash equivalents at end of year.................................................... $ 1,314 $ 2,409
---------- ---------
---------- ---------
Cash paid during the year:
Interest.................................................................................. $ 12 $ 296
---------- ---------
---------- ---------
Income taxes.............................................................................. $ 2,364 $ 1,446
---------- ---------
---------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
Macrovision Corporation (the "Company"), was formed in 1983 and designs,
develops, and markets video security technologies and products that provide copy
protection and video scrambling for motion pictures and other proprietary video
materials. The Company is headquartered in Sunnyvale, California and has
subsidiaries in the United Kingdom and Japan.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant intercompany
transactions have been eliminated in consolidation.
CASH, CASH EQUIVALENTS, AND INVESTMENTS
The Company considers all highly liquid investments with a maturity from
date of purchase of three months or less to be cash equivalents. Cash and cash
equivalents consist of cash on deposit with banks, money market funds and mutual
funds. All other liquid investments with maturities over three months and less
than 12 months are classified as short-term investments. Short-term investments
consisted of auction rate preferred stock, government bonds and government
agency securities. All marketable securities with maturities over one year are
classified as marketable long-term investment securities.
Management determines the appropriate classification of investment
securities at the time of purchase and reevaluates such designation as of each
balance sheet date. As of December 31, 1997 and 1996, all investment securities
were designated as "available-for-sale." Available-for-sale securities are
carried at fair value based on quoted market prices, with unrealized gains and
losses, if material, reported in stockholders' equity.
Realized gains and losses and declines in value judged to be
other-than-temporary for available-for-sale securities are included in the
consolidated statements of income. The cost of securities sold is based on the
specific identification method. Interest and dividends on securities classified
as available-for-sale are included in interest income.
The following is a summary of available-for-sale securities (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Cash equivalents--money market funds................................................. $ 622 $ 803
--------- ---------
Investments:
Auction rate preferred stock certificates.......................................... 3,400 --
Government bonds................................................................... 9,604 --
--------- ---------
13,004 --
--------- ---------
$ 13,626 $ 803
--------- ---------
--------- ---------
</TABLE>
F-7
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
As of December 31, 1997, government bond securities totaling $1,763,000 are
classified as long-term marketable investment securities in the accompanying
consolidated balance sheet.
As of December 31, 1997, the difference between the fair value and the
amortized cost of available-for-sale securities was $4,000 of unrealized gains
related to short-term government bonds which has been recorded as a component in
stockholders' equity. As of December 31, 1997, the weighted average portfolio
duration and contractual maturity was approximately six months.
INVENTORIES
Inventories are stated at the lower of first-in, first-out basis cost or
market.
PROPERTY AND EQUIPMENT
Property and equipment, including significant improvements, are carried on
the consolidated balance sheet at cost. The Company computes depreciation for
all property and equipment using the straight-line method. The estimated useful
lives of assets range from three to five years. Amortization of equipment
recorded under capital leases is computed over the shorter of the lease term or
the estimated useful life of the equipment.
PATENTS
Patent application costs of $868,000 and $604,000 as of December 31, 1997
and 1996, respectively, are included in patents and other intangibles and, upon
the granting of the related patent, are amortized using the straight-line method
over the shorter of the estimated useful life of the patent or 10 years. Prior
to January 1, 1997, the Company amortized the patents over the shorter of the
estimated useful life of the patent or 17 years. This change did not have a
material affect on the consolidated financial statements for the year ended
December 31, 1997.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company evaluates its long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceed the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell.
OTHER ASSETS
The Company owns a minority interest in Command Audio Corporation (CAC), a
developer of audio-on-demand technology, and Digimarc Corporation, a developer
of proprietary digital watermarking technology, and accounts for such
investments under the cost method. Other-than-temporary declines in
F-8
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
the fair value of these investments are included in the consolidated statements
of income. Such investments are included in other assets on the accompanying
consolidated balance sheets. See Note 2 to Notes to Consolidated Financial
Statements.
REVENUE RECOGNITION
Advanced license fees attributable to minimum copy quantities or shared
revenues are deferred until earned. Revenue from the duplication of
videocassettes and the replication of digital versatile discs ("DVDs") is earned
based upon reported or estimated volume of each or, in the case of agreements
with minimum guaranteed payments with no specified volume, on a straight-line
basis over the life of the agreement. Retroactive rebate credits on certain
agreements that contain volume pricing adjustments or return provisions are
accrued based upon anticipated unit volume. Nonrefundable technology licensing
revenue, which applies principally to DVD and PC subassembly manufacturers,
digital pay-per-view ("PPV"), cable and satellite system operators, and set-top
decoder manufacturers, is recognized upon contract signing and performance of
all significant obligations. Royalty revenue associated with technology licenses
is recognized when earned based upon reported unit sales, transaction based
fees, or box office receipts. Revenues from the sales of encoders, decoders, and
systems incorporating the Company's video copy protection and scrambling
technologies are recognized upon shipment provided that the Company has no
significant additional performance obligations.
COST OF REVENUES
The Company has agreements with certain licensed duplicators utilized by
customers of the Company's video copy protection technology. The Company has
agreed to pay these duplicators a specified service fee per unit duplicated
utilizing the Company's video copy protection technology to help offset the cost
of operating the Company's copy protection equipment and reporting the volume of
copy protected videocassettes. Such amounts are charged to cost of revenues when
incurred and were $362,000, and $596,000 for 1997 and 1996, respectively.
Video copy protection technology has stimulated the development of "black
boxes" to defeat the video copy protection process. The Company owns patents
that it believes are infringed by these "black box" manufacturers. The Company
has successfully settled legal actions against a number of companies that
produced and distributed "black boxes." As part of the legal settlement, these
companies have agreed to cease and desist from manufacturing, distributing,
and/or selling the infringing products. The outside legal costs associated with
protecting these patents amounted to $70,000 and $30,000 during 1997 and 1996,
respectively, and are included in cost of revenues as incurred. Not included in
these patent costs are the costs associated with in-house legal staffing and
engineering support. Cost of revenues also includes amortization of patents.
INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to
F-9
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. The measurement of deferred tax assets is reduced, if necessary,
by a valuation allowance for any tax benefits of which future realization is
uncertain.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
The functional currency for the Company's foreign subsidiaries is the
applicable local currency. The translation of foreign currency denominated
financial statements into U.S. dollars is performed for balance sheet accounts
using current exchange rates in effect at the balance sheet date and for
revenues and expense accounts using a weighted average exchange rate for the
respective periods. Adjustments resulting from such translation are included in
stockholders' equity. Gains or losses resulting from foreign currency
transactions included in the consolidated statements of income were not material
in any of the periods presented.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
BUSINESS AND CONCENTRATION OF CREDIT RISK
The Company sells its video scrambling products and licenses its video copy
protection and video scrambling technologies to customers in the home
videocassette, DVD, pay-per-view, cable, satellite, and corporate communication
markets primarily in United States, Europe, Japan, and the Far East. Most of the
Company's business is attributed to the licensing of its video copy protection
technology through Motion Picture Association of America movie studios and other
rights owners. The Company also licenses its digital PPV video copy protection
technologies to satellite and cable television operators and to the equipment
manufacturers that supply the satellite and cable television industries. The
Company's video scrambling technology is licensed to manufacturers of analog
cable Pay TV set-top decoders in developing cable television markets. The
Company sells encoders and decoders that incorporate other scrambling
technologies to private analog satellite networks for business communications,
education, and special interest entertainment. The Company also sells
specialized video scrambling systems in the government, military, and law
enforcement markets.
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash, cash equivalents,
marketable securities, trade accounts receivable and long-term investments. The
Company places its cash and cash equivalents and marketable securities in
deposits and money market funds with various high credit quality financial
institutions. The carrying value of the Company's financial instruments
approximates fair market value due to the relatively short maturities of those
instruments or recency of entering into such instrument as in the case of the
Company's investments in CAC and Digimarc.
F-10
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company performs ongoing credit evaluations of its customers and to date
has not experienced any material losses. Revenues from three significant
customers aggregated 37% for the year ended December 31, 1996. Revenue from one
customer accounted for 11% of net revenue for the year ended December 31, 1997.
At December 31, 1997 receivables from one customer represented 25% of net
accounts receivable.
YEAR 2000
Many computer programs historically have been written using two digits
rather than four to define the applicable year. As a result, these programs will
not properly recognize dates subsequent to 1999. The Company's plan for the Year
2000 problem entails the research and testing of its computer systems. The plan
calls for the compliance verification with external vendors supplying the
Company software, the testing of in house engineering and manufacturing software
tools and testing software in the Company's products for the Year 2000. To date,
the Company has not encountered any material Year 2000 issues concerning its
respective computer programs. The Company plans to complete it Year 2000
research and testing by the end of 1999. All costs associated with carrying out
the Company's plan for the Year 2000 problem are being expensed as incurred. The
costs associated with the Year 2000 problem are not expected to have a material
adverse effect on the Company's business, financial condition and results of
operations.
NET INCOME PER SHARE
In 1997, the Company adopted Statement of Financial Accounting Standards
("SFAS") No. 128, EARNINGS PER SHARE ("EPS"). In accordance with SFAS No. 128,
basic EPS is computed using the weighted average number of common shares
outstanding during the period. Diluted EPS is computed using the weighted
average number of common and dilutive common equivalent shares outstanding
during the period. Dilutive common equivalent shares consist of common stock
issuable upon exercise of stock options using the treasury stock method. Common
equivalent shares from preferred stock have been excluded from the computation
of diluted EPS because the effect of the inclusion would be antidilutive. The
following is a reconciliation of the shares used in the computation of basic and
diluted EPS (in thousands except for per share amounts):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Basic EPS--weighted average number of common shares outstanding........................ 6,476 3,787
Effect of dilutive common equivalent shares -- stock options outstanding............... 484 493
--------- ---------
Diluted EPS -- weighted average number of common shares and common equivalents shares
outstanding.......................................................................... 6,960 4,280
--------- ---------
--------- ---------
</TABLE>
STOCK BASED COMPENSATION
The Company uses the intrinsic value-based method to account for all of its
employee stock-based compensation plans.
F-11
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REGISTRATION STATEMENT
In December 1996, the Board of Directors authorized the filing of a
registration statement with the SEC permitting the Company and certain
stockholders of the Company to sell shares of the Company's common stock in
connection with a proposed IPO. Upon closing of the IPO, all outstanding shares
of preferred stock automatically converted into 1,376,432 shares of common
stock.
REINCORPORATION
In December 1996, the Board of Directors approved the Company's
reincorporation in the state of Delaware which became effective on February 14,
1997. The Certificate of Incorporation of the Delaware successor corporation
authorizes 50,000,000 shares of common stock, $.001 par value per share and
5,000,000 shares of preferred stock, $.001 par value per share. The Board of
Directors also approved a 1 for 1.8 reverse stock split of common and preferred
stock which became effective on February 26, 1997. The accompanying consolidated
financial statements have been retroactively restated to give effect to the
reincorporation and reverse stock split.
(2) FINANCIAL STATEMENT DETAILS
INVENTORIES
Inventories consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Raw materials........................................................................... $ 203 $ 260
Work in progress........................................................................ -- 73
Finished goods.......................................................................... 230 217
--------- ---------
$ 433 $ 550
--------- ---------
--------- ---------
</TABLE>
PROPERTY AND EQUIPMENT, NET
Property and equipment consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Machinery and equipment.............................................................. $ 3,263 $ 2,977
Leasehold improvements............................................................... 950 913
Furniture and fixtures............................................................... 438 429
--------- ---------
4,651 4,319
Less accumulated depreciation and amortization....................................... 2,929 2,302
--------- ---------
$ 1,722 $ 2,017
--------- ---------
--------- ---------
</TABLE>
F-12
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(2) FINANCIAL STATEMENT DETAILS (CONTINUED)
Equipment recorded under capital leases aggregated $518,000 with related
accumulated amortization of $233,000 and $130,000 as of December 31, 1997 and
1996, respectively.
OTHER ASSETS
Other assets consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Investment in CAC.................................................................... $ 2,337 $ 357
Investment in Digimarc............................................................... 1,500 --
Deferred offering costs.............................................................. -- 543
Deposits and other assets............................................................ 163 96
--------- ---------
$ 4,000 $ 996
--------- ---------
--------- ---------
</TABLE>
In December 1997, the Company invested $1,500,000 in Digimarc in exchange
for shares of Digimarc's preferred stock, or 6.8% ownership. Digimarc is a
private company headquartered in Portland, Oregon. Its products include
proprietary digital watermarking technology used in information embedding,
enabling image identification, copyright protection and facilitating electronic
commerce.
ACCRUED EXPENSES
Accrued expenses consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Accrued compensation................................................................. $ 1,142 $ 1,069
Accrued professional fees............................................................ 409 234
Accrued rebates...................................................................... 30 595
Other accrued liabilities............................................................ 609 570
--------- ---------
$ 2,190 $ 2,468
--------- ---------
--------- ---------
</TABLE>
INTEREST AND OTHER INCOME (EXPENSE), NET
Interest and other income (expense), net, consisted of the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Interest income......................................................................... $ 513 $ 67
Interest expense........................................................................ (12) (284)
Other................................................................................... (23) (43)
--------- ---------
$ 478 $ (260)
--------- ---------
--------- ---------
</TABLE>
F-13
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(2) FINANCIAL STATEMENT DETAILS (CONTINUED)
SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information related to noncash investing and
financing activities is as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Acquisition of equipment under capital lease......................................... -- $ 518
--------- ---------
--------- ---------
Issuance of common stock in exchange for stockholder notes receivable................ -- $ 157
--------- ---------
--------- ---------
Conversion of convertible note into preferred stock.................................. -- $ 3,038
--------- ---------
--------- ---------
Deferred stock compensation related to stock option grants........................... -- $ 231
--------- ---------
--------- ---------
Issuance of common stock in connection with recapitalization......................... -- $ 875
--------- ---------
--------- ---------
Pro rata stock dividend distribution in connection with spin-off..................... -- $ 1,253
--------- ---------
--------- ---------
Deferred stock compensation related to spin-off...................................... -- $ 189
--------- ---------
--------- ---------
Conversion of preferred stock into common stock...................................... $ 7,433 --
--------- ---------
--------- ---------
</TABLE>
(3) DEBT
The Company issued to Pacific Media Development, Inc. ("Pacific Media"), an
indirect wholly owned subsidiary of JVC and the holder of the Series A
convertible preferred stock (see Note 5), a convertible note with a principal
value of $3,038,000, which bore interest at a rate of 16.38% per annum payable
quarterly. The note was due in June 2001 and could have been extended for an
additional 10 years upon the mutual agreement of Pacific Media and the Company.
At the option of Pacific Media, the note was convertible into 543,099 shares of
Series A convertible preferred stock, subject to adjustment based upon certain
provisions of the note agreement. The note entitled Pacific Media to voting
rights equal to one vote for each share of common stock into which the note
could be converted, and the note entitled the holder to representation on the
Company's Board of Directors. In July 1996, the note was converted into 543,099
shares of Series A convertible preferred stock.
F-14
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(4) DISCONTINUED OPERATIONS AND TRANSACTIONS WITH RELATED PARTIES
DISCONTINUED OPERATIONS
In October 1995, Command Audio Corporation ("CAC") was incorporated as a
wholly-owned subsidiary of the Company to commercialize a distinctly new
audio-on-demand technology. On June 28, 1996, the Board of Directors approved
the discontinuation of the Company's involvement in CAC. CAC's operations,
technology, and employee base were discrete and separate from those of the
Company. From its inception until separation, CAC generated no revenues and
concentrated exclusively on research and development activities. In conjunction
with this decision, the Company entered into a Recapitalization and Stock
Purchase Agreement whereby the Company invested an additional $1,000,000 into
CAC, provided 194,444 shares of the Company's common stock to CAC pursuant to a
Restricted Stock Acquisition Agreement, and surrendered the Company's 500,000
shares of CAC's Series A preferred stock in exchange for 604,000 shares of CAC
common stock and 396,000 shares of CAC Series B preferred stock. Additionally,
the Company assigned to CAC all rights in certain technology and released its
reversion rights in technology that the Company had previously assigned to CAC.
In consideration of such assignment and release, CAC agreed to pay to the
Company royalties equal to 2% of CAC's gross revenues for 12 years, beginning
when CAC has operating revenues from certain sources or, at the election of the
Company, at any time prior thereto. No amounts have been paid to the Company
under this arrangement.
In August 1996, the Company distributed a portion of the 1,604,000 shares of
CAC common stock to the Company's stockholders on a pro rata basis as a dividend
and the remainder of the CAC common stock to the Company's employees as a stock
bonus while retaining the 396,000 shares of CAC Series B preferred stock,
representing a 19.8% interest in CAC. The CAC Common Stock that was distributed
to the Company's employees resulted in the recognition of $189,000 of deferred
compensation expense. This amount is being amortized over the 17 month vesting
period.
On December 6, 1996, the Company offered to repurchase 55,555 shares of its
common stock issued to CAC pursuant to a Restricted Stock Acquisition Agreement
for $9.00 per share and CAC released their demand registration rights. The offer
was subsequently rescinded and the Company agreed to allow CAC to sell its
shares of the Company in the IPO.
Information relating to discontinued operations for the year ended December
31, 1996, is as follows (in thousands):
<TABLE>
<CAPTION>
1996
---------
<S> <C>
Costs and expenses............................................................................ $ (1,081)
---------
Operating loss.............................................................................. (1,081)
Other income, net............................................................................. 5
---------
Loss before income taxes.................................................................... (1,076)
Income tax benefit, net....................................................................... 249
---------
Loss from discontinued operations........................................................... $ (827)
---------
---------
</TABLE>
CAC maintained its own set of accounts and identified expenses directly
attributable to CAC's operations. Where the Company provided services to CAC and
the specific identification of the related expenses was not practicable, the
expenses were recorded based upon an allocation of such items. This
F-15
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(4) DISCONTINUED OPERATIONS AND TRANSACTIONS WITH RELATED PARTIES (CONTINUED)
allocation was based upon the proportional benefit received by CAC and, in
management's opinion, represents a fair and reasonable estimate of expenses
incurred by CAC. Amounts receivable from CAC related to such services are
included in the accompanying consolidated balance sheets as of December 31, 1997
and 1996, as receivable from a related party.
The Company has recorded its investment in CAC based upon its historical
cost adjusted for losses incurred by CAC. The Company intends to hold this
investment for the long-term and monitors the recoverability of this investment
based on management's estimates of the fair value of CAC based on the
achievements of milestones specified in CAC's business plan. In the future, the
Company expects to evaluate the recoverability of this investment based on
successive rounds of third-party financing obtained by CAC. The investment is
classified in other assets in the accompanying consolidated balance sheet as of
December 31, 1997 and 1996. The Company is not obligated by contract to provide
future funding to CAC and does not have the ability to exert significant
influence over the financial and operating policies of CAC. The Company accounts
for this investment by the cost method.
TRANSACTIONS WITH RELATED PARTIES
The Company and JVC are parties to a Technology Application Agreement dated
November 29, 1988 (the "Application Agreement"), a Duplicator Agreement dated
June 1, 1988 (the "Duplicator Agreement") and an Agreement dated July 15, 1994
(the "Video Agreement"). Pursuant to the Application Agreement, JVC has applied
the Company's copy protection process to prerecorded videocassettes manufactured
and distributed in Japan by JVC. Pursuant to the Duplicator Agreement, JVC has
applied the Company's copy protection process to prerecorded videocassettes
manufactured and distributed in Japan by certain of the Company's licensees.
Pursuant to the Video Agreement, JVC developed a prototype of equipment to apply
a copy protection process to prerecorded videocassettes, and granted the Company
exclusive rights to purchase such equipment from JVC for resale and to
sublicense the copy protection technology for use with the equipment. For the
years ended December 31, 1997 and 1996, the Company recorded revenue from JVC of
approximately $234,000 and $78,000, respectively, and recorded expenses payable
to JVC of approximately $22,000 and $12,000, respectively under these
agreements.
In connection with a license agreement dated September 26, 1995 among the
Company, Victor Technobrain Co., Ltd. ("Techno"), a wholly owned subsidiary of
JVC, and an unrelated party, the Company has paid Techno a development fee of
$50,000 which has been recorded as an offset to the revenue recognized from the
unrelated party. An additional $50,000 was owed to Techno as of December 31,
1996 and paid in 1997 upon receipt of the final license payment from the
unrelated party.
The Company's Japanese subsidiary and Techno are parties to a Technical
Consulting Agreement dated July 1, 1996 pursuant to which Techno provides
technical consulting services as assigned by certain officers of the Company or
Macrovision Japan in connection with technical support subject to an hourly rate
of approximately $85 per hour, subject to a minimum consulting fee of
approximately $1,700 per quarter, and reimbursement of expenses related to the
performance under the agreement.
In January 1997, the Company and JVC entered into a Copy Protection
Technology Agreement in which the Company has agreed to continue to license its
copy protection technologies to third parties in the event of the acquisition of
the Company by a party other than JVC. Further, the Company has granted
F-16
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(4) DISCONTINUED OPERATIONS AND TRANSACTIONS WITH RELATED PARTIES (CONTINUED)
to JVC the right to sublicense the Company's copy protection technologies with
95% of the royalties from such sublicenses payable to the Company or successor
in the event that the Company fails to make its copy protection technologies
generally available for licensing to third parties following an acquisition of
the Company.
In 1997, the Company entered into several agreements with JVC or its wholly
owned subsidiaries including a Copy Protection License Agreement, a Digital
Versatile Disc Player/Digital Video Cassette Recorder License Agreement for
Anticopy Technology and a Replicator Agreement. The terms and conditions of
these agreements are not more favorable to JVC or its subsidiaries than the
terms offered to other unrelated parties. The Company recorded revenues from JVC
of approximately $59,000 during the year ended December 31, 1997.
In 1996 and 1997, the Company entered into agreements with Matsushita, which
owns approximately 52% of JVC, including a Copy Protection Technology License
Agreement, a Digital Versatile Disc Player/ Digital Video Cassette Recorder
License Agreement for Anticopy Technology and a Component Supplier Non-Assertion
and Technical Services Agreement. The terms and conditions of such agreements
are not more favorable to JVC or its subsidiaries than the terms offered to
other unrelated parties. The Company recorded revenues from Matsushita of
approximately $111,000 and $56,000 during the years ended December 31, 1997 and
1996, respectively.
(5) STOCKHOLDERS' EQUITY
SERIES A CONVERTIBLE PREFERRED STOCK
The Company's Certificate of Incorporation provides for the issuance of up
to 5,000,000 shares of preferred stock, of which 1,376,432 shares were
designated as Series A. In June 1991, the Company issued to Pacific Media (the
"Purchaser") 833,333 shares of Series A convertible preferred stock for gross
proceeds of $4,500,000. The shares were convertible into the Company's common
stock on a one-for-one basis at the option of the holder or automatically upon a
qualifying IPO. Each share of Series A convertible preferred stock entitled its
holder to one vote for each share of common stock into which such shares could
be converted, not to exceed voting rights equivalent to 49% of the outstanding
voting stock. Cumulative dividends at the rate of $.54 per share per year were
payable quarterly to the holder of the Series A convertible preferred stock. The
holder of the Series A convertible preferred stock is entitled to $5.40 per
share in the event of any liquidation, dissolution, or winding up of the
Company, plus an amount equal to all declared but unpaid dividends, prior and in
preference to any distribution to the holders of common stock.
In conjunction with the issuance of the Series A convertible preferred stock
and the convertible note, the Company agreed to grant certain rights to the
Purchaser, which included a first right to purchase a pro rata share of any
equity offering of the Company excluding shares issued for (a) an IPO or (b) an
acquisition of another corporation, if such exclusions will not reduce the
purchaser's pro rata ownership share of the Company below 25%, (c) stock
dividend or splits, and (d) stock compensation plans. Further, the purchaser has
entered into an agreement with the holders of common stock and optionees of the
Company as of June 12, 1991, giving the purchaser the right to acquire all of
their shares of common stock and options at a predetermined price upon notice
from the Company that it has filed a registration
F-17
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(5) STOCKHOLDERS' EQUITY (CONTINUED)
statement in connection with an IPO. In January 1997, the Company and Pacific
Media entered into a Waiver Agreement, pursuant to which Pacific Media waived
its right to purchase shares of the Company's common stock from stockholders and
optionholders triggered by the filing of the registration statement in
connection with the IPO and any pre-effective amendments thereto filed prior to
April 1, 1997. Upon the completion of the IPO, all rights of Pacific Media to
purchase common stock of the Company from such persons expired.
RESTRICTED STOCK
On June 7, 1996, the Company issued 58,333 shares of common stock at a price
of $2.70 per share pursuant to a restricted stock purchase agreement to an
officer of the Company in exchange for a full recourse promissory note secured
by the shares in the principal amount of $157,000. Interest accrues at the rate
of 6.58% per annum. Principal and accrued interest, if any, are due and payable
on June 7, 2001. The Company has the right to repurchase the stock at the
original sales price upon the termination of the purchaser's employment with the
Company. The repurchase right lapses at a rate of 1/6 after June 7, 1997, 1/3
after June 7, 1998, and 1/2 after June 7, 1999. As of December 31, 1997, there
were 48,611 shares subject to the repurchase right and the remaining principal
of the note was $131,000.
STOCK OPTION AND PURCHASE PLANS
In December 1996, the Company adopted the 1996 Equity Incentive Plan (the
"Equity Incentive Plan"), which serves as the successor to the Company's 1988
Stock Option Plan (the "1988 Plan"). Options granted under the 1988 Plan before
its termination continue to remain outstanding in accordance with their terms,
but no further options may be granted under the 1988 Plan. Nonstatutory stock
options and incentive stock options granted under the 1988 Plan were exercisable
at prices not less than 85% and 100%, respectively, of the fair value of the
Company's common stock on the date of grant, as determined by the Company's
Board of Directors. The options were generally exercisable over a 3-year vesting
period and expire 7 to 10 years from date of grant.
Pursuant to the Equity Incentive Plan, the Company's Board of Directors has
reserved 1,332,222 shares of common stock for issuance. The Equity Incentive
Plan provides for the grant of stock options, stock appreciation rights, and
restricted stock awards by the Company to employees, officers, directors,
consultants, independent contractors, and advisers of the Company. The Equity
Incentive Plan permits the grant of either incentive or nonqualified stock
options at the then current market price. Options granted under the Equity
Incentive Plan will have a maximum term of ten years and generally vest over
three years at the rate of 1/6, 1/3 and 1/2, respectively.
In December 1996, the Company's Board of Directors adopted the 1996 Employee
Stock Purchase Plan (the "Purchase Plan") and reserved 140,000 shares of common
stock for issuance thereunder. The Purchase Plan was effective upon the
Company's proposed IPO. The Purchase Plan permits eligible employees to purchase
common stock, through payroll deductions of between 1% and 20% of the employee's
compensation, at a price equal to 85% of the lower of the fair market value of
the common stock on the first day of the offering period or on the last day of
the purchase period. The Company's stockholders approved the Purchase Plan in
February 1997. In 1997, the Company issued 11,646 shares pursuant to the
Purchase Plan.
F-18
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(5) STOCKHOLDERS' EQUITY (CONTINUED)
In December 1996, the Company's Board of Directors adopted the 1996
Directors Stock Option Plan (the "Directors Plan") and reserved 60,000 shares of
common stock for issuance thereunder. The Directors Plan provides for the
initial grant of a nonqualified option to purchase 5,000 shares of common stock
on the date the eligible director first becomes a director and the additional
grant of a nonqualified option to purchase 3,000 shares of Common Stock annually
thereafter. Options will vest at the rate of 2.08% per month so long as the
director continues to serve on the Board on such dates. The Company's
stockholders approved the Directors Plan in February 1997. During 1997, the
Company granted options to purchase 15,000 shares of common stock.
The Company uses the intrinsic value-based method to account for all of its
employee stock-based compensation plans. Accordingly, no compensation cost has
been recognized in the accompanying consolidated financial statements for its
plans because the exercise price of each option equaled or exceeded the fair
value of the underlying common stock as of the grant date for each stock option,
except for options and restricted stock granted in May and June 1996. With
respect to the options and restricted stock granted in May and June 1996, the
Company has recorded deferred stock compensation of $231,000 for the difference
at the grant date between the exercise price and the fair value, as determined
by an independent valuation, of the restricted stock and the common stock
underlying the options. This amount is being amortized on a straight-line basis
over the vesting period of the individual options and restricted stock,
generally three years.
If compensation cost for the Company's stock-based compensation plans had
been determined in a manner consistent with the fair value approach described in
SFAS No. 123, the Company's net income and net income per share as reported
would have been reduced to the pro forma amounts indicated below (in thousands,
except per share data):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1996
--------- ---------
<S> <C> <C> <C>
Net income As reported................................... $ 3,821 $ 1,008
Adjusted pro forma............................ 3,388 931
Diluted net income per share As reported................................... .53 .10
Adjusted pro forma............................ .46 .08
</TABLE>
F-19
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(5) STOCKHOLDERS' EQUITY (CONTINUED)
The fair value of each option is estimated on the date of grant using the
Black-Scholes method in 1997 and the minimum value method in 1996 with the
following weighted average assumptions for options and the ESPP plan:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1996
----------- ----------------
<S> <C> <C>
OPTION PLANS:
Dividends............................................................... None None
Expected term........................................................... 4.56 years 4.0 years
Risk free interest rate................................................. 6.07% 5.82%
Volatility rate......................................................... 64.7% None
ESPP PLAN:
Dividends............................................................... None Not applicable
Expected term........................................................... 1.25 years Not applicable
Risk free interest rate................................................. 5.42% Not applicable
Volatility rate......................................................... 62.4% Not applicable
</TABLE>
Activity under the Company's option plans is as follows:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED-AVERAGE
SHARES EXERCISE PRICE
----------- -----------------
<S> <C> <C>
Outstanding as of December 31, 1995............................. 707,889 $ 2.66
Granted......................................................... 142,050 4.26
Canceled........................................................ (83,111) 2.69
Exercised....................................................... (66,263) 2.57
-----------
Outstanding as of December 31, 1996............................. 700,565 2.99
Granted......................................................... 126,154 11.81
Canceled........................................................ (17,034) 4.17
Exercised....................................................... (111,342) 2.59
-----------
Outstanding as of December 31, 1997............................. 698,343 4.62
-----------
-----------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Options exercisable at period-end....................................... 379,042 365,258
Weighted average fair value of options granted during the
period................................................................. $ 6.87 $ .88
</TABLE>
F-20
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(5) STOCKHOLDERS' EQUITY (CONTINUED)
The following table summarizes information about fixed stock options
outstanding as of December 31, 1997:
<TABLE>
<CAPTION>
EXERCISABLE
OUTSTANDING --------------------------
------------------------------------------------- WEIGHTED
WEIGHTED AVERAGE AVERAGE
RANGE OF EXERCISE NUMBER OF REMAINING WEIGHTED AVERAGE NUMBER EXERCISE
PRICES SHARES CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE PRICE
- ---------------------- --------- ------------------- ----------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
$2.25 - 2.70.......... 530,252 6.90 year $ 2.70 369,844 $ 2.70
$7.20 - 9.00.......... 99,114 9.07 8.10 8,678 7.60
$13.62 - 14.50........ 68,977 9.78 14.44 520 14.13
--------- -----------
698,343 7.49 4.62 379,042 2.82
--------- -----------
--------- -----------
</TABLE>
(6) INCOME TAXES
Income taxes consisted of the following (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Current:
Federal.................................................................. $ 2,169 $ 1,146
Foreign.................................................................. 383 71
State.................................................................... 544 208
--------- ---------
Total current.......................................................... 3,096 1,425
--------- ---------
Deferred:
Federal.................................................................. (554) (305)
State.................................................................... (129) (146)
--------- ---------
Total deferred......................................................... (683) (451)
--------- ---------
$ 2,413 $ 974
--------- ---------
--------- ---------
</TABLE>
Total tax expense (benefit) has been allocated as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Continuing operations...................................................... $ 2,413 $ 1,223
Discontinued operations.................................................... -- (249)
--------- ---------
$ 2,413 $ 974
--------- ---------
--------- ---------
</TABLE>
F-21
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(6) INCOME TAXES (CONTINUED)
The Company's effective tax rate differs from the statutory federal tax rate
as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Computed "expected" tax expense.............................................. $ 2,120 $ 674
State tax expenses, net of federal benefit................................... 274 98
Tax credits.................................................................. (87) (45)
Foreign taxes................................................................ 47 15
Exempt interest.............................................................. (144) (13)
Write-off of discontinued operations deferred tax asset...................... -- 203
Other........................................................................ 203 42
--------- ---------
$ 2,413 $ 974
--------- ---------
--------- ---------
</TABLE>
The tax effects of the temporary differences that give rise to significant
portions of the deferred tax assets and liabilities are presented below (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Deferred tax assets:
Accrued liabilities and reserves......................................... $ 673 $ 598
Allowance for doubtful accounts.......................................... 272 106
Depreciation and amortization............................................ 707 338
Deferred revenue......................................................... 382 238
Other.................................................................... -- 32
--------- ---------
Total gross deferred tax assets........................................ 2,034 1,312
Deferred tax liabilities:
Patents.................................................................. 782 743
--------- ---------
Net deferred tax assets................................................ $ 1,252 $ 569
--------- ---------
--------- ---------
</TABLE>
Management believes that it is more likely than not that the results of
future operations will generate sufficient taxable income to realize the
deferred tax assets.
(7) COMMITMENTS
LEASES
The Company leases its facilities and certain equipment pursuant to
noncancelable operating lease agreements. Additionally, the Company leases
certain equipment pursuant to a capital lease agreement.
F-22
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(7) COMMITMENTS (CONTINUED)
Future minimum lease payments pursuant to these leases as of December 31,
1997, were as follows (in thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASE LEASES
----------- -----------
<S> <C> <C>
1998..................................................................... $ 116 $ 463
1999..................................................................... 116 448
2000..................................................................... 78 411
2001..................................................................... -- 426
2002 and thereafter...................................................... -- 217
----- -----------
Total.................................................................... 310 $ 1,965
-----------
-----------
Less amounts representing interest....................................... 14
-----
Present value of minimum capital lease payments.......................... 296
Less current portion of capital lease liability.......................... 108
-----
Capital lease liability, net of current portion.......................... $ 188
-----
-----
</TABLE>
Rent expense was $469,000, and $441,000 as of December 31, 1997 and 1996,
respectively.
EMPLOYEE BENEFIT PLAN
The Company has a 401(k) plan that allows eligible employees to contribute
up to 20% of their compensation, which contribution was limited to $9,500 in
1997. Employee contributions and earnings thereon vest immediately. The Company
is not required to contribute to the 401(k) plan and had made no voluntary
contributions. The Company made matching contributions to the 401(k) plan equal
to 20% of each participating employee's contribution, up to a maximum annual
matching contribution of $1,900 in 1997 and 1996. Matching contributions
aggregated $54,000 and $60,000 for the year ended December 31, 1997 and 1996,
respectively, and are fully vested after three years of service.
(8) CONTINGENCIES
In October 1995, a former officer and director of the Company filed suit
against the Company in the Superior Court of the State of California alleging
monetary damages suffered as a result of alleged fraud, misrepresentation, and
other malfeasance in connection with the Company's grant of stock options to
him. The plaintiff maintains that the Company induced him to accept employment
by falsely representing to him that the options granted to him eventually would
have substantial value. Between August 1990 and December 1993, the Company
granted to him options to purchase approximately 200,000 shares of the Company's
common stock with per share exercise prices of $2.25 or $2.70. Substantially all
of these options expired unexercised within three months following his departure
from the Company in June 1995. In December 1996, the court ordered this matter
to binding arbitration in accordance with a written agreement between the
plaintiff and the Company. The arbitration agreement contains limitations on the
types of damages available to him and expressly precludes punitive damages. The
plaintiff filed his claim in arbitration for this matter with the American
Arbitration Association in June 1997 and the arbitration is proceeding. The
Company believes that the case is without merit and intends to contest it
vigorously. In
F-23
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(8) CONTINGENCIES (CONTINUED)
the opinion of counsel, it is not possible to determine with precision the
probable outcome or the amount of liability, if any, under this lawsuit.
(9) SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in one industry segment and is engaged in developing
and licensing or selling its video copy protection and video scrambling
technologies to customers in the home videocassette, pay-per-view, cable,
satellite, and corporate communications markets primarily in the United States,
Europe, Japan and the Far East. The distribution of revenues, operating income,
and assets by geographic area is as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Revenues:
United States......................................................... $ 18,960 $ 15,823
Foreign operations.................................................... 1,380 1,257
--------- ---------
Total revenues........................................................ $ 20,340 $ 17,080
--------- ---------
--------- ---------
Operating income from continuing operations:
United States......................................................... $ 5,513 $ 3,064
Foreign operations.................................................... 242 254
--------- ---------
Total operating income.............................................. $ 5,755 $ 3,318
--------- ---------
--------- ---------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Identifiable assets:
United States......................................................... $ 27,524 $ 10,844
Foreign operations.................................................... 1,438 1,215
--------- ---------
Subtotal identifiable assets........................................ 28,962 12,059
Eliminations.......................................................... (106) (106)
--------- ---------
Total identifiable assets........................................... $ 28,856 $ 11,953
--------- ---------
--------- ---------
</TABLE>
United States revenue includes export sales to the following geographic
areas (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Europe..................................................................... $ 3,200 $ 2,166
Japan...................................................................... 1,500 1,099
Rest of world.............................................................. 3,382 1,947
--------- ---------
$ 8,082 $ 5,212
--------- ---------
--------- ---------
</TABLE>
F-24
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(10) SUBSEQUENT EVENTS (UNAUDITED)
On February 17, 1998, Macrovision acquired 247,500 shares (approximately
19.8%) of the common stock of C-Dilla, Ltd., a UK company (C-Dilla) for a
purchase price of L2,121,212 (approximately $3,500,000). On February 17, 1998,
the Company also entered into a Software Marketing Licence and Development
Agreement, (the Agreement) under which it has obtained, for an initial five-year
term, the world-wide exclusive license to market in the consumer multimedia
software market C-Dilla's proprietary copy protection technology for CD-ROM and
internet-delivered software products. The Company paid L606,060 (approximately
$1,000,000) in up-front license fees subject to offset against future royalties
and will pay royalty payments to C-Dilla of between 30% to 45% of revenues from
sales of software products incorporating C-Dilla's technology. In the event that
the Company fails to reach minimum royalty levels of $2,000,000 in year three of
the Agreement, $5,000,000 in year four, and $10,000,000 in year five, the
license becomes a non-exclusive license for the term of the Agreement.
Additionally, in connection with C-Dilla's granting of licenses for certain of
its products outside of the markets for which the Company has been granted
rights under the Agreement, C-Dilla will pay to the Registrant royalties of
between 7.5% to 30% of revenues from such licenses. The Company has the option
to extend the initial term of the Agreement for an additional five year period
upon payment of an option fee of $1,000,000 and an additional license fee of
$5,000,000 which fee may be paid through future increased royalty payments.
Under the terms of the Agreement, the Company also agreed to develop jointly
with C-Dilla certain other proprietary copy protection technologies for CD-ROM,
DVD-ROM and other digital delivery methods. (See Form 8-K filed March 5, 1998).
F-25
<PAGE>
EXHIBIT 23.01
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Macrovision Corporation:
We consent to incorporation by reference in the registration statement (No.
333-23213) on Form S-8 of Macrovision Corporation of our report dated February
6, 1998, relating to the consolidated balance sheets of Macrovision Corporation
and subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of income, stockholders' equity, and cash flows for the years then
ended, which report appears in the December 31, 1997, annual report on Form
10-KSB of Macrovision Corporation.
/s/ KPMG PEAT MARWICK LLP
Mountain View, California
March 27, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF MACROVISION CORPORATION FOR THE TWELVE MONTHS
ENDED DECEMBER 31, 1997, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 1314
<SECURITIES> 11241
<RECEIVABLES> 5924
<ALLOWANCES> 684
<INVENTORY> 433
<CURRENT-ASSETS> 20273
<PP&E> 4651
<DEPRECIATION> 2929
<TOTAL-ASSETS> 28856
<CURRENT-LIABILITIES> 5007
<BONDS> 0
0
0
<COMMON> 7
<OTHER-SE> 23570
<TOTAL-LIABILITY-AND-EQUITY> 28856
<SALES> 20340
<TOTAL-REVENUES> 20340
<CGS> 2422
<TOTAL-COSTS> 2422
<OTHER-EXPENSES> 12162
<LOSS-PROVISION> 553
<INTEREST-EXPENSE> 12
<INCOME-PRETAX> 6234
<INCOME-TAX> 2413
<INCOME-CONTINUING> 3821
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3821
<EPS-PRIMARY> .57
<EPS-DILUTED> .53
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF MACROVISION CORPORATION FOR THE TWELVE MONTHS ENDED
DECEMBER 31, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 2,409
<SECURITIES> 0
<RECEIVABLES> 3,643
<ALLOWANCES> 267
<INVENTORY> 550
<CURRENT-ASSETS> 7,450
<PP&E> 4,319
<DEPRECIATION> 2,302
<TOTAL-ASSETS> 11,953
<CURRENT-LIABILITIES> 5,225
<BONDS> 0
0
1
<COMMON> 4
<OTHER-SE> 6,067
<TOTAL-LIABILITY-AND-EQUITY> 11,953
<SALES> 17,080
<TOTAL-REVENUES> 17,080
<CGS> 2,579
<TOTAL-COSTS> 2,579
<OTHER-EXPENSES> 11,183
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 284
<INCOME-PRETAX> 3,058
<INCOME-TAX> 1,223
<INCOME-CONTINUING> 1,835
<DISCONTINUED> (827)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,008
<EPS-PRIMARY> .11
<EPS-DILUTED> .10
</TABLE>
