<PAGE>
FORM 10-QSB
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
/x/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 000-22023
MACROVISION CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 77-0156161
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1341 Orleans Drive
Sunnyvale, California 94089
(Address of principal executive offices) (Zip code)
(408) 743-8600
(Registrant's telephone number including area code)
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
----- -----
State the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Title Outstanding as of July 31, 1998
Common Stock, $0.001 par value 8,691,593
Transitional Small Business Disclosure Format (check one):
Yes No X
----- -----
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MACROVISION CORPORATION
FORM 10-QSB
INDEX
PART I. FINANCIAL INFORMATION Page
Item 1. Unaudited Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets
as of June 30, 1998 and December 31, 1997...................... 3
Condensed Consolidated Statements of Income
for the Three Month Periods Ended June 30, 1998 and 1997, and
Six Month Periods Ended June 30, 1998 and 1997................. 4
Condensed Consolidated Statements of Cash Flows
for the Six Month Periods Ended June 30, 1998 and 1997......... 5
Notes to Condensed Financial Statements......................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 9
Item 3. Risk Factors.................................................... 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................... 19
Item 2-3 Not Applicable
Item 4 Submission of Matters to a Vote of Security Holders............. 20
Item 5. Other Information............................................... 20
Item 6. Exhibits and Reports on Form 8-K................................ 20
Signatures................................................................ 21
2
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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
-------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 3,049 $ 1,314
Short-term investments 5,630 11,241
Receivable due from sale of stock 28,310 --
Accounts receivable, less allowance for
doubtful accounts of $737 and $684 4,162 5,240
Inventories 489 433
Deferred tax assets 1,657 1,336
Prepaid expenses and other assets 1,412 709
-------- -----------
Total current assets 44,709 20,273
Property and equipment, net 1,497 1,722
Patents and other intangibles, net 1,316 1,098
Long-term marketable investment securities 3,856 1,763
Other assets 8,588 4,000
-------- -----------
$ 59,966 $ 28,856
-------- -----------
-------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,292 $ 919
Accrued expenses 2,338 2,190
Deferred revenue 1,156 944
Income taxes payable -- 846
Current portion of capital lease obligation 110 108
-------- -----------
Total current liabilities 4,896 5,007
Capital lease obligation, net of current portion 133 188
Deferred tax liabilities 768 84
-------- -----------
5,797 5,279
Stockholders' equity:
Common stock 9 7
Additional paid-in capital 51,491 23,277
Stockholder's note receivable (78) (131)
Deferred stock compensation (25) (96)
Accumulated other comprehensive loss (270) (214)
Retained earnings 3,042 734
-------- -----------
TOTAL STOCKHOLDERS' EQUITY 54,169 23,577
-------- -----------
$ 59,966 $ 28,856
-------- -----------
-------- -----------
</TABLE>
See the accompanying notes to these condensed consolidated financial statements.
3
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MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1998 1997 1998 1997
------ ------- ------- -------
<S> <C> <C> <C> <C>
Net revenues $5,665 $ 4,722 $10,843 $ 9,286
------ ------- ------- -------
Costs and expenses:
Cost of revenues 449 697 847 1,378
Research and development 654 516 1,277 1,073
Selling and marketing 1,487 1,378 3,013 2,926
General and administrative 1,128 1,018 2,287 1,897
------ ------- ------- -------
Total costs and expenses 3,718 3,609 7,424 7,274
------ ------- ------- -------
Operating income 1,947 1,113 3,419 2,012
Interest and other income, net 172 149 303 173
------ ------- ------- -------
Income before income taxes 2,119 1,262 3,722 2,185
Income taxes 805 505 1,414 874
------ ------- ------- -------
Net income $1,314 $ 757 $ 2,308 $ 1,311
------ ------- ------- -------
------ ------- ------- -------
Computation of basic and diluted earnings per share:
Net income $1,314 $ 757 $ 2,308 $ 1,311
Preferred stock dividends -- -- -- (156)
------ ------- ------- -------
Earnings applicable to common stock $1,314 $ 757 $ 2,308 $ 1,155
------ ------- ------- -------
------ ------- ------- -------
Basic earnings per share $ 0.18 $ 0.11 $ 0.32 $ 0.20
------ ------- ------- -------
------ ------- ------- -------
Shares used in computing basic earnings per share 7,300 7,065 7,272 5,785
------ ------- ------- -------
------ ------- ------- -------
Diluted earnings per share $ 0.17 $ 0.10 $ 0.30 $ 0.18
------ ------- ------- -------
------ ------- ------- -------
Shares used in computing diluted earnings per share 7,838 7,573 7,787 6,250
------ ------- ------- -------
------ ------- ------- -------
</TABLE>
See the accompanying notes to these condensed consolidated financial statements.
4
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MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended June 30,
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,308 $ 1,311
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 486 570
Deferred income taxes 363 (484)
Amortization of deferred stock compensation 71 72
Changes in operating assets and liabilities:
Accounts receivable, inventories, and
other current assets 319 (978)
Accounts payable, accrued expenses,
deferred revenue and income
taxes payable (113) 107
Other (47) 68
-------- --------
Net cash provided by operating activities 3,387 666
-------- --------
Cash flows from investing activities:
Purchases of long-term marketable investment
securities (3,104) --
Sales or maturities of long-term marketable
investment securities 1,011 --
Purchases of short-term investments (4,271) (23,520)
Sales or maturities of short-term investments 9,890 10,120
Investment in related party -- (247)
Acquisition of property and equipment (138) (301)
Payments for patents and other intangibles (358) (151)
Investment in C-Dilla Limited (3,553) --
Prepaid future royalties to C-Dilla Limited (1,015) --
Other, net (20) (91)
-------- --------
Net cash used in investing activities (1,558) (14,190)
-------- --------
Cash flows from financing activities:
Payments on capital lease obligations (53) (53)
Proceeds from issuance of common stock, net 354 13,873
Payment of stockholder's note receivable 53 --
Deferred offering costs (448) --
Cash dividends -- (156)
-------- --------
Net cash (used in) provided by
financing activities (94) 13,664
-------- --------
Net increase in cash and cash equivalents 1,735 140
Cash and cash equivalents at beginning of period 1,314 2,409
-------- --------
Cash and cash equivalents at end of period $ 3,049 $ 2,549
-------- --------
-------- --------
Supplemental cash flow information:
Interest paid $ 7 $ 6
-------- --------
-------- --------
Income taxes paid $ 2,063 $ 1,200
-------- --------
-------- --------
Receivable due from sale of stock $ 28,310 $ --
-------- --------
-------- --------
</TABLE>
See the accompanying notes to these condensed consolidated financial statements.
5
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MACROVISION CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared by Macrovision Corporation (the "Company") in accordance with the
rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures, normally included in financial statements
prepared in accordance with generally accepted accounting principles, have been
condensed or omitted in accordance with such rules and regulations. In the
opinion of management, the accompanying unaudited condensed consolidated
financial statements reflect all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly the financial position of
the Company, and its results of operations and cash flows for those periods
presented. This quarterly report on Form 10-QSB should be read in conjunction
with the audited financial statements and notes thereto for the year ended
December 31, 1997, and other disclosures, including risk factors, included in
the Company's Registration Statement on Form S-3 (Registration No. 333-55757)
and in the Company's Annual Report on Form 10-KSB filed on March 30, 1998.
The results of operations for the interim periods presented are not necessarily
indicative of the results expected for the entire year ending December 31, 1998
or any other future interim period, and the Company makes no representations
related thereto.
NOTE 2 - CASH, CASH EQUIVALENTS, AND SHORT-TERM INVESTMENTS
The Company considers all highly liquid investments with a maturity from the
date of purchase of three months or less to be cash equivalents.
Investments held by the Company are classified as "available-for-sale" and are
carried at fair value based on quoted market prices, with unrealized gains and
losses, if material, reported in stockholders' equity. Such investments
consisting of U.S. government or agency issues with an original maturity beyond
3 months and less than 12 months are classified as short-term investments. All
marketable securities with maturities over one year are classified as long-term
marketable investment securities. The following is a summary of short-term
securities:
<TABLE>
<CAPTION>
June 30, 1998 December 31, 1997
Gross Gross
(In Thousands) Amortized Unreal. Amortized Unreal.
Cost Gain Fair Value Cost Gain Fair Value
--------- ------ ---------- --------- ------- ----------
<S> <C> <C> <C> <C> <C> <C>
Government bonds $ 5,627 $ 3 $ 5,630 $ 7,837 $4 $ 7,841
Auction rate
preferred
stock
certificates -- -- -- 3,400 -- 3,400
--------- ------ ---------- --------- ------- ----------
$ 5,627 $ 3 $ 5,630 $11,237 $4 $11,241
--------- ------ ---------- --------- ------- ----------
--------- ------ ---------- --------- ------- ----------
</TABLE>
NOTE 3 - SECONDARY OFFERING AND EXCERCISE OF OPTIONS
On June 30, 1998, the Company consummated an offering ("offering") of 1,500,000
shares of its Common Stock, of which 1,140,000 shares were issued and sold by
the Company and 360,000 shares were sold by shareholders of the Company. The
Underwriters also exercised in full an over-allotment option to purchase from
the Company an additional 225,000 shares of Common Stock. All shares were
sold for $22.00 per share. The net proceeds to the Company from the offering,
after deducting the underwriting discount and other expenses of the offering,
were approximately $27.9 million. Proceeds from the offering
6
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were received in July 1998. The Company did not receive any proceeds from
the sale of shares sold by the selling shareholders.
Also, during the quarter ended June 30, 1998, the Company issued 32,799 shares
of common stock and received proceeds of approximately $97,000 associated with
the exercise of stock options.
NOTE 4 - INVENTORIES
Inventories are stated at the lower of first-in, first-out cost or market and
consisted of the following:
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
(In thousands) (Unaudited) (Unaudited)
----------- -----------
<S> <C> <C>
Raw materials $207 $203
Work-in-process 104 --
Finished goods 178 230
----------- -----------
$489 $433
----------- -----------
----------- -----------
</TABLE>
NOTE 5 - NET INCOME PER SHARE
Basic earnings per share ("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 potentially dilutive common shares
outstanding during the period. Potentially dilutive common shares consist of
common stock issuable upon exercise of stock options using the treasury stock
method. Common shares issuable upon conversion of preferred stock have been
excluded from the computation of diluted EPS, prior to their conversion into
common stock on March 17, 1997, because the effect of their inclusion would be
antidilutive. The following is a reconciliation of the shares used in the
computation of basic and diluted EPS (in thousands):
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
1998 1997 1998 1997
------------ ------------- ---------- --------------
<S> <C> <C> <C> <C>
Basic EPS - weighted average
number of common shares
outstanding 7,300 7,065 7,272 5,785
Effect of dilutive common shares -
stock options outstanding 538 508 515 465
------------ ------------- ---------- --------------
Diluted EPS - weighted average
number of common shares and
common shares outstanding 7,838 7,573 7,787 6,250
------------ ------------- ---------- --------------
------------ ------------- ---------- --------------
</TABLE>
NOTE 6 - RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, REPORTING COMPREHENSIVE INCOME. SFAS No. 130 establishes standards
of reporting and display of comprehensive income and its components of net
income and "other comprehensive income" in a full set of general purpose
financial statements. "Other comprehensive income" refers to revenues,
expenses, gains and losses that are not included in net income but rather are
recorded directly in stockholders' equity. SFAS No. 130 is effective for
annual and interim periods beginning after December 15, 1997 and for periods
ended before that date when presented for comparative purposes. The Company
has not yet determined the format it will use to display the information
required by SFAS No. 130 in the financial statements for the year ending
December 31, 1998. Total comprehensive income was $2,252,000 and $1,249,000
for the six months ended June 30, 1998 and 1997, respectively. The primary
components of other comprehensive
7
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income include unrealized gains and losses resulting from the translation of
the Company's foreign subsidiaries which have a local functional currency and
unrealized holding gains and losses related to the Company's short and long
term marketable investments.
In June 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION. SFAS No. 131 establishes standards of
reporting information about operating segments in annual financial statements
by public business enterprises and requires such enterprises to report
selected information about operating segments in interim financial reports.
SFAS No. 131 is effective for fiscal years beginning after December 15, 1997,
and for periods ended before that date when presented for comparative
purposes. The required interim disclosures are not required to be made in
the initial year of application but the information for the interim periods
for the initial year is required as comparative information in the second
year of application. As such, the Company intends to display the information
required by SFAS No. 131 in the interim and annual financial statements for
the year ending December 31, 1999.
NOTE 7 - OTHER ASSETS
In February 1998, Macrovision acquired 247,500 shares (approximately 19.8%)
of the common stock of C-Dilla Limited, a UK company ("C-Dilla"), for a
purchase price of $3,553,000. In February 1998, the Company also entered
into a Software Marketing License and Development 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 $1,015,000 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. No revenue has been recorded under this arrangement.
The Company intends to hold its investments for the longterm and monitors
whether there has been an other than temporary decline in the value of these
investments based on management's estimates of their net realizable value
based on the achievement of milestones in business plans and third-party
financing. The Company records its investments using the cost basis and such
investments are classified as other assets in the accompanying condensed
consolidated balance sheets as follows:
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
-------- ------------
<S> <C> <C>
Investment in CAC $2,337 $2,337
Investment in Digimarc 1,500 1,500
Investment in C-Dilla 3,553 --
Prepayment of royalties to C-Dilla 1,015 --
Deposits and other assets 183 163
-------- ------------
$8,588 $4,000
-------- ------------
-------- ------------
</TABLE>
8
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING
OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF
THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. PREDICTIONS OF FUTURE EVENTS
ARE INHERENTLY UNCERTAIN. ACTUAL EVENTS COULD DIFFER MATERIALLY FROM THOSE
PREDICTED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF THE RISKS SET FORTH
IN THIS FORM 10-QSB AND IN THE "RISK FACTORS" SECTION OF THE COMPANY'S
PROSPECTUS DATED JUNE 25, 1998, INCLUDED IN THE COMPANY'S REGISTRATION
STATEMENT ON FORM S-3 (REGISTRATION NO. 333-55757), WHICH WAS DECLARED
EFFECTIVE BY THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 25,1998. THERE ARE
NO ASSURANCES THAT THE COMPANY HAS IDENTIFIED ALL POSSIBLE PROBLEMS THAT THE
COMPANY MIGHT FACE. ALL INVESTORS SHOULD CAREFULLY READ THE COMPANY'S
REGISTRATION STATEMENT ON FORM S-3, TOGETHER WITH THIS FORM 10-QSB, AND
CONSIDER ALL SUCH RISKS BEFORE MAKING AN INVESTMENT DECISION WITH RESPECT TO
THE COMPANY'S STOCK.
OVERVIEW
The Company 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 revenues of the Company primarily
consists of licensing fees for videocassette and DVD copy protection, licensing
of digital Pay-Per-View copy protection, licensing fees for multimedia software
copy protection and licensing and selling products incorporating its PhaseKrypt
video scrambling technology to cable television system operators, law
enforcement agencies, television broadcasters and private analog satellite
networks.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30, 1997
The following table provides revenue information by general product lines for
the three-month period ended as indicated (dollars in thousands):
<TABLE>
<CAPTION>
June 30, June 30,
1998 % 1997 % % Change
------- --- -------- ----- ----------
<S> <C> <C> <C> <C> <C>
Copy Protection Group $5,459 96 $4,022 85 36 %
Video Scrambling Group 206 4 659 14 (69)%
Other -- -- 41 1 --
------- --- -------- -----
Total $5,665 100 $4,722 100.0 20 %
------- --- -------- -----
------- --- -------- -----
</TABLE>
NET REVENUES
Consolidated net revenues for the second quarter of 1998 increased 20% to $5.7
million from $4.7 million in the second quarter of 1997. Revenues from the
Copy Protection Group increased 36% to $5.5 million from $4.0 million due to
royalties from the higher volume of videocassettes from studio business and
increases in DVD replication as compared to the second quarter of 1997.
Licensing fees from PC subassembly manufacturers also contributed to the
increased revenue in the second quarter of 1998 over the second quarter of
1997. Revenues from the Video Scrambling Group decreased 69% to $206,000 from
$659,000. This was due to the decreased demand for VES products from various
government law enforcement agencies and decreases for the analog decoding
equipment primarily due to the Southeast Asian financial situation which has
delayed expected cable TV system upgrades and, consequently, the ability of the
Company's licensees' to sell addressable set-top converters that include the
Company's PhaseKrypt TM scrambling technology.
9
<PAGE>
GROSS MARGIN
Gross margin for the second quarter of 1998 was 92% compared to 85% for the
second quarter of 1997. The Company's gross margin is influenced by its sales
mix, which in the second quarter of 1998 benefited from increased license fees
and higher margin home video royalties and reduced lower margin scrambling
product sales. Lower processor costs during the second quarter of 1998 also
added to the higher margin compared to the second quarter of 1997. Cost of
revenues includes items such as product costs, duplicator fees, processor costs
and patent amortization.
RESEARCH AND DEVELOPMENT
Research and development expenses increased by $138,000 or 27% in the second
quarter of 1998 compared to the second quarter of 1997. Research and
development expenses increased as a percentage of net revenues from 11% to 12%.
These increases were primarily due to higher compensation and benefit expenses
from additional personnel and higher depreciation from equipment purchased in
the second half of 1997.
SELLING AND MARKETING
Selling and marketing expenses increased by $109,000 or 8% in the second
quarter of 1998 compared to the second quarter of 1997 primarily due to higher
compensation and benefit expenses from additional personnel along with
increased advertising and marketing expenses related to the DVD market. This
increase caused selling and marketing expenses to decline as a percentage of
net revenues from 29% to 26%.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased by $110,000 or 11% in the second
quarter of 1998 compared to the second quarter of 1997 due to increased legal,
consulting, and accounting expenses relating to the evaluation of investment
opportunities, plus higher compensation and benefit expenses associated with
increased personnel. This increase in general and administrative expenses
caused such expenses to decline as a percentage of net revenues from 22% to
20%.
INTEREST AND OTHER INCOME
Other income increased by $23,000 or 15% in the second quarter of 1998 compared
to the second quarter of 1997 primarily from interest income and miscellaneous
income.
INCOME TAXES
Income tax expense represents combined federal and state taxes at effective
rates of 38% and 40% for the three months ended June 30, 1998 and 1997,
respectively. The lower rate for 1998 was due to higher tax exempt interest
earned in 1998 and lower foreign taxes related to lower income in the second
quarter of 1998.
NET INCOME
Net income for the second quarter of 1998 was $1,314,000 compared to $757,000
in the second quarter of 1997.
10
<PAGE>
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
The following table provides revenue information by general product lines for
the six-month period ended as indicated (dollars in thousands):
<TABLE>
<CAPTION>
June 30, June 30,
1998 % 1997 % % Change
------- --- -------- ----- ----------
<S> <C> <C> <C> <C> <C>
Copy Protection Group $ 9,862 91 $ 7,577 82 30 %
Video Scrambling Group 981 9 1,630 18 (40)%
Other -- -- 79 -- --
------- --- -------- -----
Total $10,843 100 $ 9,286 100.0 17 %
------- --- -------- -----
------- --- -------- -----
</TABLE>
NET REVENUES
Consolidated net revenues for the first six months of 1998 increased 17% to
$10.8 million from $9.3 million for the first six months of 1997. Revenues
from the Copy Protection Group increased 30% to $9.9 million from $7.6 million
due to the higher volumes of videocassettes from studio business and increases
in DVD replication as compared to the first six months of 1997. Increases in
licensing fees from PC subassembly manufacturers and the licensing fees from
DIVX also contributed to the increased revenue in the first six months of 1998
over the first six months of 1997. Revenues from the Video Scrambling Group
decreased 40% to $981,000 from $1.6 million. due to the decreased demand for
VES products from various government law enforcement agencies and decreases in
demand for analog decoding equipment primarily due to the Southeast Asian
financial situation which has delayed expected cable TV system upgrades and,
consequently, the ability of the Company's licensees' to sell addressable set-
top converters which include the Company's PhaseKrypt TM scrambling technology.
GROSS MARGIN
Gross margin for the six months ended June 30, 1998 was 92% compared to 85%
for the comparable period of 1997. The Company's gross margin is influenced by
its sales mix, which in 1998 benefited from increased license fees and higher
margin royalty based revenue and reduced lower margin scrambling product sales.
Also contributing to the better margin in 1998 were lower processor costs. The
lower margin for the six months of 1997 was also affected by higher inventory
reserve requirements for the scrambling business. Cost of sales includes items
such as product costs, duplicator fees, processor costs and patent
amortization.
RESEARCH AND DEVELOPMENT
Research and development expenses increased by $204,000 or 19% during the first
half of 1998 compared to the same period in 1997 primarily due to higher
compensation and benefit expenses from additional personnel and higher
depreciation from equipment purchased in the second half of 1997. Research and
development expenses remained approximately constant at approximately 12% of
net revenues.
SELLING AND MARKETING
Selling and marketing expenses increased by $87,000 or 3% during the first half
of 1998 compared to the same period in 1997 primarily due to higher
compensation and benefit expenses from additional personnel and increased
advertising and marketing expenses related to the DVD market offset slightly by
lower consulting fees. This dollar increase caused selling and marketing
expenses to decline as a percentage of net revenues to 28% from 32%.
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<PAGE>
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased by $390,000 or 21% during the
first half of 1998 compared to the same period in 1997. These expenses
increased as a percentage of net revenues to 21% from 20%. This increase was
primarily due to increased legal, consulting, and accounting expenses and
travel relating to the evaluation of investment opportunities, increased
expenses associated with being a public company and higher compensation and
benefit expenses associated with increased personnel and insurance expenses.
INTEREST AND OTHER INCOME
Other income during the first six months of 1998 increased $130,000 or 75%
compared to the same period in 1997 and related primarily to interest income
earned on the proceeds from the Company's initial public offering in March 1997
and miscellaneous income.
INCOME TAXES
Income tax expense represents combined federal and state taxes an effective
rates of 38% and 40% for the six months ended June 30, 1998 and 1997,
respectively. The lower rate for 1998 was due to higher tax exempt interest
earned in 1998 and also in the first six months of 1998 lower foreign taxes
relating to lower income.
NET INCOME
Net income for the six months ended June 30, 1998 was $2.3 million compared to
$1.3 million for the first six months of 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily from cash generated by
operations, principally by its copy protection business. The Company's
operating activities provided net cash of $3.4 million and $666,000 for the six
months ended June 30, 1998 and 1997, respectively. For the first six months of
1998, net cash was provided primarily by net income before noncash charges, and
to a lesser extent, reductions in working capital. For the first six months of
1997, net cash was provided primarily by net income and an increase in deferred
revenue offset slightly by an increase in receivables, prepaids and deferred
tax assets and decreases in accounts payable and accrued expenses.
Investing activities used cash of $1.6 million and $14.2 million in the six
months ended June 30, 1998 and 1997, respectively. For the first six months of
1998, net cash used in investing activities was primarily an investment in C-
Dilla and payment of royalties to C-Dilla, offset in part by net sales and
maturities of short-term investments. During this period, the Company invested
approximately $3,553,000 in C-Dilla to acquire an approximately 19.8% equity
ownership interest. The Company intends to hold this investment for the long-
term. The Company also paid approximately $1,015,000 for up-front license fees
subject to offset against future royalties due under a Software Marketing
License and Development 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 accounts for
the investment in C-Dilla using the cost basis. In the first six months of
1997, net cash used in investing activities resulted primarily from net
purchases of short-term investments. The Company also made capital expenditures
of $138,000 and $301,000 in the six months ended June 30, 1998 and 1997,
respectively. In addition, the Company paid $358,000 and $151,000 in the six
months ended June 30, 1998 and 1997, respectively, for costs associated with
obtaining patents and other intangibles.
For the six months ended June 30, 1998, the Company used $94,000 in
financing activities relating to the deferred offering costs offset by the
issuance of common stock from the exercise of stock options and the Company's
stock purchase plan. For the six months ended June 30, 1997, the Company
received net cash of $13.8 million from the initial public offering, which
represented substantially all of the cash provided by financing activities in
that period. On June 30, 1998, the Company consummated an offering of 1,500,000
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shares of its Common Stock, of which 1,140,000 shares were issued and sold by
the Company and 360,000 shares were sold by existing shareholders of the
Company. The Underwriters also exercised in full an over-allotment option to
purchase from the Company an additional 225,000 shares of Common Stock. All
shares were sold for $22.00 per share. The net proceeds to the Company from the
offering, after deducting the underwriting discount and other expenses of the
offering, were approximately $27.9 million. The Company did not receive any
proceeds from the sale of shares sold by the selling shareholders. The Company
received the proceeds from the offering in July 1998.
At June 30, 1998, the Company had $3.0 million in cash and cash equivalents
(not including cash from the public offering, which was received on July 1,
1998), $5.6 million in short-term investments and $3.9 million in long-term
marketable investment securities. The Company had no material commitments for
capital expenditures but anticipates that capital expenditures for the next 12
months will aggregate approximately $400,000. The Company also has future
minimum lease payments of approximately $1.8 million under operating leases and
approximately $243,000 under capital leases. In July 1998, the Company invested
$500,000 in Command Audio Corporation ("CAC") as part of a round of third-party
financing. The Company believes that the remaining net proceeds of its initial
public offering and the secondary offering, together with available funds and
cash flows generated from operations, will be sufficient to meet its working
capital and capital expenditure requirements for the foreseeable future. The
Company may also utilize cash to acquire or invest in businesses or to obtain
the right to use technologies.
The Company paid interest of $7,000 and $6,000 in the six months ended June 30,
1998 and 1997, respectively. The interest expense relates primarily to a
capital lease agreement. The Company paid $2,063,000 and $1,200,000 in taxes
for the six months ended June 30, 1998 and 1997, respectively.
ITEM 3. 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 and DVDs
during the year-end holiday shopping season. The Company anticipates that
revenues, if any, from multimedia CD-ROM copy protection will also reflect
this seasonal trend. In addition, revenues have tended to be lower in the
summer months, particularly in Europe.
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
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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. Further, the Company may not be in a
position to anticipate a decline in revenues in any quarter until late in the
quarter, due primarily to the delay inherent in revenue reporting from
licensees and replicators, resulting in a potentially more significant level
of volatility in the price of the Company's Common Stock.
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 75.4%, 62.0% and 63.6% of the Company's net
revenues during 1996, 1997 and the first six months of 1998, 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 the
release 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 in
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. 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. For 1997, one customer accounted
for 11% of the Company's net revenues. For the first six months of 1998,
revenues from the Company's two largest customers represented 23% of the
Company's net revenues, and each accounted for more than 10% of the Company's
net revenues. The Motion Picture Association of America ("MPAA") studios as a
group accounted for 47.1%, 38.6% and 41.1% of the Company's net revenues in
1996, 1997 and the first six months of 1998, respectively. The Company expects
that revenues from the MPAA studios will continue to account for a substantial
portion of the Company's net revenues for the foreseeable future. The Company
has agreements with three of the MPAA studios and PolyGram for copy protection
of substantially all of their packaged media in the United States, which
agreements expire at various times ranging from December 1998 to June 2000.
The failure of any of these customers to renew their contracts or enter into
new contracts with the Company on terms that are favorable to the Company
would likely result in a substantial decline in the Company's net revenues and
operating income, and would have a material adverse effect on the Company's
business, financial condition and results of operations. Most of the Company's
other videocassette copy protection customers license the Company's technology
on an annual contract basis or title-by-title or month-by-month. There can be
no assurance that
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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 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 AND DIGITAL PPV 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 uncertainty in the
marketplace engendered by alternative standards for DVD and for DVD
recordable devices, 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
ten million digital set-top decoders manufactured by certain of the leading
set-top decoder manufacturers, only five programmers on one direct broadcast
satellite network in Japan and one system operator in Hong Kong have
activated copy protection for digital PPV programming. Four programmers in
Japan distribute adult PPV programming, which the Japanese government has
required that all such programming be copy protected and one programmer
distributes movies. 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 or Hong Kong. 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 seeks to expand its copy protection business through licensing
arrangements and strategic investments. The Company and Digimarc in
collaboration with Royal Philips Electronics N.V. ("Philips") are jointly
developing a digital media watermarking copy protection solution to address
the digital-to-digital copying issues associated with the next generation of
DVD and digital videocassette recording devices. They expect to submit
their proposed solution to the Copy Protection Technical Working Group
("CPTWG"). At least five other companies have also submitted proposals to
the CPTWG. The company whose digital media watermarking copy protection
solution is selected by the CPTWG will have a significant advantage in
licensing its technology to video rights owners worldwide and in working with
consumer electronics manufacturers, PC platform companies and their suppliers
to implement digital-to-digital copy protection. The IEEE 1394 transmission
protocol has also been proposed as a digital-to-digital copy protection
solution which is intended to be used in combination with the watermarking
technology. If the solution being developed by the Company, Digimarc and
Philips is not the selected solution or otherwise is not widely adopted by
studios or consumer electronics manufacturers, the Company, Digimarc and
Philips will be at a competitive disadvantage in marketing their solution.
There can be no assurance that the solution being developed by the Company,
Digimarc and Philips will be selected as the standard by the CPTWG or that
such solution will achieve market acceptance as the market and the standards
for digital-to-digital copy protection evolve.
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ENTRANCE INTO NEW MARKET. The Company has an exclusive marketing agreement
with C-Dilla for copy protection technology for CD-ROM software products in
the consumer multimedia market. The market for copy protection of CD-ROMs is
unproven. For the Company to be successful in entering this new market,
producers of multimedia CD-ROMs must accept copy protection generally and
also adopt the solution developed by C-Dilla and marketed by the Company.
There can be no assurance that copy protection of multimedia CD-ROMs will be
accepted. For example, consumers may react negatively to the introduction of
copy protected CD-ROMs if they are prohibited from copying the content of
their favorite applications or if copy protection impairs the playability of
the CD-ROM. Moreover, copy protection may not be effective on all hardware
platforms or configurations or may prove to be easily circumvented. A number
of competitors and potential competitors are developing CD-ROM copy
protection solutions. Many of these competitors and potential competitors
have substantially greater name recognition and financial, technical and
marketing resources than the Company. There can be no assurance that there
will be demand for CD-ROM copy protection or that the solution marketed by
the Company will achieve or sustain market acceptance under emerging industry
standards or will meet, or continue to meet, the changing demands of
multimedia software providers.
DEPENDENCE ON PROPRIETARY TECHNOLOGY. The Company's success is heavily
dependent upon its proprietary technologies. The Company relies 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 41 United States
patents and has 39 United States patent applications pending. In addition,
the Company has 147 foreign patents and 238 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 has received claims from third parties that
the Company's technologies and products infringe the intellectual property
rights of such third parties. Krypton Co., Ltd., a Japanese company, has
filed an invalidation claim against one of the Company's anti-copy patents
in Japan. After consultation with Japanese patent counsel, the Company
believes that 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 might 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. In
addition, as the Company acquires or licenses a portion of the technology
included in its products from third parties, its exposure to infringement
actions may increase because the Company must rely upon such third parties
for information as to the origin and ownership of such acquired or licensed
technology. Although the Company intends to obtain representations as to the
origins and ownership of such acquired or licensed software and obtain
indemnification to cover any breach of any such representations, there can be
no assurance that such representations will be accurate or that such
indemnification will provide adequate compensation for any breach of such
representations. The Company and C-Dilla have received communications from
Ablex Audio Video Limited and its subsidiary, Pan Technologies, notifying
them
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that these companies assert rights to the technology that C-Dilla licenses to
the Company and claiming that the Company's agreements with C-Dilla violate
understandings that these companies had allegedly reached with C-Dilla. The
Company has been informed that a number of potential customers for the CD-ROM
copy protection solution to be marketed by the Company have received similar
communications. The Company believes that these assertions and claims are
without merit. If, as threatened, these companies commence litigation against
the Company or C-Dilla or if the Company or C-Dilla initiates litigation to
establish its or their rights to the technology, further uncertainty could
develop as to the Company's rights to the CD-ROM copy protection technology,
which could impair the Company's ability to market the technology and have a
material adverse effect on the Company's business, financial condition and
results of operations. To the extent that these or any other communications
or any litigation create further uncertainty in the marketplace, acceptance
of the technology to be marketed by the Company would be delayed, which
could have a material adverse effect on the Company's business, financial
condition and results of operations. These and any other such claims of
infringement, with or without merit, could be time consuming to defend,
result in costly litigation, divert management's attention from day-to-day
operations, 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 nine United States and 23 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 might suffer from the legal availability of such a
circumvention device or obtain rights to the offending devices. The legal
availability of circumvention devices 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, which
could have a material adverse effect on the Company's business, financial
condition and results of operations. There is legislation before the United
States Congress and certain foreign legislative bodies that would make such
circumvention devices illegal. The Company is supporting the legislative
effort 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
circumvention 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 infringement or invalidity. There can be no
assurance that any such litigation will be successful. Such litigation could
result in substantial costs, including indemnification of customers, 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 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.
RISKS ASSOCIATED WITH STRATEGIC INVESTMENTS. The Company has recently expanded
its technological base in current as well as new markets through strategic
investments in companies with complementary or compatible technologies or
products. The Company currently holds minority equity interests in Command
Audio Corporation, Digimarc and C-Dilla. Such investments, which total $8.4
million and represented 14.0% of the Company's total assets at June 30, 1998,
involve a number of risks. The negotiation, creation and management of these
strategic relationships typically involve a substantial commitment of
management time and resources by the Company, and there can be no assurance
that the Company will ever recover the cost of such management resources.
Because these companies are privately held, there is no active trading market
for their securities, and the Company's investments in them are
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illiquid. There may never be an opportunity for the Company to realize a
return on its investment in any of these companies, and the Company may in
the future be required to write off all or part of one or more of these
investments. The write-off of all or part of one or more of these
investments could have a material adverse affect on the Company's business,
financial condition and results of operations.
The Company's strategic investments typically involve joint development or
marketing efforts or technology licensing. There can be no assurance that any
joint development efforts will result in the successful introduction of new
products by the Company or a third party, or that any joint marketing efforts
will result in increased demand for the Company's products. Further, there
can be no assurance that any current or future strategic investments by the
Company will allow the Company to enter and compete effectively in new
markets or improve the Company's performance in current markets.
RISKS ASSOCIATED WITH INTERNATIONAL AND EXPORT SALES. In 1996, 1997 and the
six months ended June 30, 1998, international and export sales together
represented 37.9%, 46.5% and 48.7%, respectively, of the Company's net
revenues. Included in this revenue is business generated pursuant to United
States based agreements with certain Hollywood studios. 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
particular, the net revenues that the Company derives from video scrambling
decreased 39.8% from the first six months of 1997 to the first six months of
1998, due to decreased demand for analog decoding equipment that resulted
primarily from the financial crisis in Southeast Asia. In addition, this
crisis has delayed expected cable television system upgrades in that region
and, consequently, has adversely affected the ability of the Company's
licensees to sell addressable set-top decoders that include the Company's
PhaseKrypt video scrambling technology. 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 circumvention 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. 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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YEAR 2000 ISSUES. Certain organizations anticipate that they will experience
operational difficulties at the beginning of the Year 2000 as a 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 calls for
compliance verification with external vendors supplying software to the
Company, testing in-house engineering and manufacturing software tools,
testing software in the Company's products for Year 2000 problems and
communication with significant suppliers to determine the readiness of third
parties' remediation of their own Year 2000 issues. 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 1998. All costs associated with carrying out the
Company's plan for the Year 2000 problem are being expensed as incurred. The
costs associated with preparation for the Year 2000 are not expected to have
a material adverse effect on the Company's business, financial condition and
results of operations. Nevertheless, there is uncertainty concerning the
potential costs and effects associated with any Year 2000 compliance. Any
Year 2000 compliance problems of the Company or its customers or suppliers
could have a material adverse effect on the Company's business, financial
condition and results of operations. During the past three years, the
Company completed an effort to convert its financial applications to
commercial products that, according to their suppliers, are Year 2000
compliant. The Company has received confirmations from its primary suppliers
indicating that they are either Year 2000 compliant or have plans in place
to ensure readiness. As part of the Company's assessment, it is evaluating
the level of validation it will require of third parties to ensure their Year
2000 readiness.
PART II. OTHER INFORMATION
ITEM 1. 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 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
Company and Mr. Swyt. 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 arbitration hearings are scheduled
for October 1998. 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. A decision against the Company could
have a material adverse effect on the Company's business, financial condition
and results of operations.
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ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) The Company held its Annual Meeting of Stockholders on May 18, 1998.
(b) The Company's stockholders voted upon the following matters:
(1) Election of directors. All nominees were elected, with
the votes indicated below:
<TABLE>
<CAPTION>
Authority
Name Votes For Withheld
<S> <C> <C>
John O. Ryan 5,668,136 5,300
William A. Krepick 5,668,136 5,300
Richard S. Matuszak 5,668,136 5,300
Donna S. Birks 5,671,336 2,100
William N. Stirlen 5,670,836 2,600
Thomas Wertheimer 5,670,836 2,600
</TABLE>
(2) Appointment of KPMG Peat Marwick LLP as the Company's
independent auditors for the 1998 fiscal year. 5,668,835
votes were cast in favor of the appointment, 2,426 votes
were cast against and there were 2,175 abstentions.
(3) Adoption of an amendment to the Company's 1996 Equity
Incentive Plan ("Plan") to increase the number of shares
authorized to be issued under the Plan by 400,000 shares.
4,189,395 votes were cast in favor of the amendment,
555,301 votes were cast against, there were 20,641
abstentions and 908,099 broker non-votes.
ITEM 5 - OTHER INFORMATION.
On August 3, 1998, the Company filed a Form S-8 to register the additional
400,000 shares reserved for issuance under the Company's 1996 Equity
Incentive Plan.
In July 1998, the Company invested an additional $500,000 as part of a round
of third-party financing obtained by CAC. Subsequently, CAC repaid its
outstanding note to the Company including accrued interest, in the amount of
$355,000.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8K.
(a) Exhibits.
27.1 - 1998 Financial Data Schedule.
27.2 - 1997 Financial Data Schedule
(b) Reports on Form 8-K.
During the quarter ended June 30, 1998, the Company filed no Current
Reports on Form 8-K.
20
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Macrovision Corporation
Date: August 13, 1998 By: /S/ William A. Krepick
--------------- -------------------------------------
William A. Krepick, President and
Chief Operating Officer
Date: August 13, 1998 By: /S/ Victor A. Viegas
--------------- -------------------------------------
Victor A. Viegas, Vice President,
Finance and Administration and
Chief Financial Officer
21
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF MACROVISION CORPORATION FOR THE SIX MONTHS
ENDED JUNE 30, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
CONSOLIDATED FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 3049
<SECURITIES> 5630
<RECEIVABLES> 4899
<ALLOWANCES> 737
<INVENTORY> 489
<CURRENT-ASSETS> 44709
<PP&E> 4611
<DEPRECIATION> 3114
<TOTAL-ASSETS> 59966
<CURRENT-LIABILITIES> 4896
<BONDS> 0
0
0
<COMMON> 9
<OTHER-SE> 54160
<TOTAL-LIABILITY-AND-EQUITY> 59966
<SALES> 10843
<TOTAL-REVENUES> 10843
<CGS> 847
<TOTAL-COSTS> 847
<OTHER-EXPENSES> 6577
<LOSS-PROVISION> 97
<INTEREST-EXPENSE> 7
<INCOME-PRETAX> 3722
<INCOME-TAX> 1414
<INCOME-CONTINUING> 2308
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2308
<EPS-PRIMARY> .32
<EPS-DILUTED> .30
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF MACROVISION CORPORATION FOR THE SIX MONTHS
ENDED JUNE 30, 1997, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
CONSOLIDATED FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 2549
<SECURITIES> 13385
<RECEIVABLES> 4539
<ALLOWANCES> 418
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<PP&E> 4496
<DEPRECIATION> 2683
<TOTAL-ASSETS> 26503
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0
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<SALES> 9286
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<CGS> 1378
<TOTAL-COSTS> 1378
<OTHER-EXPENSES> 5896
<LOSS-PROVISION> 235
<INTEREST-EXPENSE> 6
<INCOME-PRETAX> 2185
<INCOME-TAX> 874
<INCOME-CONTINUING> 1311
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1311
<EPS-PRIMARY> .20
<EPS-DILUTED> .18
</TABLE>
