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FORM 10-KSB
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[_] TRANSITION REPORT PURSUANT TO 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)
DELAWARE 77-0156161
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
1341 Orleans Drive
Sunnyvale, California 94089
(Address of principal executive offices) (Zip code)
(408) 743-8600
(Issuer's telephone number including area code)
Securities registered under Section 12(b) of the Exchange Act: None.
Securities registered under 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 Exchange Act 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]
The issuer's revenues for the fiscal year ended December 31, 1998 totaled
$24,434,422.
As of March 22, 1999, the aggregate market value of the voting and
non-voting common equity held by non-affiliates of the registrant, based on the
closing price for the registrant's common stock on that day, was approximately
$275,327,000.
Transitional Small Business Disclosure Format (check one):
Yes[_] No [X]
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date.
Title Outstanding as of March 22, 1999
Common Stock 8,925,229
Documents incorporated by reference: Certain exhibits hereto have been
specifically incorporated by reference herein in Item 13 under Part III hereof.
Certain portions of registrant's definitive Proxy Statement, which will be filed
with the Securities and Exchange Commission in connection with the registrant's
annual meeting of stockholders to be held on May 18, 1999, are incorporated by
reference in Items 10-13 of Part III hereof.
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MACROVISION CORPORATION
FORM 10-KSB
INDEX
PART I
<TABLE>
<S> <C>
ITEM 1. Description of Business ........................................................................ 3
ITEM 2. Description of Property ........................................................................ 26
ITEM 3. Legal Proceedings .............................................................................. 26
ITEM 4. Submission of Matters to a Vote of Security Holders ............................................ 27
PART II
ITEM 5. Market for Common Equity and Related Stockholder Matters ....................................... 27
ITEM 6. Management's Discussion and Analysis of Financial Condition and Results of Operations .......... 28
ITEM 7. Financial Statements ........................................................................... 35
ITEM 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure ..................................................................... 35
PART III
ITEM 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with
Section 16(a) of the Exchange Act ............................................................ 35
ITEM 10. Executive Compensation ......................................................................... 35
ITEM 11. Security Ownership of Certain Beneficial Owners and Management ................................. 35
ITEM 12. Certain Relationships and Related Transactions ................................................. 35
ITEM 13. Exhibits and Reports on Form 8-K ............................................................... 36
</TABLE>
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This Annual Report on Form 10-KSB for Macrovision Corporation
("Macrovision" or "we") contains forward-looking statements that involve risks
and uncertainties. Our actual results may differ significantly from the results
discussed in the forward-looking statements. Factors that might cause these
differences include, but are not limited to, the factors 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.
We design, develop and market 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 ("DVDs") or other media or are transmitted by means of cable, satellite or
microwave transmission. Our 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. During 1998, we
broadened our focus to include copy protection of other media, including
multimedia computer software on CD-ROMs.
Our copy protection technologies enable consumers to view or utilize video
or other information stored on prerecorded videocassettes, DVDs and CD-ROMs or
transmitted as digital pay-per-view ("PPV") programs via cable, direct broadcast
satellite ("DBS"), or video-on-demand networks, but deter unauthorized consumer
copying of this material. We believe that approximately one-third of all
commercial videocassettes produced worldwide during 1998 were copy protected,
and that substantially all of those copy protected videocassettes incorporated
our technology. All of the Motion Picture Association of America ("MPAA")
studios have used our copy protection technologies to protect some or all of
their videocassettes and/or DVDs in one or more countries around the world.
Studios such as Disney, Columbia Tri-Star, PolyGram, Paramount and Dreamworks
have signed agreements to apply our copy protection technologies to
substantially all of the motion pictures that they release in videocassette and
DVD format in the United States. We believe that our video copy protection
technologies are accepted as the de facto standard for preventing video from
being copied by consumer videocassette recorders. In May 2000, when the Digital
Millennium Copyright Act takes effect, all new VCRs manufactured or sold in the
United States will be required to be specifically designed to make poor quality
copies of programming encoded with our copy protection technology. The new law
also provides for both criminal and civil penalties for companies or individuals
who import, produce or distribute devices designed to circumvent our technology.
We do not license and have no plans to license our technology for use in
deterring consumer copying of free television broadcasts.
Our encryption technologies are incorporated into other companies'
addressable analog set-top decoders and are used by international cable
television system operators in connection with analog PPV and Pay TV
programming. We also sell scrambling products that are used by broadcasters,
businesses, governments and other organizations to provide for the secure
transmission of video and audio signals.
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. Entertainment media
analyst Paul Kagan Associates, Inc. ("Paul Kagan") estimates that the studios'
1998 revenues from the various venues were: Theatrical Box Office $3.1 billion;
Home Video $6.7 billion; Pay-Per-View (PPV) $357 million and Subscription Pay TV
$1.6 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 the United States, PPV releases generally follow home video releases
by 30-90 days. In foreign countries, PPV releases generally follow home video
releases by approximately six months and Subscription Pay TV releases generally
follow PPV releases by approximately six months.
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Video 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 37.0 million
households in the United States (approximately 45% of all households with VCRs)
owned two or more VCRs in December 1998, and thus were capable of making
unauthorized copies of prerecorded videocassettes. Based on a 1996
Macrovision-sponsored national survey, we estimate that unauthorized consumer
copying of prerecorded videocassettes costs the industry approximately $370
million in annual lost revenues. To protect their revenues in the home video and
subsequent release venues, many studios look to copy protection technology to
prevent unauthorized copies of motion pictures from entering the marketplace.
Recently, studios have begun to participate in the revenue stream from the
rental of motion pictures on videocassettes through agreements with video rental
businesses. We believe that revenue sharing could provide further incentive for
the studios to support videocassette copy protection. 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. 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 release a motion picture on PPV one to three months after it
is released on videocassette. Digital PPV 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 movies 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. Our opportunity
to introduce effective copy protection for PPV is expected to grow as DBS gains
wider acceptance and as digital cable PPV replaces existing analog cable PPV
systems, so long as copying of digital PPV movies is considered to be a problem
by the studios.
DVD hardware and media became commercially available in the United States
in 1997, and approximately 1.4 million DVD players had been shipped by
manufacturers as of December 31, 1998. The introduction of DVDs presents serious
concerns to the studios. Without effective copy protection, any one of the
approximately 450 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 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
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publications have projected that the market for addressable analog Pay TV
decoders will be approximately $1.2 billion annually for the years 1999 and
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.
Computer Software Copy Protection
The Interactive Digital Software Association estimates that computer
software and video game companies based in the United States lost $3.2 billion
worldwide in 1997 due to software piracy, primarily professional counterfeiting.
Recently CD recordable drives have been introduced in the consumer electronics
industry that are priced as low as $200. In addition, blank CD-ROM disks can be
purchased for less than $1 in the United States. As a result, computer software
and video game companies are facing an additional threat of lost revenues due to
consumer copying of CD-ROM software.
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 Pay TV and PPV system
operators, governments, businesses and equipment manufacturers. During 1998, we
began offering copy protection for CD-ROM based multimedia software in the
consumer market through our relationship with C-Dilla Limited ("C-Dilla"), a UK
company. See "--Strategic Investments."
Video Copy Protection
Our 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 deter unauthorized consumer copying of such programming.
Videocassettes are encoded with our copy protection process as they are
manufactured. In digital PPV and DVD applications, our 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
Our 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 techniques. This
provides a high level of security against signal theft while maintaining low
decoder cost. For cable and microwave PayTV applications of our 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. We have also developed products
implementing other video scrambling technologies that serve growing niche
markets, such as law enforcement and private networks.
Computer Software Copy Protection
Under an agreement with C-Dilla, we have the exclusive marketing rights for
consumer multimedia software applications of certain copy protection
technologies developed by C-Dilla for CD-ROM. In September 1998, we and C-Dilla
introduced our CD-ROM copy protection technology, called SafeDisc. As of
December 1998, we had copy protected over 1.7 million CD-ROMs with SafeDisc. We
believe that our expertise in marketing video copy protection technology and our
reputation for providing high quality copy protection solutions will give us an
advantage in marketing CD-ROM copy protection technology.
The Macrovision Strategy
We are dedicated to providing advanced video and software security
technologies and products to our customers. We intend to maintain and enhance
our position as a leading provider of these technologies and products by
focusing on the following key strategies:
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Pursue Royalty-Based Licensing Model. We are 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 and DVDs to the MPAA studios, we typically license our technology
under unit-based pricing schedules. In addition, we use unit-based pricing
schedules when licensing copy protection technology for set-top boxes, PPV
programming and CD-ROMs. Royalties and other fees are currently paid by
copyright holders, commercial duplicators, hardware manufacturers, program
distributors and publishers. We intend whenever feasible to continue to license
our technologies to third parties for unit or transaction-based royalties and
fees.
Leverage Key Customer Relationships. Over the past ten years, we have
developed strong relationships with our customers, including the major Hollywood
studios and key participant companies of the video duplication industry, as well
as the cable and satellite television system operators and the equipment
manufacturers that serve these customers. We attempt to develop strategic
relationships with our customers, to broaden the use of existing applications
for our technologies and to enhance the security and future sales opportunities
of our customers' video properties.
Increase Market Penetration of Video Copy Protection Business. We estimate
that we have 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. We intend to make
our copy protection technology available and affordable to all video copyright
holders in all prerecorded packaged media and digital PPV venues and seek to
have our technology specified by all PPV system operators, digital set-top
decoder manufacturers and DVD hardware manufacturers.
Introduce New Product Applications and Technologies. We intend to continue
to expand our technological base, primarily in intellectual property copy
protection, in current as well as new markets, through internal development,
strategic investments, licensing arrangements, joint ventures or potential
acquisitions of products, technologies or companies. In addition to our
internally-developed video copy protection technology, we entered into an
agreement with Digimarc in 1997 to develop products for DVD copy protection and
with C-Dilla in 1998 to license and develop products for DVD-ROM and CD-ROM copy
protection.
Protect Patent Position. We believe that our future success will depend, in
part, on the continued protection of our proprietary technologies. We have
obtained patents to protect our copy protection and video scrambling
technologies and intend to continue to pursue patent protection aggressively. We
have invested substantial resources in developing and obtaining patents covering
a number of processes and devices that unauthorized parties could use to
circumvent our consumer copy protection technologies. We have used these patents
in the past to limit the proliferation of such devices and have initiated a
number of disputes relating to infringement of these patents. We intend to
continue to protect and defend our patented technologies aggressively through
further technological innovation, legal action and support of existing and
future legislative initiatives to protect rights owners.
Technologies and Products
Our technologies are either licensed or sold, depending upon the particular
application or product. For videocassette copy protection, copyright holders and
licensed duplicators typically pay us a per unit licensing fee for the right to
apply our technology. In addition, copyright holders typically pay us a per unit
license fee to apply copy protection to DVDs. For digital PPV, cable and
satellite television system operators pay us a one-time license fee for the
right to incorporate our copy protection technology into their networks and have
entered into agreements with us that entitle us to receive transaction-based
royalty payments at the time when copy protection for digital PPV programming is
activated. Set-top decoder manufacturers also license our copy protection and
video scrambling technologies for an up-front fee and a per unit hardware
royalty. In addition, semiconductor manufacturers pay us a small one-time
service fee to verify proper implementation of our copy protection technologies
in integrated circuits for DVD players and digital set-top decoders. For the DVD
market, we offer licenses to consumer electronics and personal computer
manufacturers and charge rights owners a per unit fee similar to our
videocassette copy protection licensing model. In the video scrambling business,
we both license our PhaseKrypt technology on a per-decoder or per-encoder basis,
and sell PhaseKrypt decoder components and PhaseKrypt encoders. We also sell a
line of products based on our various video scrambling technologies for
applications in television broadcasting and niche markets such as law
enforcement and private networks. For the CD-ROM copy protection business,
software manufacturers typically pay us a per unit license fee to apply SafeDisc
to CD-ROMs.
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Video Copy Protection Technologies
Our 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. Our 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. We believe that
copyright holders justify the decision to pay for our technology through a
combination of increased unit sales and rentals, increased revenues from
downstream venues, stronger relationships with retailers and a favorable return
on investment compared to equivalent advertising expenditures.
Our copy protection technology is applied electronically to videocassettes
at the time of duplication at over 260 commercial duplication facilities in 37
countries. Macrovision-owned copy protection equipment is installed and
maintained by us in each duplication facility. We license 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 us, we pay service fees to
the commercial duplicators. Our copy protection technology has been applied to
more than two billion videocassettes worldwide since 1985, and was applied to
more than 600 million videocassettes in 1998. All of the MPAA studios have used
our copy protection technologies to protect some or all of their videocassettes
and/or DVDs in one or more countries around the world. In 1998 and 1997, three
of these studios applied our technology to a majority of the videocassettes they
produced. In addition, we believe that more than 1,500 corporate, educational
and special interest copyright holders have contracted with our licensed
duplicators to apply our copy protection process to their videocassettes.
We have developed an enhanced version of our 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 our 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 prevents a DVD player or a digital set-top
decoder from being used a source to make commercial quality videocassette copies
of the DVD or PPV program.
We have licensed our copy protection technology for digital PPV to 43
set-top decoder manufacturers and nine digital PPV system operators. As of
December 31, 1998, ten program providers had applied copy protection through two
digital PPV system operators in Japan. In addition, one system operator in Hong
Kong and one in the United Kingdom had activated copy protection for digital PPV
programming. Our copy protection technology is embedded in approximately 13
million digital set-top decoders currently in use worldwide, for which we have
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. We believe that our copy protection technology is currently
the only digital-to-analog copy protection solution that satisfies these
principles. As of December 31, 1998, 97 companies that manufacture DVD players
or DVD-ROM drives had signed agreements with us to incorporate our DVD copy
protection technology into their hardware.
Copy protection licensing represented 92.6% of our net revenues in 1998 and
85.6% of our net revenues in 1997.
Video Scrambling Technologies and Products
Our video scrambling technologies are used to prevent unauthorized viewing
of video content during analog video transmissions from one location to another
location. These technologies are used in PPV, Pay TV, business television,
broadcast television and government, military and law enforcement markets.
Our 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 analog Pay TV systems 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 us. Cable television
operators purchase PhaseKrypt-enabled set-top decoders and encoder hardware from
our licensees for installation in their systems.
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Our video encryption system technology is incorporated into a variety of
scrambling products that we sell rather than license. One of our video
encryption system products is a professional, broadcast-quality video scrambling
system that is available in NTSC and PAL versions. Primary applications include
broadcast television distribution to network affiliate stations and
retransmission facilities, programming delivery to cable television head-ends,
programming contribution circuits and backhauls. We have 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 6.0% of our net revenues in 1998 and
13.5% of our net revenues in 1997.
Computer Software Copy Protection Technologies
Macrovision and C-Dilla introduced their CD-ROM copy protection technology,
called SafeDisc, in September 1998. We have an exclusive license from C-Dilla to
market and license SafeDisc for consumer multimedia software applications.
SafeDisc is comprised of an embedded, non-copiable digital signature on the
CD-ROM, combined with encrypted software content and authentication instructions
that preclude decryption unless the authentication digital signature is found.
We believe that SafeDisc provides a relatively secure, low cost means of
protecting CD-ROM software from consumer copying without adversely affecting the
consumer's legitimate use of the CD-ROM content.
Computer Software Copy Protection represented 1.4% of our net revenues in
1998.
Customers
Our 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 $100,000 of our net revenues during 1998:
<TABLE>
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Commercial
Home Video Suppliers Videocassette Duplicators
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BMG Entertainment Allied Digital Technologies
Buena Vista Home Video, Inc.(Disney) Vaughn Communications, Inc.
Columbia House Victor Company of Japan
Columbia TriStar Home Video (Sony Pictures Entertainment)
Digital Video Express (DIVX)
Dreamworks Home Video
HBO Home Video
New Line Home Video
Paramount Pictures
Polygram Video
Twentieth Century Fox Home Entertainment, Inc.
Universal Studios Home Video
Warner Home Video
</TABLE>
For 1998, revenues from one of our customers represented 12% of our net
revenues. For 1997, another customer accounted for 11% of our net revenues. The
MPAA studios as a group accounted for 45.1% of our net revenues in 1998 and
38.6% of our net revenues in 1997. We expect that revenues from the MPAA studios
will continue to account for a substantial portion of our net revenues for the
foreseeable future.
We also license our videocassette copy protection technology to special
interest customers that include independent video producers and corporations.
Licensed commercial duplicators act as distributors of our videocassette copy
protection technology to special interest customers. Revenues from domestic
special interest customers accounted for approximately 11.5% of our net revenues
in 1998 and 12.1% of our net revenues in 1997.
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We have licensed our copy protection technology for digital PPV to 43
set-top decoder manufacturers, including the following:
<TABLE>
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Set-Top Decoder Manufacturers
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Echostar Communications Corporation Philips Consumer Electronics
General Instrument Corporation Scientific-Atlanta, Inc.
Nokia Satellite Systems, A.B. Sony Corporation
Pace Micro Technology, Ltd. Thomson Consumer Electronics (RCA brand)
</TABLE>
We generally receive an up-front fee and a per unit royalty from each
digital set-top decoder manufacturer that licenses our technology. We have also
authorized 48 companies to incorporate our digital PPV and DVD copy protection
technologies in their semiconductor designs. These companies include Analog
Devices Corporation, Brooktree Division of Rockwell Corporation, Crystal
Semiconductor, Inc., Mitsubishi Electric Corporation, Motorola, Inc., NEC
Corporation, OKI Electric Industry, Co., Ltd., B.V., Raytheon Company, Samsung
Electronics Co., Ltd., Sony Electronics Inc., Texas Instruments and VLSI
Technology, Inc. These companies generally pay a small one-time service fee for
verification of proper implementation of our 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.
As of December 31, 1998, 97 companies that manufacture DVD players or DVD-ROM
drives had signed agreements with us to incorporate our DVD copy protection
technology in their hardware. These companies pay an initial license fee at the
beginning of the license and annual renewal fees.
System Operators
We have licensed our digital PPV copy protection technology for
incorporation into the networks of nine system operators, including British Sky
Broadcasting Limited, EchoStar, DIRECTV (USA and Japan), Galaxy Latin America,
Hong Kong Telecom, the Kirsch Group, Sky Latin America and Sky Perfect. These
system operators have paid a one-time license fee to us and have entered into
agreements with us that entitle us to transaction-based royalty payments at the
time copy protection for digital PPV programming is activated. Other system
operators have specified Macrovision-capable set-top decoders in their networks
or have signed agreements with us to test our digital PPV copy protection
technology on a limited basis. These system operators include Adelphia
Communications, Comcast Corporation, Cox Enterprises, Inc., TeleCommunications,
Inc. and Time Warner Inc.
Video Scrambling Customers
Our 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 us or pay us a unit-based royalty for encoder and
decoder components when they manufacture these components under our license.
Customers for our video encryption system products include government, military
and law enforcement agencies as well as broadcasters and private network
operators. The following is a representative list of our video scrambling
customers, each of which accounted for at least $25,000 of our net revenues
during 1998:
<TABLE>
<CAPTION>
Video Encryption System Customers Pay TV Components and Licenses
------------------------------- ------------------------------
<S> <C>
Department of Defense (US Army) Eastern Electronics Co., Ltd. (Taiwan)
Experimental Wings Efforts Development International, Ltd. (Hong Kong)
Government of Israel Pacific Satellite International, Ltd. (Hong Kong)
Gujarat Communications Ltd. (India)
Integrated Telecommunications Systems (Canada)
M. Paz Logistics Ltd. (Israel)
Skehan Televideo Service Inc.
</TABLE>
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Computer Software Copy Protection Customers
Our first copy protection product for the interactive software market,
SafeDisc, has been applied to over 1.7 million CD-ROMs since its commercial
release in September 1998. Publishers that have protected CD ROMs using our
technology include GT Interactive, Interplay, Microprose, Red Storm
Entertainment, Take 2 Interactive Software, TalonSoft and Ubi Soft
Entertainment.
Sales, Marketing and Customer Support
We market our 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. We also provide ongoing technical
support to the two major duplicators that manufacture most of the videocassettes
for the MPAA studios. We are constantly looking to expand our network of
authorized duplication, authoring and replication facilities throughout the
world , in order to better service our rights owners. In addition, we support
licensed duplicator sales personnel by providing sales training and sales
incentive programs and literature and by participating in trade shows.
We market our video scrambling technologies through a combination of direct
sales and licensing, as well as independent distributors and system integrators
in the United States and internationally. We have a total of 16 distributors,
sales representatives and licensees serving 29 countries that sell products
based on our video scrambling technologies. Our video encryption system products
are sold directly or through distributors to end users. We license our
PhaseKrypt technology and sell encoder hardware and decoder components directly
to manufacturers of cable television set-top decoders. Technical support is
provided from our Sunnyvale headquarters.
We market our computer software copy protection technologies directly to
major PC games publishers. Software toolkits are provided to publishers to
encrypt individual game titles. In 1998, we put in place the infrastructure to
allow implementation and support of the SafeDisc product. We have licensed and
certified 24 CD-ROM replication facilities worldwide to apply the technology. In
addition, we developed and implemented a customer training program to allow
software publishers to train their own employees in using the SafeDisc authoring
software.
We market our video and consumer software copy protection technologies
internationally from our Sunnyvale headquarters and through our subsidiaries in
Japan and the United Kingdom. In addition, video and computer software copy
protection technologies are marketed through exclusive licensing arrangements
with third parties in Egypt, Hungary and South Korea. International and export
sales together represented 44.5% of our net revenues in 1998 and 46.5% of our
net revenues in 1997. We expect that international and export sales will
continue to represent a substantial portion of our net revenues for the
foreseeable future. Due to our reliance on international and export sales, we
are subject to the risks of conducting business internationally.
We supplement our direct sales efforts with a variety of marketing
initiatives, including trade show participation, trade advertisements, industry
education and newsletters. We provide technical support to our licensed
duplicators, including hardware installation assistance and quality control. As
of December 31, 1998, we employed 27 sales and marketing personnel and 10
additional employees who assisted in customer technical support.
Technology
Video 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 used to make the copy and
the VCR/TV 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
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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 high playability while maintaining adequate
effectiveness.
Our videocassette copy protection technology involves the patented
technique of inserting a series of bipolar electronic pulses in the vertical
blanking interval of a standard video signal. The vertical blanking interval 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
circuit in the recording system of most VHS videocassette recorders, but not to
affect a similar circuit in the television set. Therefore, when a copy protected
prerecorded videocassette is played, the picture is clean and crisp, but when a
copy of that same videocassette is played, the picture typically has
substantially reduced entertainment value. Our copy protection technology is
effective against most consumer copying, but generally does not deter
professional pirates who use professional duplication and video processing
equipment.
The DVD and digital PPV versions of our copy protection technologies employ
both the electronic pulses used in videocassettes and in all territories
throughout the world except the United Kingdom and Europe, 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 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
Our 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. Our technology uses
the largest number of bits currently allowable by 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 and satellite
television set-top decoders in developing countries. PhaseKrypt video scrambling
is often accompanied by one of our patented audio scrambling technologies.
Consumer Software Copy Protection
C-Dilla's proprietary SafeDisc technology seeks to prevent the copying of
CD-ROMs by using encryption-protected content, an authenticating digital
signature and "anti-hacking" software. Each CD-ROM published with the SafeDisc
technology is premastered with encrypted content, containing authenticating
instructions and a unique SafeDisc digital signature. The authentication
software must detect the digital signature before it decrypts the contents of
the CD-ROM. The digital signature and authentication process is transparent to
the user. If a casual or professional counterfeiter uses a CD-recordable device
or professional mastering equipment to duplicate a CD-ROM, SafeDisc is designed
to inhibit the transmission of the digital signature. Because decryption will
not take place without the digital signature, the copy will not run. SafeDisc
also contains anti-hacking technology to prevent the compromise of its security
features.
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Research and Development
Our research and development efforts are focused on developing enhancements
to existing products, new applications for our current technologies and new
technologies related to the video, software and audio security market. Our 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. We also have
expertise in developing security software, which is used to restrict access to
encoding and decoding devices.
During 1998, we began building new competencies in software engineering to
address the growing PC software copy protection market. As of December 31, 1998,
the software engineering group consisted of five engineers and technicians. This
group of engineers and technicians will help us to support CD-ROM copy
protection technologies, as well as to evaluate and develop new technologies
that will help us compete in the changing marketplace. As part of our Software
Marketing License and Development Agreement with C-Dilla, C-Dilla has agreed to
provide research and development support for the copy protection products
specified in the agreement. C-Dilla has also agreed to provide training to our
customer support staff.
For our copy protection technologies, we support the efforts of television,
VCR and DVD hardware manufacturers to design hardware that is compatible with
our technologies. We also assist semiconductor manufacturers in incorporating
our copy protection technologies into digital video-based ASICs that are used to
convert digital video input to analog output. We regularly test the
effectiveness and transparency of our copy protection technologies on
representative samples of consumer televisions and VCRs to determine whether
modifications or enhancements may be necessary. For our video scrambling
technologies, our primary focus is the development of enhancements to our
PhaseKrypt-based Pay TV encoder and decoder products.
In September 1997, Macrovision and Digimarc agreed to develop a digital
video watermarking solution to address the digital-to-digital copying issues
associated with the next generation of DVD and digital videocassette recording
devices. In July 1998, we extended our development alliance to include Philips
Electronics Corporation ("Philips"). Digital watermarks embedded in motion
pictures and other video material act as an invisible data carrier providing
basic copyright identification information as well as various directions either
to allow or to disallow playback, viewing and copying onto another digital
device. The new technology will be based upon various published patents held by
Philips, Digimarc or Macrovision in digital watermarking and play control
technologies. The digital watermarks are designed to be imperceptible to the
viewer, but to be read easily by special purpose decoders that can be built into
software or semiconductor chips. This jointly developed technology is intended
to protect motion pictures and other video content from unauthorized
reproduction using digital recording devices. See "--Strategic Investments."
As of December 31, 1998, our research and development staff consisted of 15
engineers and technicians. We believe that our ability to attract, train and
retain qualified development personnel is essential to the success of our
development programs. In 1998 and 1997, our expenses for research and
development were $2.6 million and $2.2 million, respectively.
Intellectual Property Rights
We hold 42 United States patents and have 30 United States patent
applications pending. Of the issued United States patents, 26 relate to copy
protection, 12 relate to video scrambling and four relate to audio scrambling.
Our issued United States patents expire between June 2000 and March 2015. The
earliest of our core videocassette and DVD copy protection patents expires in
2005; however, we have filed applications for improvement patents that, if
issued, will extend the expiration dates beyond 2010. We also have 168 foreign
patents and 305 foreign patent applications pending in 44 countries. Of the
issued foreign patents, 95 relate to copy protection, 59 relate to video
scrambling and 14 relate to audio scrambling. Included in the patents related to
our copy protection technologies are nine United States and 20 foreign patents
covering a number of processes and devices that unauthorized parties could use
to circumvent our copy protection technologies. We use these patents to limit
the proliferation of devices intended to circumvent our copy protection
technologies.
From time to time, we have received claims from third parties that our
technologies and products infringe their intellectual property rights. Krypton
Co., Ltd., a Japanese company, has filed an invalidation claim against one of
our anti-copy patents in Japan. After consultation with Japanese patent counsel,
we believe that this claim
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is without merit, and we plan to contest the claim aggressively in the Japanese
Patent Office. We also have one lawsuit pending in an effort to protect our copy
protection technology.
We have nine United States and 20 foreign patents covering a number of
processes and devices that unauthorized parties could use to circumvent our copy
protection technologies. We use these patents to limit the proliferation of
devices intended to circumvent our copy protection technologies. We have
initiated a number of patent infringement disputes against manufacturers and
distributors of these devices. In October 1998, President Clinton signed the
Digital Millennium Copyright Act into law. This new law will require all new
VCRs manufactured or sold in the United States, beginning in May 2000, to be
specifically designed to make poor quality copies of programming encoded with
our copy protection technology. Existing VCRs that respond to our technology
(over 90% of all new VCRs) are required to maintain their compliant designs. The
new law also provides for both criminal and civil penalties for companies or
individuals who import, produce, or distribute devices designed to circumvent
our technology.
Additional litigation may be necessary in the future to limit the sale of
circumvention technologies, to enforce our patents and other intellectual
property rights, to protect our trade secrets, to determine the validity and
scope of the proprietary rights of others or to defend against claims of
infringement or invalidity.
Competition
Video Copy Protection
We believe that we have had no significant videocassette copy protection
competitor for the last five years other than companies that have occasionally
developed hardware based on our technology in foreign countries where we do not
have patents issued. Our copy protection technologies are proprietary and have
broad international patent coverage. As a result, none of our 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, our
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 our business, financial condition and results of operations.
Macrovision, Philips and Digimarc are jointly developing a digital media
copy protection solution to address the digital-to-digital copying issues
associated with the next generation of DVD and digital videocassette recording
devices. The Macrovision, Philips and Digimarc solution has been submitted to
the Copy Protection Technical Working Group ("CPTWG"). We, Philips and Digimarc
are competing with at least one other group of companies that have submitted
similar proposals to the CPTWG. These companies (IBM, NEC, Sony, Pioneer and
Hitachi) collectively have substantially greater name recognition and
significantly greater financial, technical, marketing and other resources than
our group. There can be no assurance that we, Philips and Digimarc will be able
to compete successfully in presenting our proposal to the CPTWG. The company
whose digital media 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.
If the solution being developed by our group is not the selected solution or
otherwise is not widely adopted by studios or consumer electronics
manufacturers, our group would be at a competitive disadvantage in marketing our
solution. If the CPTWG adopts our group's solution, there can be no assurance
that other companies will elect not to compete in this market.
Video Scrambling
The market for video scrambling products and technologies is highly
competitive. As a recent entrant into these markets, we compete directly or
through licensed manufacturers with many companies, including General Instrument
Corporation, Pioneer Electronic Corporation, Scientific-Atlanta, Inc., Tandberg
Cryptovision A.S. and VTech-HYH Broadcast Systems. These companies have
substantially greater name recognition, larger installed customer bases and
market shares and significantly greater financial, technical, marketing and
other resources than we and our licensees, many of which are manufacturing and
selling addressable set-top decoders for the first time. We and our licensees
may not be able to compete successfully in the video scrambling systems markets;
we may not be able to make technological advances necessary to improve or even
maintain our competitive position; and our products may not achieve market
acceptance. In addition, there can be no assurance that technological changes
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or development efforts by our competitors will not render our video scrambling
products obsolete or uncompetitive. We believe 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. We or our licensees may not
be able to compete successfully against current and potential competitors,
especially against those with significantly greater financial, marketing,
service, support, technical and other resources.
Computer Software Copy Protection
The market for CD-ROM copy protection technologies is highly competitive.
We compete with companies such as TTR, LaserLock and Sony's Digital Optical
Replication Division. We may not be able to compete successfully in the computer
software copy protection market; we may not be able to make the technological
advances necessary to improve or even maintain our position; and our products
may not achieve market acceptance. In addition, technological changes or
development efforts by our competitors might render our computer software copy
protection products obsolete or uncompetitive. Finally, Internet posted hacks
may be used to circumvent our technology.
Manufacturing
Our preferred manufacturing strategy is to license our technologies to
third parties that manufacture products incorporating those technologies. We
generate royalty revenues from these licenses, generally in the form of an
up-front fee and a per unit royalty. For example, licensees of our PhaseKrypt
technology can either manufacture PhaseKrypt decoder components or purchase the
components from us.
Our manufacturing operations are limited to low volume products that
require us to do significant quality control, such as the video encryption
system products, PhaseKrypt encoders and Macrovision-owned videocassette 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. We
generally use domestic independent contractors to manufacture and assemble
printed circuit boards, which enables us to configure the hardware and software
in combinations to meet a wide variety of customer requirements. We install our
software into electronically programmable read-only memory to maintain quality
control and security. We utilize "burn-in" procedures, functional and system
integration testing and comprehensive inspections to assure quality and
reliability of our products.
Legislative and Technology Initiatives
We have been an active participant in the DVD Copy Protection Technical
Working Group ("CPTWG") that is comprised of representatives from the following
associations and their 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. In 1996, the CPTWG adopted a set of copy protection principles that
established prerequisites for commercial availability of DVD hardware and media.
Adoption of these principles has resulted in worldwide digital-to-analog copy
protection standards for DVD players and media. We believe that our copy
protection technology is currently the only digital-to-analog copy protection
solution that satisfies these principles. The CPTWG is continuing to evaluate
digital-to-digital copy protection solutions, in anticipation of the
introduction of digital videocassette recorders and DVD recorders. Our joint
development project with Philips and Digimarc is directed to this opportunity.
In October 1998, President Clinton signed the Digital Millennium Copyright
Act into law. This new law will require all new VCRs manufactured or sold in the
United States, beginning in May 2000, to be specifically designed to make poor
quality copies of programming encoded with our copy protection technology.
Existing VCRs that respond to our technology (over 90% of all new VCRs) are
required to maintain their compliant designs. The new law also provides for both
criminal and civil penalties for companies or individuals who import, produce,
or distribute devices designed to circumvent our technology.
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Strategic Investments
We have sought to continue to expand our technological base in current as
well as new markets through the following strategic investments in companies
with complementary or compatible technologies or products.
Command Audio Corporation
In October 1995, Command Audio Corporation ("CAC") was incorporated as a
wholly-owned subsidiary of Macrovision to commercialize a distinct and new
audio-on-demand technology. In June 1996, our Board of Directors approved the
discontinuation of our involvement in CAC. In August 1996, we divested all but
19.8% of the outstanding stock of CAC. Subsequently in 1998, our ownership
interest was diluted to 11.9% after an additional round of external third-party
financing was obtained by CAC, in which we elected not to fully participate. CAC
is developing an audio-on-demand system consisting of a program center that
provides continuously updated news, content 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 Thomson Consumer Electronics for branding,
distribution and manufacturing the hand-held receivers. It has also acquired
brand-name content from a variety of respected sources. CAC began beta trials in
late 1998 and is aiming to introduce the service in two cities in early 1999. We
have no plans to increase our ownership above the 11.9% minority position, but
do have a right of first refusal to acquire additional stock to maintain our
percentage ownership if and when CAC offers additional stock, subject to certain
exceptions. During 1996, we assigned to CAC all rights in certain technology and
released our reversion rights in technology that we had previously assigned to
CAC. In consideration of such assignment and release, CAC agreed to pay us
royalties equal to 2.0% of CAC's gross revenues for 12 years, beginning when CAC
has operating revenues from certain sources or, at our election, at any time
prior thereto.
Digimarc Corporation
In December 1997, we invested $1.5 million in Digimarc in exchange for
shares of Digimarc's preferred stock that represents a 6.8% ownership interest
on an as-converted basis. Digimarc is a private company that was founded in
1995. We, Digimarc and Philips are jointly developing a digital media copy
protection solution to address the digital-to-digital copying issues associated
with the next generation of DVD and digital videocassette recording devices. We,
Digimarc and Philips have presented our proposed solution to the CPTWG and are
currently working on prototype systems.
C-Dilla Limited
In February 1998, we purchased 247,500 shares, or approximately 19.8%, of
the common stock of C-Dilla, for a purchase price of (pound)2,121,212, or
approximately $3.6 million. C-Dilla is a private company founded in 1991.
C-Dilla provides rights management software for high value-added information and
software publishers.
In February 1998, we also entered into a Software Marketing License and
Development Agreement under which we have for an initial five-year term, the
worldwide exclusive license to market C-Dilla's proprietary copy protection
technology for CD-ROM software products in the consumer multimedia software
market. Under this agreement, we paid (pound)606,060, or approximately $1.0
million, in up-front license fees subject to offset against future royalties and
will pay royalties to C-Dilla of between 30% to 45% of revenues from sales of
software products incorporating C-Dilla's technology. In the event that we fail
to reach minimum royalty levels of $2.0 million in the third year of our
agreement, $5.0 million in the fourth year, or $10.0 million in the fifth year,
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 we have been granted rights under
the agreement, C-Dilla will pay to us royalties of between 7.5% to 30% of
revenues from such licenses. We have the option to extend the initial term of
the agreement for an additional five-year period upon payment of an option fee
of $1.0 million and an additional license fee of $5.0 million, which fee may be
paid through future increased royalty payments. Under the terms of the
agreement, we and C-Dilla also agreed to develop jointly certain other
proprietary copy protection technologies for CD-ROM, DVD-ROM and other digital
delivery methods.
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Employees
As of December 31, 1998, we had 83 employees, including eight in
manufacturing, 15 in research, engineering and development, 27 in sales and
marketing plus 10 in technical support and 23 in general and administrative
capacities. Fifteen of these employees are based outside of the United States.
None of our employees are covered by a collective bargaining agreement or is
represented by a labor union with respect to employment by us. We have not
experienced any organized work stoppages and consider our relations with our
employees to be good.
RISK FACTORS
We expect to experience fluctuations in future operating results and
seasonality.
Our 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. These factors include, but are not limited to:
o the timing of releases of popular motion pictures on videocassettes or
DVDs or by digital PPV transmission;
o the ability of the MPAA studios to produce "blockbuster" titles;
o the degree of acceptance of our copy protection technologies by major
motion picture studios;
o consolidation in the entertainment industry;
o the mix of products sold and technologies licensed;
o any change in product or license pricing;
o the seasonality of revenues;
o changes in our operating expenses;
o personnel changes;
o the development of our direct and indirect distribution channels;
o foreign currency exchange rates; and
o general economic conditions.
We 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 us to invest significantly
greater resources in research and development or marketing efforts, our future
operating results may be adversely affected. As a high percentage of our
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.
We have experienced significant seasonality in our business, and our
financial condition and results of operations are likely to be affected by
seasonality in the future. We have typically experienced our 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. We believe that this trend has been principally due to the
tendency of certain of our customers to release their more popular motion
pictures on videocassettes and DVDs during the year-end holiday shopping season.
We anticipate that revenues 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, we believe that our 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 we will be
able to grow in future periods or that we will be able to sustain our level of
net revenues or our rate of revenue growth on a quarterly or annual basis. It is
likely that, in some future quarter, our operating results will be below the
expectations of stock market analysts and investors. In this event, the price of
our common stock could be materially adversely affected. Further, we 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 our common stock.
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We depend on videocassette copy protection technology and on advocacy of this
technology by major motion picture studios.
We currently derive a substantial majority of our net revenues and
operating income from fees for the application of our patented video copy
protection technology to prerecorded videocassettes of motion pictures and other
copyrighted materials that are sold or rented to consumers. These fees
represented 64.5% of our net revenues during 1998 and 62.0% of our net revenues
during 1997. We expect these fees to account for a majority of our net revenues
and operating income at least through 1999. This portion of our business has not
grown significantly in recent years, and there can be no assurance that revenues
from these fees will grow significantly or at all. Any future growth in revenues
from these fees will depend on the use of our copy protection technology on a
larger number of videocassettes. In order to increase or maintain our market
penetration, we 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, our 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
our copy protection technology were to determine that the benefits of using our
technology did not justify the cost of licensing the technology, demand for our
technology would decline. Any factor that results in a decline in demand for our
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 our copy protection technology, would have a material
adverse effect on our business, financial condition and results of operations.
Moreover, our ability to expand our 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 our copy protection technologies or otherwise determines not to
copy protect a significant portion of prerecorded video on videocassettes or DVD
or digital PPV programs, our business, financial condition and results of
operations would be materially adversely affected.
We depend on our key customers.
Our 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, we have derived a substantial majority of our
net revenues from relatively few customers. For 1998, revenues from one of our
customers accounted for more than 12% of our net revenues. For 1997, another
customer accounted for 11% of our net revenues. The MPAA studios as a group
accounted for 45.1% of our net revenues in 1998 and 38.6% of our net revenues in
1997. We expect that revenues from the MPAA studios will continue to account for
a substantial portion of our net revenues for the foreseeable future. We have
agreements with three of the MPAA studios and with PolyGram and Dreamworks for
copy protection of substantially all of their videocassettes and/or DVDs in the
United States. These agreements expire at various times ranging from February
2000 to March 2001. The failure of any of these customers to renew its contracts
or enter into a new contract with us on terms that are favorable to us would
likely result in a substantial decline in our net revenues and operating income,
and would have a material adverse effect on our business, financial condition
and results of operations. Most of our other videocassette copy protection
customers license our technology on an annual contract basis or title-by-title
or month-by-month. There can be no assurance that our current customers will
continue to use our technology at current or increased levels, if at all, or
that we 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 our business, financial condition and results of operations.
We are introducing products into the evolving market for DVD and digital PPV
copy protection.
Our 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 our copy protection technologies. A number
of factors will affect our ability to derive revenues from DVD and digital PPV
copy protection. These factors include the cost and effectiveness of our copy
protection technology in our 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, our ability to obtain commitments from the motion picture
studios to require copy protection on DVD media and digital PPV transmissions
and the
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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, our future growth
would be adversely affected if DVD players and digital PPV set-top decoders that
do not include our copy protection components achieve market acceptance.
While our copy protection capability is embedded in approximately 13
million digital set-top decoders manufactured by certain of the leading set-top
decoder manufacturers, only four system operators have activated copy protection
for digital PPV programming. In Japan, DirectTV Japan and SkyPerfecTV copy
protect all adult programming channels and certain PPV motion pictures. In Hong
Kong, one system operator copy protects all video-on-demand movies. In the
United Kingdom, British Sky Broadcasting has to date copy protected all 48
digital channels of PPV motion pictures. 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 copy protection in other
digital PPV networks outside of Japan, Hong Kong or the United Kingdom. Also,
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 and PPV programs, as well as free
broadcast programming. In addition, certain television sets or combinations of
VCRs and television sets may 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, our
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 our solution does not
achieve or sustain market acceptance, our business, financial condition and
results of operations would be materially adversely affected.
We seek to expand our copy protection business through licensing
arrangements and strategic investments. Macrovision, Philips and Digimarc are
jointly developing a digital media copy protection solution to address the
digital-to-digital copying issues associated with the next generation of DVD and
digital videocassette recording devices. We have submitted our proposed solution
to the Copy Protection Technical Working Group ("CPTWG"). At least one other
group (IBM, NEC, Sony, Pioneer and Hitachi) of companies has also submitted
proposals to the CPTWG. The companies whose digital media 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. If the solution being developed by Macrovision, Philips and Digimarc
is not the selected solution or otherwise is not widely adopted by studios or
consumer electronics manufacturers, Macrovision, Philips and Digimarc will be at
a competitive disadvantage in marketing their solution. There can be no
assurance that the solution being developed by Macrovision, Philips and Digimarc
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.
We are also just beginning to enter the market for computer software copy
protection.
We have 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 us 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 us. 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 prevented 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 we do. There may not be demand for CD-ROM copy protection.
Software developed for CD-ROM may migrate to DVD-ROM, a format in which we nor
C-Dilla have developed copy protection technology. Internet posted hacks may be
used to circumvent the technology. Further, the solution we are
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marketing may not achieve or sustain market acceptance under emerging industry
standards or may not meet, or continue to meet, the changing demands of
multimedia software providers. If the market for CD-ROM copy protection fails to
develop or develops more slowly than expected, or if our solution does not
achieve or sustain market acceptance, our business, financial condition and
results of operations would be materially adversely affected.
Our intellectual property rights may not be adequately protected.
Our success is heavily dependent upon our proprietary technologies. We rely
on a combination of patent, trademark, copyright and trade secret laws,
nondisclosure and other contractual provisions, and technical measures to
protect our intellectual property rights. Our patents, trademarks or copyrights
may be challenged and invalidated or circumvented. Any patents that issue from
our pending or future patent applications or the claims in issued patents or
pending patent applications may not be of sufficient scope or strength or be
issued in all countries where our products can be sold or our technologies can
be licensed to provide meaningful protection or any commercial advantage to us.
The expiration of certain patents may have a material adverse effect on our
business, financial condition and results of operations. Others may develop
technologies that are similar or superior to our technologies, duplicate our
technologies or design around our patents. Effective intellectual property
protection may be unavailable or limited in certain foreign countries. Despite
efforts to protect our proprietary rights, unauthorized parties may attempt to
copy or otherwise use aspects of processes and devices that we regard as
proprietary. Policing unauthorized use of our proprietary information is
difficult, and there can be no assurance that the steps we have taken will
prevent misappropriation of our technologies. In the event that our intellectual
property protection is insufficient to protect our intellectual property rights,
we could face increased competition in the market for our products and
technologies, which could have a material adverse effect on our business,
financial condition and results of operations.
Litigation may be necessary in the future to enforce our patents and other
intellectual property rights, to protect our trade secrets or to determine the
validity and scope of the proprietary rights of others. There can be no
assurance that any litigation of these types will be successful. Litigation
could result in substantial costs, including indemnification of customers, and
diversion of resources and could have a material adverse effect on our business,
financial condition and results of operations, whether or not such litigation is
determined adversely to us. In the event of an adverse ruling in any litigation,
we 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. Our failure to develop or
license a substitute technology could have a material adverse effect on our
business, financial condition and results of operations.
It can be time consuming and costly to defend against infringement claims.
From time to time, we have received claims from third parties that our
technologies and products infringe their intellectual property rights. Krypton
Co., Ltd., a Japanese company, has filed an invalidation claim against one of
our anti-copy patents in Japan. After consultation with Japanese patent counsel,
we believe that this claim is without merit, and we will aggressively contest
the claim in the Japanese Patent Office. In the event of an adverse ruling on
this claim, we might incur legal competition from clones of our own copy
protection technology in Japan and a corresponding decline in demand for our
technology, which could have a material adverse effect on our business,
financial condition and results of operations. We also have one pending lawsuit
in an effort to protect our copy protection technology. In addition, as we
acquire or license a portion of the technology included in our products from
third parties, our exposure to infringement actions may increase because we must
rely upon these third parties for information as to the origin and ownership of
the acquired or licensed technology. Although we intend to obtain
representations as to the origin and ownership of the acquired or licensed
software and obtain indemnification to cover any breach of any of these
representations, these representations may not be accurate or indemnification
may not provide adequate compensation for any breach of these representations.
To the extent that these or any other communications or any litigation create
further uncertainty in the marketplace, acceptance of the technology that we
market would be delayed, which could have a material adverse effect on our
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 us to cease
utilizing the infringing technology unless it can enter into royalty or
licensing agreements. Royalty or licensing agreements might not be available on
terms
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acceptable to us, or at all, which could have a material adverse effect on our
business, financial condition and results of operations.
It can be time-consuming and costly to limit the spread of circumvention
devices.
We have nine United States and 20 foreign patents covering a number of
processes and devices that unauthorized parties could use to circumvent our copy
protection technologies. We use these patents to limit the proliferation of
devices intended to circumvent our copy protection technologies. We have
initiated a number of patent infringement disputes against manufacturers and
distributors of these devices. In the event of an adverse ruling in a patent
infringement lawsuit, we might suffer from the legal availability of the
circumvention device or have to obtain rights to the offending device. The legal
availability of circumvention devices could result in the increased
proliferation of devices that defeat our copy protection technology and a
decline in demand for our technologies, which could have a material adverse
effect on our business, financial condition and results of operations. In
October 1998, President Clinton signed the Digital Millennium Copyright Act into
law. This new law will require all new VCRs manufactured or sold in the United
States, beginning in May 2000, to be specifically designed to make poor quality
copies of programming encoded with our copy protection technology. Existing VCRs
that currently respond to our technology (over 90% of all new VCRs) are required
to maintain their compliant designs. The new law also provides for both criminal
and civil penalties for companies or individuals who import, produce, or
distribute devices designed to circumvent our technology.
We compete in an industry characterized by rapid technological change.
The video security industry in which we compete, and in which our
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, in countries not covered by the Digital Millennium Copyright Act, new
industry standards for VCRs or television sets could adversely affect the
effectiveness or transparency of our copy protection technology. Our
videocassette copy protection technology exploits the automatic gain control
circuit in VHS VCRs. While most VCR manufacturers use a standard automatic gain
control circuit that responds to our copy protection process, there can be no
assurance, other than the Digital Millennium Copyright Act in the United States,
that VCR manufacturers will not use alternative automatic gain control circuits
that do not respond to our copy protection technology, thereby lessening the
effectiveness of our 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
our copy protection technologies when they display original, copy protected
videocassettes, DVDs and digital PPV programming.
The success of our PhaseKrypt video scrambling technology will depend upon
the growth of analog cable Pay TV networks in the Pacific Rim, South America and
other developing areas and the ability of our licensees to sell into those
markets. The financial crisis in Southeast Asia has delayed expected cable
television system upgrades in that region and, consequently, has adversely
affected the ability of our licensees to sell addressable set-top decoders that
include our PhaseKrypt video scrambling technology. 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 our PhaseKrypt video scrambling technology.
Our future success will depend in large part on our ability to enhance our
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. We may not
be successful in developing or acquiring 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. Also, we may experience
difficulties that delay or prevent the successful development, introduction and
license or sale of these enhancements, technologies or products. These
enhancements, technologies or products may not adequately meet the requirements
of the marketplace and achieve market acceptance. Any failure by us 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 our
technologies or products and would have a material adverse effect on our
business, financial condition and results of operations.
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Third parties may attempt to use circumvention technologies.
Attempts by third parties to circumvent our copy protection technologies
have been and are expected to be a persistent problem, even in the face of the
new United States Digital Millennium Copyright Act which outlaws copy protection
circumvention devices and technologies. To counter circumvention technologies,
we have developed and patented a number of processes and devices in the
videocassette and DVD fields that could be used by unauthorized parties to
circumvent our copy protection technologies. We have then attempted to use these
patents as barriers to the manufacture and sale of such devices by others. We
have no similar patents specifically directed to the digital-to-digital or
CD-ROM copy protection fields. Notwithstanding our patent position, a number of
devices have been available, and currently are available, that circumvent copy
protection. Moreover, our 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 circumvention
technologies that do not infringe our patents or that we will be able to obtain
patents on circumvention technologies developed in the future. A number of
factors could cause copyright holders to choose not to use our copy protection
technology, including a perception that the inability of our technology to deter
professional pirates renders our technology less useful, the interference with
legitimate consumer use of the original copyrighted product, the commercial
availability of products that circumvent our copy protection technology, or any
significant reduction in the effectiveness of our copy protection technology in
deterring consumer copying. We have implemented numerous anti-hack features to
protect our CD-ROM copy protection technology, but Internet posted hacks defeat
certain versions of copy protection technology and there can be no assurance
that future copy protection technology will not be hacked. Any reduction in
demand for our products could have a material adverse effect on our business,
financial condition and results of operations.
We are exposed to the risks associated with expanding our technological base
through strategic investments.
We have recently expanded our technological base in current as well as new
markets through strategic investments in companies with complementary or
synergistic technologies or products. We currently hold minority equity
interests in Command Audio Corporation, Digimarc and C-Dilla. These investments,
which total $7.9 million and represented 12.0% of our total assets at December
31, 1998, involve a number of risks. The negotiation, creation and management of
these strategic relationships typically involve a substantial commitment of our
management time and resources, and there can be no assurance that we will ever
recover the cost of these management resources. Because these companies are
privately held, there is no active trading market for their securities, and our
investments in them are illiquid. There may never be an opportunity for us to
realize a return on our investment in any of these companies, and we 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 our business, financial condition and results of
operations.
Our 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 us or a third party, or that any joint marketing efforts will result in
increased demand for our products. Further, there can be no assurance that any
current or future strategic investments by us will allow us to enter and compete
effectively in new markets or improve our performance in current markets.
We depend on suppliers and third-party manufacturers.
We depend upon third-party manufacturers and suppliers for components,
subassemblies and printed circuit boards used in our video encryption system
products, PhaseKrypt encoders, PhaseKrypt decoder components and videocassette
copy protection processors. Our product designs are proprietary but generally
incorporate industry-standard hardware components that are obtainable from
multiple sources. Our ability to deliver our 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. We obtain certain
electronic components and subassemblies from a single source or a limited number
of sources. For example, Atmel Corporation is currently our sole source of
integrated circuits for our 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
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that would require us to seek alternative sources of supply could result in our
inability to deliver certain of our products on a timely basis, which in turn
could result in a deterioration of our customer relationships and have a
material adverse effect on our business, financial condition and results of
operations.
We need to establish and maintain licensing relationships with companies in
related fields.
Our future success will depend in part upon our ability to establish and
maintain licensing relationships with companies in related business fields,
including videocassette duplicators, international distributors of
videocassettes, DVD authoring facilities and replicators, semiconductor and
equipment manufacturers, operators of digital PPV systems, consumer electronics
hardware manufacturers and CD-ROM mastering facilities and replicators. We
believe that these current and future relationships can allow us greater access
to manufacturing, sales and distribution resources. However, the amount and
timing of resources to be devoted to these activities by these other companies
are not within our control. We may not be able to maintain our existing
relationships or enter into beneficial relationships in the future. Other
parties may not perform their obligations as expected. Our reliance on others
for the development, manufacturing and distribution of our technologies and
products may result in unforeseen problems. Our reliance on the service
providers of our partners may also result in unforeseen problems. Substantially
all of our license agreements are non-exclusive, and therefore these licensees
are free to enter into similar agreements with third parties, including our
current or potential competitors. There can be no assurance that our licensees
will not develop or pursue alternative technologies either on their own or in
collaboration with others, including our competitors, as a means of developing
or marketing products targeted by the collaborative programs and by our
products. The failure of any of our current or future collaboration efforts
could have a material adverse effect on our ability to introduce new products or
applications and therefore could have a material adverse effect on our business,
financial condition and results of operations.
Certain markets in which we compete are highly competitive.
We believe that we have had no significant videocassette copy protection
competitor for the last five years other than companies that have occasionally
developed hardware based on our technology in foreign countries where we do not
have patents issued. It is possible, however, that a competitive copy protection
technology could be developed in the future. For example, our 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 our business, financial condition and results of operations.
Macrovision, Philips and Digimarc are jointly developing a digital media
copy protection solution to address the digital-to-digital copying issues
associated with the next generation of DVD and digital videocassette recording
devices and have submitted their proposed solution to the CPTWG. Our group is
competing with at least one other group of companies that 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 our group. There can be no assurance that our group will be
able to compete successfully in presenting its proposal to the CPTWG. The
company whose digital media 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. If the solution being developed by our group is not the selected
solution or otherwise is not widely adopted by studios or consumer electronics
manufacturers, our group would be at a competitive disadvantage in marketing its
solution. Even if the CPTWG adopts our group's solution other companies may
still elect to compete in this market.
The market for video scrambling products and technologies is highly
competitive. As a recent entrant into these markets, we compete directly or
through licensed manufacturers with many companies, including General Instrument
Corporation, Pioneer Electronic Corporation, Scientific-Atlanta, Inc., Tandberg
Cryptovision A.S. and VTech-HYH Broadcast Systems. These companies have
substantially greater name recognition, larger installed customer bases and
market shares and significantly greater financial, technical, marketing and
other resources than do we and our licensees, many of which are manufacturing
and selling addressable set-top decoders for the first time. There can be no
assurance that we and our licensees will be able to compete successfully in the
video scrambling systems markets, that we will be able to make technological
advances necessary to improve or even maintain our competitive position or that
our products will achieve market acceptance. In addition, technological
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changes or development efforts by our competitors may render our video
scrambling products obsolete or uncompetitive.
The market for CD-ROM copy protection technologies is highly competitive.
We compete with companies such as TTR, LaserLock and Sony's Digital Optical
Replication Division. There can be no assurance that we will be able to compete
successfully in the computer software copy protection market, that we will be
able to make technological advances necessary to improve or even maintain our
position or that our products will achieve market acceptance. In addition,
technological changes or development efforts by our competitors may render our
computer software copy protection products obsolete or uncompetitive. Finally,
Internet posted hacks may be used to circumvent our technology.
We face a number of risks associated with international and export sales.
International and export sales together represented 44.5% of our net
revenues in 1998 and 46.5% of our net revenues in 1997. We expect that these
sales will continue to represent a substantial portion of our net revenues for
the foreseeable future. Our future growth will depend to a large extent on
worldwide deployment of digital PPV programming and DVDs and the use of copy
protection in these media, as well as addressable analog cable television
systems. 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 our ability to sell
our products or license our technologies into these markets would have a
material adverse effect on our business, financial condition and results of
operations. In particular, the net revenues that we derived from video
scrambling decreased 46.5% from 1997 to 1998, due to decreased demand for analog
decoding equipment that resulted primarily from the financial crisis in
Southeast Asia and Latin America. This crisis has also delayed expected cable
television system upgrades in that region and, consequently, has adversely
affected the ability of our licensees to sell addressable set-top decoders that
include our PhaseKrypt video scrambling technology. In addition, the laws of
certain foreign countries may not protect our intellectual property rights to
the same extent as do the laws of the United States, which increases the risk of
unauthorized use of our 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 our
copy protection and video scrambling technologies.
Due to our reliance on international and export sales, we are 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 our 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 our 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 us to redesign our products or technologies or prevent us from
selling our products and licensing our technologies internationally. While
international and export sales are typically denominated in United States
dollars, fluctuations in currency exchange rates could cause our 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 our future results of operations will not be materially adversely
affected by currency fluctuations. Our business and operating results could be
materially adversely affected if foreign markets do not continue to develop, or
if we do not receive additional orders to supply our technologies or products
for use in foreign prerecorded video, PPV and Pay TV networks and other
applications requiring our video security solutions.
We need to manage our growth.
The growth of our business has placed, and is expected to continue to
place, significant demands on our personnel, management and other resources. Our
future results of operations will depend in part on the ability of our officers
and other key employees to continue to implement and expand our operational,
customer support and
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financial control systems and to expand, train and manage our employee base. In
order to manage our future growth, if any, successfully, we will be required to
hire additional personnel and to augment our existing financial and management
systems or to implement new systems. There can be no assurance that management
will be able to augment or to implement these systems efficiently or on a timely
basis, and the failure to do so could have a material adverse effect on our
business, financial condition and results of operations. We may not be able to
manage any future expansion successfully, and any inability to do so would have
a material adverse effect on our business, financial condition and results of
operations. We typically receive license fees for videocassette, DVD and CD-ROM
copy protection based upon the number of copy protected videocassettes, DVDs and
CD-ROMs that are produced by the MPAA studios or other rights holders.
Information relating to the number of copy protected units may not be reported
to us until one to three months after the period of actual usage. As a result,
we recognize revenue based upon estimates of historical usage, recent trends,
market information and specific customer communications. While to date our
estimates have been reasonably accurate, as our product offerings expand, and if
the revenues generated from copy protection of CD-ROMs, PPV programming and
DVDs, as well as royalties from digital set-top decoders, increase, deriving
such estimates will become more complex. There can be no assurance that, in a
future period, our estimates as to the usage of our copy protection technology
will be accurate. Adjustments to record the difference between estimated and
actual revenue could have a material adverse effect on our business, financial
condition and results of operations for the period in which the adjustment is
recorded.
We are dependent on certain key personnel.
Because of the specialized nature of our business, our future performance
is highly dependent upon the continued service of members of our senior
management and other key research and development and sales and marketing
personnel. The loss of any of these persons could have a material adverse effect
on our business, financial condition and results of operations. We do not have
employment contracts for a fixed term with any of our employees in the United
States. We believe that our future success will depend upon our continuing
ability to identify, attract, train and retain other highly skilled managerial,
technical, sales and marketing personnel, particularly as we enter new markets.
Hiring for such personnel is competitive. There can be no assurance that we will
be able to continue to attract, assimilate and retain the qualified personnel
necessary for the development of our 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 our business, financial
condition and results of operations.
We are parties to certain transactions with our affiliates.
We are a party to a number of transactions with affiliated entities. Victor
Company of Japan, Limited, the parent of one of our principal stockholders,
licenses and utilizes various technologies of ours pursuant to several
agreements. Matsushita Electric Industrial Co., Ltd., which owns approximately
52% of Victor Company of Japan, Limited, also is a party to various agreements
with us. We have certain agreements with a former subsidiary, Command Audio
Corp., in which we currently have an 11.9% interest. In addition, we have
agreements with C-Dilla, in which we have a 19.8% interest.
We are currently involved in a litigation that could have a material impact on
us.
In October 1995, Joseph Swyt, one of our former officers and directors,
filed suit against us 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 our grant of stock options to him. Mr. Swyt
maintains that we 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, we granted to Mr. Swyt 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 Macrovision in June 1995. In December 1996,
the court ordered this matter to binding arbitration in accordance with a
written agreement between us and Mr. Swyt. The arbitration agreement contains
limitations on the types of damages available to Mr. Swyt 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 were completed in February 1999. On March 16, 1999, a majority of the
arbitrators rendered a decision in our favor, finding that we had no liability
to Mr. Swyt on any of his claims and that his claims were without merit. We are
seeking and expect to have the arbitrators' decision confirmed by the Superior
Court. However, in the unlikely event that the Court were to set aside the
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arbitrators' decision instead of confirming it, a subsequent decision against us
could have a material adverse effect on our business, financial condition and
results of operations. For details on additional litigation, please see "--It
can be time-consuming and costly to defend against infringement claims."
We face Year 2000 risks.
Many currently installed computer systems and software products are unable
to distinguish between twentieth century dates and twenty-first century dates
because such systems may have been developed using two digits rather than four
to determine the applicable year. This could result in system failures or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities. As a result, many companies' software and
computer systems may need to be upgraded or replaced to comply with such "Year
2000" requirements. Our business is dependent on the operation of numerous
systems that could potentially be impacted by Year 2000 related problems. Those
systems include, among others: hardware and software systems used internally by
us in the management of our business; hardware and software products developed
by us; the internal systems of our customers and suppliers; and non-information
technology systems and services used by us in the management of our business,
such as telephone systems and building systems. We believe our products are Year
2000 ready; however, success of our Year 2000 readiness efforts may depend on
the success of our customers in dealing with their Year 2000 issues. We sell our
products to companies in a variety of industries each experiencing different
issues with Year 2000 readiness. Customer difficulties with Year 2000 issues
could interfere with the use of our products, which might require us to devote
additional resources to resolve the underlying problems. Although we believe
that our Year 2000 readiness efforts are designed to appropriately identify and
address those Year 2000 issues that are within our control, there can be no
assurance that our efforts will be fully effective or that the Year 2000 issues
will not have a material adverse effect on our business, financial condition or
results of operations. We do not presently have a contingency plan for handling
Year 2000 issues that are not detected and corrected prior to their occurrence.
Any failure by us to address any unforeseen Year 2000 issue could adversely
affect our business, financial condition and results of operations. For more
details on our Year 2000 risks, please see "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Year 2000 Issues."
Our charter documents contain provisions that could discourage a takeover.
Our 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 Macrovision. We have no
present plans to issue shares of preferred stock. Additionally, our charter
documents contain a provision eliminating the ability of our stockholders to
take action by written consent. This provision is designed to reduce our
vulnerability to an unsolicited acquisition proposal, to maintain independent
ownership and control of our copy protection technologies and to render the use
of stockholder written consent unavailable as a tactic in a proxy fight.
However, this provision could have the effect of discouraging others from making
tender offers for our shares, thereby inhibiting increases in the market price
of our shares that could result from actual or rumored takeover attempts. Such
provision also may have the effect of preventing changes in our management.
Further, our Bylaws limit the ability of our stockholders 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 we are 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 Macrovision.
Pursuant to the terms of a Copy Protection Technology Agreement (the
"Technology Agreement") between us and Victor Company of Japan, Limited, we have
agreed to continue to license our copy protection technologies to third parties
in the event of the acquisition of Macrovision by a party other than Victor
Company. Further, we have granted to Victor Company the right to sublicense our
copy protection technologies in the event that we fail to make our copy
protection technologies generally available for licensing to third parties
following an acquisition of Macrovision. The Technology Agreement could have the
effect of making Macrovision less attractive to third parties as an acquisition
candidate.
We experienced volatility in our stock price.
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The market price of our common stock has been and in the future could be
significantly affected by factors such as actual or anticipated fluctuations in
our operating results, announcements of technical innovations, new products or
new contracts by us, our competitors or their customers, governmental regulatory
action, developments with respect to patents or proprietary rights, changes in
financial estimates by securities analysts, lawsuits, general market conditions
and other factors, certain of which could be unrelated to us or outside our
control. In addition, announcements by the Copy Protection Technical Working
Group, the Motion Picture Association of America or its members, satellite
television operators, cable television operators or others regarding motion
picture distribution, business combinations, evolving industry standards or
other developments could cause the market price of our 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 the stocks of many technology companies, including us, 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 has been initiated against such a company. There can be no
assurance that such litigation will not occur in the future with respect to
Macrovision. 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 our business, financial condition and results of
operations. Any settlement or adverse determination in such litigation could
also subject us to significant liability, which could have a material adverse
effect on our 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. In addition, because of
our dependence on the reports of our customers to derive revenue estimates, we
may not be in a position to identify any shortfall of anticipated revenue until
late in or after any particular quarter. Failure to detect any such shortfall
until such time would result in our inability to advise or warn our stockholders
and analysts about such shortfalls and potentially subject our stock price to
grater volatility.
ITEM 2. Description of Property.
Our principal operations are located in a 43,960 square foot building in
Sunnyvale, California. Our lease for this building expires on June 30, 2002. We
also lease space for sales, marketing and technical support operations near
London, England and in Tokyo, Japan. We believe that our existing facilities are
adequate to meet our current needs.
ITEM 3. Legal Proceedings.
Swyt Litigation
In October 1995, Joseph Swyt, one of our former officers and directors,
filed suit against us 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 our grant of stock options to him. Mr. Swyt
maintains that we 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, we 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 Macrovision in June 1995. In December 1996, the
court ordered this matter to binding arbitration in accordance with a written
agreement between Mr. Swyt and Macrovision. 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 were
completed in February 1999. On March 16, 1999, a majority of the arbitrators
rendered a decision in our favor, finding that we had no liability to Mr. Swyt
on any of his claims and that his claims were without merit. We are seeking and
expect to have the arbitrators' decision confirmed by the Superior Court.
However, in the unlikely event that the Court were to set aside the arbitrators'
decision instead of confirming it, a subsequent decision against us could have a
material adverse effect on our business, financial condition and results of
operations.
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Patent Litigation
We have been notified that a Japanese company has filed an invalidation
claim against one of our anti-copy patents in Japan. We and our Japanese patent
counsel believe this claim is without merit and will be aggressively contested
by us in the Japanese Patent Office. In the event of an adverse ruling on this
claim, we might incur legal competition from clones of our own copy protection
technology in Japan and a corresponding decline in demand for our technology.
From time to time, we may receive claims from third parties that our
technologies and products infringe their intellectual property rights, and we
may receive similar claims in the future. Any infringement claims, with or
without merit, could be time-consuming to defend, result in costly litigation,
cause product shipment delays or require us to cease utilizing the infringing
technology unless we can enter into royalty or licensing agreements. Such
royalty or licensing agreements might not be available on terms acceptable to
us, or at all, which could have a material adverse effect on our business,
financial condition and results of operations.
We now have pending one patent infringement lawsuit in an effort to protect
our copy protection technology. In the event of an adverse ruling in this
litigation, we might incur legal competition from clones of our own copy
protection technology, which could have a material adverse effect on our
business, financial condition and results of operations.
ITEM 4. Submission of Matters to a Vote of Security Holders.
We did not submit any matters to a vote of security holders during the
quarter ended December 31, 1998.
PART II
ITEM 5. Market for Common Equity and Related Stockholder Matters.
(a) Our common stock has been traded on the Nasdaq National Market under
the symbol "MVSN" since our initial public offering on March 17, 1997. The
following table sets forth, for the periods indicated, the reported high and low
closing prices for our common stock.
High Low
---- ---
1997
First Quarter (Commencing March 17, 1997) ..... $ 9.000 $ 8.000
Second Quarter ................................ 14.750 8.250
Third Quarter ................................. 18.125 12.750
Fourth Quarter ................................ 17.125 12.750
1998
First Quarter ................................. 19.313 14.750
Second Quarter ................................ 24.500 17.500
Third Quarter ................................. 29.750 17.750
Fourth Quarter ................................ 44.625 25.000
As of March 22, 1999, there were 105 holders of record of our common stock,
based upon information furnished by Boston EquiServe, Boston, MA, the transfer
agent for our securities. We believe, based upon security positions listings,
that there are more than 1,800 beneficial owners of our common stock. As of
March 22, 1999, there were 8,925,229 shares of common stock outstanding.
We have not declared or paid any cash dividends on our common stock since
1994. We do not anticipate paying any cash dividends on our common stock in the
foreseeable future. We intend to retain all earnings for use in our business
operations and in the expansion of our business.
In March and April 1997, we completed an initial public offering of our
common stock, $0.001 par value (the "Offering"). The managing underwriters in
the Offering were Montgomery Securities, Hambrecht & Quist LLC and Cowen &
Company (the "Underwriters"). We registered 2,702,500 shares of common stock
under the Securities Act of 1933, as amended, on a Registration Statement on
Form SB-2 (No. 333-19373) (the "Registration Statement"). which was declared
effective by the Securities and Exchange Commission on March 12, 1997.
We commenced the Offering on March 13, 1997 and terminated it on April 11,
1997 after 2,680,000 shares (including 330,000 shares sold pursuant to the
exercise of the underwriters' over-allotment option) had been sold.
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Of the 2,680,000 shares sold, we sold 1,764,016 shares and certain of our
stockholders sold 915,984 shares. The initial public offering price was $9.00
per share and thus our gross proceeds were $15.9 million.
We paid an aggregate of $1.1 million in underwriting discounts and
commissions and $1.5 million in other expenses. None of these amounts were paid
directly or indirectly to any of our directors, officers or general partners or
their associates, persons owning 10% or more of any class of our equity
securities or any of our affiliates. After deducting the underwriting discounts
and commissions and other Offering expenses, our net proceeds from the Offering
were approximately $13.2 million. As of December 31, 1998, these proceeds were
invested in interest-bearing, investment grade securities.
ITEM 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The discussion in this Item 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 those set
forth below and those set forth above under the caption "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,
we have derived most of our revenues and operating income from licensing our
video copy protection technologies. Videocassette copy protection revenues
represented 64.5% of our net revenues in 1998 and 62.0% of our net revenues in
1997. We expect these license fees to account for a majority of our net revenues
and operating income at least through 1999. Our videocassette copy protection
customers have included the home video divisions of the seven members of the
MPAA. We also have a variety of special interest videocassette copy protection
customers, including more than 150 videocassette duplication companies and a
number of rights holders, such as independent producers of exercise, sports and
educational videocassettes. We typically receive 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 1998 and 1997.
In 1993, we began licensing our 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 our copy protection technologies that can be
activated to apply video copy protection to digital PPV transmissions. Our
digital PPV copy protection revenues have been derived from up-front license
fees, hardware royalties and limited PPV programming royalties. Digital PPV
up-front license fees, hardware royalties and PPV programming royalties
decreased to 15.4% of our net revenues in 1998 from 18.2% of net revenues in
1997. Our agreements with digital PPV system operators entitle us to
transaction-based royalty payments at such time as copy protection for digital
PPV programming is activated.
In 1994, we began licensing and selling our PhaseKrypt video scrambling
technology to manufacturers of analog set-top decoders for sale to cable
television system operators in developing cable television markets. We also sell
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, we sell specialized analog
video scrambling systems in the government, military and law enforcement
markets, primarily for covert surveillance applications. Video scrambling
revenues decreased to 6.0% of our net revenues in 1998 from 13.5% in 1997, due
to the lower than expected Components and Licensing revenues from Asia and lower
than expected sales of video encryption system products to government agencies.
Gross margins on sales of our video scrambling products have been significantly
lower than on our licenses of copy protection or video scrambling technologies
because of the hardware product costs associated with a more traditional
manufacturing environment. We expect this trend to continue for the foreseeable
future.
In 1997, we derived our first revenues from royalties and hardware license
fees associated with DVD copy protection. The initial customers implementing the
DVD copy protection, from which the royalties have been derived, have been
members of the MPAA and to a lesser extent special interest rights owners. DVD
hardware license fees are generated from an initial license fee paid at the
beginning of a license and subsequent annual renewal fees. DVD copy protection
has increased to 12.7% of our net revenues in 1998 from 5.3% in 1997.
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Revenue is expected to grow in both absolute dollars and as a percentage of
revenue in 1999 as the number of DVDs, DVD titles and DVD players in the market
increases.
In October 1995, Command Audio Corporation was incorporated by us as a
wholly-owned subsidiary to commercialize a distinct and new audio-on-demand
technology that our founder developed during 1994 and 1995. This technology does
not involve copy protection or video scrambling, but rather digitally stores
broadcast audio programs so that a user can listen to these programs at his or
her convenience. In August 1996, we divested all but 19.8% of our ownership in
CAC. Additionally, in 1996, we assigned to CAC all rights in certain technology
and released our reversion rights in technology that we had previously assigned
to CAC. In consideration of this assignment and release, CAC agreed to pay to us
royalties equal to 2.0% of its gross revenues for 12 years, beginning when CAC
has operating revenues from certain sources or, at our election, at any time
prior thereto. During 1997, we maintained our 19.8% ownership in CAC with an
additional cash investment of approximately $2.0 million in connection with
various rounds of third-party financing obtained by CAC. In 1998, we invested
$500,000 in CAC in connection with an additional round of external financing
obtained by CAC. Our investment was less than 19.8% of the total investment
financing obtained by CAC and thus reduced our previous 19.8% ownership of CAC
to 11.9%.
In December 1997, we invested $1.5 million in Digimarc in exchange for
shares of Digimarc's preferred stock that represent a 6.8% ownership interest on
an as-converted basis. Digimarc is a private company that was founded in 1995.
We, Digimarc and Philips are jointly developing a digital media copy protection
solution to address the digital-to-digital copying issues associated with the
next generation of DVD and digital videocassette recording devices. We have
presented our proposed solution to the CPTWG and are currently working on
prototype systems.
In 1998, we entered into a Software Marketing License and Development
Agreement with C-Dilla under which we have, for an initial five-year term, the
worldwide exclusive license to market, in the consumer multimedia software
market, C-Dilla's proprietary copy protection technology. In September 1998, we
and C-Dilla introduced our CD-ROM copy protection technology, called SafeDisc.
As of December 31, 1998, we had protected over 1.7 million CD-ROMs with
SafeDisc. The initial customers implementing the multimedia software copy
protection included nine publishers. We expect revenues in both absolute dollars
and as a percentage of revenue from multimedia software copy protection to
increase in 1999 due to the increasing usage, by multimedia content owners, of
the SafeDisc technology to reduce the unauthorized coping of their content due
to the availability of low price CD recorders. Revenues from multimedia software
royalties in 1998 represented 1.4% of our net revenues.
Our cost of revenues consists primarily of manufacturing costs associated
with our video scrambling product revenues, service fees paid to licensed
duplicators that apply our videocassette copy protection whenever rights owners
license the technology directly from us, costs associated with equipment used in
applying the copy protection process at the licensed duplicators and royalties
due C-Dilla based on revenues from copy protection of CD-ROMs. Also included in
cost of revenues are patent amortization costs and legal costs associated with
our efforts to prevent the sale of devices that attempt to circumvent our video
copy protection technologies. Our research and development expenses are
comprised primarily of employee compensation and benefits, consulting fees,
tooling and supplies and an allocation of facilities costs. Our selling and
marketing expenses are comprised primarily of employee compensation and
benefits, consulting and recruiting fees, travel, advertising and an allocation
of facilities costs. Our general and administrative expenses are comprised
primarily of employee compensation and benefits, consulting and recruiting fees,
travel, professional fees and an allocation of facilities costs.
We have experienced significant seasonality in our business, and our
financial condition and results of operations are likely to be affected by
seasonality in the future. We have typically experienced our 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. We believe that this trend has been principally due to the
tendency of certain of our customers to release their more popular motion
pictures on videocassettes and DVDs during the year-end holiday shopping season
and having our operating expenses incurred more evenly throughout the year. We
anticipate that revenues 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.
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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:
Year Ended December 31,
----------------------
1998 1997
------ ------
Net revenues ..................................... 100.0% 100.0%
------ ------
Costs and expenses:
Cost of revenues ............................... 8.5 11.9
Research and development ....................... 10.6 11.1
Selling and marketing .......................... 24.5 28.3
General and administrative ..................... 18.9 20.4
------ ------
Total costs and expenses ..................... 62.5 71.7
------ ------
Operating income ............................. 37.5 28.3
Interest and other income, net ................... 4.5 2.4
------ ------
Income before income taxes ................... 42.0 30.7
Income taxes ..................................... 16.0 11.9
------ ------
Net income ................................... 26.0% 18.8%
====== ======
The following information provides revenue information by general product
lines for the periods indicated (dollars in thousands):
For Period Ended December 31,
-------------------------------------------
1998 % 1997 % % Change
------- ----- ------- ----- --------
Video Copy Protection ............. $22,626 92.6 $17,412 85.6 29.9%
Video Scrambling .................. 1,464 6.0 2,739 13.5 (46.5)
Computer Software Copy Protection . 344 1.4 -- -- --
Other ............................. -- -- 189 .9 --
------- ----- ------- ----- ----
Total ............................. $24,434 100.0 $20,340 100.0 20.1
======= ===== ======= ===== ====
Net Revenues
Our net revenues increased 20.1% from $20.3 million in 1997 to $24.4
million in 1998. Our video copy protection revenues are derived from
videocassette and DVD copy protection and digital PPV. Videocassette copy
protection revenues increased $3.2 million or 25.0% from $12.6 million in 1997
to $15.8 million in 1998, principally due to increased copy protection royalty
revenue from three Hollywood studios which had no significant usage of copy
protection in 1997. DVD copy protection revenues increased $2.0 million or
185.6% from $1.1 million in 1997 to $3.1 million in 1998, due to increased
royalty revenue from the replication of DVDs and license fees from PC and DVD
ROM manufacturers. Revenues from PPV for 1998 were $3.8 million, reflecting an
increase of $47,000 or 1.3% from 1997 as a result of increased shipments of
set-top decoders from licensed manufacturers offset by a decrease in initial
license fees. Our video scrambling revenues decreased $1.3 million or 46.5% from
1997 to 1998. Video scrambling revenues are derived from sales of video
scrambling system products and components and licensing of our PhaseKrypt
technology. Video encryption system product revenue decreased $279,000 or 36.9%
from $756,000 in 1997 to $477,000 in 1998 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 1998 was $987,000, a $996,000 or
50.2% decrease from 1997. The decrease in the components and licensing area was
due primarily to the Southeast Asian and Latin American financial situation,
which has delayed expected cable TV system upgrades and, consequently, limited
the ability of our licensees' to sell addressable set-top converters that
include our PhaseKrypt TM scrambling technology. We recorded our first
multimedia software revenues in 1998 of $344,000 associated with the software
copy protection of computer CD-ROMs involving nine publishers. Due primarily to
the increase in usage of copy protection by three Hollywood studios which
included the hit title "Titanic," along with the increased volume of DVD discs
from the market growth of DVD players coupled with the slight increase in our
digital PPV copy protection and the decrease in the video scrambling businesses,
copy protection revenues
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from the MPAA studios in the United States increased from 27.3% of our net
revenues in 1997 to 32.1% of our net revenues in 1998. There can be no assurance
that we will be able to grow in future periods or that we will be able to
sustain our level of net revenues or our rate of growth on a quarterly or annual
basis.
Our international and export revenues increased from $9.5 million, or 46.5%
of our net revenues in 1997, to $10.9 million, or 44.5% of our net revenues in
1998. International and export revenues grew primarily as a result of increased
usage of videocassette copy protection technology by the MPAA studios in
international markets which included the title "Titanic," overseas shipments of
copy protection enabled digital PPV set-top decoders from manufacturers offset
by the decrease in PhaseKrypt component sales and licensing fees. We expect that
international and export revenues will continue to represent a significant
portion of our net revenues and that our 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 declined to 8.5% in 1998
from 11.9% in 1997. This decrease was 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 and computer software copy protection
increase as a percentage of net revenues, cost of revenues as a percentage of
net revenues will increase. In addition, processor equipment costs, the
inventory reserve provision and product hardware related costs were reduced, but
were offset by increased service fees for duplicators and replicators and
royalty expense. As revenues increase from multimedia software copy protection,
cost of revenues as a percentage of net revenues may increase due to the higher
cost of sales associated with the royalties due to C-Dilla and other costs. See
Note 1 of Notes to Consolidated Financial Statements.
Research and Development
Research and development expenses increased from $2.2 million in 1997 to
$2.6 million in 1998, but decreased as a percentage of net revenues from 11.1%
in 1997 to 10.6% in 1998. This increase in absolute dollars was principally due
to higher compensation related expenses. In 1997, we began a joint development
effort with Digimarc to develop a video watermarking solution for DVD and other
video platforms. Development continued through 1998, with Philips joining the
development effort. With our entrance into the computer software copy protection
market, ongoing support is needed to create technology with commercial
applications. We believe 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.
Selling and Marketing
Selling and marketing expenses were increased from $5.8 million in 1997 to
$6.0 million in 1998, but decreased as a percentage of net revenues from 28.3%
of net revenues in 1997 to 24.5% of net revenues in 1998. The increase in
absolute dollars from 1997 to 1998 were primarily a result of higher
compensation related expenses and advertising and marketing for DVD and computer
software copy protection and expenses related to the entrance into the computer
software copy protection market, offset by C-Dilla's $500,000 reimbursement of
specific marketing related expenses under the joint marketing agreement. We
believe that the dollar amount of selling and marketing expenses will increase
in the future as we incur the additional costs related to new business
development in the computer software copy protection market. There can be no
assurance, however, that net revenues will grow more rapidly than selling and
marketing expenses.
General and Administrative
General and administrative expenses increased from $4.1 million in 1997 to
$4.6 million in 1998, but decreased as a percentage of the net revenues from
20.4% of the net revenues in 1997 to 18.9% of the net revenues in 1998. The
increase in absolute dollars was primarily related to increased compensation and
benefits, the reversal of sales tax expense due to a favorable judicial ruling
in a tax case that lowered our expenses on a one-time basis in 1997 and higher
consulting fees offset by lower legal fees and bad debt expense. We believe that
the dollar amount of general and administrative expenses will increase in the
future as we evaluate new business opportunities. There can be no assurance that
net revenues will grow more rapidly than general and administration expenses.
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Interest and Other Income, Net
Interest and other income, net, consists primarily of interest income net
of interest expense on capitalized equipment leases. Interest expense was
$11,000 in 1998 and $12,000 in 1997. Interest income was $1.1 million in 1998
and $513,000 in 1997. The increase in interest income 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
initial public offering in March 1997, and the secondary offering of Macrovision
shares completed in July 1998. See Note 2 to Consolidated Financial Statements.
Income Taxes
Our effective rate of taxation was 38.3% in 1998 and 38.7% in 1997. The
provision for income taxes consists primarily of federal income taxes, state
taxes and international taxes withheld on foreign revenue. The lower rate in
1998 was primarily due to an increase in tax credits and an increase in tax
exempt interest associated with increased tax free investments. See Note 5 of
Notes to Consolidated Financial Statements.
Liquidity and Capital Resources
The Company's working capital increased 93.1% from $15.3 million in 1997 to
$29.5 million in 1998, primarily from proceeds generated from our secondary
offering of Macrovision shares in 1998. The net proceeds to us from that
offering, after underwriting discounts and commissions and other expenses, were
approximately $27.9 million. In addition, we have financed our operations
primarily from cash generated by operating activities, principally by our copy
protection business. Our operating activities provided net cash of $7.6 million
in 1998 and $2.4 million in 1997. In 1998, net cash was provided by net income,
noncash charges, increases in tax benefit from employee stock benefit plans,
accrued expenses and deferred revenue, partially offset by increases in accounts
receivable and prepaids and decreases in accounts payable and income taxes
payable. In 1997, net cash was provided by net income, noncash charges and
increases in income taxes payable and deferred revenue, partially offset by
increases in accounts receivable.
Investing activities used cash of $34.1 million in 1998 and $17.5 million
in 1997. In 1998, net cash used in investing activities was primarily the
investment of the proceeds from the secondary offering, partially offset by, an
investment in and payment of royalties to C-Dilla and an additional investment
in CAC. In February 1998, we acquired 247,500 shares (approximately 19.8%) of
the common stock of C-Dilla, a U.K. company, for a purchase price of $3.6
million. In February 1998, we also entered into a Software Marketing License and
Development Agreement under which we have 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. We paid $1.0
million 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. During 1998,
$143,000 of the $1.0 million offset the prepayment of royalties to C-Dilla. In
1998, we invested $500,000 in Command Audio Corporation ("CAC") in connection
with an additional round of external third-party financing obtained by CAC. Our
investment was less than 19.8% of the total investment financing obtained by CAC
and thus reduced our previous 19.8% ownership of CAC to 11.9%. Subsequently, CAC
paid in full the note due to us including accrued interest. We account for the
investments in C-Dilla and CAC using the cost method. In 1998 we made capital
expenditures of $285,000 and paid $666,000 related to patents and other
intangibles during those periods. In 1997, net cash used in investing activities
resulted primarily from purchases of short and long-term marketable investment
securities and investments of $1.5 million in Digimarc and approximately $2.0
million in CAC.
We had net cash provided from financing activities of $28.7 million in 1998
and $13.9 million in 1997, relating in each year primarily to the sale of stock
in a public offering and, to a lesser extent, the issuance of common stock upon
the exercise of stock options and under our stock purchase plan. We received net
proceeds of $13.8 million in 1997 from our initial public offering, which
represented substantially all of the cash provided by financing activities. In
July, 1998, we consummated an offering of 1,500,000 shares of our common stock,
of which 1,140,000 shares were issued and sold by us and 360,000 shares were
sold by our existing stockholders. The Underwriters also exercised in full an
over-allotment option to purchase from us an additional 225,000 shares of common
stock. The net proceeds to us from the offering, after deducting the
underwriting discount and other expenses of the offering, were approximately
$27.9 million. In addition, we paid cash dividends on our Series A Preferred
Stock of $156,000 in 1997.
32
<PAGE>
At December 31, 1998, we had $3.5 million in cash and cash equivalents,
$22.9 million in short-term investments and $18.8 million in long-term
marketable investment securities. We had no material commitments for capital
expenditures as of that date, but we anticipate that capital expenditures for
1999 will aggregate approximately $600,000.
We also had future minimum lease payments of approximately $2.0 million
under operating leases and approximately $194,000 under capital leases. In the
future, we may also elect to purchase additional stock in CAC to maintain our
percentage equity ownership in CAC.
We believe that our existing cash and cash equivalents, short-term
investments, long-term marketable investment securities and cash provided by
operating activities will be sufficient to meet our working capital and capital
expenditure requirements for at least the next 12 months. To the extent that we
experience growth in the future, we anticipate that our operating and investing
activities may use cash. Consequently, any such growth may require us to obtain
additional equity or debt financing. There can be no assurance that any
necessary additional financing will be available to us on commercially
reasonable terms, if at all. Management intends to invest our excess cash in
short-term and long-term, interest bearing, investment grade securities.
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, we evaluate potential
acquisitions of businesses, products or technologies that are complementary to
ours and may in the future use a portion of our cash to acquire or invest in
complementary businesses or products or obtain the right to use complementary
technologies.
Year 2000 Issues
Background
Many currently installed computer systems and software products are unable
to distinguish between twentieth century dates and twenty-first century dates
because these systems may have been developed using two digits rather than four
to determine the applicable year. For example, computer systems that have
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This error could result in system failures or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities. As a result, many companies' software and
computer systems may need to be upgraded or replaced to comply with such "Year
2000" requirements.
State of Readiness
Our business is dependent on the operation of numerous systems that could
potentially be impacted by Year 2000 related problems. Those systems include,
among others:
o hardware and software systems that we use internally in the management
of our business;
o hardware and software products that we have developed;
o the internal systems of our customers and suppliers; and
o non-information technology systems and services that we use in the
management of our business, such as telephone systems and building
systems.
Based on an analysis of the systems potentially impacted by conducting
business in the twenty-first century, we are applying a phased approach to
making such systems, and accordingly our operations, Year 2000 ready. Beyond
awareness of the issues and scope of systems involved, the phases of activities
in progress include:
o an assessment of specific underlying computer systems, programs and/or
hardware;
o remediation or replacement of Year 2000 non-compliant technology;
o validation and testing of technologically Year 2000 ready solutions;
and
o implementation of the Year 2000 ready systems.
33
<PAGE>
The table below provides the status and timing of these phased activities:
<TABLE>
<CAPTION>
Targeted
Impacted Systems Status Implementation
---------------- ------- --------------
<S> <C> <C>
Hardware and software products that we Assessment completed, conducting Q1 1999
license or sell validation and testing (see details
below)
Hardware and software systems that we Assessment completed; certain Q1 1999
use internally in the management of components replaced; conducting
our business validation and testing
Internal systems of our customers and Assessment not yet completed Q3 1999
suppliers
Non-information technology systems and Assessment completed; certain Q2 1999
services that we use in the management components replaced, conducting
of our business, internal and validation and testing
external, such as telephone systems
and building systems
</TABLE>
Products Status
Macrovision's products that do not include a microprocessor or other
digital-based technology and are not date or time sensitive are Year 2000 ready.
These products include the following:
Video Copy Protection Products; All versions of ACP Processors (ACP-100,
ACP-170, ACP-180; ACP-182 and ACP-184); the Standard ACP-100 and ACP-180
Chassis and the Secured ACP-180 Chassis.
Video Scrambling Products; VM-100; TurboKrypt Chassis and Processor; Video
Tilt Corrector; MacroPlus Generator; VGA Copy Processor; ColorStripe
Generator; and the WaterMark Embedder.
Macrovision's products that do contain a microprocessor or other digital
based technology, and have been tested and verified as Year 2000 ready, include
the following:
Video Copy Protection Products; ACP-180 Security Chassis; ACP Time Key.
Video Scrambling Products; VES-TM; VES-TL; VES-MX; VES-TP; VES-TS; VES-TX;
VES-TX NET Software; VES-P; VES-C1; VES-C2; VES-TD; PK-410/415 Chassis &
CPU; AV-8; AV-10; PK-430A; PK-430M; PK-430C; StarShaker Encoder; StarShaker
Decoder; and the StarShaker Software.
Macrovision products currently in the process of being tested for Year 2000
readiness, include the following:
SafeDisc Developers ToolKit.
Year 2000 readiness does not include the performance or functionality of
third party products, including hardware or software with which any of our
products interfaces.
Costs to Address Year 2000 Readiness
We have expensed as incurred all costs directly related to Year 2000
readiness, even in cases where non-compliant information technology systems have
been replaced. To date, these costs have been insignificant. The replacement
cost of non-information technology systems would have been incurred, regardless
of the Year 2000 issue, to accommodate our growth.
We do not believe that future expenditures to upgrade internal systems and
applications will have a material adverse effect on our business, financial
condition and results of operations. In addition, while the potential costs of
redeployment of personnel and any delays in implementing other projects is not
known, the costs are anticipated to be immaterial.
Risks of the Year 2000 Issues
We believe our products are Year 2000 ready; however, success of our Year
2000 readiness efforts may depend on the success of our customers in dealing
with their Year 2000 issues. We sell our products to companies in a variety of
industries each experiencing different issues with Year 2000 readiness. Customer
difficulties with Year 2000
34
<PAGE>
issues could interfere with the use of our products, which might require us to
devote additional resources to resolve the underlying problems. If the problem
is found to lie in our products, our business, financial condition and results
of operations could be materially adversely affected.
Furthermore, the purchasing patterns of these customers or potential
customers may be affected by Year 2000 issues as companies expend significant
resources to become Year 2000 ready. The costs of becoming Year 2000 ready for
current or potential customers may result in reduced funds available to purchase
and implement our products. In addition, we rely on various entities that are
common to many businesses, such as public utilities. If these entities were to
experience Year 2000 failures, our ability to conduct business would be
disrupted.
Although we believe that our Year 2000 readiness efforts are designed to
appropriately identify and address those Year 2000 issues that are within our
control, there can be no assurance that our efforts will be fully effective or
that the Year 2000 issues will not have a material adverse effect on our
business, financial condition or results of operations. The novelty and
complexity of the issues presented and our dependence on the preparedness of
third parties are among the factors that could cause our efforts to be less than
fully effective. Moreover, Year 2000 issues present many risks that are beyond
our control, such as the potential effects of Year 2000 issues on the economy in
general and on our business partners and customers in particular.
Contingency Plans
We have conducted an assessment of certain of our Year 2000 exposure areas
in order to determine what steps beyond those identified by our internal review
were advisable and no additional work was recommended. We do not presently have
a contingency plan for handling Year 2000 issues that are not detected and
corrected prior to their occurrence. Any failure by us to address any unforeseen
Year 2000 issue could adversely affect our business, financial condition and
results of operations.
ITEM 7. 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.
None.
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
information under the caption "Election of Directors," with respect to
Directors, and under the caption "Management," with respect to Executive
Officers, contained in our definitive Proxy Statement, which will be filed with
the Securities and Exchange Commission in connection with the solicitation of
proxies for our 1999 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 Relationships and Related Transactions"
to be contained in the Proxy Statement.
35
<PAGE>
ITEM 13. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit
Number Exhibit Title
------ -------------
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 November29, 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 November29, 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 June30, 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.*
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.*
36
<PAGE>
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.*
10.28 Subscription Agreement between Macrovision Corporation and C-Dilla
Limited dated February 17, 1998.**/***
10.29 Software Marketing License and Development Agreement between
Macrovision Corporation and C-Dilla Limited dated February 19,
1998.**/****
21.01 List of subsidiaries.*
23.01 Consent of Independent Auditors.
27.01 1998 Financial Data Schedule.
27.02 1997 Financial Data Schedule
* Incorporated by reference to the exhibit of the same number in our
Registration Statement on Form SB-2 (Registration No. 333-19373), which was
declared effective on March 12, 1997.
** Confidential treatment has been granted with respect to certain portions of
these Exhibits. These portions have been omitted from this filing and have
been filed separately with the Securities and Exchange Commission.
*** Incorporated by reference to Exhibit 10.01 to our Form 10-QSB/A filed on
June 23, 1998.
**** Incorporated by reference to Exhibit 10.02 to our Form 10-QSB filed on May
15, 1998.
(b) Reports on Form 8-K
We did not file a Current Report on Form 8-K during the quarter ended
December 31, 1998.
37
<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 30th day of March, 1999.
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>
Name Title Date
----- ---- ----
<S> <C> <C>
Principal Executive Officer:
/s/ John O. Ryan Chairman of the Board of Directors, Chief March 30, 1999
- -------------------------------- Executive Officer, Secretary and Director
John O. Ryan
Principal Financial Officer and
Principal Accounting Officer:
/s/ Victor A. Viegas Vice President, Finance and Administration March 30, 1999
- -------------------------------- and Chief Financial Officer
Victor A. Viegas
Additional Directors
/s/ William A. Krepick Director March 30, 1999
- --------------------------------
William A. Krepick
/s/ Richard S. Matuszak Director March 30, 1999
- --------------------------------
Richard S. Matuszak
/s/ Donna S. Birks Director March 30, 1999
- --------------------------------
Donna S. Birks
/s/ William N. Stirlen Director March 30, 1999
- --------------------------------
William N. Stirlen
/s/ Thomas Wertheimer Director March 30, 1999
- --------------------------------
Thomas Wertheimer
</TABLE>
38
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
PAGE
Report of KPMG LLP, Independent Auditors ................................. 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
F-1
<PAGE>
Report of KPMG 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, 1998 and 1997, 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, 1998 and 1997, and the results
of their operations and their cash flows for the years then ended in conformity
with generally accepted accounting principles.
/s/ KPMG LLP
Mountain View, California
February 1, 1999, except for Note 8,
which is as of March 16, 1999
F-2
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share data)
<TABLE>
<CAPTION>
ASSETS
December 31,
--------------------
1998 1997
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents ................................................... $ 3,513 $ 1,314
Short-term investments ...................................................... 22,877 11,241
Accounts receivable, net of allowance for doubtful accounts of
$838 and $684 as of December 31, 1998 and 1997, respectively .............. 5,574 5,240
Inventories ................................................................. 325 433
Receivable from related party ............................................... -- 279
Deferred tax assets ......................................................... 1,669 1,336
Prepaid expenses and other current assets ................................... 1,008 430
-------- --------
Total current assets ...................................................... 34,966 20,273
Property and equipment, net ................................................... 1,297 1,722
Patents and other intangibles, net of accumulated amortization of $1,034
and $796 as of December 31, 1998 and 1997, respectively ..................... 1,526 1,098
Long-term marketable investment securities .................................... 18,795 1,763
Other assets .................................................................. 8,910 4,000
-------- --------
$ 65,494 $ 28,856
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................................ $ 803 $ 919
Accrued expenses ............................................................ 2,691 2,190
Deferred revenue ............................................................ 1,207 944
Income taxes payable ........................................................ 680 846
Current portion of capital lease obligations ................................ 112 108
-------- --------
Total current liabilities ................................................. 5,493 5,007
Capital lease obligations, net of current portion ............................. 76 188
Deferred tax liabilities ...................................................... 383 84
-------- --------
5,952 5,279
-------- --------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, 5,000,000 shares authorized;
none issued ............................................................... -- --
Common stock, $.001 par value; 100,000,000 shares authorized as of
December 31, 1998 and 1997; 8,802,570 and 7,215,195 shares issued
and outstanding as of December 31, 1998 and 1997, respectively ............ 9 7
Additional paid-in capital .................................................. 52,617 23,277
Stockholder notes receivable ................................................ (78) (131)
Deferred stock compensation ................................................. -- (96)
Accumulated other comprehensive losses ...................................... (82) (214)
Retained earnings ........................................................... 7,076 734
-------- --------
Total stockholders' equity ............................................ 59,542 23,577
-------- --------
$ 65,494 $ 28,856
======== ========
</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,
-------------------------------------
1998 1997
----------- -----------
<S> <C> <C>
Net revenues ............................................ $ 24,434 $ 20,340
----------- -----------
Costs and expenses:
Cost of revenues ...................................... 2,081 2,422
Research and development .............................. 2,578 2,248
Selling and marketing ................................. 5,985 5,765
General and administrative ............................ 4,621 4,149
----------- -----------
Total costs and expenses ........................ 15,265 14,584
----------- -----------
Operating income ........................................ 9,169 5,756
Interest and other income (expense), net ................ 1,102 478
----------- -----------
Income before income taxes ...................... 10,271 6,234
Income taxes ............................................ 3,929 2,413
----------- -----------
Net income ...................................... $ 6,342 $ 3,821
=========== ===========
Computation of basic and diluted earnings per share:
Net income ............................................ $ 6,342 $ 3,821
Preferred stock dividends ............................. -- (156)
----------- -----------
Earnings applicable to common stock ................... $ 6,342 $ 3,665
=========== ===========
Basic earnings per share ................................ $ .79 $ .57
=========== ===========
Shares used in computing basic earnings per share ....... 8,004,000 6,476,000
=========== ===========
Diluted earnings per share .............................. $ .74 $ .53
----------- -----------
Shares used in computing diluted earnings per share ..... 8,553,000 6,960,000
=========== ===========
</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>
Additional
Preferred stock Common stock paid-in
Shares Amount Shares Amount capital
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balances as of December 31, 1996 .............. 1,376,432 $ 1 3,951,759 $ 4 $ 9,530
----------- ----------- ----------- ----------- -----------
Comprehensive income
Net income ...................................
Other comprehensive income
Translation adjustment .....................
Unrealized gain (loss) in investments, net .
Total comprehensive income ...................
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 ....... -- -- -- -- --
Amortization of deferred stock compensation .. -- -- -- -- --
Tax benefit associated with stock plans ...... -- -- -- -- 138
----------- ----------- ----------- ----------- -----------
Balances as of December 31, 1997 .............. -- -- 7,215,195 7 23,277
----------- ----------- ----------- ----------- -----------
Comprehensive income
Net income ..................................
Other comprehensive income
Translation adjustment .....................
Unrealized gain (loss) in investments, net .
Total comprehensive income ...................
Issuance of common stock in secondary public
offering, net of issuance costs of $438 ..... -- -- 1,365,000 2 27,870
Issuance of common stock upon exercise of
options ..................................... -- -- 185,336 -- 561
Issuance of common stock under stock
purchase plan ............................... -- -- 37,039 -- 292
Payment on stockholder note receivable ....... -- -- -- -- --
Amortization of deferred stock compensation .. -- -- -- -- --
Tax benefit associated with stock plans ...... -- -- -- -- 617
----------- ----------- ----------- ----------- -----------
Balances as of December 31, 1998 .............. -- $ -- 8,802,570 $ 9 $ 52,617
=========== =========== =========== =========== ===========
<CAPTION>
Accumulated (Accumulated
Stockholder Deferred other deficit) Total
notes stock comprehensive retained stockholders'
receivable compensation loss earnings equity
----------- ------------ ------------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Balances as of December 31, 1996 .............. $ (157) $ (240) $ (135) $ (2,931) $ 6,072
----------- ----------- ----------- ----------- -----------
Comprehensive income
Net income ................................... -- 3,821 3,821
Other comprehensive income
Translation adjustment ..................... (83) (83)
Unrealized gain (loss) in investments, net . 4 4
----------- -----------
Total comprehensive income ................... (79) 3,742
----------- -----------
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 -- -- -- 26
Amortization of deferred stock compensation .. -- 144 -- -- 144
Tax benefit associated with stock plans ...... -- -- -- -- 138
----------- ----------- ----------- ----------- -----------
Balances as of December 31, 1997 .............. (131) (96) (214) 734 23,577
----------- ----------- ----------- ----------- -----------
Comprehensive income
Net income .................................. -- 6,342 6,342
Other comprehensive income
Translation adjustment ..................... (12) (12)
Unrealized gain (loss) in investments, net . 144 144
----------- -----------
Total comprehensive income ................... 132 6,474
----------- -----------
Issuance of common stock in secondary public
offering, net of issuance costs of $438 ..... -- -- -- -- 27,872
Issuance of common stock upon exercise of
options ..................................... -- -- -- -- 561
Issuance of common stock under stock
purchase plan ............................... -- -- -- -- 292
Payment on stockholder note receivable ....... 53 -- -- -- 53
Amortization of deferred stock compensation .. -- 96 -- -- 96
Tax benefit associated with stock plans ...... -- -- -- -- 617
----------- ----------- ----------- ----------- -----------
Balances as of December 31, 1998 .............. $ (78) $ -- $ (82) $ 7,076 $ 59,542
=========== =========== =========== =========== ===========
</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,
-----------------------
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income ....................................................... $ 6,342 $ 3,821
Adjustments to reconcile net income to net cash provided by
continuing operations:
Depreciation and amortization ................................ 931 1,156
Amortization of prepaid future royalties to C-Dilla Limited .. 143 --
Deferred income taxes ........................................ (34) (683)
Amortization of deferred stock compensation .................. 96 144
Loss on disposal of fixed assets ............................. 17 105
Tax benefit from employee stock benefit plans ................ 617 138
Change in provision for accounts and notes receivable ........ 123 467
Changes in operating assets and liabilities:
Accounts receivable, inventories, and other current assets . (958) (2,408)
Accounts payable, accrued liabilities, deferred revenue, and
income taxes payable ..................................... 482 (221)
Other ...................................................... (12) (83)
-------- --------
Net cash provided by operating activities ................ 7,747 2,436
-------- --------
Cash flows from investing activities:
Purchases of long-term marketable investment securities ............ (19,495) (1,763)
Purchases of short-term investments .............................. (56,527) (51,737)
Sales or maturities of long-term marketable investments .......... 2,541 --
Sales or maturities of short-term investments .................... 44,957 40,500
Acquisition of property and equipment ............................ (285) (571)
Payments for patents and other intangibles ....................... (666) (332)
Proceeds from related party receivable ........................... 310 --
Investment in C-Dilla Limited, Command Audio Corporation and
Digimarc Corporation ........................................... (4,053) (3,480)
Prepaid future royalties to C-Dilla Limited ...................... (1,015) --
Other, net ....................................................... 15 (67)
-------- --------
Net cash used in investing activities .................... (34,218) (17,450)
-------- --------
Cash flows from financing activities:
Payments on capital lease obligations ............................ (108) (105)
Proceeds from issuance of common stock upon exercise of options .. 561 288
Proceeds from issuance of common stock under employee stock
purchase plan .................................................. 292 89
Payment of stockholder note receivable ........................... 53 26
Proceeds from sale of common stock, net of issuance costs and
payments of deferred offering costs ............................ 27,872 13,777
Cash dividends ................................................... -- (156)
-------- --------
Net cash provided by financing activities ................ 28,670 13,919
-------- --------
Net (decrease) increase in cash and cash equivalents ............... 2,199 (1,095)
Cash and cash equivalents at beginning of year ..................... 1,314 2,409
-------- --------
Cash and cash equivalents at end of year ........................... $ 3,513 $ 1,314
======== ========
Cash paid during the year:
Interest ......................................................... $ 11 $ 12
======== ========
Income taxes ..................................................... $ 3,209 $ 2,364
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(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 that are stored on videocassettes, DVDs or other media or are
transmitted by means of cable, satellite or microwave transmission. During 1998
the Company broadened its focus to include the copy protection of other media,
including multimedia computer software on CD-ROMs. 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
certain 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 long-term marketable 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, 1998 and 1997, 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, reported in comprehensive income, a separate component of 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):
December 31,
------------------
1998 1997
------- -------
Cash equivalents-- money market funds .................... $ 3,098 $ 622
------- -------
Investments:
Auction rate preferred stock certificates .............. -- 3,400
Municipal preferred certificates ....................... 1,000 --
United States government bonds and agency securities ... 40,672 9,604
------- -------
41,672 13,004
------- -------
$44,770 $13,626
======= =======
As of December 31, 1998 and 1997, government bond securities totaling $18.8
million and $1.8 million, respectively, are classified as long-term marketable
investment securities in the accompanying consolidated balance sheet.
As of December 31, 1998 and 1997, the difference between the fair value and
the amortized cost of available-for-sale securities was $148,000 and $4,000,
respectively. These unrealized gains related to short-term and long-term
F-7
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997
(1) The Company and Summary of Significant Accounting Policies (continued)
government bonds which have been recorded as a component in comprehensive
income. As of December 31, 1998 and 1997, the weighted average portfolio
duration and contractual maturity was approximately ten months and six months,
respectively.
Inventories
Inventories are stated at the lower of first-in, first-out cost basis or
market.
Property and Equipment
Property and equipment, including significant improvements, are recorded 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 $1.4 million and $868,000 as of December 31,
1998 and 1997, 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.
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 C-Dilla, Limited ("C-Dilla") a
developer of copy protection technology for CD-ROM and Internet-delivered
software products, 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 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. Included in other assets is $872,000 related to prepaid
royalties paid to C-Dilla subject to offset against future royalties from sales
of products incorporating C-Dilla's technology. 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") and
CD-ROMs 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 pricing adjustments or return provisions are
accrued based upon anticipated respective unit volumes. 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 or transaction based fees. Revenues from the sales of
encoders, decoders, and systems incorporating the Company's
F-8
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997
(1) The Company and Summary of Significant Accounting Policies (continued)
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 and
replicators utilized by customers of the Company's video copy protection
technology. The Company has agreed to pay these duplicators and replicators a
specified service fee per unit duplicated/replicated 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.
These service fees amounted to $428,000 and $362,000, for 1998 and 1997,
respectively.
Cost of revenues includes outside legal costs of $227,000 and $70,000 in
1998 and 1997, respectively, associated with litigation to enforce the Company's
patents. Amortization of patents is also included in cost of revenues.
In February 1998, the Company entered into an exclusive worldwide Software
Marketing License and Development Agreement with C-Dilla to market, in the
consumer multimedia software market, C-Dilla's proprietary copy protection
technology. Pursuant to the agreement, the Company will pay royalty payments to
C-Dilla of between 30% to 45% of revenues from sales of software products
incorporating C-Dilla's technology. These royalty amounts are charged to cost of
revenues when incurred and were approximately $191,000 for 1998.
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 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 United States 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
comprehensive income, a separate component of 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.
Comprehensive Income
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 primary components of other
comprehensive income include unrealized gains and
F-9
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997
(1) The Company and Summary of Significant Accounting Policies (continued)
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.
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, CD-ROM copy protection and video scrambling technologies to
customers in the home videocassette, DVD, pay-per-view, cable, satellite,
corporate communication markets and multimedia software markets primarily in the
United States, Europe, Japan, and the Far East. In 1998, 45.1% of the Company's
business is attributed to the licensing of its video copy protection technology
through Motion Picture Association of America ("MPAA") movie studios.
Accordingly, the ability of the Company to grow its operations has been
dependent on MPAA movie studios continued success in the production and
distribution of movies utilizing the companies technology. 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. The Company licenses its
CD-ROM copy protection to publishers of software in the multimedia software
markets. In addition, 44.5% and 46.5% of the Company's sales in 1998 and 1997,
respectively, are from export or foreign operations. The Company's business has
been and may continue to be negatively impacted by foreign economic conditions
such as the Southeast Asian and Latin American economic problems.
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 C-Dilla and Digimarc. CAC is also held at fair market
value, due to recency of additional rounds of financing.
The Company performs ongoing credit evaluations of its customers. Revenue
from one customer accounted for 12% of net revenue for the year ended December
31, 1998. Another customer accounted for 11% of net revenue for the year ended
December 31, 1997. At December 31, 1998 and 1997 receivables from one customer
represented 16% and 25%, respectively, of net accounts receivable.
F-10
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997
(1) The Company and Summary of Significant Accounting Policies (continued)
Net Income Per Share
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. In
1997, 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):
December 31,
---------------
1998 1997
----- -----
Basic EPS -- weighted average number of common
shares outstanding ....................................... 8,004 6,476
Effect of dilutive common equivalent shares-- stock
options outstanding ...................................... 549 484
----- -----
Diluted EPS -- weighted average number of common
shares and common equivalents shares outstanding ......... 8,553 6,960
===== =====
Stock Based Compensation
The Company uses the intrinsic value-based method to account for all of its
employee stock-based compensation plans.
Recent Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP No. 98-1
requires that entities capitalize certain cost related to internal-use software
once certain criteria have been met. The Company expects that the adoption of
SOP No. 98.1 will have no material impact on its financial position, results of
operations or cash flows. The Company will be required to implement SOP No. 98-1
for the year ending December 31, 1999.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-Up Activities." SOP No. 98-5 requires that all start-up costs related to
new operations must be expensed as incurred. In addition, all start-up costs
that were capitalized in the past must be written off when SOP No. 98-5 is
adopted. The Company expects that the adoption of SOP No. 98-5 will have no
material impact on its financial position, results of operations or cash flows.
The Company will be required to implement SOP No. 98-5 for the year ending
December 31, 1999.
In June 1998 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 established methods of
accounting for derivative financial instruments and hedging activities related
to those instruments as well as other hedging activities. Because the Company
currently holds no derivative instruments and does not engage in hedging
activities, the Company expects that the adoption of SFAS No. 133 will have no
material impact on its financial position, results of operations or cash flows.
The Company will be required to implement SFAS No. 133 for the year ending
December 31, 2000.
In December 1998, the AICPA issued SOP No. 98-9, "Modification of SOP No.
97-2, Software Revenue Recognition, with Respect to Certain Transactions." SOP
No. 98-9 requires recognition of revenue using the "residual method" in a
multiple element software arrangement when fair value does not exist for one or
more of the delivered elements in the arrangement. Under the "residual method,"
the total fair value of the undelivered elements is deferred and recognized in
accordance with SOP No. 97-2. The Company will be required to
F-11
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997
implement SOP No. 98-9 for the year ending December 31, 2000. SOP No. 98-9 also
extends the deferral of the application of SOP No. 97-2 to certain other
multiple-element software arrangements through the Company's year ending
December 31, 1999. The Company is evaluating the provisions of SOP 98-9 and the
impact it will have on its financial position, results of operations or cash
flows.
(2) Financial Statement Details
Inventories
Inventories consisted of the following (in thousands):
December 31,
-------------------
1998 1997
---- ----
Raw materials .................... $138 $203
Finished goods ................... 187 230
---- ----
$325 $433
==== ====
Property and Equipment, Net
Property and equipment consisted of the following (in thousands):
December 31,
---------------
1998 1997
------ ------
Machinery and equipment ...................... $2,968 $3,263
Leasehold improvements ....................... 950 950
Furniture and fixtures ....................... 444 438
------ ------
4,362 4,651
Less accumulated depreciation and amortization 3,065 2,929
------ ------
$1,297 $1,722
====== ======
Equipment recorded under capital leases aggregated $518,000 with related
accumulated amortization of $337,000 and $233,000 as of December 31, 1998 and
1997, respectively.
Other Assets
Other assets consisted of the following (in thousands):
December 31,
-----------------
1998 1997
------ ------
Investment in CAC ........................ $2,837 $2,337
Investment in Digimarc ................... 1,500 1,500
Investment in C-Dilla .................... 3,553 --
Prepayment of royalties to C-Dilla ....... 872 --
Deposits and other assets ................ 148 163
------ ------
$8,910 $4,000
====== ======
In February 1998, Macrovision acquired 247,500 shares (approximately 19.8%)
of the common stock of C-Dilla, a UK company, for a purchase price of $3.6
million. 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. The Company
paid $1.0 million in up-front royalties 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
F-12
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997
(2) Financial Statement Details(continued)
C-Dilla's technology. During 1998, the Company recorded revenue under this
agreement of $344,000 and cost of sales of $230,000 of which $143,000 offset the
prepayment of royalties to C-Dilla.
In 1998, the Company invested $500,000 in CAC in connection with a round of
external third-party financing obtained by CAC. This investment by Macrovision
was less than 19.8% of the total investment financing made and thus reduced
Macrovision's previous 19.8% ownership of CAC to 11.9%. Subsequently, CAC paid
in full the note due Macrovision including accrued interest.
In December 1997, the Company invested $1.5 million in preferred stock of
Digimarc, 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):
December 31,
----------------
1998 1997
------ ------
Accrued compensation .............. $1,810 $1,142
Accrued professional fees ......... 308 409
Accrued rebates ................... -- 30
Other accrued liabilities ......... 573 609
------ ------
$2,691 $2,190
====== ======
Interest and Other Income (Expense), Net
Interest and other income (expense), net, consisted of the following (in
thousands):
Year ended December 31,
-----------------------
1998 1997
-------- --------
Interest income ............... $ 1,062 $ 513
Interest expense .............. (11) (12)
Other ......................... 51 (23)
------- -------
$ 1,102 $ 478
======= =======
Supplemental Cash Flow Information
Supplemental cash flow information related to noncash investing and
financing activities is as follows (in thousands):
Year ended December 31,
----------------------
1998 1997
---- ------
Conversion of preferred stock into common stock ....... $ -- $7,433
==== ======
(3) 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
F-13
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997
(3) Transactions with Related Parties (continued)
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, 1998 and
1997, the Company recorded revenue from JVC of approximately $211,000 and
$234,000, respectively, and recorded expenses payable to JVC of approximately
$36,000 and $22,000, respectively under these agreements.
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 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 Technology 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 $6,000 and $59,000 during the year ended December 31, 1998 and
1997, respectively.
In 1998, the Company entered into a Copy Protection Technology Application
and Duplicator Agreement with JVC and a third party duplicator by which JVC
agrees to pay all fees to Macrovision on behalf of the duplicator. 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 has recorded no
revenue pursuant to this contract.
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 this
agreement are not more favorable to Matsushita or its subsidiaries than the
terms offered to other unrelated parties. The Company recorded revenues from
Matsushita of approximately $148,000 and $111,000 during the years ended
December 31, 1998 and 1997, respectively.
In 1998, the Company entered into agreements with Matsushita including an
Authoring and Replicator Agreement and a DVD Copy Protection Technology
Application Agreement. The terms and conditions of such agreements are not more
favorable to Matsushita or its subsidiaries than the terms offered to other
unrelated parties. The Company has recorded no revenue and paid no service fees
pursuant to these contracts.
In February, 1998, the Company entered into a Software Marketing License
and Development Agreement with C-Dilla 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. In February, 1998, C-Dilla also agreed to reimburse the Company for
specific marketing related expenses up to $500,000. As of December 31, 1998 the
Company had received the full amount reimbursable, under the co-marketing
agreement with C-Dilla.
F-14
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997
(4) 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 converted into the Company's common
stock on a one-for-one basis in connection with its 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 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, 1998, there
were 29,167 shares subject to the repurchase right and the remaining principal
of the note was $78,000.
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 1,272,222 shares of common stock for issuance. In May 1998, an
additional 400,000 shares were reserved by approval of the Board of
F-15
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997
(4) Stockholders' Equity (continued)
Directors and stockholders. 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. During 1998, no stock options were granted to
consultants, independent contractors or 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 1998 and 1997, the Company issued 37,039 and 11,646
shares, respectively, pursuant to the Purchase Plan.
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 1998 and 1997,
the Company granted options to purchase 9,000 and 15,000 shares, respectively,
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,
-------------------------
1998 1997
------- -------
<S> <C> <C> <C>
Net income As reported ........... $ 6,342 $ 3,821
Adjusted pro forma .... 5,091 3,388
Basic net income per share As reported ........... .79 .57
Adjusted pro forma .... .64 .52
Diluted net income per share As reported ........... .74 .53
Adjusted pro forma .... .59 .46
</TABLE>
F-16
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997
(4) Stockholders' Equity (continued)
The provisions of SFAS No. 123 are effective for options granted beginning
January 1, 1996. Options vest over several years and new options are generally
granted each year. Because of these factors, the pro forma effect shown above
may not be representative of the pro forma effect of SFAS No. 123 in future
years.
The fair value of each option is estimated on the date of grant using the
Black-Scholes method in 1998 and 1997, with the following weighted average
assumptions for options and the ESPP plan:
Year ended December 31,
------------------------
1998 1997
------- ------
Option Plans:
Dividends ............................ None None
Expected term ........................ 4.34 years 4.56 years
Risk free interest rate .............. 6.45% 6.07%
Volatility rate ...................... 66.8% 64.7%
ESPP Plan:
Dividends ............................ None None
Expected term ........................ 1.24 years 1.25 years
Risk free interest rate .............. 5.47% 5.42%
Volatility rate ...................... 62.6% 62.4%
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, 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
Granted ................................... 206,395 17.12
Canceled .................................. (12,772) 12.95
Exercised ................................. (185,336) 3.03
--------
Outstanding as of December 31, 1998 ......... 706,630 8.54
========
</TABLE>
<TABLE>
<CAPTION>
December 31,
-------------------------
1998 1997
------- -------
<S> <C> <C>
Options exercisable at end of year 348,729 379,042
Weighted average fair value of options granted
during the period $ 10.00 $ 6.87
</TABLE>
The following table summarizes information about fixed stock options
outstanding as of December 31, 1998:
<TABLE>
<CAPTION>
Outstanding Exercisable
--------------------------------------------- ---------------------------
Weighted
average Weighted Weighted
Range of Number remaining average Number average
exercise prices of shares contractual life exercise price exercisable exercise price
--------------- --------- ---------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$2.70 - 2.70 354,617 5.93 years $ 2.70 314,486 $ 2.70
$7.20 - 15.00 314,113 8.77 13.05 33,057 10.34
$20.00 - 27.75 37,900 9.68 25.88 1,186 21.35
------- -------
706,630 7.39 8.54 348,729 3.49
======= =======
</TABLE>
F-17
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997
(5) Income Taxes
Income taxes consisted of the following (in thousands):
December 31,
------------------
1998 1997
------- -------
Current:
Federal ......................................... $ 2,119 $ 2,031
Foreign ......................................... 354 383
State ........................................... 873 544
------- -------
Total current ................................. 3,346 2,958
------- -------
Deferred:
Federal ......................................... (34) (554)
State ........................................... -- (129)
------- -------
Total deferred ................................ (34) (683)
------- -------
Charges in lieu of income taxes associated with the
exercise of stock options ....................... 617 138
------- -------
$ 3,929 $ 2,413
======= =======
The Company's effective tax rate differs from the statutory federal tax
rate as follows (in thousands):
Year ended December 31,
-----------------------
1998 1997
------- -------
Computed "expected" tax expense .......... $ 3,492 $ 2,120
State tax expenses, net of federal benefit 576 274
Tax credits .............................. (304) (87)
Foreign taxes ............................ 192 47
Exempt interest .......................... (320) (144)
Other .................................... 293 203
------- -------
$ 3,929 $ 2,413
======= =======
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):
December 31,
-------------------------
1998 1997
------ ------
Deferred tax assets:
Accrued liabilities and reserves ....... $ 826 $ 673
Allowance for doubtful accounts ........ 341 272
Depreciation and amortization .......... 483 707
Deferred revenue ....................... 502 382
------ ------
Total gross deferred tax assets ...... 2,152 2,034
Deferred tax liabilities:
Patents ................................ 866 782
------ ------
Net deferred tax assets .............. $1,286 $1,252
====== ======
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.
F-18
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997
(6) 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.
Future minimum lease payments pursuant to these leases as of December 31,
1998, were as follows (in thousands):
Capital Operating
lease leases
------- ---------
1999 $ 116 $ 507
2000 78 505
2001 -- 519
2002 -- 307
2003 and thereafter -- 154
------ ------
Total $ 194 $1,992
====== ======
Less amounts representing interest 6
------
Present value of minimum capital lease payments 188
Less current portion of capital lease liability 112
------
Capital lease liability, net of current portion $ 76
======
Rent expense was $501,000 and $469,000 as of December 31, 1998 and 1997,
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 $10,000 in
1998. 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 $2,000 and $1,900 in 1998 and 1997, respectively.
Matching contributions aggregated $60,000 and $54,000 for the year ended
December 31, 1998 and 1997, respectively, and are fully vested after three years
of service.
(7) Segment and Geographic Information
The Company operates in three industry segments as follows: Video Copy
Protection, Video Scrambling and Computer Software Copy Protection. Video Copy
Protection licenses Macrovision's anti-copy video technologies to customers in
the home videocassette, DVD and digital pay-per-view markets. Video Scrambling
licenses and sells products utilizing the Company's PhaseKrypt video scrambling
technology to manufacturer analog set-top decoders for sale to cable television
system operators in developing cable television markets, to television
broadcasters for securing incoming contribution circuits to network control
centers and outbound rebroadcast circuits and to the government, military and
law enforcement agencies for covert surveillance applications. The Computer
Software Copy Protection licenses copy protection technology in the multimedia
software market.
The Company identifies segments based principally upon the type of products
sold. The accounting policies of these reportable segments are the same as those
described in the consolidated entity. The Company evaluates the performance of
its segments based on revenue and segment income. In addition, as the Company's
assets are primarily located in its corporate office in the United States and
not allocated to any specific segment, the Company does not produce reports for
or measure the performance of its segments based on any asset-based metrics.
Therefore, segment information is presented only for revenue and segment income.
F-19
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997
(7) Segment and Geographic Information (continued)
The following segment reporting information of the Company is provided
(dollars in thousands):
Year ended December 31,
-----------------------
1998 1997
-------- --------
Revenue:
Video Copy Protection ............................ $ 22,626 $ 17,412
Video Scrambling ................................. 1,464 2,739
Computer Software Copy Protection ................ 344 --
Other ............................................ -- 189
-------- --------
Total ............................................ $ 24,434 $ 20,340
======== ========
Year ended December 31,
-----------------------
1998 1997
-------- --------
Operating Income:
Video Copy Protection ............................ $ 17,115 $ 12,509
Video Scrambling ................................. (504) 309
Computer Software Copy Protection ................ (126) --
Other ............................................ (117) (665)
-------- --------
Segment income ................................. 16,368 12,153
Research and development ......................... 2,578 2,248
General and administrative ....................... 4,621 4,149
-------- --------
Operating income ............................... 9,169 5,756
Interest and other income (expense), net ......... 1,102 478
-------- --------
Income before taxes ............................ $ 10,271 $ 6,234
======== ========
Year ended December 31,
-----------------------
1998 1997
-------- --------
Depreciation and Amortization:
Video Copy Protection ............................ $ 311 $ 451
Video Scrambling ................................. 221 281
Computer Software Copy Protection ................ 13 --
Other ............................................ -- 73
Research and development ......................... 206 169
General and administrative ....................... 180 182
-------- --------
Total ............................................ $ 931 $ 1,156
======== ========
Year ended December 31,
-----------------------
1998 1997
-------- --------
Information on Revenue by Significant Product Group:
Video Copy Protection:
Videocassette .................................. $ 15,770 $ 12,616
DVD ............................................ 3,096 1,084
Pay-Per-View ................................... 3,760 3,712
Video Scrambling:
Video Scrambling Systems ....................... 477 756
Components & Licensing ......................... 987 1,983
Computer Software Copy Protection ................ 344 --
Other ............................................ -- 189
-------- --------
Total ............................................ $ 24,434 $ 20,340
======== ========
F-20
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997
(7) Segment and Geographic Information (continued)
Year ended December 31,
-----------------------
1998 1997
------- -------
Information on Revenue by Geographic Areas:
United States ................................... $13,563 $10,878
Japan ........................................... 2,738 2,181
Export & Foreign Operations ..................... 8,133 7,281
------- -------
Total Revenue ................................... $24,434 $20,340
======= =======
Geographic area information is based upon country of destination for
products shipped and country of contract holder for royalties and license fees.
Both the United States and Japan account for over 10% of the Company's revenues
in both 1998 or 1997. Revenue from one customer of the Video Copy Protection
accounted for 12% of net revenue for the year ended December 31, 1998. Another
customer of the Video Copy Protection accounted for 11% of net revenue for the
year ended December 31, 1997. At December 31, 1998 and 1997 receivables from one
customer of the Video Copy Protection represented 16% and 25%, respectively, of
net accounts receivable.
(8) Subsequent Events
In October 1995, Joseph Swyt, one of the Company's former officers and
directors, 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 our 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 Macrovision
in June 1995. In December 1996, the court ordered this matter to binding
arbitration in accordance with a written agreement between Mr. Swyt and
Macrovision. 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 were completed in February
1999. On March 16, 1999, a decision in favor of the Company was rendered by a
majority of the arbitrators in the Swyt litigation, finding that we had no
liability to Mr. Swyt on any of his claims and that his claims were without
merit. The Company is seeking and expects to have the arbitrators decision
confirmed by the Superior Court.
Exhibit 23.01
Consent of Independent Auditors
The Board of Directors
Macrovision
We consent to incorporation by reference in the registration statements
(Nos. 333-2313 and 333-60499) on Form S-8 of Macrovision Corporation of our
report dated February 1, 1999, except as to Note 8, which is as of March 16,
1999, relating to the consolidated balance sheets of Macrovision Corporation and
subsidiaries as of December 31, 1998 and 1997, and the related consolidated
statements of income, stockholders' equity, and cash flows for the years then
ended, which report appears in the December 31, 1998, annual report of Form
10-KSB of Macrovision Corporation.
/s/ KPMG LLP
Mountain View, California
March 29, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Financial Statements of Macrovision Corporation for the twelve months ended
December 31, 1998, and is qualified in its entirety by reference to such
Financial Statements.
(In thousands, except per share data)
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-Mos
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 3,513
<SECURITIES> 22,877
<RECEIVABLES> 6,412
<ALLOWANCES> 838
<INVENTORY> 325
<CURRENT-ASSETS> 34,966
<PP&E> 4,362
<DEPRECIATION> 3,065
<TOTAL-ASSETS> 65,494
<CURRENT-LIABILITIES> 5,493
<BONDS> 0
0
0
<COMMON> 9
<OTHER-SE> 59,533
<TOTAL-LIABILITY-AND-EQUITY> 65,494
<SALES> 24,434
<TOTAL-REVENUES> 24,434
<CGS> 2,081
<TOTAL-COSTS> 2,081
<OTHER-EXPENSES> 13,184
<LOSS-PROVISION> 193
<INTEREST-EXPENSE> 11
<INCOME-PRETAX> 10,271
<INCOME-TAX> 3,929
<INCOME-CONTINUING> 6,342
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,342
<EPS-PRIMARY> .79
<EPS-DILUTED> .74
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schecdule 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.
(In thousands, except per share data)
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 1,314
<SECURITIES> 11,241
<RECEIVABLES> 5,924
<ALLOWANCES> 684
<INVENTORY> 433
<CURRENT-ASSETS> 20,273
<PP&E> 4,651
<DEPRECIATION> 2,929
<TOTAL-ASSETS> 28,856
<CURRENT-LIABILITIES> 5,007
<BONDS> 0
0
0
<COMMON> 7
<OTHER-SE> 23,570
<TOTAL-LIABILITY-AND-EQUITY> 28,856
<SALES> 20,340
<TOTAL-REVENUES> 20,340
<CGS> 2,422
<TOTAL-COSTS> 2,422
<OTHER-EXPENSES> 12,162
<LOSS-PROVISION> 553
<INTEREST-EXPENSE> 12
<INCOME-PRETAX> 6,234
<INCOME-TAX> 2,413
<INCOME-CONTINUING> 3,821
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,821
<EPS-PRIMARY> .57
<EPS-DILUTED> .53
</TABLE>