FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|x| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 000-22023
Macrovision Corporation
(Exact name of registrant as specified in its charter)
Delaware 77-0156161
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1341 Orleans Drive
Sunnyvale, California 94089
(Address of principal executive offices) (Zip code)
(408) 743-8600
(Registrant's telephone number including area code)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes _X_ No ___
State the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Title Outstanding as of July 30, 1999
Common Stock, $0.001 par value 9,121,251
<PAGE>
MACROVISION CORPORATION
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
Page
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<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets
as of June 30, 1999 and December 31, 1998 ....................................... 3
Condensed Consolidated Statements of Operations
for the Three Month Periods Ended June 30, 1999 and 1998, and
the Nine Month Periods Ended June 30, 1999 and 1998 ............................. 4
Condensed Consolidated Statements of Cash Flows
for the Six Month Periods Ended June 30, 1999 and 1998........................... 5
Notes to Condensed Consolidated Financial Statements................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations ......................................................................... 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk............................. 17
Risk Factors........................................................................... 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................................................... 26
Item 2. Changes in Securities.................................................................. 26
Item 4 Submission of Matters to a Vote of Security Holders.................................... 26
Item 5. Other Information ..................................................................... 27
Item 6. Exhibits and Reports on Form 8-K ...................................................... 27
Signatures ...................................................................................... 28
</TABLE>
2
<PAGE>
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements.
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
June 30,
1999 December 31,
(Unaudited) 1998
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 6,327 $ 3,513
Short-term investments 9,635 22,877
Accounts receivable, less allowance for doubtful
accounts of $967 and $838 7,505 5,574
Inventories 170 325
Deferred tax assets 1,743 1,669
Prepaid expenses and other assets 1,212 1,008
------------ ------------
Total current assets 26,592 34,966
Property and equipment, net 1,788 1,297
Patents and other intangibles, net 1,638 1,526
Long-term marketable investment securities 18,924 18,795
Intangibles associated with C-Dilla Ltd acquisition, net 16,294 --
Other assets 7,802 8,910
------------ ------------
$ 73,038 $ 65,494
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities:
Accounts payable $ 1,197 $ 803
Accrued expenses 3,290 2,691
Deferred revenue 1,627 1,207
Income taxes payable -- 680
Note payable 235 --
Current portion of capital lease obligation 113 112
------------ ------------
Total current liabilities 6,462 5,493
Capital lease obligation, net of current portion 19 76
Deferred tax liabilities -- 383
------------ ------------
6,481 5,952
Stockholders' equity:
Common stock 9 9
Additional paid-in capital 58,466 52,617
Stockholder's note receivable -- (78)
Accumulated other comprehensive loss (252) (82)
Retained earnings 8,334 7,076
------------ ------------
Total stockholders' equity 66,557 59,542
------------ ------------
$ 73,038 $ 65,494
============ ============
</TABLE>
See the accompanying notes to these condensed consolidated financial statements.
3
<PAGE>
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- --------------------
1999 1998 1999 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net revenues $ 8,057 $ 5,665 $15,220 $10,843
------- ------- ------- -------
Costs and expenses:
Cost of revenues 768 449 1,439 847
Research and development 1,108 654 1,739 1,277
Selling and marketing 2,064 1,487 3,946 3,013
General and administrative 1,196 1,128 2,577 2,287
Amortization of intangibles from acquisition 109 -- 109 --
In process research and development 4,286 -- 4,286 --
------- ------- ------- -------
Total costs and expenses 9,531 3,718 14,096 7,424
------- ------- ------- -------
Operating (loss) income (1,474) 1,947 1,124 3,419
Interest and other income, net 405 172 823 303
------- ------- ------- -------
(Loss) income before income taxes (1,069) 2,119 1,947 3,722
Income taxes (benefit) (469) 805 689 1,414
------- ------- ------- -------
Net (loss) income $ (600) $ 1,314 $ 1,258 $ 2,308
======= ======= ======= =======
Computation of basic and diluted earnings per share:
Basic (loss) earnings per share $ (.07) $ .18 $ .14 $ .32
======= ======= ======= =======
Shares used in computing basic (loss) earnings per share 8,975 7,300 8,931 7,272
======= ======= ======= =======
Diluted (loss) earnings per share $ (.07) $ .17 $ .13 $ .30
======= ======= ======= =======
Shares used in computing diluted (loss) earnings per share 8,975 7,838 9,390 7,787
======= ======= ======= =======
</TABLE>
See the accompanying notes to these condensed consolidated financial statements.
4
<PAGE>
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended June 30,
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,258 $ 2,308
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 618 486
Amortization of prepaid future royalties to C-Dilla Limited 166 --
Deferred income taxes (368) 363
Amortization of deferred stock compensation -- 71
In process research and development 4,286 --
Changes in operating assets and liabilities:
Accounts receivable, inventories, and other current assets (1,673) 319
Accounts payable, accrued expenses, deferred revenue
and income taxes payable (684) (113)
Other (2) (47)
------------ ------------
Net cash provided by operating activities 3,601 3,387
------------ ------------
Cash flows from investing activities:
Purchases of long-term marketable investment securities (11,698) (3,104)
Sales or maturities of long-term marketable investment securities 11,451 1,011
Purchases of short-term investments (13,246) (4,271)
Sales or maturities of short-term investments 26,440 9,890
Acquisition of property and equipment (315) (138)
Payments for patents and other intangibles (279) (358)
Investment in Digimarc (2,000) --
Investment in C-Dilla Limited -- (3,553)
Acquisition of C-Dilla Limited, net of cash acquired (11,960) --
Prepaid future royalties to C-Dilla Limited -- (1,015)
Other, net 34 (20)
------------ ------------
Net cash used in investing activities (1,573) (1,558)
------------ ------------
Cash flows from financing activities:
Payments on capital lease obligations (56) (53)
Payments on note payable (12) --
Proceeds from issuance of common stock, net 776 354
Payment of stockholder's note receivable 78 53
Deferred offering costs -- (448)
------------ ------------
Net cash provided by financing activities 786 (94)
------------ ------------
Net increase in cash and cash equivalents 2,814 1,735
Cash and cash equivalents at beginning of period 3,513 1,314
------------ ------------
Cash and cash equivalents at end of period $ 6,327 $ 3,049
============ ============
Supplemental cash flow information and non cash transactions:
Interest paid $ 3 $ 7
============ ============
Income taxes paid $ 2,027 $ 2,063
============ ============
Receivable due from sale of stock $ -- $ 28,310
============ ============
Stock issued for C-Dilla Limited $ 5,073 $ --
============ ============
</TABLE>
See the accompanying notes to these condensed consolidated financial statements.
5
<PAGE>
MACROVISION CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared by Macrovision Corporation (the "Company") in accordance with the rules
and regulations of the Securities and Exchange Commission. Certain information
and footnote disclosures, normally included in financial statements prepared in
accordance with generally accepted accounting principles, have been condensed or
omitted in accordance with such rules and regulations. In the opinion of
management, the accompanying unaudited condensed consolidated financial
statements reflect all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the financial position of the Company,
and its results of operations and cash flows for those periods presented. This
quarterly report on Form 10-Q should be read in conjunction with the audited
financial statements and notes thereto for the year ended December 31, 1998, and
other disclosures, including risk factors, included in the Company's Annual
Report on Form 10-KSB filed on March 30, 1999.
The results of operations for the interim periods presented are not necessarily
indicative of the results expected for the entire year ending December 31, 1999
or any other future interim period, and the Company makes no representations
related thereto.
NOTE 2 - CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Company considers all highly liquid investments with a maturity from the
date of purchase of three months or less to be cash equivalents.
Investments held by the Company are classified as "available-for-sale" and are
carried at fair value based on quoted market prices, with unrealized gains and
losses, if material, reported in stockholders' equity. Such investments
consisting of U.S. government or agency issues with an original maturity beyond
3 months and less than 12 months are classified as short-term investments. All
marketable securities with maturities over one year are classified as long-term
marketable investment securities. Available-for-sale securities are carried at
fair value based on quoted market prices, with unrealized gains and losses, if
material, reported in stockholders' equity. The following is a summary of
available -for-sale securities:
(In thousands) June 30, December 31,
1999 1998
------- -------
Cash equivalents - money market funds $ 3,449 $ 3,098
Investments:
Municipal preferred certificates -- 1,000
United States government bonds and agency
securities 28,559 40,672
------- -------
28,559 41,672
------- -------
$32,008 $44,770
======= =======
Government bond securities totaling $18,924,000 and $18,795,000 as of June 30,
1999 and December 31, 1998, respectively, are classified as long-term marketable
investment securities.
The difference between the fair value and the amortized cost of
available-for-sale securities was a loss of $18,000 and a gain of $148,000 as of
June 30, 1999 and December 31, 1998, respectively, which has been recorded under
"Accumulated other comprehensive loss" as a component in stockholders' equity.
NOTE 3 - EXERCISE OF OPTIONS AND DIRECTOR FEES
During the quarter ended June 30, 1999, the Company issued 58,232 shares of
common stock and received proceeds of approximately $224,000 associated with the
exercise of stock options. Also during the quarter ended
6
<PAGE>
June 30, 1999, the Company issued 500 shares to three members of the Board of
Directors in lieu of fees amounting to $24,938.
NOTE 4 - INVENTORIES
Inventories are stated at the lower of first-in, first-out cost or market and
consisted of the following:
June 30, December 31,
(In thousands) 1999 1998
---- ----
Raw materials $ 65 $138
Work in process 10 --
Finished goods 95 187
---- ----
$170 $325
==== ====
NOTE 5 - OTHER ASSETS
The Company intends to hold its investments for the long term and monitors
whether there has been an other than a temporary decline in the value of these
investments based on management's estimates of their net realizable value taking
into account the achievement of milestones in business plans and third-party
financing. The Company records its investments using the cost method, and such
investments are classified as other assets in the accompanying condensed
consolidated balance sheets as follows:
(In thousands)
June 30, December 31,
1999 1998
------ ------
Investment in CAC $2,837 $2,837
Investment in Digimarc 3,500 1,500
Investment in C-Dilla -- 3,553
Prepayment of royalties to C-Dilla -- 872
Long term deferred tax assets 1,351 --
Deposits and other assets 114 148
------ ------
$7,802 $8,910
====== ======
On June 18, 1999, the Company acquired the remaining shares of C-Dilla Limited
of Woodley, UK, developers of copy protection and rights management technologies
for CD-ROM and internet-delivered software products. The Company paid
approximately $12,327,000 in cash and 109,199 shares of Macrovision stock. The
Company's previous minority investment was included as a component of the
purchase price. During the quarter, the Company also invested an additional
$2,000,000 in Digimarc in connection with a third-party financing obtained by
Digimarc.
7
<PAGE>
NOTE 6 - ACQUISITIONS
In June 1999, the Company acquired the remaining shares of C-Dilla Limited of
Woodley, UK, developers of copy protection and rights management technologies
for CD-ROM and internet-delivered software products. The Company paid
approximately $12,810,000 in cash and acquisition costs and 109,199 shares of
Macrovision stock valued at $5,073,000. The transaction has been accounted for
under the purchase method. The excess purchase price over the net tangible
assets acquired was $20,689,000 of which, based on management's estimates
prepared in conjunction with a third party valuation consultant was allocated as
follows:
(In thousands)
In-process research and development $ 4,286
Developed technology 3,824
Core technology 7,844
Acquired workforce 497
Covenant not to compete 1,788
Goodwill 2,450
----------------
$ 20,689
================
In connection with the purchase of C-Dilla Ltd., we allocated $4,286,000 of the
$21,437,000 total purchase price to in-process research and development
projects. Accordingly, this non-recurring charge for in-process research and
development, net of income taxes, reduced basic earnings per share by
approximately $.31 in the second quarter of 1999. This preliminary allocation
represents the estimated fair value based on risk-adjusted cash flows related to
the incomplete research and development projects. At the date of the
acquisition, this amount was expensed as a non-recurring charge as the
in-process technology had not yet reached technological feasibility and had no
alternative future uses. C-Dilla Ltd. had five major copy protection projects in
progress at the time of acquisition. These projects include a product which is
being designed to protect DVD-ROMs from unauthorized replication or copying,
three products that are being designed to prohibit the unauthorized copying of
audio products and a product which is being designed to allow DVD manufacturers
to track where any DVD has been manufactured and trace illegal copies. As of the
acquisition date, costs to complete the development of the projects acquired
were expected to be approximately $1.4 million. We currently expect to complete
the development of these projects at various dates through fiscal 2001.
The nature of the efforts required to develop the acquired in-process technology
into commercially viable products principally relate to the completion of all
planning, designing and testing activities necessary to establish that the
product will meet its design requirements including functions, features and
technical performance requirements. Though we currently expect that the acquired
in process technology will be successfully developed, there can be no assurance
that commercial or technical viability of these products will be achieved.
Furthermore, future developments in the computer software industry, changes in
the delivery of audio products, changes in other product offerings or other
developments may cause us to alter or abandon these plans.
The value assigned to purchased in-process technology was determined by
estimating the completion percentage of research and development efforts at the
acquisition date, forecasting risk adjusted revenues considering completion
percentage, estimating the resulting net cash flows from the projects and
discounting the net cash flows to their present values. The completion
percentages were estimated based on cost incurred to date, importance of
completed development tasks and elapsed portion of the total project time. A net
revenue projection of $52,489,000 beginning in the year 2000 through the year
2007 was used to value the in-process research and development. This projection
is based on sales forecasts and adjusted to consider only the revenue related to
achievements completed at the acquisition date. Net cash flow estimates include
cost of goods sold, sales and marketing and general and administrative expenses
and taxes forecasted based on historical operating characteristics. In addition,
net cash flow estimates were adjusted to allow for fair return on working
capital and fixed assets, charges for technology leverage and return on other
intangibles. Appropriate risk adjusted discount rates ranging from 20% to 30%
were used to discount the net cash flows back to their present values.
The remaining excess purchase price was allocated to existing products and
technologies, retention of workforce and non compete agreements. The Company
used the income approach to determine the value allocated to existing products
and technologies and non-compete agreements and used the replacement cost
approach to determine the value allocated to workforce. The residual excess
purchase price was allocated to goodwill.
The Company will amortize such intangibles on a straight line basis over three
to seven years based on expected useful lives of existing products and
technologies, retention of workforce, noncompete agreements and goodwill. If the
identified projects are not successfully developed, we may not realize the value
assigned to the in-process research and development projects and the value of
the acquired intangible assets may also become impaired.
8
<PAGE>
The results of C-Dilla Ltd. and the estimated fair value of assets acquired and
liabilities assumed are included in the Company's financial statements from the
date of acquisition. In connection with the C-Dilla Ltd. acquisition, the
purchase price has been allocated to the assets and liabilities assumed based
upon fair values on the date of acquisition, as follows:
(In thousands)
Current assets $ 675
Property and equipment, net 521
In process research and development 4,286
Deferred tax asset 1,440
Intangibles associated with C-Dilla Ltd acquisition 16,403
Current liabilities (1,888)
---------------
$ 21,437
===============
The following summary, prepared on an unaudited pro forma basis, reflects the
condensed consolidated results of operations for the three and six month periods
ended June 30. 1998, assuming C-Dilla Ltd. had been acquired as of the beginning
of the periods presented:
<TABLE>
<CAPTION>
(In thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues $ 8,389 $ 6,050 $ 15,890 $ 11,459
Net loss attributed to common stockholders $ 2,119 $ (77) $ 2,558 $ (335)
Basic net income (loss) per share $ .23 $ (.01) $ .28 $ (.05)
Shares used in pro forma per share computation 9,069 7,409 9,032 7,381
</TABLE>
The pro forma results are not necessarily indicative of what would have occurred
if the acquisition had been in effect for the periods presented. In addition,
they are not intended to be a projection of future results and do not reflect
any synergies that might be achieved from combined operations.
9
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NOTE 7 - 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 except for periods of operating loss for which no common share
equivalents are included because their effect would be antidilutive. Dilutive
common equivalent shares consist of common stock issuable upon exercise of stock
options using the treasury stock method. The following is a reconciliation of
the shares used in the computation of basic and diluted EPS:
<TABLE>
<CAPTION>
(In thousands)
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Basic EPS - weighted average number of
common shares outstanding 8,975 7,300 8,931 7,272
Effect of dilutive common shares -
stock options outstanding -- 538 459 515
-------- -------- -------- --------
Diluted EPS - weighted average number
of common shares and common shares
outstanding 8,975 7,838 9,390 7,787
======== ======== ======== ========
</TABLE>
NOTE 8 - 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 costs related to internal-use software once
certain criteria have been met. The Company adopted SOP No. 98-1 on January 1,
1999, with no material effect.
In April 1998, the AICPA issued SOP No. 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 adopted SOP No. 98-5 on January 1, 1999, with no material
effect.
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, 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 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 does not expect the adoption of SOP No. 98-9 to have a material impact
on its financial position, results of operations or cash flows.
NOTE 9 - SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in three industry segments as follows: Video Copy
Protection, Video Scrambling and Computer Software Copy Protection. In the Video
Copy Protection segment, the Company licenses its anti-copy video technologies
to customers in the home videocassette, DVD and digital pay-per-view markets. In
the Video Scrambling segment, the Company licenses and sells products utilizing
the Company's PhaseKrypt video scrambling technology to manufacturers of 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. In the Computer Software Copy Protection segment, the
Company 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
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<PAGE>
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.
The following segment reporting information of the Company is provided (dollars
in thousands):
<TABLE>
<CAPTION>
Revenue:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- -----------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Video Copy Protection $ 7,474 $ 5,459 $ 14,339 $ 9,862
Video Scrambling 117 206 202 981
Computer Software Copy Protection 466 -- 679 --
--------- --------- --------- ---------
Total $ 8,057 $ 5,665 $ 15,220 $ 10,843
========= ========= ========= =========
<CAPTION>
Operating Income:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- -----------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Video Copy Protection $ 5,963 $ 4,098 $ 11,291 $ 7,230
Video Scrambling (244) (319) (557) (73)
Computer Software Copy Protection (494) (65) (899) (65)
Other -- 15 -- (109)
--------- --------- --------- ---------
Segment income 5,225 3,729 9,835 6,983
Research and development 1,108 654 1,739 1,277
General and administrative 1,196 1,128 2,577 2,287
Amortization of intangibles from acquisition 109 -- 109 --
In process research and development 4,286 -- 4,286 --
--------- --------- --------- ---------
Operating (loss) income (1,474) 1,947 1,124 3,419
Interest and other income, net 405 172 823 303
--------- --------- --------- ---------
(Loss) income before income taxes $ (1,069) $ 2,119 $ 1,947 $ 3,722
========= ========= ========= =========
</TABLE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Statements concerning future
matters such as the Company's expectations for gross margins, operating expenses
and capital needs and other statements regarding matters that are not historical
are forward-looking statements. Predictions of future events are inherently
uncertain. Actual events could differ materially from those predicted in the
forward-looking statements as a result of the risks set forth in this Form 10-Q
and in the "Risk Factors" section of the Company's 1998 Annual Report on Form
10-KSB filed on March 30, 1999.. There are no assurances that the Company has
identified all possible problems that the Company might face. All investors
should carefully read the annual report on Form 10-KSB together with this Form
10-Q, and consider all such risks before making an investment decision with
respect to the Company's stock.
Overview
The 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. Our revenues primarily consist of licensing
fees for videocassette and DVD copy protection, licensing fees for digital
Pay-Per-View copy protection, licensing fees for computer/multimedia software
copy protection and licensing and selling products incorporating our PhaseKrypt
11
<PAGE>
video scrambling technology to cable television equipment manufacturers, law
enforcement agencies, television broadcasters and private analog satellite
networks.
On June 18, 1999, we acquired the remaining outstanding shares of C-Dilla Ltd.
for $12.8 million in cash and acquisition costs and 109,200 shares of
Macrovision stock. Including the $3.6 million we paid for our initial stake in
C-Dilla Ltd. in 1998, the total acquisition was valued at $21.4 million.
Results of Operations
Three Months Ended June 30, 1999 Compared to Three Months Ended June 30, 1998
The following table provides revenue information by general product lines for
the three-month period ended as indicated:
<TABLE>
<CAPTION>
(In thousands)
June 30, June 30,
1999 % 1998 % % Change
------------- ------ ------------- ----- -------------
<S> <C> <C> <C> <C> <C>
Video Copy Protection $7,474 93 $5,459 96 37%
Video Scrambling 117 1 206 4 (43)%
Computer Software Copy Protection 466 6 -- -- --
------------- ------ ------------- -----
Total $8,057 100 $5,665 100 42%
============= ====== ============= =====
</TABLE>
Net Revenues
Consolidated net revenues for the second quarter of 1999 increased 42% to $8.1
million from $5.7 million in the second quarter of 1998. Revenues from the Copy
Protection Group increased 37% to $7.5 million from $5.5 million. Within this
group, revenue from videocassettes was $4.1 million in the second quarter of
1999 compared to $3.7 million in 1998 due to royalties from the higher volume of
videocassettes from studio business and the copy protection of the fitness video
"Tae-Bo" from NCP Marketing. DVD revenue was $1.7 million in 1999 compared to
$697,000 in 1998 due to increases in DVD replication as the new market of DVD
players and retail outlets distributing the product continued to expand.
Pay-per-view revenue was $1.7 million in the second quarter of 1999 compared to
$1.0 million in 1998 due to continued increases in the shipments of digital
set-top boxes as the digital subscriber base grew in the direct broadcast
satellite (DBS) and cable TV domestic and international markets. Revenues from
the Video Scrambling Group decreased 43% to $117,000 in the second quarter of
1999 from $206,000 in the second quarter of 1998. Within the Video Scrambling
Group the overall demand for VES products from various government law
enforcement agencies continued to be low. Revenues for the second quarter of
1999 were $43,000 compared to $79,000 in the second quarter of 1998. Revenue for
analog decoding equipment decreased $53,000 or 41% from $127,000, primarily due
to the Southeast Asian and Brazilian financial situations, which continues to
delay expected cable TV system upgrades and, consequently, limited the ability
of the our licensees to sell addressable set-top converters that include our
PhaseKrypt TM scrambling technology. We recorded Computer Software Copy
Protection revenues in the second quarter of 1999 of $466,000 compared to none
in the second quarter of 1998. The revenue is from contracts with major
publishers for the application of the copy protection to their discs.
Gross Margin
Gross margin for the second quarter of 1999 was 90% compared to 92% for the same
period in 1998. The decrease in margin was due to the royalty costs and fees
associated with the Computer Software Copy Protection business in the second
quarter of 1999 compared with no costs in the second quarter of 1998. Cost of
revenues increased in absolute dollars for the second quarter of 1999 compared
to the second quarter of 1998 due primarily to higher royalty fees,
duplicator/replicator fees and patent defense costs. Cost of revenues includes
items such as product costs, duplicator fees, processor costs, patent
amortization and royalty expense prior to the acquisition of C-Dilla Ltd. With
the acquisition of C-Dilla Ltd., we expect margins to increase as a result of
the elimination of royalty expenses offset partially by the patent defense costs
associated with current patent litigation. As revenues increase from Video
Scrambling, gross margin could decrease due to the higher cost of sales
associated with the hardware cost of sales and other costs.
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<PAGE>
Research and Development
Research and development expenses increased by $454,000 or 69% in the second
quarter of 1999 compared to the second quarter of 1998. The increased expenses
were a result of a one-time licensing fee of $300,000 related to technology for
a current project, one-time continuation bonuses of $99,000 paid to engineering
employees of C-Dilla Ltd. and the research and development expenses at C-Dilla
Ltd. since the acquisition on June 18, 1999. Research and development expenses
increased as a percentage of net revenues from 12% in the second quarter of 1998
to 14% in the second quarter of 1999. If not for the one-time charges noted
above, the percentage would have declined to 9%. We expect research and
development expenses to increase over prior year period as a result of the
research and development activity at C-Dilla Ltd. and as we expand into new
technologies and products.
Selling and Marketing
Selling and marketing expenses increased by $577,000 or 39% in the second
quarter of 1999 compared to the second quarter of 1998. This increase was
primarily from one-time continuation bonuses of $290,000 paid to sales and
marketing employees of C-Dilla Ltd., higher compensation and benefits associated
with additional headcount in the Computer Software Copy Protection business and
the marketing and selling expenses at C-Dilla Ltd. since the acquisition on June
18, 1999. Selling and marketing expenses remained relatively level as a
percentage of net revenues at 26% for the second quarter of 1999 and 1998. Not
including the one-time charges noted above, selling and marketing expenses would
have been 22% of net revenues in the second quarter of 1999. Selling and
marketing expenses are expected to increase over prior year periods as we
continue our efforts in selling and marketing Computer Software Copy Protection
and other products including the newly acquired C-Dilla Ltd. products.
General and Administrative
General and administrative expenses increased by $68,000 or 6% in the second
quarter of 1999 compared to the second quarter of 1998 primarily due to one-time
continuation bonuses of $48,000 paid to administrative employees of C-Dilla
Ltd., higher compensation and benefits from increased personnel and the
administrative expenses from C-Dilla Ltd. since the acquisition on June 18,
1999. General and administrative expenses declined as a percentage of net
revenues from 20% in the second quarter of 1998 to 15% in the second quarter of
1999.
Amortization of Intangibles from Acquisitions
In connection with the acquisition C-Dilla Ltd. in June 1999, the amounts of the
purchase price allocated to other intangibles are amortized over lives ranging
from three to seven years resulting in amortization of $109,000 for the second
quarter ended June 30, 1999.
In-process Research and Development
In connection with the purchase of C-Dilla Ltd. in June 1999, we allocated
$4,286,000 of the $21,437,000 total purchase price to in-process research and
development projects. This preliminary allocation represents the estimated fair
value based on risk-adjusted cash flows related to the incomplete research and
development projects. At the date of the acquisition, this amount was expensed
as a non-recurring charge as the in-process technology had not yet reached
technological feasibility and had no alternative future uses. C-Dilla Ltd. had
five major copy protection projects in progress at the time of acquisition.
These projects include a product which is being designed to protect DVD-ROMs
from unauthorized replication or copying, three products that are being designed
to prohibit the unauthorized copying of audio products and a product which is
being designed to allow DVD manufacturers to track where any DVD has been
manufactured and trace illegal copies. As of the acquisition date, costs to
complete the development of the projects acquired were expected to be
approximately $1.4 million. We currently expect to complete the development of
these projects at various dates through fiscal 2001.
The nature of the efforts required to develop the acquired in-process technology
into commercially viable products principally relate to the completion of all
planning, designing and testing activities necessary to establish that the
product will meet its design requirements including functions, features and
technical performance requirements. Though we currently expect that the acquired
in process technology will be successfully developed, there can be no assurance
that commercial or technical viability of these products will be achieved.
Furthermore, future developments in the computer software industry, changes in
the delivery of audio products, changes in other product offerings or other
developments may cause us to alter or abandon these plans.
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The value assigned to purchased in-process technology was determined by
estimating the completion percentage of research and development efforts at the
acquisition date, forecasting risk adjusted revenues considering completion
percentage, estimating the resulting net cash flows from the projects and
discounting the net cash flows to their present values. The completion
percentages were estimated based on cost incurred to date, importance of
completed development tasks and elapsed portion of the total project time. A net
revenue projection of $52,489,000 beginning in the year 2000 through the year
2007 was used to value the in-process research and development. This projection
is based on sales forecasts and adjusted to consider only the revenue related to
achievements completed at the acquisition date. Net cash flow estimates include
cost of goods sold, sales and marketing and general and administrative expenses
and taxes forecasted based on historical operating characteristics. In addition,
net cash flow estimates were adjusted to allow for fair return on working
capital and fixed assets, charges for technology leverage and return on other
intangibles. Appropriate risk adjusted discount rates ranging from 20% to 30%
were used to discount the net cash flows back to their present values.
The remaining excess purchase price was allocated to existing products and
technologies, retention of workforce and non compete agreements. The Company
used the income approach to determine the value allocated to existing products
and technologies and noncompete agreements and used the replacement cost
approach to determine the value allocated to workforce. The residual excess
purchase price was allocated to goodwill.
The Company will amortize such intangibles on a straight line basis over three
to seven years based on expected useful lives of existing products and
technologies, retention of workforce, noncompete agreements and goodwill. If the
identified projects are not successfully developed, we may not realize the value
assigned to the in-process research and development projects and the value of
the acquired intangible assets may also become impaired.
Interest and Other Income
Other income increased by $233,000 or 135% in the second quarter of 1999
compared to the second quarter of 1998, primarily from interest income received
on the proceeds of our public stock offering in late June 1998.
Income Taxes
Income tax benefit represents combined federal and state taxes at an effective
rate of 44% for the quarter ended June 30, 1999 compared to an interest tax
expense effective rate of 38% for the quarter ended June 30, 1998. The income
tax benefit in the quarter ending June 30, 1999 was the result of the
availability of net operating losses to reduce 1999 taxes from the acquisition
of C-Dilla Ltd.
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Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
The following table provides revenue information by general product lines for
the six-month period ended as indicated:
<TABLE>
<CAPTION>
(In thousands)
June 30, June 30,
1999 % 1998 % % Change
------------- ------ ------------- ----- -------------
<S> <C> <C> <C> <C> <C>
Video Copy Protection $14,339 94 $9,862 91 45%
Video Scrambling 202 1 981 9 (79)%
Computer Software Copy Protection 679 5 -- -- --
------------- ------ ------------- -----
Total $15,220 100 $10,843 100 40%
============= ====== ============= =====
</TABLE>
Net Revenues
Consolidated net revenues for the first six months of 1999 increased 40% to
$15.2 million from $10.8 million for the first six months of 1998. Revenues from
the Copy Protection Group increased 45% to $14.3 million from $9.9 million.
Within this group, revenue from videocassettes was $8.3 million in the first six
months of 1999 compared to $6.9 million in 1998 due to royalties from the higher
volume of videocassettes from studio business and the copy protection of the
fitness video "Tae-Bo" from NCP Marketing. DVD revenue was $3.0 million in the
first six months of 1999 compared to $1.3 million in 1998 due to increases in
DVD replication as the new market of DVD players and retail outlets distributing
the product continued to expand. A one time licensing fee from DIVX is included
in the 1998 revenue. Pay-per-view revenue was $3.0 million in 1999 compared to
$1.7 million in 1998 due to continued increases in the shipments of digital
set-top boxes as the digital subscriber base grew in the direct broadcast
satellite (DBS) and cable TV domestic and international markets. Revenues from
the Video Scrambling Group decreased 79% to $202,000 in the first six months of
1999 from $981,000 in the first six months of 1998. Within the Video Scrambling
Group the overall demand for VES products from various government law
enforcement agencies continued to be low. Revenues for the first six months of
1999 were $54,000 compared to $290,000 in first six months of 1998. Revenue for
analog decoding equipment decreased $543,000 or 79% from $691,000, primarily due
to the Southeast Asian and Brazilian financial situations, which continues to
delay expected cable TV system upgrades and, consequently, limited the ability
of the our licensees to sell addressable set-top converters that include our
PhaseKrypt TM scrambling technology. We recorded Computer Software Copy
Protection revenues in the first six months of 1999 of $679,000 compared to none
in the first six months of 1998. The revenue is from contracts with major
publishers for the application of the copy protection to their discs.
Gross Margin
Gross margin for the six months ended June 30, 1999 was 90% compared to 92% for
the comparable period of 1998. The decrease in margin was due to the royalty
costs and fees associated with the Computer Software Copy Protection business in
the first six months of 1999 compared with no costs in the first six months of
1998. Cost of revenues increased in absolute dollars for the first six months of
1999 compared to the first six months of 1998 due primarily to higher royalty
fees, duplicator/replicator fees and patent defense costs. Cost of revenues
includes items such as product costs, duplicator fees, processor costs, patent
amortization and royalty expense prior to the acquisition of C-Dilla Ltd. With
the acquisition of C-Dilla Ltd., we expect the margins to increase as a result
of the elimination of royalty expenses offset partially by the patent defense
costs associated with current patent litigation. To the extent revenues increase
from Video Scrambling, gross margin could decrease due to the higher cost of
sales associated with the hardware cost of sales and other costs.
Research and Development
Research and development expenses increased by $462,000 or 36% in the first six
months of 1999 compared to the first six months of 1998. The increased expenses
were a result of a one-time licensing fee of $300,000 related to technology for
a current project, one-time continuation bonuses of $99,000 paid to engineering
employees of C-Dilla Ltd. and the research and development expenses at C-Dilla
Ltd. since the acquisition on June 18, 1999. Research and development expenses
decreased as a percentage of net revenues from 12% in the first six months
quarter of 1998 to 11% in the first six months of 1999. If not for the one-time
charges noted above, the percentage would have declined further to 9%. We expect
research and development expenses to increase over prior year period as a result
of the research and development activity at C-Dilla Ltd. and as weexpand into
new technologies and products.
Selling and Marketing
Selling and marketing expenses increased by $933,000 or 31% in the first six
months of 1999 compared to the first six months of 1998. This increase was
primarily from one-time continuation bonuses of $290,000 paid to sales and
marketing employees of C-Dilla Ltd., higher compensation and benefits associated
with additional headcount in the Computer Software Copy Protection business
along with the increased advertising and marketing for the business unit and the
marketing and selling expenses at C-Dilla Ltd. since the acquisition on June 18,
1999. Selling and marketing expenses declined as a percentage of net revenues to
26% for the first six months of 1999 compared to 28% for the first six months of
1998. If not for the one-time charges noted above, the percentage
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would have declined further to 24%. Selling and marketing expenses are expected
to increase over the prior year period as we continue our efforts in selling and
marketing Computer Software Copy Protection and other products including the
newly acquired C-Dilla Ltd. products.
General and Administrative
General and administrative expenses increased by $290,000 or 13% in the first
six months of 1999 compared to the first six months of 1998 primarily due to
one-time continuation bonuses of $48,000 paid to administrative employees of
C-Dilla Ltd., higher compensation and benefits from increased personnel, higher
legal fees associated with the favorable decision in the Swyt litigation, legal
and accounting, and the administrative expenses from C-Dilla Ltd. since the
acquisition on June 18, 1999. General and administrative expenses declined as a
percentage of net revenues from 21% in the first six months of 1998 to 17% in
the first six months of 1999.
Interest and Other Income
Other income during the first six months of 1999 increased $520,000 or 172%
compared to the same period in 1998, primarily from interest income received on
the proceeds of our public stock offering in late June 1998.
Income Taxes
Income tax expense represents combined federal and state taxes at effective
rates of 35% and 38% for the six months ended June 30, 1999 and 1998,
respectively. The lower rate for 1999 was the result of the availability of net
operating losses to reduce 1999 taxes from the acquisition of C-Dilla Ltd. and
to higher tax exempt interest earned in 1999.
Net Income
Net income for the six months ended June 30, 1999 was $1.3 million compared to
$2.3 million for the first six months of 1998. The lower net income was a result
of the one-time charge to earnings of $4.3 million
Liquidity and Capital Resources
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 $4.1 million for the six months ended June 30,
1999 and $3.4 million for the six months ended June 30, 1998. For the first six
months of 1999, net cash was provided primarily by net income adjusted for
noncash charges and in-process research and development, reduced by an increase
in accounts receivable offset slightly by an increase in accounts payable and
income taxes payable. For the first six months of 1998, net cash was provided
primarily by net income adjusted for noncash charges, and to a lesser extent,
reductions in working capital.
Investing activities used cash of $2.1 million in the six months ended June 30,
1999 and $1.6 million in the first six months ended June 30, 1998. For the first
six months of 1999, net cash used in investing activities was primarily the
acquisition of C-Dilla Ltd.and the additional investment in Digimarc, offset by
the net investment in short and long-term investment securities. The investment
in Digimarc was in connection with a round of third-party financing obtained by
Digimarc. For the first six months of 1998, net cash used in investing
activities was primarily the initial investment in and prepayment of future
royalties to C-Dilla Ltd., offset in part by net purchases, sales and maturities
of short-term and long-term investment securities. We also made capital
expenditures of $315,000 in the six months ended June 30, 1999 and $138,000 in
the six months ended June 30, 1998. In addition, we paid $279,000 in the six
months ended June 30, 1999 and $358,000 in the six months ended June 30, 1998,
for costs associated with obtaining patents.
For the six months ended June 30, 1999 and 1998, we had net cash provided (used)
from financing activities of $786,000 and ($94,000), respectively. In 1999, the
net cash provided from financing activities was primarily related to the
issuance of common stock upon the exercise of stock options, stock purchases
under the our stock purchase plan and the final payment of a stockholder's note
receivable. In 1998, the net cash used in financing activities was related to
the deferred offering costs offset by the issuance of common stock upon the
exercise of stock options and stock purchases under our stock purchase plan.
At June 30, 1999, we had $6.3 million in cash and cash equivalents, $9.6 million
in short-term investments and $18.9 million in long-term marketable investment
securities. We had no material commitments for capital
16
<PAGE>
expenditures but anticipate that capital expenditures for the next 12 months
will aggregate approximately $600,000. We also have future minimum lease
payments of approximately $1.9 million under operating leases and approximately
$132,000 under capital leases. We believe that the current available funds and
cash flows generated from operations will be sufficient to meet our working
capital and capital expenditure requirements for the foreseeable future. We may
also use cash to acquire or invest in businesses or to obtain the rights to use
certain technologies.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to financial market risks, including changes in interest rates,
foreign exchange rates and security investments. Changes in these factors may
cause fluctuations in the Company's earnings and cash flows. We evaluate and
manage the exposure to these market risks as follows:
Fixed Income Investments
We have an investment portfolio of fixed income securities, including those
classified as cash equivalents, short-term investments and long-term marketable
investments securities, of $34.9 million as of June 30, 1999. These securities
are subject to interest rate fluctuations. An increase in interest rates could
adversely affect the market value of the Company's fixed income securities.
We do not use derivative financial instruments in our investment portfolio to
manage interest rate risk. We limit our exposure to interest rate and credit
risk, however, by establishing and strictly monitoring clear policies and
guidelines for our fixed income portfolios. The primary objective of these
policies is to preserve principal while at the same time maximizing yields,
without significantly increasing risk. A hypothetical 50 basis point increase in
interest rates would result in an approximate $152,000 decrease (approximately
0.5%) in the fair value of the Company's available-for-sale securities as of
June 30, 1999.
Foreign Exchange Rates
Due to our reliance on international and export sales, we are subject to the
risks of fluctuations in currency exchange rates. While a substantial majority
of our international and export revenues 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. Our future
results of operations could be materially adversely affected by currency
fluctuations. Our subsidiaries in England and Japan operate in their local
currency, which mitigates a portion of the exposure related to the respective
currency royalties collected. We use yen options to hedge anticipated balance
sheet exposures.
Strategic Investments
We have expanded our technological base in current as well as new markets
through strategic investments in companies or synergistic technologies or
products. We currently hold minority equity interests in Command Audio
Corporation and Digimarc. These investments, totaling $6.3 million, represented
8.7% of our total assets as of June 30, 1999. 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.
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 Motion Picture Association of America ("MPAA")
studios to produce "blockbuster" titles;
17
<PAGE>
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. Because 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 decline. 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.
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 62.0%, 64.5% and 54.8% of our net revenues during 1997, 1998 and the
first six months of 1999, respectively. 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 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,
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<PAGE>
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
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 1997, revenues from one of our
customers accounted for 11% of our net revenues. For 1998, another one of our
customers accounted for more than 12% of our net revenues. For the first six
months of 1999, no one customer accounted for more than 10% of our net revenues.
The MPAA studios as a group accounted for 38.6%, 45.1% and 38.2% of our net
revenues in 1997, 1998 and the first six months of 1999. 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 five of the
major home video companies 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 to 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 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 uncertain. 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 more than 20.2 million
digital set-top decoders manufactured by some 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 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
19
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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 of companies (IBM, NEC, Sony, Pioneer and Hitachi) 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 acquired C-Dilla Ltd. on June 18, 1999. C-Dilla's products include copy
protection technology for CD-ROM software products in the consumer multimedia
market. Previous to June 18, 1999, we had an exclusive marketing agreement with
C-Dilla Ltd. for this product. 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 or compatible with 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 have not developed copy protection
technology. Internet posted hacks may be used to circumvent the technology.
Further, the solution we are 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.
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Additional 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. A
Japanese company has filed an invalidation claim against one of our anti-copy
patents in Japan. After a hearing in March 1999, the Japanese Patent Office has
recommended that this patent be invalidated. We believe that this conclusion was
reached in error, and we intend to seek a reconsideration by the Japanese Patent
Office. If necessary, the matter is expected to be decided by the Tokyo High
Court sometime in the year 2000. Until a decision is rendered, the patent
remains valid and part of our business. In connection with this reconsideration,
we may reduce the scope of our claims under the patent but the reduction in
scope, if any, is not expected to have a material effect on the value of this
patent to our business. If an adverse ruling ultimately is reached on this
invalidation 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 in Japan which could have a material adverse effect on our business,
financial condition and results of operations.
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 we can enter into royalty or
licensing agreements. 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.
In January 1999, we filed a complaint against Dwight-Cavendish Developments Ltd.
in the United States District Court for the District of Northern California
(Case No. 99-20011). The complaint alleges that Cavendish infringes a United
States patent held by Macrovision. We seek to recover compensatory damages,
treble damages and costs and to obtain injunctive relief arising from these
claims. Cavendish's response to the complaint contained a counterclaim alleging
that Macrovision has violated the federal Sherman Antitrust Act and the Lanham
Act and the California false advertising laws and Unfair Competition Act. The
counterclaim seeks injunctive relief, compensatory damages, treble damages and
costs. It also seeks a declaratory judgment that the United States patent held
by Macrovision is invalid and that Cavendish's products do not infringe the
patent. We intend to defend the allegations in the counterclaim vigorously.
It can be time-consuming and costly to limit the spread of circumvention
devices.
We have nine United States and 29 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. In the past, we
have initiated a number of patent infringement disputes against manufacturers
and distributors of these devices. We currently have one such suit pending in
Germany. 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
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<PAGE>
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.
Any patent infringement or similar claims or claims under the Digital Millenium
Copyright Act that we may initiate could be time-consuming to pursue, result in
costly litigation, and divert management's attention from day-to-day 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 and Digimarc. These investments, which
total $6.3 million and represented 8.7% of our total assets at June 30, 1999,
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 any 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 any current
markets.
We face a number of risks associated with international and export sales.
International and export sales together represented 46.5%, 44.5% and 42.8% of
our net revenues in 1997, 1998 and the six months ended June 30, 1999,
respectively. 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
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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.
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.
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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.
The table below provides the status and timing of these phased activities:
<TABLE>
<CAPTION>
Status/Anticipated
Impacted Systems Processes Completion
---------------- --------- ----------
<S> <C> <C>
Hardware and software products that we Assessment completed, conducted Completed Q1 1999
license or sell validation and testing (see
details below)
Hardware and software systems that we use Assessment completed; certain Completed Q1 1999
internally in the management of our business components replaced; conducted
validation and testing
Internal systems of our customers Assessment not yet completed In Process
and suppliers
Non-information technology systems and Assessment completed; certain Completed Q1 1999
services that we use in the management of our components replaced, conducted
business, internal and external, such as validation and testing
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.
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 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.
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<PAGE>
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.
25
<PAGE>
Part II. Other Information
Item 1. 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
maintained that we induced him to accept employment by falsely representing to
him that the options granted to him eventually would have substantial value and
that we misled him into not exercising substantially all of these options, which
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. 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 , 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. The arbitrators'
decision was confirmed by the Superior Court in July 1999.
Patent Litigation
A Japanese company has filed an invalidation claim against one of our anti-copy
patents in Japan. After a hearing in March 1999, the Japanese Patent Office has
recommended that this patent be invalidated. We believe that this conclusion was
reached in error, and we intend to seek a reconsideration by the Japanese Patent
Office. If necessary, the matter is expected to be decided by the Tokyo High
Court sometime in the year 2000. Until a decision is rendered, the patent
remains valid and part of our business. In connection with this reconsideration,
we may reduce the scope of our claims under the patent but the reduction in
scope, if any, is not expected to have a material effect on the value of this
patent to our business. If an adverse ruling ultimately is reached on this
invalidation 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 in Japan.
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.
Reference is made to our Quarterly Report on Form 10Q for the quarter ended
March 31, 1999 for further information in response to this item.
Item 2 - Changes in Securities
On June 18, 1999, we acquired all of the outstanding stock of C-Dilla Ltd., a
privately held corporation headquartered in the United Kingdom ("C-Dilla"),
pursuant to an Agreement for Sale of Shares dated as of June 18, 1999 among
Macrovision and certain shareholders and employees of C-Dilla (the "C-Dilla
Shareholders"). Immediately prior to our acquisition of the outstanding stock of
C-Dilla, we owned approximately 19.8% of the outstanding stock of C-Dilla.
We purchased C-Dilla's outstanding stock directly from the C-Dilla Shareholders
in exchange for: (i) our payment to the C-Dilla Shareholders, as a group, of a
total of $12,327,245 in cash; and (ii) our issuance to the C-Dilla Shareholders
of a total of 109,199 shares of Macrovision Common Stock. The shares were issued
under the exemption form registration under the 1933 Act provided by Regulation
S and are "restricted securities" as defined in Rule 144 under the 1933 Act.
Each purchaser agreed to sell or transfer the shares only in accordance with the
provisions of Regulation S, pursuant to registration under the 1933 Act, or
pursuant to an available exemption from registration, including Rule 144.
Item 4 - Submission of Matters to a Vote of Security Holders.
(a) The Company held its Annual Meeting of Stockholders on May 18, 1999.
(b) The Company's stockholders voted upon the following matters:
(1) Election of directors. All nominees were elected, with the votes
indicated below:
Authority
Name Votes For Withheld
---- --------- --------
John O. Ryan 7,467,428 1,338
William A. Krepick 7,467,428 1,338
Richard S. Matuszak 7,467,369 1,397
Donna S. Birks 7,467,428 1,338
William N. Stirlen 7,467,428 1,338
Thomas Wertheimer 7,467,428 1,338
(2) Appointment of KPMG LLP as the Company's independent auditors for the
1999 fiscal year. 7,466,068 votes were cast in favor of the
appointment, 783 votes were cast against and there were 1,915
abstentions.
Item 5 - Other Information.
On April 23, 1999, the Board of Directors approved the following changes to the
"Macrovision Corporation 1996 Directors Stock Option Plan" and outside
directors' compensation.
1. The initial option grant to new outside directors will increase from 5,000
to 10,000 shares.
2. The option granted on each outside director's anniversary date after the
initial option grant will increase from 3,000 to 7,500 shares.
3. The vesting for all such options will be monthly over a 3 year period
(reduced from 4 years).
4. Each outside director will be paid in addition to meeting fees, a retainer
of $10,000 in stock or at the director's option, in equal amounts of cash
and stock, on an annual basis.
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On July 26, 1999, Macrovision announced a two-for-one stock split in the form of
a common stock dividend, payable to the corporation's stockholders of record as
of August 6, 1999. Macrovision stockholders of record at the close of business
on August 6, 1999, will receive stock certificates representing one additional
share of Macrovision common stock for each share of common stock then held.
Distribution of additional shares issued as a result of the split is expected to
occur on or about August 31, 1999.
Item 6 - Exhibits and Reports on Form 8-K.
(a) Exhibits.
10.30 Macrovision Corporation 1996 Directors Stock Option Plan.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K.
On July 6, 1999, Macrovision filed a Current Report on Form 8-K regarding
the acquisition of C-Dilla Ltd on June 18, 1999.
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<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Macrovision Corporation
Date: August 16, 1999 By: /S/ William A. Krepick
----------------------- ----------------------------------------
William A. Krepick, President
and Chief Operating Officer
Date: August 16, 1999 By: /S/ Michael J. Peters
---------------------- ----------------------------------------
Michael J. Peters, Controller
28
Exhibit 10.30
MACROVISION CORPORATION 1996 DIRECTORS STOCK OPTION PLAN
MACROVISION CORPORATION
1996 DIRECTORS STOCK OPTION PLAN
As Adopted by the Board of Directors on
December 3, 1996 Restated for Merger
effective February 14, 1997
Restated for Reverse Stock Split effective February 26, 1997
Restated for Amendment Adopted April 23, 1999
1. Purpose. The purpose of the Macrovision Corporation 1996 Directors Stock
Option Plan (the "Plan") is to grant to non-employee members of the Company's
Board of Directors ("Outside Directors") of Macrovision Corporation, a Delaware
corporation (the "Company") the opportunity to acquire Common Stock of the
Company, thereby encouraging such persons to accept or continue their service on
the Company's Board of Directors; to align the interests of such persons with
those of the Company's stockholders through stock ownership; and to furnish such
persons an additional incentive to improve operations and increase profits of
the Company.
To accomplish the foregoing objectives, this Plan provides a means whereby
Outside Directors may receive options to purchase Common Stock. Options granted
under this Plan will be nonstatutory (nonqualified) stock options.
2. Administration. The Plan shall be administered by the Company's Board of
Directors (the "Administrator"), which shall have the power and authority to
grant stock options consistent with the terms of the Plan, including the power
and authority:
(a) to determine the terms and conditions of the stock option
agreements entered into between the Company and any Outside
Director;
(b) to interpret the Plan;
(c) to modify or amend any such option; and
(d) to make all determinations necessary or advisable for the
administration of the Plan.
29
<PAGE>
3. Eligibility; Number.
(a) Each Outside Director who first becomes a member of the Company's Board
of Directors after the effective date of the Registration Statement on Form SB-2
for the initial public offering of the Company's Common Stock (the "IPO Date")
shall be granted options to purchase shares of the Company's Common Stock
effective as of the date he or she first becomes a member of the Company's Board
of Directors (the "Initial Grant Date"). The number of shares of the Company's
Common Stock subject to options granted to each such Outside Director on his or
her Initial Grant Date shall be five thousand (5,000) shares if the Initial
Grant Date is on or before April 22, 1999, and shall be ten thousand (10,000)
shares if the Initial Grant Date is on or after April 23, 1999 (each such number
of shares is after taking into account the reverse split of the Common Stock
effected February 26, 1997).
(b) Each Outside Director who first becomes a member of the Company's Board
of Directors after the IPO Date shall be granted options to purchase additional
shares of the Company's Common Stock annually on each successive anniversary of
the Initial Grant Date commencing on the one (1) year anniversary of the Initial
Grant Date, provided that such Outside Director continues to serve on the
Company's Board of Directors on such dates. Each Outside Director who is serving
as a member of the Company's Board of Directors on the IPO Date will be granted
an option to purchase shares of the Company's Common Stock annually on each
successive anniversary of the IPO Date commencing on the one (1) year
anniversary of the IPO Date, provided that such Outside Director continues to
serve on the Company's Board of Directors on such dates. Each employee member of
the Company's Board of Directors who becomes an Outside Director as a result of
ceasing to be an employee of the Company will be granted an option to purchase
shares of the Company's Common Stock annually on each successive anniversary of
the IPO Date commencing on the first anniversary of the IPO Date on which such
individual serves as an Outside Director, provided that such individual
continues to serve as an Outside Director on the Company's Board of Directors on
such dates, but such an individual will not receive any initial grant of an
option to purchase shares of the Company's Common Stock under Subsection 3(a)
above. The number of shares of the Company's Common Stock subject to options
granted to each Outside Director annually under this Subsection 3(b) shall be
three thousand (3,000) shares for options granted on or before April 22, 1999,
and shall be seven thousand five hundred (7,500) shares for options granted on
or after April 23, 1999 (each such number of shares is after taking into account
the reverse split of the Common Stock effected February 26, 1997).
4. Exercise Price. The exercise price of each option to purchase a share of
the Company's Common Stock shall be the fair market value of a share of the
Company's Common Stock on the date on which such option is granted. For all
purposes of this Plan, the fair market value of the Company's Common Stock on
any particular date shall be the closing price on the trading day next preceding
that date on the principal securities exchange on which the Company's Common
Stock is listed, or, if such Common Stock is not then listed on any securities
exchange, then the fair market value of the Common Stock on such date shall be
the closing price as reported by the National Association of Securities Dealers,
Inc. Automated Quotation System ("NASDAQ") on the trading day next preceding
such date. In the event that the Company's Common Stock is neither listed on a
securities exchange nor quoted by NASDAQ, then the Administrator shall determine
the fair market value of the Company's Common Stock on such date.
5. Common Stock Subject to Plan.
(a) There shall be reserved for issue upon the exercise of options granted
under the Plan sixty thousand (60,000) shares of Common Stock (which number is
after taking into account the reverse split of the Common Stock effected
February 26, 1997), subject to adjustment as provided in Section 9 hereof. If an
option granted under the Plan shall expire or terminate for any reason without
having been exercised in full, the unpurchased shares subject thereto shall
again be available for the purposes of the Plan.
(b) Notwithstanding any other provisions of this Plan, the aggregate number
of shares of Common Stock subject to outstanding options granted under this
Plan, plus the aggregate number of shares issued upon the exercise of all
options granted under this Plan, shall never be permitted to exceed the number
of shares specified in the first sentence of Subsection 5(a) above.
6. Terms of Options. Each option granted under the Plan shall be evidenced
by a nonstatutory stock option agreement between the individual to whom the
option is granted (the "optionee") and the Company. Each such agreement shall
designate the option thereby granted as a nonstatutory stock option. Each such
agreement shall be subject to the terms and conditions set forth in this Section
6, and to such other terms and conditions not inconsistent herewith as the
Administrator may deem appropriate in each case. All options granted under this
Plan shall be subject to the following terms and conditions:
30
<PAGE>
(a) Term of Options. The period or periods within which an option may be
exercised shall be determined by the Administrator at the time the option is
granted, but in no event shall such period extend beyond ten (10) years from the
date the option is granted.
(b) Method of Payment for Common Stock. Payment for stock purchased upon
any exercise of an option granted under this Plan shall be made in full
concurrently with such exercise by any one of the following methods: (i) in
cash; (ii) if and to the extent the instrument evidencing the option so provides
and if the Company is not then prohibited from purchasing or acquiring shares of
such stock, with shares of the same class of stock as are subject to the option
that have been held by the optionee for the requisite period necessary to avoid
a charge to the Company's earnings for financial reporting purposes, delivered
in lieu of cash, with the shares so delivered to be valued on the basis of the
fair market value of the stock (determined in a manner specified in the
instrument evidencing the option) on the date of exercise; (iii) through a "same
day sale" commitment from the optionee and a broker-dealer that is a member of
the National Association of Securities Dealers (the "NASD Dealer") whereby the
optionee irrevocably elects to exercise the option and to sell a portion of the
shares so purchased to pay for the exercise price, and whereby the NASD Dealer
irrevocably commits upon receipt of such shares to forward the exercise price
directly to the Company; (iv) through a "margin" commitment from the optionee
and a NASD Dealer whereby the optionee irrevocably elects to exercise the option
and to pledge the shares so purchased to the NASD Dealer in a margin account as
security for a loan from the NASD Dealer in the amount of the exercise price ,
and whereby the NASD Dealer irrevocably commits upon receipt of such shares to
forward the exercise price directly to the Company; or (v) any combination of
the foregoing.
(c) Vesting. Options granted under this Plan on or before April 22, 1999,
shall become first exercisable ratably over a four (4) year period such that
each option shall become first exercisable as to one forty-eighth (1/48) of the
option shares on the last day of each month, beginning with the first full month
following the date of grant, provided that the optionee continues to serve on
the Company's Board of Directors on such dates. Options granted under this Plan
on or after April 23, 1999, shall become first exercisable ratably over a three
(3) year period such that each option shall become first exercisable as to one
thirty-sixth (1/36) of the option shares on the last day of each month,
beginning with the first full month following the date of grant, provided that
the optionee continues to serve on the Company's Board of Directors on such
dates. Notwithstanding the foregoing, all options granted to an optionee under
this Plan will become exercisable immediately upon the optionee's death or
disability while serving on the Company's Board of Directors.
(d) Death; Disability; Resignation. In the event of an optionee's death or
disability while serving on the Company's Board of Directors, all options
granted to that optionee under this Plan may be exercised by the optionee or the
optionee's estate for a period of one (1) year after the date on which the
optionee ceases to serve on the Company's Board and will terminate if not
exercised during such period, subject to termination on the expiration of the
stated term of the option, if earlier. If an optionee resigns from the Company's
Board of Directors or declines to stand for reelection, options that have become
exercisable through the last date on which the optionee serves on the Company's
Board may be exercised for a period of three (3) months thereafter and will
terminate if not exercised during such period, subject to termination on the
expiration of the stated term of the option, if earlier. If an optionee is
removed from the Board by action of the Company's Stockholders or Board of
Directors, options that have become exercisable through the date of such removal
may be exercised for a period of one (1) week thereafter and will terminate if
not exercised during such period, subject to termination on the expiration of
the stated term of the option, if earlier. The "optionee's estate" shall mean
the duly authorized conservator or guardian of the estate of the optionee or the
executor of the optionee's last will or the duly authorized administrator or
special administrator of the optionee's probate estate or any other legal
representative of the optionee's estate duly appointed as a result of the
optionee's death or incapacity or any person who acquires the right to exercise
this option by reason of the optionee's death under the optionee's will or the
laws of intestate succession.
(e) Withholding and Employment Taxes. At the time of exercise of an option,
the optionee shall remit to the Company in cash the amount of any and all
applicable federal and state withholding and employment taxes.
31
<PAGE>
7. Stock Issuance and Rights as Stockholder. Notwithstanding any other
provisions of the Plan, no optionee shall have any of the rights of a
stockholder (including the right to vote and receive dividends) of the Company,
by reason of the provisions of this Plan or any action taken hereunder, until
the date such optionee shall both have paid the exercise price for the Common
Stock and shall have been issued (as evidenced by the appropriate entry on the
books of the Company or of a duly authorized transfer agent of the Company) the
stock certificate evidencing such shares.
8. Non-Transferability of Options. No option shall be transferable by the
optionee otherwise than by will or by the laws of descent and distribution and
all options shall be exercisable, during the optionee's lifetime, only by the
optionee. Notwithstanding the foregoing, the Administrator may provide in any
option agreement that the optionee may transfer, without consideration for the
transfer, such option to members of his immediate family, to trusts for the
benefit of such family members, to partnerships in which such family members are
the only partners, or to charitable organizations, provided that the transferee
agrees in writing with the Company to be bound by all of the terms and
conditions of the Plan and the applicable option agreement.
9. Adjustments Upon Changes in Capitalization or Merger.
(a) Subject to any required action by the Company's stockholders, the
number of shares of Common Stock covered by this Plan as provided in Section 5,
the number of shares covered by each outstanding option granted hereunder and
the exercise price thereof shall be proportionately adjusted for any increase or
decrease in the number of issued shares of Common Stock resulting from a split,
reverse split, subdivision or consolidation of such shares or the payment of a
stock dividend (but only on the Common Stock) or any other increase or decrease
in the number of such outstanding shares of Common Stock effected without the
receipt of consideration by the Company; provided, however, that the conversion
of any convertible securities of the Company shall not be deemed to have been
"effected without receipt of consideration."
(b) In the event of (i) a dissolution or liquidation of the Company; (ii) a
merger or consolidation in which the Company is the not the surviving
corporation (other than a merger or consolidation with a wholly-owned
subsidiary, a reincorporation of the Company in a different jurisdiction, or
other transaction in which there is no substantial change in the stockholders of
the Company or their relative stock holdings and the options granted under this
Plan are assumed, converted or replaced by the successor corporation, which
assumption will be binding on all optionees); (iii) a merger in which the
Company is the surviving corporation but after which the stockholders of the
Company (other than any stockholder which merges (or which owns or controls
another corporation which merges) with the Company in such merger) cease to own
their shares or other equity interests in the Company; (iv) the sale of
substantially all of the assets of the Company; or (v) any other transaction
which qualifies as a "corporate transaction" under Section 424(a) of the
Internal Revenue Code of 1986, as amended, wherein the stockholders of the
Company give up all of their equity interest in the Company (except for the
acquisition, sale or transfer of all or substantially all of the outstanding
shares of the Company from or by the stockholders of the Company), any and all
outstanding options under this Plan shall become fully exercisable,
notwithstanding any other provision of this Plan and without regard to any
vesting provisions contained in the options, for a reasonable period of time
prior to the consummation of such event. Upon any such event, the successor
corporation (if any) may assume, convert or replace any outstanding options that
are not exercised prior to the consummation of the event or may substitute
equivalent options or provide substantially similar consideration to the
optionees as was provided to the stockholders (after taking into account the
existing provisions of the option grants). In the event such successor
corporation (if any) does not assume or substitute options, as provided above,
upon an event described in this Subsection 9(b), such options will terminate on
the consummation of such event at such time and on such conditions as the
Company's Board of Directors shall determine.
(c) To the extent that any adjustments described in this Section 9 relate
to stock or securities of the Company, such adjustments shall be made by the
Company's Board of Directors, whose determination in that respect shall be
final, binding and conclusive.
(d) Except as expressly provided in this Section 9, no optionee shall have
any rights by reason of any subdivision or consolidation of shares of the
capital stock of any class or the payment of any stock dividend or any other
increase or decrease in the number of shares of any class or by reason of any
dissolution, liquidation, merger or consolidation or spin-off of assets or stock
of another corporation, and any issue by the Company of shares of stock of any
class or of securities convertible into shares of stock of any class shall not
affect, and no adjustment by reason thereof shall be made with respect to, the
number or price of shares subject to any option granted hereunder.
(e) The grant of an option pursuant to this Plan shall not affect in any
way the right or power of the Company to make adjustments, reclassifications,
reorganizations or changes of its capital or business structure or to merge or
consolidate or to dissolve, liquidate, sell or transfer all or any part of its
business or assets.
32
<PAGE>
10. Securities Law Requirements.
(a) The Administrator may require an individual as a condition of the grant
and of the exercise of an option, to represent and establish to the satisfaction
of the Administrator that all shares of Common Stock to be acquired upon the
exercise of such option will be acquired for investment and not for resale. The
Administrator shall cause such legends to be placed on certificates evidencing
shares of Common Stock issued upon exercise of an option as, in the opinion of
the Company's counsel, may be required by federal and applicable state
securities laws.
(b) No shares of Common Stock shall be issued upon the exercise of any
option unless and until counsel for the Company determines that: (i) the Company
and the optionee have satisfied all applicable requirements under the Securities
Act of 1933, as amended (the "Securities Act") and the Exchange Act; (ii) any
applicable listing requirement of any stock exchange on which the Company's
Common Stock is listed has been satisfied; and (iii) all other applicable
provisions of state and federal law have been satisfied.
11. Financial Assistance. The Company shall have the authority under this
Plan to assist any Outside Director to whom an option is granted hereunder in
the payment of the purchase price payable on exercise of that option, by lending
the amount of such purchase price to such Outside Director on such terms and at
such rates of interest and upon such security as shall have been authorized by
or under authority of the Company's Board of Directors.
12. Amendment. The Company's Board of Directors may terminate the Plan or
amend the Plan from time to time in such respects as the Board may deem
advisable.
13. Termination. The Plan shall terminate automatically on December 1,
2006, and may be terminated at any earlier date by the Company's Board of
Directors. No option shall be granted hereunder after termination of the Plan,
but such termination shall not affect the validity of any option then
outstanding.
14. Time of Granting Options. The date of grant of an option hereunder
shall, for all purposes, be the date on which the Administrator makes the
determination granting such option.
15. Reservation of Shares. The Company, during the term of this Plan, will
at all times reserve and keep available such number of shares of its Common
Stock as shall be sufficient to satisfy the requirements of the Plan.
16. Effective Date. This Plan was adopted by the Company's Board of
Directors on December 3, 1996, and was approved by the stockholders of the
Company on February 25, 1997. However, no options shall be granted under the
Plan prior to the IPO Date.
33
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Consolidated Financial Statements of Macrovision Corporation for the six months
ended June 30, 1999, and is qualified in its entirety by reference to such
Consolidated Financial Statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 6,327
<SECURITIES> 9,635
<RECEIVABLES> 8,472
<ALLOWANCES> 967
<INVENTORY> 170
<CURRENT-ASSETS> 26,592
<PP&E> 5,806
<DEPRECIATION> 4,018
<TOTAL-ASSETS> 73,038
<CURRENT-LIABILITIES> 6,462
<BONDS> 0
0
0
<COMMON> 9
<OTHER-SE> 66,548
<TOTAL-LIABILITY-AND-EQUITY> 73,038
<SALES> 15,220
<TOTAL-REVENUES> 15,220
<CGS> 1,439
<TOTAL-COSTS> 1,439
<OTHER-EXPENSES> 12,657
<LOSS-PROVISION> 125
<INTEREST-EXPENSE> 3
<INCOME-PRETAX> 1,947
<INCOME-TAX> 689
<INCOME-CONTINUING> 1,258
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,258
<EPS-BASIC> .14
<EPS-DILUTED> .13
</TABLE>
