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 March 31, 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 April 30, 1999
Common Stock, $0.001 par value 8,938,761
<PAGE>
MACROVISION CORPORATION
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page
<S> <C>
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets
as of March 31, 1999 and December 31, 1998 ............................ 3
Condensed Consolidated Statements of Income
for the Three Month Periods Ended March 31, 1999 and 1998 ............. 4
Condensed Consolidated Statements of Cash Flows
for the Three Month Periods Ended March 31, 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 ............................................................... 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk................... 12
Risk Factors................................................................. 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................ 20
Item 5. Other Information ........................................................... 21
Item 6. Exhibits and Reports on Form 8-K ............................................ 21
Signatures ............................................................................ 22
</TABLE>
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Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements.
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
March 31,
1999 December 31,
(Unaudited) 1998
----------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 5,057 $ 3,513
Short-term investments 23,580 22,877
Accounts receivable, less allowance for doubtful
accounts of $902 and $838 6,076 5,574
Inventories 224 325
Deferred tax assets 1,892 1,669
Prepaid expenses and other assets 1,049 1,008
-------- --------
Total current assets 37,878 34,966
Property and equipment, net 1,213 1,297
Patents and other intangibles, net 1,550 1,526
Long-term marketable investment securities 20,076 18,795
Other assets 8,827 8,910
======== ========
$ 69,544 $ 65,494
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities:
Accounts payable $ 1,101 $ 803
Accrued expenses 2,010 2,691
Deferred revenue 2,028 1,207
Income taxes payable 1,922 680
Current portion of capital lease obligation 113 112
-------- --------
Total current liabilities 7,174 5,493
Capital lease obligation, net of current portion 48 76
Deferred tax liabilities 400 383
-------- --------
7,622 5,952
Stockholders' equity:
Common stock 9 9
Additional paid-in capital 53,142 52,617
Stockholder's note receivable (78) (78)
Accumulated other comprehensive loss (85) (82)
Retained earnings 8,934 7,076
-------- --------
Total stockholders' equity 61,922 59,542
-------- --------
$ 69,544 $ 65,494
======== ========
</TABLE>
See the accompanying notes to these condensed consolidated financial statements.
3
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MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------------
1999 1998
------ ------
<S> <C> <C>
Net revenues $7,163 $5,178
------ ------
Costs and expenses:
Cost of revenues 671 398
Research and development 631 623
Selling and marketing 1,882 1,526
General and administrative 1,381 1,159
------ ------
Total costs and expenses 4,565 3,706
------ ------
Operating income 2,598 1,472
Interest and other income, net 418 131
------ ------
Income before income taxes 3,016 1,603
Income taxes 1,158 609
------ ------
Net income $1,858 $ 994
====== ======
Computation of basic and diluted earnings per share:
Basic earnings per share $ 0.21 $ 0.14
====== ======
Shares used in computing basic earnings per share 8,887 7,244
====== ======
Diluted earnings per share $ 0.20 $ 0.13
====== ======
Shares used in computing diluted earnings per share 9,339 7,735
====== ======
</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>
Three Months Ended March 31,
1999 1998
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,858 $ 994
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 232 266
Amortization of prepaid future royalties to C-Dilla Limited 69 --
Deferred income taxes (206) (94)
Amortization of deferred stock compensation -- 35
Change in provision of accounts receivable 64 (3)
Changes in operating assets and liabilities:
Accounts receivable, inventories, and other current assets (510) 1,005
Accounts payable, accrued expenses, deferred revenue
and income taxes payable 1,680 333
Other 11 12
------- -------
Net cash provided by operating activities 3,198 2,548
------- -------
Cash flows from investing activities:
Purchases of long-term marketable investment securities (6,512) --
Sales or maturities of long-term marketable investment securities 5,210 1,013
Purchases of short-term investments (7,073) (3,197)
Sales or maturities of short-term investments 6,377 5,619
Acquisition of property and equipment (79) (86)
Payments for patents and other intangibles (93) (123)
Investment in C-Dilla Limited -- (3,553)
Prepaid future royalties to C-Dilla Limited -- (1,015)
Other, net 18 34
------- -------
Net cash used in investing activities (2,152) (1,308)
------- -------
Cash flows from financing activities:
Payments on capital lease obligations (27) (27)
Proceeds from issuance of common stock, net 525 257
------- -------
Net cash provided by financing activities 498 230
------- -------
Net increase in cash and cash equivalents 1,544 1,470
Cash and cash equivalents at beginning of period 3,513 1,314
------- -------
Cash and cash equivalents at end of period $ 5,057 $ 2,784
======= =======
Supplemental cash flow information:
Interest paid $ 1 $ 5
======= =======
Income taxes paid $ 87 $ 581
======= =======
</TABLE>
See the accompanying notes to these condensed consolidated financial statements.
5
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MACROVISION CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared by Macrovision Corporation (the "Company") in accordance with the rules
and regulations of the Securities and Exchange Commission. Certain information
and footnote disclosures, normally included in financial statements prepared in
accordance with generally accepted accounting principles, have been condensed or
omitted in accordance with such rules and regulations. In the opinion of
management, the accompanying unaudited condensed consolidated financial
statements reflect all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the financial position of the Company,
and its results of operations and cash flows for those periods presented. This
quarterly report on Form 10-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 and the Company's Registration
Statement on Form S-3 (Registration No. 333-55757).
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):
March 31, December 31,
1999 1998
--------- ------------
Cash equivalents - money market funds $ 4,270 3,098
Investments:
Municipal preferred certificates -- 1,000
United States government bonds and agency
securities 43,656 40,672
------- -------
43,656 41,672
======= =======
$47,926 44,770
======= =======
Government bond securities totaling $20,076,000 and $18,795,000 as of March 31,
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 $134,000 and $148,000 as of March 31, 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 EMPLOYEE STOCK PURCHASE PLAN
During the quarter ended March 31, 1999, the Company issued 109,420 shares of
common stock and received proceeds of approximately $393,000 associated with the
exercise of stock options. Also during the quarter ended
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March 31, 1999, the Company issued 15,494 shares of common stock under the
Employee Stock Purchase Plan and received proceeds of approximately $133,000.
NOTE 4 - INVENTORIES
Inventories are stated at the lower of first-in, first-out cost or market and
consisted of the following:
March 31, December 31,
(In thousands) 1999 1998
--------- ------------
Raw materials $ 93 $138
Finished goods 131 187
==== ====
$224 $325
==== ====
NOTE 5 - NET INCOME PER SHARE
Basic EPS is computed using the weighted average number of common shares
outstanding during the period. Diluted EPS is computed using the weighted
average number of common and dilutive common equivalent shares outstanding
during the period. Dilutive common equivalent shares consist of common stock
issuable upon exercise of stock options using the treasury stock method. The
following is a reconciliation of the shares used in the computation of basic and
diluted EPS (in thousands):
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------
1999 1998
----- -----
<S> <C> <C>
Basic EPS - weighted average number of common shares outstanding 8,887 7,244
Effect of dilutive common equivalent shares - stock options outstanding 452 491
----- -----
Diluted EPS - weighted average number of common shares and common
equivalents shares outstanding 9,339 7,735
===== =====
</TABLE>
NOTE 6 - 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
7
<PAGE>
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 7 - 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:
March 31, December 31,
1999 1998
--------- ------------
Investment in CAC $2,837 $2,837
Investment in Digimarc 1,500 1,500
Investment in C-Dilla 3,553 3,553
Prepayment of royalties to C-Dilla 803 872
Deposits and other assets 134 148
------ ------
$8,827 $8,910
====== ======
Under a Software Marketing License and Development Agreement with C-Dilla
Limited, the Company has obtained, for an initial five-year term, the worldwide
exclusive license to market, in the consumer multimedia software market,
C-Dilla's proprietary copy protection technology for CD-ROM and
internet-delivered software products. The Company paid $1,015,000 in up-front
license fees subject to offset against future royalties and will pay royalty
payments to C-Dilla of between 30% to 45% of revenues from sales of software
products incorporating C-Dilla's technology. During the quarter ended March 31,
1999, the Company recorded revenue under this arrangement of $213,000 and offset
the prepayment of royalties to C-Dilla in the amount of $69,000.
NOTE 8 - 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 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.
8
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The following segment reporting information of the Company is provided (dollars
in thousands):
Revenue:
Three Months Ended
March 31,
-----------------------
1999 1998
------- -------
Video Copy Protection $ 6,865 $ 4,403
Video Scrambling 85 775
Computer Software Copy Protection 213 --
------- -------
Total $ 7,163 $ 5,178
======= =======
Operating Income:
Three Months Ended
March 31,
-----------------------
1999 1998
------- -------
Video Copy Protection $ 5,328 $ 3,132
Video Scrambling (313) 246
Computer Software Copy Protection (405) --
Other -- (124)
------- -------
Segment income 4,610 3,254
Research and development 631 623
General and administrative 1,381 1,159
------- -------
Operating income 2,598 1,472
Interest and other income, net 418 131
------- -------
Income before income taxes $ 3,016 $ 1,603
======= =======
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 and the Company's Registration Statement on Form
S-3 (Registration No. 333-55757), which was declared effective by the Securities
and Exchange Commission on June 25,1998. There are no assurances that the
Company has identified all possible problems that the Company might face. All
investors should carefully read the annual report on Form 10-KSB and the
Company's Registration Statement on Form S-3, 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 Company was founded in 1983 to develop video security solutions for major
motion picture studios and independent video producers. Since that time, the
Company has derived most of its revenues and operating income from licensing its
video copy protection technologies. The revenues of the Company primarily
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 its PhaseKrypt video scrambling technology to cable television
equipment manufacturers, law enforcement agencies, television broadcasters and
private analog satellite networks.
Results of Operations
Three Months Ended March 31, 1999 Compared to Three Months Ended March 31, 1998
The following table provides revenue information by general product lines for
the three-month period ended as indicated (dollars in thousands):
<TABLE>
<CAPTION>
March 31, March 31,
1999 % 1998 % % Change
--------- ------ --------- ------ --------
<S> <C> <C> <C> <C> <C>
Video Copy Protection $6,865 96 $4,403 85 56%
Video Scrambling 85 1 775 15 (89)%
Computer Software Copy Protection 213 3 -- -- --
------ ------ ------ ------
Total $7,163 100 $5,178 100 38%
====== ====== ====== ======
</TABLE>
Net Revenues
Consolidated net revenues for the first quarter of 1999 increased 38% to $7.2
million from $5.2 million in the first quarter of 1998. Revenues from the Copy
Protection Group increased 56% to $6.9 million from $4.4 million. Within this
group, revenue from videocassettes was $4.2 million in 1999 compared to $3.2
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 $1.4 million in 1999 compared to $568,000 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
$1.3 million in 1999 compared to $681,000 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 89% to $85,000 from
$775,000. 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 quarter of 1999 were $11,000 compared to $212,000 in the first
quarter of 1998. Revenue for analog decoding equipment decreased $489,000 or 87%
from $563,000, primarily due to the Southeast Asian and Brazilian financial
situations, which delayed expected cable TV system upgrades and, consequently,
limited the ability of the Company's licensees to sell addressable set-top
converters that include the Company's PhaseKrypt TM scrambling technology. The
Company recorded Computer Software Copy Protection revenues in the first quarter
of 1999 of $213,000 with over 1 million Safedisc(TM) copy protected CD-ROMs.
Gross Margin
Gross margin for the first quarter of 1999 was 91% compared to 92% for the same
period in 1998. The slight decrease in margin was due to the royalty costs and
fees associated with the Computer Software Copy Protection business in the first
quarter of 1999 compared with no costs in the first quarter of 1998. Cost of
revenues increased in absolute dollars for the first quarter of 1999 compared to
the first of 1998 due primarily to higher royalty fees, duplicator/replicator
fees, patent defense costs and unabsorbed overhead, offset slightly by lower
patent amortization and hardware costs. Cost of revenues includes items such as
product costs, duplicator fees, processor costs, patent amortization and royalty
expense. As revenues increase from Computer Software Copy Protection or Video
Scrambling, gross margin could decrease due to the higher cost of sales
associated with the royalties, hardware cost of sales and other costs.
Research and Development
Research and development expenses increased by $8,000 or 1% in the first quarter
of 1999 compared to the first quarter of 1998. Research and development expenses
declined as a percentage of net revenues from 12% in the first quarter of 1998
to 9% in the first quarter of 1999. The Company expects research and development
expenses to increase as the Company expands into new technologies and products.
Selling and Marketing
Selling and marketing expenses increased by $356,000 or 23% in the first quarter
of 1999 compared to the first quarter of 1998. This increase was primarily from
higher compensation and benefits associated with additional headcount in the
Computer Software Copy Protection business along with increased advertising and
marketing for that business unit. Selling and marketing expenses declined as a
percentage of net revenues from 29% in the first quarter of 1998 to 26% in the
first quarter of 1999. Selling and marketing expenses are expected to increase
as the Company continues its efforts in selling and marketing Computer Software
Copy Protection and other products.
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<PAGE>
General and Administrative
General and administrative expenses increased by $222,000 or 19% in the first
quarter of 1999 compared to the first quarter of 1998 primarily due to legal
expenses related to the Swyt arbitration and new business related consulting.
General and administrative expenses declined as a percentage of net revenues
from 22% in the first quarter of 1998 to 19% in the first quarter of 1999.
Interest and Other Income
Other income increased by $287,000 or 219% in the first quarter of 1999 compared
to the first quarter of 1998 primarily from interest income received on the
proceeds of the Company's public stock offering received in early July 1998 and
miscellaneous income.
Income Taxes
Income tax expense represents combined federal and state taxes at an effective
rate of 38% for the quarters ended March 31, 1999 and 1998.
Liquidity and Capital Resources
The Company has financed its operations primarily from cash generated by
operating activities, principally by its copy protection business. The Company's
operating activities provided net cash of $3.2 million and $2.5 million for the
three months ended March 31, 1999 and 1998, respectively. For the first three
months of 1999, net cash was provided primarily by net income adjusted for
noncash charges and an increase in accounts payable, deferred revenue and income
taxes payable, offset slightly by an increase in accounts receivable and a
decrease in accrued expenses. For the first three months of 1998, net cash was
provided primarily by net income adjusted for noncash charges and a decrease in
accounts receivable and an increase in deferred revenue, offset slightly by an
increase in inventories and a decrease in accrued expenses.
Investing activities used cash of $2.1 million and $1.3 million in the three
months ended March 31, 1999 and 1998, respectively. For the first three months
of 1999, net cash used in investing activities was primarily the net investment
in short and long-term investment securities. For the first three months of
1998, net cash used in investing activities was primarily an investment in and
prepayment of future royalties to C-Dilla, offset in part by net purchases,
sales and maturities of short-term and long-term investment securities. During
this period, the Company invested approximately $3.6 million in C-Dilla to
acquire an approximate 19.8% equity ownership interest. The Company intends to
hold this investment for the long-term. The Company also paid approximately $1.0
million for up-front license fees subject to offset against future royalties due
under a Software Marketing License and Development Agreement under which it had
obtained, for an initial five-year term, the world-wide exclusive license to
market, in the consumer multimedia software market, C-Dilla's proprietary copy
protection technology for CD-ROM and internet-delivered software products. The
Company accounts for the investment in C-Dilla using the cost method. The
Company also made capital expenditures of $79,000 and $86,000 in the three
months ended March 31, 1999 and 1998, respectively. In addition, the Company
paid $53,000 and $123,000 in the three months ended March 31, 1999 and 1998,
respectively, for costs associated with obtaining patents and other intangibles.
For the three months ended March 31, 1999 and 1998, the Company had net cash
provided from financing activities of $498,000 and $230,000, respectively,
relating primarily to the issuance of common stock upon the exercise of stock
options and under the Company's stock purchase plan.
At March 31, 1999, the Company had $5.0 million in cash and cash equivalents,
$23.6 million in short-term investments and $20.1 million in long-term
marketable investment securities. The Company had no material commitments for
capital expenditures but anticipates that capital expenditures for the next 12
months will aggregate approximately $600,000. The Company also has future
minimum lease payments of approximately $1.9 million under operating leases and
approximately $161,000 under capital leases. The Company believes that the
current available funds and cash flows generated from operations will be
sufficient to meet its working capital and capital expenditure requirements for
the foreseeable future. The Company may also utilize cash to acquire or invest
in businesses or to obtain the rights to use certain technologies.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
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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 $47.9 million as of March 31, 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 60 basis point increase in
interest rates would result in an approximate $220,000 decrease (approximately
.5%) in the fair value of the Company's available-for-sale securities as of
March 31, 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. There can be
no assurance that our future results of operations will not be materially
adversely affected by currency fluctuations. The subsidiaries of the Company 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, Digimarc and C-Dilla. These investments, totaling $7.9 million,
represented 11.3% of our total assets as of March 31, 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;
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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 be materially adversely affected. Further, we may not be
in a position to anticipate a decline in revenues in any quarter until late in
the quarter, due primarily to the delay inherent in revenue reporting from
licensees and replicators, resulting in a potentially more significant level of
volatility in the price of our common stock.
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 58.9% of our net revenues during 1997, 1998 and the
first three 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 and/or subsequent revenues from other venues. In this regard,
our copy protection technologies are intended to deter consumer copying and are
not effective against professional duplication and video processing equipment.
In the event that the major motion picture studios or other customers of our
copy protection technology were to determine that the benefits of using our
technology did not justify the cost of licensing the technology, demand for
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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 three
months of 1999, revenues from one of our customers accounted for 11% of our net
revenues. The MPAA studios as a group accounted for 38.6%, 45.1% and 38.0% of
our net revenues in 1997, 1998 and the first three 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
three of the MPAA studios and with PolyGram and Dreamworks for copy protection
of substantially all of their videocassettes and/or DVDs in the United States.
These agreements expire at various times ranging from February 2000 to March
2001. The failure of any of these customers to renew its contracts or 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 subject to a high
level of uncertainty. Much of the DVD and digital PPV technology and
infrastructure is unproven, and it is difficult to predict with any assurance
whether, or to what extent, these evolving markets will grow. In this regard,
our future growth would be adversely affected if DVD players and digital PPV
set-top decoders that do not include our copy protection components achieve
market acceptance.
While our copy protection capability is embedded in approximately 17.7 million
digital set-top decoders manufactured by certain of the leading set-top decoder
manufacturers, only four system operators have activated copy protection for
digital PPV programming. In Japan, DirectTV Japan and SkyPerfecTV copy protect
all adult programming channels and certain PPV motion pictures. In Hong Kong,
one system operator copy protects all video-on-demand movies. In the United
Kingdom, British Sky Broadcasting has to date copy protected all 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
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managed, or if there are technical compatibility problems, our business,
financial condition and results of operations would be materially adversely
affected. If the market for DVD or digital PPV copy protection fails to develop
or develops more slowly than expected, or if our solution does not achieve or
sustain market acceptance, our business, financial condition and results of
operations would be materially adversely affected.
We seek to expand our copy protection business through licensing arrangements
and strategic investments. Macrovision, Philips and Digimarc are jointly
developing a digital media copy protection solution to address the
digital-to-digital copying issues associated with the next generation of DVD and
digital videocassette recording devices. We have submitted our proposed solution
to the Copy Protection Technical Working Group ("CPTWG"). At least one other
group 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 have an exclusive marketing agreement with C-Dilla for copy protection
technology for CD-ROM software products in the consumer multimedia market. The
market for copy protection of CD-ROMs is unproven. For us to be successful in
entering this new market, producers of multimedia CD-ROMs must accept copy
protection generally and also adopt the solution developed by C-Dilla and
marketed by us. There can be no assurance that copy protection of multimedia
CD-ROMs will be accepted. For example, consumers may react negatively to the
introduction of copy protected CD-ROMs if they are prevented from copying the
content of their favorite applications or if copy protection impairs the
playability of the CD-ROM. Moreover, copy protection may not be effective 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 neither we nor C-Dilla have 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. Krypton
Co., Ltd., a Japanese company, has filed an invalidation claim against one of
our anti-copy patents in Japan. After consultation with Japanese patent counsel,
we believe that this claim is without merit, and we will aggressively contest
the claim in the Japanese Patent Office. In the event of an adverse ruling on
this claim, we might incur legal competition from clones of our own copy
protection technology in Japan and a corresponding decline in demand for our
technology, which could have a material adverse effect on our business,
financial condition and results of operations.
We also have two pending lawsuits in an effort to protect our copy protection
technology. In addition, as we acquire or license a portion of the technology
included in our products from third parties, our exposure to infringement
actions may increase because we must rely upon these third parties for
information as to the origin and ownership of the acquired or licensed
technology. Although we intend to obtain representations as to the origin and
ownership of the acquired or licensed software and obtain indemnification to
cover any breach of any of these representations, these representations may not
be accurate or indemnification may not provide adequate compensation for any
breach of these representations. To the extent that these or any other
communications or any litigation create further uncertainty in the marketplace,
acceptance of the technology that we market would be delayed, which could have a
material adverse effect on our business, financial condition and results of
operations. These and any other such claims of infringement, with or without
merit, could be time-consuming to defend, result in costly litigation, divert
management's attention from day-to-day operations, cause product shipment delays
or require us to cease utilizing the infringing technology unless 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 20 foreign patents covering a number of processes
and devices that unauthorized parties could use to circumvent our copy
protection technologies. We use these patents to limit the proliferation of
devices intended to circumvent our copy protection technologies. We have
initiated a number of patent infringement disputes against manufacturers and
distributors of these devices. In the event of an adverse ruling in a patent
infringement lawsuit, we might suffer from the legal availability of the
circumvention device or have to obtain rights to the offending device. The legal
availability of circumvention devices could result in the increased
proliferation of devices that defeat our copy protection technology and a
decline in demand for our technologies, which could have a material adverse
effect on our business, financial condition and results of operations. In
October 1998, President Clinton signed the Digital Millennium Copyright Act into
law. This new law will require all new VCRs manufactured or sold in the United
States, beginning in May 2000, to be specifically designed to make poor quality
copies of programming encoded with our copy protection technology. Existing VCRs
that currently respond to our technology (over 90% of all new VCRs) are required
to maintain their compliant designs. The new law also provides for both criminal
and civil penalties for companies or individuals who import, produce, or
distribute devices designed to circumvent our technology. Any patent
infringement or similar claims or claims
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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, Digimarc and C-Dilla. These investments,
which total $7.9 million and represented 11.3% of our total assets at March 31,
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 three months ended March 31, 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 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
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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.
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 and suppliers Assessment not yet completed In Process
Non-information technology systems and Assessment completed; certain Completed Q1 1999
services that we use in the management components replaced, conducted
of our business, internal and external, such as validation and testing
telephone systems and building systems
</TABLE>
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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.
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
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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.
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 16, 1999, a majority of the arbitrators
rendered a decision in our favor, finding that we had no liability to Mr. Swyt
on any of his claims and that his claims were without merit. We are seeking to
have the arbitrators' decision confirmed by the Superior Court.
Patent Litigation
We have been notified that a Japanese company has filed an invalidation claim
against one of our anti-copy patents in Japan. We and our Japanese patent
counsel believe this claim is without merit and will be aggressively contested
by us in the Japanese Patent Office. In the event of an adverse ruling on this
claim, we might incur legal competition from clones of our own copy protection
technology in Japan and a corresponding decline in demand for our technology.
From time to time, we may receive claims from third parties that our
technologies and products infringe their intellectual property rights, and we
may receive similar claims in the future. Any infringement claims, with or
without merit, could be time-consuming to defend, result in costly litigation,
cause product shipment delays or require us to cease utilizing the infringing
technology unless we can enter into royalty or licensing agreements. Such
royalty or licensing agreements might not be available on terms acceptable to
us, or at all, which could have a material adverse effect on our business,
financial condition and results of operations.
We now have pending two patent infringement lawsuits in an effort to protect our
copy protection technology. In the event of an adverse ruling in this
litigation, we might incur legal competition from clones of our own copy
protection technology, which could have a material adverse effect on our
business, financial condition and results of operations.
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
20
<PAGE>
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.
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.
Item 6 - Exhibits and Reports on Form 8-K.
(a) Exhibits.
27.1 - Financial Data Schedule.
(b) Reports on Form 8-K.
During the quarter ended March 31, 1999, the Company filed no Current
Reports on Form 8-K.
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: May 14, 1999 By:/S/ William A. Krepick
---------------- -------------------------------------
William A. Krepick,
President and Chief Operating Officer
Date: May 14, 1999 By: /S/ Victor A. Viegas
--------------- -------------------------------------
Victor A. Viegas, Vice President,
Finance and Administration and
Chief Financial Officer
21
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Consolidated Financial Statements of Macrovision Corporation for the three
months ended March 31, 1999, and is qualified in its entirety by reference to
such Consolidated Financial Statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-Mos
<FISCAL-YEAR-END> Dec-31-1999
<PERIOD-START> Jan-1-1999
<PERIOD-END> Mar-31-1999
<CASH> 5,057
<SECURITIES> 23,580
<RECEIVABLES> 6,978
<ALLOWANCES> 902
<INVENTORY> 224
<CURRENT-ASSETS> 37,878
<PP&E> 4,441
<DEPRECIATION> 3,228
<TOTAL-ASSETS> 69,544
<CURRENT-LIABILITIES> 7,174
<BONDS> 0
0
0
<COMMON> 9
<OTHER-SE> 61,913
<TOTAL-LIABILITY-AND-EQUITY> 69,544
<SALES> 7,163
<TOTAL-REVENUES> 7,163
<CGS> 671
<TOTAL-COSTS> 671
<OTHER-EXPENSES> 3,894
<LOSS-PROVISION> 62
<INTEREST-EXPENSE> 1
<INCOME-PRETAX> 3,016
<INCOME-TAX> 1,158
<INCOME-CONTINUING> 1,858
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,858
<EPS-PRIMARY> .21
<EPS-DILUTED> .20
</TABLE>
