FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|X| ANNUAL REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
|_| TRANSITION REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 000-22023
Macrovision Corporation
(Exact name of registrant as specified in its charter)
DELAWARE 77-0156161
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
1341 Orleans Drive
Sunnyvale, California 94089
(Address of principal executive offices) (Zip code)
(408) 743-8600
(Registrant's telephone number including area code)
Securities registered under Section 12(b) of the Exchange Act: None.
Securities registered under Section 12(g) of the Exchange Act: Common
Stock, $0.001 par value.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes |X| No |_|
Indicate by check if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein and will not be contained, to the best of
the Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
form 10-K. |X|
As of March 20, 2000, the aggregate market value of the voting and non-voting
common equity held by non-affiliates of the registrant, based on the closing
price for the registrant's common stock on that day, was approximately
$2,309,565,930.
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
As of March 20, 2000, there were 40,166,364 shares of the Registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain exhibits hereto have been specifically incorporated by reference herein
in Item 13 under Part III hereof. Certain portions of registrant's definitive
Proxy Statement, which will be filed with the Securities and Exchange Commission
in connection with the registrant's annual meeting of stockholders to be held on
May 31, 2000, are incorporated by reference in Items 10-13 of Part III hereof.
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MACROVISION CORPORATION
FORM 10-K
INDEX
PART I
ITEM 1 Business ..................................................... 4
ITEM 2 Properties ................................................... 24
ITEM 3 Legal Proceedings ............................................ 24
ITEM 4 Submission of Matters to a Vote of Security Holders .......... 25
PART II
ITEM 5 Market for Common Equity and Related Stockholder Matters ..... 26
ITEM 6 Selected Financial Data ...................................... 26
ITEM 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations .......................... 27
ITEM 7a Quantitative and Qualitative Disclosures About Market Risk ... 37
ITEM 8 Financial Statements and Supplementary Data .................. 37
ITEM 9 Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ...................... 38
PART III
ITEM 10 Directors and Executive Officers ............................. 38
ITEM 11 Executive Compensation ....................................... 38
ITEM 12 Security Ownership of Certain Beneficial
Owners and Management ........................................ 38
ITEM 13 Certain Relationships and Related Transactions ............... 38
PART IV
ITEM 14 Exhibits and Reports on Form 8-K ............................. 38
Signatures ................................................... 43
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This Annual Report on Form 10-K for Macrovision Corporation
("Macrovision," "us" or "we") contains forward-looking statements that involve
risks and uncertainties. Our actual results may differ significantly from the
results discussed in the forward-looking statements. Factors that might cause
these differences include, but are not limited to, the factors discussed in the
sections entitled "Business-Factors Affecting Operating Results and Market Price
of Stock" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
PART I
ITEM 1. BUSINESS.
Macrovision Corporation, a Delaware corporation formed in 1983, designs,
develops and licenses copy protection and rights management technologies. We are
a leading provider of copyright protection and rights management technologies
for major Hollywood studios, independent video producers, PC games and
educational software publishers, digital set-top box manufacturers and digital
PPV network operators. We provide content owners with the means to protect
content such as videocassette, DVD and PPV movies, PC games and educational
software against unauthorized copying and distribution, as well as the means to
electronically market that content in a secure manner.
Our technology has been used to copy protect over 2.7 billion
videocassettes worldwide since 1985. All Motion Picture Association of America
studios use our video copy protection technologies to protect some or all of
their movie releases on videocassette or DVD. Our customers include Disney,
Paramount, Sony Pictures Entertainment, Twentieth Century Fox, Universal
Studios, Warner Brothers and DreamWorks. We believe that our video copy
protection technologies are accepted as the industry standard. The October 1998
Digital Millennium Copyright Act mandates compliance with the automatic gain
control video copy protection technology, such as that of Macrovision, for all
VCR manufacturers that sell or import their hardware into the U.S.
As a result of our June 1999 acquisition of C-Dilla , Ltd., we expanded
our copy protection technology business into the PC games and educational
software markets, and into rights management applications. We have licensed a
majority of the top PC games publishers, including Electronic Arts, Microsoft,
Eidos, GT Interactive, Havas, and Hasbro. We believe that our SafeDisc(R)
computer software/CD-ROM copy protection technology has been used on
approximately 30 million CD-ROMs. Additionally, we are developing a suite of
rights management technologies, called SafeCast, that will provide our customers
more options to market and securely distribute software products using either
the Internet or packaged media.
We have built and continue to extend a large patent portfolio which
provides the basis for our licensing business model. We license our technologies
and receive high margin, recurring revenues from a variety of sources. These
include unit-based royalties on videocassettes, DVDs, CD-ROMs, and set-top
boxes, transaction or use-based royalties for PPV movies, and license fees from
a range of hardware manufacturers, and digital satellite and cable network
operators.
To further expand our copy protection capabilities, we entered into a
strategic relationship with Digimarc, a leading digital watermarking technology
company, to develop a digital watermarking copy protection solution to address
digital-to-digital copying issues. We also have a strategic relationship with
Audiosoft, a developer of secure Internet music delivery technology and
copyright management reporting systems. We recently entered into a strategic
relationship with TTR Technologies to develop copy protection technology for
audio CDs. We intend to continue to evaluate and pursue additional strategic
relationships that are complementary to our existing technologies.
Industry Background
As the world moves toward a digital media age, content owners are
increasingly vulnerable to unauthorized copying. Consumers' ability to make
unauthorized copies has increased due to the proliferation of inexpensive,
easy-to-use devices, such as VCRs, CD-ROM recorders, audio CD recorders and
personal video recorders that allow in-home copying of videocassettes, DVDs,
digital PPV programs, CD-ROMs, and audio CDs. As techno-
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logical advances facilitate digital copying at declining prices, motion picture
studios and software developers have become more concerned with protecting their
intellectual material.
Content owners lose billions of dollars every year to casual copying and
piracy. The Motion Picture Association of America estimates that in 1998 video
piracy cost the major studios more than $2.5 billion in lost revenues. The
Software Information & Industry Association estimates that computer software and
video game companies based in the United States lost $11 billion worldwide in
1998 due to software piracy.
With film production costs continually growing, studio profitability has
become increasingly dependent on the development of new venues, such as home
video and digital PPV, and new formats, such as DVD. Motion picture studios
generally release major movies to various venues, such as theaters and home
video in a series of "release windows" to maximize revenues from each venue. In
the United States, movies are released first to the box office, then to home
video, then to pay-per-view, then to subscription pay TV, such as HBO, and
finally to syndication broadcast TV, syndication or basic cable. In the past few
years, home video has surpassed the theatrical box office as the largest source
of revenues for the motion picture industry. Further, as reported by Adams Media
Research, DVD revenues now comprise more than 15% of the studios' home video
business.
Legislative Response. Various government and legislative initiatives in
recent years have encouraged copy protection technologies.
In the United States, the Digital Millennium Copyright Act was enacted in
October 1998. This law requires all VCRs to comply with analog copy protection
technologies, such as those covered in Macrovision's patents, beginning in May
2000. Approximately 80% of all VCRs manufactured prior to 1999 comply. The Act
includes a clause that outlaws all circumvention devices and technologies that
could be used to defeat any type of copy protection technology. The United
States law is based on a set of guidelines adopted by the World Intellectual
Property Organization in 1996 for amending basic copyright laws to deal with the
protection of digital media.
The European Union is currently discussing a proposed copyright directive,
which we believe includes a provision aimed at controlling hardware or software
circumvention devices and technologies.
In Japan, a revised copyright law that went into effect in October 1999
prohibits the sale, manufacturing, and import of circumvention devices. The
Japan Industry Standard requires all digital recording devices to be responsive
to analog copy protection technologies that utilize automatic gain control
techniques, such as those covered in Macrovision patents.
Video Copy Protection.
Videocassette Protection. Content owners wish to maximize the economic
value from each feature film or other video program over its copyright life,
currently 75 years. Independent studies show that studios and video retailers
lose videocassette sales and rental revenues when consumers make copies of
movies, whether from home video or PPV releases. The International Recording
Media Association has estimated that 50% of all households in the United States
own two or more VCRs. These households are capable of making unauthorized copies
of prerecorded videocassettes. Because almost 90% of all United States
households own at least one VCR, any of these households that also owns a DVD
player or a digital PPV set top box can make high quality videocassette copies
directly from their DVD players or set-top boxes, unless the programs are copy
protected. Even with the focus on digital media and growth in DVD, VCR sales
have continued at a record pace in the past two years. The Consumer Electronics
Association reported that 1999 unit sales of VCRs increased by approximately 25%
over 1998 sales in the U.S. With over 500 million VCRs installed throughout the
world, and with VCR sales continuing at a rapid pace, we believe that VCRs will
remain a home copying threat to video content owners for many years to come.
DVD Video Copy Protection. DVD hardware and media became commercially
available in the United States in 1997, and through the end of 1999
approximately 6.5 million DVD players had been shipped by manufacturers,
according to the Consumer Electronics Association. The introduction and
increasing usage of DVDs presents serious copy protection concerns to the
studios. Without effective copy protection, any one of the approximately 500
million VCRs throughout the world, when combined with a DVD player, can make
unlimited videocassette copies of a non-copy protected DVD that are nearly equal
in quality to a professionally prerecorded videocassette. Because of their
superior picture quality, lower manufacturing cost, relative ease of use and
smaller size, DVDs
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are expected to supplant videocassettes over time as the preferred home video
distribution medium. As DVD becomes the standard in home viewing, the need for
reliable copy protection is expected to become more important. DVD has
experienced substantial growth in the past two years, and a recent report by the
International Recording Media Association estimates that 165 million DVD discs
were manufactured in 1999, growing to 970 million in 2003, representing a 56%
compound annual growth rate.
PPV Copy Protection. Digital PPV enables consumers to view movies and
other programming in their homes through cable or satellite systems for an
additional fee for each viewing. We believe that digital PPV revenues at the
studio level were approximately $540 million in 1999. By contrast, studio
revenues from their home video business exceeded $8 billion in 1999. At present,
PPV revenues represent less than 10% of the home video market. PPV distribution
offers motion picture studios higher profit margins than they receive from home
video rentals or sales. Studios have realized the importance of copy protection
in digital PPV networks, and many of them have required, as a condition of
licensing their PPV movies, that digital PPV system operators install copy
protection capability in their digital set-top boxes.
In an effort to protect their home video revenues, studios typically
release a movie on PPV one to three months after it is released on videocassette
or DVD. Digital PPV providers, such as DIRECTV, EchoStar, ATT and Time Warner
have demonstrated that they can substantially increase the buy rates for PPV by
offering subscribers up to 60 PPV channels per cable/DBS system, and by
promoting convenience of frequent start times and greater variety of movies. In
the United States, the digital PPV system operators have fulfilled their studio
contracts by installing copy protection capability in their digital set top
boxes. However, they have told the studios that they will not activate copy
protection until and unless the studios release their movies to the PPV system
operators much closer to when they release them to home video. We believe that
this copy protection standoff between the system operators and the studios is
less of an issue in international markets, because the legacy PPV business is
not as well defined, the PPV operators are not as solidly entrenched with their
subscriber base, and the release window between home video and PPV is not as
contentious as in the United States.
Computer Software/CD-ROM Copy Protection. With the proliferation of
inexpensive high capacity PC-based hard disc drives, the increased penetration
of Internet connections to the home, and the availability of higher speed
bandwidth, consumers now have the means to widely distribute copies of software
and audio. Many consumers have the capability to copy from a CD-ROM, download
computer software and audio CDs to their hard drives, copy those downloaded
files onto a CD-recorder device, and distribute the unauthorized copied
software/audio through CD-ROMs or electronically over the Internet. Recently,
CD-recordable drives have been introduced that are priced below $150 and are
expected to become standard features in personal computers in the near future.
In addition, blank CD-ROM discs can be purchased for less than $1 in the United
States. As a result, computer software and PC-based video game companies are
facing an additional threat of lost revenues due to consumer copying of CD-ROM
software.
Internet Copy Protection. The Internet is increasingly being used as a
means to distribute software and audio and video content. The proliferation of
online content providers combined with new and evolving methods of online
content delivery have created a large market opportunity for copy protection
solutions as current technologies are highly susceptible to unauthorized usage
and duplication. We believe that there is a significant need for copy protection
solutions that address these new and emerging Internet downloading and streaming
technologies.
The Macrovision Solution
We develop and market a broad array of copy protection and rights
management technologies and solutions. We offer video copy protection
technologies and products that address the video content protection needs of
motion picture studios and other content owners, program distributors, and cable
and satellite PPV system operators. We offer CD-ROM copy protection and rights
management technologies to a variety of software publishers in the PC games,
home education, information publishing, and application software markets. We are
actively involved in developing and acquiring various technologies to meet the
needs of emerging delivery systems such as downloading and streaming of media
through the Internet, as well as technologies to prevent the unauthorized
copying of audio CDs.
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Video Copy Protection. Our video copy protection technologies allow
consumers to view programming stored on prerecorded videocassettes or DVDs or
transmitted as digital PPV programs through cable or by satellite, but deter
unauthorized consumer copying of such programming. Videocassettes are encoded
with our video copy protection signal as they are manufactured. Our licensed
copy protection signal generator equipment is installed in over 230 commercial
duplication facilities in 35 countries around the world. The unique patented
aspects of our copy protection signal are transparent to a TV set, but are
disruptive to the recording circuits of VCRs. The result is that videocassettes
encoded with our anticopy process will play normally on a TV set, but will cause
unwatchable copies to be made on the vast majority of VCRs. Our patented
technology takes advantage of the differences in TV signal processing circuits,
VCR playback circuits, and VCR recording circuits without the need for the
installation of any Macrovision components in VCRs.
In the DVD and digital PPV markets, we have implemented a more robust
version of our video copy protection technology. By utilizing another copy
protection component, called Colorstripe, we have made it more difficult for a
casual copier to defeat or circumvent our technology. In these digital video
applications, the copy protection is actually applied within the consumer
device. The copy protection signal generator is part of an integrated circuit
that converts digital video to analog video for output to a standard TV set or
VCR. The Macrovision capable chips remain dormant, until activated by data
commands which are either embedded in the DVD, or are sent along with the PPV
movie transmission to the subscriber's set-top box.
Computer Software/CD-ROM Copy Protection. Our SafeDisc technology seeks to
prevent the copying of CD-ROM computer software by encrypting the executable
files, embedding an authenticating digital signature and adding multi-layered
anti-hacking software. This is a proprietary software-based copy protection
solution that does not require any changes to standard PC or CD-ROM hardware.
Because SafeDisc is designed to operate while the disc is in the CD-ROM drive,
it is ideally suited to PC games and home education software. The technology is
licensed directly to interactive software publishers, and to mastering and
replication facilities that embed our patented digital signature in a CD-ROM
during the manufacturing process. SafeDisc was introduced in September 1998 and
has been licensed to more than 20 software publishers and 75 replicators
worldwide.
Products Under Development
We have four primary new product development programs in progress, which
we anticipate may result in commercial products in the year 2000: SafeDisc HD,
SafeCast, Audio CD copy protection and digital watermarking.
SafeDisc HD. SafeDisc HD is a version of SafeDisc designed to extend our
copy protection technology to any application software beyond the PC games and
education software markets. Several of our customers have requested a version of
SafeDisc that deters users from installing the same software in multiple hard
drives. SafeDisc HD will allow the CD-ROM to authenticate itself at the time of
initial installation, and will autotransfer an encrypted license manager module
from the CD-ROM to the user's hard drive. This gives the software publisher the
option of periodically requiring the user to reinsert the original disc to
verify ownership, or to reinsert the disc only when the hard drive is upgraded
or replaced. SafeDisc HD is currently in beta testing with a targeted release
date in mid-2000.
SafeCast. SafeCast is a family of digital rights management products
designed to provide software publishers with a variety of marketing options for
both packaged media and Internet delivery. SafeCast authenticates the end user's
license by transferring the software publisher's embedded digital rights
management technology from either a CD-ROM disc or from Internet downloaded
software to the user's PC hard drive at the time the application is initially
installed. SafeCast protects the launch of a licensed application by confirming
that the session conforms to the license terms established by the application's
publisher. These license terms can be promotional in nature. For example, a
software publisher may want to give the user a limited free trial period that
expires after a certain time. At the end of that period, the user would have to
pay the publisher for a permanent license. In addition to providing limited time
trials of full product versions for evaluation, electronic software distribution
publishers want to be able to support licensing networked applications beyond
Windows operating systems. Our SafeCast family of products is in various stages
of development and testing. We anticipate that we will introduce the first of
these products in the first half of 2000.
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Audio CD Copy Protection. Audio CD copy protection is a technology based
on TTR Technologies, Inc's ("TTR") Musicguard (TM) audio copy protection
technology. Our joint development/joint marketing arrangement with TTR gives us
the exclusive worldwide rights to market audio copy protection technology. The
major music labels have expressed interest in a technology, which would prevent
the copying of audio CDs to a PC or CD recordable device. We believe that the
music industry is a $40 billion per year industry compared to the $16 billion
per year home video industry. We believe that there has never been an effective
copy protection technology for audio because no one has been able to develop a
copy protection technique that does not interfere with the playback of the
original music. We recently began our joint development program with TTR and our
goal is to introduce the technology to the market in the second half of 2000.
Because of the limited testing and development to date, the development project
should be considered high risk, and it may not result in a commercial product.
Digital Watermarking. Digital watermarking is a digital-to-digital copy
protection solution designed to address the next generation of digital video
recording devices. We are working with Philips and Digimarc to refine our
solution currently under evaluation by Matsushita and the Copy Protection
Technical Working Group.
The Macrovision Strategy
Pursue Multiple Sources of Royalty-Based Licensing Revenue. As the sole
provider of copy protection for prerecorded videocassettes, DVDs and digital
PPV, and as the leading provider of CD-ROM based computer software copy
protection, we seek to license our technology to content owners pursuant to
unit-based and volume-based royalty schedules. We receive royalties and other
fees from:
o content owners;
o hardware manufacturers;
o digital PPV program distributors; and
o commercial replicators/duplicators.
We believe that there is a large and growing need for our copy protection
and rights management technologies and that we can continue to expand our
licensing business.
Introduce New Product Applications and Technologies. We have committed
significant resources to expand our technological base, to enhance our existing
products and to develop and market additional products in order to continue to
provide customers with leading copyright protection technologies. We intend to
propagate our technologies and maintain our technology leadership by investing
significant resources in research and development, and by leveraging our role in
industry standard-setting efforts and organizations. We intend to pursue
opportunities for copy protection and rights management in the following areas:
o digital video;
o audio CDs;
o Internet downloaded and streamed audio and video files;
o Internet downloaded software files;
o DVD-ROM; and
o improved authentication, compression, and encryption technologies.
Continue to Make Strategic Investments. We have made strategic equity
investments in Digimarc, AudioSoft and TTR, and we acquired C-Dilla after making
a strategic equity investment. We intend to continue to expand our existing
technologies and products by pursuing licensing arrangements, joint ventures,
strategic investments and acquisitions of companies whose products or
technologies extend or enhance the features or value of our copy protection and
rights management technologies.
Expand and Protect Patent Position. We believe that our future success
will depend, in part, on the continued protection of our proprietary copy
protection and rights management technologies. We have invested substantial
resources in developing and obtaining patents covering a number of processes and
devices that unauthorized
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parties could use to circumvent our video copy protection technologies. We use
these patents to limit the proliferation of such devices and we have initiated a
number of disputes relating to infringement of these patents. We intend to
continue to obtain patents and to protect and defend our patented technologies
aggressively through further technological innovation, legal action and support
of further legislative initiatives to protect content owners.
Leverage Key Customer Relationships. We strive to broaden the use of
existing applications for our technologies and to offer new or enhanced copy
protection and rights management technologies to secure our customers' content
and help them maximize their revenues. We currently maintain strong
relationships with customers in various industry and market segments, including:
o content providers such as the major Hollywood studios and the
leading PC games companies;
o content distributors such as the leading cable and satellite
television system operators;
o videocassette duplication and CD/DVD replication companies; and
o equipment manufacturers such as consumer electronics companies which
manufacture and sell DVD players, CD-ROM drives, and digital set-top
boxes.
We believe that increasing the number of content providers, distributors and
replicators, and equipment manufacturers that incorporate our copy protection
technologies into their mass market products enhances the attractiveness of our
solutions to rights owners. We intend to work with our customers to provide them
with solutions that exploit the full value, flexibility and breadth of our
technologies.
Technology Licensing and Marketing
Technology Licensing. We license, rather than sell our technologies. We
believe that content owners utilize our solutions to realize increased packaged
media sales, and increased revenues from downstream venues and to strengthen
relationships with retailers. We receive royalty payments as follows:
o content owners typically pay us a per unit licensing fee for the
right to use our proprietary technology for videocassette, DVD and
CD-ROM copy protection;
o licensed duplicators serving the low volume special interest video
content owner market pay us a per-unit fee for applying
videocassette copy protection;
o digital set-top box manufacturers typically license our video copy
protection technologies for an up-front fee and a per unit hardware
royalty;
o cable and satellite television system operators pay us a one-time
license fee for the right to incorporate our video copy protection
technology into their networks for PPV. In addition, we are entitled
to transaction-based royalty payments when copy protection for
digital PPV programming is activated by system operators;
o DVD-ROM and CD-ROM hardware manufacturers license our technology for
an up-front fee and an annual maintenance certification; and
o semiconductor manufacturers pay us a small one-time service fee to
verify proper implementation of our video copy protection
technologies in their integrated circuits.
Marketing. We market our videocassette, DVD and digital PPV and computer
software/CD-ROM copy protection technologies directly to content owners and
video producers. Our primary sales strategy for major accounts is to sell at the
headquarters level, covering customers' international operations. We supplement
our direct sales efforts with a variety of marketing initiatives, including
trade show participation, trade advertisements, industry education and
newsletters.
We develop worldwide product specifications and marketing programs for our
copy protection technologies in our Sunnyvale headquarters, and sell and support
our products and technologies through our own headquarters sales force, and
through our wholly owned subsidiaries in Japan and the United Kingdom. As of
December 31, 1999, we employed 33 sales and marketing personnel and an
additional 38 employees assisted in customer technical support.
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Customers
Video Copy Protection Licensees. Our copy protection technology has been
applied to more than 2.7 billion videocassettes worldwide since 1985, including
more than 550 million videocassettes in 1998 and more than 600 million
videocassettes in 1999. Leading studios and over 1,500 corporate, educational
and special interest content owners have contracted with licensed duplicators to
apply our copy protection process to their videocassettes. Our packaged media
copy protection technology for videocassettes and DVDs is used by the following
leading major motion picture studios and home video suppliers:
o Artisan Home Entertainment;
o Buena Vista Home Video (Disney);
o Columbia House;
o Columbia TriStar Home Video (Sony Pictures Entertainment);
o DreamWorks;
o HBO Home Video;
o New Line Home Video;
o NCP Marketing (Tae-Bo exercise tapes);
o Paramount Pictures;
o Twentieth Century Fox Home Entertainment;
o Universal Studios Home Video; and
o Warner Home Video.
No customer accounted for more than 10% of our net revenues in 1999. For
1998, revenues from one customer represented 12% of our net revenues. For 1997,
revenues from another customer accounted for 11% of our net revenues.
We also license our videocassette copy protection technology to special
interest customers that include independent video producers and corporations.
Licensed commercial duplicators act as distributors of our videocassette copy
protection technology to special interest customers. Revenues from special
interest customers in the United States accounted for approximately 11%, 11% and
12% of our video copy protection revenues in 1999, 1998, and 1997, respectively.
Consumer Electronics Hardware Manufacturers. We believe that our copy
protection technology is currently the only digital-to-analog copy protection
solution that satisfies the principles established by the DVD licensing and
standards group. As of December 31, 1999, 131 companies that manufacture DVD
players or DVD-ROM drives had signed agreements with us to incorporate our DVD
copy protection technology in their hardware.
Our copy protection technology is embedded in more than 30 million digital
set-top boxes currently in use worldwide. We have licensed our copy protection
technology for digital PPV to 51 set-top box manufacturers, including:
o A.B. Pace Micro Technology; o Philips;
o EchoStar; o Scientific-Atlanta;
o Motorola (General Instrument division); o Sony; and
o Hughes; o THOMSON multimedia.
o Nokia;
We have also authorized 57 companies to incorporate our digital PPV and
DVD copy protection technologies in their semiconductor designs. These companies
generally pay a one time service fee for verification of proper
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implementation of our video copy protection technology in digital-to-analog
application specific integrated circuits that are embedded in digital set-top
boxes and DVD hardware. They are authorized to sell their Macrovision-capable
integrated circuits to Macrovision-licensed DVD hardware manufacturers and to
Macrovision-licensed digital set-top box manufacturers.
System Operators. We have licensed our digital PPV copy protection
technology for incorporation into the networks of 15 system operators,
including:
o British Sky Broadcasting; o Hong Kong Telecom;
o DF-1; o NTL;
o DIRECTV; o Sky Latin America;
o EchoStar. o Sky Perfect; and
o Galaxy Latin America; o VNL.
These system operators have paid a one-time license fee to us and have
entered into agreements with us pursuant to which we are entitled to
transaction-based royalty payments at such time as copy protection for digital
PPV programming is activated. Other notable system operators which have not
signed license agreements with us, but which are requiring Macrovision-capable
set-top boxes in their networks include: AT&T, Comcast, Cox Enterprises,
Deutsche Telecom, Rogers Cable, Time Warner and Via Digital.
Computer Software/CD-ROM Publishers. We entered the computer software market
in 1998 with our SafeDisc product, aimed at the PC games market. We estimate
that over 30 million discs will be copy-protected with SafeDisc in 1999. Our
packaged media copy protection technology for computer software/CD-ROMs is used
by the following leading software publishers:
o Electronic Arts; o Lego;
o Eidos; o Mattel;
o GT Interactive; o Microsoft;
o Hasbro; o Take 2;
o Havas; o 3DO; and
o Interplay; o Ubisoft.
Our PC games software customers have a wide choice of licensed replicators
that they can use throughout the world. Over 75 replicators have been licensed
with the majority having already installed SafeDisc mastering and quality
assurance systems from authorized suppliers of these systems, including:
o Americ Disc; o MPO Disque Compact;
o Cinram International; o Nimbus
Manufacturing; and
o JVC Disc America; o Sonopress.
To expand our SafeDisc business beyond our direct licensing program with
the major publishers, we are in the process of setting up a reseller program
that will allow replicators to be our value added resellers so they can sell
SafeDisc copy protection to smaller publishers.
Technology
Videocassette Copy Protection. Effective video copy protection systems are
difficult to develop because of the need to address the dual requirements of
playability and effectiveness. Consumers must be able to view the copy protected
content using a VCR and a television set without the need for any intervening
devices, while the quality of an unauthorized copy must be reduced to such an
extent that it loses its entertainment value. The extent to which the
entertainment value is reduced varies, depending on the VCR model and the VCR
and television combination that plays the unauthorized copy. To prevent VCRs
from making good copies, the copy-protected video
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must differ in some manner from the standard video signal because, by design,
all VCRs will make good copies from standard video signals. Television sets are
designed to play standard or near-standard video signals. As a result, there is
a risk that making a video signal non-standard in order to prevent copying will
decrease playability by causing some television sets to generate impaired or
distorted pictures. In the tradeoff between effectiveness and playability,
designers of copy protection systems must favor playability while maintaining
effectiveness.
Our videocassette copy protection technology involves the patented
technique of inserting a series of electronic pulses in the vertical blanking
interval of a standard video signal. The vertical blanking interval is the blank
space between the video fields on television sets that are refreshed at a rate
of 60 fields per second. The copy protection pulses are embedded electronically
in the prerecorded content of the videocassettes in the process of videocassette
manufacturing. The electronic pulses are not visible in the television picture.
The pulses are intended to affect the automatic gain control circuit in the
recording system of most VCRs, but not to affect a similar circuit in the
television set. Therefore, when the consumer plays a copy protected prerecorded
videocassette, the picture is clean and crisp, but when the consumer plays an
unauthorized consumer-made copy of that same videocassette, the picture
typically is very distorted and has substantially reduced entertainment value.
Our video copy protection technology is effective against most consumer copying,
but generally does not deter professional pirates who use professional
duplication and video processing equipment.
DVD and Digital PPV Copy Protection. The DVD and digital PPV versions of
our video copy protection technologies employ both the electronic pulses used in
videocassettes and a second patented copy protection process called Colorstripe.
Colorstripe affects the color playback circuit of a VCR causing colored
horizontal stripes to appear in the picture of an unauthorized copy. The
combination of the two processes provides a higher level of effectiveness than
that provided by either process alone. In addition, Colorstripe is more
effective against circumvention by currently available professional duplication
equipment. Copy protection is implemented in DVD and digital PPV applications by
embedding a copy protection signal generator integrated circuit within the DVD
player or digital set-top box. The integrated circuit is activated by copy
protection control codes, which are integrated into the DVD media or the PPV
transmission. Once the integrated circuit is activated, it adds the copy
protection signal to the analog output of the DVD player or digital set-top box.
As with videocassette copy protection, consumers are able to see a clear picture
on their television sets, but generally cannot make a usable videocassette copy
on a VCR.
Computer Software/CD-ROM Copy Protection. Each CD-ROM published with the
SafeDisc technology is premastered with encrypted executable files and contains
authenticating instructions and a unique SafeDisc digital signature. The digital
signature, which cannot be copied by CD recorders or transferred from a CD-ROM
to a hard disc drive, or sent over the Internet, is added to each original disc
during the mastering/replication process. When a user inserts an original disc
in a CD-ROM drive, the authentication software reads the digital signature,
allowing the program to be decrypted and run normally. The digital signature and
authentication process is transparent to the user. If a consumer or pirate uses
a CD-recordable device or professional mastering equipment to duplicate a CD-ROM
and make an unauthorized copy, SafeDisc is designed to inhibit the transmission
of the digital signature, decryption will not take place and the copy will not
run.
SafeDisc also contains anti-hacking technology to prevent the compromise
of its security features. The anti-hacking technology is designed not only to
deter consumer copying, but also to thwart destructive hackers and commercial
hackers. Because of our widespread penetration in the PC games' market, hackers
have targeted and successfully cracked, to various degrees, several versions of
SafeDisc. In order for us to continue to be successful in this market, we must
continually stay a step ahead of the hacker community. Our customers have
indicated that if we can provide them with an approximate three-week time
between when they release a SafeDisc protected title, and when a hack is
developed on the Internet, they believe the technology is valuable since it
protects the most important period of their initial sales. We develop new
product releases approximately four to eight times per year incorporating new
anti-hacking features.
SafeDisc is covered by a pending patent application, and is compliant with
Philips' worldwide Yellow Book CD-ROM standard. We believe that SafeDisc is the
only copy protection technology that has received Philips' certification for
compliance.
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Research and Development
Our research and development efforts are focused on developing
enhancements to existing products, new applications for our current technologies
and new patentable technologies related to our various copy protection and
rights management markets. Our core technological competencies are in software
development, encryption, anti-hacking software, video and audio engineering,
watermarking, CD-ROM architecture, and integrated circuit designs.
We are developing with Philips and Digimarc a digital video watermarking
solution to address the digital-to-digital copying issues associated with the
next generation of DVD recording devices. Digital watermarks embedded in movies
and other video material act as an invisible identity providing basic copyright
identification information as well as various directions either to allow or to
disallow playback, viewing and copying onto another digital device. The jointly
developed technology is based on our patented play control technology,
Digimarc's patented watermarking technology, and Philips' patented watermarking
and authentication technology. Our solution can survive numerous
transformations, such as from digital to analog and back to digital, or from one
video format to another. The digital watermarks are designed to be imperceptible
to the viewer, but to be read easily by special purpose applications software or
semiconductor chips. This jointly developed technology is intended to protect
movies and other video content from unauthorized reproduction using digital
recording devices.
Following our acquisition of C-Dilla, we established their experienced
software development team as our mainstream software development organization.
This team is responsible for developing our computer software/CD-ROM and audio
CD copy protection products, as well as our Internet rights management
solutions.
As of December 31, 1999, our research and development staff consisted of
29 engineers and technicians. In 1999, 1998 and 1997, our expenses for research
and development were $4.4 million, $2.6 million, and $2.2 million, respectively.
Intellectual Property Rights
Patents Issued & Pending. We hold 44 United States patents and have 42
United States patent applications pending, 4 of which are patent applications
relating to computer software copy protection. Of the issued United States
patents, 27 relate to our copy protection technologies, 13 relate to video
scrambling, and 4 relate to audio scrambling. Our issued United States patents
expire between June 2000 and March 2015. The earliest of our core videocassette
and DVD copy protection patents expires in 2005. However, we have filed
applications for improvement patents, which, if issued, will extend such
expiration dates beyond 2010. We also have 213 foreign patents and 321 foreign
patent applications pending in 40 countries. Of the issued foreign patents, 152
relate to our copy protection technologies, 43 relate to video scrambling and 18
relate to audio scrambling.
Circumvention Technology Patents. Included in the patents related to our
copy protection technologies are 10 United States and 31 foreign patents
covering a number of processes and devices that unauthorized parties could use
to circumvent our video copy protection technologies. We have historically used
these patents to limit the proliferation of devices intended to circumvent our
video copy protection technologies. We have initiated a number of patent
infringement disputes against manufacturers and distributors of such devices. We
have one lawsuit of this type pending in Germany to require the defendants to
discontinue the sale of devices that circumvent our video copy protection
technologies and infringe one or more of our circumvention patents. In the event
of an adverse ruling in this litigation or in any similar litigation, the value
of our protection technology might decline due to the legal availability of such
a circumvention device or we might have to obtain rights to the offending
devices to protect the value of our technology.
Competition
Video Copy Protection. We believe that there are currently no significant
video copy protection competitors. Occasionally, companies have developed
hardware based on our technology for sale in small foreign markets where we have
not sought patent protection. Our video copy protection technologies are
proprietary and have broad international patent coverage. It is possible,
however, that a competitive video copy protection technology could be developed
in the future. For example, one of our customers could attempt to promote
competition by sup-
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porting the development of alternative copy protection technologies or
solutions, including solutions that deter professional duplication.
Digimarc, Philips, and ourselves, together known as the Millennium Group,
are jointly developing a digital media copy protection solution, using
proprietary watermarking and play control technologies, to address the
digital-to-digital copying issues associated with the next generation of DVD
recording devices. Our group submitted its proposed solution to the Copy
Protection Technical Working Group, an industry standards body. A technology of
choice for the Copy Protection Technical Working Group will be selected by
Matsushita Electric Industries, which is acting as the decision-maker given
their role as the lead DVD licensing entity. The Millennium Group is competing
with another consortium, the Galaxy Group, which is comprised of IBM, NEC, Sony,
Hitachi, and Pioneer. We believe that our group's solution offers a number of
advantages in security and resistance to hacking, as well as in the economics of
implementation. We also believe that our group has a dominant patent position
with 16 issued patents. The group whose digital media copy protection solution
is selected as the industry standard by Matsushita will have a significant
advantage in licensing its technology to video content owners worldwide and in
working with consumer electronics manufacturers, PC platform companies and their
suppliers to implement digital-to-digital copy protection.
Computer Software/CD-ROM Copy Protection. We believe that there are a
limited number of competitors in the computer software/CD-ROM copy protection
market, including LaserLock, PAN Technologies and Sony's DADC optical disk
manufacturing subsidiary. None of these companies appear to have made
significant penetration with major publishers in developed countries, and we
believe we have captured the majority market share of the PC games market.
It is possible that our own customers may develop software copy protection
technologies on their own. It is also possible that personal computer operating
system and microprocessor companies like Microsoft, Sun Microsystems, Red Hat,
and Intel, may develop or license copy protection modules or systems which are
internal to the PC.
We believe that our ability to compete depends on many factors both within
and beyond our control, including:
o the performance of our technology including ease of use by software
developers, compatibility with installed base of PC and CD-ROM
drives, resistance to hackers;
o the effectiveness of our sales and marketing efforts;
o our ability to establish and support a worldwide base of licensed
replicators, and to provide through third party replication
equipment vendors the digital signature technology and associated
quality control systems; and
o our ability to match our licensing and pricing programs to the value
of our technology.
SafeDisc HD and SafeCast. We do not believe we have any significant
competitors for SafeDisc HD. Our target market for SafeCast has been broadly
defined as electronic software distribution, and electronic license delivery for
application software. Both markets are new, intensely competitive, and rapidly
evolving. Our primary competition currently comes from, or is expected to come
from:
o companies offering digital rights management, electronic licensing,
or electronic software distribution technology;
o companies who have historically offered hardware dongle products and
who are shifting to software-based protection;
o companies who are operating system manufacturers or microprocessor
suppliers, who may choose to integrate rights management solutions
into their products; and
o companies who are software resellers who have developed their own
e-commerce solutions.
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Operations and Technical Support
We have a sizeable technical support/certification operation to support
our DVD manufacturer licensees, set top box licensees, authorized semiconductor
manufacturers, and our other hardware licensees. This operation is responsible
for analyzing our licensees' products to ensure that they have implemented the
video copy protection features with our specifications for both video waveforms
and security/tamper resistance.
We provide technical support to our videocassette, DVD, digital PPV and
Computer Software/CD-ROM customers in various ways:
o we support our licensed duplicators with hardware installation
assistance and quality control. In addition, we support licensed
duplicator sales personnel by providing sales training and sales
incentive programs and literature and by participating in trade
shows;
o we support the efforts of television, VCR and DVD hardware
manufacturers, digital PPV system operators and PPV set-top box
manufacturers to design hardware that is compatible with our video
copy protection technologies;
o we assist semiconductor manufacturers in incorporating our video
copy protection technologies into digital video integrated circuits
for digital to analog converters;
o we regularly test the effectiveness and transparency of our video
copy protection technologies on representative samples of consumer
televisions and VCRs to determine whether modifications or
enhancements may be necessary; and
o we provide training and application support for the SafeDisc
toolkit; and
o we test for SafeDisc compatibility with PC and CD-ROM drive
combinations.
In the Computer Software/CD-ROM copy protection business line, we have
taken the same rigorous approach to testing for compatibility and effectiveness
as we do for video copy protection. We have assembled two separate consumer test
groups with more than 500 individuals, one in the United States and one in the
United Kingdom that we utilize for major releases of software. These individuals
have a wide variety of PC and CD-ROM drive combinations, and they are invaluable
in stress testing the SafeDisc software.
We have minimal manufacturing operations. Our strategy is to license our
technologies to third parties that manufacture products incorporating our
technologies. Our manufacturing operations are limited to low volume video copy
protection hardware products that require in-house system integration and
quality control efforts.
Strategic Investments
We intend to expand our technology base in current as well as new markets,
through the strategic investments in companies with complementary or compatible
technologies or products. We have made strategic investments in the following
companies:
Digimarc Corporation. In December 1997, we invested $1.5 million in
Digimarc and we invested another $2 million in June 1999. Digimarc completed an
initial public offering in December 1999, and we currently own approximately
7.7% of the company. We have an agreement with Digimarc to jointly develop a
digital video watermarking copy protection solution to address the
digital-to-digital copying issues associated with the next generation of
recordable DVD and digital videocassette recording devices.
Digimarc is a leading provider of patented digital watermarking
technologies that allow imperceptible digital code to be embedded in traditional
and digital content, including movies, photographic images and documents such as
financial instruments, passports and event tickets. Digimarc's technologies
enable new communications capabilities related to protecting copyrights,
deterring counterfeiting or piracy and, for the first time, directly linking
physical content with the Internet.
We are working with Digimarc and Philips in a consortium known as the
Millennium Group to jointly develop a watermarking copy protection solution to
address the digital-to-digital copying issues associated with the next
generation of DVD and digital videocassette recording devices. The only other
competitor is the Galaxy Group, which is a consortium of IBM, NEC, Sony, Pioneer
and Hitachi. Both groups have proposed solutions to the Copy
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Protection Technical Working Group, an industry group comprised of the Motion
Picture Association of America studios, PC manufacturers and consumer
electronics companies. Currently Matsushita Electric Industries and members of
the Copy Protection Technology Working Group are evaluating results of systems
testing and proposed terms and conditions.
TTR Technologies, Ltd. In January 2000, we invested $4.0 million to
acquire an 11.4% equity interest in TTR. In addition, we have entered into an
agreement with TTR to jointly develop and market a copy protection product
designed to inhibit casual copying of music CDs using dual-deck CD recorder
systems and personal computer based CD recordable drives. TTR is a provider of
proprietary digital anti-piracy technologies and products.
AudioSoft International. In August 1999, we invested $750,000 in AudioSoft
for approximately 7.3% of the outstanding shares of the company. We have
committed to invest an additional $750,000 should AudioSoft attain certain
commercial milestones by March 31, 2000. As part of our agreement with
AudioSoft, we will also provide strategic marketing and technical consulting
services to AudioSoft and will assist AudioSoft in gaining adoption of its
technologies and systems. We will also work with AudioSoft to extend its core
technologies into the video domain. AudioSoft is an e-commerce solutions company
dedicated to the secure electronic distribution of music over the Internet.
AudioSoft technologies provide the music industry with a turnkey solution to
deliver copyrighted music electronically over the Internet on a worldwide basis
and to ensure that in-country music copyright collection societies are properly
compensated for performing and mechanical rights.
Command Audio Corporation. In October 1995, Command Audio Corporation, or
CAC, was initially incorporated as our wholly-owned subsidiary to commercialize
a distinct and new audio-on-demand technology. CAC's audio-on-demand system
consists of a program center that provides continuously updated news and
information on a subscription basis and a hand-held portable receiver that
stores the information. The system allows consumers to control the timing and
content of the program playback. In August 1996, we divested all but 19.8% of
our ownership in CAC. We assigned to CAC all rights in specified technology and
released its reversion rights in technology that we had previously assigned to
CAC. CAC agreed to pay to us royalties equal to 2.0% of its gross revenues for
12 years, beginning when CAC has operating revenues from certain sources or, at
our election, at any time prior thereto. As of December 31, 1999, we have
invested $3.7 million and own approximately 7.8% of the outstanding shares of
CAC.
RPK Security, Inc. In March 2000, we invested $1.0 million to acquire a
5.3% equity interest in RPK Security, Inc. ("RPK"). RPK develops encryption
technology for high data flow Internet applications such as streaming media and
digital communication.
Employees
As of December 31, 1999, we had 129 employees. We had 33 in sales and
marketing, 29 in engineering, 38 in technical support and operations and 29 in
general and administrative capacities. Of these employees, 51 are based outside
of the United States. None of our employees is covered by a collective
bargaining agreement or is represented by a labor union with respect to their
employment by us. We have not experienced any organized work stoppages
andconsider our relations with our employees to be good.
We use a variety of incentive programs to motivate our employees,
including annual performance-based bonuses, stock purchase plans, stock options,
special recognition awards, and a package of other benefit programs including a
401(k) plan, medical/dental benefits, compensating time for community service
and health club reimbursement.
Our engineering teams work on new products and enhancements, and also
contribute to our technical due diligence efforts when we invest in partner
companies, conclude joint development agreements, or acquire exclusive rights to
certain partner technologies. In connection with our acquisition of C-Dilla we
acquired its software development organization. C-Dilla's engineering staff
consists of highly skilled software architects, encryption specialists, and
senior software developers. We intend to use this resource to develop our
SafeCast management technology products, as well as our proposed audio copy
protection solution.
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Our technical support staff provides customer sales support and conducts
extensive compatibility and effectiveness tests for our various copy protection
technologies. In addition, this staff runs an extensive certification lab to
confirm that our licensees have implemented our video copy protection
technologies properly in integrated circuits and DVD or set-top box hardware.
Our sales and marketing groups include senior executives who run our
business lines and provide executive level account management to our major
customers. Our in-house legal department provides licensing and patent counsel
to our business line vice presidents.
In addition to the other information contained in this Annual Report on
Form 10-K, you should consider carefully the following risks. If any of these
risks occurs, our business, financial condition or operating results could be
adversely affected.
RISK FACTORS
Company Risks
We depend on video copy protection technology and on advocacy of this technology
by major motion picture studios, and failure of the major motion picture studios
to support out technology could harm our business.
In the event that the major motion picture studios, or other customers of
our video copy protection technology were to determine that the benefits of
using our technology did not justify the cost of licensing the technology,
demand for our technology would decline. We currently derive a majority of our
net revenues and operating income from fees for the application of our patented
video copy protection technology to prerecorded videocassettes and DVDs of
movies and other copyrighted materials that video retailers sell or rent to
consumers. These fees represented 65.5%, 77.2% and 67.3% of our net revenues
during 1999, 1998 and 1997, respectively.
Any future growth in revenues from these fees will depend on the use of
our video copy protection technology on a larger number of videocassettes, DVDs
or digital pay-per-view, or PPV, programs. In order to increase or maintain our
market penetration, we must continue to persuade content owners that the cost of
licensing the technology is outweighed by the increase in revenues that the
content 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.
Any factor that results in a decline in demand for our video copy
protection technology, including a change of video copy protection policy by the
major motion picture studios or a decline in sales of prerecorded videocassettes
and DVDs that are encoded with our video copy protection technology, would have
a material adverse effect on our business. If several of the motion picture
studios withdraw their support for our copy protection technologies or otherwise
determine not to copy protect a significant portion of prerecorded
videocassettes or DVD or digital PPV programs, our business would be harmed.
We may experience fluctuations in future operating results, which may adversely
affect the price of our common stock.
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. We
may not be able to grow in future periods, or we may not 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
reporting from licensees and videocassette and optical disc manufacturers, or
replicators, resulting in a potentially more significant level of volatility in
the price of our common stock. Factors which could cause the price of our common
stock to decline include:
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o the timing of releases of popular movies on videocassettes or DVDs
or by digital PPV transmission;
o the ability of the Motion Picture Association of America studios to
produce one or more "blockbuster" titles on an annual basis;
o the degree of acceptance of our copy protection technologies by
major motion picture studios and software companies;
o the timing of releases of computer software CD-ROM multimedia
titles: and
o the degree to which various hacking technologies are viewed to be
successful by our customers.
We experience seasonality in our operating results, which may affect the price
of our common stock.
We have experienced significant seasonality in our business, and our
business is 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 our customers to release
their more popular movies 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, our revenues have
tended to be lower in the summer months, particularly in Europe.
We depend on a small number of key customers for a high percentage of our
revenues and the loss of a significant customer could result in a substantial
decline in our revenues and profits.
Our customer base is highly concentrated among a limited number of
customers, primarily due to the fact that the Motion Picture Association of
America studios dominate the motion picture industry. Historically, we have
derived the majority of our net revenues from a relatively small number
customers. For 1999, no one customer accounted for more than 10% of our net
revenues. For 1998, one of our customers accounted for more than 12% of our net
revenues. For 1997, revenues from another one of our customers accounted for 11%
of our net revenues. The Motion Picture Association of America studios as a
group accounted for 34.4%, 45.1% and 38.6% of our net revenues in 1999, 1998 and
1997, respectively.
We expect that revenues from the Motion Picture Association of America
studios will continue to account for a substantial portion of our net revenues
for the foreseeable future. We have agreements with six of the major home video
companies for copy protection of a substantial part of their videocassettes
and/or DVDs in the United States. These agreements expire at various times
ranging from March 2000 to December 2004. The failure of any one of these
customers to renew its contract 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 our business would be harmed.
Most of our other videocassette copy protection customers license our
technology on an annual contract basis or title-by-title or month-by-month. Our
current customers may not continue to use our technology at current or increased
levels, if at all, or we may not be able to obtain new customers. The loss of,
or any significant reduction in revenues from, a key customer would harm our
business.
We are dependent on international sales for a substantial amount of our revenue.
We face diverse risks of international business, which could adversely affect
our operating results.
International and export sales together represented 45.6%, 44.5% and 46.5%
of our net revenues in 1999, 1998 and 1997, respectively. We expect that
international and export 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 networks, DVDs, and
computer software CD-ROMs, and the use of copy protection in these media.
To the extent that foreign governments impose restrictions on importation of
programming, technology or components from the United States, the requirement
for copy protection in these markets could diminish. In addition, the laws of
some 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 avail-
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ability 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 technology.
Due to our reliance on international and export sales, we are subject to
the risks of conducting business internationally, including:
o foreign government regulation;
o changes in diplomatic and trade relationships;
o changes in, or imposition of, regulatory requirements;
o tariffs or taxes and other trade barriers and restrictions; and
o difficulty in staffing and managing foreign operations.
Our business could be materially adversely affected if foreign markets do
not continue to develop, if we do not receive additional orders to supply our
technologies or products for use in foreign prerecorded video, PPV and other
applications requiring our copy protection solutions or if regulations governing
our international business change. For example, under the United States Export
Administration Act of 1979, encryption algorithms such as those used in our
computer software copy protection technology 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.
Foreign currency fluctuations could adversely affect our operating results.
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. Our future
results of operations may be materially adversely affected by currency
fluctuations.
We may be unable to manage our growth, and if we cannot do so, it could harm our
business.
The growth of our business has placed, and is expected to continue to
place, significant demands on our personnel, management and other resources. Our
future results of operations will depend in part on the ability of our officers
and other key employees to continue to implement and expand our operational,
customer support and financial control systems and to expand, train and manage
our employee base. In order to manage our future growth successfully, we will
need to hire additional personnel and augment our existing financial and
management systems or implement new systems. We may not be able to augment or to
implement these systems efficiently, or on a timely basis, or to manage any
future expansion successfully. The failure to do so could harm our business.
Potential intellectual property claims and litigation could subject us to
significant liability for damages and invalidation of our property rights.
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. We are currently subject
to several legal proceedings. See "Legal Proceedings."
Litigation could harm our business and result in:
o substantial settlement or related costs, including indemnification
of customers;
o diversion of management and technical resources;
o discontinuing the use and sale of infringing products;
o expending significant resources to develop non-infringing
technology; and
o obtaining licenses to infringed technology.
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
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to protect our intellectual property rights. Our patents, trademarks or
copyrights may be challenged and invalidated or circumvented. Our patents may
not be of sufficient scope or strength or be issued in all countries where our
products can be sold. The expiration of some of our patents may harm our
business.
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 some 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 the steps we have taken may not prevent
misappropriation of our technologies.
It may be time-consuming and costly to enforce our patents against devices and
hacking techniques that attempt to circumvent our copy protection technology,
and our failure to control them could harm our business.
We use our patents to limit the proliferation of devices intended to
circumvent our video copy protection technologies. In the past, we have
initiated a number of patent infringement disputes against manufacturers and
distributors of these devices. Any legal action that we may initiate could be
time-consuming to pursue, result in costly litigation, and divert management's
attention from day-to-day operations.
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.
A limited number of DVD manufacturers may build products which either do
not contain our copy protection technology, or include features that allow
consumers to bypass copy protection. Though we believe this is in contravention
of the Digital Copyright Millennium Copyright Act, as well as the basic DVD CSS
license, proliferation of these products could cause a decline in demand for our
technologies, which could harm our business. Any legal or other enforcement
action that we may initiate could be time consuming to pursue, result in costly
litigation, and divert management's attention from day-to-day activities.
In the computer software copy protection market, a number of individuals
have developed and posted SafeDisc hacks on the Internet. If we are not able to
generate frequent SafeDisc software releases, which deter the hackers from
developing circumvention techniques, our customers could reduce their usage of
our technology because it was compromised. Although the anti-circumvention
provisions in the Digital Millennium Copyright Act may be applicable to Internet
service providers who support the hacker sites, any legal action that we
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 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
technologies or products, which may not prove to be of long-term benefit to us.
We currently hold minority equity interests in three privately held companies,
Command Audio Corporation, AudioSoft and RPK, and two publicly traded companies,
Digimarc and TTR.
The negotiation, creation and management of these strategic relationships
typically involve a substantial commitment of our management time and resources,
and we may never recover the cost of these management resources. We may in the
future be required to write off all or part of one or more of these investments
which could harm our business.
Our strategic investments typically involve joint development or marketing
efforts or technology licensing. Any joint development efforts may not result in
the successful introduction of any new products by us or a third party, and any
joint marketing efforts may not result in increased demand for our products.
Further, any current or future strategic investments by us may not allow us to
enter and compete effectively in new markets or improve our performance in any
current markets.
We depend on third parties to develop SafeDisc compatible encoding and quality
assurance applications.
20
<PAGE>
We rely on third party vendors such as DCA, Eclipse, Media Morphics, CD
Associates, Koch Media and Audio Development to develop add-on enabling software
modules that will:
o apply the SafeDisc digital signature at licensed replication
facilities;
o allow replicators to run specialized quality assurance tests to
ensure the SafeDisc technology is applied; and
o check for manufacturing defects in the mass produced discs.
Our operations could be disrupted if our relationships with third party
vendors are disrupted or if their products are defective, not available or not
accepted by licensed replicators. This could result in a loss of customer orders
and revenue.
We must establish and maintain licensing relationships to continue to expand our
business, and failure to do so could harm our business prospects.
Our future success will depend upon our ability to establish and maintain
licensing relationships with companies in related business fields, including:
o videocassette duplicators;
o international distributors of videocassettes;
o DVD authoring facilities and replicators;
o DVD authoring tools software companies;
o DVD hardware manufacturers;
o semiconductor and equipment manufacturers;
o operators of digital PPV networks;
o consumer electronics and digital PPV set-top hardware manufacturers;
and
o CD-ROM mastering facilities and replicators.
Other parties may not perform their obligations as expected and our
reliance on others for the development, manufacturing and distribution of our
technologies and products may result in unforeseen problems. Substantially all
of our license agreements are non-exclusive, and therefore our licensees are
free to enter into similar agreements with third parties, including our
competitors. Our licensees may develop or pursue alternative technologies either
on their own or in collaboration with others, including our competitors.
If we do not retain our key employees and attract new employees, our ability to
execute our business strategy will be impaired.
We compete for employees in California's Silicon Valley, one of the most
challenging employer environments in the United States. Hiring for key personnel
is highly competitive. Because of the specialized nature of our business, our
future success will depend upon our continuing ability to identify, attract,
train and retain other highly skilled managerial, technical, sales and marketing
personnel, particularly as we enter new markets. The loss of key employees could
harm our business.
Industry Risks
We are introducing products into the evolving market for digital PPV copy
protection, and if this market does not develop or we are unable to effectively
serve this market, our revenues will be adversely affected.
While our copy protection capability is embedded in more than 30 million
digital set-top boxes manufactured by the leading digital set-top box
manufacturers, only four system operators have activated copy protection for
digital PPV programming. Our ability to expand our markets in additional home
entertainment venues such as digital PPV will depend in large part on the
support of the major motion picture studios in advocating the incorporation of
copy protection technology into the hardware and network infrastructure required
to distribute such video
21
<PAGE>
programming. The Motion Picture Association of America studios may not require
copy protection for any of their PPV movies or PPV system operators may not
activate copy protection in other digital PPV networks outside of Japan, Hong
Kong or the United Kingdom.
Further, consumers may react negatively to copy protected PPV programming
because 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, some television sets or combinations of VCRs
and television sets may exhibit impaired pictures while displaying a copy
protected digital PPV program. If there is consumer dissatisfaction that cannot
be managed, or if there are technical compatibility problems, our business would
be harmed.
Potential revenue may be lost if our digital video watermarking technology is
not selected as an industry standard.
In cooperation with Philips and Digimarc, we are jointly developing a
digital video watermarking solution to address the digital-to-digital copying
issues associated with the next generation of DVD recording devices. Our group
has submitted a proposed solution to the DVD Copy Control Association, or
DVD/CCA, a wholly owned subsidiary of Matsushita Electric Industries, which has
assumed responsibility for selecting the industry standard. Our group is
competing with a consortium of five other companies, comprised of IBM, NEC,
Sony, Hitachi and Pioneer, that have submitted a similar proposal to the DVD/
CCA. Some of these companies have substantially greater name recognition and
significantly greater financial, technical, marketing and other resources than
Philips, Digimarc and ourselves.
Our digital watermarking technology may not be selected by the DVD/CCA.
The group whose digital video watermarking solution is selected will have a
significant advantage in licensing its technology to video content owners
worldwide, and in working with consumer electronics manufacturers, PC platform
companies and their suppliers to implement digital-to-digital copy protection.
Even if the DVD/CCA adopts our solution, other companies may elect to compete in
this market. If the solution being developed by Philips, Digimarc and ourselves
is not the selected solution or otherwise is not widely adopted by studios or
consumer electronics manufacturers, our group will be at a competitive
disadvantage in marketing our solution. The solution being developed by our
group may not be selected as the standard by the DVD/CCA or our solution may not
achieve market acceptance as the market and the standards for digital-to-digital
copy protection evolve.
We have recently entered the market for computer software copy protection, and
we do not know if we will be successful in selling our products in this market.
We acquired C-Dilla in June 1999. C-Dilla's products include SafeDisc, our
copy protection technology for CD-ROM software products in the consumer
multimedia market. The market for copy protection of CD-ROMs is unproven, and we
may not be successful in developing this market.
For us to be successful in entering this new market, producers of
multimedia CD-ROMs must accept copy protection generally and also adopt our
SafeDisc solution. Copy protection of multimedia CD-ROMs may not 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 a CD-ROM.
Moreover, copy protection may not be effective or compatible with all PC and
CD-ROM 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. 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 would be harmed.
We are entering the market for music CD copy protection and we do not know if we
will be successful in selling our products in this market.
We have entered into a strategic relationship with TTR to develop and
market a copy protection system that will inhibit casual copying of music CDs
using dual-deck CD recorder systems or personal computer systems. A number of
competitors and potential competitors may be developing similar and related
music copy protection
22
<PAGE>
solutions. The solution we expect to market may not achieve or sustain market
acceptance, or may not meet, or continue to meet, the demands of the music
industry. It is possible that there could be significant consumer resistance to
audio copy protection, as consumers may feel that they are entitled to copy
audio CDs, because no technology has been used in the past to prevent copying.
It is not clear what the reaction of the major music labels would be to any
consumer resistance.
If the market for music CD copy protection fails to develop, or develops
more slowly than expected, if our solution does not achieve or sustain market
acceptance or if there is consumer resistance to this technology, our business
would be harmed.
If we are unable to successfully compete against competitive technologies that
may be developed in the future our business will be harmed.
We believe that there are currently no significant videocassette copy
protection competitors other than companies that have occasionally developed
hardware based on our technology for sale in small foreign markets, where we
have not sought patent protection. It is possible, however, that a competitive
copy protection technology could be developed in the future. For example, our
customers could attempt to promote competition by supporting the development of
alternative copy protection technologies or solutions, including solutions that
deter professional duplication. Increased competition would be likely to result
in price reductions and loss of market share, either of which could harm our
business.
Problems related to the year 2000 risks may not appear for several months after
January 1, 2000.
We believe that we have successfully rendered our product, internal
management and other administrative systems and external information systems
year 2000 compliant. Since January 1, 2000 we have experienced no disruptions in
our business operations as a result of year 2000 compliance problems or
otherwise, and have received no reports of any year 2000 compliance problems
with our products. To date, the total cost of our efforts to address year 2000
compliance has not been material.
Nonetheless, some problems related to the year 2000 risks may not appear
until several months after January 1, 2000. Year 2000 issues could include
problems with our own products or with third-party products or technology that
we use. Any problems that are not identified and corrected successfully and
completely could adversely affect our business.
Investment Risks
Our management has broad discretion as to how to use the proceeds from our
recent offering and the proceeds may not be used appropriately.
We expect to use the net proceeds of our recent offering primarily for
strategic investments, working capital and other general corporate purposes. In
particular, we intend to pursue strategic investments in businesses, products or
technology which would complement our existing products, expand our market
coverage or enhance our technological capabilities. We have no specific plan as
to how we will spend the majority of the proceeds of this offering. If our
management uses poor judgment in spending the proceeds, our business will be
adversely affected. Investment of the proceeds from this offering may not yield
a favorable return or any return.
Substantial sales of our common stock in the public market could cause our stock
price to fall.
If our stockholders sell substantial amounts of our common stock in the
public market, including shares issued upon the exercise of outstanding options,
the trading price of our common stock could fall. Such sales also might make it
more difficult for us to raise capital in the future at a time and price that we
deem appropriate.
JVC is entitled to register up to 3,161,952 of its shares under the
Securities Act of 1933. JVC has the right to participate in any registration of
shares we undertake on our own, except a registration of shares in connection
with an employee benefit plan or merger. If JVC exercises its registration
rights, a large number of our shares may be registered and sold in the public
market. This could adversely affect the trading price for our shares. If we
attempted to raise money through a registration and sale of our stock and JVC
required us to allow them to participate in
23
<PAGE>
the registration, our ability to raise the amount of money we need to execute
our business plan could be adversely affected.
The price of our common stock may be volatile.
The market price of our common stock has been, and in the future could be,
significantly affected by factors such as:
o actual or anticipated fluctuations in operating results;
o announcements of technical innovations;
o new products or new contracts;
o competitors or their customers;
o governmental regulatory action;
o developments with respect to patents or proprietary rights;
o changes in financial estimates by securities analysts; and
o general market conditions.
In addition, announcements by the Motion Picture Association of America or
its members, satellite television operators, cable television operators or
others regarding motion picture distribution, computer software companies
business combinations, evolving industry standards or other developments could
cause the market price of our common stock to fluctuate substantially.
Further, the trading prices of the stocks of many technology companies,
including our share price, are at or near historical highs and reflect
price/earnings ratios substantially above historical levels. There can be no
assurance that these trading prices and price/earnings ratios will be sustained.
In the past, following periods of volatility in the market price of a company's
securities, securities class action litigation has been initiated against that
company.
ITEM 2. PROPERTIES.
Our principal operations are located in a 43,960 square foot building in
Sunnyvale, California. The lease for this building expires on June 30, 2002 and
we have the right to renew the lease for two additional terms of five years
each. We also lease space for sales, marketing and technical support operations
in South Ruislip, United Kingdom and in Tokyo, Japan. Our C-Dilla software
development team is based in a leased facility in Woodley, United Kingdom. We
believe that our existing facilities are adequate to meet our current needs.
ITEM 3. LEGAL PROCEEDINGS.
We are involved in legal proceedings related to some of our intellectual
property rights.
Krypton Co., Ltd., a Japanese company, filed an invalidation claim against
one of our copy protection patents in Japan. After a hearing in March 1999, the
Japanese Patent Office has recommended that our patent be invalidated. We
believe that this conclusion was reached in error. On December 27, 1999, we
submitted to the Tokyo High Court a written statement indicating that the
decision of invalidity of the Macrovision patent should be overturned. In
February 2000, a second round of preparatory proceedings was conducted before
the Tokyo High Court, with Oral Arguments in March 2000. On March 21, 2000 the
Tokyo High Court rendered a decision revoking the Japanese Patent Office
invalidation of June 7, 1999. It is believed that in accordance with the Tokyo
High Court decision, the Japanese Patent Office will automatically issue the
above described decision. In connection with this process, the scope of our
claims under the patent have been very slightly reduced in scope. This reduction
in scope is not expected to have a material affect on the the value of this
patent to our business. This means that the present patent will be maintained in
the form of the claims after amendment.
24
<PAGE>
Until a final decision by the Japanese Patent Office is rendered, the
patent remains valid and part of our business. If there is an adverse ruling in
the Japanese Patent Office on this invalidation claim, we might incure 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.
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 us. 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 we have 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 us is invalid and that Cavendish's products do not infringe the patent. We
intend to defend the allegations in the counterclaim vigorously.
We initiated a patent infringement lawsuit in March 1999 against Vitec
Audio und Video GmbH, a German company, which manufactures what we believe to be
a video copy protection circumvention device. Vitec has filed a reply brief
arguing that its product does not infringe. The case is being heard in the
District Court of Dusseldorf, Germany. In the event of an adverse ruling, we may
incur a corresponding decline in demand for our video copy protection
technology, which could harm our business in our Germany operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
We did not submit any matters to a vote of security holders during the
quarter ended December 31, 1999.
25
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) Our common stock has been traded on the Nasdaq National Market under
the symbol "MVSN" since our initial public offering on March 13, 1997. The
following table sets forth, for the periods indicated, the reported high and low
split adjusted closing prices for our common stock.
High Low
1998
First Quarter .......................... 4.828 3.688
Second Quarter ......................... 6.125 4.375
Third Quarter .......................... 7.438 4.438
Fourth Quarter ......................... 11.156 6.250
1999
First Quarter .......................... 10.063 7.406
Second Quarter ......................... 18.719 8.344
Third Quarter .......................... 23.531 14.031
Fourth Quarter ......................... 39.250 21.625
As of March 20, 2000, there were 120 holders of record of our common
stock, based upon information furnished by Boston EquiServe, Boston, MA, the
transfer agent for our securities. As of March 20, 2000, there were 40,166,364
shares of common stock outstanding.
We have not declared or paid any cash dividends on our common stock since
1994. We do not anticipate paying any cash dividends on our common stock in the
foreseeable future. We intend to retain all earnings for use in our business
operations and in the expansion of our business.
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected consolidated financial data and
other operating information. The financial data and other operating information
do not purport to indicate results of operations as of any future date or for
any future period. The financial data and operating information is derived from
our consolidated financial statements and should be read in conjunction with the
consolidated financial statements, related notes and other financial information
included herein.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------------
1999 1998 1997 1996 1995
----- ----- ----- ----- -----
(in thousands, except per share data)
Consolidated Statement of Income Data:
<S> <C> <C> <C> <C> <C>
Net revenues ......................................... $ 37,390 $ 24,434 $ 20,340 $ 17,080 $ 14,189
-------- -------- -------- -------- --------
Costs and expenses:
Cost of revenues ................................... 3,012 2,081 2,422 2,579 2,457
Research and development ........................... 4,402 2,578 2,248 2,527 2,161
Selling and marketing .............................. 8,973 5,985 5,765 5,090 4,270
General and administrative ......................... 5,529 4,621 4,149 3,566 3,118
Amortization of intangibles from
acquisition (1) ...................................... 1,600 -- -- -- --
In process research and development (1) .............. 4,286 -- -- -- --
-------- -------- -------- -------- --------
Total costs and expenses ............................. 27,802 15,265 14,584 13,762 12,006
-------- -------- -------- -------- --------
Operating income from continuing
operations ........................................... 9,588 9,169 5,756 3,318 2,183
-------- -------- -------- -------- --------
Interest and other income (expense), net ............. 1,603 1,102 478 (260) (433)
-------- -------- -------- -------- --------
</TABLE>
26
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C>
Income from continuing operations
before income taxes ................................ 11,191 10,271 6,234 3,058 1,750
Income taxes ......................................... 3,961 3,929 2,413 1,223 694
-------- -------- -------- -------- --------
Income from continuing operations .................... 7,230 6,342 3,821 1,835 1,056
Loss from discontinued operations,
net of tax benefit ................................. -- -- -- (827) (125)
-------- -------- -------- -------- --------
Net income ........................................... 7,230 6,342 3,821 1,008 931
Preferred stock dividends ............................ -- -- (156) (587) --
-------- -------- -------- -------- --------
$ 7,230 $ 6,342 $ 3,665 $ 421 $ 931
======== ======== ======== ======== ========
Basic earnings per share ............................. $ 0.20 $ 0.20 $ 0.14
======== ======== ========
Shares used in computing basic
earnings per share (2) ............................. 36,196 32,016 25,904
======== ======== ========
Diluted earnings per share ........................... $ 0.19 $ 0.19 $ 0.13
======== ======== ========
Shares used in computing diluted
earnings per share (2) ............................. 38,262 34,212 27,840
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------------
1999 1998 1997 1996 1995
----- ----- ----- ----- -----
Consolidated Balance Sheet Data: (in thousands)
<S> <C> <C> <C> <C> <C>
Cash, cash equivalents and
short-term investments ...................... $ 35,769 $ 26,390 $ 12,555 $ 2,409 $ 3,486
Working capital ............................... 40,435 29,473 15,266 2,225 3,848
Total assets .................................. 127,850 65,494 28,856 11,953 10,943
Convertible note .............................. -- -- -- -- 3,038
Long-term obligations,
net of current portion (3) .................. -- 76 188 296 554
Total stockholders' equity .................... 103,060 59,542 23,577 6,072 2,846
</TABLE>
- ----------
(1) See Note 7 of Notes to Consolidated Financial Statements.
(2) For an explanation of the determination of the number of shares used in
computing basic and diluted earnings (loss) per share, see Note 1 of Notes
to Consolidated Financial Statements.
(3) See Note 6 of Notes to Consolidated Financial Statements
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following commentary should be read in conjunction with the financial
statements and related notes contained elsewhere in the Form 10-K. The
discussion contains forward-looking statements that involve risks and
uncertainties. These statements relate to future events or our future financial
performance. In many cases, you can identify forward looking statements by
terminology such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential," "intend," or "continue," or
the negative of such terms and other comparable terminology. These statements
are only predictions. Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of a variety of
factors, including, but not limited to, those set forth under "Risk Factors" and
elsewhere in this Form 10-K.
Overview
We were founded in 1983 to develop copy protection and video security
solutions for major motion picture studios and independent video producers. Our
initial products were designed to prevent the unauthorized duplication and
distribution of videocassettes. We have expanded our copy protection
technologies to address the unauthorized copying and distribution of DVDs,
digital PPV programs and CD-ROMs. We derive royalty-based licens-
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<PAGE>
ing revenue from multiple sources, including content owners, hardware
manufacturers, digital set-top box manufacturers, digital PPV system operators
and commercial replicators/duplicators.
The following table provides net revenues information by product line
(dollars in thousands):
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------------
1999 1998 1997
-------- -------- --------
Video Copy Protection:
<S> <C> <C> <C>
Videocassette ............................ $ 15,877 $ 15,770 $ 12,616
DVD ...................................... 8,629 3,096 1,084
Pay-Per-View ............................. 7,477 3,760 3,712
Computer Software Copy Protection .......... 4,754 344 --
Video Scrambling Systems ................... 548 1,464 2,739
Other ...................................... 105 -- 189
--------- --------- ---------
Total ...................................... $ 37,390 $ 24,434 $ 20,340
========= ========= =========
</TABLE>
The following table provides percentage of net revenue information by
product line:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------
1999 1998 1997
--------- --------- ---------
Video Copy Protection:
<S> <C> <C> <C>
Videocassette ............................ 42.5% 64.5% 62.0%
DVD ...................................... 23.1 12.7 5.3
Pay-Per-View ............................. 20.0 15.4 18.3
Computer Software Copy Protection .......... 12.7 1.4 --
Video Scrambling Systems ................... 1.4 6.0 13.5
Other ...................................... .3 -- .9
--------- --------- ---------
Total ...................................... 100.0% 100.0% 100.0%
========= ========= =========
</TABLE>
Video Copy Protection
Videocassette Copy Protection. Since inception, we have derived the
majority of our revenues and operating income from licensing our videocassette
copy protection technology. Our customers have included the home video divisions
of members of the Motion Picture Association of America, more than 150
videocassette duplication companies and a number of low volume content owners,
such as independent producers of exercise, sports and educational
videocassettes. We typically receive license fees based upon the number of copy
protected videocassettes that are produced by Motion Picture Association of
America studios or other content owners. License fees from Motion Picture
Association of America studios represented a significant portion of such fees in
1999, 1998 and 1997. Videocassette Copy Protection revenues represented 42.5%,
64.5% and 62.0% of our net revenues in 1999, 1998 and 1997, respectively. We
expect that our videocassette copy protection licenses will generate a
substantial part of our net revenues and operating income at least through 2000.
We believe videocassette copy protection revenues will continue to decline as a
percentage of our revenues and in absolute terms, as the studios focus more of
their resources and marketing dollars on the DVD business.
DVD Copy Protection. In 1997, we introduced copy protection for DVDs. Our
customers have included members of the Motion Picture Association of America and
to a lesser extent special interest rights owners. Our customers pay per unit
royalties for DVD copy protection. Additionally, we derive annual license fees
from DVD hardware manufacturers. DVD copy protection has increased from 5.3% of
net revenues in 1997 to 12.7% of net revenues in 1998 and further to 23.1% of
our net revenues in 1999. Revenues from DVD copy protection solutions are
expected to grow in both absolute dollars and as a percentage of net revenues in
2000 as the number of DVDs and DVD players in the market increases.
PPV Copy Protection. In 1993, we introduced copy protection for digital
PPV to satellite and cable system operators and to the equipment manufacturers
that supply the satellite and cable industries. We derive digital PPV copy
protection revenues from hardware royalties, up-front license fees, and PPV
programming royalties. Digital PPV revenues were 20.0%, 15.4% and 18.3% of our
net revenues in 1999, 1998 and 1997, respectively. Our agree-
28
<PAGE>
ments with digital PPV system operators entitle us to transaction-based royalty
payments when copy protection for digital PPV programming is activated. To date,
such transaction-based royalty payments have not been significant. Revenues from
PPV copy protection are expected to grow in absolute dollars in 2000.
Computer Software/CD-ROM Copy Protection.
In 1998, we made an initial equity investment in C-Dilla and entered into
a Software Marketing License and Development Agreement. In June 1999, we
acquired the remaining shares of C-Dilla for approximately $12.8 million in cash
and acquisition costs, 218,398 shares of our common stock valued at $5.1 million
and stock option grants in Macrovision valued at $1.8 million. In September
1998, in conjunction with C-Dilla, we introduced our CD-ROM copy protection
technology, called SafeDisc. Customers implementing SafeDisc include the major
PC game and educational software publishers. Due to the increased availability
of CD-ROM recorders, we expect revenues from Computer Software/CD-ROM Copy
Protection to increase in 2000. We typically receive license fees for Computer
Software/CD-ROM Copy Protection based upon the number of copy protected CD-ROMs
that are produced by PC game and educational software publishers or content
owners. Computer software/CD-ROM copy protection revenues represented 12.7% of
our net revenues for 1999. We expect that our computer software/CD-ROM copy
protection licenses will generate a substantial part of our net revenues and
operating income, in absolute dollars and as a percentage of net revenues, at
least through 2000.
Video Scrambling Technologies.
Our Video Scrambling business line is made up of our video scrambling
products, components and licensing which use our PhaseKrypt technology. Revenues
for these products have declined due to reduced demand for analog scrambling
technologies. Video Scrambling revenues were 1.4%, 6.0% and 13.5% of our net
revenues in 1999, 1998 and 1997, respectively. We do not expect this business to
comprise a material part of our revenue going forward.
Our cost of revenues consists primarily of service fees paid to licensed
duplicators and replicators that produce videocassettes, DVDs and CD-ROMs for
content owners who license the technology directly from us, costs associated
with equipment used in applying the copy protection process at the licensed
duplicators and royalties due C-Dilla based on revenues from copy protection of
CD-ROMs prior to our acquisition. Also included in cost of revenues are patent
amortization and enforcement costs. Our research and development expenses are
comprised primarily of employee compensation and benefits, consulting fees,
tooling and supplies and an allocation of facilities costs. Our selling and
marketing expenses are comprised primarily of employee compensation and
benefits, consulting and recruiting fees, travel, advertising and an allocation
of facilities costs. Our general and administrative expenses are comprised
primarily of employee compensation and benefits, consulting and recruiting fees,
travel, professional fees and an allocation of facilities costs.
We have experienced significant seasonality in our business, and our
financial condition and results of operations are likely to be affected by
seasonality in the future. We have typically experienced our highest revenues in
the fourth quarter of each calendar year followed by lower revenues and
operating income in the first quarter, and at times in subsequent quarters, of
the next year. We believe that this trend has been principally due to the
tendency of certain of our customers to release their more popular movies on
videocassettes and DVDs during the year-end holiday shopping season, while our
operating expenses are incurred more evenly throughout the year. We anticipate
that revenues from multimedia CD-ROM copy protection will also reflect this
seasonal trend. In addition, revenues tend to be lower in the summer months,
particularly in Europe.
29
<PAGE>
Results of Operations
The following table sets forth selected consolidated statements of income
data expressed as a percentage of net revenues for the periods indicated:
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Net revenues ......................................... 100.0% 100.0% 100.0%
Costs and expenses:
Cost of revenues ................................... 8.0 8.5 11.9
Research and development ........................... 11.8 10.6 11.1
Selling and marketing .............................. 24.0 24.5 28.3
General and administrative ......................... 14.8 18.9 20.4
Amortization of intangibles from acquisition ....... 4.3 -- --
In process research and development ................ 11.5 -- --
----- ----- -----
Total costs and expenses ......................... 74.4 62.5 71.7
----- ----- -----
Operating income ................................. 25.6 37.5 28.3
Interest and other income, net ....................... 4.3 4.5 2.4
----- ----- -----
Income before income taxes ....................... 29.9 42.0 30.7
Income taxes ......................................... 10.6 16.0 11.9
----- ----- -----
Net income ....................................... 19.3% 26.0% 18.8%
===== ===== =====
</TABLE>
Comparison of Years Ended December 31, 1999 and 1998
The following table provides revenue information by specific product
segments for the periods indicated (dollars in thousands):
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------------
$ %
1999 1998 Change Change
-------- ------- ------- -------
<S> <C> <C> <C> <C>
Video Copy Protection
Videocassette ....................... $15,877 $15,770 $ 107 0.7%
DVD ................................. 8,629 3,096 5,533 178.7%
Pay-Per-View ........................ 7,477 3,760 3,717 98.9%
Computer Software Copy Protection ..... 4,754 344 4,410 1,282.0%
Video Scrambling ...................... 548 1,464 (916) (62.6)%
Other ................................. 105 -- 105 --
------- ------- --------
Total ................................. $37,390 $24,434 $ 12,956 53.0%
======= ======= ========
</TABLE>
Net Revenues. Our net revenues for 1999 increased 53.0% from $24.4 million
in 1998 to $37.4 million in 1999. Revenues from videocassette copy protection
increased $107,000 from $15.8 million in 1998 to $15.9 million in 1999 due to
increased videocassette copy protection royalties for the hit fitness video
"Tae-Bo," offset by a slight decrease in Hollywood studio royalties and copy
protected videocassette volume. DVD copy protection revenues increased $5.5
million or 178.7% from $3.1 million in 1998 to $8.6 million in 1999 due to
increases in DVD shipments as the market for both DVD players and DVD titles
continued to expand. Digital PPV copy protection revenues increased $3.7 million
or 98.9% from $3.8 million in 1998 to $7.5 million in 1999 due to continued
increases in the shipments of copy protection enabled 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 Motion Picture
Association of America studios declined as a percentage of net revenues from
45.1% in 1998 to 34.4% in 1999, as revenues increased in other business segments
such as Computer Software/CD-ROM and PPV. Computer Software/CD-ROM Copy
Protection revenues increased $4.4 million from $344,000 in 1998 to $4.8 million
in 1999 as new customers implemented our SafeDisc copy protection on their PC
games and other consumer multimedia software during the year, with strong growth
in copy protected units during the traditionally strong third quarter in
anticipation of holiday season releases. Revenues from Video Scrambling products
decreased 62.6% from $1.5 in 1998 to $548,000 in 1999. During this period, we
continued to experience weak
30
<PAGE>
demand for Video Scrambling products. We recorded other revenue of $105,000 in
1999 compared to none in 1998 relating to a consulting contract with AudioSoft.
Our international and export revenues as a percentage of net revenues
increased from 44.5% for 1998 to 45.6% for 1999 due to higher videocassette,
DVD, set-top box and Computer Software/CD-ROM revenues.
Cost of Revenues. Cost of revenues as a percentage of net revenues
declined from 8.5% for 1998 to 8.0% 1999. This decrease was primarily due to the
higher level of revenue in 1999 primarily from royalties and licensing fees,
which have virtually no cost of revenues. Cost of revenues increased $931,000
from $2.1 million in 1998 to $3.0 million in 1999 primarily due higher
duplicator/replicator fees associated with a higher volume of duplication and
higher patent defense costs. Cost of revenues includes items such as product
costs, duplicator/replicator fees, video copy protection processor costs, patent
amortization, patent defense costs and royalty expense prior to the acquisition
of C-Dilla. We expect the gross margin to increase as a result of the
elimination of royalty expenses payable to C-Dilla, although these will be
offset partially by the patent defense costs associated with current patent
litigation.
Research and Development. Research and development expenses increased by
$1.8 million or 70.8% from $2.6 million in 1998 to $4.4 million in 1999. The
increased expenses were a result of a one-time licensing fee of $300,000 related
to technology acquisition in support of a current project, one-time continuation
bonuses of $99,000 paid to engineering employees of C-Dilla and the absorption
of research and development expenses at C-Dilla following its acquisition.
Research and development expenses increased as a percentage of net revenues from
10.6% for 1998 to 11.8% for 1999. If not for the one-time charges noted above,
the percentage would have remained relatively stable for 1999. We expect
research and development expenses to increase in absolute terms over the prior
year periods as a result of the research and development activity at C-Dilla and
as we develop new technologies in other areas.
Selling and marketing. Selling and marketing expenses increased by $3.0
million or 50.0% from $6.0 million in 1998 to $9.0 million in 1999. This
increase was primarily for one-time continuation bonuses of $290,000 paid to
sales and marketing employees of C-Dilla, higher compensation and benefits
associated with additional headcount in the Computer Software/ CD-ROM Copy
Protection business along with the increased advertising and marketing for the
business unit. Many of these expenses were offset in 1998 by C-Dilla's
reimbursement of specific marketing related expenses under the joint marketing
agreement and the marketing and selling expenses at C-Dilla prior to its
acquisition. Selling and marketing expenses decreased as a percentage of net
revenues from 24.5% for 1998 to 24.0%. If not for the one time charges noted
above, the percentage would have declined further to 23.2% for 1999. Selling and
marketing expenses are expected to increase over the prior year periods as we
continue to expand our efforts in selling and marketing Computer Software/CD-ROM
Copy Protection and other rights management products from C-Dilla.
General and Administrative. General and administrative expenses increased
by $908,000 or 19.6% from $4.6 million in 1998 to $5.5 million in 1999 primarily
due higher compensation and benefits from increased personnel, higher legal
fees, accounting fees, and the administrative expenses incurred by C-Dilla.
General and administrative expenses declined as a percentage of net revenues
from 18.9% in 1998 to 14.8% in 1999. General and administrative expenses are
expected to increase over the prior periods as we continue to expand our new
business development efforts.
In Process Research and Development. In June 1999, we allocated $4.3
million of the $23.2 million total purchase price for C-Dilla to in process
research and development projects. This 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 had five
major copy protection/rights management projects in progress at the time of
acquisition. These projects include a product that 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
that 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. The projects have progressed as expected, and we
currently expect to complete the development of these projects at various dates
through 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
31
<PAGE>
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, commercial or
technical viability of these products may not 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 $52.5 million from year 2000 through 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. We 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.
We will amortize these intangibles on a straight line basis over three to
seven years based on expected useful lives of existing products and
technologies, retention of workforce, non-compete 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 $501,000 or 45.5% from
$1.1 million in 1998 to $1.6 million in 1999, 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 35.4% and 38.3% for 1999 and 1998, respectively. The
lower rate for 1999 was the result of utilizing post acquisition C-Dilla net
operating losses to reduce our 1999 taxes combined with higher tax-exempt
interest earned in 1999.
Net Income. Net income for 1999 was $7.2 million compared to $6.3 million
for 1998. For 1999 the amortization of intangibles associated with the
acquisition of C-Dilla was $1.6 million. We also took a one-time charge to
earnings of $4.3 million for C-Dilla in process research and development.
Comparison of Years Ended December 31, 1997 and 1998
The following table provides revenue information by general product lines
for the periods indicated (dollars in thousands):
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------------------
$ %
1999 1998 Change Change
-------- -------- ------- -------
<S> <C> <C> <C> <C>
Video Copy Protection
Videocassette ............................... $15,770 $12,616 3,154 25.0%
DVD ......................................... 3,096 1,084 2,012 185.6%
Pay-Per-View ................................ 3,760 3,712 48 1.3%
Computer Software Copy Protection ............. 344 -- 344 --
Video Scrambling .............................. 1,464 2,739 (1,275) (46.5)%
Other ......................................... -- 189 (189) --
------- ------ -----
Total ......................................... $24,434 $20,340 4,094 20.1%
======= ======= ======
</TABLE>
32
<PAGE>
Net Revenues. Our net revenues increased 20.1% from $20.3 million in 1997
to $24.4 million in 1998. Videocassette copy protection revenues increased $3.2
million or 25.0% from $12.6 million in 1997 to $15.8 million in 1998,
principally due to increased copy protection revenues from three Hollywood
studios which had no significant usage of copy protection in 1997. DVD copy
protection revenues increased $2.0 million or 185.6% from $1.1 million in 1997
to $3.1 million in 1998, due to increased revenues from the replication of DVDs
and license fees from PC and DVD ROM manufacturers. Revenues from PPV for 1998
were $3.8 million, reflecting an increase of $48,000 or 1.3% from 1997 as result
of increased shipments of set-top boxes from licensed manufacturers offset by a
decrease in initial license fees. Revenues from the Motion Picture Association
of America studios increased as a percentage of net revenues from 38.6% to
45.1%, primarily as a result of new customer business, including the hit title
"Titanic." In 1998 we recorded our first multimedia software revenues of
$344,000 from our Computer Software/CD-ROM Copy Protection technology. Our Video
Scrambling revenues decreased $1.3 million or 46.5% to $1.5 million from 1997 to
1998.
Our international and export revenues increased from $9.5 million, or
46.5% of our net revenues in 1997, to $10.9 million, or 44.5% of our net
revenues in 1998. International and export revenues grew primarily as a result
of increased usage of videocassette copy protection technology by the Motion
Picture Association of America studios in international markets including usage
for the title "Titanic" and overseas shipments of copy protection enabled
digital PPV set-top boxes, offset by the decrease in Video Scrambling products.
Cost of Revenues. Cost of revenues as a percentage of net revenues
declined from 11.9% in 1997 to 8.5% in 1998. This decrease was primarily due to
changes in revenue mix between Video Scrambling products, which have a
relatively high cost of revenues, and licensing revenues, which have a
relatively low cost of revenues. In addition, processor equipment costs, the
inventory reserve provision and product hardware related costs were reduced, but
were offset by increased service fees for duplicators and replicators and
royalty expense.
Research and Development. Research and development expenses increased from
$2.2 million in 1997 to $2.6 million in 1998, but decreased as a percentage of
net revenues from 11.1% in 1997 to 10.6% in 1998. The increase in absolute
dollars was principally due to higher compensation related expenses. In 1997, we
began a joint development effort with Digimarc to develop a video watermarking
solution for DVD and other digital video platforms. Development continued
through 1998, with Philips joining the development effort.
Selling and Marketing. Selling and marketing expenses increased from $5.8
million in 1997 to $6.0 million in 1998, but decreased as a percentage of net
revenues from 28.3% of net revenues in 1997 to 24.5% of net revenues in 1998.
The increase in absolute dollars from 1997 to 1998 was primarily a result of
higher compensation related expenses, advertising and marketing for DVD and
Computer Software/CD-ROM Copy Protection, offset by reimbursement of specific
marketing related expenses.
General and Administrative. General and administrative expenses increased
from $4.1 million in 1997 to $4.6 million in 1998, but decreased as a percentage
of the net revenues from 20.4% of the net revenues in 1997 to 18.9% of the net
revenues in 1998. The increase in absolute dollars was primarily related to
increased compensation and benefits, the reversal of sales tax expense due to a
favorable judicial ruling in a tax case that lowered our expenses on a one time
basis in 1997 and higher consulting fees offset by lower legal fees and bad debt
expense.
Interest and Other Income, Net. Interest and other income, net, consists
primarily of interest income net of interest expense on capitalized equipment
leases. Interest expense was $12,000 in 1997 and $11,000 in 1998. Interest
income was $513,000 in 1997 and $1.1 million in 1998. The increase in interest
income was a result of interest earned from cash and cash equivalents,
short-term investments and long-term marketable investment securities primarily
from the proceeds received from our initial public offering in March 1997, and
the offering of our common stock completed in July 1998.
Income Taxes. Our effective rate of taxation was 38.7% in 1997 and 38.3%
in 1998. The provision for income taxes consists primarily of federal income
taxes, state taxes and international taxes withheld on foreign revenue. The
lower rate in 1998 was primarily due to an increase in tax credits and an
increase in tax exempt interest associated with increased tax free investments.
33
<PAGE>
Quarterly Results of Operations
The following table sets forth certain quarterly unaudited consolidated
financial data for the periods indicated, as well as the percentage of the
Company's net revenues represented by such data. These data have been derived
from the Company's unaudited consolidated financial statements that, in the
opinion of management, have been prepared on substantially the same basis as the
audited consolidated financial statements, and include all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of such data. Such data should be read in conjunction with the
Company's audited consolidated financial statements and notes thereto appearing
elsewhere in this Form 10-K. The results of operations for any quarter are not
necessarily indicative of the results to be expected for any future period.
<TABLE>
<CAPTION>
(Unaudited) Quarter ended
1998
Mar. 31 Jun. 30 Sep. 30 Dec. 31 Mar. 31
---------- ---------- ---------- ---------- ----------
(in thousands)
<S> <C> <C> <C> <C> <C>
Net revenues ................ $ 5,178 $ 5,665 $ 6,307 $ 7,284 $ 7,163
Costs and expenses:
Cost of revenues .......... 398 449 592 642 671
Research and development .. 623 654 690 611 631
Selling and marketing ..... 1,526 1,487 1,354 1,618 1,882
General and administrative 1,159 1,128 1,114 1,220 1,381
Amortization of intangibles -- -- -- -- --
In process research and
development ............. -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Total costs and expenses 3,706 3,718 3,750 4,091 4,565
---------- ---------- ---------- ---------- ----------
Operating income ........ 1,472 1,947 2,557 3,193 2,598
Interest and other income
(expense), net ............ 131 172 382 417 418
---------- ---------- ---------- ---------- ----------
Income (loss) before
income taxes .......... 1,603 2,119 2,939 3,610 3,016
Income taxes ................ 609 805 1,129 1,386 1,158
---------- ---------- ---------- ---------- ----------
Net income (loss) ....... $ 994 $ 1,314 $ 1,810 $ 2,224 $ 1,858
========== ========== ========== ========== ==========
Earnings per common share
Basic ................... $ 0.03 $ 0.05 $ 0.05 $ 0.06 $ 0.05
Diluted ................. $ 0.03 $ 0.04 $ 0.05 $ 0.06 $ 0.05
As a percentage of net revenues
Net revenues ................ 100% 100% 100% 100% 100%
Costs and expenses:
Cost of revenues .......... 7.7 7.9 9.4 8.8 9.4
Research and development .. 12.0 11.5 10.9 8.4 8.8
Selling and marketing ..... 29.5 26.3 21.5 22.2 26.2
General and administrative 22.4 19.9 17.7 16.8 19.3
Amortization of intangibles -- -- -- -- --
In process research and
development ............. -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Total costs and expenses 71.6 65.6 59.5 56.2 63.7
---------- ---------- ---------- ---------- ----------
Operating income ........ 28.4 34.4 40.5 43.8 36.3
Interest and other income
(expense), net ............ 2.6 3.0 6.1 5.8 5.8
---------- ---------- ---------- ---------- ----------
Income (loss) before
income taxes .......... 31.0 37.4 46.6 49.6 42.1
Income taxes ................ 11.8 14.2 17.9 19.1 16.2
---------- ---------- ---------- ---------- ----------
Net income (loss) ....... 19.2% 23.2% 28.7% 30.5% 25.9%
========== ========== ========== ========== ==========
<CAPTION>
(Unaudited) Quarter ended
1999
Jun. 30 Sep. 30 Dec. 31
---------- ---------- ----------
<S> <C> <C> <C>
Net revenues ................ $ 8,057 $ 9,363 $ 12,807
Costs and expenses:
Cost of revenues .......... 768 701 872
Research and development .. 1,108 1,167 1,496
Selling and marketing ..... 2,064 2,246 2,781
General and administrative 1,196 1,405 1,547
Amortization of intangibles 109 682 809
In process research and
development ............. 4,286 -- --
---------- ---------- ----------
Total costs and expenses 9,531 6,201 7,505
---------- ---------- ----------
Operating income ........ (1,474) 3,162 5,302
Interest and other income
(expense), net ............ 405 375 405
---------- ---------- ----------
Income (loss) before
income taxes .......... (1,069) 3,537 5,707
Income taxes ................ (469) 1,252 2,020
---------- ---------- ----------
Net income (loss) ....... $ (600) $ 2,285 $ 3,687
========== ========== ==========
Earnings per common share
Basic ................... $ (0.02) $ 0.06 $ 0.10
Diluted ................. $ (0.02) $ 0.06 $ 0.09
As a percentage of net revenues
Net revenues ................ 100% 100% 100%
Costs and expenses:
Cost of revenues .......... 9.5 7.5 6.8
Research and development .. 13.8 12.4 11.7
Selling and marketing ..... 25.6 24.0 21.7
General and administrative 14.8 15.0 12.1
Amortization of intangibles 1.4 7.3 6.3
In process research and
development ............. 53.2 -- --
---------- ---------- ----------
Total costs and expenses 118.3 66.2 58.6
---------- ---------- ----------
Operating income ........ (18.3) 33.8 41.4
Interest and other income
(expense), net ............ 5.0 4.0 3.2
---------- ---------- ----------
Income (loss) before
income taxes .......... (13.3) 37.8 44.6
Income taxes ................ (5.9) 13.4 15.8
---------- ---------- ----------
Net income (loss) ....... (7.4%) 24.4% 28.8%
========== ========== ==========
</TABLE>
34
<PAGE>
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. Net revenues increased 15.5% from the third quarter of 1998 to
the fourth quarter of 1998 as a result of an increase in copy protected
videocassettes and DVDs for the holiday season, along with an increase in Video
Scrambling sales and license royalties. Net revenues increased 16.2% from the
second quarter of 1999 to the third quarter of 1999 and 36.8% from the third
quarter of 1999 to the fourth quarter of 1999 primarily due to DVD royalties
from higher volumes, higher digital PPV set-top box shipments and increased
volume of computer CD-ROMs copy protected with SafeDisc.
Our cost of revenues is subject to seasonal and quarterly fluctuations due
to changes in net revenues. In the first quarter of 1998, cost of revenues as a
percentage of net revenues was lower than previous quarters as Video Scrambling
products represented a smaller proportion of our net revenues. Cost of revenues
as a percentage of net revenues increased in the third quarter of 1998 through
the second quarter of 1999 due to increased patent defense costs and royalties
due to C-Dilla for SafeDisc sales. Cost of revenues as a percentage of net
revenues decreased in the third and fourth quarters due to the elimination of
royalties due C-Dilla as a result of its acquisition in June 1999.
Our research and development expenses fluctuate quarterly depending on the
stages of various projects, the use of consultants and temporary employees, and
the utilization of prototype materials. The increase in research and development
expenses in the second quarter of 1999 compared to prior quarters was due to a
one time licensing fee related to technology for a project and one time
continuation bonuses paid to C-Dilla engineers. The increase in research and
development expenses in the third and fourth quarters of 1999 compared to first
quarter of 1999 is the result of absorbing the research and development expenses
at C-Dilla following its acquisition.
Our selling and marketing expenses increased in the fourth quarter of 1998
compared to the third quarter of 1998 due to higher marketing expenses in Europe
and expenses for the SafeDisc product. The increase in the first and second
quarters in 1999 compared to the fourth quarter of 1998 was due to the selling
and marketing related to the Computer Software/CD-ROM Copy Protection business
and the one-time continuation bonuses paid to sales and marketing employees of
C-Dilla in the second quarter. The increase in the third and fourth quarters of
1999 compared to the second quarter of 1999 was the result of absorbing the
selling and marketing expenses at C-Dilla following its acquisition.
The increase in general and administrative expenses in the first quarter
of 1999 compared to the fourth quarter of 1998 was due to legal expenses and new
business related consulting. The increase in general and administrative expenses
in the third and fourth quarters of 1999 compared to the second quarter of 1999
was the result of absorbing the general and administrative expenses at C-Dilla
following its acquisition.
The increase in interest income beginning in the third quarter of 1998 was
the result of investing the proceeds from our June 1998 public offering.
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. Such factors include the timing of release of
popular titles on videocassettes or DVDs or by digital PPV transmission, the
timing of release of popular computer games on CD-ROM, the degree of acceptance
of our copy protection technologies by major motion picture studios and computer
game publishers, the mix of products sold and technologies licensed, any change
in product or license pricing, the seasonality of revenues, changes in our
operating expenses, personnel changes, the development of our direct and
indirect distribution channels, foreign currency exchange rates and general
economic conditions. We may choose to reduce royalties and fees or increase
spending in response to competition or new technologies or elect to pursue new
market opportunities. Because a high percentage of our operating expenses are
fixed, a small variation in the timing of recognition of revenues can cause
significant variations in operating results from period to period.
35
<PAGE>
Liquidity and Capital Resources
We have financed our operations primarily from cash generated by
operations, principally our copy protection businesses. Our operating activities
provided net cash of $12.0 million, $7.7 million and $2.4 million in 1999, 1998,
1997, respectively. In 1999, net cash was provided primarily by net income
before depreciation and amortization adjusted for noncash charges and in-process
research and development, reduced by an increase in accounts receivable,
deferred revenue, accrued expenses and income taxes payable. In 1998, net cash
was provided by net income before depreciation and amortization, noncash
charges, increases in tax benefit from employee stock benefit plans, accrued
expenses and deferred revenue, partially offset by increases in accounts
receivable and prepaids and decreases in accounts payable and income taxes
payable. In 1997, net cash was provided primarily by net income before
depreciation and amortization and increases in income taxes payable, deferred
revenue, and accounts receivable.
Investing activities used net cash of $12.5 million, $34.2 million, and
$17.5 million in 1999, 1998 and 1997, respectively. For 1999, net cash used in
investing activities was primarily the acquisition of C-Dilla and the
investments in Digimarc and AudioSoft, offset by the net sales and maturities in
short and long-term investment securities. The investment in Digimarc and
AudioSoft were in connection with separate rounds of third-party financing
obtained by each company. In 1998, net cash used in investing activities was
primarily the investment of the proceeds from our June 1998 public offering,
partially offset by an investment in, and payment of royalties to, C-Dilla and
an additional investment in CAC. Subsequently, CAC paid in full a note due to us
including accrued interest. In February 1998, we acquired approximately 19.8% of
the common stock of C-Dilla for a purchase price of $3.6 million. In February
1998, we also entered into a software marketing license and development
agreement under which we obtained certain rights to C-Dilla's proprietary copy
protection technology. We paid $1.0 million in up-front license fees, subject to
offset against future royalty payments to C-Dilla of between 30% to 45% of
revenues from sales of software products incorporating C-Dilla's technology. In
1997, net cash used in investing activities resulted primarily from purchases of
short and long-term marketable investment securities and investments of $1.5
million in Digimarc and approximately $2.0 million in CAC. We made capital
expenditures of $386,000, $285,000 and $571,000 in 1999, 1998 and 1997,
respectively. We also paid $541,000, $666,000 and $332,000 in 1999, 1998 and
1997, respectively, related to patents and other intangibles during those
periods.
Net cash provided by financing activities was $1.3 million, $28.7 million
and $13.9 million in 1999, 1998 and 1997, 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 our stock
purchase plan and the final payment of a stockholder's note receivable offset by
payments on loans. For 1998 and 1997, almost all the cash provided from
financing activities resulted from our June 1998 public offering and our 1997
initial public offering.
In August 1999, we participated in a convertible bridge loan to CAC by
which investors would fund expenditures of CAC up to a predetermined amount. Our
commitment under the convertible note purchase agreement was $836,733. In
December 1999, we converted our convertible bridge loan in the amount of
$836,733 and accrued interest into preferred stock of CAC as part of a round of
third-party financing.
At December 31, 1999, we had $4.3 million in cash and cash equivalents,
$31.5 million in short-term investments and $52.2 million in long-term
marketable investment securities, which includes the fair market valuation of
our holdings in Digimarc (Nasdaq symbol "DMRC"), which we presently intend to
hold for the long term. We have no material commitments for capital expenditures
but anticipate that capital expenditures for the next 12 months will aggregate
approximately $1.0 million. The anticipated increase in capital expenditures is
necessary to support the growth of our new business initiatives. We also have
future minimum lease payments of approximately $1.7 million under operating
leases and approximately $76,000 under capital leases. We are also committed to
provide an additional investment of $750,000 in AudioSoft, subject to the
achievement of specific milestones. On January 24, 2000 we raised approximately
$146 million in a public offering of our common stock in which we sold 3,820,000
shares, of which 2,874,000 shares were issued and sold by the Company and
946,000 shares were sold by Shareholders of the Company. All shares were sold
for $58.438. 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.
36
<PAGE>
Year 2000 Update
We believe that we have successfully rendered our product, internal
management and other administrative systems and external information systems
year 2000 compliant. Since January 1, 2000 we have experienced no disruptions in
our business operations as a result of year 2000 compliance problems or
otherwise, and have received no reports of any year 2000 compliance problems
with our products. To date, the total cost of our efforts to address year 2000
compliance has not been material.
Nonetheless, some problems related to the year 2000 risks may not appear
until several months after January 1, 2000. Year 2000 issues could include
problems with our own products or with third-party products or technology that
we use. Any problems that are not identified and corrected successfully and
completely could adversely affect our business.
Recent Accounting Pronouncements
See Note 1 of Notes to Consolidated Financial Statements.
ITEM 7A. 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 our 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 $41.8 million as
of December 31, 1999. These securities are subject to interest rate
fluctuations. An increase in interest rates could adversely affect the market
value of our 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 $110,000 decrease (approximately
0.5%) in the fair value of our available-for-sale securities as of December 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.
Because 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 subsidiaries in England and Japan operate in
their local currency, which mitigates a portion of the exposure related to the
respective currency royalties collected.
Strategic Investments. We have expanded our technological base in current
as well as new markets through strategic investments in companies, technologies,
or products. We currently hold minority equity interests in CAC, Digimarc and
AudioSoft. These investments, totaling $50.7 million, represented 38.6% of our
total assets as of December 31, 1999. We subsequently invested an additional
$4.0 million for a minority interest in TTR and $1.0 million for a minority
interest in RPK. CAC, RPK and AudioSoft are privately held companies. There is
no active trading market for their securities and our investments in them are
illiquid. We may never have an opportunity to realize a return on our investment
in CAC or AudioSoft, and we may in the future be required to write off all or
part of one or more of these investments. In December 1999, Digimarc completed
its initial public offering and its shares are traded on the Nasdaq National
Market under the symbol "DMRC." We currently own approximately 7.7% of the
outstanding shares of Digimarc.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLELEMENTARY DATA.
The information required by this item is submitted in a separate section
of this report beginning on F-1 of this report.
37
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS.
The information required by this item is incorporated by reference from
the information under the caption "Election of Directors," with respect to
Directors, and under the caption "Management," with respect to Executive
Officers, contained in our definitive Proxy Statement, which will be filed with
the Securities and Exchange Commission in connection with the solicitation of
proxies for our 2000 Annual Meeting of Stockholders ( the "Proxy Statement") to
be held on May 31, 2000.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated by reference to the
information under the caption "Executive Compensation" to be contained in the
Proxy Statement for the 2000 Annual Meeting of Stockholders to be held on May
31, 2000.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is incorporated by reference to the
information under the caption "Security Ownership of Certain Beneficial Owners
and Management" to be contained in the Proxy Statement for the 2000 Annual
Meeting of Stockholders to be held on May 31, 2000.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated by reference to the
information under the caption "Certain Relationships and Related Transactions"
to be contained in the Proxy Statement for the 2000 Annual Meeting of
Stockholders to be held on May 31, 2000.
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) 1. Financial Statements
The following statements are filed as part of this report:
o Report of Independent Auditors (See F-2)
o Consolidated Balance Sheets at December 31, 1999 and 1998 (See
F-3)
o Consolidated Statements of Income for the Years Ended December
31, 1999, 1998 and 1997 (see F-4)
o Consolidated Statements of Stockholders Equity for the Years
Ended December 31, 1999, 1998 and 1997 (see F-5)
o Consolidated Statements of Cash Flows for the Years Ended
December 31, 1999, 1998 and 1997 (See F-7)
o Notes to Consolidated Financial Statements (See F-8)
2. Financial Statement Schedules
The Schedule of Valuation and Qualifying Accounts is contained in footnote
2 to the Consolidated Financial Statements.
38
<PAGE>
3. Exhibits
Exhibit
Number Exhibit Title
2.01 Form of Merger Agreement by and between Macrovision Corporation, a
Delaware Corporation, and Macrovision Corporation, a California
corporation.*
3.01 Certificate of Incorporation of Macrovision Corporation.*
3.02 Amended and Restated Certificate of Incorporation of Macrovision
Corporation.
3.03 Bylaws of Macrovision Corporation.*
3.04 Amended and Restated Bylaws of Macrovision Corporation.*
3.05 Certificate of Amendment of Certificate of Incorporation of
Macrovision Corporation.
10.01 Stock Option Plan and related documents of Macrovision Corporation.*
10.02 Macrovision Corporation's 1996 Equity Incentive Plan and related
documents.*
10.03 Macrovision Corporation's 1996 Directors Stock Option Plan and
related documents.*
10.04 Macrovision Corporation's 1996 Employee Stock Purchase Plan and
related documents.*
10.05 Macrovision Corporation's Executive Incentive Plan.*
10.06 Employment Agreement dated as of June 5, 1996, between Macrovision
Corporation and Victor A. Viegas.*
10.07 Restricted Stock Purchase Agreement dated as of June 7, 1996,
between Macrovision Corporation and Victor A. Viegas and related
documents, including Promissory Note and Stock Pledge Agreement.*
10.08 Form of Indemnification Agreement to be entered into by Macrovision
Corporation with each of its directors and executive officers.*
10.09 Recapitalization and Stock Purchase Agreement dated as of July 31,
1996, between Macrovision Corporation and Command Audio
Corporation.*
10.10 Restricted Stock Acquisition Agreement dated as of July 31, 1996,
between Macrovision Corporation and Command Audio Corporation, and
First Amendment dated as of November 29, 1996.*
10.11 Technology Transfer and Royalty Agreement dated as of July 31, 1996,
between Macrovision Corporation and Command Audio Corporation, and
First Amendment dated as of November 29, 1996.*
10.12 Letter dated December 6, 1996 from Macrovision Corporation to
Command Audio Corporation.*
10.13 License Agreement dated September 26, 1995, among Macrovision
Corporation, Victor Technobrain Co., Ltd. And Video Culture
Institute, Inc., Amendment Number One dated June 30, 1996 and
Amendment Number Two dated September 30, 1996.*
10.14 Duplicator Agreement dated as of June 1, 1988, by and between and
Victor Company of Japan, Limited.*
10.15 Technology Application Agreement dated November 29, 1988, by and
between Macrovision Corporation and Victor Company of Japan,
Limited.*
10.16 Agreement dated July 15, 1994, by and between Macrovision
Corporation and Victor Company of Japan, Limited.*
10.17 Copy Protection Technology Agreement dated as of January 7, 1997,
between Macrovision Corporation and Victor Company of Japan,
Limited.*
10.18 Waiver Agreement dated as of January 6, 1997, between Macrovision
Corporation and Pacific Media Development, Inc.*
10.19 Stock and Convertible Note Purchase Agreement dated as of May 24,
1991, among Macrovision Corporation, a trustee for Pacific Media
Development, Inc. and A. Victor Farrow and Carol Ann Farrow as
Trustees of the Farrow Family Trust U/T/D December 18, 1990.*
10.20 Lease Agreement dated April 21, 1995, by and between Macrovision
Corporation and Caribbean Geneva Investors.*
10.21 Standard Sublease dated September 21, 1995, by and between
Macrovision Corporation and Deutsch Technology Research, together
with Lease Agreement dated May 26, 1992, by and between Macrovision
Corporation and Crossroads Investment Group.*
10.22 Letter Agreement dated January 14, 1997 by and between Macrovision
Corporation and Buena Vista Home Video.*/**
39
<PAGE>
10.23 Technical Consulting Agreement dated as of July 1, 1996 by and
between Macrovision Corporation and Victor Technobrain Co., Ltd.*
10.24 Second Amendment to Restricted Stock Acquisition Agreement dated as
of January 29, 1997 by and between Macrovision Corporation and
Command Audio Corporation.*
10.25 Letter dated February 10, 1997 from Macrovision Corporation to
Command Audio Corporation.*
10.26 Promissory Note dated January 7, 1997 executed by Command Audio
Corporation.*
10.27 Digital Versatile Disc Player/Digital Video Cassette Recorder
License Agreement for Anticopy Technology dated as of February 18,
1997 by and between Macrovision Corporation and Victor Company of
Japan, Limited.*
10.28 Subscription Agreement between Macrovision Corporation and C-Dilla
Limited dated February 17, 1998.**/***
10.29 Software Marketing License and Development Agreement between
Macrovision Corporation and C-Dilla Limited dated February 19,
1998.**/****
21.01 List of subsidiaries.*
23.01 Consent of KPMG LLP, Independent Auditors.
27.01 1999 Financial Data Schedule.
* Incorporated by reference to the exhibit of the same number in our
Registration Statement on Form SB-2 (Registration No. 333-19373), which
was declared effective on March 12, 1997.
** Confidential treatment has been granted with respect to certain portions
of this Exhibit. These portions have been omitted from this filing and
have been filed separately with the Securities and Exchange Commission.
*** Incorporated by reference to Exhibit 10.01 to our Form 10-QSB/A filed on
June 23, 1998.
**** Incorporated by reference to Exhibit 10.02 to our Form 10-QSB filed on May
15, 1998.
(b) Reports on Form 8-K
We filed a Form 8-K during the third quarter of 1999, related to the
acquisition of C-Dilla
40
<PAGE>
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant caused this report to be signed on its
behalf by the undersigned thereunto duly authorized on this 30th day of March,
2000.
MACROVISION CORPORATION
By: /s/ William Krepick
-------------------------------
William A. Krepick
President and Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant, and in the capacities and on the date indicated.
<TABLE>
<CAPTION>
Name Title Date
- ----- ---- ----
<S> <C> <C>
Principal Executive Officer:
/s/ John O. Ryan Chairman of the Board of Directors, Chief March 30, 2000
- ------------------------------ Executive Officer, Secretary and Director
John O. Ryan
Principal Financial Officer and
Principal Accounting Officer:
/s/ Ian R. Halifax Vice President, Finance and Administration March 30, 2000
- ------------------------------ and Chief Financial Officer
Ian R. Halifax
Additional Directors:
/s/ William A. Krepick Director March 30, 2000
- ------------------------------
William A. Krepick
/s/ Richard S. Matuszak Director March 30, 2000
- ------------------------------
Richard S. Matuszak
/s/ Donna S. Birks Director March 30, 2000
- ------------------------------
Donna S. Birks
/s/ William N. Stirlen Director March 30, 2000
- ------------------------------
William N. Stirlen
/s/ Thomas Wertheimer Director March 30, 2000
- ------------------------------
Thomas Wertheimer
</TABLE>
42
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Report of KPMG LLP, Independent Auditors............................... F-2
Consolidated Balance Sheets............................................ F-3
Consolidated Statements of Income...................................... F-4
Consolidated Statements of Stockholders' Equity........................ F-5
Consolidated Statements of Cash Flows.................................. F-7
Notes to Consolidated Financial Statements............................. F-8
F-1
<PAGE>
Report of KPMG LLP, Independent Auditors
The Board of Directors and Stockholders
Macrovision Corporation and Subsidiaries:
We have audited the accompanying consolidated balance sheets of
Macrovision Corporation and subsidiaries (the Company) as of December 31, 1999
and 1998, and the related consolidated statements of income, stockholders'
equity, and cash flows for each of the years in the three-year period ended
December 31, 1999. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Macrovision
Corporation and subsidiaries as of December 31, 1999 and 1998, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1999 in conformity with generally accepted accounting
principles.
/s/ KPMG LLP
Mountain View, California
February 8, 2000, except
for Note 10, which is as of
March 28, 2000
F-2
<PAGE>
MACROVISION CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share data)
<TABLE>
<CAPTION>
ASSETS
December 31,
-------------------
1999 1998
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents ...................................... $ 4,317 $ 3,513
Short-term investments ......................................... 31,452 22,877
Accounts receivable, net of allowance for doubtful accounts of
$984 and $838 as of December 31, 1999 and 1998, respectively . 11,662 5,574
Inventories .................................................... 178 325
Deferred tax assets ............................................ 2,477 1,669
Prepaid expenses and other current assets ...................... 1,066 1,008
-------- --------
Total current assets ........................................ 51,152 34,966
Property and equipment, net ...................................... 1,655 1,297
Patents and other intangibles, net of accumulated amortization of
$1,313 and $1,034 as of December 31, 1999 and 1998, respectively 1,647 1,526
Long-term marketable investment securities ....................... 52,241 18,795
Intangibles associated with the C-Dilla Ltd. acquisition, net of
accumulated amortization of $1,600 as of December 31, 1999 ..... 16,631 --
Other assets ..................................................... 4,524 8,910
-------- --------
$127,850 $ 65,494
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................... $ 1,267 $ 803
Accrued expenses ............................................... 4,726 2,691
Deferred revenue ............................................... 3,124 1,207
Income taxes payable ........................................... 1,524 680
Current portion of capital lease obligations ................... 76 112
-------- --------
Total current liabilities ................................... 10,717 5,493
Capital lease obligations, net of current portion ................ -- 76
Deferred tax liabilities ......................................... 14,073 383
-------- --------
24,790 5,952
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, 5,000,000 shares authorized;
none issued .................................................. -- --
Common stock, $.001 par value; 50,000,000 shares authorized;
36,830,982 and 35,210,280 shares issued and outstanding as of
December 31, 1999 and 1998, respectively ..................... 36 35
Additional paid-in capital ..................................... 63,553 52,591
Stockholder notes receivable ................................... -- (78)
Accumulated other comprehensive gains (losses) ................. 25,165 (82)
Retained earnings .............................................. 14,306 7,076
-------- --------
Total stockholders' equity .................................. 103,060 59,542
-------- --------
$127,850 $ 65,494
======== ========
</TABLE>
See accompanying notes to consolidated financial statements
F-3
<PAGE>
MACROVISION CORPORATION AND SUBSIDIARIES
Consolidated Statement of Income
(In thousands, except share data)
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Net revenues ....................................... $ 37,390 $ 24,434 $ 20,340
-------- -------- --------
Costs and expenses:
Cost of revenues ................................. 3,012 2,081 2,422
Research and development ......................... 4,402 2,578 2,248
Selling and marketing ............................ 8,973 5,985 5,765
General and administrative ....................... 5,529 4,621 4,149
Amortization of intangibles from acquisition ..... 1,600 -- --
In process research and development .............. 4,286 -- --
-------- -------- --------
Total costs and expenses ....................... 27,802 15,265 14,584
-------- -------- --------
Operating income ............................... 9,588 9,169 5,756
Interest and other income, net ..................... 1,603 1,102 478
-------- -------- --------
Income before income taxes ..................... 11,191 10,271 6,234
Income taxes ....................................... 3,961 3,929 2,413
-------- -------- --------
Net income ..................................... $ 7,230 $ 6,342 $ 3,821
======== ======== ========
Computation of basic and diluted earnings per share:
Net income ....................................... $ 7,230 $ 6,342 $ 3,821
Preferred stock dividends ........................ -- -- (156)
-------- -------- --------
Net income applicable to common stock ............ $ 7,230 $ 6,342 $ 3,665
======== ======== ========
Basic earnings per share ........................... $ .20 $ .20 $ .14
======== ======== ========
Shares used in computing basic earnings per share .. 36,196 32,016 25,904
======== ======== ========
Diluted earning per share .......................... $ .19 $ .19 $ .13
======== ======== ========
Shares used in computing diluted earnings per share 38,262 34,212 27,840
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements
F-4
<PAGE>
MACROVISION CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(In thousands, except share data)
<TABLE>
<CAPTION>
Additional Stockholder
Preferred stock Common stock paid-in notes
Shares Amount Shares Amount capital receivable
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balances as of December 31, 1996 ............... 5,505,728 $ 6 15,807,036 $ 16 $ 9,513 $ (157)
Comprehensive income
Net income .................................
Other comprehensive income:
Translation adjustment ...................
Unrealized gain (loss) in investments, net
Total comprehensive income ...................
Conversion of preferred stock to common
Stock ...................................... (5,505,728) (6) 5,505,728 6 -- --
Issuance of common stock in initial public
offering, net of issuance costs of $1,531 .. -- -- 7,056,064 7 13,227 --
Issuance of common stock upon exercise of
options .................................... -- -- 445,368 -- 288 --
Issuance of common stock under stock
purchase plan .............................. -- -- 46,584 -- 89 --
Cash dividends of $.01875 per share .......... -- -- -- -- -- --
Payment on stockholder note receivable ....... -- -- -- -- -- 26
Amortization of deferred stock compensation .. -- -- -- -- -- --
Tax benefit associated with stock plans ...... -- -- -- -- 138 --
---------- ---------- ---------- ---------- ---------- ----------
Balances as of December 31, 1997 ............... -- $ -- 28,860,780 $ 29 $ 23,255 $ (131)
---------- ---------- ---------- ---------- ---------- ----------
Comprehensive income:
Net income .................................
Other comprehensive income
Translation adjustment .....................
Unrealized gain in investments, net ........
Total comprehensive income ...................
Issuance of common stock in secondary public
offering, net of issuance costs of $438 .... -- -- 5,460,000 5 27,867 --
Issuance of common stock upon exercise of
options .................................... -- -- 741,344 1 560 --
Issuance of common stock under stock
purchase plan .............................. -- -- 148,156 -- 292 --
Payment on stockholder note receivable ....... -- -- -- -- -- 53
Amortization of deferred stock compensation .. -- -- -- -- -- --
Tax benefit associated with stock plans ...... -- -- -- -- 617 --
---------- ---------- ---------- ---------- ---------- ----------
Balances as of December 31, 1998 ............... -- $ -- 35,210,280 $ 35 $ 52,591 $ (78)
---------- ---------- ---------- ---------- ---------- ----------
<CAPTION>
Accumulated
other (Accumulated Total
Deferred stock comprehensive deficit) retained stockholders'
compensation loss earnings equity
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Balances as of December 31, 1996 ............... $ (240) $ (135) $ (2,931) $ 6,072
Comprehensive income
Net income ................................. -- 3,821 3,821
Other comprehensive income:
Translation adjustment ................... (83) (83)
Unrealized gain (loss) in investments, net 4 4
---------- ----------
Total comprehensive income ................... (79) 3,742
---------- ----------
Conversion of preferred stock to common
Stock ...................................... -- -- -- --
Issuance of common stock in initial public
offering, net of issuance costs of $1,531 .. -- -- -- 13,234
Issuance of common stock upon exercise of
options .................................... -- -- -- 288
Issuance of common stock under stock
purchase plan .............................. -- -- -- 89
Cash dividends of $.01875 per share .......... -- -- (156) (156)
Payment on stockholder note receivable ....... -- -- -- 26
Amortization of deferred stock compensation .. 144 -- -- 144
Tax benefit associated with stock plans ...... -- -- -- 138
---------- ---------- ---------- ----------
Balances as of December 31, 1997 ............... $ (96) $ (214) $ 734 $ 23,577
---------- ---------- ---------- ----------
Comprehensive income:
Net income ................................. -- 6,342 6,342
Other comprehensive income
Translation adjustment ..................... (12) (12)
Unrealized gain in investments, net ........ 144 144
---------- ----------
Total comprehensive income ................... 132 6,474
---------- ----------
Issuance of common stock in secondary public
offering, net of issuance costs of $438 .... -- -- -- 27,872
Issuance of common stock upon exercise of
options .................................... -- -- -- 561
Issuance of common stock under stock
purchase plan .............................. -- -- -- 292
Payment on stockholder note receivable ....... -- -- -- 53
Amortization of deferred stock compensation .. 96 -- -- 96
Tax benefit associated with stock plans ...... -- -- -- 617
---------- ---------- ---------- ----------
Balances as of December 31, 1998 ............... $ -- $ (82) $ 7,076 $ 59,542
---------- ---------- ---------- ----------
</TABLE>
F-5
<PAGE>
<TABLE>
<CAPTION>
Additional Stockholder
Preferred stock Common stock paid-in notes
Shares Amount Shares Amount capital receivable
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Comprehensive income
Net income ...............................
Other comprehensive income:
Translation adjustment ...................
Unrealized gain in investments, net of tax
Total comprehensive income .................
Issuance of common stock upon exercise of
options .................................. -- -- 1,087,122 1 1,297 --
Issuance of common stock under stock
purchase plan ............................ -- -- 94,784 -- 331 --
Issuance of common stock for payment of
director fees under the stock option plan -- -- 2,000 -- 25 --
Issuance of common stock in acquisition of
C-Dilla Ltd .............................. -- -- 436,796 -- 5,073 --
Issuance of options in acquisition of
C-Dilla Ltd .............................. -- -- -- -- 1,829 --
Payment on stockholder note receivable ..... 78
Tax benefit associated with stock plans .... -- -- -- -- 2,407 --
---------- ---------- ---------- ---------- ---------- ----------
Balances as of December 31, 1999 ............. -- $ -- 36,830,982 $ 36 $ 63,553 $ --
========== ========== ========== ========== ========== ==========
<CAPTION>
Accumulated
other (Accumulated Total
Deferred stock comprehensive deficit) retained stockholders'
compensation loss earnings equity
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Comprehensive income
Net income ............................... 7,230 7,230
Other comprehensive income:
Translation adjustment ................... 132 132
Unrealized gain in investments, net of tax 25,115 25,115
---------- ----------
Total comprehensive income ................. 25,247 25,247
---------- ----------
Issuance of common stock upon exercise of
options .................................. -- -- -- 1,298
Issuance of common stock under stock
purchase plan ............................ -- -- -- 331
Issuance of common stock for payment of
director fees under the stock option plan -- -- -- 25
Issuance of common stock in acquisition of
C-Dilla Ltd .............................. -- -- -- 5,073
Issuance of options in acquisition of
C-Dilla Ltd .............................. -- -- -- 1,829
Payment on stockholder note receivable ..... -- -- 78
Tax benefit associated with stock plans .... -- -- -- 2,407
---------- ---------- ---------- ----------
Balances as of December 31, 1999 ............. $ -- $ 25,165 $ 14,306 $ 103,060
========== ========== ========== ==========
</TABLE>
F-6
<PAGE>
MACROVISION CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income .............................................................. $ 7,230 $ 6,342 $ 3,821
Adjustments to reconcile net income to net cash provided by
continuing operations:
Depreciation and amortization ......................................... 2,554 931 1,156
Amortization of prepaid future royalties to C-Dilla Ltd ............... 166 143 --
Deferred income taxes ................................................. (3,050) (34) (683)
Amortization of deferred stock compensation ........................... -- 96 144
Loss on disposal of fixed assets ...................................... 15 17 105
Tax benefit from employee stock plans ................................. 2,408 617 138
In process research and development ................................... 4,286 -- --
Change in provision for accounts and notes receivable ................. 146 123 467
Changes in operating assets and liabilities:
Accounts receivable, inventories, and other current assets ........ (5,769) (958) (2,408)
Accounts payable, accrued expenses, deferred revenue, and income
taxes payable ................................................... 3,843 482 (221)
Other ............................................................. 132 (12) (83)
-------- -------- --------
Net cash provided by operating activities ..................... 11,961 7,747 2,436
-------- -------- --------
Cash flows from investing activities:
Purchases of long-term marketable investment securities ................. (11,578) (19,495) (1,763)
Purchases of short-term investments ..................................... (39,513) (56,527) (51,737)
Sales or maturities of long-term marketable investments ................. 24,218 2,541 --
Sales or maturities of short-term investments ........................... 30,838 44,957 40,500
Acquisition of property and equipment ................................... (386) (285) (571)
Payments for patents and other intangibles .............................. (541) (666) (332)
Proceeds from related party receivable .................................. -- 310 --
Acquisition of C-Dilla Ltd., net of cash acquired ....................... (11,960) -- --
Investment in C-Dilla Ltd., Command Audio, Digimarc and AudioSoft ....... (3,601) (4,053) (3,480)
Prepaid future royalties to C-Dilla Ltd ................................. -- (1,015) --
Other, net .............................................................. 62 15 (67)
-------- -------- --------
Net cash used in investing activities ......................... (12,461) (34,218) (17,450)
-------- -------- --------
Cash flows from financing activities:
Payments on capital lease obligations ................................... (112) (108) (105)
Payments on debt ........................................................ (247) -- --
Proceeds from issuance of common stock upon exercise of options ......... 1,298 561 288
Proceeds from issuance of common stock under employee stock purchase plan 331 292 89
Proceeds from issuance of common stock for director fees ................ 25 -- --
Payment of stockholder note receivable .................................. 78 53 26
Proceeds from sale of common stock, net of issuance costs and payments of
deferred offering costs ............................................... (69) 27,872 13,777
Cash dividends .......................................................... -- -- (156)
-------- -------- --------
Net cash provided by financing activities ..................... 1,304 28,670 13,919
-------- -------- --------
Net (decrease) increase in cash and cash equivalents ...................... 804 2,199 (1,095)
Cash and cash equivalents at beginning of year ............................ 3,513 1,314 2,409
-------- -------- --------
Cash and cash equivalents at end of year .................................. $ 4,317 $ 3,513 $ 1,314
======== ======== ========
Cash paid during the year:
Interest .............................................................. $ 10 $ 11 $ 12
======== ======== ========
Income taxes .......................................................... $ 3,377 $ 3,209 $ 2,364
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE>
MACROVISION CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
(1) The Company and Summary of Significant Accounting Policies
The Company
Macrovision Corporation (the "Company") was formed in 1983 and designs,
develops and markets video copy protection and rights management technologies
that provide copy protection for motion pictures and other proprietary content
stored on videocassettes, DVDs or other media or is transmitted by cable,
satellite or microwave transmission or through the Internet. In 1998, the
Company broadened its focus to include the copy protection of other media,
including multimedia computer software on CD-ROMs. The Company is headquartered
in Sunnyvale, California and has subsidiaries in the United Kingdom and Japan.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant intercompany
transactions have been eliminated in consolidation.
In August 1999 and March 2000, the Company issued one additional share for
every share outstanding, thus effecting a 2 for 1 stock split. All share and per
share information presented have been retroactively adjusted for the effect of
both such stock splits.
Cash, Cash Equivalents, and Investments
The Company considers all highly liquid investments with a maturity from
date of purchase of three months or less to be cash equivalents. Cash and cash
equivalents consist of cash on deposit with banks and money market funds. All
other liquid investments with maturities over three months and less than 12
months are classified as short-term investments. Short-term investments
consisted of government bonds, government agency securities and corporate
securities. All marketable securities with maturities over one year or which the
Company's intent is to retain for the long-term are classified as long-term
marketable investment securities.
Management determines the appropriate classification of investment
securities at the time of purchase and reevaluates such designation as of each
balance sheet date. The Company enters into certain equity investments for the
promotion of business and strategic objectives, and typically does not attempt
to reduce or eliminate the inherent market risks on these investments. In
December 1999, Digimarc, in which the Company has a minority interest of 924,475
shares, consummated an initial public offering for which the fair market
valuation as of December 31, 1999 is classified as long-term marketable
investment securities on the consolidated balance sheet. As of December 31, 1999
and 1998, all investment securities were designated as "available-for-sale."
Available-for-sale securities are carried at fair value based on quoted market
prices, with unrealized gains and losses, reported in comprehensive income, a
separate component of stockholders' equity.
Realized gains and losses and declines in value judged to be
other-than-temporary for available-for-sale securities are included in the
consolidated statements of income. The cost of securities sold is based on the
specific identification method. Interest and dividends on securities classified
as available-for-sale are included in interest income.
F-8
<PAGE>
The following is a summary of available-for-sale securities (in
thousands):
December 31,
------------------
1999 1998
------- -------
Cash equivalents -- money market funds ................... $ 2,951 $ 3,098
Investments:
Corporate preferred certificates ....................... 2,000 --
Municipal preferred certificates ....................... 2,000 1,000
United States government bonds and agency securities ... 33,469 40,672
Equity investments ..................................... 46,224 --
83,693 41,672
------- -------
$86,644 $44,770
======= =======
As of December 31, 1999 and 1998 government bond securities and equity
investments totaling $52.2 million and $18.8 million respectively, are
classified as long-term marketable investment securities in the accompanying
consolidated balance sheet.
As of December 31, 1999 and 1998, the difference between the fair value
and the amortized cost of available-for-sale securities was a gain of
$42,634,000 and $148,000, respectively. These unrealized gains, net of deferred
income tax, related to short-term and long-term government bonds and investment
securities, have been recorded as a component of comprehensive income. As of
December 31, 1999 and 1998 the weighted average portfolio duration and
contractual maturity for the government bonds was approximately eight months and
ten months, respectively.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method.
Property and Equipment
Property and equipment, including significant improvements, are recorded
at cost. The Company computes depreciation for all property and equipment using
the straight-line method. The estimated useful lives of assets range from three
to five years. Amortization of furniture, fixtures and equipment recorded under
capital leases is computed over the shorter of the lease term or the estimated
useful life of the equipment.
Patents
Patent application costs of $1.5 million and $1.4 million as of December
31, 1999 and 1998, respectively, are included in patents and other intangibles
and, upon the granting of the related patent, are amortized using the
straight-line method over the shorter of the estimated useful life of the patent
or 10 years.
Other Intangible Assets
Other intangibles include the fair value of developed technology,
workforce, noncompete agreements and goodwill associated with the acquisition of
C-Dilla. The Company amortizes such intangibles on a straight-line basis over
three to seven years based on expected lives of the associated assets.
The Company reviews intangible assets for impairment based on a comparison
of the undiscounted expected future cash flows of the products relating to the
acquisition to the carrying value of associated intangibles. Accordingly, if the
Company were unable to generate sufficient revenues from its acquired
technology, goodwill and other intangibles would be adjusted through earnings to
reflect its net realizable value.
Impairment of Long-Lived Assets
The Company evaluates its long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment
F-9
<PAGE>
to be recognized is measured by the amount by which the carrying amount of the
assets exceed the fair value of the assets. Assets to be disposed of are
reported at the lower of the carrying amount or fair value less costs to sell.
Other Assets
The Company owns a minority interest in AudioSoft International SA
("AudioSoft") a developer of secure e-music delivery technology and copyright
management royalty reporting systems and Command Audio, a developer of
audio-on-demand technology, and accounts for such investments under the cost
method. In February 1998, the Company acquired a minority interest in C-Dilla
Ltd., a developer of copy protection and rights management technologies for
CD-ROM and Internet-delivered software products. In June 1999, the Company
acquired the remaining shares of C-Dilla Ltd (See Note 7 to Consolidated
Financial Statements). In December 1999, Digimarc (NASDAQ symbol DMRC), in which
the Company has a minority interest, consummated an initial public offering of
4,000,000 shares at a price of $20. The Company did not participate in the
offering and currently holds 924,475 shares of Digimarc. The fair market value
of shares held in Digimarc as of December 31, 1999 is included in long-term
marketable investment securities because of the Company's intent to hold its
Digimarc investment for the long-term. Other-than-temporary declines in the fair
value of these investments are included in the consolidated statements of
income. No such declines have been recorded in any of the years presented. See
Note 2 to Notes to Consolidated Financial Statements.
Revenue Recognition
Advanced license fees attributable to minimum copy quantities or shared
revenues are deferred until earned. Revenue from the duplication of
videocassettes and the replication of digital versatile discs ("DVDs") and
CD-ROMs is earned based upon reported or estimated volume of each or, in the
case of agreements with minimum guaranteed payments with no specified volume, on
a straight-line basis over the life of the agreement. Retroactive credits on
certain agreements that contain pricing adjustments or return provisions are
accrued based upon anticipated respective unit volumes. Nonrefundable technology
licensing revenue, which applies principally to DVD and PC subassembly
manufacturers, digital pay-per-view ("PPV"), cable and satellite system
operators, and set-top decoder manufacturers, is recognized upon persuasive
evidence of an arrangement, performance of all significant obligations and
determination that collection of a fixed and determinable license fee is
considered probable. Royalty revenue associated with technology licenses is
recognized when earned based upon reported unit sales or transaction based fees.
In fiscal 1999, the Company began recognizing royalty revenue associated with
PPV set top boxes on an as reported basis rather than based on estimates. The
change in estimate resulted in approximately $350,000 reduction in 1999 revenue.
This change did not have a material effect on the current year financial
statements. Revenues from the sales of encoders, decoders, and systems
incorporating the Company's video copy protection and scrambling technologies
are recognized upon shipment provided that the Company has no significant
additional performance obligations.
Cost of Revenues
The Company has agreements with certain licensed duplicators, DVD and CD
replicators, DVD authoring facilities and CD mastering facilities utilized by
customers of the Company's video copy protection and software copy protection
technologies. The Company has agreed to pay these licensees a specified fixed
service fee or on a per unit basis utilizing the Company's copy protection
technologies to help offset the cost of operating the Company's copy protection
equipment and reporting requirements of their contracts. Such amounts are
charged to cost of revenues when incurred. These service fees amounted to
$722,000, $428,000 and $362,000 for 1999, 1998 and 1997 respectively.
Cost of revenues includes outside legal costs of $715,000, $227,000 and
$70,000 in 1999, 1998 and 1997, respectively, associated with litigation to
enforce the Company's patents. Amortization of patents is also included in cost
of revenues.
Prior to the acquisition of C-Dilla by the Company in June 1999, the
Company had an exclusive worldwide Software Marketing License and Development
Agreement with C-Dilla to market, in the consumer multimedia software market,
C-Dilla's proprietary copy protection technology. Pursuant to the agreement, the
Company made royalty payments to C-Dilla of between 30% to 45% of revenues from
sales of software products incorporating C-Dilla's technology. These royalty
amounts were charged to cost of revenues when incurred and were approximately
$221,000 and $191,000 for 1999 and 1998, respectively.
F-10
<PAGE>
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. The measurement of deferred tax assets is reduced, if necessary,
by a valuation allowance for any tax benefits of which future realization is
uncertain.
Foreign Currency Translation and Transactions
The functional currency for the Company's foreign subsidiaries is the
applicable local currency. The translation of foreign currency denominated
financial statements into United States dollars is performed for balance sheet
accounts using current exchange rates in effect at the balance sheet date and
for revenues and expense accounts using a weighted average exchange rate for the
respective periods. Adjustments resulting from such translation are included in
comprehensive income. Gains or losses resulting from foreign currency
transactions included in the consolidated statements of income were not material
in any of the periods presented.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Accordingly, actual results could differ from those estimates.
Business and Concentration of Credit Risk
The Company sells its video scrambling products and licenses its video
copy protection, CD-ROM copy protection and video scrambling technologies to
customers in the home videocassette, DVD, pay-per-view, cable, satellite,
corporate communication markets and multimedia software markets primarily in the
United States, Europe, Japan, and the Far East. In 1999, 34.1% of the Company's
business is attributed to the licensing of its video copy protection technology
through Motion Picture Association of America ("MPAA") movie studios.
Accordingly, the ability of the Company to grow its video copy protection
operations has been dependent on MPAA movie studios continued success in the
production and distribution of movies utilizing the company's technology. The
Company also licenses its digital PPV video copy protection technologies to
satellite and cable television operators and to the equipment manufacturers that
supply the satellite and cable television industries. The Company licenses its
CD-ROM copy protection to publishers of software in the multimedia and
educational software and rights management application markets. The Company's
video scrambling technologies are utilized in analog cable Pay TV decoders, in
encoders and decoders in private analog satellite networks for business
communications, education, and special interest entertainment and in scrambling
systems in the government, military, and law enforcement markets. In addition,
45.6%, 44.5% and 46.5% of the Company's sales in 1999, 1998 and 1997,
respectively, are from export or foreign operations. The Company's business has
been and may continue to be negatively impacted by foreign economic conditions
such as the Southeast Asian and Latin American economic problems.
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash, cash equivalents,
marketable securities, trade accounts receivable and long-term investments. The
Company places its cash and cash equivalents and marketable securities in
deposits and money market funds with various high credit quality financial
institutions. The carrying value of the Company's financial instruments
approximates fair market value due to the relatively short maturities of those
instruments, the recency of entering into such instruments, the recency of
additional rounds of financing for AudioSoft and CAC or the ending price of
shares as represented on a national exchange for the Company's investment
Digimarc.
The Company performs ongoing credit evaluations of its customers. No one
customer accounted for more than 10% of net revenue for the year ended December
31, 1999. One customer accounted for 12% of net revenue
F-11
<PAGE>
for the year ended December 31, 1998. Another customer accounted for 11% of net
revenue for the year ended December 31, 1997. At December 31, 1999 receivables
from two customers aggregated approximately 24.5% of net accounts receivable. At
December 31, 1998 receivables from one customer represented 16% of net accounts
receivable.
Earnings Per Share (EPS)
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. In August, 1999 and March, 2000, the
Company issued one additional share for every share outstanding, thus affecting
a 2 for 1 stock splits. All share information presented has been retroactively
adjusted for the effect of both such stock splits. The following is a
reconciliation of the shares used in the computation of basic and diluted EPS
(in thousands):
<TABLE>
<CAPTION>
December 31,
------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Basic EPS-- weighted average number of common shares outstanding ...... 36,196 32,016 25,904
Effect of dilutive common equivalent shares-- stock options outstanding 2,066 2,196 1,936
------ ------ ------
Diluted EPS-- weighted average number of common shares and
common equivalents shares outstanding ............................... 38,262 34,212 27,840
====== ====== ======
</TABLE>
In 1999, 1998 and 1997, the average number of stock options that were not
included in the diluted earnings per share calculation because the exercise
price was greater than the average market price, totaled 40,000, 6,000 and
15,000 shares, respectively.
Advertising Expense
The cost of advertising is expensed as incurred. Such costs are included
in selling and marketing expense and totaled $1.1 million, $879,000 and $537,000
for the years ended December 31, 1999, 1998 and 1997, respectively.
Stock Based Compensation
The Company uses the intrinsic value-based method to account for all of
its employee stock-based compensation plans.
Recent Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP No. 98-1
requires that entities capitalize certain 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 on financial position or results of operations.
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 on financial position or results of operations.
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
F-12
<PAGE>
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.
In June 1999, the Financial Accounting Standards Board (FASB) issued SFAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities, Deferral
of the Effective Date of SFAS No. 133", which amends the effective date of SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities. SFAS No.
133 establishes accounting and reporting standards for derivative instruments
and hedging activities and requires the Company to recognize all derivatives as
either assets or liabilities on the balance sheet and measure them at fair
value. Gains and losses resulting from changes in fair value would be accounted
for based on the intended use of the derivative and whether it is designated and
qualifies for hedge accounting. The Company will adopt SFAS No. 133 for its
first quarter of fiscal 2001. The Company has not determined the impact that
SFAS No. 133 will have on its financial statements and believes that such
determination will not be meaningful until closer to the date of the initial
adoption.
(2) Financial Statement Details
Inventories
Inventories consisted of the following (in thousands):
December 31,
-------------------
1999 1998
---- ----
Raw materials .................................... $ 72 $138
Work in progress ................................. 26 --
Finished goods ................................... 80 187
---- ----
$178 $325
==== ====
Property and Equipment, Net
Property and equipment consisted of the following (in thousands):
December 31,
------------------
1999 1998
------ ------
Machinery and equipment ................................ $3,446 $2,968
Leasehold improvements ................................. 1,071 950
Furniture and fixtures ................................. 669 444
------ ------
5,186 4,362
Less accumulated depreciation and amortization ......... 3,531 3,065
------ ------
$1,655 $1,297
====== ======
Equipment recorded under capital leases aggregated $518,000 with related
accumulated amortization of $433,000 and $337,000 as of December 31, 1999 and
1998, respectively.
Other Assets
See Note 7 of Notes to Consolidated Financial Statements for a description
of the Company's investment in C-Dilla Ltd.
During 1997, the Company invested an additional $2.0 million in Command
Audio ("CAC") as part of various external rounds of third-party financing by CAC
thus maintaining its 19.8% ownership. In 1998, the Company invested $500,000 in
CAC in connection with a round of external third-party financing obtained by
CAC. This investment by the Company was less than the 19.8% of the total
investment financing made and thus reduced the Company's previous of CAC to
11.9%. Subsequently, CAC paid in full the note due the Company including accrued
interest. In December 1999, the Company converted its convertible bridge loan in
the amount of $836,733 and accrued interest to CAC into equity shares as part of
a round of third-party financing. As of December 31, 1999, the Company owns
approximately 7.8% equity in CAC. The Company does not have the ability to exert
significant influence over CAC.
F-13
<PAGE>
In December 1997, the Company invested $1.5 million in Digimarc in
exchange for shares of Digimarc's preferred stock. In June 1999, the Company
invested an additional $2.0 million in Digimarc in connection with a third-party
financing obtained by Digimarc. In December 1999, Digimarc (NASDAQ symbol DMRC),
consummated an initial public offering of 4,000,000 shares at a price of $20.
The Company did not participate in the offering and currently holds 924,475
shares of Digimarc. As of December 31, 1999, the fair market value of the shares
held in Digimarc is included in long-term marketable investment securities.
Digimarc is a company that was founded in 1995 and headquartered in Portland,
Oregon. Its products include proprietary digital watermarking technology used in
information embedding, enabling image identification, copyright protection and
facilitating electronic commerce.
In August 1999, the Company acquired a 7.3% ownership interest in
AudioSoft, a developer of secure e-music delivery technology and copyright
management royalty reporting systems. The Company does not have the ability to
exert significant influence over AudioSoft. The Company has committed to invest
an additional $750,000 should Audiosoft attain certain commercial milestones by
March 31, 2000. In addition, the Company entered into a consulting agreement
with AudioSoft to provide technical, business and strategic consulting to
AudioSoft over a term of one year. The Company will receive a fixed fee of
$500,000 from AudioSoft payable in four equal installments ending May 1, 2000,
and recognized the associated revenue based on consulting hours provided to
AudioSoft.
The Company intends to hold its investments for the long-term and monitors
the recoverability of these investments based on management's estimates of the
net realizable value based on the achievements of milestones in business plans
and third-party financings. The carrying amounts of such investments, which are
accounted for on the cost basis, are as follows (in thousands):
December 31,
---------------------
1999 1998
------ ------
Investment in CAC ................................ $3,688 $2,837
Investment in Digimarc ........................... -- 1,500
Investment in C-Dilla ............................ -- 3,553
Investment in AudioSoft .......................... 750 --
Prepayment of royalties to C-Dilla ............... -- 872
Deposits and other assets ........................ 86 148
------ ------
$4,524 $8,910
====== ======
Accrued Expenses
Accrued expenses consisted of the following (in thousands):
December 31,
-----------------------
1999 1998
------ ------
Accrued compensation ......................... $2,890 $1,810
Accrued professional fees .................... 527 308
Accrued credits .............................. 437 --
Other accrued liabilities .................... 872 573
------ ------
$4,726 $2,691
====== ======
F-14
<PAGE>
Interest and Other Income (Expense), Net
Interest and other income (expense), net, consisted of the following (in
thousands):
Year ended December 31,
---------------------------------------
1999 1998 1997
------- ------- -------
Interest income ................ $ 1,499 $ 1,062 $ 513
Interest expense ............... (10) (11) (12)
Other .......................... 114 51 (23)
------- ------- -------
$ 1,603 $ 1,102 $ 478
======= ======= =======
Valuation and Qualifying Accounts (in thousands)
<TABLE>
<CAPTION>
Balance at Charged to
Beginning of Costs and Balance at
Period Expenses Deductions End of Period
------- -------- ---------- -------------
<S> <C> <C> <C> <C>
Allowance for doubtful accounts:
1997 ................................. $ 267 553 136 $ 684
1998 ................................. $ 684 193 40 $ 838
1999 ................................. $ 838 353 207 $ 984
</TABLE>
Supplemental Cash Flow Information
Supplemental cash flow information related to noncash investing and
financing activities is as follows (in thousands):
Year ended December 31,
-----------------------
1999 1998 1997
------- ---- ------
Conversion of preferred stock into common stock ...... -- -- $7,433
======= ==== ======
Stock issued for C-Dilla Ltd ......................... $ 5,073 -- --
======= ==== ======
Issuance of options in acquisition of C-Dilla Ltd .... $ 1,829 -- --
======= ==== ======
Unrealized gain on investments, net of tax ........... $25,115 -- --
======= ==== ======
(3) Transactions with Related Parties
In 1996, the Company divested itself of CAC and records its current
investment in CAC based upon its historical cost adjusted for losses incurred by
CAC through the date in which it ceased having significant influence over CAC.
The Company intends to hold this investment for the long-term and evaluates the
recoverability of this investment based on successive rounds of third-party
financing obtained by CAC. The investment is classified in other assets in the
accompanying consolidated balance sheet as of December 31, 1999 and 1998 (See
Note 2 to the Consolidated Financial Statements). The Company is not obligated
by contract to provide future funding to Command Audio and does not have the
ability to exert significant influence over the financial and operating policies
of CAC. The Company accounts for this investment by the cost method.
In August 1999, the Company entered into a consulting agreement with
AudioSoft, in which it has approximately a 7.3% ownership interest. Under the
agreement, the Company is to provide technical, business and strategic
consulting to AudioSoft over a term of one year. The Company will receive a
fixed fee of $500,000 from AudioSoft payable in four equal installments ending
May 1, 2000, and recognizes the associated revenue based on consulting hours
provided to AudioSoft. As of December 31, 1999, the Company recorded
approximately $105,000 in revenue under the agreement.
The Company and JVC are parties to a Technology Application Agreement
dated November 29, 1988 (the "Application Agreement"), a Duplicator Agreement
dated June 1, 1988 (the "Duplicator Agreement") and an Agreement dated July 15,
1994 (the "Video Agreement"). Pursuant to the Application Agreement, JVC has
applied the Company's copy protection process to prerecorded videocassettes
manufactured and distributed in Japan by
F-15
<PAGE>
JVC. Pursuant to the Duplicator Agreement, JVC has applied the Company's copy
protection process to prerecorded videocassettes manufactured and distributed in
Japan bycertain of the Company's licensees. Pursuant to the Video Agreement, JVC
developed a prototype of equipment to apply a copy protection process to
prerecorded videocassettes, and granted the Company exclusive rights to purchase
such equipment from JVC for resale and to sublicense the copy protection
technology for use with the equipment. For the years ended December 31, 1999,
1998 and 1997 the Company recorded revenue from JVC of approximately $410,000,
$211,000 and $234,000, respectively, and recorded expenses payable to JVC of
approximately $69,000, $36,000 and $22,000, respectively under these agreements.
In January 1997, the Company and JVC entered into a Copy Protection
Technology Agreement in which the Company has agreed to continue to license its
copy protection technologies to third parties in the event of the acquisition of
the Company by a party other than JVC. Further, the Company has granted to JVC
the right to sublicense the Company's copy protection technologies with 95% of
the royalties from such sublicenses payable to the Company or successor in the
event that the Company fails to make its copy protection technologies generally
available for licensing to third parties following an acquisition of the
Company.
During 1997, the Company entered into several agreements with JVC or its
wholly owned subsidiaries including a Copy Protection Technology License
Agreement, a Digital Versatile Disc Player/Digital Video Cassette Recorder
License Agreement for Anticopy Technology, and a Replicator Agreement. The terms
and conditions of these agreements are not more favorable to JVC or its
subsidiaries than the terms offered to other unrelated parties. The Company
recorded revenues from JVC of approximately $3,000, $6,000, and $59,000 during
the year ended December 31, 1999, 1998 and 1997, respectively.
In 1998, the Company entered into a Copy Protection Technology Application
and Duplicator Agreement with JVC and a third party duplicator by which JVC
agrees to pay all fees to Macrovision on behalf of the duplicator. The terms and
conditions of such agreements are not more favorable to JVC or its subsidiaries
than the terms offered to other unrelated parties. Under this contract, the
Company has recorded $5,000 and no revenue during the year ended December 31,
1999 and 1998. The contract was terminated in 1999.
In 1998, the Company's current subsidiary, C-Dilla, and JVC Disc America,
a JVC subsidiary, entered into an Authorised Safedisc Mastering and Replication
Service Agreement. The terms and conditions of such agreement are not more
favorable to JVC or its subsidiaries than the terms offered to other unrelated
parties. No revenues are generated from this agreement and Macrovision pays JVC
Disc America an insignificant service fee per unit mastered or replicated.
In 1999, the Company and JVC entered into a Component Supplier
Non-Assertion and Technical Services Agreement. The terms and conditions of such
agreement are not more favorable to JVC or its subsidiaries than the terms
offered to other unrelated parties. JVC has paid Macrovision a $15,000 fee under
this agreement.
In 1996 and 1997, the Company entered into agreements with Matsushita,
which owns approximately 52% of JVC, including a Copy Protection Technology
License Agreement, a Digital Versatile Disc Player/Digital Video Cassette
Recorder License Agreement for Anticopy Technology and a Component Supplier
Non-Assertion and Technical Services Agreement. The terms and conditions of this
agreement are not more favorable to Matsushita or its subsidiaries than the
terms offered to other unrelated parties. The Company recorded revenues from
Matsushita of approximately $186,000, $148,000 and $111,000 during the years
ended December 31, 1999, 1998 and 1997, respectively.
In 1998, the Company entered into agreements with Matsushita including an
Authoring and Replicator Agreement and a DVD Copy Protection Technology
Application Agreement. The terms and conditions of such agreements are not more
favorable to Matsushita or its subsidiaries than the terms offered to other
unrelated parties. The Company has recorded revenue from Matsushita of
approximately $49,000 and none during the years ended December 31, 1999 and 1998
and minimal service fees pursuant to these contracts.
In February, 1998, the Company entered into a Software Marketing License
and Development Agreement with C-Dilla Ltd. under which it has obtained, for an
initial five-year term, the world-wide exclusive license to market, in the
consumer multimedia software market, C-Dilla Ltd.'s proprietary copy protection
technology. In February 1998, C-Dilla Ltd. also agreed to reimburse the Company
for specific marketing related expenses up to
F-16
<PAGE>
$500,000. As of December 31, 1998 the Company had received the full amount
reimbursable, under the co-marketing agreement with C-Dilla Ltd.
(4) Stockholders' Equity
Series A Convertible Preferred Stock
The Company's Certificate of Incorporation provides for the issuance of up
to 5,000,000 shares of $0.001 par value preferred stock.
Restricted Stock
On June 7, 1996, the Company issued 233,332 shares of common stock at a
price of $0.675 per share pursuant to a restricted stock purchase agreement to
an officer of the Company in exchange for a full recourse promissory note
secured by the shares in the principal amount of $157,000. Interest accrued at
the rate of 6.58% per annum. Principal and accrued interest, if any, were due
and payable on June 7, 2001. The Company had the right to repurchase the stock
at the original sales price upon the termination of the purchaser's employment
with the Company. The repurchase right lapsed at a rate of 1/6 after June 7,
1997, 1/3 after June 7, 1998, and 1/2 after June 7, 1999. As of December 31,
1998, there were 116,668 shares subject to the repurchase right and the
remaining principal of the note was $78,000. As of December 31, 1999, there were
no shares subject to the repurchase right and the note had been paid in full.
Stock Option and Purchase Plans
In December 1996, the Company adopted the 1996 Equity Incentive Plan (the
"Equity Incentive Plan"), which serves as the successor to the Company's 1988
Stock Option Plan (the "1988 Plan"). Options granted under the 1988 Plan before
its termination continue to remain outstanding in accordance with their terms,
but no further options may be granted under the 1988 Plan. Nonstatutory stock
options and incentive stock options granted under the 1988 Plan were exercisable
at prices not less than 85% and 100%, respectively, of the fair value of the
Company's common stock on the date of grant, as determined by the Company's
Board of Directors. The options were generally exercisable over a 3-year vesting
period and expire 7 to 10 years from date of grant.
Pursuant to the Equity Incentive Plan, the Company's Board of Directors
has reserved 5,088,888 shares of common stock for issuance. In May 1998, an
additional 1,600,000 shares were reserved by approval of the Board of Directors
and stockholders. The Equity Incentive Plan provides for the grant of stock
options, stock appreciation rights, and restricted stock awards by the Company
to employees, officers, directors, consultants, independent contractors, and
advisers of the Company. The Equity Incentive Plan permits the grant of either
incentive or nonqualified stock options at the then current market price.
Options granted under the Equity Incentive Plan will have a maximum term of ten
years and generally vest over three years at the rate of 1/6, 1/3 and 1/2,
respectively.
In December 1996, the Company's Board of Directors adopted the 1996
Employee Stock Purchase Plan (the "Purchase Plan") and reserved 560,000 shares
of common stock for issuance thereunder. The Purchase Plan was effective upon
the Company's initial public offering in March, 1997. The Purchase Plan permits
eligible employees to purchase common stock, through payroll deductions of
between 1% and 20% of the employee's compensation, at a price equal to 85% of
the lower of the fair market value of the common stock on the first day of the
offering period or on the last day of the purchase period. The Company's
stockholders approved the Purchase Plan in February 1997. In 1999, 1998 and
1997, the Company issued 94,784, 148,156 and 46,584 shares, respectively,
pursuant to the Purchase Plan.
In December 1996, the Company's Board of Directors adopted the 1996
Directors Stock Option Plan (the "Directors Plan") and reserved 240,000 shares
of common stock for issuance thereunder. The Directors Plan provides for the
initial grant of a nonqualified option to purchase 10,000 shares of common stock
on the date the eligible director first becomes a director and the additional
grant of a nonqualified option to purchase 6,000 shares of Common Stock annually
thereafter. Options will vest at the rate of 2.08% per month so long as the
director continues to serve on the Board on such dates. The Company's
stockholders approved the Directors Plan in February 1997. 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.
F-17
<PAGE>
1. The initial option grant to new outside directors will increase from
10,000 to 20,000 shares.
2. The option granted on each outside director's anniversary date after the
initial option grant will increase from 6,000 to 15,000 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.
During 1999, 1998 and 1997, the Company granted options to purchase
90,000, 36,000 and 60,000 shares, respectively, of common stock.
The Company uses the intrinsic value-based method to account for all of
its employee stock-based compensation plans. Accordingly, no compensation cost
has been recognized in the accompanying consolidated financial statements for
its plans because the exercise price of each option equaled or exceeded the fair
value of the underlying common stock as of the grant date for each stock option,
except for options and restricted stock granted in May and June 1996. With
respect to the options and restricted stock granted in May and June 1996, the
Company has recorded deferred stock compensation of $231,000 for the difference
at the grant date between the exercise price and the fair value, as determined
by an independent valuation, of the restricted stock and the common stock
underlying the options. This amount was amortized on a straight-line basis over
the vesting period of the individual options and restricted stock.
If compensation cost for the Company's stock-based compensation plans had
been determined in a manner consistent with the fair value approach described in
SFAS No. 123, the Company's net income and net income per share as reported
would have been reduced to the pro forma amounts indicated below (in thousands,
except per share data):
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C> <C>
Net income As reported $ 7,230 $ 6,342 $ 3,821
Adjusted pro forma 2,399 5,091 3,388
Basic net income per share As reported .20 .20 .14
Adjusted pro forma .07 .16 .13
Diluted net income per share As reported .19 .19 .13
Adjusted pro forma .06 .15 .12
</TABLE>
Options vest over several years and new options are generally granted each
year. Because of these factors, the pro forma effect shown above may not be
representative of the pro forma effect of SFAS No. 123 in future years.
The fair value of each option is estimated on the date of grant using the
Black-Scholes method with the following weighted average assumptions for options
and the ESPP plan:
Year ended December 31,
------------------------------
1999 1998 1997
------ ------ ------
Option Plans:
Dividends ........................... None None None
Expected term ....................... 4.32 years 4.34 years 4.56 years
Risk free interest rate ............. 5.62% 6.45% 6.07%
Volatility rate ..................... 71.7% 66.8% 64.7%
ESPP Plan:
Dividends ........................... None None None
Expected term ....................... 1.25 years 1.25 years 1.25 years
Risk free interest rate ............. 5.92% 5.47% 5.42%
Volatility rate ..................... 65.7% 62.6% 62.4%
F-18
<PAGE>
Activity under the Company's option plans is as follows:
<TABLE>
<CAPTION>
Number of Weighted-average
shares exercise price
---------- ---------------
<S> <C> <C>
Outstanding as of December 31, 1996 ................. 2,802,260 $ 0.75
Granted ............................................. 504,616 2.96
Canceled ............................................ (68,136) 1.05
Exercised ........................................... (445,368) .65
----------
Outstanding as of December 31, 1997 ................. 2,793,372 1.16
Granted ............................................. 825,580 4.28
Canceled ............................................ (51,088) 3.24
Exercised ........................................... (741,344) 0.76
----------
Outstanding as of December 31, 1998 ................. 2,826,520 2.14
Granted ............................................. 1,933,040 12.32
Canceled ............................................ (242,540) 5.56
Exercised ........................................... (1,089,122) 1.22
----------
Outstanding as of December 31, 1999 ................. 3,427,898 7.92
==========
</TABLE>
<TABLE>
<CAPTION>
December 31,
-------------------------------------------
1999 1998 1997
----------- ------------- -------------
<S> <C> <C> <C>
Options exercisable at end of year ............................. 859,106 1,394,916 1,516,168
Weighted average fair value of options granted during the period $ 7.72 $ 2.50 $ 1.72
</TABLE>
The following table summarizes information about fixed stock options
outstanding as of December 31, 1999:
<TABLE>
<CAPTION>
Outstanding Exercisable
----------------------------------------------- -----------------------------
Weighted average Weighted
Number remaining Weighted average Number average
Range of exercise prices of shares contractual life exercise price exercisable exercise price
- ------------------------ --------- ---------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$ 0.68 - 3.63 957,202 5.79 years $ 1.55 766,256 $1.16
$ 3.75 - 8.79 1,291,828 8.76 6.60 78,062 4.80
$ 9.63 - 12.91 930,868 9.45 12.70 11,664 9.63
$18.66 - 23.32 248,000 9.69 21.50 3,124 18.66
--------- --------
3,427,898 8.19 7.92 859,106 1.67
========= ========
</TABLE>
(5) Income Taxes
Income taxes consisted of the following (in thousands):
December 31,
-----------------------------
1999 1998 1997
------- ------- -------
Current:
Federal ..................................... $ 3,135 $ 2,119 $ 2,031
Foreign ..................................... 500 354 383
State ....................................... 970 873 544
------- ------- -------
Total current ............................. 4,605 3,346 2,958
------- ------- -------
Deferred:
Federal ..................................... (2,447) (34) (554)
State ....................................... (604) -- (129)
------- ------- -------
Total deferred ............................ (3,051) (34) (683)
------- ------- -------
Charges in lieu of income taxes associated
with the exercise of stock options ......... 2,407 617 138
------- ------- -------
$ 3,961 $ 3,929 $ 2,413
======= ======= =======
F-19
<PAGE>
The Company's effective tax rate differs from the statutory federal tax
rate as follows (in thousands):
Year ended December 31,
-----------------------------
1999 1998 1997
------- ------- -------
Computed "expected" tax expense ............... $ 3,817 $ 3,492 $ 2,120
State tax expenses, net of federal benefit .... 607 576 274
Tax credits ................................... (287) (304) (87)
Foreign taxes ................................. 45 192 47
Exempt interest ............................... (482) (320) (144)
Other ......................................... 261 293 203
------- ------- -------
$ 3,961 $ 3,929 $ 2,413
======= ======= =======
The tax effects of the temporary differences that give rise to significant
portions of the deferred tax assets and liabilities are presented below (in
thousands):
December 31,
----------------------
1999 1998
-------- ------
Deferred tax assets:
Accrued liabilities and reserves ................ $ 724 $ 826
Allowance for doubtful accounts ................. 402 341
Depreciation and amortization ................... 524 483
Deferred revenue ................................ 1,351 502
Goodwill ........................................ 2,052 --
Net operating losses ............................ 1,440 --
-------- ------
Total gross deferred tax assets ............... 6,493 2,152
Deferred tax liabilities:
Patents ......................................... 717 866
Unrealized gains ................................ 17,372 --
-------- ------
Total gross deferred tax liabilities .......... 18,089 866
-------- ------
Net deferred tax (liability) asset ............ $(11,596) $1,286
======== ======
Net deferred tax liabilities as of December 31, 1999 include a deferred
tax asset of approximately $1.4 million of net operating loss carryovers, which
were acquired in the acquisition of C-Dilla. These net operating losses are
available to offset the taxable net income of C-Dilla on its United Kingdom
income tax returns.
Net deferred tax liabilities as of December 31, 1999 also include a
deferred tax liability of approximately $17.3 million related to net unrealized
capital gains. The net unrealized capital gain relates primarily to the
Company's investment in Digimarc.
Management believes that it is more likely than not that the results of
future operations will generate sufficient taxable income to realize the
deferred tax assets.
(6) Commitments
Leases
The Company leases its facilities and certain equipment pursuant to
noncancelable operating lease agreements. Additionally, the Company leases
certain equipment pursuant to a capital lease agreement.
Future minimum lease payments pursuant to these leases as of December 31,
1999, were as follows (in thousands):
F-20
<PAGE>
Capital Operating
Lease Leases
------- ---------
2000 .................................................... $77 $ 601
2001 .................................................... -- 575
2002 .................................................... -- 328
2003 .................................................... -- 98
2004 and thereafter ..................................... -- 121
--- ------
Total ................................................... $77 $1,723
=== ======
Less amounts representing interest ...................... 1
---
Present value of minimum capital lease payments ......... 76
Less current portion of capital lease liability ......... 76
---
Capital lease liability, net of current portion ......... $--
===
Rent expense was $566,000, $501,000, and $469,000 as of December 31, 1999,
1998 and 1997, respectively.
Employee Benefit Plan
The Company has a 401(k) plan that allows eligible employees to contribute
up to 20% of their compensation, which contribution was limited to $10,000 in
1999. Employee contributions and earnings thereon vest immediately. The Company
is not required to contribute to the 401(k) plan and had made no voluntary
contributions. The Company made matching contributions to the 401(k) plan equal
to 20% of each participating employee's contribution, up to a maximum annual
matching contribution of $2,000, $2,000 and $1,900 in 1999, 1998 and 1997,
respectively. Matching contributions aggregated $65,000, $60,000 and $54,000 for
the year ended December 31, 1999, 1998 and 1997, respectively, and are fully
vested after three years of service.
Strategic Investments
As discussed in Note 2 to Consolidated Financial Statements, the Company
is committed to invest an additional $750,000 in AudioSoft in the event
AudioSoft attains certain commercial milestones by March 31, 2000.
(7) Acquisitions
In June 1999, the Company acquired the remaining shares of C-Dilla Ltd.,
developers of copy protection and rights management technologies for CD-ROM and
Internet-delivered software products. The Company paid approximately $12.8
million in cash and acquisition costs, 436,796 shares of the Company's stock
valued at $5.1 million and option grants in Macrovision valued at $1.8 million.
The Company previously invested approximately $3.6 million in C-Dilla. The
transaction has been accounted for under the purchase method. The excess
purchase price over the net tangible assets acquired was $22.5 million 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 .................................... 4,278
---------
$ 22,517
=========
In connection with the purchase of C-Dilla Ltd., the Company allocated
$4.3 million of the $23.3 million total purchase price to in-process research
and development projects. This 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-
F-21
<PAGE>
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. The Company currently expects 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 the Company
currently expects 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 $52.5 million 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. The
estimated total costs are equal to approximately 78% of the projected revenue.
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 noncompete 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, the Company 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.
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 .. 18,231
Current liabilities ................................... (1,888)
--------
$ 23,265
========
The following summary, prepared on an unaudited pro forma basis, reflects
the condensed consolidated results of operations for the year ended December 31,
1999 and 1998 assuming C-Dilla Ltd. had been acquired as of the beginning of the
periods presented (in thousands, except per share data):
F-22
<PAGE>
Year ended December 31,
-----------------------
1999 1998
------- --------
Net revenues ................................. $38,060 $ 25,728
Net income attributed to common stockholders . $ 8,454 $ (28)
Basic net income per share ................... $ .23 $ --
Shares used in pro forma per share computation 36,396 32,452
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 the synergies that might be achieved from combined operations. The pro
forma results exclude the write off associated with in-process research and
development due to its non recurring nature.
(8) Segment and Geographic Information
The Company operates in three industry segments as follows: Video Copy
Protection, Computer Software/CD-ROM Copy Protection and Video Scrambling. The
Company licenses its technologies to customers in the videocassette, DVD,
digital pay-per-view markets and multimedia software markets. The Company also
licenses products utilizing the Company's video scrambling technology. The
Computer Software/CD-ROM Copy Protection licenses copy protection technology in
the multimedia software market.
The Company identifies segments based principally upon the type of
products sold. The accounting policies of these reportable segments are the same
as those described in the consolidated entity. The Company evaluates the
performance of its segments based on revenue and segment income. In addition, as
the Company's assets are primarily located in its corporate office in the United
States and not allocated to any specific segment, the Company does not produce
reports for or measure the performance of its segments based on any asset-based
metrics. Therefore, segment information is presented only for revenue and
segment income.
The following segment reporting information of the Company is provided
(dollars in thousands):
Revenue:
Year ended December 31,
-----------------------------
1999 1998 1997
------- ------- -------
Video Copy Protection ......................... $31,983 $22,626 $17,412
Computer Software/CD-ROM Copy Protection ...... 4,754 344 --
Video Scrambling .............................. 548 1,464 2,739
Other ......................................... 105 -- 189
------- ------- -------
Total ......................................... $37,390 $24,434 $20,340
======= ======= =======
F-23
<PAGE>
<TABLE>
<CAPTION>
Operating Income:
Year ended December 31,
--------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Video Copy Protection .............................. $ 25,026 $ 17,115 $ 12,509
Computer Software/CD-ROM Copy Protection ........... 1,157 (126) --
Video Scrambling ................................... (856) (504) 309
Other .............................................. 78 (117) (665)
-------- -------- --------
Segment income ................................... 25,405 16,368 12,153
Research and development ........................... 4.402 2,578 2,248
General and administrative ......................... 5,529 4,621 4,149
Amortization of intangibles from acquisition ....... 1,600 -- --
In process research and development ................ 4,286 -- --
-------- -------- --------
Operating income ................................. 9,588 9,169 5,756
Interest and other income, net ................... 1,603 1,102 478
-------- -------- --------
Income before taxes .............................. $ 11,191 $ 10,271 $ 6,234
======== ======== ========
<CAPTION>
Depreciation and Amortization:
Year ended December 31,
--------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Video Copy Protection .............................. $ 1,799 $ 311 $ 451
Computer Software Copy Protection .................. 75 13 --
Video Scrambling ................................... 219 221 281
Other .............................................. -- -- 73
Research and development ........................... 297 206 169
General and administrative ......................... 164 180 182
-------- -------- --------
Total .............................................. $ 2,554 $ 931 $ 1,156
======== ======== ========
<CAPTION>
Information on Revenue by Significant Product Group:
Year ended December 31,
--------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Video Copy Protection:
Videocassette .................................... $ 15,877 $ 15,770 $ 12,616
DVD .............................................. 8,629 3,096 1,084
Pay-Per-View ..................................... 7,477 3,760 3,712
Computer Software Copy Protection .................. 4,754 344 --
Video Scrambling:
Video Scrambling Systems ......................... 35 477 756
Components & Licensing ........................... 513 987 1,983
Other .............................................. 105 -- 189
-------- -------- --------
Total .............................................. $ 37,390 $ 24,434 $ 20,340
======== ======== ========
<CAPTION>
Information on Revenue by Geographic Areas:
Year ended December 31,
--------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
United States ...................................... $ 20,350 $ 13,563 $ 10,878
Japan .............................................. 4,113 2,738 2,181
Export & Foreign Operations ........................ 12,927 8,133 7,281
-------- -------- --------
Total Revenue ...................................... $ 37,390 $ 24,434 $ 20,340
======== ======== ========
</TABLE>
F-24
<PAGE>
Geographic area information is based upon country of destination for
products shipped and country of contract holder for royalties and license fees.
Both the United States and Japan account for over 10% of the Company's revenues
in 1999, 1998 and 1997. No one customer accounted for more than 10% of net
revenue for the year ended December 31, 1999. One customer of the Video Copy
Protection accounted for 12% of net revenues for the year ended December 31,
1998. Revenue from another customer of the Video Copy Protection accounted for
11% of net revenues for the year ended December 31, 1997. At December 31, 1999
receivables from two customers aggregated approximately 24.5% of net accounts
receivable. At December 31, 1998 and 1997 receivables from one customer of the
Video Copy Protection represented 16% and 25%, respectively, of net accounts
receivable.
(9) Comprehensive Income (Loss)
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130 (SFAS 130), "Reporting Comprehensive Income," which
establishes standards for displaying comprehensive income and its components.
The components of accumulated other comprehensive income (loss) consist of
the following items (in thousands):
Balance at Current
Beginning of Period Balance at
Period Change End of Period
----------- ------- ------------
Translation Gain (Loss):
1999 ................................... $(230) 132 $ (98)
1998 ................................... $(218) (12) $ (230)
1997 ................................... $(135) (83) $ (218)
Unrealized Gain (Loss) in Investments:
1999 ................................... $ 148 42,487 $ 42,635
1998 ................................... $ 4 144 $ 148
1997 ................................... $ -- 4 $ 4
The tax effect on components of comprehensive income was an expense of
$17,372,000 for 1999.
(10) Subsequent Events
a) In December 1999, the Company entered into a letter agreement with TTR
Technologies Ltd, to develop and market a copy protection system, which
will inhibit casual copying of Music CDs using dual-deck CD recorder
systems and personal computer systems. The two companies intend to work
cooperatively with encoder manufacturers and CD replicators to implement
the manufacturing and quality control systems necessary to commercialize
the jointly developed Music CD copy protection technology. In January
2000, as part of the strategic partnership agreement, the Company made an
11.4% equity investment in TTR in the amount of $4 million.
b) In January 2000, the Company consummated an offering ("offering") of
3,820,000 shares of its Common Stock, of which 2,874,000 shares were
issued and sold by the Company and 946,000 shares were sold by
shareholders of the Company. All shares were sold for $53.438 per share.
The net proceeds to the Company from the offering, after deducting the
underwriting discount and other expenses of the offering, were
approximately $146 million. The Company did not receive any proceeds from
the sale of shares sold by the selling shareholders.
c) In March 2000, the Company issued one additional share for every share
outstanding, thus affecting a 2 for 1 stock split. All share information
presented in Form 10-K has been retroactively adjusted for the effect of
such stock split.
F-25
<PAGE>
d) In March 2000, the Company made a $1.0 million strategic investment in RPK
Security, Inc. ("RPK"). RPK develops encryption technology for high data
flow Internet applications such as streaming media and digital
communication. The investment will be accounted for on a cost basis.
e) In March 2000, the Company signed a letter of intent to acquire all
outstanding shares and vested stock options of GLOBEtrotter for 11.2
million shares of Macrovision common stock. GLOBEtrotter is a San Jose,
California based OEM supplier of business-to-business electronic licensing
and license management techology to software vendors and a direct supplier
of software asset management products to corporate customers worldwide.
The acquisition is subject to completion of due diligence, the approval of
the Company's board of directors and stockholders, regulatory approvals,
and the completion of a definitive agreement.
F-26
Exhibit 23.01
Consent of Independent Auditors
The Board of Directors
Macrovision Corporation:
We consent to incorporation by reference in the registration statements
(Nos. 333-23213 and 333-60499) on Form S-8 of Macrovision Corporation of our
report dated February 8, 2000, except for Note 10, which is as of March 28,
2000, relating to the consolidated balance sheets of Macrovision Corporation and
subsidiaries as of December 31, 1999 and 1998, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the years
in the three-year period ended December 31, 1999, which report appears in the
December 31, 1999, annual report on Form 10-K of Macrovision Corporation.
/s/ KPMG LLP
Mountain View, California
March 28, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Financial Statements of Macrovision Corporation for the twelve months ended
December 31, 1999, and is qualified in its entirety by reference to such
Financial Statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 4317
<SECURITIES> 31452
<RECEIVABLES> 12646
<ALLOWANCES> 984
<INVENTORY> 178
<CURRENT-ASSETS> 51152
<PP&E> 5797
<DEPRECIATION> 4142
<TOTAL-ASSETS> 127850
<CURRENT-LIABILITIES> 10717
<BONDS> 0
0
0
<COMMON> 18
<OTHER-SE> 103060
<TOTAL-LIABILITY-AND-EQUITY> 127850
<SALES> 37390
<TOTAL-REVENUES> 37390
<CGS> 3012
<TOTAL-COSTS> 3012
<OTHER-EXPENSES> 24790
<LOSS-PROVISION> 353
<INTEREST-EXPENSE> 10
<INCOME-PRETAX> 11191
<INCOME-TAX> 3961
<INCOME-CONTINUING> 7230
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7230
<EPS-BASIC> .20
<EPS-DILUTED> .19
</TABLE>
