FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED June 30, 2000
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 000-22023
Macrovision Corporation
(Exact name of registrant as specified in its charter)
Delaware 77-0156161
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1341 Orleans Drive
Sunnyvale, California 94089
(Address of principal executive offices) (Zip code)
(408) 743-8600
(Registrant's telephone number including area code)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes |X| No |_|
State the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Title Outstanding as of July 31, 2000
Common Stock, $0.001 par value 40,450,148
<PAGE>
MACROVISION CORPORATION
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION Page
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets
as of June 30, 2000 and December 31, 1999 .................. 3
Condensed Consolidated Statements of Operations
for the Three Month Period Ended June 30, 2000 and 1999
and the Six Month Period Ended June 30, 2000 and 1999 ...... 4
Condensed Consolidated Statements of Cash Flows
for the Six Month Period Ended June 30, 2000 and 1999....... 5
Notes to Condensed Consolidated Financial Statements.............. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ........................................ 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk........ 17
Risk Factors...................................................... 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................. 25
Item 5. Other Information ................................................ 25
Item 6. Exhibits and Reports on Form 8-K ................................. 25
Signatures ................................................................ 26
2
<PAGE>
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements.
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
June 30,
2000 December 31,
(Unaudited) 1999
--------------- ---------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 13,141 $ 4,317
Short-term investments 119,650 31,452
Accounts receivable, less allowance for doubtful
accounts of $1,007 and $984 9,603 11,662
Inventories 89 178
Deferred tax assets 2,262 2,477
Prepaid expenses and other assets 4,012 1,066
--------------- ---------------
Total current assets 148,757 51,152
Property and equipment, net 1,613 1,655
Patents and other intangibles, net 1,459 1,647
Long-term marketable investment securities 104,723 52,241
Intangibles associated with C-Dilla Ltd acquisition, net 15,145 16,631
Other assets 7,464 4,524
--------------- ---------------
$ 279,159 $ 127,850
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,674 $ 1,267
Accrued expenses 4,389 4,726
Deferred revenue 2,941 3,124
Income taxes payable 411 1,524
Current portion of capital lease obligation 19 76
--------------- ---------------
Total current liabilities 9,434 10,717
Deferred tax liabilities 11,630 14,073
--------------- ---------------
21,064 24,790
Stockholders' equity:
Common stock 40 36
Additional paid-in capital 212,121 63,553
Accumulated other comprehensive gain 21,700 25,165
Retained earnings 24,234 14,306
--------------- ---------------
Total stockholders' equity 258,095 103,060
--------------- ---------------
$ 279,159 $ 127,850
=============== ===============
</TABLE>
See the accompanying notes to these condensed consolidated financial statements.
3
<PAGE>
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net revenues $ 13,520 $ 8,057 $ 26,246 $ 15,220
-------- -------- -------- --------
Costs and expenses:
Cost of revenues 610 768 1,764 1,439
Research and development 1,239 1,108 2,340 1,739
Selling and marketing 2,665 2,064 5,174 3,946
General and administrative 2,029 1,196 4,030 2,577
Amortization of intangibles from acquisition 743 109 1,487 109
In process research and development -- 4,286 -- 4,286
-------- -------- -------- --------
Total costs and expenses 7,286 9,531 14,795 14,096
-------- -------- -------- --------
Operating income (loss) 6,234 (1,474) 11,451 1,124
Interest and other income, net 2,928 405 4,932 823
-------- -------- -------- --------
Income (loss) before income taxes 9,162 (1,069) 16,383 1,947
Income tax expense (benefit) 3,610 (469) 6,455 689
-------- -------- -------- --------
Net income (loss) $ 5,552 $ (600) $ 9,928 $ 1,258
======== ======== ======== ========
Computation of basic and diluted earnings (loss) per share:
Basic earnings (loss) per share $ 0.14 $ (0.02) $ 0.25 $ 0.04
======== ======== ======== ========
Shares used in computing basic earnings (loss) per share 40,275 35,901 39,742 35,725
======== ======== ======== ========
Diluted earnings (loss) per share $ 0.13 $ (0.02) $ 0.24 $ 0.03
======== ======== ======== ========
Shares used in computing diluted earnings (loss) per share 42,435 35,901 41,981 37,561
======== ======== ======== ========
</TABLE>
See the accompanying notes to these condensed consolidated financial statements.
4
<PAGE>
MACROVISION CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended June 30,
2000 1999
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 9,928 $ 1,258
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 2,062 618
Amortization of prepaid future royalties to C-Dilla Limited -- 166
Deferred income taxes 138 (368)
Loss on disposal of assets 440 --
Tax benefit from employee stock plans 655 --
In-process research and development -- 4,286
Stock compensation 105 --
Changes in operating assets and liabilities:
Accounts receivable, inventories, and other current assets 180 (1,673)
Accounts payable, accrued expenses, deferred revenue
and income taxes payable (1,226) (684)
Other (9) (2)
--------- ---------
Net cash provided by operating activities 12,273 3,601
--------- ---------
Cash flows from investing activities:
Purchases and sales (net) of long-term and short-term marketable
Investment securities (142,490) 12,947
Acquisition of property and equipment (395) (315)
Payments for patents and other intangibles (391) (279)
Prepaid acquisition costs (763) --
Investment in Digimarc -- (2,000)
Minority equity investments in companies (6,950) --
Acquisition of C-Dilla Limited, net of cash acquired -- (11,960)
Receivable from related party (215) --
Other, net -- 34
--------- ---------
Net cash used in investing activities (151,204) (1,573)
--------- ---------
Cash flows from financing activities:
Payments on capital lease obligations (57) (56)
Payments on note payable -- (12)
Payment of stockholder's note receivable -- 78
Proceeds from stock offering, net 146,104 --
Proceeds from issuance of common stock, net 1,708 776
--------- ---------
Net cash provided by financing activities 147,755 786
--------- ---------
Net increase in cash and cash equivalents 8,824 2,814
Cash and cash equivalents at beginning of period 4,317 3,513
--------- ---------
Cash and cash equivalents at end of period $ 13,141 $ 6,327
========= =========
Supplemental cash flow information:
Interest paid $ 5 $ 3
========= =========
Income taxes paid $ 6,452 $ 2,027
========= =========
Unrealized gain on investments, net of tax $ 21,819 $ --
========= =========
Stock issued for C-Dilla Ltd. $ -- $ 5,073
========= =========
Issuance of options in acquisition of C-Dilla Ltd. $ -- $ 1,829
========= =========
</TABLE>
See the accompanying notes to these condensed consolidated financial statements.
5
<PAGE>
MACROVISION CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared by Macrovision Corporation and its subsidiaries (the "Company") in
accordance with the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures, normally included in
financial statements prepared in accordance with generally accepted accounting
principles, have been condensed or omitted in accordance with such rules and
regulations. In the opinion of management, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the financial position
of the Company, and their results of operations and cash flows for those periods
presented. This quarterly report on Form 10-Q should be read in conjunction with
the audited financial statements and notes thereto for the year ended December
31, 1999, and other disclosures, including risk factors, included in the
Company's Annual Report on Form 10-K filed on March 30, 2000, as amended, and
the Company's Registration Statement on Form S-3 (Registration No. 333-95337).
The results of operations for the interim periods presented are not necessarily
indicative of the results expected for the entire year ending December 31, 2000
or any other future interim period.
In August 1999 and March 2000, the Company issued one additional share for every
share outstanding, thus effecting 2 for 1 stock splits. All share and per share
information presented have been retroactively adjusted for the effect of such
stock splits.
NOTE 2 - CASH, CASH EQUIVALENTS AND SHORT-TERM 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 (or
approximately 7.7%), consummated an initial public offering. In January 2000,
the Company invested $4.0 million in TTR Technologies, Inc., a public company,
representing 1,880,937 shares or approximately 11.4%. The fair market valuation
for Digimarc and TTR is classified as long-term marketable investment securities
on the consolidated balance sheets. As of June 30, 2000 and December 31, 1999,
all investment securities were designated as "available-for-sale."
Available-for-sale securities are carried at fair market value based on quoted
market prices, with unrealized gains and losses, reported in comprehensive
income, as a separate component of stockholders' equity.
Realized gains and losses and declines in value judged to be
other-than-temporary for available-for-sale securities are included in the
consolidated statements of income. The cost of securities sold is based on the
specific identification method. Interest and dividends on securities classified
as available-for-sale are included in interest income.
The following is a summary of available-for-sale securities (in thousands):
6
<PAGE>
June 30, December 31,
2000 1999
-------- ------------
Cash equivalents - money market funds .................. $ 12,178 $ 2,951
-------- --------
Investments:
Corporate preferred certificates .................... -- 2,000
Corporate bonds ..................................... 157,927 --
Municipal preferred certificates .................... -- 2,000
United States government bonds and agency securities 21,563 33,469
Equity investments .................................. 44,884 46,224
-------- --------
224,374 83,693
-------- --------
$236,552 $ 86,644
======== ========
As of June 30, 2000 and December 31, 1999 government bond securities and
equity investments totaling $104.7 million and $52.2 million, respectively, are
classified as long-term marketable investment securities in the accompanying
consolidated balance sheet.
As of June 30, 2000 and December 31, 1999, the difference between the fair
value and the amortized cost of available-for-sale securities was a gain of
$36,825,000 and $42,634,000, 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 June 30, 2000 and December 31, 1999, the weighted average
portfolio duration and contractual maturity for the government bonds and other
instruments was approximately ten months and eight months, respectively.
NOTE 3 - PUBLIC OFFERING, EXERCISE OF OPTIONS AND EMPLOYEE STOCK PURCHASE PLAN
On January 26, 2000, the Company consummated an offering (the "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 stockholders of the Company.
All shares were sold for $53.44 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 stockholders.
During the quarter ended June 30, 2000, the Company issued 241,957 shares of
common stock and received proceeds of approximately $695,000 associated with the
exercise of stock options.
NOTE 4 - INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined using
the first-in, first-out method and consisted of the following:
June 30, December 31,
(In thousands) 2000 1999
------------- ------------
Raw materials $ 42 $ 72
Work in progress 24 26
Finished goods 23 80
------------- ------------
$ 89 $ 178
============= ============
NOTE 5 - OTHER ASSETS
The Company intends to hold its investments for the long term and monitors
whether there has been something other than a temporary decline in the value of
these investments based on management's estimates of their net realizable value
taking into account the achievement of milestones in business plans and
third-party financing. The Company records its investments using the cost
method, and these investments are classified as other assets in the accompanying
condensed consolidated balance sheets as follows:
7
<PAGE>
(In thousands)
June 30, December 31,
2000 1999
-------- ------------
Investment in CAC $3,688 $3,688
Minority equity investments in companies 3,700 750
Deposits and other assets 74 86
------ ------
$7,462 $4,524
====== ======
During the quarter ended June 30, 2000, the Company made an additional $750,000
strategic investment, pursuant to the agreement signed in August 1999, 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 the company.
NOTE 6: ACQUISITION
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-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.
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 expected that the
acquired in-process technology will be successfully developed, there is no
assurance that commercial or technical viability of these products would 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.
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.
8
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The Company amortizes 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
========
NOTE 7- NET INCOME PER SHARE
Basic "EPS" is computed using the weighted average number of common shares
outstanding during the period. Diluted EPS is computed using the weighted
average number of common and dilutive common equivalent shares outstanding
during the period except for periods of operating loss for which no common share
equivalents are included because their effect would be antidilutive. Dilutive
common equivalent shares consist of common stock issuable upon exercise of stock
options using the treasury stock method. In August 1999 and again in March 2000,
the Company issued one additional share for every share outstanding, thus
effecting two 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):
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
------ ------ ------ ------
Basic EPS - weighted average
number of common shares
outstanding 40,275 35,901 39,742 35,725
Effect of dilutive common shares
- stock options outstanding 2,160 -- 2,239 1,836
------ ------ ------ ------
Diluted EPS - weighted average
number of common shares and
common shares outstanding 42,435 35,901 41,981 37,561
====== ====== ====== ======
NOTE 8 - RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." As amended
by SFAS No. 137 and 138, SFAS No. 133 establishes methods of accounting for
derivative financial instruments and hedging activities related to those
instruments as well as other hedging activities. The Company anticipates that
the adoption of SFAS No. 133 will not have a material impact on its financial
position, results of operations or cash flows. The Company will adopt SFAS No.
133 in its first fiscal quarter of 2001.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting bulletin No. 101 (SAB 101), Revenue Recognition in Financial
Statements. SAB 101 provides guidance on Applying generally accepted accounting
principles to revenue recognition issues in financial statements. In March 2000,
the SEC issued Staff Accounting bulletin No. 101A (SAB 101A), Amendment; Revenue
Recognition in Financial Statements. SAB 101A delays the implementation date of
SAB 101 for registrants with fiscal years that begin between December 16, 1999
and March 15, 2000. The Company will adopt SAB 101 as required in the third
quarter of 2000 and is evaluating the effect that such adoption might have on
its financial statements.
In March 2000, the FASB issued interpretation No. 44 (FIN 44), Accounting for
Certain Transactions Involving Stock Compensation - an Interpretation of APB 25.
This Interpretation clarifies (a) the definition of an employee for purposes of
applying Opinion 25, (b) the criteria for determining whether a plan qualifies
as a noncompensatory plan, (c) the accounting consequences of various
modifications to the terms of a previously fixed
9
<PAGE>
stock option or award, and (d) the accounting for an exchange of stock
compensation awards in a business combination. This Interpretation is effective
July 1, 2000, but certain conclusions in this interpretation cover specific
events that occur after either December 15, 1998, or January 12, 2000. The
Company is currently evaluating FIN 44 and has not yet determined the impact, if
any, of adopting this Interpretation.
NOTE 9 - SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in three industry segments as follows: Video Copy
Protection, Video Scrambling and Computer Software Copy Protection. In the Video
Copy Protection segment, the Company licenses its anti-copy video technologies
to customers in the home videocassette, DVD and digital pay-per-view markets. In
the Video Scrambling segment, the Company licenses and sells products utilizing
the Company's PhaseKrypt video scrambling technology to manufacturers of analog
set-top decoders for sale to cable television system operators in developing
cable television markets, to television broadcasters for securing incoming
contribution circuits to network control centers and outbound rebroadcast
circuits and to the government, military and law enforcement agencies for covert
surveillance applications. In the Computer Software Copy Protection segment, the
Company licenses copy protection technology in the multimedia software market.
The Company identifies segments based principally upon the type of products
sold. The accounting policies of these reportable segments are the same as those
described for 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 income.
The following segment reporting information of the Company is provided (dollars
in thousands):
Revenue:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ---------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Video Copy Protection $ 11,857 $ 7,474 $ 21,728 $ 14,339
Computer Software Copy Protection 1,235 466 3,702 679
Video Scrambling 409 117 761 202
Other 19 -- 55 --
-------- -------- -------- --------
Total $ 13,520 $ 8,057 $ 26,246 $ 15,220
======== ======== ======== ========
</TABLE>
Operating Income:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ---------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Video Copy Protection $ 9,963 $ 5,963 $ 18,012 $ 11,291
Computer Software Copy Protection (79) (244) 1,100 (899)
Video Scrambling 348 (494) 157 (557)
Other 13 -- 39 --
-------- -------- -------- --------
Segment income 10,245 5,225 19,308 9,835
Research and development 1,239 1,108 2,340 1,739
General and administrative 2,029 1,196 4,030 2,577
Amortization of intangibles from acquisition 743 109 1,487 109
In process research and development -- 4,286 -- 4,286
-------- -------- -------- --------
Operating income (loss) 6,234 (1,474) 11,451 1,124
Interest and other income, net 2,928 405 4,932 823
-------- -------- -------- --------
Income (loss) before income taxes $ 9,162 $ (1,069) $ 16,383 $ 1,947
======== ======== ======== ========
</TABLE>
10
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Statements concerning future
matters such as the Company's expectations for gross margins, operating expenses
and capital needs and other statements regarding matters that are not historical
are forward-looking statements. Predictions of future events are inherently
uncertain. Actual events could differ materially from those predicted in the
forward-looking statements as a result of the risks set forth in this Form 10-Q
and in the "Risk Factors" section of the Company's 1999 Annual Report on Form
10-K filed on March 30, 2000 and the Company's Registration Statement on Form
S-3 (Registration No. 333-95337), which was declared effective by the Securities
and Exchange Commission on January 25, 2000. There are no assurances that the
Company has identified all possible problems that the Company might face. All
investors should carefully read the annual report on Form 10-K and the Company's
Registration Statement on Form S-3, together with this Form 10-Q, and consider
all such risks before making an investment decision with respect to the
Company's stock.
Overview
The Company was 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
over 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.
Results of Operations
Three Months Ended June 30, 2000 Compared to Three Months Ended June 30, 1999
The following table provides revenue information by specific product segments
for the periods indicated (dollars in thousands):
Three Months ended
June 30,
------------------
$ %
2000 1999 Change Change
------- ---------------------------------
Video Copy Protection
Videocassette $ 3,342 $ 4,112 $ (770) (18.7)%
DVD 4,138 1,664 2,474 148.7
Pay-Per-View 4,377 1,698 2,679 157.8
Computer Software Copy
Protection 1,235 466 769 165.2
Video Scrambling 409 117 292 249.6
Other 19 -- 19 --
------- ------- -------
Total $13,520 $ 8,057 $ 5,463 67.8%
======= ======= =======
Net Revenues
Our net revenues for the second quarter of 2000 increased 67.8% from $8.1
million in the second quarter of 1999 to $13.5 million in 2000. Revenues from
videocassette copy protection decreased $770,000 from $4.1 million in the second
quarter of 1999 to $3.3 million in 2000 due to the explosive growth in the
studio DVD business. Many of the studios are decreasing the use of copy
protection on movies on VHS format and focusing on the DVD format. DVD copy
protection revenues increased $2.5 million or 148.7% from $1.6 million in the
second quarter of 1999 to $4.1 million in the first quarter of 2000 due to
increases in DVD shipments as the market for both DVD players and DVD titles
continued to expand including the international market. Digital PPV copy
protection revenues increased $2.7 million or 157.8% from $1.7 million in the
second quarter of 1999 to $4.4 million in the second quarter of 2000 due to
continued increases in the shipments of copy protection enabled digital set-top
boxes, new system operator licenses, and increased usage royalties.
Computer Software/CD-ROM Copy Protection revenues increased $769,000 from
$466,000 in the second quarter of 1999 to $1.2 million in the second quarter of
2000 as the installed base of customers implemented our SafeDisc copy protection
on their PC games and other consumer multimedia software. Revenues from Video
Scrambling products increased 249.6% from $117,000 in the second quarter of 1999
to $409,000 in the second quarter of 2000 primarily due to shipments of
Phasekrypt-enabled analog cable set-top boxes from one of our licensees to their
customers in Brazil . Other revenue for the second quarter of 2000 was $19,000
relating to a consulting agreement.
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We expect that, although the videocassette copy protection will remain a
significant part of our business, it will continue to decline as a percentage of
our revenues and profits and in absolute terms as our copy protection business
in DVD, digital PPV and computer software continue to grow at much higher rates.
Gross Margin
Gross margin for the second quarter of 2000 was 95% compared to 90% for the same
period in 1999. The increased percentage was a result of a higher proportion of
revenues from our higher-margin DVD and digital pay-per-view businesses. Cost of
revenues includes items such as product costs, duplicator/replicator fees,
videocassette copy protection processor costs, patent amortization and
litigation, and SafeDisc royalty expense prior to the acquisition of C-Dilla
Ltd. We expect gross margins to decrease slightly in the future due to increased
costs as our current patent litigation progresses.
Research and Development
Research and development expenses increased by $131,000 or 11.8% from $1.1
million in the second quarter of 1999 to $1.2 million in 2000. The increased
expenses were a result of higher expenses relating to the software development
at C-Dilla that was not part of Macrovision for the full quarter in 1999. These
expenses were offset slightly by the reimbursement from TTR Technologies of
expenses relating to the SafeAudio(TM) CD copy protection project and the
one-time charges in 1999 relating to licensing fee for technology and bonuses
paid to engineering employees at C-Dilla. Research and development expenses
decreased as a percentage of net revenues from 14% for the second quarter of
1999 to 9% for the second quarter of 2000. 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 $601,000 or 29.1% from $2.1 million
in the second quarter of 1999 to $2.7 million in the second quarter of 2000.
This increase was primarily due to the increased selling and marketing expenses
in our Computer Software /CD-ROM Copy Protection business. Selling and marketing
expenses decreased as a percentage of net revenues from 25.6% for the second
quarter of 1999 to 19.7% for the second quarter of 2000. Selling and marketing
expenses are expected to increase over the prior year periods as we continue to
expand our efforts in building market share in our Computer Software/CD-ROM Copy
Protection and other digital rights management products.
General and Administrative
General and administrative expenses increased by $833,000 or 69.6% from $1.2
million in the second quarter of 1999 to $2.0 million in the second quarter of
2000 primarily due to a tax consulting project, increased insurance expenses and
increased general and administrative expenses relating to our Computer
Software/CD-ROM Copy Protection business. General and administrative expenses
increased slightly as a percentage of net revenues from 14.8% in the second
quarter of 1999 to 15.0% in the second quarter of 2000. General and
administrative expenses are expected to increase over the prior periods as we
continue to expand our new business in a number of new product areas.
Amortization of Intangibles from Acquisitions
The Company amortizes intangibles relating to the acquisition of C-Dilla in June
of 1999 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 the value of the acquired intangible assets may also
become impaired.
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
included a product being designed to protect DVD-ROMs from unauthorized
replication or copying, three products being designed to prohibit
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the unauthorized copying of audio products and a product being designed to allow
DVD manufacturers to track where any DVD has been manufactured and trace illegal
copies.
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 expected that the
acquired in process technology will be successfully developed, there could be no
assurance that commercial or technical viability of these products would 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.
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 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 $2.5 million or 623.0% from $405,000 in the second
quarter of 1999 to $2.9 million in the second quarter of 2000, primarily from
interest income received on the proceeds of our public stock offering in late
January 2000.
Income Tax Expense (Benefit)
Income tax expense represents combined federal and state taxes at effective
rates of 39% and 44% for the second quarter of 2000 and 1999, respectively. A
tax benefit for the second quarter of 1999 was the result of the availability of
operating losses and credits from the acquisition of C-Dilla.
Net Income
Net income for the second quarter of 2000 was $5.6 million compared to a loss of
$600,000 for the second quarter of 1999. The loss in 1999 resulted primarily
from the in-process research and development write-off and amortization of
intangibles related to the acquisition of C-Dilla.
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Six Months Ended June 30, 2000 Compared to Six Months Ended June 30, 1999
The following table provides revenue information by specific product segments
for the periods indicated (dollars in thousands):
Six Months ended
June 30,
--------------------
$ %
2000 1999 Change Change
-------- -----------------------------------
Video Copy Protection
Videocassette $ 6,907 $ 8,334 $ (1,427) (17.1)%
DVD 7,764 3,033 4,731 156.0
Pay-Per-View 7,057 2,972 4,085 137.4
Computer Software Copy
Protection 3,702 679 3,023 445.2
Video Scrambling 761 202 559 276.7
Other 55 -- 55 --
-------- -------- --------
Total $ 26,246 $ 15,220 $ 11,026 72.4%
======== ======== ========
Net Revenues
Our net revenues for the first six months of 2000 increased 72.4% from $15.2
million in the six months ended June 30, 1999 to $26.2 million for the first six
months of 2000. Revenues from videocassette copy protection decreased $1.4
million from $8.3 million in the first six months of 1999 to $6.9 million in the
comparable period of 2000 due to the explosive growth in the studio DVD
business. Many of the studios are decreasing the use of copy protection on
movies on VHS format and focusing on the DVD format. DVD copy protection
revenues increased $4.7 million or 156.0% from $3.0 million in the first six
months of 1999 to $7.7 million in the first six months of 2000 due to increases
in DVD shipments as the domestic and international markets for both DVD players
and DVD titles continued to expand at a rapid rate. Digital PPV copy protection
revenues increased $4.1 million or 137.4% from $3.0 million in the first six
months of 1999 to $7.1million in the six months ended June 30, 2000 due to
continued increases in the shipments of copy protection enabled digital set-top
boxes, new system operator licenses, and usage royalties from the activation of
copy protection on PPV programs.
Computer Software/CD-ROM Copy Protection revenues increased $3.0 million from
$679,000 in the first six months of 1999 to $3.7 million in the first six months
of 2000 as the installed base of customers implemented our SafeDisc copy
protection on their PC games and other consumer multimedia software. Revenues
from Video Scrambling products increased 276.7% from $202,000 in the first six
months of 1999 to $761,000 in the first six months of 2000 primarily due to
Phasekrypt-enabled analog set top box shipments from one of our licensees to
their customers in Brazil . Other revenue for the first six months of 2000 was
$55,000 relating to a consulting agreement.
We expect that, although videocassette copy protection will remain a significant
part of our business, it will continue to decline as a percentage of our
revenues and profits, and in absolute terms as our copy protection business in
DVD, digital PPV and computer software continue to grow at much higher rates.
Our international and export revenues as a percentage of net revenues increased
from 42.8% for the first six months of 1999 to 51.4% for the first six months of
2000 due to higher video copy protection revenues in DVD and digital PPV, and
Computer Software/CD-ROM copy protection revenues.
Gross Margin
Gross margin for the first six months of 2000 was 93% compared to 91% for the
same period in 1999. The increased percentage was a result of a higher
proportion of revenues from our higher-margin DVD and digital pay-per-view
businesses, offset slightly by the write-down of patents, assets and inventory
related to the Video Scrambling Group as the Company redirects its efforts to
other growing markets that it serves. Cost of revenues includes items such as
product costs, duplicator/replicator fees, videocassette copy protection
processor costs, patent amortization and litigation, and SafeDisc royalty
expense prior to the acquisition of C-Dilla Ltd. We expect gross margins to
decrease slightly in the future due to increased costs as our current patent
litigation progresses.
Research and Development
Research and development expenses increased by $601,000 or 34.6% from $1.7
million in the first six months of 1999 to $2.3 million in 2000. The increased
expenses were a result of higher expenses relating to the software development
at C-Dilla that was not part of Macrovision for the full six months of 1999.
These expenses were offset slightly by the reimbursement from TTR Technologies
for expenses relating to the SafeAudio(TM) CD copy protection project and the
one-time charges in 1999 relating to licensing fee for technology and bonuses
paid to engineering employees at C-Dilla. Research and development expenses
decrease as a percentage of net revenues from 14% for the second quarter of 1999
to 9% for the second quarter of 2000. 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.
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Selling and Marketing
Selling and marketing expenses increased by $1.2 million or 31.1% from $4.0
million in the first six months of 1999 to $5.2 million in the second quarter of
2000. This increase was primarily due to the increased selling and marketing
expenses in our Computer Software /CD-ROM Copy Protection. Selling and marketing
expenses decreased as a percentage of net revenues from 25.9% for the first six
months of 1999 to 19.7% for the first six months of 2000. 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 digital rights management products.
General and Administrative
General and administrative expenses increased by $1.4 million or 36.1% from $2.6
million in the first six months of 1999 to $4.0 million in the first six months
of 2000 primarily due to a tax consulting project, increased insurance expenses
and general and administrative expenses relating to our Computer Software/CD
Copy Protection business. General and administrative expenses decreased slightly
as a percentage of net revenues from 16.9% in the first six months of 1999 to
15.4% in the first six months of 2000. General and administrative expenses are
expected to increase over the prior periods as we continue to expand our
business in a number of new product areas.
Amortization of Intangibles from Acquisitions
The Company amortizes intangibles relating to the acquisition of C-Dilla in June
of 1999 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 the value of the acquired intangible assets may also
become impaired.
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
included a product being designed to protect DVD-ROMs from unauthorized
replication or copying, three products being designed to prohibit the
unauthorized copying of audio products and a product being designed to allow DVD
manufacturers to track where any DVD has been manufactured and trace illegal
copies.
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 expected that the
acquired in process technology will be successfully developed, there could be no
assurance that commercial or technical viability of these products would 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.
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 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.
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<PAGE>
Interest and Other Income
Other income increased $4.1 million or 499.3% from $823,000 in the first six
months of 1999 to $4.9 million in the first six months of 2000, primarily from
interest income received on the proceeds of our public stock offering in late
January 2000.
Income Tax Expense
Income tax expense represents combined federal and state taxes at effective
rates of 39% and 35% for the first six months of 2000 and 1999, respectively.
The lower rate in 1999 was due to higher tax-exempt interest and the
availability of operating losses and credits from the acquisition of C-Dilla.
Net Income
Net income for the first six months of 2000 was $9.9 million compared to $1.3
million for the first six months of 1999, which included the in-process research
and development write-off as well as amortization of intangibles related to the
acquisition of C-Dilla.
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 $12.3 and $3.6 million in the first six months of 2000 and 1999,
respectively. In the first six months of 2000, net cash was provided primarily
by net income, reduced by an increase in prepaids and a decrease in income taxes
offset by decreases in accounts receivables and an increase in accounts payable.
For the first six months of 1999, net cash was provided primarily by net income,
reduced by an increase in accounts receivable offset slightly by an increase in
accounts payable and income taxes payable.
Investing activities used net cash of $151.2 million and $1.6 million in the
first first six months of 2000 and 1999, respectively. For the first six months
of 2000, net cash used in investing activities was primarily for the net
purchases of short and long-term investment securities from the funds received
from the public offering, the minority equity investments in companies and the
prepaid expenses related to the acquisition of GLOBEtrotter. For the first six
months of 1999, net cash used in investing activities was primarily the
acquisition of C-Dilla Ltd. and the additional investment in Digimarc, offset by
the net investment in short and long-term investment securities. The investment
in Digimarc was in connection with a round of third-party financing obtained by
Digimarc. We made capital expenditures of $395,000 and $315,000 in the first six
months of 2000 and 1999, respectively. We also paid $391,000 and $279,000 in the
first six months of 2000 and 1999, respectively, related to patents and other
intangibles during those periods.
Net cash provided by financing activities was $147.8 million in the first six
months of 2000 resulted from our January public offering. In 1999, the net cash
provided from financing activities was primarily related to the issuance of
common stock upon the exercise of stock options, stock purchases under the our
stock purchase plan and the final payment of a stockholder's note receivable.
16
<PAGE>
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to financial market risks, including changes in interest rates,
foreign exchange rates and security investments. Changes in these factors may
cause fluctuations in 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 $192.6 million as
of June 30, 2000. 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 $684,000 decrease (approximately
0.4%) in the fair value of our available-for-sale securities as of June 30,
2000.
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 technology 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,
AudioSoft, TTR Technologies, RPK and InterActual Technologies. These
investments, totaling $52.3 million, represented 18.7% of our total assets as of
June 30, 2000. CAC, AudioSoft, RPK and InterActual 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 these companies, and we may in the future be required to write off
all or part of one or more of these investments. Digimarc and TTR Technologies
are publicly traded companies.
In March 2000, we announced that we signed a letter of intent to acquire
privately held GLOBEtrotter Software of San Jose, California. In June 2000, we
signed a definitive acquisition agreement with GLOBEtrotter. GLOBEtrotter is a
leading OEM supplier of B2B (business-to-business) electronic licensing and
license management technology to software vendors and the leading direct
supplier of software asset management products to corporate customers worldwide.
Assuming stockholders approval regarding certain necessary actions such as the
issuance of our shares, increasing the authorized shares of our stock and
approving the 2000 Equity Incentive Plan, we will acquire all outstanding shares
of GLOBEtrotter for 8.9 million shares of Macrovision common stock and to assume
all vested and unvested GLOBEtrotter stock options in exchange for options to
purchase approximately 760,000 shares of Macrovision common stock.
On July 18, 2000, we filed a definitive proxy statement requesting the necessary
approvals at the annual meeting of stockholders on August 24, 2000. Regulatory
approvals of the merger are also being obtained.
RISK FACTORS
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 77.2%, 65.5% and 55.9% of our net revenues during 1998, 1999 and the
first six months of 2000, 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. 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.
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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:
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 1998, one of
our customers accounted for more than 12% of our net revenues. For 1999, no one
customer accounted for more than 10% of our net revenues. For the first six
months of 2000, revenues from one of our customers accounted for 11% of our net
revenues. The Motion Picture Association of America studios as a group accounted
for 45.1%, 34.4% and 31.4 % of our net revenues in 1998, 1999 and the first six
months of 2000, 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 2000 to 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.
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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 44.5%, 45.6% and 51.4% of
our net revenues in 1998, 1999 and the first six months of 2000, 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 availability or use of
circumvention technologies. Such laws also may not be conducive to copyright
protection of video materials and digital media, which reduces the need for our
copy protection 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. 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;
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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 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 that 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, or CD cloning software. If
we are not able to develop frequent SafeDisc software releases and new digital
signatures, which deter the hackers from developing circumvention or cloning
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 four privately held companies,
Command Audio Corporation, AudioSoft, RPK and Interactual 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
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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.
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.
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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 43 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 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. If this happens, our future revenue opportunities will
be negatively impacted.
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.
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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 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. As of June 30, 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 for
some time 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
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participate in 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.
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Part II. Other Information
Item 1. 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 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. In its ruling on March 21, 2000, the
Tokyo High Court revoked the Japanese Patent Office's decision. In connection
with this ruling, the scope of our claims under the patent is slightly reduced
but is not expected to have a material effect on the value of this patent to our
business. In short, the patent remains valid and part of 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. In July 2000, The District Court
issued a ruling on claim construction regarding patent infringement. It is not
clear, however, whether the claim construction ruling would be adverse against
us in effect. Trial is scheduled to commence in May 2001. If an adverse ruling
is ultimately reached on patent infringement, we may incur legal competition
from Dwight-Cavendish and a corresponding decline in demand for our technology
could have a material adverse effect on our business.
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 filed a reply brief arguing that its
product does not infringe. The case was heard in the District Court of
Dusseldorf, Germany. The District Court of Dusseldorf ruled adversely against
us. We have in turn appealed the District Court's ruling in July 2000. If an
adverse ruling on the appeal is ultimately reached against us, we may incur a
corresponding decline in demand for our video copy protection technology, which
could harm our business in Germany.
Item 5 - Other Information.
In March 2000, we announced that we signed a letter of intent to acquire
privately held GLOBEtrotter Software of San Jose, California. In June 2000, we
signed a definitive acquisition agreement with GLOBEtrotter. GLOBEtrotter is the
leading OEM supplier of B2B (business-to-business) electronic licensing and
license management technology to software vendors and the leading direct
supplier of software asset management products to corporate customers worldwide.
If approved by our stockholders and the GLOBEtrotter stockholders, we will
acquire all outstanding shares of GLOBEtrotter for 8.9 million shares of
Macrovision common stock and assume all vested and unvested GLOBEtrotter stock
options in exchange for options to purchase approximately 760,000 shares of
Macrovision common stock.
On July 18, 2000, we filed a definitive proxy statement requesting the approvals
by Macrovision's stockholders at the annual meeting of stockholders on August
24, 2000. Regulatory approvals of the merger are also being obtained.
Item 6 - Exhibits and Reports on Form 8-K.
(a) Exhibits.
27.1 - Financial Data Schedule.
(b) Reports on Form 8-K.
During the quarter ended June 30, 2000, the Company filed no Current
Reports on Form 8-K.
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SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Macrovision Corporation
Date: August 11, 2000 By: /S/ William A. Krepick
---------------- --------------------------------------------------
William A. Krepick, President and Chief Operating
Officer
Date: August 11, 2000 By: /S/ Ian R. Halifax
---------------- --------------------------------------------------
Ian Halifax, Vice President, Finance and
Administration, Chief Financial Officer and
Secretary
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