Macrovision Corp – ‘10KSB’ for 12/31/98

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Annual Report — Small Business   —   Form 10-KSB
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10KSB       Annual Report -- Small Business                       59    345K 
 2: EX-23.01    Consent of Independent Auditors                        1      6K 
 3: EX-27.01    FDS for the 12 Months Ended 12/31/98                   1      8K 
 4: EX-27.02    FDS for the Twelve Months Ended 12/31/97               1      8K 

10KSB   —   Annual Report — Small Business
Document Table of Contents

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================================================================================

FORM 10-KSB 

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

[X]  ANNUAL REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES  EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998               

[_]  TRANSITION  REPORT  PURSUANT  TO  SECTION  13 OR  15(d)  OF THE  SECURITIES
EXCHANGE ACT OF 1934                                                  

 Commission File No. 000-22023

 Macrovision Corporation
(Name of small business issuer in its charter)

    DELAWARE                                        77-0156161
(State or other jurisdiction                           (I.R.S. Employer   
of incorporation or organization)                     Identification Number)  

1341 Orleans Drive
 Sunnyvale, California 94089
 (Address of principal executive offices) (Zip code)

(408) 743-8600
 (Issuer's telephone number including area code)

Securities registered under Section 12(b) of the Exchange Act: None.

     Securities  registered  under  Section  12(g) of the Exchange  Act:  Common
Stock, $0.001 par value.                                                        

     Check whether the issuer (1) has filed all reports  required to be filed by
Section 13 or 15(d) of the  Exchange  Act during the past 12 months (or for such
shorter period that the  registrant was required to file such reports),  and (2)
has been subject to such filing requirements for the past 90 days. Yes[X] No[_] 

     Check if there is no disclosure  of  delinquent  filers in response to Item
405 of  Regulation  S-B  contained  in  this  form,  and no  disclosure  will be
contained,  to the  best of  registrant's  knowledge,  in  definitive  proxy  or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]                                       

     The issuer's  revenues for the fiscal year ended  December 31, 1998 totaled
$24,434,422.                                                                    

     As of  March  22,  1999,  the  aggregate  market  value of the  voting  and
non-voting common equity held by non-affiliates of the registrant,  based on the
closing price for the registrant's  common stock on that day, was  approximately
$275,327,000.                                                                   

Transitional Small Business Disclosure Format (check one):            

Yes[_]     No [X]   

     State the number of shares  outstanding of each of the issuer's  classes of
common equity, as of the latest practicable date.                               

      Title                         Outstanding as of March 22, 1999
Common Stock                  8,925,229                 

     Documents  incorporated  by reference:  Certain  exhibits  hereto have been
specifically  incorporated by reference herein in Item 13 under Part III hereof.
Certain portions of registrant's definitive Proxy Statement, which will be filed
with the Securities and Exchange  Commission in connection with the registrant's
annual meeting of stockholders  to be held on May 18, 1999, are  incorporated by
reference in Items 10-13 of Part III hereof.                                    

================================================================================

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 MACROVISION CORPORATION

 FORM 10-KSB

 INDEX

PART I

                                                        [Enlarge/Download Table]
                                                                                                             
ITEM 1.  Description of Business ........................................................................  3 

ITEM 2.  Description of Property ........................................................................ 26 

ITEM 3.  Legal Proceedings .............................................................................. 26 

ITEM 4.  Submission of Matters to a Vote of Security Holders ............................................ 27 

                                  PART II                                                                    

ITEM 5.  Market for Common Equity and Related Stockholder Matters ....................................... 27 

ITEM 6.  Management's Discussion and Analysis of Financial Condition and Results of Operations .......... 28 

ITEM 7.  Financial Statements ........................................................................... 35 

ITEM 8.  Changes in and Disagreements with Accountants on Accounting                                         
           and Financial Disclosure ..................................................................... 35 

                                 PART III                                                                    

ITEM 9.  Directors, Executive Officers, Promoters and Control Persons; Compliance with                       
           Section 16(a) of the Exchange Act ............................................................ 35 

ITEM 10. Executive Compensation ......................................................................... 35 

ITEM 11. Security Ownership of Certain Beneficial Owners and Management ................................. 35 

ITEM 12. Certain Relationships and Related Transactions ................................................. 35 

ITEM 13. Exhibits and Reports on Form 8-K ............................................................... 36 

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     This   Annual   Report  on  Form   10-KSB   for   Macrovision   Corporation
("Macrovision" or "we") contains  forward-looking  statements that involve risks
and uncertainties.  Our actual results may differ significantly from the results
discussed  in the  forward-looking  statements.  Factors  that might cause these
differences  include,  but are not  limited  to, the  factors  discussed  in the
sections entitled "Business-Factors Affecting Operating Results and Market Price
of Stock" and "Management's  Discussion and Analysis of Financial  Condition and
Results of Operations."                                                         

PART I

ITEM 1. Description of Business.                                                

     We design, develop and market video security technologies and products that
provide  copy  protection  and video  scrambling  for motion  pictures and other
proprietary video materials that are stored on videocassettes, digital versatile
discs ("DVDs") or other media or are transmitted by means of cable, satellite or
microwave transmission. Our two primary technologies,  copy protection and video
scrambling, are distinct in their application, but can be complementary in their
ability to  protect  copyright  holders'  video  programming.  During  1998,  we
broadened  our  focus to  include  copy  protection  of other  media,  including
multimedia computer software on CD-ROMs.                                        

     Our copy protection  technologies enable consumers to view or utilize video
or other information stored on prerecorded  videocassettes,  DVDs and CD-ROMs or
transmitted as digital pay-per-view ("PPV") programs via cable, direct broadcast
satellite ("DBS"), or video-on-demand  networks, but deter unauthorized consumer
copying  of this  material.  We  believe  that  approximately  one-third  of all
commercial  videocassettes  produced  worldwide during 1998 were copy protected,
and that substantially all of those copy protected  videocassettes  incorporated
our  technology.  All of the Motion  Picture  Association  of  America  ("MPAA")
studios  have used our copy  protection  technologies  to protect some or all of
their  videocassettes  and/or  DVDs in one or more  countries  around the world.
Studios such as Disney,  Columbia Tri-Star,  PolyGram,  Paramount and Dreamworks
have  signed   agreements  to  apply  our  copy   protection   technologies   to
substantially  all of the motion pictures that they release in videocassette and
DVD  format in the United  States.  We  believe  that our video copy  protection
technologies  are accepted as the de facto  standard for  preventing  video from
being copied by consumer videocassette  recorders. In May 2000, when the Digital
Millennium  Copyright Act takes effect, all new VCRs manufactured or sold in the
United States will be required to be specifically  designed to make poor quality
copies of programming encoded with our copy protection  technology.  The new law
also provides for both criminal and civil penalties for companies or individuals
who import, produce or distribute devices designed to circumvent our technology.
We do not  license  and have no  plans  to  license  our  technology  for use in
deterring consumer copying of free television broadcasts.                       

     Our  encryption   technologies  are  incorporated   into  other  companies'
addressable  analog  set-top  decoders  and  are  used  by  international  cable
television   system   operators  in  connection  with  analog  PPV  and  Pay  TV
programming.  We also sell  scrambling  products that are used by  broadcasters,
businesses,  governments  and other  organizations  to  provide  for the  secure
transmission of video and audio signals.                                        

Industry Background                                                             

     Motion picture studios  generally  release major motion pictures to various
venues (e.g.,  theaters,  hotels/airlines or home video) in a series of "release
windows" in order to maximize  revenues  from each  venue.  Entertainment  media
analyst Paul Kagan  Associates,  Inc. ("Paul Kagan") estimates that the studios'
1998 revenues from the various venues were:  Theatrical Box Office $3.1 billion;
Home Video $6.7 billion; Pay-Per-View (PPV) $357 million and Subscription Pay TV
$1.6 billion.                                                                   

     In the past few years,  home video has surpassed the  theatrical box office
as the  largest  source  of  revenues  for the  motion  picture  industry.  With
production  costs   continually   growing,   studio   profitability  has  become
increasingly  dependent on the development of new venues, such as home video and
digital  PPV.  Theatrical  box office  release in  foreign  countries  generally
follows  theatrical  box office  release  in the United  States by at least four
months. In the United States,  PPV releases generally follow home video releases
by 30-90 days. In foreign  countries,  PPV releases  generally follow home video
releases by approximately six months and Subscription Pay TV releases  generally
follow PPV releases by approximately six months.                                

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Video Copy Protection                                                           

     Copyright  holders wish to maximize  the  economic  value from each feature
film or other video program over its copyright  life,  currently 75 years.  When
consumers  make copies of motion  pictures,  whether from hotel,  airline,  home
video or PPV releases, independent studies show that studios and video retailers
lose video sales and rental  revenues.  Paul Kagan  estimates  that 37.0 million
households in the United States  (approximately 45% of all households with VCRs)
owned  two or more  VCRs in  December  1998,  and thus  were  capable  of making
unauthorized   copies   of   prerecorded   videocassettes.   Based   on  a  1996
Macrovision-sponsored  national survey, we estimate that  unauthorized  consumer
copying of  prerecorded  videocassettes  costs the industry  approximately  $370
million in annual lost revenues. To protect their revenues in the home video and
subsequent  release venues,  many studios look to copy protection  technology to
prevent  unauthorized  copies of motion pictures from entering the  marketplace.
Recently,  studios  have begun to  participate  in the  revenue  stream from the
rental of motion pictures on videocassettes through agreements with video rental
businesses.  We believe that revenue sharing could provide further incentive for
the studios to support  videocassette copy protection.  Other copyright holders,
such as independent video producers,  governments,  businesses and institutions,
also  benefit  from  preventing   unauthorized   copying  of  special  interest,
educational and other prerecorded video programming.                            

     Emerging  trends  in the PPV  market  are  also  increasing  the  need  for
effective copy protection technologies.  PPV television, which enables consumers
to view motion pictures and other  programming in their homes via their existing
cable or satellite  television  systems for an additional  fee for each viewing,
has  generated to date only a small  fraction of the revenues  generated by home
video.  However,  motion picture studios  typically  receive revenue each time a
consumer  views a motion  picture on PPV, which results in higher profit margins
than home video. Analog cable television systems provide few PPV channels, which
limits the number of  available  motion  pictures  and the  frequency of viewing
times.  In  addition,  the  studios,  in an effort to  protect  their home video
revenues, typically release a motion picture on PPV one to three months after it
is released on videocassette.  Digital PPV provides  consumers with the benefits
of more channels,  a greater variety of motion pictures and more frequent motion
picture viewing times. However,  viewers can copy PPV movies in their homes with
a single VCR. When the transmission is digital, copy quality is better than that
of  copies  made  from  videocassettes  or analog  cable  television.  It is not
economically  feasible to retrofit the analog cable television systems currently
in place in the United States with copy protection  technology.  Our opportunity
to introduce  effective copy protection for PPV is expected to grow as DBS gains
wider  acceptance  and as digital cable PPV replaces  existing  analog cable PPV
systems,  so long as copying of digital PPV movies is considered to be a problem
by the studios.                                                                 

     DVD hardware and media became  commercially  available in the United States
in  1997,  and  approximately  1.4  million  DVD  players  had been  shipped  by
manufacturers as of December 31, 1998. The introduction of DVDs presents serious
concerns to the  studios.  Without  effective  copy  protection,  any one of the
approximately  450 million VCRs  throughout the world,  when combined with a DVD
player, can make unlimited videocassette copies of a non-copy protected DVD that
are  nearly  equal in  quality to a  professionally  prerecorded  videocassette.
Because of their superior picture quality,  lower  manufacturing  cost, relative
ease of use and smaller size, DVDs are expected to supplant  videocassettes over
time as the preferred home video distribution  medium. As a result, the need for
reliable  copy  protection  is expected to become more  important as DVDs become
more readily available.                                                         

Video Scrambling                                                                

     Cable  television   system   operators   require  secure  video  scrambling
technology  to  prevent  unauthorized  viewing  of PPV and  Pay TV  programming.
Unauthorized  or  "pirate"  descramblers  for  existing  analog  PPV  and Pay TV
scrambling systems are readily available to consumers at low cost, allowing them
to view programming  without paying the system operator.  Based on a 1992 survey
of  cable   television   system   operators,   the  National  Cable   Television
Association's Office of Cable Signal Theft reported that unauthorized viewing of
cable  television  premium  channels and PPV  translated  into an estimated $4.7
billion per year in  potentially  lost  revenues to system  operators and motion
picture  studios.  However,  the  substantial  installed  base of analog set-top
decoders makes the cost of providing a new, more secure analog scrambling system
in the United States prohibitive.                                               

     Although  system  operators  in the United  States and  Western  Europe are
upgrading  their networks with digital  compression,  analog cable and microwave
Pay TV systems  continue  to be built,  particularly  in  developing  countries,
because analog systems are far less expensive to build than digital  systems and
these  emerging  markets do not  require  the range of  programming  and channel
capacity that digital compression provides. Industry                            

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publications  have  projected  that the  market  for  addressable  analog Pay TV
decoders  will be  approximately  $1.2  billion  annually for the years 1999 and
2000. MPAA studios are increasingly  requiring  international cable operators to
install effective and secure  scrambling  systems as a precondition to receiving
their motion pictures.  International system operators now offer premium and PPV
channels  that require new  addressable  analog  systems  that provide  security
against signal theft, are cost effective, can support a variety of program tiers
and can be authorized remotely by the system operator.                          

Computer Software Copy Protection                                               

     The  Interactive  Digital  Software  Association  estimates  that  computer
software and video game  companies  based in the United States lost $3.2 billion
worldwide in 1997 due to software piracy, primarily professional counterfeiting.
Recently CD recordable  drives have been introduced in the consumer  electronics
industry that are priced as low as $200. In addition,  blank CD-ROM disks can be
purchased for less than $1 in the United States. As a result,  computer software
and video game companies are facing an additional threat of lost revenues due to
consumer copying of CD-ROM software.                                            

The Macrovision Solution                                                        

     Macrovision  offers copy protection and video  scrambling  technologies and
products that address the video  security  needs of motion  picture  studios and
other  copyright  holders,  program  distributors,  cable Pay TV and PPV  system
operators, governments,  businesses and equipment manufacturers. During 1998, we
began  offering  copy  protection  for CD-ROM based  multimedia  software in the
consumer market through our relationship with C-Dilla Limited ("C-Dilla"),  a UK
company. See "--Strategic Investments."                                         

Video Copy Protection                                                           

     Our copy protection technologies allow consumers to view programming stored
on prerecorded videocassettes or DVDs or transmitted as digital PPV programs via
cable or satellite, but deter unauthorized consumer copying of such programming.
Videocassettes  are  encoded  with  our  copy  protection  process  as they  are
manufactured.  In  digital  PPV and DVD  applications,  our copy  protection  is
activated by a copy  protection  signal  generator  circuit  embedded within the
cable or satellite digital set-top decoder or the DVD player.                   

Video Scrambling                                                                

     Our video scrambling  technologies  prevent  unauthorized  viewing of video
programming  unless the viewer has paid for, or otherwise has been granted,  the
right  to view  such  programming.  The  video  signals  are  scrambled  using a
combination of analog video scrambling and digital encryption  techniques.  This
provides a high level of security  against  signal theft while  maintaining  low
decoder  cost.  For cable and microwave  PayTV  applications  of our  PhaseKrypt
technology,  the cost of decoding the scrambled  picture is minimized by using a
secure  analog  technology  that  partially  relies  on the  electronics  of the
television  set to make the  image  viewable.  We have also  developed  products
implementing  other  video  scrambling  technologies  that serve  growing  niche
markets, such as law enforcement and private networks.                          

Computer Software Copy Protection                                               

     Under an agreement with C-Dilla, we have the exclusive marketing rights for
consumer   multimedia   software   applications   of  certain  copy   protection
technologies  developed by C-Dilla for CD-ROM. In September 1998, we and C-Dilla
introduced  our  CD-ROM  copy  protection  technology,  called  SafeDisc.  As of
December 1998, we had copy protected over 1.7 million CD-ROMs with SafeDisc.  We
believe that our expertise in marketing video copy protection technology and our
reputation for providing high quality copy protection  solutions will give us an
advantage in marketing CD-ROM copy protection technology.                       

The Macrovision Strategy                                                        

     We  are  dedicated  to  providing  advanced  video  and  software  security
technologies  and products to our  customers.  We intend to maintain and enhance
our  position  as a leading  provider  of these  technologies  and  products  by
focusing on the following key strategies:                                       

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     Pursue  Royalty-Based  Licensing  Model.  We are  pursuing a  royalty-based
licensing  model that  results in a high margin,  transaction-oriented  business
with recurring revenues. As the sole provider of copy protection for prerecorded
videocassettes and DVDs to the MPAA studios, we typically license our technology
under  unit-based  pricing  schedules.  In addition,  we use unit-based  pricing
schedules  when  licensing copy  protection  technology  for set-top boxes,  PPV
programming  and  CD-ROMs.  Royalties  and  other  fees  are  currently  paid by
copyright  holders,  commercial  duplicators,  hardware  manufacturers,  program
distributors and publishers.  We intend whenever feasible to continue to license
our  technologies to third parties for unit or  transaction-based  royalties and
fees.                                                                           

     Leverage  Key  Customer  Relationships.  Over the past ten  years,  we have
developed strong relationships with our customers, including the major Hollywood
studios and key participant companies of the video duplication industry, as well
as the  cable  and  satellite  television  system  operators  and the  equipment
manufacturers  that serve  these  customers.  We  attempt  to develop  strategic
relationships  with our customers,  to broaden the use of existing  applications
for our technologies and to enhance the security and future sales  opportunities
of our customers' video properties.                                             

     Increase Market Penetration of Video Copy Protection Business.  We estimate
that we have penetrated  approximately  one-third of the worldwide videocassette
copy  protection  market,  which leaves a large potential  opportunity,  even as
digital PPV and DVDs begin to displace analog videocassettes.  We intend to make
our copy protection  technology  available and affordable to all video copyright
holders in all  prerecorded  packaged  media and  digital PPV venues and seek to
have our  technology  specified  by all PPV system  operators,  digital  set-top
decoder manufacturers and DVD hardware manufacturers.                           

     Introduce New Product Applications and Technologies.  We intend to continue
to expand our  technological  base,  primarily  in  intellectual  property  copy
protection,  in current as well as new markets,  through  internal  development,
strategic  investments,  licensing  arrangements,  joint  ventures or  potential
acquisitions  of  products,  technologies  or  companies.  In  addition  to  our
internally-developed  video  copy  protection  technology,  we  entered  into an
agreement with Digimarc in 1997 to develop  products for DVD copy protection and
with C-Dilla in 1998 to license and develop products for DVD-ROM and CD-ROM copy
protection.                                                                     

     Protect Patent Position. We believe that our future success will depend, in
part,  on the  continued  protection of our  proprietary  technologies.  We have
obtained   patents  to  protect  our  copy   protection  and  video   scrambling
technologies and intend to continue to pursue patent protection aggressively. We
have invested substantial resources in developing and obtaining patents covering
a number  of  processes  and  devices  that  unauthorized  parties  could use to
circumvent our consumer copy protection technologies. We have used these patents
in the past to limit the  proliferation  of such  devices  and have  initiated a
number of  disputes  relating to  infringement  of these  patents.  We intend to
continue to protect and defend our patented  technologies  aggressively  through
further  technological  innovation,  legal  action and support of  existing  and
future legislative initiatives to protect rights owners.                        

Technologies and Products                                                       

     Our technologies are either licensed or sold, depending upon the particular
application or product. For videocassette copy protection, copyright holders and
licensed duplicators  typically pay us a per unit licensing fee for the right to
apply our technology. In addition, copyright holders typically pay us a per unit
license  fee to apply  copy  protection  to DVDs.  For  digital  PPV,  cable and
satellite  television  system  operators  pay us a one-time  license fee for the
right to incorporate our copy protection technology into their networks and have
entered into  agreements  with us that  entitle us to receive  transaction-based
royalty payments at the time when copy protection for digital PPV programming is
activated.  Set-top decoder  manufacturers  also license our copy protection and
video  scrambling  technologies  for an  up-front  fee and a per  unit  hardware
royalty.  In  addition,  semiconductor  manufacturers  pay us a  small  one-time
service fee to verify proper implementation of our copy protection  technologies
in integrated circuits for DVD players and digital set-top decoders. For the DVD
market,  we  offer  licenses  to  consumer  electronics  and  personal  computer
manufacturers   and  charge  rights  owners  a  per  unit  fee  similar  to  our
videocassette copy protection licensing model. In the video scrambling business,
we both license our PhaseKrypt technology on a per-decoder or per-encoder basis,
and sell PhaseKrypt decoder components and PhaseKrypt  encoders.  We also sell a
line  of  products  based  on our  various  video  scrambling  technologies  for
applications  in  television   broadcasting   and  niche  markets  such  as  law
enforcement  and  private  networks.  For the CD-ROM copy  protection  business,
software manufacturers typically pay us a per unit license fee to apply SafeDisc
to CD-ROMs.                                                                     

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Video Copy Protection Technologies                                              

     Our copy  protection  technologies  are  designed to allow  motion  picture
studios and other copyright holders to protect their copyrighted and proprietary
video  material  from  unauthorized   consumer  copying.   Our  copy  protection
technologies  for  videocassettes  and DVDs generally are priced as low as a few
pennies per unit,  depending  upon such  factors as the term of the contract and
the annual  volume  commitment  made by the  copyright  holder.  We believe that
copyright  holders  justify  the  decision to pay for our  technology  through a
combination  of  increased  unit  sales and  rentals,  increased  revenues  from
downstream venues,  stronger relationships with retailers and a favorable return
on investment compared to equivalent advertising expenditures.                  

     Our copy protection technology is applied  electronically to videocassettes
at the time of duplication at over 260 commercial  duplication  facilities in 37
countries.   Macrovision-owned   copy  protection  equipment  is  installed  and
maintained by us in each duplication facility. We license commercial duplicators
to act as  distributors  and  sales  agents  in  return  for a share of the copy
protection fees duplicators receive from their customers.  In cases in which the
rights owner  licenses the  technology  directly from us, we pay service fees to
the commercial  duplicators.  Our copy protection technology has been applied to
more than two billion  videocassettes  worldwide  since 1985, and was applied to
more than 600 million  videocassettes in 1998. All of the MPAA studios have used
our copy protection  technologies to protect some or all of their videocassettes
and/or DVDs in one or more countries  around the world. In 1998 and 1997,  three
of these studios applied our technology to a majority of the videocassettes they
produced.  In addition,  we believe that more than 1,500 corporate,  educational
and  special  interest  copyright  holders  have  contracted  with our  licensed
duplicators to apply our copy protection process to their videocassettes.       

     We have developed an enhanced version of our videocassette  copy protection
technology  for the DVD format and for the digital PPV  networks  that are being
developed  and  deployed  by direct  broadcast  satellite  and cable  television
operators.  This enhanced copy protection technology is applied by an integrated
circuit that is embedded  within the DVD player or digital  set-top  decoder and
that can  later be  activated  by copy  protection  control  codes in the  video
program or PPV network  access control  system.  Upon  activation,  the embedded
integrated  circuit  generates our copy protection  signal and applies it to the
program  material at the analog output port of the DVD player or digital set-top
decoder.  This copy protection signal prevents a DVD player or a digital set-top
decoder from being used a source to make commercial quality videocassette copies
of the DVD or PPV program.                                                      

     We have  licensed  our copy  protection  technology  for  digital PPV to 43
set-top  decoder  manufacturers  and nine  digital PPV system  operators.  As of
December 31, 1998, ten program providers had applied copy protection through two
digital PPV system operators in Japan. In addition,  one system operator in Hong
Kong and one in the United Kingdom had activated copy protection for digital PPV
programming.  Our copy  protection  technology is embedded in  approximately  13
million digital set-top decoders  currently in use worldwide,  for which we have
received   license  fees  and  royalties  from  the  digital   set-top   decoder
manufacturers.                                                                  

     In October 1996, a  multi-industry  technical  working  group  comprised of
major motion picture studios,  consumer  electronics  manufacturers and personal
computer  hardware  and  software  companies  adopted  a set of copy  protection
principles that  established  prerequisites  for commercial  availability of DVD
hardware and media. We believe that our copy protection  technology is currently
the  only  digital-to-analog  copy  protection  solution  that  satisfies  these
principles.  As of December 31, 1998, 97 companies that  manufacture DVD players
or DVD-ROM  drives had signed  agreements  with us to  incorporate  our DVD copy
protection technology into their hardware.                                      

     Copy protection licensing represented 92.6% of our net revenues in 1998 and
85.6% of our net revenues in 1997.                                              

Video Scrambling Technologies and Products                                      

     Our video scrambling  technologies are used to prevent unauthorized viewing
of video content during analog video  transmissions from one location to another
location.  These  technologies  are used in PPV,  Pay TV,  business  television,
broadcast television and government, military and law enforcement markets.      

     Our PhaseKrypt video scrambling  technology is a relatively secure, easy to
use,  low cost  alternative  to other  widely  used analog  scrambling  systems.
PhaseKrypt  is  intended  for use in analog Pay TV systems in  developing  cable
television  markets such as South  America,  South Korea,  Taiwan,  the People's
Republic of China and the  Philippines.  Analog  set-top  decoder  manufacturers
either license PhaseKrypt for an up-front fee and a per unit hardware royalty or
purchase  encoder  hardware and decoder  components  from us.  Cable  television
operators purchase PhaseKrypt-enabled set-top decoders and encoder hardware from
our licensees for installation in their systems.                                

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     Our video encryption  system  technology is incorporated  into a variety of
scrambling  products  that  we  sell  rather  than  license.  One of  our  video
encryption system products is a professional, broadcast-quality video scrambling
system that is available in NTSC and PAL versions.  Primary applications include
broadcast   television   distribution   to  network   affiliate   stations   and
retransmission  facilities,  programming delivery to cable television head-ends,
programming  contribution  circuits and  backhauls.  We have also  developed two
miniaturized  DC-powered  scrambling  systems that are used primarily for covert
law enforcement,  military  surveillance and broadcast television news gathering
applications. A miniaturized multiplexer product is also available that combines
two video signals for transmission over single channel video links.             

     Video scrambling products  represented 6.0% of our net revenues in 1998 and
13.5% of our net revenues in 1997.                                              

Computer Software Copy Protection Technologies                                  

     Macrovision and C-Dilla introduced their CD-ROM copy protection technology,
called SafeDisc, in September 1998. We have an exclusive license from C-Dilla to
market and license  SafeDisc  for  consumer  multimedia  software  applications.
SafeDisc is  comprised  of an embedded,  non-copiable  digital  signature on the
CD-ROM, combined with encrypted software content and authentication instructions
that preclude  decryption unless the authentication  digital signature is found.
We  believe  that  SafeDisc  provides  a  relatively  secure,  low cost means of
protecting CD-ROM software from consumer copying without adversely affecting the
consumer's legitimate use of the CD-ROM content.                                

     Computer  Software Copy Protection  represented 1.4% of our net revenues in
1998.                                                                           

Customers                                                                       

     Our packaged media copy protection  technology for  videocassettes and DVDs
is used by the following  major motion picture  studios and home video suppliers
and by  the  following  commercial  videocassette  duplicators,  each  of  which
accounted for at least $100,000 of our net revenues during 1998:                

                                                        [Enlarge/Download Table]

                                                                  Commercial          
                    Home Video Suppliers                   Videocassette Duplicators  
                    --------------------                   ---------------------------
                                                                                      
BMG Entertainment                                          Allied Digital Technologies
Buena Vista Home Video, Inc.(Disney)                       Vaughn Communications, Inc.
Columbia House                                             Victor Company of Japan    
Columbia TriStar Home Video (Sony Pictures Entertainment)                             
Digital Video Express (DIVX)                                                          
Dreamworks Home Video                                                                 
HBO Home Video                                                                        
New Line Home Video                                                                   
Paramount Pictures                                                                    
Polygram Video                                                                        
Twentieth Century Fox Home Entertainment, Inc.                                        
Universal Studios Home Video                                                          
Warner Home Video                                                                     

     For 1998,  revenues  from one of our customers  represented  12% of our net
revenues.  For 1997, another customer accounted for 11% of our net revenues. The
MPAA  studios as a group  accounted  for 45.1% of our net  revenues  in 1998 and
38.6% of our net revenues in 1997. We expect that revenues from the MPAA studios
will continue to account for a  substantial  portion of our net revenues for the
foreseeable future.                                                             

     We also license our  videocassette  copy  protection  technology to special
interest  customers that include  independent  video producers and corporations.
Licensed  commercial  duplicators act as distributors of our videocassette  copy
protection  technology  to special  interest  customers.  Revenues from domestic
special interest customers accounted for approximately 11.5% of our net revenues
in 1998 and 12.1% of our net revenues in 1997.                                  

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     We have  licensed  our copy  protection  technology  for  digital PPV to 43
set-top decoder manufacturers, including the following:                         

                                                        [Enlarge/Download Table]

                    Set-Top Decoder Manufacturers                                        
                    -----------------------------                                        

                                                                                         
Echostar Communications Corporation              Philips Consumer Electronics            
General Instrument Corporation                   Scientific-Atlanta, Inc.                
Nokia Satellite Systems, A.B.                    Sony Corporation                        
Pace Micro Technology, Ltd.                      Thomson Consumer Electronics (RCA brand)

     We  generally  receive an  up-front  fee and a per unit  royalty  from each
digital set-top decoder manufacturer that licenses our technology.  We have also
authorized 48 companies to incorporate  our digital PPV and DVD copy  protection
technologies in their  semiconductor  designs.  These  companies  include Analog
Devices  Corporation,   Brooktree  Division  of  Rockwell  Corporation,  Crystal
Semiconductor,  Inc.,  Mitsubishi  Electric  Corporation,  Motorola,  Inc.,  NEC
Corporation,  OKI Electric Industry, Co., Ltd., B.V., Raytheon Company,  Samsung
Electronics  Co.,  Ltd.,  Sony  Electronics  Inc.,  Texas  Instruments  and VLSI
Technology,  Inc. These companies generally pay a small one-time service fee for
verification  of proper  implementation  of our copy  protection  technology  in
digital-to-analog  application  specific  integrated circuits ("ASICs") that are
embedded in digital  set-top  decoders and DVD players.  They are  authorized to
sell  the  Macrovision-capable   ASICs  to  Macrovision-licensed   DVD  hardware
manufacturers and to Macrovision-licensed digital set-top decoder manufacturers.
As of December 31, 1998, 97 companies  that  manufacture  DVD players or DVD-ROM
drives had signed  agreements  with us to  incorporate  our DVD copy  protection
technology in their hardware.  These companies pay an initial license fee at the
beginning of the license and annual renewal fees.                               

System Operators                                                                

     We  have  licensed  our  digital  PPV  copy   protection   technology   for
incorporation into the networks of nine system operators,  including British Sky
Broadcasting Limited,  EchoStar,  DIRECTV (USA and Japan), Galaxy Latin America,
Hong Kong Telecom,  the Kirsch Group,  Sky Latin America and Sky Perfect.  These
system  operators  have paid a one-time  license fee to us and have entered into
agreements with us that entitle us to transaction-based  royalty payments at the
time copy  protection  for digital PPV  programming  is activated.  Other system
operators have specified  Macrovision-capable set-top decoders in their networks
or have  signed  agreements  with us to test our  digital  PPV  copy  protection
technology  on  a  limited  basis.   These  system  operators  include  Adelphia
Communications,  Comcast Corporation, Cox Enterprises, Inc., TeleCommunications,
Inc. and Time Warner Inc.                                                       

Video Scrambling Customers                                                      

     Our customers for video scrambling Pay TV components and licenses are cable
television  system  hardware  manufacturers  that sell their  products  to cable
operators in developing  markets.  These customers purchase encoder hardware and
decoder  components  from us or pay us a  unit-based  royalty  for  encoder  and
decoder  components when they  manufacture  these  components under our license.
Customers for our video encryption system products include government,  military
and law  enforcement  agencies  as  well as  broadcasters  and  private  network
operators.  The  following  is a  representative  list of our  video  scrambling
customers,  each of which  accounted  for at least  $25,000 of our net  revenues
during 1998:                                                                    

                                                        [Enlarge/Download Table]

Video Encryption System Customers                   Pay TV Components and Licenses                 
-------------------------------                     ------------------------------                 
                                                                                                   
Department of Defense (US Army)                 Eastern Electronics Co., Ltd. (Taiwan)             
Experimental Wings                              Efforts Development International, Ltd. (Hong Kong)
Government of Israel                            Pacific Satellite International, Ltd. (Hong Kong)  
Gujarat Communications Ltd. (India)                                                                
Integrated Telecommunications Systems (Canada)                                                     
M. Paz Logistics Ltd. (Israel)                                                                     
Skehan Televideo Service Inc.                                                                      

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Computer Software Copy Protection Customers                                     

     Our first copy  protection  product for the  interactive  software  market,
SafeDisc,  has been  applied to over 1.7 million  CD-ROMs  since its  commercial
release in  September  1998.  Publishers  that have  protected CD ROMs using our
technology   include   GT   Interactive,   Interplay,   Microprose,   Red  Storm
Entertainment,   Take  2   Interactive   Software,   TalonSoft   and  Ubi   Soft
Entertainment.                                                                  

Sales, Marketing and Customer Support                                           

     We market our  videocassette  copy  protection and digital PPV and DVD copy
protection   technologies  directly  to  the  MPAA  studios  and  certain  major
independent rights owners and video producers. We also provide ongoing technical
support to the two major duplicators that manufacture most of the videocassettes
for the MPAA  studios.  We are  constantly  looking  to expand  our  network  of
authorized  duplication,  authoring and  replication  facilities  throughout the
world , in order to better  service our rights owners.  In addition,  we support
licensed  duplicator  sales  personnel  by  providing  sales  training and sales
incentive programs and literature and by participating in trade shows.          

     We market our video scrambling technologies through a combination of direct
sales and licensing, as well as independent  distributors and system integrators
in the United States and  internationally.  We have a total of 16  distributors,
sales  representatives  and  licensees  serving 29 countries  that sell products
based on our video scrambling technologies. Our video encryption system products
are  sold  directly  or  through  distributors  to end  users.  We  license  our
PhaseKrypt  technology and sell encoder hardware and decoder components directly
to manufacturers  of cable television  set-top  decoders.  Technical  support is
provided from our Sunnyvale headquarters.                                       

     We market our computer  software copy protection  technologies  directly to
major PC games  publishers.  Software  toolkits  are provided to  publishers  to
encrypt  individual game titles. In 1998, we put in place the  infrastructure to
allow  implementation and support of the SafeDisc product.  We have licensed and
certified 24 CD-ROM replication facilities worldwide to apply the technology. In
addition,  we developed  and  implemented a customer  training  program to allow
software publishers to train their own employees in using the SafeDisc authoring
software.                                                                       

     We market our video and  consumer  software  copy  protection  technologies
internationally from our Sunnyvale  headquarters and through our subsidiaries in
Japan and the United  Kingdom.  In addition,  video and computer  software  copy
protection  technologies are marketed through exclusive  licensing  arrangements
with third parties in Egypt,  Hungary and South Korea.  International and export
sales  together  represented  44.5% of our net revenues in 1998 and 46.5% of our
net  revenues  in 1997.  We expect  that  international  and  export  sales will
continue  to  represent  a  substantial  portion  of our  net  revenues  for the
foreseeable  future.  Due to our reliance on international  and export sales, we
are subject to the risks of conducting business internationally.                

     We  supplement  our  direct  sales  efforts  with a  variety  of  marketing
initiatives, including trade show participation, trade advertisements,  industry
education  and  newsletters.  We  provide  technical  support  to  our  licensed
duplicators,  including hardware installation assistance and quality control. As
of  December  31,  1998,  we employed 27 sales and  marketing  personnel  and 10
additional employees who assisted in customer technical support.                

Technology                                                                      

Video Copy Protection                                                           

     Effective copy  protection  systems are difficult to develop because of the
need  to  address  the  dual  requirements  of  playability  and  effectiveness.
Consumers must be able to view the copy  protected  content using a consumer VCR
and a television set without the need for any intervening devices, while, at the
same time, the quality of an unauthorized copy must be reduced to such an extent
that it loses its  entertainment  value.  The extent to which the  entertainment
value is reduced  varies,  depending  on the VCR model used to make the copy and
the VCR/TV  combination that plays the  unauthorized  copy. To prevent VCRs from
making good copies, the copy protected video must differ in some manner from the
standard video signal  because,  by design,  all VCRs will make good copies from
standard  video  signals.  Television  sets are  designed  to play  standard  or
near-standard  video signals.  As a result,  there is a risk that making a video
signal non-standard in order to prevent copying will decrease                   

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playability by causing some  television  sets to generate  impaired or distorted
pictures.  In the tradeoff between  effectiveness and playability,  designers of
copy protection  systems must favor high playability while maintaining  adequate
effectiveness.                                                                  

     Our  videocassette  copy  protection   technology   involves  the  patented
technique  of  inserting a series of bipolar  electronic  pulses in the vertical
blanking interval of a standard video signal.  The vertical blanking interval is
the blank space between the video fields on  television  sets that are refreshed
at a rate of 60 fields per  second.  The copy  protection  pulses  are  embedded
electronically in the prerecorded  content of the  videocassettes in the process
of  videocassette  manufacturing.  The electronic  pulses are not visible in the
television picture. The pulses are intended to affect the automatic gain control
circuit in the recording system of most VHS videocassette  recorders, but not to
affect a similar circuit in the television set. Therefore, when a copy protected
prerecorded  videocassette is played, the picture is clean and crisp, but when a
copy  of  that  same   videocassette  is  played,   the  picture  typically  has
substantially  reduced  entertainment  value. Our copy protection  technology is
effective  against  most  consumer   copying,   but  generally  does  not  deter
professional  pirates  who use  professional  duplication  and video  processing
equipment.                                                                      

     The DVD and digital PPV versions of our copy protection technologies employ
both  the  electronic  pulses  used  in  videocassettes  and in all  territories
throughout  the world except the United  Kingdom and Europe,  a second  patented
copy  protection  process  called  Colorstripe.  Colorstripe  affects  the color
playback  circuit of a VCR causing colored  horizontal  stripes to appear in the
picture of an unauthorized copy. The combination of the two processes provides a
higher level of  effectiveness  than that provided by either process  alone.  In
addition,  Colorstripe  is more  effective  against  circumvention  by currently
available professional duplication equipment.  Copy protection is implemented in
DVD and digital PPV applications by embedding a copy protection signal generator
integrated  circuit  within  the DVD  player or  digital  set-top  decoder.  The
integrated  circuit is activated by copy  protection  control  codes,  which are
integrated  into the DVD  media  or the PPV  transmission.  Once the  integrated
circuit is activated, it adds the copy protection signal to the analog output of
the  DVD  player  or  digital  set-top  decoder.   As  with  videocassette  copy
protection,  consumers are able to see a clear picture on their television sets,
but generally cannot make a usable videocassette copy on a VCR .                

Video Scrambling                                                                

     Our  PhaseKrypt  technology  utilizes a combination  of digital  encryption
techniques and analog video scrambling to scramble video signals.  The resulting
scrambled picture  oscillates at random rates,  which makes it almost impossible
to watch. Because the encoding or scrambling technique is digitally  controlled,
the level of security  against  signal theft can be increased by increasing  the
number of bits that are used in the encryption  algorithm.  Our technology  uses
the largest number of bits currently  allowable by law for export products.  The
scrambled  picture is decoded using the secure PhaseKrypt analog technology that
partially  relies on the  electronics  of the  television  set to make the image
viewable.  The  combination  of the digital  encoding  process,  which  provides
security,  and the  analog  decoding  technology,  which is  inexpensive,  makes
PhaseKrypt  a  cost-effective  solution  for  analog-based  cable and  satellite
television set-top decoders in developing countries. PhaseKrypt video scrambling
is often accompanied by one of our patented audio scrambling technologies.      

Consumer Software Copy Protection                                               

     C-Dilla's  proprietary  SafeDisc technology seeks to prevent the copying of
CD-ROMs  by  using  encryption-protected   content,  an  authenticating  digital
signature and "anti-hacking"  software.  Each CD-ROM published with the SafeDisc
technology is premastered  with  encrypted  content,  containing  authenticating
instructions  and  a  unique  SafeDisc  digital  signature.  The  authentication
software  must detect the digital  signature  before it decrypts the contents of
the CD-ROM. The digital signature and  authentication  process is transparent to
the user. If a casual or professional  counterfeiter uses a CD-recordable device
or professional mastering equipment to duplicate a CD-ROM,  SafeDisc is designed
to inhibit the transmission of the digital  signature.  Because  decryption will
not take place without the digital  signature,  the copy will not run.  SafeDisc
also contains anti-hacking  technology to prevent the compromise of its security
features.                                                                       

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Research and Development                                                        

     Our research and development efforts are focused on developing enhancements
to existing  products,  new  applications  for our current  technologies and new
technologies related to the video,  software and audio security market. Our core
technological  competencies  are  in  video  engineering,   which  involves  the
generation  and  modification  of electronic  signals in both digital and analog
form and the  transformation  of such signals  between digital and analog forms,
and in ASIC design. Such technologies are primarily hardware based. We also have
expertise in developing  security software,  which is used to restrict access to
encoding and decoding devices.                                                  

     During 1998, we began building new competencies in software  engineering to
address the growing PC software copy protection market. As of December 31, 1998,
the software engineering group consisted of five engineers and technicians. This
group  of  engineers  and  technicians  will  help  us to  support  CD-ROM  copy
protection  technologies,  as well as to evaluate  and develop new  technologies
that will help us compete in the changing  marketplace.  As part of our Software
Marketing License and Development Agreement with C-Dilla,  C-Dilla has agreed to
provide  research  and  development  support  for the copy  protection  products
specified in the agreement.  C-Dilla has also agreed to provide  training to our
customer support staff.                                                         

     For our copy protection technologies, we support the efforts of television,
VCR and DVD hardware  manufacturers  to design  hardware that is compatible with
our technologies.  We also assist  semiconductor  manufacturers in incorporating
our copy protection technologies into digital video-based ASICs that are used to
convert   digital  video  input  to  analog   output.   We  regularly  test  the
effectiveness   and   transparency  of  our  copy  protection   technologies  on
representative  samples of consumer  televisions  and VCRs to determine  whether
modifications  or  enhancements  may be  necessary.  For  our  video  scrambling
technologies,  our  primary  focus is the  development  of  enhancements  to our
PhaseKrypt-based Pay TV encoder and decoder products.                           

     In September  1997,  Macrovision  and Digimarc  agreed to develop a digital
video  watermarking  solution to address the  digital-to-digital  copying issues
associated with the next generation of DVD and digital  videocassette  recording
devices.  In July 1998, we extended our development  alliance to include Philips
Electronics  Corporation  ("Philips").  Digital  watermarks  embedded  in motion
pictures and other video  material act as an  invisible  data carrier  providing
basic copyright identification  information as well as various directions either
to allow or to  disallow  playback,  viewing and copying  onto  another  digital
device.  The new technology will be based upon various published patents held by
Philips,  Digimarc  or  Macrovision  in digital  watermarking  and play  control
technologies.  The digital  watermarks are designed to be  imperceptible  to the
viewer, but to be read easily by special purpose decoders that can be built into
software or semiconductor  chips. This jointly developed  technology is intended
to  protect   motion   pictures  and  other  video  content  from   unauthorized
reproduction using digital recording devices. See "--Strategic Investments."    

     As of December 31, 1998, our research and development staff consisted of 15
engineers  and  technicians.  We believe that our ability to attract,  train and
retain  qualified  development  personnel  is  essential  to the  success of our
development   programs.  In  1998  and  1997,  our  expenses  for  research  and
development were $2.6 million and $2.2 million, respectively.                   

Intellectual Property Rights                                                    

     We  hold  42  United  States  patents  and  have 30  United  States  patent
applications  pending.  Of the issued United States  patents,  26 relate to copy
protection,  12 relate to video scrambling and four relate to audio  scrambling.
Our issued United States  patents  expire  between June 2000 and March 2015. The
earliest of our core  videocassette  and DVD copy protection  patents expires in
2005;  however,  we have filed  applications  for  improvement  patents that, if
issued,  will extend the expiration  dates beyond 2010. We also have 168 foreign
patents and 305 foreign  patent  applications  pending in 44  countries.  Of the
issued  foreign  patents,  95  relate  to copy  protection,  59  relate to video
scrambling and 14 relate to audio scrambling. Included in the patents related to
our copy protection  technologies  are nine United States and 20 foreign patents
covering a number of processes and devices that  unauthorized  parties could use
to circumvent our copy  protection  technologies.  We use these patents to limit
the  proliferation  of  devices  intended  to  circumvent  our  copy  protection
technologies.                                                                   

     From time to time,  we have  received  claims from third  parties  that our
technologies and products infringe their intellectual  property rights.  Krypton
Co., Ltd., a Japanese  company,  has filed an invalidation  claim against one of
our anti-copy patents in Japan. After consultation with Japanese patent counsel,
we believe that this claim                                                      

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is without merit, and we plan to contest the claim  aggressively in the Japanese
Patent Office. We also have one lawsuit pending in an effort to protect our copy
protection technology.                                                          

     We have nine  United  States  and 20 foreign  patents  covering a number of
processes and devices that unauthorized parties could use to circumvent our copy
protection  technologies.  We use these  patents to limit the  proliferation  of
devices  intended  to  circumvent  our  copy  protection  technologies.  We have
initiated a number of patent  infringement  disputes against  manufacturers  and
distributors  of these devices.  In October 1998,  President  Clinton signed the
Digital  Millennium  Copyright  Act into law.  This new law will require all new
VCRs  manufactured  or sold in the United  States,  beginning in May 2000, to be
specifically  designed to make poor quality copies of  programming  encoded with
our copy  protection  technology.  Existing VCRs that respond to our  technology
(over 90% of all new VCRs) are required to maintain their compliant designs. The
new law also  provides for both  criminal and civil  penalties  for companies or
individuals who import,  produce,  or distribute  devices designed to circumvent
our technology.                                                                 

     Additional  litigation  may be necessary in the future to limit the sale of
circumvention  technologies,  to  enforce  our  patents  and other  intellectual
property  rights,  to protect our trade  secrets,  to determine the validity and
scope of the  proprietary  rights  of  others  or to  defend  against  claims of
infringement or invalidity.                                                     

Competition                                                                     

Video Copy Protection                                                           

     We believe that we have had no significant  videocassette  copy  protection
competitor for the last five years other than  companies that have  occasionally
developed  hardware based on our technology in foreign countries where we do not
have patents issued.  Our copy protection  technologies are proprietary and have
broad  international  patent coverage.  As a result, none of our competitors has
been successful in the past. It is possible,  however,  that a competitive  copy
protection  technology  could be  developed  in the  future.  For  example,  our
customers could attempt to promote  competition by supporting the development of
alternative copy protection technologies or solutions,  including solutions that
deter professional duplication.  Increased competition would be likely to result
in price  reductions and loss of market share,  either of which could materially
adversely affect our business, financial condition and results of operations.   

     Macrovision,  Philips and Digimarc are jointly  developing a digital  media
copy  protection  solution  to address  the  digital-to-digital  copying  issues
associated with the next generation of DVD and digital  videocassette  recording
devices.  The Macrovision,  Philips and Digimarc  solution has been submitted to
the Copy Protection Technical Working Group ("CPTWG").  We, Philips and Digimarc
are  competing  with at least one other group of companies  that have  submitted
similar  proposals to the CPTWG.  These companies  (IBM, NEC, Sony,  Pioneer and
Hitachi)   collectively   have   substantially   greater  name  recognition  and
significantly greater financial,  technical,  marketing and other resources than
our group.  There can be no assurance that we, Philips and Digimarc will be able
to compete  successfully  in presenting  our proposal to the CPTWG.  The company
whose digital media copy protection  solution is selected by the CPTWG will have
a  significant  advantage in licensing  its  technology  to video rights  owners
worldwide and in working with consumer  electronics  manufacturers,  PC platform
companies and their suppliers to implement  digital-to-digital  copy protection.
If the solution  being  developed  by our group is not the selected  solution or
otherwise   is  not  widely   adopted  by   studios  or   consumer   electronics
manufacturers, our group would be at a competitive disadvantage in marketing our
solution.  If the CPTWG adopts our group's  solution,  there can be no assurance
that other companies will elect not to compete in this market.                  

Video Scrambling                                                                

     The  market  for  video  scrambling  products  and  technologies  is highly
competitive.  As a recent  entrant into these  markets,  we compete  directly or
through licensed manufacturers with many companies, including General Instrument
Corporation, Pioneer Electronic Corporation,  Scientific-Atlanta, Inc., Tandberg
Cryptovision  A.S.  and  VTech-HYH  Broadcast  Systems.   These  companies  have
substantially  greater name  recognition,  larger  installed  customer bases and
market shares and  significantly  greater  financial,  technical,  marketing and
other resources than we and our licensees,  many of which are  manufacturing and
selling  addressable  set-top  decoders for the first time. We and our licensees
may not be able to compete successfully in the video scrambling systems markets;
we may not be able to make  technological  advances necessary to improve or even
maintain our  competitive  position;  and our  products  may not achieve  market
acceptance. In addition, there can be no assurance that technological changes   

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or development  efforts by our competitors  will not render our video scrambling
products  obsolete or uncompetitive.  We believe that the principal  competitive
factors affecting these markets include the level of security  provided,  price,
quality, product reputation,  customer service and support, the effectiveness of
sales and marketing efforts and company reputation.  We or our licensees may not
be able to compete  successfully  against  current  and  potential  competitors,
especially  against  those  with  significantly  greater  financial,  marketing,
service, support, technical and other resources.                                

Computer Software Copy Protection                                               

     The market for CD-ROM copy protection  technologies is highly  competitive.
We compete with  companies  such as TTR,  LaserLock and Sony's  Digital  Optical
Replication Division. We may not be able to compete successfully in the computer
software copy protection  market;  we may not be able to make the  technological
advances  necessary to improve or even maintain our  position;  and our products
may not  achieve  market  acceptance.  In  addition,  technological  changes  or
development  efforts by our competitors  might render our computer software copy
protection  products obsolete or uncompetitive.  Finally,  Internet posted hacks
may be used to circumvent our technology.                                       

Manufacturing                                                                   

     Our  preferred  manufacturing  strategy is to license our  technologies  to
third parties that manufacture  products  incorporating those  technologies.  We
generate  royalty  revenues  from these  licenses,  generally  in the form of an
up-front fee and a per unit royalty.  For example,  licensees of our  PhaseKrypt
technology can either manufacture  PhaseKrypt decoder components or purchase the
components from us.                                                             

     Our  manufacturing  operations  are  limited  to low volume  products  that
require  us to do  significant  quality  control,  such as the video  encryption
system products,  PhaseKrypt encoders and  Macrovision-owned  videocassette copy
protection  processors  used  by  commercial  videocassette  duplicators.  These
manufacturing  operations  consist  primarily  of component  procurement,  final
assembly  and test,  and  quality  control  of  subassemblies  and  systems.  We
generally  use domestic  independent  contractors  to  manufacture  and assemble
printed circuit boards,  which enables us to configure the hardware and software
in combinations to meet a wide variety of customer requirements.  We install our
software into electronically  programmable  read-only memory to maintain quality
control and security.  We utilize  "burn-in"  procedures,  functional and system
integration  testing  and  comprehensive   inspections  to  assure  quality  and
reliability of our products.                                                    

Legislative and Technology Initiatives                                          

     We have been an active  participant  in the DVD Copy  Protection  Technical
Working Group ("CPTWG") that is comprised of representatives  from the following
associations   and  their   member   companies:   MPAA,   Consumer   Electronics
Manufacturers  Association,  Information Technology Industries Council, Business
Software  Alliance,  Recording Industry  Association of America,  Home Recording
Rights  Coalition,  Interactive  Multimedia  Association  and DVD  Manufacturers
Consortium.  In 1996, the CPTWG adopted a set of copy protection principles that
established prerequisites for commercial availability of DVD hardware and media.
Adoption of these  principles has resulted in worldwide  digital-to-analog  copy
protection  standards  for DVD  players  and  media.  We  believe  that our copy
protection  technology is currently the only  digital-to-analog  copy protection
solution that satisfies  these  principles.  The CPTWG is continuing to evaluate
digital-to-digital   copy   protection   solutions,   in   anticipation  of  the
introduction  of digital  videocassette  recorders and DVD recorders.  Our joint
development project with Philips and Digimarc is directed to this opportunity.  

     In October 1998,  President Clinton signed the Digital Millennium Copyright
Act into law. This new law will require all new VCRs manufactured or sold in the
United States,  beginning in May 2000, to be specifically  designed to make poor
quality  copies of  programming  encoded  with our copy  protection  technology.
Existing  VCRs that  respond  to our  technology  (over 90% of all new VCRs) are
required to maintain their compliant designs. The new law also provides for both
criminal and civil penalties for companies or individuals  who import,  produce,
or distribute devices designed to circumvent our technology.                    

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Strategic Investments                                                           

     We have sought to continue to expand our  technological  base in current as
well as new markets  through the following  strategic  investments  in companies
with complementary or compatible technologies or products.                      

Command Audio Corporation                                                       

     In October 1995,  Command Audio  Corporation  ("CAC") was incorporated as a
wholly-owned  subsidiary  of  Macrovision  to  commercialize  a distinct and new
audio-on-demand  technology.  In June 1996, our Board of Directors  approved the
discontinuation  of our  involvement in CAC. In August 1996, we divested all but
19.8% of the  outstanding  stock of CAC.  Subsequently  in 1998,  our  ownership
interest was diluted to 11.9% after an additional round of external  third-party
financing was obtained by CAC, in which we elected not to fully participate. CAC
is  developing an  audio-on-demand  system  consisting of a program  center that
provides  continuously  updated news,  content and information on a subscription
basis and a hand-held portable receiver that stores the information.  The system
allows consumers to control the timing and content of the program playback.  CAC
has entered into an agreement with Thomson  Consumer  Electronics  for branding,
distribution and  manufacturing  the hand-held  receivers.  It has also acquired
brand-name content from a variety of respected sources. CAC began beta trials in
late 1998 and is aiming to introduce the service in two cities in early 1999. We
have no plans to increase our ownership above the 11.9% minority  position,  but
do have a right of first  refusal to acquire  additional  stock to maintain  our
percentage ownership if and when CAC offers additional stock, subject to certain
exceptions. During 1996, we assigned to CAC all rights in certain technology and
released our reversion  rights in technology that we had previously  assigned to
CAC. In  consideration  of such  assignment  and  release,  CAC agreed to pay us
royalties equal to 2.0% of CAC's gross revenues for 12 years, beginning when CAC
has  operating  revenues from certain  sources or, at our election,  at any time
prior thereto.                                                                  

Digimarc Corporation                                                            

     In December  1997,  we invested  $1.5  million in Digimarc in exchange  for
shares of Digimarc's  preferred stock that represents a 6.8% ownership  interest
on an  as-converted  basis.  Digimarc is a private  company  that was founded in
1995.  We,  Digimarc  and Philips are jointly  developing  a digital  media copy
protection solution to address the digital-to-digital  copying issues associated
with the next generation of DVD and digital videocassette recording devices. We,
Digimarc and Philips have  presented our proposed  solution to the CPTWG and are
currently working on prototype systems.                                         

C-Dilla Limited                                                                 

     In February 1998, we purchased 247,500 shares,  or approximately  19.8%, of
the common  stock of  C-Dilla,  for a  purchase  price of  (pound)2,121,212,  or
approximately  $3.6  million.  C-Dilla  is a private  company  founded  in 1991.
C-Dilla provides rights management software for high value-added information and
software publishers.                                                            

     In February  1998,  we also entered into a Software  Marketing  License and
Development  Agreement  under which we have for an initial  five-year  term, the
worldwide  exclusive  license to market  C-Dilla's  proprietary  copy protection
technology  for CD-ROM  software  products in the consumer  multimedia  software
market.  Under this agreement,  we paid  (pound)606,060,  or approximately  $1.0
million, in up-front license fees subject to offset against future royalties and
will pay  royalties  to C-Dilla of between 30% to 45% of revenues  from sales of
software products incorporating C-Dilla's technology.  In the event that we fail
to reach  minimum  royalty  levels  of $2.0  million  in the  third  year of our
agreement,  $5.0 million in the fourth year, or $10.0 million in the fifth year,
the  license  becomes a  non-exclusive  license  for the term of the  agreement.
Additionally,  in connection with C-Dilla's  granting of licenses for certain of
its products  outside of the markets for which we have been granted rights under
the  agreement,  C-Dilla  will pay to us  royalties  of  between  7.5% to 30% of
revenues  from such  licenses.  We have the option to extend the initial term of
the agreement for an additional  five-year  period upon payment of an option fee
of $1.0 million and an additional license fee of $5.0 million,  which fee may be
paid  through  future  increased  royalty  payments.  Under  the  terms  of  the
agreement,  we  and  C-Dilla  also  agreed  to  develop  jointly  certain  other
proprietary copy protection  technologies for CD-ROM,  DVD-ROM and other digital
delivery methods.                                                               

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Employees                                                                       

     As  of  December  31,  1998,  we  had  83  employees,  including  eight  in
manufacturing,  15 in research,  engineering  and  development,  27 in sales and
marketing  plus 10 in  technical  support and 23 in general  and  administrative
capacities.  Fifteen of these  employees are based outside of the United States.
None of our  employees  are covered by a collective  bargaining  agreement or is
represented  by a labor  union  with  respect to  employment  by us. We have not
experienced  any organized  work  stoppages and consider our relations  with our
employees to be good.                                                           

RISK FACTORS

We  expect  to  experience   fluctuations  in  future   operating   results  and
seasonality.                                                                    

     Our  operating  results have  fluctuated  in the past,  and are expected to
continue to  fluctuate  in the  future,  on an annual and  quarterly  basis as a
result of a number of factors. These factors include, but are not limited to:   

     o    the timing of releases of popular motion pictures on videocassettes or
DVDs or by digital PPV transmission;                        

o    the ability of the MPAA studios to produce "blockbuster" titles; 

     o    the degree of acceptance of our copy protection  technologies by major
motion picture studios;                                     

o    consolidation in the entertainment industry;                     

o    the mix of products sold and technologies licensed;              

o    any change in product or license pricing;                        

o    the seasonality of revenues;                                     

o    changes in our operating expenses;                               

o    personnel changes;                                               

o    the development of our direct and indirect distribution channels;

o    foreign currency exchange rates; and                             

o    general economic conditions.                                     

     We may  choose to  reduce  prices  or  increase  spending  in  response  to
competition or new technologies or elect to pursue new market opportunities.  If
new  competitors,  technological  advances in the industry or by existing or new
competitors  or other  competitive  factors  require us to invest  significantly
greater resources in research and development or marketing  efforts,  our future
operating  results  may  be  adversely  affected.  As a high  percentage  of our
operating  expenses is fixed, a small  variation in the timing of recognition of
revenues can cause  significant  variations in operating  results from period to
period.                                                                         

     We  have  experienced  significant  seasonality  in our  business,  and our
financial  condition  and  results of  operations  are likely to be  affected by
seasonality in the future. We have typically experienced our highest revenues in
the  fourth  quarter  of each  calendar  year  followed  by lower  revenues  and
operating income in the first quarter, and at times in subsequent  quarters,  of
the next  year.  We  believe  that this  trend has been  principally  due to the
tendency  of  certain of our  customers  to release  their more  popular  motion
pictures on videocassettes and DVDs during the year-end holiday shopping season.
We anticipate  that revenues from  multimedia  CD-ROM copy  protection will also
reflect this seasonal  trend.  In addition,  revenues have tended to be lower in
the summer months, particularly in Europe.                                      

     Based upon the factors  enumerated above, we believe that our quarterly and
annual revenues,  expenses and operating results could vary significantly in the
future  and that  period-to-period  comparisons  should  not be  relied  upon as
indications  of future  performance.  There can be no assurance  that we will be
able to grow in future  periods or that we will be able to sustain  our level of
net revenues or our rate of revenue growth on a quarterly or annual basis. It is
likely that, in some future  quarter,  our  operating  results will be below the
expectations of stock market analysts and investors. In this event, the price of
our common stock could be materially adversely affected.  Further, we may not be
in a position to  anticipate a decline in revenues in any quarter  until late in
the quarter,  due  primarily  to the delay  inherent in revenue  reporting  from
licensees and replicators,  resulting in a potentially more significant level of
volatility in the price of our common stock.                                    

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We depend on  videocassette  copy protection  technology and on advocacy of this
technology by major motion picture studios.                                     

     We  currently  derive  a  substantial  majority  of our  net  revenues  and
operating  income  from fees for the  application  of our  patented  video  copy
protection technology to prerecorded videocassettes of motion pictures and other
copyrighted  materials  that  are  sold  or  rented  to  consumers.  These  fees
represented  64.5% of our net revenues during 1998 and 62.0% of our net revenues
during 1997.  We expect these fees to account for a majority of our net revenues
and operating income at least through 1999. This portion of our business has not
grown significantly in recent years, and there can be no assurance that revenues
from these fees will grow significantly or at all. Any future growth in revenues
from these fees will depend on the use of our copy  protection  technology  on a
larger  number of  videocassettes.  In order to increase or maintain  our market
penetration,  we must  continue  to  persuade  rights  owners  that  the cost of
licensing  the  technology  is  outweighed  by the increase in revenues that the
rights owners and retailers would achieve as a result of using copy  protection,
such as revenues from  additional  sales of the copy protected  material  and/or
subsequent  revenues  from other  venues.  In this regard,  our copy  protection
technologies  are  intended  to deter  consumer  copying  and are not  effective
against professional duplication and video processing equipment.                

     In the event that the major motion  picture  studios or other  customers of
our copy protection  technology were to determine that the benefits of using our
technology did not justify the cost of licensing the technology,  demand for our
technology would decline. Any factor that results in a decline in demand for our
copy protection technology,  including a change of copy protection policy by the
major motion picture studios or a decline in sales of prerecorded videocassettes
that are  encoded  with our copy  protection  technology,  would have a material
adverse effect on our business,  financial  condition and results of operations.
Moreover,  our ability to expand our markets in  additional  home  entertainment
venues  such as digital PPV and DVDs will depend in large part on the support of
the major  motion  picture  studios  in  advocating  the  incorporation  of copy
protection into the hardware and network  infrastructure  required to distribute
such video programming.  In the event that the motion picture industry withdraws
its support for our copy protection  technologies or otherwise determines not to
copy protect a significant portion of prerecorded video on videocassettes or DVD
or digital  PPV  programs,  our  business,  financial  condition  and results of
operations would be materially adversely affected.                              

We depend on our key customers.                                                 

     Our  customer  base is  highly  concentrated  among  a  limited  number  of
customers,  primarily due to the fact that the MPAA studios  dominate the motion
picture industry.  Historically,  we have derived a substantial  majority of our
net revenues from relatively few customers.  For 1998,  revenues from one of our
customers  accounted  for more than 12% of our net revenues.  For 1997,  another
customer  accounted  for 11% of our net  revenues.  The MPAA  studios as a group
accounted for 45.1% of our net revenues in 1998 and 38.6% of our net revenues in
1997. We expect that revenues from the MPAA studios will continue to account for
a substantial  portion of our net revenues for the foreseeable  future.  We have
agreements  with three of the MPAA studios and with PolyGram and  Dreamworks for
copy protection of substantially all of their videocassettes  and/or DVDs in the
United States.  These  agreements  expire at various times ranging from February
2000 to March 2001. The failure of any of these customers to renew its contracts
or enter into a new  contract  with us on terms that are  favorable  to us would
likely result in a substantial decline in our net revenues and operating income,
and would have a material  adverse effect on our business,  financial  condition
and  results of  operations.  Most of our other  videocassette  copy  protection
customers  license our technology on an annual contract basis or  title-by-title
or  month-by-month.  There can be no assurance  that our current  customers will
continue to use our  technology  at current or increased  levels,  if at all, or
that we will be able to obtain new  customers.  The loss of, or any  significant
reduction in revenues from, a key customer would have a material  adverse effect
on our business, financial condition and results of operations.                 

We are  introducing  products  into the evolving  market for DVD and digital PPV
copy protection.                                                                

     Our future  growth and  operating  results will depend to a large extent on
the  successful  introduction,  marketing and  commercial  viability of DVDs and
digital PPV programming that utilize our copy protection technologies.  A number
of factors will affect our ability to derive  revenues  from DVD and digital PPV
copy  protection.  These factors include the cost and  effectiveness of our copy
protection   technology  in  our  various   applications,   the  development  of
alternative  technologies or standards for DVD copy protection,  the uncertainty
in the  marketplace  engendered  by  alternative  standards  for DVD and for DVD
recordable  devices,  our ability to obtain  commitments from the motion picture
studios to require copy  protection  on DVD media and digital PPV  transmissions
and the                                                                         

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relative  ease of copying,  as well as the quality of the copies of  unprotected
video  materials  distributed  in new  digital  formats.  Because of their early
stages of development,  demand for and market acceptance of DVD and digital PPV,
as well as demand for associated copy protection, are subject to a high level of
uncertainty.  Much of the DVD and digital PPV technology and  infrastructure  is
unproven,  and it is difficult to predict with any assurance whether, or to what
extent,  these  evolving  markets will grow.  In this regard,  our future growth
would be adversely affected if DVD players and digital PPV set-top decoders that
do not include our copy protection components achieve market acceptance.        

     While our copy  protection  capability  is  embedded  in  approximately  13
million digital set-top decoders  manufactured by certain of the leading set-top
decoder manufacturers, only four system operators have activated copy protection
for digital PPV  programming.  In Japan,  DirectTV  Japan and  SkyPerfecTV  copy
protect all adult programming channels and certain PPV motion pictures.  In Hong
Kong,  one system  operator copy  protects all  video-on-demand  movies.  In the
United  Kingdom,  British Sky  Broadcasting  has to date copy  protected  all 48
digital channels of PPV motion  pictures.  There can be no assurance that any of
the MPAA  studios  will  require  copy  protection  for any of their PPV  motion
pictures or that PPV system  operators  will activate  copy  protection in other
digital PPV networks  outside of Japan,  Hong Kong or the United Kingdom.  Also,
consumers may react  negatively to copy protected PPV  programming  because,  to
date,   they  have   routinely   copied  for  later  viewing  analog  cable  and
satellite-delivered  subscription  television and PPV programs,  as well as free
broadcast programming.  In addition,  certain television sets or combinations of
VCRs and television sets may exhibit  impaired  pictures while displaying a copy
protected DVD or digital PPV program. If there is consumer  dissatisfaction that
cannot  be  managed,  or if there  are  technical  compatibility  problems,  our
business,  financial  condition  and results of  operations  would be materially
adversely  affected.  If the market for DVD or digital PPV copy protection fails
to develop or develops  more slowly than  expected,  or if our solution does not
achieve or sustain  market  acceptance,  our business,  financial  condition and
results of operations would be materially adversely affected.                   

     We  seek  to  expand  our  copy  protection   business  through   licensing
arrangements and strategic  investments.  Macrovision,  Philips and Digimarc are
jointly  developing  a digital  media copy  protection  solution  to address the
digital-to-digital copying issues associated with the next generation of DVD and
digital videocassette recording devices. We have submitted our proposed solution
to the Copy Protection  Technical  Working Group  ("CPTWG").  At least one other
group (IBM,  NEC,  Sony,  Pioneer and Hitachi) of companies  has also  submitted
proposals  to the CPTWG.  The  companies  whose  digital  media copy  protection
solution is selected by the CPTWG will have a significant advantage in licensing
its  technology  to video rights  owners  worldwide and in working with consumer
electronics  manufacturers,   PC  platform  companies  and  their  suppliers  to
implement   digital-to-digital  copy  protection.  The  IEEE  1394  transmission
protocol  has  also  been  proposed  as  a  digital-to-digital  copy  protection
solution.  If the solution being developed by Macrovision,  Philips and Digimarc
is not the selected  solution or  otherwise is not widely  adopted by studios or
consumer electronics manufacturers, Macrovision, Philips and Digimarc will be at
a  competitive  disadvantage  in  marketing  their  solution.  There  can  be no
assurance that the solution being developed by Macrovision, Philips and Digimarc
will be selected as the standard by the CPTWG or that such solution will achieve
market  acceptance as the market and the standards for  digital-to-digital  copy
protection evolve.                                                              

We are also just  beginning  to enter the  market  for  computer  software  copy
protection.                                                                     

     We have an exclusive  marketing  agreement with C-Dilla for copy protection
technology for CD-ROM software products in the consumer  multimedia  market. The
market for copy  protection  of CD-ROMs is unproven.  For us to be successful in
entering  this new market,  producers  of  multimedia  CD-ROMs  must accept copy
protection  generally  and also adopt the  solution  developed  by  C-Dilla  and
marketed by us. There can be no assurance  that copy  protection  of  multimedia
CD-ROMs will be accepted.  For example,  consumers  may react  negatively to the
introduction  of copy  protected  CD-ROMs if they are prevented from copying the
content  of  their  favorite  applications  or if copy  protection  impairs  the
playability of the CD-ROM. Moreover, copy protection may not be effective on all
hardware platforms or configurations or may prove to be easily  circumvented.  A
number of  competitors  and potential  competitors  are  developing  CD-ROM copy
protection  solutions.  Many of these competitors and potential competitors have
substantially  greater name  recognition and financial,  technical and marketing
resources  than we do.  There  may not be demand  for  CD-ROM  copy  protection.
Software  developed for CD-ROM may migrate to DVD-ROM,  a format in which we nor
C-Dilla have developed copy protection technology.  Internet posted hacks may be
used to circumvent the  technology.  Further,  the solution we are              

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marketing may not achieve or sustain market  acceptance under emerging  industry
standards  or may not  meet,  or  continue  to meet,  the  changing  demands  of
multimedia software providers. If the market for CD-ROM copy protection fails to
develop or develops  more  slowly than  expected,  or if our  solution  does not
achieve or sustain  market  acceptance,  our business,  financial  condition and
results of operations would be materially adversely affected.                   

Our intellectual property rights may not be adequately protected.               

     Our success is heavily dependent upon our proprietary technologies. We rely
on a  combination  of  patent,  trademark,  copyright  and  trade  secret  laws,
nondisclosure  and other  contractual  provisions,  and  technical  measures  to
protect our intellectual property rights. Our patents,  trademarks or copyrights
may be challenged and invalidated or  circumvented.  Any patents that issue from
our pending or future  patent  applications  or the claims in issued  patents or
pending  patent  applications  may not be of sufficient  scope or strength or be
issued in all countries where our products can be sold or our  technologies  can
be licensed to provide meaningful  protection or any commercial advantage to us.
The  expiration  of certain  patents may have a material  adverse  effect on our
business,  financial  condition  and results of  operations.  Others may develop
technologies  that are similar or superior to our  technologies,  duplicate  our
technologies  or design  around our  patents.  Effective  intellectual  property
protection may be unavailable or limited in certain foreign  countries.  Despite
efforts to protect our proprietary rights,  unauthorized  parties may attempt to
copy or  otherwise  use  aspects  of  processes  and  devices  that we regard as
proprietary.  Policing  unauthorized  use  of  our  proprietary  information  is
difficult,  and there can be no  assurance  that the  steps we have  taken  will
prevent misappropriation of our technologies. In the event that our intellectual
property protection is insufficient to protect our intellectual property rights,
we  could  face  increased  competition  in the  market  for  our  products  and
technologies,  which  could  have a  material  adverse  effect on our  business,
financial condition and results of operations.                                  

     Litigation  may be necessary in the future to enforce our patents and other
intellectual  property rights,  to protect our trade secrets or to determine the
validity  and  scope  of the  proprietary  rights  of  others.  There  can be no
assurance  that any  litigation  of these types will be  successful.  Litigation
could result in substantial costs, including  indemnification of customers,  and
diversion of resources and could have a material adverse effect on our business,
financial condition and results of operations, whether or not such litigation is
determined adversely to us. In the event of an adverse ruling in any litigation,
we might be required to pay substantial damages, discontinue the use and sale of
infringing  products,  expend  significant  resources to develop  non-infringing
technology or obtain licenses to infringed technology. Our failure to develop or
license a  substitute  technology  could have a material  adverse  effect on our
business, financial condition and results of operations.                        

It can be time consuming and costly to defend against infringement claims.      

     From time to time,  we have  received  claims from third  parties  that our
technologies and products infringe their intellectual  property rights.  Krypton
Co., Ltd., a Japanese  company,  has filed an invalidation  claim against one of
our anti-copy patents in Japan. After consultation with Japanese patent counsel,
we believe that this claim is without merit,  and we will  aggressively  contest
the claim in the Japanese  Patent  Office.  In the event of an adverse ruling on
this  claim,  we might  incur  legal  competition  from  clones  of our own copy
protection  technology  in Japan and a  corresponding  decline in demand for our
technology,  which  could  have a  material  adverse  effect  on  our  business,
financial condition and results of operations.  We also have one pending lawsuit
in an effort to protect  our copy  protection  technology.  In  addition,  as we
acquire or license a portion of the  technology  included in our  products  from
third parties, our exposure to infringement actions may increase because we must
rely upon these third parties for  information as to the origin and ownership of
the   acquired   or   licensed   technology.   Although   we  intend  to  obtain
representations  as to the origin and  ownership  of the  acquired  or  licensed
software  and  obtain  indemnification  to  cover  any  breach  of any of  these
representations,  these  representations  may not be accurate or indemnification
may not provide adequate  compensation for any breach of these  representations.
To the extent that these or any other  communications  or any litigation  create
further  uncertainty in the  marketplace,  acceptance of the technology  that we
market  would be  delayed,  which  could have a material  adverse  effect on our
business,  financial  condition and results of  operations.  These and any other
such claims of infringement,  with or without merit,  could be time-consuming to
defend,  result  in  costly  litigation,   divert  management's  attention  from
day-to-day  operations,  cause  product  shipment  delays or require us to cease
utilizing  the  infringing  technology  unless  it can  enter  into  royalty  or
licensing agreements.  Royalty or licensing agreements might not be available on
terms                                                                           

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acceptable to us, or at all,  which could have a material  adverse effect on our
business, financial condition and results of operations.                        

It can be  time-consuming  and  costly  to limit  the  spread  of  circumvention
devices.                                                                        

     We have nine  United  States  and 20 foreign  patents  covering a number of
processes and devices that unauthorized parties could use to circumvent our copy
protection  technologies.  We use these  patents to limit the  proliferation  of
devices  intended  to  circumvent  our  copy  protection  technologies.  We have
initiated a number of patent  infringement  disputes against  manufacturers  and
distributors  of these  devices.  In the event of an adverse  ruling in a patent
infringement  lawsuit,  we might  suffer  from  the  legal  availability  of the
circumvention device or have to obtain rights to the offending device. The legal
availability   of   circumvention   devices   could  result  in  the   increased
proliferation  of devices  that  defeat  our copy  protection  technology  and a
decline  in demand for our  technologies,  which  could have a material  adverse
effect on our  business,  financial  condition  and  results of  operations.  In
October 1998, President Clinton signed the Digital Millennium Copyright Act into
law. This new law will require all new VCRs  manufactured  or sold in the United
States,  beginning in May 2000, to be specifically designed to make poor quality
copies of programming encoded with our copy protection technology. Existing VCRs
that currently respond to our technology (over 90% of all new VCRs) are required
to maintain their compliant designs. The new law also provides for both criminal
and civil  penalties  for  companies  or  individuals  who import,  produce,  or
distribute devices designed to circumvent our technology.                       

We compete in an industry characterized by rapid technological change.          

     The  video  security  industry  in  which  we  compete,  and in  which  our
technologies and products are utilized,  is characterized by rapid technological
change,  frequent product  introductions and  enhancements,  changes in customer
demands and evolving industry standards. The emergence of new industry standards
and the introduction of new technologies or products  embodying new technologies
can render existing  technologies  or products  obsolete and  unmarketable.  For
example,  in countries not covered by the Digital Millennium  Copyright Act, new
industry  standards  for VCRs or  television  sets  could  adversely  affect the
effectiveness   or  transparency  of  our  copy   protection   technology.   Our
videocassette  copy  protection  technology  exploits the automatic gain control
circuit in VHS VCRs. While most VCR manufacturers use a standard  automatic gain
control  circuit that responds to our copy protection  process,  there can be no
assurance, other than the Digital Millennium Copyright Act in the United States,
that VCR manufacturers will not use alternative  automatic gain control circuits
that do not respond to our copy  protection  technology,  thereby  lessening the
effectiveness of our consumer copy protection solution over time as new VCRs are
sold into the  market.  Moreover,  there  can be no  assurance  that  television
manufacturers  will continue to design  television  sets that are transparent to
our copy  protection  technologies  when they display  original,  copy protected
videocassettes, DVDs and digital PPV programming.                               

     The success of our PhaseKrypt video scrambling  technology will depend upon
the growth of analog cable Pay TV networks in the Pacific Rim, South America and
other  developing  areas and the  ability  of our  licensees  to sell into those
markets.  The  financial  crisis in Southeast  Asia has delayed  expected  cable
television  system  upgrades  in that region and,  consequently,  has  adversely
affected the ability of our licensees to sell addressable  set-top decoders that
include our PhaseKrypt  video  scrambling  technology.  The development of lower
cost digital video  scrambling  systems could result in a transition from analog
to digital  scrambling  systems  in the  developing  cable Pay TV markets  and a
reduction in demand for our PhaseKrypt video scrambling technology.             

     Our future  success will depend in large part on our ability to enhance our
current  technologies  and  products in a timely,  cost-effective  manner and to
develop or acquire new  technologies  and  products  that meet  changing  market
conditions,  which  include  emerging  industry  standards,   changing  customer
demands, new competitive product offerings and changing  technology.  We may not
be  successful  in  developing  or  acquiring  and  marketing,  on a timely  and
cost-effective  basis  or  at  all,  fully  functional  and  integrated  product
enhancements  or new  technologies  or products  that  respond to  technological
change, updates or enhancements to other consumer electronics products,  changes
in customer requirements or evolving industry standards. Also, we may experience
difficulties that delay or prevent the successful development,  introduction and
license  or  sale  of  these  enhancements,   technologies  or  products.  These
enhancements,  technologies or products may not adequately meet the requirements
of  the  marketplace  and  achieve  market  acceptance.  Any  failure  by  us to
anticipate  or to respond  adequately  to  changing  market  conditions,  or any
significant delays in technology or product  development or introduction,  could
cause  customers  to  delay  or  decide  against  licensing  or  purchasing  our
technologies  or  products  and  would  have a  material  adverse  effect on our
business, financial condition and results of operations.                        

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Third parties may attempt to use circumvention technologies.                    

     Attempts by third parties to circumvent  our copy  protection  technologies
have been and are expected to be a persistent  problem,  even in the face of the
new United States Digital Millennium Copyright Act which outlaws copy protection
circumvention devices and technologies.  To counter circumvention  technologies,
we have  developed  and  patented  a number  of  processes  and  devices  in the
videocassette  and DVD  fields  that  could be used by  unauthorized  parties to
circumvent our copy protection technologies. We have then attempted to use these
patents as barriers to the  manufacture  and sale of such devices by others.  We
have no similar  patents  specifically  directed  to the  digital-to-digital  or
CD-ROM copy protection fields.  Notwithstanding our patent position, a number of
devices have been available,  and currently are available,  that circumvent copy
protection. Moreover, our copy protection technologies are not effective against
professional  duplication  and  video  processing  equipment.  There  can  be no
assurance  that  third  parties  will  not  be  able  to  develop  circumvention
technologies  that do not infringe our patents or that we will be able to obtain
patents on  circumvention  technologies  developed  in the  future.  A number of
factors could cause  copyright  holders to choose not to use our copy protection
technology, including a perception that the inability of our technology to deter
professional  pirates renders our technology less useful,  the interference with
legitimate  consumer use of the original  copyrighted  product,  the  commercial
availability of products that circumvent our copy protection technology,  or any
significant  reduction in the effectiveness of our copy protection technology in
deterring consumer copying.  We have implemented  numerous anti-hack features to
protect our CD-ROM copy protection technology,  but Internet posted hacks defeat
certain  versions of copy  protection  technology  and there can be no assurance
that future copy  protection  technology  will not be hacked.  Any  reduction in
demand for our products  could have a material  adverse  effect on our business,
financial condition and results of operations.                                  

We are exposed to the risks  associated  with expanding our  technological  base
through strategic investments.                                                  

     We have recently expanded our technological  base in current as well as new
markets  through  strategic  investments  in  companies  with  complementary  or
synergistic   technologies  or  products.  We  currently  hold  minority  equity
interests in Command Audio Corporation, Digimarc and C-Dilla. These investments,
which total $7.9 million and  represented  12.0% of our total assets at December
31, 1998, involve a number of risks. The negotiation, creation and management of
these strategic  relationships typically involve a substantial commitment of our
management  time and resources,  and there can be no assurance that we will ever
recover the cost of these  management  resources.  Because  these  companies are
privately held, there is no active trading market for their securities,  and our
investments in them are illiquid.  There may never be an  opportunity  for us to
realize a return on our investment in any of these companies,  and we may in the
future be required to write off all or part of one or more of these investments.
The  write-off of all or part of one or more of these  investments  could have a
material  adverse  affect on our  business,  financial  condition and results of
operations.                                                                     

     Our strategic  investments typically involve joint development or marketing
efforts  or  technology  licensing.  There  can be no  assurance  that any joint
development  efforts will result in the successful  introduction of new products
by us or a third  party,  or that any joint  marketing  efforts  will  result in
increased demand for our products.  Further,  there can be no assurance that any
current or future strategic investments by us will allow us to enter and compete
effectively in new markets or improve our performance in current markets.       

We depend on suppliers and third-party manufacturers.                           

     We depend upon  third-party  manufacturers  and suppliers  for  components,
subassemblies  and printed  circuit boards used in our video  encryption  system
products,  PhaseKrypt encoders,  PhaseKrypt decoder components and videocassette
copy  protection  processors.  Our product designs are proprietary but generally
incorporate  industry-standard  hardware  components  that are  obtainable  from
multiple sources. Our ability to deliver our products in a timely manner depends
upon the  availability  of quality  components and  subassemblies  used in these
products and, in part, on the ability of subcontractors to manufacture, assemble
and deliver certain items in a timely and satisfactory manner. We obtain certain
electronic components and subassemblies from a single source or a limited number
of sources.  For example,  Atmel  Corporation  is  currently  our sole source of
integrated  circuits for our  PhaseKrypt  decoders.  The reliance on third-party
manufacturers  and  sole or  limited  suppliers  involves  a  number  of  risks,
including  a  potential  inability  to obtain  an  adequate  supply of  required
components,  subassemblies  and printed  circuit boards and reduced control over
pricing,  quality and timely delivery of components,  subassemblies  and printed
circuit boards. A significant  interruption in the delivery of any such items or
any other  circumstance                                                         

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that would require us to seek alternative  sources of supply could result in our
inability to deliver  certain of our products on a timely  basis,  which in turn
could  result  in a  deterioration  of our  customer  relationships  and  have a
material  adverse  effect on our  business,  financial  condition and results of
operations.                                                                     

We need to establish  and maintain  licensing  relationships  with  companies in
related fields.                                                                 

     Our future  success will depend in part upon our ability to  establish  and
maintain  licensing  relationships  with companies in related  business  fields,
including    videocassette    duplicators,    international    distributors   of
videocassettes,  DVD authoring  facilities and  replicators,  semiconductor  and
equipment manufacturers,  operators of digital PPV systems, consumer electronics
hardware  manufacturers  and CD-ROM  mastering  facilities and  replicators.  We
believe that these current and future  relationships can allow us greater access
to  manufacturing,  sales and distribution  resources.  However,  the amount and
timing of resources to be devoted to these  activities by these other  companies
are  not  within  our  control.  We may not be able  to  maintain  our  existing
relationships  or enter  into  beneficial  relationships  in the  future.  Other
parties may not perform their  obligations  as expected.  Our reliance on others
for the  development,  manufacturing  and  distribution of our  technologies and
products  may  result  in  unforeseen  problems.  Our  reliance  on the  service
providers of our partners may also result in unforeseen problems.  Substantially
all of our license agreements are  non-exclusive,  and therefore these licensees
are free to enter into similar  agreements  with third  parties,  including  our
current or potential  competitors.  There can be no assurance that our licensees
will not develop or pursue  alternative  technologies  either on their own or in
collaboration with others,  including our competitors,  as a means of developing
or  marketing  products  targeted  by  the  collaborative  programs  and  by our
products.  The  failure of any of our  current or future  collaboration  efforts
could have a material adverse effect on our ability to introduce new products or
applications and therefore could have a material adverse effect on our business,
financial condition and results of operations.                                  

Certain markets in which we compete are highly competitive.                     

     We believe that we have had no significant  videocassette  copy  protection
competitor for the last five years other than  companies that have  occasionally
developed  hardware based on our technology in foreign countries where we do not
have patents issued. It is possible, however, that a competitive copy protection
technology  could be developed in the future.  For example,  our customers could
attempt to promote competition by supporting the development of alternative copy
protection   technologies   or  solutions,   including   solutions   that  deter
professional  duplication.  Increased  competition  would be likely to result in
price  reductions  and loss of market  share,  either of which could  materially
adversely affect our business, financial condition and results of operations.   

     Macrovision,  Philips and Digimarc are jointly  developing a digital  media
copy  protection  solution  to address  the  digital-to-digital  copying  issues
associated with the next generation of DVD and digital  videocassette  recording
devices and have submitted  their proposed  solution to the CPTWG.  Our group is
competing with at least one other group of companies that have submitted similar
proposals to the CPTWG.  Certain of these companies have  substantially  greater
name recognition and significantly greater financial,  technical,  marketing and
other resources than our group. There can be no assurance that our group will be
able to compete  successfully  in  presenting  its  proposal  to the CPTWG.  The
company whose digital  media copy  protection  solution is selected by the CPTWG
will have a significant  advantage in licensing  its  technology to video rights
owners  worldwide and in working with  consumer  electronics  manufacturers,  PC
platform  companies  and their  suppliers to implement  digital-to-digital  copy
protection.  If the  solution  being  developed by our group is not the selected
solution or otherwise is not widely  adopted by studios or consumer  electronics
manufacturers, our group would be at a competitive disadvantage in marketing its
solution.  Even if the CPTWG adopts our group's  solution  other  companies  may
still elect to compete in this market.                                          

     The  market  for  video  scrambling  products  and  technologies  is highly
competitive.  As a recent  entrant into these  markets,  we compete  directly or
through licensed manufacturers with many companies, including General Instrument
Corporation, Pioneer Electronic Corporation,  Scientific-Atlanta, Inc., Tandberg
Cryptovision  A.S.  and  VTech-HYH  Broadcast  Systems.   These  companies  have
substantially  greater name  recognition,  larger  installed  customer bases and
market shares and  significantly  greater  financial,  technical,  marketing and
other  resources than do we and our licensees,  many of which are  manufacturing
and selling  addressable  set-top  decoders for the first time.  There can be no
assurance that we and our licensees will be able to compete  successfully in the
video  scrambling  systems markets,  that we will be able to make  technological
advances necessary to improve or even maintain our competitive  position or that
our products will achieve market acceptance. In addition,  technological        

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changes  or  development  efforts  by  our  competitors  may  render  our  video
scrambling products obsolete or uncompetitive.                                  

     The market for CD-ROM copy protection  technologies is highly  competitive.
We compete with  companies  such as TTR,  LaserLock and Sony's  Digital  Optical
Replication Division.  There can be no assurance that we will be able to compete
successfully in the computer  software copy protection  market,  that we will be
able to make  technological  advances  necessary to improve or even maintain our
position or that our  products  will  achieve  market  acceptance.  In addition,
technological  changes or development  efforts by our competitors may render our
computer software copy protection  products obsolete or uncompetitive.  Finally,
Internet posted hacks may be used to circumvent our technology.                 

We face a number of risks associated with international and export sales.       

     International  and  export  sales  together  represented  44.5%  of our net
revenues  in 1998 and 46.5% of our net  revenues  in 1997.  We expect that these
sales will continue to represent a  substantial  portion of our net revenues for
the  foreseeable  future.  Our future  growth will  depend to a large  extent on
worldwide  deployment  of digital PPV  programming  and DVDs and the use of copy
protection  in these  media,  as well as  addressable  analog  cable  television
systems.   To  the  extent  that  foreign  governments  impose  restrictions  on
importation of programming, technology or components from the United States, the
requirement  for copy  protection  and video  scrambling  in these markets would
diminish.  Any  limitation on the growth of these markets or our ability to sell
our  products  or  license  our  technologies  into these  markets  would have a
material  adverse  effect on our  business,  financial  condition and results of
operations.  In  particular,  the  net  revenues  that  we  derived  from  video
scrambling decreased 46.5% from 1997 to 1998, due to decreased demand for analog
decoding  equipment  that  resulted  primarily  from  the  financial  crisis  in
Southeast  Asia and Latin America.  This crisis has also delayed  expected cable
television  system  upgrades  in that region and,  consequently,  has  adversely
affected the ability of our licensees to sell addressable  set-top decoders that
include our PhaseKrypt video  scrambling  technology.  In addition,  the laws of
certain foreign  countries may not protect our  intellectual  property rights to
the same extent as do the laws of the United States, which increases the risk of
unauthorized  use of our  technologies  and  the  ready  availability  or use of
circumvention  technologies.  Such laws also may not be  conducive  to copyright
protection of video materials and digital media,  which reduces the need for our
copy protection and video scrambling technologies.                              

     Due to our reliance on  international  and export sales,  we are subject to
the risks of conducting business  internationally,  including foreign government
regulation  and  general  geopolitical  risks  such as  political  and  economic
instability,   potential   hostilities  and  changes  in  diplomatic  and  trade
relationships.  International  and export sales are subject to other risks, such
as changes  in, or  imposition  of,  regulatory  requirements,  decision  making
control to use our products by studio headquarters operations,  tariffs or taxes
and other trade  barriers  and  restrictions,  foreign  government  regulations,
fluctuations in currency  exchange rates,  interpretations  or enforceability of
local  patent  or other  intellectual  property  laws,  longer  payment  cycles,
difficulty  in  collecting   accounts   receivable,   potentially   adverse  tax
consequences,  the  burdens  of  complying  with  a  variety  of  foreign  laws,
difficulty  in staffing  and  managing  foreign  operations  and  political  and
economic instability. For example, under the United States Export Administration
Act of 1979, as amended,  and  regulations  promulgated  thereunder,  encryption
algorithms  such  as  those  used  in  our  video  scrambling  technologies  are
classified as munitions and subject to stringent export controls. Any changes to
the statute or the regulations with respect to export of encryption technologies
could  require us to redesign  our products or  technologies  or prevent us from
selling our products  and  licensing  our  technologies  internationally.  While
international  and  export  sales are  typically  denominated  in United  States
dollars,  fluctuations  in currency  exchange  rates could cause our products to
become relatively more expensive to customers in a particular  country,  leading
to a  reduction  in sales or  profitability  in that  country.  There  can be no
assurance that our future results of operations will not be materially adversely
affected by currency  fluctuations.  Our business and operating results could be
materially  adversely affected if foreign markets do not continue to develop, or
if we do not receive  additional  orders to supply our  technologies or products
for  use in  foreign  prerecorded  video,  PPV  and Pay TV  networks  and  other
applications requiring our video security solutions.                            

We need to manage our growth.                                                   

     The growth of our  business  has  placed,  and is  expected  to continue to
place, significant demands on our personnel, management and other resources. Our
future results of operations  will depend in part on the ability of our officers
and other key  employees  to continue to implement  and expand our  operational,
customer support and                                                            

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financial control systems and to expand,  train and manage our employee base. In
order to manage our future growth, if any, successfully,  we will be required to
hire additional  personnel and to augment our existing  financial and management
systems or to implement new systems.  There can be no assurance that  management
will be able to augment or to implement these systems efficiently or on a timely
basis,  and the  failure to do so could have a  material  adverse  effect on our
business,  financial condition and results of operations.  We may not be able to
manage any future expansion successfully,  and any inability to do so would have
a material  adverse effect on our business,  financial  condition and results of
operations. We typically receive license fees for videocassette,  DVD and CD-ROM
copy protection based upon the number of copy protected videocassettes, DVDs and
CD-ROMs  that  are  produced  by the  MPAA  studios  or  other  rights  holders.
Information  relating to the number of copy protected  units may not be reported
to us until one to three months after the period of actual  usage.  As a result,
we recognize  revenue based upon estimates of historical  usage,  recent trends,
market  information  and  specific  customer  communications.  While to date our
estimates have been reasonably accurate, as our product offerings expand, and if
the revenues  generated from copy  protection of CD-ROMs,  PPV  programming  and
DVDs, as well as royalties from digital  set-top  decoders,  increase,  deriving
such  estimates will become more complex.  There can be no assurance  that, in a
future period,  our estimates as to the usage of our copy protection  technology
will be accurate.  Adjustments  to record the difference  between  estimated and
actual revenue could have a material  adverse effect on our business,  financial
condition  and results of operations  for the period in which the  adjustment is
recorded.                                                                       

We are dependent on certain key personnel.                                      

     Because of the specialized  nature of our business,  our future performance
is  highly  dependent  upon the  continued  service  of  members  of our  senior
management  and other  key  research  and  development  and sales and  marketing
personnel. The loss of any of these persons could have a material adverse effect
on our business,  financial condition and results of operations.  We do not have
employment  contracts  for a fixed term with any of our  employees in the United
States.  We believe  that our future  success  will depend  upon our  continuing
ability to identify,  attract, train and retain other highly skilled managerial,
technical, sales and marketing personnel,  particularly as we enter new markets.
Hiring for such personnel is competitive. There can be no assurance that we will
be able to continue to attract,  assimilate  and retain the qualified  personnel
necessary for the development of our business. The failure to recruit additional
key  personnel  in a timely  manner,  or the  failure  to retain  new or current
personnel,  would  have a material  adverse  effect on our  business,  financial
condition and results of operations.                                            

We are parties to certain transactions with our affiliates.                     

     We are a party to a number of transactions with affiliated entities. Victor
Company  of Japan,  Limited,  the parent of one of our  principal  stockholders,
licenses  and  utilizes  various   technologies  of  ours  pursuant  to  several
agreements.  Matsushita  Electric Industrial Co., Ltd., which owns approximately
52% of Victor Company of Japan,  Limited,  also is a party to various agreements
with us. We have certain  agreements  with a former  subsidiary,  Command  Audio
Corp.,  in which we  currently  have an 11.9%  interest.  In  addition,  we have
agreements with C-Dilla, in which we have a 19.8% interest.                     

We are currently  involved in a litigation  that could have a material impact on
us.                                                                             

     In October 1995,  Joseph Swyt,  one of our former  officers and  directors,
filed suit against us in the Superior Court of the State of California  alleging
monetary  damages suffered as a result of alleged fraud,  misrepresentation  and
other malfeasance in connection with our grant of stock options to him. Mr. Swyt
maintains that we induced him to accept  employment by falsely  representing  to
him that the options  granted to him eventually  would have  substantial  value.
Between  August  1990 and  December  1993,  we  granted to Mr.  Swyt  options to
purchase approximately 200,000 shares with per-share exercise prices of $2.25 or
$2.70.  Substantially  all of these  options  expired  unexercised  within three
months  following his departure from Macrovision in June 1995. In December 1996,
the court  ordered  this  matter to binding  arbitration  in  accordance  with a
written  agreement between us and Mr. Swyt. The arbitration  agreement  contains
limitations  on the  types  of  damages  available  to Mr.  Swyt  and  expressly
precludes  punitive  damages.  Mr. Swyt filed his claim in arbitration  for this
matter with the American  Arbitration  Association in June 1997 and  arbitration
hearings were  completed in February  1999. On March 16, 1999, a majority of the
arbitrators  rendered a decision in our favor,  finding that we had no liability
to Mr. Swyt on any of his claims and that his claims were without merit.  We are
seeking and expect to have the arbitrators'  decision  confirmed by the Superior
Court.  However,  in the  unlikely  event  that the Court  were to set aside the

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arbitrators' decision instead of confirming it, a subsequent decision against us
could have a material  adverse effect on our business,  financial  condition and
results of operations.  For details on additional  litigation,  please see "--It
can be time-consuming and costly to defend against infringement claims."        

We face Year 2000 risks.                                                        

     Many currently  installed computer systems and software products are unable
to distinguish  between twentieth  century dates and twenty-first  century dates
because such systems may have been  developed  using two digits rather than four
to  determine  the  applicable  year.  This could  result in system  failures or
miscalculations  causing  disruptions  of  operations,  including,  among  other
things, a temporary inability to process  transactions,  send invoices or engage
in similar normal business activities. As a result, many companies' software and
computer  systems  may need to be upgraded or replaced to comply with such "Year
2000"  requirements.  Our  business is  dependent  on the  operation of numerous
systems that could potentially be impacted by Year 2000 related problems.  Those
systems include, among others:  hardware and software systems used internally by
us in the management of our business;  hardware and software products  developed
by us; the internal systems of our customers and suppliers;  and non-information
technology  systems and services  used by us in the  management of our business,
such as telephone systems and building systems. We believe our products are Year
2000 ready;  however,  success of our Year 2000 readiness  efforts may depend on
the success of our customers in dealing with their Year 2000 issues. We sell our
products to companies in a variety of  industries  each  experiencing  different
issues with Year 2000  readiness.  Customer  difficulties  with Year 2000 issues
could  interfere with the use of our products,  which might require us to devote
additional  resources to resolve the  underlying  problems.  Although we believe
that our Year 2000 readiness efforts are designed to appropriately  identify and
address  those Year 2000  issues  that are within our  control,  there can be no
assurance that our efforts will be fully  effective or that the Year 2000 issues
will not have a material adverse effect on our business,  financial condition or
results of operations.  We do not presently have a contingency plan for handling
Year 2000 issues that are not detected and corrected prior to their  occurrence.
Any failure by us to address  any  unforeseen  Year 2000 issue  could  adversely
affect our business,  financial  condition and results of  operations.  For more
details on our Year 2000 risks, please see "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Year 2000 Issues."            

Our charter documents contain provisions that could discourage a takeover.      

     Our Board of Directors has the authority to issue up to 5,000,000 shares of
preferred stock and to determine the price, rights, preferences,  privileges and
restrictions,  including voting rights, of those shares without any further vote
or action by the stockholders. The rights of the holders of common stock will be
subject to, and may be  adversely  affected by, the rights of the holders of any
preferred  stock that may be issued in the future.  The  issuance  of  preferred
stock may delay, defer or prevent a change in control of Macrovision. We have no
present  plans to issue shares of  preferred  stock.  Additionally,  our charter
documents  contain a provision  eliminating  the ability of our  stockholders to
take  action by  written  consent.  This  provision  is  designed  to reduce our
vulnerability to an unsolicited  acquisition  proposal,  to maintain independent
ownership and control of our copy protection  technologies and to render the use
of  stockholder  written  consent  unavailable  as a  tactic  in a proxy  fight.
However, this provision could have the effect of discouraging others from making
tender offers for our shares,  thereby inhibiting  increases in the market price
of our shares that could result from actual or rumored takeover  attempts.  Such
provision  also may have the effect of  preventing  changes  in our  management.
Further,  our Bylaws limit the ability of our stockholders to raise matters at a
meeting of  stockholders  without giving advance  notice  thereof.  In addition,
Section 203 of the Delaware  General  Corporation  Law, to which we are subject,
restricts  certain business  combinations  with any "interested  stockholder" as
defined by such  statute.  The statute  may delay,  defer or prevent a change in
control of Macrovision.                                                         

     Pursuant  to the  terms  of a Copy  Protection  Technology  Agreement  (the
"Technology Agreement") between us and Victor Company of Japan, Limited, we have
agreed to continue to license our copy protection  technologies to third parties
in the event of the  acquisition  of  Macrovision  by a party  other than Victor
Company.  Further, we have granted to Victor Company the right to sublicense our
copy  protection  technologies  in the  event  that we fail  to  make  our  copy
protection  technologies  generally  available  for  licensing to third  parties
following an acquisition of Macrovision. The Technology Agreement could have the
effect of making  Macrovision less attractive to third parties as an acquisition
candidate.                                                                      

We experienced volatility in our stock price.                                   

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     The market  price of our common  stock has been and in the future  could be
significantly affected by factors such as actual or anticipated  fluctuations in
our operating results,  announcements of technical innovations,  new products or
new contracts by us, our competitors or their customers, governmental regulatory
action,  developments with respect to patents or proprietary rights,  changes in
financial estimates by securities analysts,  lawsuits, general market conditions
and other  factors,  certain of which  could be  unrelated  to us or outside our
control.  In addition,  announcements by the Copy Protection  Technical  Working
Group,  the Motion  Picture  Association  of America or its  members,  satellite
television  operators,  cable  television  operators or others  regarding motion
picture  distribution,  business  combinations,  evolving industry  standards or
other developments could cause the market price of our common stock to fluctuate
substantially.  The stock market has from time to time  experienced  significant
price and volume fluctuations that have particularly  affected the market prices
for the common stocks of technology companies and that often have been unrelated
or disproportionate to the operating performance of such companies. Further, the
trading prices of the stocks of many technology companies,  including us, are at
or near historical highs and reflect  price/earnings  ratios substantially above
historical  levels.  There can be no  assurance  that these  trading  prices and
price/earnings  ratios  will be  sustained.  In the past,  following  periods of
volatility  in the market  price of a  company's  securities,  securities  class
action  litigation  has been initiated  against such a company.  There can be no
assurance  that such  litigation  will not occur in the future  with  respect to
Macrovision.  Such litigation, if instituted,  could result in substantial costs
and a diversion of  management's  attention  and  resources,  which could have a
material  adverse  effect on our  business,  financial  condition and results of
operations.  Any settlement or adverse  determination  in such litigation  could
also subject us to significant  liability,  which could have a material  adverse
effect on our business,  financial  condition and results of  operations.  These
market price  fluctuations,  as well as general  economic,  political and market
conditions  such as  recessions  or  international  currency  fluctuations,  may
adversely  affect the market price of the common stock. In addition,  because of
our dependence on the reports of our customers to derive revenue  estimates,  we
may not be in a position to identify any shortfall of anticipated  revenue until
late in or after any  particular  quarter.  Failure to detect any such shortfall
until such time would result in our inability to advise or warn our stockholders
and analysts about such  shortfalls and  potentially  subject our stock price to
grater volatility.                                                              

ITEM 2. Description of Property.                                                

     Our  principal  operations  are located in a 43,960 square foot building in
Sunnyvale,  California. Our lease for this building expires on June 30, 2002. We
also lease space for sales,  marketing and  technical  support  operations  near
London, England and in Tokyo, Japan. We believe that our existing facilities are
adequate to meet our current needs.                                             

ITEM 3. Legal Proceedings.                                                      

Swyt Litigation                                                                 

     In October 1995,  Joseph Swyt,  one of our former  officers and  directors,
filed suit against us in the Superior Court of the State of California  alleging
monetary  damages suffered as a result of alleged fraud,  misrepresentation  and
other malfeasance in connection with our grant of stock options to him. Mr. Swyt
maintains that we induced him to accept  employment by falsely  representing  to
him that the options  granted to him eventually  would have  substantial  value.
Between  August 1990 and  December  1993,  we granted to him options to purchase
approximately  200,000 shares with per-share  exercise prices of $2.25 or $2.70.
Substantially  all of these  options  expired  unexercised  within  three months
following his departure  from  Macrovision  in June 1995. In December  1996, the
court ordered this matter to binding  arbitration  in accordance  with a written
agreement between Mr. Swyt and Macrovision.  The arbitration  agreement contains
limitations  on the types of damages  available to him and  expressly  precludes
punitive  damages.  Mr. Swyt filed his claim in arbitration for this matter with
the American Arbitration  Association in June 1997 and arbitration hearings were
completed in February  1999.  On March 16,  1999, a majority of the  arbitrators
rendered a decision in our favor,  finding  that we had no liability to Mr. Swyt
on any of his claims and that his claims were without merit.  We are seeking and
expect  to have the  arbitrators'  decision  confirmed  by the  Superior  Court.
However, in the unlikely event that the Court were to set aside the arbitrators'
decision instead of confirming it, a subsequent decision against us could have a
material  adverse  effect on our  business,  financial  condition and results of
operations.                                                                     

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Patent Litigation                                                               

     We have been  notified  that a Japanese  company has filed an  invalidation
claim against one of our anti-copy  patents in Japan. We and our Japanese patent
counsel believe this claim is without merit and will be  aggressively  contested
by us in the Japanese  Patent Office.  In the event of an adverse ruling on this
claim, we might incur legal  competition  from clones of our own copy protection
technology in Japan and a  corresponding  decline in demand for our  technology.
From  time  to  time,  we  may  receive  claims  from  third  parties  that  our
technologies and products infringe their  intellectual  property rights,  and we
may receive  similar  claims in the future.  Any  infringement  claims,  with or
without merit,  could be time-consuming to defend,  result in costly litigation,
cause product  shipment  delays or require us to cease  utilizing the infringing
technology  unless we can enter  into  royalty  or  licensing  agreements.  Such
royalty or licensing  agreements  might not be available on terms  acceptable to
us, or at all,  which  could have a  material  adverse  effect on our  business,
financial condition and results of operations.                                  

     We now have pending one patent infringement lawsuit in an effort to protect
our copy  protection  technology.  In the  event of an  adverse  ruling  in this
litigation,  we  might  incur  legal  competition  from  clones  of our own copy
protection  technology,  which  could  have a  material  adverse  effect  on our
business, financial condition and results of operations.                        

ITEM 4. Submission of Matters to a Vote of Security Holders.                    

     We did not submit  any  matters to a vote of  security  holders  during the
quarter ended December 31, 1998.                                                

 PART II

ITEM 5. Market for Common Equity and Related Stockholder Matters.               

     (a) Our common  stock has been traded on the Nasdaq  National  Market under
the symbol  "MVSN"  since our initial  public  offering on March 17,  1997.  The
following table sets forth, for the periods indicated, the reported high and low
closing prices for our common stock.                                            

                                                           High          Low
                                                           ----          ---
1997                                                                    
       First Quarter (Commencing March 17, 1997) .....  $   9.000      $   8.000
       Second Quarter ................................     14.750          8.250
       Third Quarter .................................     18.125         12.750
       Fourth Quarter ................................     17.125         12.750

1998                                                                    
       First Quarter .................................     19.313         14.750
       Second Quarter ................................     24.500         17.500
       Third Quarter .................................     29.750         17.750
       Fourth Quarter ................................     44.625         25.000

     As of March 22, 1999, there were 105 holders of record of our common stock,
based upon information  furnished by Boston EquiServe,  Boston, MA, the transfer
agent for our securities.  We believe,  based upon security positions  listings,
that there are more than 1,800  beneficial  owners of our  common  stock.  As of
March 22, 1999, there were 8,925,229 shares of common stock outstanding.        

     We have not  declared or paid any cash  dividends on our common stock since
1994. We do not anticipate  paying any cash dividends on our common stock in the
foreseeable  future.  We intend to retain all  earnings  for use in our business
operations and in the expansion of our business.                                

     In March and April 1997,  we  completed an initial  public  offering of our
common stock,  $0.001 par value (the "Offering").  The managing  underwriters in
the  Offering  were  Montgomery  Securities,  Hambrecht  & Quist LLC and Cowen &
Company (the  "Underwriters").  We registered  2,702,500  shares of common stock
under the  Securities Act of 1933, as amended,  on a  Registration  Statement on
Form SB-2 (No.  333-19373) (the  "Registration  Statement").  which was declared
effective by the Securities and Exchange Commission on March 12, 1997.          

     We commenced the Offering on March 13, 1997 and  terminated it on April 11,
1997 after  2,680,000  shares  (including  330,000  shares sold  pursuant to the
exercise  of the  underwriters'  over-allotment  option)  had been sold.        

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Of the  2,680,000  shares  sold,  we sold  1,764,016  shares and  certain of our
stockholders  sold 915,984  shares.  The initial public offering price was $9.00
per share and thus our gross proceeds were $15.9 million.                       

     We  paid an  aggregate  of  $1.1  million  in  underwriting  discounts  and
commissions and $1.5 million in other expenses.  None of these amounts were paid
directly or indirectly to any of our directors,  officers or general partners or
their  associates,  persons  owning  10% or  more  of any  class  of our  equity
securities or any of our affiliates.  After deducting the underwriting discounts
and commissions and other Offering expenses,  our net proceeds from the Offering
were approximately  $13.2 million.  As of December 31, 1998, these proceeds were
invested in interest-bearing, investment grade securities.                      

ITEM 6. Management's  Discussion and Analysis of Financial Condition and Results
of Operations.                                                                  

     The   discussion   in  this  Item   contains   trend   analysis  and  other
forward-looking  statements  within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended.  Actual results could differ  materially from those projected in the
forward-looking  statements  as a result of risk  factors,  including  those set
forth below and those set forth above under the caption "Risk Factors."         

Overview                                                                        

     Macrovision  was founded in 1983 to develop  video  security  solutions for
major motion picture studios and independent  video producers.  Since that time,
we have derived most of our revenues and  operating  income from  licensing  our
video copy  protection  technologies.  Videocassette  copy  protection  revenues
represented  64.5% of our net  revenues in 1998 and 62.0% of our net revenues in
1997. We expect these license fees to account for a majority of our net revenues
and operating  income at least through 1999. Our  videocassette  copy protection
customers  have  included the home video  divisions of the seven  members of the
MPAA. We also have a variety of special interest  videocassette  copy protection
customers,  including more than 150  videocassette  duplication  companies and a
number of rights holders, such as independent producers of exercise,  sports and
educational videocassettes.  We typically receive license fees for videocassette
copy protection based upon the number of copy protected  videocassettes that are
produced by MPAA studios or other rights holders. License fees from MPAA studios
represented a majority of such fees in 1998 and 1997.                           

     In  1993,  we  began  licensing  our  digital  PPV  video  copy  protection
technologies  to satellite  and cable  television  system  operators  and to the
equipment   manufacturers   that  supply  the  satellite  and  cable  television
industries.  These  manufacturers  include  in their  digital  set-top  decoders
integrated circuits  incorporating our copy protection  technologies that can be
activated  to apply  video copy  protection  to digital PPV  transmissions.  Our
digital PPV copy  protection  revenues have been derived from  up-front  license
fees,  hardware  royalties and limited PPV  programming  royalties.  Digital PPV
up-front  license  fees,  hardware  royalties  and  PPV  programming   royalties
decreased  to 15.4% of our net  revenues  in 1998 from 18.2% of net  revenues in
1997.  Our  agreements  with  digital  PPV  system   operators   entitle  us  to
transaction-based  royalty  payments at such time as copy protection for digital
PPV programming is activated.                                                   

     In 1994, we began  licensing and selling our  PhaseKrypt  video  scrambling
technology  to  manufacturers  of  analog  set-top  decoders  for  sale to cable
television system operators in developing cable television markets. We also sell
other analog scrambling systems to television broadcasters for securing incoming
contribution  circuits  to network  control  centers  and  outbound  rebroadcast
circuits to affiliate and regional stations. Finally, we sell specialized analog
video  scrambling  systems  in the  government,  military  and  law  enforcement
markets,  primarily  for  covert  surveillance  applications.  Video  scrambling
revenues  decreased to 6.0% of our net revenues in 1998 from 13.5% in 1997,  due
to the lower than expected Components and Licensing revenues from Asia and lower
than expected sales of video encryption system products to government  agencies.
Gross margins on sales of our video scrambling  products have been significantly
lower than on our licenses of copy protection or video  scrambling  technologies
because  of the  hardware  product  costs  associated  with  a more  traditional
manufacturing environment.  We expect this trend to continue for the foreseeable
future.                                                                         

     In 1997, we derived our first revenues from royalties and hardware  license
fees associated with DVD copy protection. The initial customers implementing the
DVD copy  protection,  from which the  royalties  have been  derived,  have been
members of the MPAA and to a lesser extent special  interest rights owners.  DVD
hardware  license  fees are  generated  from an initial  license fee paid at the
beginning of a license and subsequent  annual renewal fees. DVD copy  protection
has increased to 12.7% of our net revenues in 1998 from 5.3% in 1997.           

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Revenue is expected to grow in both  absolute  dollars  and as a  percentage  of
revenue in 1999 as the number of DVDs,  DVD titles and DVD players in the market
increases.                                                                      

     In October 1995,  Command Audio  Corporation  was  incorporated  by us as a
wholly-owned  subsidiary  to  commercialize  a distinct and new  audio-on-demand
technology that our founder developed during 1994 and 1995. This technology does
not involve copy protection or video  scrambling,  but rather  digitally  stores
broadcast  audio  programs so that a user can listen to these programs at his or
her  convenience.  In August 1996, we divested all but 19.8% of our ownership in
CAC. Additionally,  in 1996, we assigned to CAC all rights in certain technology
and released our reversion rights in technology that we had previously  assigned
to CAC. In consideration of this assignment and release, CAC agreed to pay to us
royalties  equal to 2.0% of its gross revenues for 12 years,  beginning when CAC
has  operating  revenues from certain  sources or, at our election,  at any time
prior  thereto.  During 1997, we maintained  our 19.8%  ownership in CAC with an
additional  cash  investment of  approximately  $2.0 million in connection  with
various  rounds of third-party  financing  obtained by CAC. In 1998, we invested
$500,000 in CAC in  connection  with an additional  round of external  financing
obtained  by CAC.  Our  investment  was less than 19.8% of the total  investment
financing  obtained by CAC and thus reduced our previous 19.8%  ownership of CAC
to 11.9%.                                                                       

     In December  1997,  we invested  $1.5  million in Digimarc in exchange  for
shares of Digimarc's preferred stock that represent a 6.8% ownership interest on
an as-converted  basis.  Digimarc is a private company that was founded in 1995.
We, Digimarc and Philips are jointly  developing a digital media copy protection
solution to address the  digital-to-digital  copying issues  associated with the
next  generation of DVD and digital  videocassette  recording  devices.  We have
presented  our  proposed  solution  to the CPTWG and are  currently  working  on
prototype systems.                                                              

     In 1998,  we entered  into a Software  Marketing  License  and  Development
Agreement with C-Dilla under which we have, for an initial  five-year  term, the
worldwide  exclusive  license to market,  in the  consumer  multimedia  software
market, C-Dilla's proprietary copy protection technology.  In September 1998, we
and C-Dilla introduced our CD-ROM copy protection  technology,  called SafeDisc.
As of  December  31,  1998,  we had  protected  over 1.7  million  CD-ROMs  with
SafeDisc.  The initial  customers  implementing  the  multimedia  software  copy
protection included nine publishers. We expect revenues in both absolute dollars
and as a percentage  of revenue from  multimedia  software  copy  protection  to
increase in 1999 due to the increasing  usage, by multimedia  content owners, of
the SafeDisc  technology to reduce the unauthorized  coping of their content due
to the availability of low price CD recorders. Revenues from multimedia software
royalties in 1998 represented 1.4% of our net revenues.                         

     Our cost of revenues consists  primarily of manufacturing  costs associated
with our video  scrambling  product  revenues,  service  fees  paid to  licensed
duplicators that apply our videocassette copy protection  whenever rights owners
license the technology directly from us, costs associated with equipment used in
applying the copy protection  process at the licensed  duplicators and royalties
due C-Dilla based on revenues from copy protection of CD-ROMs.  Also included in
cost of revenues are patent  amortization  costs and legal costs associated with
our efforts to prevent the sale of devices that attempt to circumvent  our video
copy  protection  technologies.   Our  research  and  development  expenses  are
comprised  primarily of employee  compensation  and benefits,  consulting  fees,
tooling and supplies and an  allocation  of  facilities  costs.  Our selling and
marketing  expenses  are  comprised  primarily  of  employee   compensation  and
benefits,  consulting and recruiting fees, travel, advertising and an allocation
of  facilities  costs.  Our general and  administrative  expenses are  comprised
primarily of employee compensation and benefits, consulting and recruiting fees,
travel, professional fees and an allocation of facilities costs.                

     We  have  experienced  significant  seasonality  in our  business,  and our
financial  condition  and  results of  operations  are likely to be  affected by
seasonality in the future. We have typically experienced our highest revenues in
the  fourth  quarter  of each  calendar  year  followed  by lower  revenues  and
operating income in the first quarter, and at times in subsequent  quarters,  of
the next  year.  We  believe  that this  trend has been  principally  due to the
tendency  of  certain of our  customers  to release  their more  popular  motion
pictures on videocassettes  and DVDs during the year-end holiday shopping season
and having our operating  expenses  incurred more evenly throughout the year. We
anticipate  that  revenues  from  multimedia  CD-ROM copy  protection  will also
reflect this seasonal  trend.  In addition,  revenues have tended to be lower in
the summer months, particularly in Europe.                                      

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Results of Operations                                                           

     The following  table sets forth selected  consolidated  statement of income
data expressed as a percentage of net revenues for the periods indicated:       

                                                         Year Ended December 31,
                                                        ----------------------
                                                        1998            1997
                                                        ------          ------
Net revenues .....................................        100.0%          100.0%
                                                        ------          ------
Costs and expenses:                                                             
 Cost of revenues ...............................          8.5            11.9
 Research and development .......................         10.6            11.1
 Selling and marketing ..........................         24.5            28.3
 General and administrative .....................         18.9            20.4
                                                        ------          ------
   Total costs and expenses .....................         62.5            71.7
                                                        ------          ------
   Operating income .............................         37.5            28.3
Interest and other income, net ...................          4.5             2.4 
                                                        ------          ------
   Income before income taxes ...................         42.0            30.7
Income taxes .....................................         16.0            11.9 
                                                        ------          ------
    Net income ...................................         26.0%           18.8%
                                                        ======          ======

     The following  information  provides revenue information by general product
lines for the periods indicated (dollars in thousands):                         

                                     For Period Ended December 31,
                                     -------------------------------------------
                                       1998      %      1997       %    % Change
                                     -------   -----   -------   -----  --------
Video Copy Protection .............  $22,626    92.6   $17,412    85.6    29.9% 
Video Scrambling ..................    1,464     6.0     2,739    13.5   (46.5) 
Computer Software Copy Protection .      344     1.4        --      --      --  
Other .............................       --      --       189      .9      --  
                                   -------   -----   -------   -----    ----
Total .............................  $24,434   100.0   $20,340   100.0    20.1  
                                   =======   =====   =======   =====    ====

Net Revenues                                                                    

     Our net  revenues  increased  20.1%  from  $20.3  million  in 1997 to $24.4
million  in  1998.  Our  video  copy   protection   revenues  are  derived  from
videocassette  and DVD copy  protection  and  digital  PPV.  Videocassette  copy
protection  revenues  increased $3.2 million or 25.0% from $12.6 million in 1997
to $15.8 million in 1998,  principally due to increased copy protection  royalty
revenue from three  Hollywood  studios  which had no  significant  usage of copy
protection  in 1997.  DVD copy  protection  revenues  increased  $2.0 million or
185.6%  from $1.1  million  in 1997 to $3.1  million in 1998,  due to  increased
royalty  revenue from the  replication  of DVDs and license fees from PC and DVD
ROM manufacturers.  Revenues from PPV for 1998 were $3.8 million,  reflecting an
increase  of $47,000  or 1.3% from 1997 as a result of  increased  shipments  of
set-top  decoders  from licensed  manufacturers  offset by a decrease in initial
license fees. Our video scrambling revenues decreased $1.3 million or 46.5% from
1997 to  1998.  Video  scrambling  revenues  are  derived  from  sales  of video
scrambling  system  products and  components  and  licensing  of our  PhaseKrypt
technology.  Video encryption system product revenue decreased $279,000 or 36.9%
from  $756,000  in 1997 to  $477,000  in 1998 as a result of a decline in orders
from various  government  law  enforcement  agencies.  Components  and licensing
revenue  from  PhaseKrypt  related  royalties  and  hardware  and chip  sales to
licensed cable TV equipment  manufacturers  in 1998 was $987,000,  a $996,000 or
50.2%  decrease from 1997. The decrease in the components and licensing area was
due primarily to the Southeast  Asian and Latin  American  financial  situation,
which has delayed expected cable TV system upgrades and,  consequently,  limited
the  ability of our  licensees'  to sell  addressable  set-top  converters  that
include  our  PhaseKrypt  TM  scrambling  technology.   We  recorded  our  first
multimedia  software  revenues in 1998 of $344,000  associated with the software
copy protection of computer CD-ROMs involving nine publishers.  Due primarily to
the  increase  in usage of copy  protection  by three  Hollywood  studios  which
included the hit title  "Titanic,"  along with the increased volume of DVD discs
from the market  growth of DVD players  coupled with the slight  increase in our
digital PPV copy protection and the decrease in the video scrambling businesses,
copy  protection  revenues                                                      

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from the MPAA  studios  in the  United  States  increased  from 27.3% of our net
revenues in 1997 to 32.1% of our net revenues in 1998. There can be no assurance
that we will be  able  to  grow  in  future  periods  or that we will be able to
sustain our level of net revenues or our rate of growth on a quarterly or annual
basis.                                                                          

     Our international and export revenues increased from $9.5 million, or 46.5%
of our net revenues in 1997, to $10.9  million,  or 44.5% of our net revenues in
1998.  International and export revenues grew primarily as a result of increased
usage  of  videocassette  copy  protection  technology  by the MPAA  studios  in
international  markets which included the title "Titanic," overseas shipments of
copy protection enabled digital PPV set-top decoders from  manufacturers  offset
by the decrease in PhaseKrypt component sales and licensing fees. We expect that
international  and export  revenues  will  continue to  represent a  significant
portion of our net  revenues  and that our future  growth will depend to a large
extent on continued increases in international and export opportunities.        

Cost of Revenues                                                                

     Cost of revenues as a percentage  of net revenues  declined to 8.5% in 1998
from 11.9% in 1997.  This  decrease was  primarily due to changes in revenue mix
between  product  sales,  which have a  relatively  high cost of  revenues,  and
licensing revenues,  which have a relatively low cost of revenues.  In the event
that  revenues  from video  scrambling  and computer  software  copy  protection
increase as a percentage  of net  revenues,  cost of revenues as a percentage of
net  revenues  will  increase.  In  addition,  processor  equipment  costs,  the
inventory reserve provision and product hardware related costs were reduced, but
were offset by  increased  service  fees for  duplicators  and  replicators  and
royalty expense.  As revenues increase from multimedia software copy protection,
cost of revenues as a percentage  of net revenues may increase due to the higher
cost of sales  associated with the royalties due to C-Dilla and other costs. See
Note 1 of Notes to Consolidated Financial Statements.                           

Research and Development                                                        

     Research and  development  expenses  increased from $2.2 million in 1997 to
$2.6 million in 1998,  but  decreased as a percentage of net revenues from 11.1%
in 1997 to 10.6% in 1998. This increase in absolute  dollars was principally due
to higher compensation  related expenses.  In 1997, we began a joint development
effort with Digimarc to develop a video watermarking  solution for DVD and other
video platforms.  Development  continued  through 1998, with Philips joining the
development effort. With our entrance into the computer software copy protection
market,   ongoing  support  is  needed  to  create  technology  with  commercial
applications. We believe that research and development expenses will increase in
dollar  amount in the future,  but may decline as a percentage  of net revenues.
There can be no assurance,  however, that net revenues will grow as a percentage
more rapidly than research and development expenses.                            

Selling and Marketing                                                           

     Selling and marketing  expenses were increased from $5.8 million in 1997 to
$6.0 million in 1998,  but  decreased as a percentage of net revenues from 28.3%
of net  revenues  in 1997 to 24.5% of net  revenues  in 1998.  The  increase  in
absolute   dollars  from  1997  to  1998  were  primarily  a  result  of  higher
compensation related expenses and advertising and marketing for DVD and computer
software copy protection and expenses  related to the entrance into the computer
software copy protection market,  offset by C-Dilla's $500,000  reimbursement of
specific  marketing  related  expenses under the joint marketing  agreement.  We
believe that the dollar amount of selling and  marketing  expenses will increase
in the  future  as we  incur  the  additional  costs  related  to  new  business
development in the computer  software copy  protection  market.  There can be no
assurance,  however,  that net revenues  will grow more rapidly than selling and
marketing expenses.                                                             

General and Administrative                                                      

     General and administrative  expenses increased from $4.1 million in 1997 to
$4.6 million in 1998,  but  decreased as a percentage  of the net revenues  from
20.4% of the net  revenues  in 1997 to 18.9% of the net  revenues  in 1998.  The
increase in absolute dollars was primarily related to increased compensation and
benefits,  the reversal of sales tax expense due to a favorable  judicial ruling
in a tax case that lowered our  expenses on a one-time  basis in 1997 and higher
consulting fees offset by lower legal fees and bad debt expense. We believe that
the dollar  amount of general and  administrative  expenses will increase in the
future as we evaluate new business opportunities. There can be no assurance that
net revenues will grow more rapidly than general and administration expenses.   

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Interest and Other Income, Net                                                  

     Interest and other income,  net, consists  primarily of interest income net
of  interest  expense on  capitalized  equipment  leases.  Interest  expense was
$11,000 in 1998 and $12,000 in 1997.  Interest  income was $1.1  million in 1998
and $513,000 in 1997.  The increase in interest  income was a result of interest
earned from cash and cash  equivalents,  short-term  investments  and  long-term
marketable  investment  securities primarily from the proceeds received from the
initial public offering in March 1997, and the secondary offering of Macrovision
shares completed in July 1998. See Note 2 to Consolidated Financial Statements. 

Income Taxes                                                                    

     Our  effective  rate of taxation  was 38.3% in 1998 and 38.7% in 1997.  The
provision for income taxes  consists  primarily of federal  income taxes,  state
taxes and  international  taxes withheld on foreign  revenue.  The lower rate in
1998 was  primarily  due to an  increase  in tax  credits and an increase in tax
exempt interest  associated with increased tax free  investments.  See Note 5 of
Notes to Consolidated Financial Statements.                                     

Liquidity and Capital Resources                                                 

     The Company's working capital increased 93.1% from $15.3 million in 1997 to
$29.5  million in 1998,  primarily  from proceeds  generated  from our secondary
offering  of  Macrovision  shares  in 1998.  The net  proceeds  to us from  that
offering,  after underwriting discounts and commissions and other expenses, were
approximately  $27.9  million.  In addition,  we have  financed  our  operations
primarily from cash generated by operating  activities,  principally by our copy
protection business.  Our operating activities provided net cash of $7.6 million
in 1998 and $2.4 million in 1997. In 1998,  net cash was provided by net income,
noncash  charges,  increases in tax benefit from employee  stock benefit  plans,
accrued expenses and deferred revenue, partially offset by increases in accounts
receivable  and  prepaids  and  decreases  in accounts  payable and income taxes
payable.  In 1997,  net cash was  provided  by net income,  noncash  charges and
increases in income  taxes  payable and deferred  revenue,  partially  offset by
increases in accounts receivable.                                               

     Investing  activities  used cash of $34.1 million in 1998 and $17.5 million
in 1997.  In 1998,  net cash used in  investing  activities  was  primarily  the
investment of the proceeds from the secondary offering,  partially offset by, an
investment in and payment of royalties to C-Dilla and an  additional  investment
in CAC. In February 1998, we acquired  247,500 shares  (approximately  19.8%) of
the common  stock of  C-Dilla,  a U.K.  company,  for a  purchase  price of $3.6
million. In February 1998, we also entered into a Software Marketing License and
Development  Agreement  under which we have obtained,  for an initial  five-year
term, the world-wide  exclusive  license to market,  in the consumer  multimedia
software market, C-Dilla's proprietary copy protection technology.  We paid $1.0
million in up-front  license fees subject to offset against future royalties and
will pay royalty  payments  to C-Dilla of between  30% to 45% of  revenues  from
sales of software  products  incorporating  C-Dilla's  technology.  During 1998,
$143,000 of the $1.0 million offset the  prepayment of royalties to C-Dilla.  In
1998, we invested  $500,000 in Command Audio  Corporation  ("CAC") in connection
with an additional round of external third-party  financing obtained by CAC. Our
investment was less than 19.8% of the total investment financing obtained by CAC
and thus reduced our previous 19.8% ownership of CAC to 11.9%. Subsequently, CAC
paid in full the note due to us including accrued  interest.  We account for the
investments  in C-Dilla and CAC using the cost  method.  In 1998 we made capital
expenditures  of  $285,000  and paid  $666,000  related  to  patents  and  other
intangibles during those periods. In 1997, net cash used in investing activities
resulted primarily from purchases of short and long-term  marketable  investment
securities and  investments of $1.5 million in Digimarc and  approximately  $2.0
million in CAC.                                                                 

     We had net cash provided from financing activities of $28.7 million in 1998
and $13.9 million in 1997,  relating in each year primarily to the sale of stock
in a public offering and, to a lesser extent,  the issuance of common stock upon
the exercise of stock options and under our stock purchase plan. We received net
proceeds  of $13.8  million  in 1997 from our  initial  public  offering,  which
represented  substantially all of the cash provided by financing activities.  In
July,  1998, we consummated an offering of 1,500,000 shares of our common stock,
of which  1,140,000  shares were  issued and sold by us and 360,000  shares were
sold by our existing  stockholders.  The Underwriters  also exercised in full an
over-allotment option to purchase from us an additional 225,000 shares of common
stock.  The  net  proceeds  to  us  from  the  offering,   after  deducting  the
underwriting  discount and other  expenses of the offering,  were  approximately
$27.9  million.  In addition,  we paid cash  dividends on our Series A Preferred
Stock of $156,000 in 1997.                                                      

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     At December  31, 1998,  we had $3.5  million in cash and cash  equivalents,
$22.9  million  in  short-term   investments  and  $18.8  million  in  long-term
marketable  investment  securities.  We had no material  commitments for capital
expenditures  as of that date, but we anticipate that capital  expenditures  for
1999 will aggregate approximately $600,000.                                     

     We also had future  minimum lease  payments of  approximately  $2.0 million
under operating leases and  approximately  $194,000 under capital leases. In the
future,  we may also elect to purchase  additional  stock in CAC to maintain our
percentage equity ownership in CAC.                                             

     We  believe  that  our  existing  cash  and  cash  equivalents,  short-term
investments,  long-term  marketable  investment  securities and cash provided by
operating  activities will be sufficient to meet our working capital and capital
expenditure  requirements for at least the next 12 months. To the extent that we
experience  growth in the future, we anticipate that our operating and investing
activities may use cash. Consequently,  any such growth may require us to obtain
additional  equity  or  debt  financing.  There  can be no  assurance  that  any
necessary   additional  financing  will  be  available  to  us  on  commercially
reasonable  terms,  if at all.  Management  intends to invest our excess cash in
short-term  and  long-term,   interest  bearing,  investment  grade  securities.
Although  there are no other present  understandings,  commitments or agreements
with respect to any acquisition of other  businesses,  products or technologies,
from time to time in the  ordinary  course of  business,  we evaluate  potential
acquisitions of businesses,  products or technologies  that are complementary to
ours and may in the  future  use a portion  of our cash to  acquire or invest in
complementary  businesses  or products or obtain the right to use  complementary
technologies.                                                                   

Year 2000 Issues                                                                

Background                                                                      

     Many currently  installed computer systems and software products are unable
to distinguish  between twentieth  century dates and twenty-first  century dates
because these systems may have been developed  using two digits rather than four
to  determine  the  applicable  year.  For example,  computer  systems that have
date-sensitive  software may recognize a date using "00" as the year 1900 rather
than  the  year  2000.   This  error   could   result  in  system   failures  or
miscalculations  causing  disruptions  of  operations,  including,  among  other
things, a temporary inability to process  transactions,  send invoices or engage
in similar normal business activities. As a result, many companies' software and
computer  systems  may need to be upgraded or replaced to comply with such "Year
2000" requirements.                                                             

State of Readiness                                                              

Our  business is  dependent  on the  operation  of numerous  systems  that could
potentially be impacted by Year 2000 related  problems.  Those systems  include,
among others:                                                                   

     o    hardware and software systems that we use internally in the management
of our business;                                            

o    hardware and software products that we have developed;           

o    the internal systems of our customers and suppliers; and         

     o    non-information  technology  systems and  services  that we use in the
          management  of our  business,  such as telephone  systems and building
systems.                                                    

     Based on an  analysis  of the systems  potentially  impacted by  conducting
business  in the  twenty-first  century,  we are  applying a phased  approach to
making such systems,  and accordingly our  operations,  Year 2000 ready.  Beyond
awareness of the issues and scope of systems involved,  the phases of activities
in progress include:                                                            

     o    an assessment of specific underlying computer systems, programs and/or
hardware;                                                   

o    remediation or replacement of Year 2000 non-compliant technology;

     o    validation and testing of  technologically  Year 2000 ready solutions;
and                                                         

o    implementation of the Year 2000 ready systems.                   

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      The table below provides the status and timing of these phased activities:

                                                        [Enlarge/Download Table]

                                                                                Targeted   
            Impacted Systems                          Status                 Implementation
            ----------------                          -------                --------------
                                                                                           
Hardware and software products that we  Assessment completed, conducting         Q1 1999   
license or sell                         validation and testing (see details                
                                        below)                                             
Hardware and software systems that we   Assessment completed; certain            Q1 1999   
use internally in the management of     components replaced; conducting                    
our business                            validation and testing                             
Internal systems of our customers and   Assessment not yet completed             Q3 1999   
suppliers                                                                                  
Non-information technology systems and  Assessment completed; certain            Q2 1999   
services that we use in the management  components replaced, conducting                    
of our business, internal and           validation and testing                             
external, such as telephone systems                                                        
and building systems                                                                       

Products Status                                                                 

     Macrovision's  products  that do not  include  a  microprocessor  or  other
digital-based technology and are not date or time sensitive are Year 2000 ready.
These products include the following:                                           

     Video Copy Protection  Products;  All versions of ACP Processors  (ACP-100,
     ACP-170,  ACP-180;  ACP-182 and ACP-184);  the Standard ACP-100 and ACP-180
Chassis and the Secured ACP-180 Chassis.                              

     Video Scrambling Products;  VM-100; TurboKrypt Chassis and Processor; Video
     Tilt  Corrector;  MacroPlus  Generator;  VGA  Copy  Processor;  ColorStripe
Generator; and the WaterMark Embedder.                                

     Macrovision's  products that do contain a  microprocessor  or other digital
based technology,  and have been tested and verified as Year 2000 ready, include
the following:                                                                  

 Video Copy Protection Products; ACP-180 Security Chassis; ACP Time Key.

     Video Scrambling Products;  VES-TM; VES-TL; VES-MX; VES-TP; VES-TS; VES-TX;
     VES-TX NET Software;  VES-P; VES-C1; VES-C2;  VES-TD;  PK-410/415 Chassis &
     CPU; AV-8; AV-10; PK-430A; PK-430M; PK-430C; StarShaker Encoder; StarShaker
Decoder; and the StarShaker Software.                                 

     Macrovision products currently in the process of being tested for Year 2000
readiness, include the following:                                               

SafeDisc Developers ToolKit.                                          

     Year 2000 readiness does not include the  performance or  functionality  of
     third party products,  including hardware or software with which any of our
products interfaces.                                                  

Costs to Address Year 2000 Readiness                                            

     We have  expensed  as  incurred  all costs  directly  related  to Year 2000
readiness, even in cases where non-compliant information technology systems have
been replaced.  To date,  these costs have been  insignificant.  The replacement
cost of non-information technology systems would have been incurred,  regardless
of the Year 2000 issue, to accommodate our growth.                              

     We do not believe that future  expenditures to upgrade internal systems and
applications  will have a material  adverse  effect on our  business,  financial
condition and results of operations.  In addition,  while the potential costs of
redeployment of personnel and any delays in  implementing  other projects is not
known, the costs are anticipated to be immaterial.                              

Risks of the Year 2000 Issues                                                   

     We believe our products are Year 2000 ready;  however,  success of our Year
2000  readiness  efforts may depend on the success of our  customers  in dealing
with their Year 2000  issues.  We sell our products to companies in a variety of
industries each experiencing different issues with Year 2000 readiness. Customer
difficulties with Year 2000                                                     

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issues could  interfere with the use of our products,  which might require us to
devote additional resources to resolve the underlying  problems.  If the problem
is found to lie in our products,  our business,  financial condition and results
of operations could be materially adversely affected.                           

     Furthermore,  the  purchasing  patterns  of these  customers  or  potential
customers  may be affected by Year 2000 issues as companies  expend  significant
resources to become Year 2000 ready.  The costs of becoming  Year 2000 ready for
current or potential customers may result in reduced funds available to purchase
and implement our products.  In addition,  we rely on various  entities that are
common to many businesses,  such as public utilities.  If these entities were to
experience  Year  2000  failures,  our  ability  to  conduct  business  would be
disrupted.                                                                      

     Although we believe  that our Year 2000  readiness  efforts are designed to
appropriately  identify  and address  those Year 2000 issues that are within our
control,  there can be no assurance that our efforts will be fully  effective or
that the  Year  2000  issues  will not have a  material  adverse  effect  on our
business,  financial  condition  or  results  of  operations.  The  novelty  and
complexity of the issues  presented and our  dependence on the  preparedness  of
third parties are among the factors that could cause our efforts to be less than
fully effective.  Moreover,  Year 2000 issues present many risks that are beyond
our control, such as the potential effects of Year 2000 issues on the economy in
general and on our business partners and customers in particular.               

Contingency Plans                                                               

     We have  conducted an assessment of certain of our Year 2000 exposure areas
in order to determine what steps beyond those  identified by our internal review
were advisable and no additional work was recommended.  We do not presently have
a  contingency  plan for  handling  Year 2000 issues that are not  detected  and
corrected prior to their occurrence. Any failure by us to address any unforeseen
Year 2000 issue could  adversely  affect our business,  financial  condition and
results of operations.                                                          

ITEM 7. Financial Statements.                                                   

     The response to this item is submitted in a separate section of this report
beginning on F-1.                                                               

ITEM  8.  Changes  in and  Disagreements  with  Accountants  on  Accounting  and
Financial Disclosures.                                      

None.                                                                 

PART III

ITEM 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
with Section 16(a) of the Exchange Act.                         

     The information required by this item is incorporated by reference from the
information   under  the  caption  "Election  of  Directors,"  with  respect  to
Directors,  and  under the  caption  "Management,"  with  respect  to  Executive
Officers,  contained in our definitive Proxy Statement, which will be filed with
the Securities and Exchange  Commission in connection  with the  solicitation of
proxies for our 1999 Annual Meeting of Stockholders ( the "Proxy Statement").   

ITEM 10. Executive Compensation.                                                

     The  information  required by this item is incorporated by reference to the
information  under the caption  "Executive  Compensation" to be contained in the
Proxy Statement.                                                                

ITEM 11. Security Ownership of Certain Beneficial Owners and Management.        

     The  information  required by this item is incorporated by reference to the
information under the caption "Security  Ownership of Certain  Beneficial Owners
and Management" to be contained in the Proxy Statement.                         

ITEM 12. Certain Relationships and Related Transactions.                        

     The  information  required by this item is incorporated by reference to the
information under the caption "Certain  Relationships and Related  Transactions"
to be contained in the Proxy Statement.                                         

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ITEM 13. Exhibits and Reports on Form 8-K.                                      

(a)  Exhibits                                                         

Exhibit                                                             
Number                         Exhibit Title                        
------                         -------------                        

       2.01   Form of Merger Agreement by and between Macrovision Corporation, a
           Delaware Corporation, and Macrovision Corporation, a California
corporation.*                                       

3.01   Certificate of Incorporation of Macrovision Corporation.*  

     3.02   Amended and Restated Certificate of Incorporation of Macrovision
Corporation.                                        

3.03   Bylaws of Macrovision Corporation.*                        

3.04   Amended and Restated Bylaws of Macrovision Corporation.*   

3.05   Certificate of Amendment of Certificate of Incorporation of
Macrovision Corporation.                            

10.01  Stock Option Plan and related documents of Macrovision     
Corporation.*                                       

     10.02  Macrovision Corporation's 1996 Equity Incentive Plan and related
documents.*                                         

   10.03  Macrovision Corporation's 1996 Directors Stock Option Plan and
related documents.*                                 

    10.04  Macrovision Corporation's 1996 Employee Stock Purchase Plan and
related documents.*                                 

10.05  Macrovision Corporation's Executive Incentive Plan.*       

       10.06  Employment Agreement dated as of June 5, 1996, between Macrovision
Corporation and Victor A. Viegas.*                  

  10.07  Restricted Stock Purchase Agreement dated as of June 7, 1996,
            between Macrovision Corporation and Victor A. Viegas and related
             documents, including Promissory Note and Stock Pledge Agreement.*

10.08  Form of Indemnification Agreement to be entered into by    
            Macrovision Corporation with each of its directors and executive
officers.*                                          

       10.09  Recapitalization and Stock Purchase Agreement dated as of July 31,
   1996, between Macrovision Corporation and Command Audio
Corporation.*                                       

      10.10  Restricted Stock Acquisition Agreement dated as of July 31, 1996,
              between Macrovision Corporation and Command Audio Corporation, and
First Amendment dated as of November29, 1996.*      

   10.11  Technology Transfer and Royalty Agreement dated as of July 31,
   1996, between Macrovision Corporation and Command Audio
           Corporation, and First Amendment dated as of November29, 1996.*

  10.12  Letter dated December 6, 1996 from Macrovision Corporation to
Command Audio Corporation.*                         

  10.13  License Agreement dated September 26, 1995, among Macrovision
       Corporation, Victor Technobrain Co., Ltd. And Video Culture
        Institute, Inc., Amendment Number One dated June30, 1996 and
Amendment Number Two dated September 30, 1996.*     

      10.14  Duplicator Agreement dated as of June 1, 1988, by and between and
Victor Company of Japan, Limited.*                  

     10.15  Technology Application Agreement dated November 29, 1988, by and
        between Macrovision Corporation and Victor Company of Japan,
Limited.*                                           

10.16  Agreement dated July 15, 1994, by and between Macrovision  
Corporation and Victor Company of Japan, Limited.*  

      10.17  Copy Protection Technology Agreement dated as of January 7, 1997,
        between Macrovision Corporation and Victor Company of Japan,
Limited.*                                           

      10.18  Waiver Agreement dated as of January 6, 1997, between Macrovision
Corporation and Pacific Media Development, Inc.*    

      10.19  Stock and Convertible Note Purchase Agreement dated as of May 24,
            1991, among Macrovision Corporation, a trustee for Pacific Media
          Development, Inc. and A. Victor Farrow and Carol Ann Farrow as
         Trustees of the Farrow Family Trust U/T/D December 18, 1990.*

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     10.20  Lease Agreement dated April 21, 1995, by and between Macrovision
Corporation and Caribbean Geneva Investors.*        

10.21  Standard Sublease dated September 21, 1995, by and between 
             Macrovision Corporation and Deutsch Technology Research, together
   with Lease Agreement dated May 26, 1992, by and between
     Macrovision Corporation and Crossroads Investment Group.*

       10.22  Letter Agreement dated January 14, 1997 by and between Macrovision
Corporation and Buena Vista Home Video.*/**         

   10.23  Technical Consulting Agreement dated as of July 1, 1996 by and
             between Macrovision Corporation and Victor Technobrain Co., Ltd.*

     10.24  Second Amendment to Restricted Stock Acquisition Agreement dated
             as of January 29, 1997 by and between Macrovision Corporation and
Command Audio Corporation.*                         

   10.25  Letter dated February 10, 1997 from Macrovision Corporation to
Command Audio Corporation.*                         

    10.26  Promissory Note dated January 7, 1997 executed by Command Audio
Corporation.*                                       

  10.27  Digital Versatile Disc Player/Digital Video Cassette Recorder
              License Agreement for Anticopy Technology dated as of February 18,
             1997 by and between Macrovision Corporation and Victor Company of
Japan, Limited.*                                    

       10.28  Subscription Agreement between Macrovision Corporation and C-Dilla
Limited dated February 17, 1998.**/***              

 10.29  Software Marketing License and Development Agreement between
          Macrovision Corporation and C-Dilla Limited dated February 19,
1998.**/****                                        

21.01  List of subsidiaries.*                                     

23.01  Consent of Independent Auditors.                           

27.01  1998 Financial Data Schedule.                              

27.02  1997  Financial  Data Schedule                             

*    Incorporated  by  reference  to the  exhibit  of  the  same  number  in our
     Registration Statement on Form SB-2 (Registration No. 333-19373), which was
declared effective on March 12, 1997.                                 

**   Confidential treatment has been granted with respect to certain portions of
     these Exhibits.  These portions have been omitted from this filing and have
been filed separately with the Securities and Exchange Commission.    

***  Incorporated  by reference to Exhibit 10.01 to our Form  10-QSB/A  filed on
June 23, 1998.                                                        

**** Incorporated  by reference to Exhibit 10.02 to our Form 10-QSB filed on May
15, 1998.                                                             

(b)  Reports on Form 8-K                                              

We did not file a Current Report on Form 8-K during the quarter ended 
December 31, 1998.                                                              

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Signatures

    In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned thereunto duly 
authorized on this 30th day of March, 1999.                                     

             MACROVISION CORPORATION

                By: /s/ William A. Krepick
                                   -----------------------------
                        William A. Krepick
                                           President and Chief Operating Officer

   In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant, and in the capacities and on 
the date indicated.                                                             

                                                        [Enlarge/Download Table]

               Name                                   Title                          Date   
               -----                                  ----                           ----   

                                                                                            
Principal Executive Officer:                                                                

/s/ John O. Ryan                  Chairman of the Board of Directors, Chief   March 30, 1999
--------------------------------  Executive Officer, Secretary and Director                 
John O. Ryan                                                                                

Principal Financial Officer and                                                             
Principal Accounting Officer:                                                               

/s/ Victor A. Viegas              Vice President, Finance and Administration  March 30, 1999
--------------------------------  and Chief Financial Officer                               
Victor A. Viegas                                                                            

Additional Directors                                                                        

/s/ William A. Krepick            Director                                    March 30, 1999
--------------------------------                                                            
William A. Krepick                                                                          

/s/ Richard S. Matuszak           Director                                    March 30, 1999
--------------------------------                                                            
Richard S. Matuszak                                                                         

/s/ Donna S. Birks                Director                                    March 30, 1999
--------------------------------                                                            
Donna S. Birks                                                                              

/s/ William N. Stirlen            Director                                    March 30, 1999
--------------------------------                                                            
William N. Stirlen                                                                          

/s/ Thomas Wertheimer             Director                                    March 30, 1999
--------------------------------                                                            
Thomas Wertheimer                                                                           

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MACROVISION CORPORATION 
AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997

                                                                            PAGE

Report of KPMG LLP, Independent Auditors .................................   F-2

Consolidated Balance Sheets ..............................................   F-3

Consolidated Statements of Income ........................................   F-4

Consolidated Statements of Stockholder's Equity ..........................   F-5

Consolidated Statements of Cash Flows ....................................   F-6

Notes to Consolidated Financial Statements ...............................   F-7

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Report of KPMG LLP, Independent Auditors

The Board of Directors and Stockholders                                         
Macrovision Corporation and Subsidiaries:                                       

     We have audited the accompanying consolidated balance sheets of Macrovision
Corporation and subsidiaries (the Company) as of December 31, 1998 and 1997, and
the related consolidated  statements of income,  stockholders'  equity, and cash
flows for the years then ended. These consolidated  financial statements are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.         

     We conducted  our audits in accordance  with  generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.          

     In our opinion,  the consolidated  financial  statements  referred to above
present fairly, in all material respects,  the financial position of Macrovision
Corporation  and  subsidiaries as of December 31, 1998 and 1997, and the results
of their  operations and their cash flows for the years then ended in conformity
with generally accepted accounting principles.                                  

                                            /s/ KPMG LLP

Mountain View, California                                                       
February 1, 1999, except for Note 8,                                            
which is as of March 16, 1999                                                   

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AND SUBSIDIARIES

 Consolidated Balance Sheets
 (In thousands, except share data)

                                                        [Enlarge/Download Table]

                                     ASSETS                                                            

                                                                                      December 31,     
                                                                                  -------------------- 
                                                                                    1998        1997   
                                                                                  --------    -------- 
                                                                                                       
Current assets:                                                                                        
    Cash and cash equivalents ................................................... $  3,513    $  1,314 
    Short-term investments ......................................................   22,877      11,241 
    Accounts receivable, net of allowance for doubtful accounts of                                     
      $838 and $684 as of December 31, 1998 and 1997, respectively ..............    5,574       5,240 
    Inventories .................................................................      325         433 
    Receivable from related party ...............................................       --         279 
    Deferred tax assets .........................................................    1,669       1,336 
    Prepaid expenses and other current assets ...................................    1,008         430 
                                                                                  --------    -------- 
      Total current assets ......................................................   34,966      20,273 
  Property and equipment, net ...................................................    1,297       1,722 
  Patents and other intangibles, net of accumulated amortization of $1,034                             
    and $796 as of December 31, 1998 and 1997, respectively .....................    1,526       1,098 
  Long-term marketable investment securities ....................................   18,795       1,763 
  Other assets ..................................................................    8,910       4,000 
                                                                                  --------    -------- 

                                                                                  $ 65,494    $ 28,856 
                                                                                  ========    ======== 

                      LIABILITIES AND STOCKHOLDERS' EQUITY                                             

  Current liabilities:                                                                                 
    Accounts payable ............................................................ $    803    $    919 
    Accrued expenses ............................................................    2,691       2,190 
    Deferred revenue ............................................................    1,207         944 
    Income taxes payable ........................................................      680         846 
    Current portion of capital lease obligations ................................      112         108 
                                                                                  --------    -------- 
      Total current liabilities .................................................    5,493       5,007 
  Capital lease obligations, net of current portion .............................       76         188 
  Deferred tax liabilities ......................................................      383          84 
                                                                                  --------    -------- 
                                                                                     5,952       5,279 
                                                                                  --------    -------- 
  Commitments and contingencies                                                                        
  Stockholders' equity:                                                                                
    Preferred stock, $.001 par value, 5,000,000 shares authorized;                                     
      none issued ...............................................................       --          -- 
  Common stock, $.001 par value; 100,000,000 shares authorized as of                                   
      December 31, 1998 and 1997; 8,802,570 and 7,215,195 shares issued                                
      and outstanding as of December 31, 1998 and 1997, respectively ............        9           7 
    Additional paid-in capital ..................................................   52,617      23,277 
    Stockholder notes receivable ................................................      (78)       (131)
    Deferred stock compensation .................................................       --         (96)
    Accumulated other comprehensive losses ......................................      (82)       (214)
    Retained earnings ...........................................................    7,076         734 
                                                                                  --------    -------- 
          Total stockholders' equity ............................................   59,542      23,577 
                                                                                  --------    -------- 
                                                                                  $ 65,494    $ 28,856 
                                                                                  ========    ======== 

See accompanying notes to consolidated financial statements.

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AND SUBSIDIARIES

 Consolidated Statements of Income
 (In thousands, except share data)

                                                        [Enlarge/Download Table]

                                                                  Year ended December 31,      
                                                          -------------------------------------
                                                              1998                     1997    
                                                          -----------              ----------- 

                                                                                               
Net revenues ............................................ $    24,434              $    20,340 
                                                          -----------              ----------- 
Costs and expenses:                                                                            
  Cost of revenues ......................................       2,081                    2,422 
  Research and development ..............................       2,578                    2,248 
  Selling and marketing .................................       5,985                    5,765 
  General and administrative ............................       4,621                    4,149 
                                                          -----------              ----------- 
        Total costs and expenses ........................      15,265                   14,584 
                                                          -----------              ----------- 
Operating income ........................................       9,169                    5,756 
Interest and other income (expense), net ................       1,102                      478 
                                                          -----------              ----------- 
        Income before income taxes ......................      10,271                    6,234 
Income taxes ............................................       3,929                    2,413 
                                                          -----------              ----------- 
        Net income ...................................... $     6,342              $     3,821 
                                                          ===========              =========== 

Computation of basic and diluted earnings per share:                                           
  Net income ............................................ $     6,342              $     3,821 
  Preferred stock dividends .............................          --                     (156)
                                                          -----------              ----------- 
  Earnings applicable to common stock ................... $     6,342              $     3,665 
                                                          ===========              =========== 

Basic earnings per share ................................ $       .79              $       .57 
                                                          ===========              =========== 
Shares used in computing basic earnings per share .......   8,004,000                6,476,000 
                                                          ===========              =========== 

Diluted earnings per share .............................. $       .74              $       .53 
                                                          -----------              ----------- 
Shares used in computing diluted earnings per share .....   8,553,000                6,960,000 
                                                          ===========              =========== 

See accompanying notes to consolidated financial statements.

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MACROVISION CORPORATION AND SUBSIDIARIES
 Consolidated Statements of Stockholders' Equity
(In thousands, except share data) 

                                                        [Enlarge/Download Table]


                                                                                                           Additional     
                                                      Preferred stock               Common stock            paid-in       
                                                   Shares         Amount        Shares         Amount       capital       
                                                -----------    -----------    -----------   -----------   -----------     
                                                                                                                          
Balances as of December 31, 1996 ..............   1,376,432    $         1      3,951,759   $         4   $     9,530     
                                                -----------    -----------    -----------   -----------   -----------     
Comprehensive income                                                                                                      
 Net income ...................................                                                                           
  Other comprehensive income                                                                                              
   Translation adjustment .....................                                                                           
   Unrealized gain (loss) in investments, net .                                                                           

 Total comprehensive income ...................                                                                           

 Conversion of preferred stock to                                                                                         
  common stock ................................  (1,376,432)            (1)     1,376,432             1            --     
 Issuance of common stock in initial public                                                                               
  offering,  net of issuance costs of $1,531 ..          --             --      1,764,016             2        13,232     
 Issuance of common stock upon exercise                                                                                   
  of options ..................................          --             --        111,342            --           288     
 Issuance of common stock under stock                                                                                     
  purchase plan ...............................          --             --         11,646            --            89     
 Cash dividends of $.075 per share paid on                                                                                
  1,376,432 shares of preferred stock .........          --             --             --            --            --     
 Payment on stockholder note receivable .......          --             --             --            --            --     
 Amortization of deferred stock compensation ..          --             --             --            --            --     
 Tax benefit associated with stock plans ......          --             --             --            --           138     
                                                -----------    -----------    -----------   -----------   -----------     
Balances as of December 31, 1997 ..............          --             --      7,215,195             7        23,277     
                                                -----------    -----------    -----------   -----------   -----------     
 Comprehensive income                                                                                                     
  Net income ..................................                                                                           
  Other comprehensive income                                                                                              
   Translation adjustment .....................                                                                           
   Unrealized gain (loss) in investments, net .                                                                           

 Total comprehensive income ...................                                                                           

 Issuance of common stock in secondary public                                                                             
  offering, net of issuance costs of $438 .....          --             --      1,365,000             2        27,870     
 Issuance of common stock upon exercise of                                                                                
  options .....................................          --             --        185,336            --           561     
 Issuance of common stock under stock                                                                                     
  purchase plan ...............................          --             --         37,039            --           292     
 Payment on stockholder note receivable .......          --             --             --            --            --     
 Amortization of deferred stock compensation ..          --             --             --            --            --     
 Tax benefit associated with stock plans ......          --             --             --            --           617     
                                                -----------    -----------    -----------   -----------   -----------     
Balances as of December 31, 1998 ..............          --    $        --      8,802,570   $         9   $    52,617     
                                                ===========    ===========    ===========   ===========   ===========     


                                                                               Accumulated    (Accumulated                
                                                 Stockholder     Deferred         other          deficit)       Total     
                                                    notes         stock       comprehensive     retained     stockholders'
                                                 receivable    compensation        loss         earnings        equity    
                                                 -----------   ------------   -------------   ------------   -----------  
                                                                                                                          
Balances as of December 31, 1996 ..............  $      (157)   $      (240)   $      (135)   $    (2,931)   $     6,072  
                                                 -----------    -----------    -----------    -----------    -----------  
Comprehensive income                                                                                                      
 Net income ...................................                                         --          3,821          3,821  
  Other comprehensive income                                                                                              
   Translation adjustment .....................                                        (83)                          (83) 
   Unrealized gain (loss) in investments, net .                                          4                             4  
                                                                               -----------                   -----------  
 Total comprehensive income ...................                                        (79)                        3,742  
                                                                               -----------                   -----------  
 Conversion of preferred stock to                                                                                         
  common stock ................................           --             --             --             --             --  
 Issuance of common stock in initial public                                                                               
  offering,  net of issuance costs of $1,531 ..           --             --             --             --         13,234  
 Issuance of common stock upon exercise                                                                                   
  of options ..................................           --             --             --             --            288  
 Issuance of common stock under stock                                                                                     
  purchase plan ...............................           --             --             --             --             89  
 Cash dividends of $.075 per share paid on                                                                                
  1,376,432 shares of preferred stock .........           --             --             --           (156)          (156) 
 Payment on stockholder note receivable .......           26             --             --             --             26  
 Amortization of deferred stock compensation ..           --            144             --             --            144  
 Tax benefit associated with stock plans ......           --             --             --             --            138  
                                                 -----------    -----------    -----------    -----------    -----------  
Balances as of December 31, 1997 ..............         (131)           (96)          (214)           734         23,577  
                                                 -----------    -----------    -----------    -----------    -----------  
 Comprehensive income                                                                                                     
  Net income ..................................                                         --          6,342          6,342  
  Other comprehensive income                                                                                              
   Translation adjustment .....................                                        (12)                          (12) 
   Unrealized gain (loss) in investments, net .                                        144                           144  
                                                                               -----------                   -----------  
 Total comprehensive income ...................                                        132                         6,474  
                                                                               -----------                   -----------  
 Issuance of common stock in secondary public                                                                             
  offering, net of issuance costs of $438 .....           --             --             --             --         27,872  
 Issuance of common stock upon exercise of                                                                                
  options .....................................           --             --             --             --            561  
 Issuance of common stock under stock                                                                                     
  purchase plan ...............................           --             --             --             --            292  
 Payment on stockholder note receivable .......           53             --             --             --             53  
 Amortization of deferred stock compensation ..           --             96             --             --             96  
 Tax benefit associated with stock plans ......           --             --             --             --            617  
                                                 -----------    -----------    -----------    -----------    -----------  
Balances as of December 31, 1998 ..............  $       (78)   $        --    $       (82)   $     7,076    $    59,542  
                                                 ===========    ===========    ===========    ===========    ===========  

See accompanying notes to consolidated financial statements.

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AND SUBSIDIARIES

 Consolidated Statements of Cash Flows
(In thousands)

                                                        [Enlarge/Download Table]

                                                                      Year ended December 31,
                                                                      -----------------------
                                                                        1998          1997   
                                                                      --------      -------- 
                                                                                             
Cash flows from operating activities:                                                        
  Net income .......................................................  $  6,342      $  3,821 
  Adjustments to reconcile net income to net cash provided by                                
    continuing operations:                                                                   
      Depreciation and amortization ................................       931         1,156 
      Amortization of prepaid future royalties to C-Dilla Limited ..       143            -- 
      Deferred income taxes ........................................       (34)         (683)
      Amortization of deferred stock compensation ..................        96           144 
      Loss on disposal of fixed assets .............................        17           105 
      Tax benefit from employee stock benefit plans ................       617           138 
      Change in provision for accounts and notes receivable ........       123           467 
      Changes in operating assets and liabilities:                                           
        Accounts receivable, inventories, and other current assets .      (958)       (2,408)
        Accounts payable, accrued liabilities, deferred revenue, and                         
          income taxes payable .....................................       482          (221)
        Other ......................................................       (12)          (83)
                                                                      --------      -------- 
          Net cash provided by operating activities ................     7,747         2,436 
                                                                      --------      -------- 
Cash flows from investing activities:                                                        
Purchases of long-term marketable investment securities ............   (19,495)       (1,763)
  Purchases of short-term investments ..............................   (56,527)      (51,737)
  Sales or maturities of long-term marketable investments ..........     2,541            -- 
  Sales or maturities of short-term investments ....................    44,957        40,500 
  Acquisition of property and equipment ............................      (285)         (571)
  Payments for patents and other intangibles .......................      (666)         (332)
  Proceeds from related party receivable ...........................       310            -- 
  Investment in C-Dilla Limited, Command Audio Corporation and                               
    Digimarc Corporation ...........................................    (4,053)       (3,480)
  Prepaid future royalties to C-Dilla Limited ......................    (1,015)           -- 
  Other, net .......................................................        15           (67)
                                                                      --------      -------- 
          Net cash used in investing activities ....................   (34,218)      (17,450)
                                                                      --------      -------- 
Cash flows from financing activities:                                                        
  Payments on capital lease obligations ............................      (108)         (105)
  Proceeds from issuance of common stock upon exercise of options ..       561           288 
  Proceeds from issuance of common stock under employee stock                                
    purchase plan ..................................................       292            89 
  Payment of stockholder note receivable ...........................        53            26 
  Proceeds from sale of common stock, net of issuance costs and                              
    payments of deferred offering costs ............................    27,872        13,777 
  Cash dividends ...................................................        --          (156)
                                                                      --------      -------- 
          Net cash provided by financing activities ................    28,670        13,919 
                                                                      --------      -------- 
Net (decrease) increase in cash and cash equivalents ...............     2,199        (1,095)
Cash and cash equivalents at beginning of year .....................     1,314         2,409 
                                                                      --------      -------- 
Cash and cash equivalents at end of year ...........................  $  3,513      $  1,314 
                                                                      ========      ======== 
Cash paid during the year:                                                                   
  Interest .........................................................  $     11      $     12 
                                                                      ========      ======== 
  Income taxes .....................................................  $  3,209      $  2,364 
                                                                      ========      ======== 

See accompanying notes to consolidated financial statements.

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Notes to Consolidated Financial Statements
December 31, 1998 and 1997

(1)  The Company and Summary of Significant Accounting Policies                 

The Company                                                                     

     Macrovision  Corporation (the  "Company"),  was formed in 1983 and designs,
develops and markets video security  technologies and products that provide copy
protection and video scrambling for motion pictures and other  proprietary video
materials  that  are  stored  on  videocassettes,  DVDs or  other  media  or are
transmitted by means of cable, satellite or microwave transmission.  During 1998
the Company  broadened its focus to include the copy  protection of other media,
including  multimedia computer software on CD-ROMs. The Company is headquartered
in Sunnyvale, California and has subsidiaries in the United Kingdom and Japan.  

Principles of Consolidation                                                     

     The accompanying  consolidated financial statements include the accounts of
the Company and its wholly  owned  subsidiaries.  All  significant  intercompany
transactions have been eliminated in consolidation.                             

Cash, Cash Equivalents, and Investments                                         

     The Company  considers all highly liquid  investments  with a maturity from
date of purchase of three months or less to be cash  equivalents.  Cash and cash
equivalents  consist of cash on  deposit  with  banks,  money  market  funds and
certain mutual funds.  All other liquid  investments  with maturities over three
months  and less  than 12  months  are  classified  as  short-term  investments.
Short-term  investments  consisted of auction rate preferred  stock,  government
bonds  and  government  agency  securities.   All  marketable   securities  with
maturities  over one year are  classified  as  long-term  marketable  investment
securities.                                                                     

     Management   determines  the  appropriate   classification   of  investment
securities at the time of purchase and reevaluates  such  designation as of each
balance sheet date. As of December 31, 1998 and 1997, all investment  securities
were  designated  as  "available-for-sale."  Available-for-sale  securities  are
carried at fair value based on quoted market prices,  with unrealized  gains and
losses,  reported in comprehensive income, a separate component of stockholders'
equity.                                                                         

     Realized   gains  and  losses   and   declines   in  value   judged  to  be
other-than-temporary  for  available-for-sale  securities  are  included  in the
consolidated  statements of income.  The cost of securities sold is based on the
specific  identification method. Interest and dividends on securities classified
as available-for-sale are included in interest income.                          

     The following is a summary of available-for-sale securities (in thousands):

                                                                December 31,
                                                              ------------------
                                                                 1998       1997
                                                              -------    -------

Cash equivalents-- money market funds ....................    $ 3,098    $   622
                                                              -------    -------
Investments:                                                                    
  Auction rate preferred stock certificates ..............         --      3,400
  Municipal preferred certificates .......................      1,000         --
  United States government bonds and agency securities ...     40,672      9,604
                                                              -------    -------
                                                               41,672     13,004
                                                              -------    -------
                                                              $44,770    $13,626
                                                              =======    =======

     As of December 31, 1998 and 1997, government bond securities totaling $18.8
million and $1.8 million,  respectively,  are classified as long-term marketable
investment securities in the accompanying consolidated balance sheet.           

     As of December 31, 1998 and 1997, the difference between the fair value and
the amortized  cost of  available-for-sale  securities  was $148,000 and $4,000,
respectively.  These  unrealized  gains  related  to  short-term  and  long-term

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  Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997

(1)  The Company and Summary of Significant Accounting Policies (continued)     

government  bonds  which have been  recorded  as a  component  in  comprehensive
income.  As of  December  31,  1998 and 1997,  the  weighted  average  portfolio
duration and contractual  maturity was  approximately ten months and six months,
respectively.                                                                   

Inventories                                                                     

     Inventories  are stated at the lower of first-in,  first-out  cost basis or
market.                                                                         

Property and Equipment                                                          

     Property and equipment, including significant improvements, are recorded at
cost. The Company computes depreciation for all property and equipment using the
straight-line  method.  The estimated useful lives of assets range from three to
five years.  Amortization of equipment recorded under capital leases is computed
over  the  shorter  of the  lease  term  or the  estimated  useful  life  of the
equipment.                                                                      

Patents                                                                         

     Patent  application  costs of $1.4  million and $868,000 as of December 31,
1998 and 1997, respectively,  are included in patents and other intangibles and,
upon the granting of the related patent,  are amortized using the  straight-line
method over the shorter of the estimated useful life of the patent or 10 years. 

Impairment of Long-Lived Assets                                                 

     The  Company  evaluates  its  long-lived  assets and  certain  identifiable
intangibles for impairment whenever events or changes in circumstances  indicate
that the carrying amount of an asset may not be recoverable.  Recoverability  of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future net cash flows expected to be generated by the asset. If such
assets are  considered  to be  impaired,  the  impairment  to be  recognized  is
measured  by the amount by which the  carrying  amount of the assets  exceed the
fair value of the assets.  Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell.                           

Other Assets                                                                    

     The Company  owns a minority  interest in C-Dilla,  Limited  ("C-Dilla")  a
developer  of copy  protection  technology  for  CD-ROM  and  Internet-delivered
software   products,   Command  Audio  Corporation   ("CAC"),   a  developer  of
audio-on-demand technology, and Digimarc Corporation, a developer of proprietary
digital  watermarking  technology,  and accounts for such investments  under the
cost  method.   Other-than-temporary   declines  in  the  fair  value  of  these
investments  are  included  in  the  consolidated  statements  of  income.  Such
investments  are  included  in other  assets  on the  accompanying  consolidated
balance  sheets.  Included  in other  assets  is  $872,000  related  to  prepaid
royalties paid to C-Dilla subject to offset against future  royalties from sales
of  products  incorporating  C-Dilla's  technology.  See  Note  2  to  Notes  to
Consolidated Financial Statements.                                              

Revenue Recognition                                                             

     Advanced  license fees  attributable  to minimum copy  quantities or shared
revenues  are  deferred   until  earned.   Revenue  from  the   duplication   of
videocassettes  and the  replication  of digital  versatile  discs  ("DVDs") and
CD-ROMs is earned  based upon  reported or  estimated  volume of each or, in the
case of agreements with minimum guaranteed payments with no specified volume, on
a straight-line basis over the life of the agreement. Retroactive rebate credits
on certain agreements that contain pricing  adjustments or return provisions are
accrued based upon anticipated respective unit volumes. Nonrefundable technology
licensing  revenue,   which  applies  principally  to  DVD  and  PC  subassembly
manufacturers,   digital  pay-per-view  ("PPV"),   cable  and  satellite  system
operators,  and set-top  decoder  manufacturers,  is  recognized  upon  contract
signing  and  performance  of  all  significant  obligations.   Royalty  revenue
associated  with  technology  licenses  is  recognized  when  earned  based upon
reported  unit  sales or  transaction  based  fees.  Revenues  from the sales of
encoders,   decoders,   and  systems  incorporating  the  Company's             

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  Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997

(1)  The Company and Summary of Significant Accounting Policies (continued)     

video copy protection and scrambling  technologies  are recognized upon shipment
provided that the Company has no significant additional performance obligations.

Cost of Revenues                                                                

     The  Company  has  agreements   with  certain   licensed   duplicators  and
replicators  utilized  by  customers  of the  Company's  video  copy  protection
technology.  The Company has agreed to pay these  duplicators  and replicators a
specified  service fee per unit  duplicated/replicated  utilizing  the Company's
video  copy  protection  technology  to help  offset the cost of  operating  the
Company's copy  protection  equipment and reporting the volume of copy protected
videocassettes.  Such  amounts are charged to cost of  revenues  when  incurred.
These  service  fees  amounted  to  $428,000  and  $362,000,  for 1998 and 1997,
respectively.                                                                   

     Cost of revenues  includes  outside  legal costs of $227,000 and $70,000 in
1998 and 1997, respectively, associated with litigation to enforce the Company's
patents. Amortization of patents is also included in cost of revenues.          

     In February 1998, the Company entered into an exclusive  worldwide Software
Marketing  License and  Development  Agreement  with  C-Dilla to market,  in the
consumer  multimedia  software  market,  C-Dilla's  proprietary  copy protection
technology.  Pursuant to the agreement, the Company will pay royalty payments to
C-Dilla of  between  30% to 45% of  revenues  from  sales of  software  products
incorporating C-Dilla's technology. These royalty amounts are charged to cost of
revenues when incurred and were approximately $191,000 for 1998.                

Income Taxes                                                                    

     Income  taxes are  accounted  for under  the  asset and  liability  method.
Deferred  tax  assets  and   liabilities  are  recognized  for  the  future  tax
consequences   attributable  to  differences  between  the  financial  statement
carrying  amounts of existing assets and  liabilities  and their  respective tax
bases  and  operating  loss  and tax  carryforwards.  Deferred  tax  assets  and
liabilities  are measured  using enacted tax rates  expected to apply to taxable
income in the years in which  those  temporary  differences  are  expected to be
recovered  or settled.  The effect on deferred tax assets and  liabilities  of a
change in tax rates is  recognized  in income in the period  that  includes  the
enactment date. The measurement of deferred tax assets is reduced, if necessary,
by a valuation  allowance  for any tax benefits of which future  realization  is
uncertain.                                                                      

Foreign Currency Translation and Transactions                                   

     The  functional  currency for the  Company's  foreign  subsidiaries  is the
applicable  local  currency.  The  translation of foreign  currency  denominated
financial  statements  into United States dollars is performed for balance sheet
accounts  using current  exchange  rates in effect at the balance sheet date and
for revenues and expense accounts using a weighted average exchange rate for the
respective periods.  Adjustments resulting from such translation are included in
comprehensive  income, a separate  component of stockholders'  equity.  Gains or
losses resulting from foreign currency transactions included in the consolidated
statements of income were not material in any of the periods presented.         

Comprehensive Income                                                            

     In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, Reporting  Comprehensive  Income. SFAS No. 130 establishes standards of
reporting and display of  comprehensive  income and its components of net income
and "other  comprehensive  income" in a full set of  general  purpose  financial
statements. "Other comprehensive income" refers to revenues, expenses, gains and
losses that are not included in net income but rather are  recorded  directly in
stockholders'  equity.  SFAS No. 130 is effective for annual and interim periods
beginning  after  December 15, 1997 and for periods  ended before that date when
presented   for   comparative   purposes.   The  primary   components  of  other
comprehensive  income  include  unrealized  gains and                           

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AND SUBSIDIARIES

  Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997

(1)  The Company and Summary of Significant Accounting Policies (continued)     

losses  resulting  from the  translation of the Company's  foreign  subsidiaries
which have a local functional  currency and unrealized  holding gains and losses
related to the Company's short and long term marketable investments.            

Use of Estimates                                                                

     The  preparation  of financial  statements  in  conformity  with  generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that  affect the  reported  amounts of assets and  liabilities  and
disclosure of  contingent  assets and  liabilities  at the date of the financial
statements  and the  reported  amounts  of  revenues  and  expenses  during  the
reporting period. Actual results could differ from those estimates.             

Business and Concentration of Credit Risk                                       

     The Company sells its video scrambling products and licenses its video copy
protection,   CD-ROM  copy  protection  and  video  scrambling  technologies  to
customers  in the  home  videocassette,  DVD,  pay-per-view,  cable,  satellite,
corporate communication markets and multimedia software markets primarily in the
United States,  Europe, Japan, and the Far East. In 1998, 45.1% of the Company's
business is attributed to the licensing of its video copy protection  technology
through   Motion  Picture   Association  of  America   ("MPAA")  movie  studios.
Accordingly,  the  ability  of the  Company  to grow  its  operations  has  been
dependent  on  MPAA  movie  studios  continued  success  in the  production  and
distribution  of movies  utilizing  the companies  technology.  The Company also
licenses its digital PPV video copy  protection  technologies  to satellite  and
cable television  operators and to the equipment  manufacturers  that supply the
satellite  and cable  television  industries.  The  Company's  video  scrambling
technology is licensed to  manufacturers of analog cable Pay TV set-top decoders
in developing cable television markets.  The Company sells encoders and decoders
that  incorporate  other  scrambling  technologies  to private analog  satellite
networks  for  business   communications,   education,   and  special   interest
entertainment.  The Company also sells specialized  video scrambling  systems in
the government,  military, and law enforcement markets. The Company licenses its
CD-ROM copy  protection  to publishers  of software in the  multimedia  software
markets.  In addition,  44.5% and 46.5% of the Company's sales in 1998 and 1997,
respectively,  are from export or foreign operations. The Company's business has
been and may continue to be negatively  impacted by foreign economic  conditions
such as the Southeast Asian and Latin American economic problems.               

     Financial  instruments that potentially  subject the Company to significant
concentrations  of credit risk consist  principally of cash,  cash  equivalents,
marketable securities,  trade accounts receivable and long-term investments. The
Company  places  its cash and cash  equivalents  and  marketable  securities  in
deposits  and money market  funds with  various  high credit  quality  financial
institutions.   The  carrying  value  of  the  Company's  financial  instruments
approximates  fair market value due to the relatively  short maturities of those
instruments  or recency of entering  into such  instrument as in the case of the
Company's  investments in C-Dilla and Digimarc.  CAC is also held at fair market
value, due to recency of additional rounds of financing.                        

     The Company performs ongoing credit  evaluations of its customers.  Revenue
from one customer  accounted for 12% of net revenue for the year ended  December
31, 1998.  Another customer  accounted for 11% of net revenue for the year ended
December 31, 1997. At December 31, 1998 and 1997  receivables  from one customer
represented 16% and 25%, respectively, of net accounts receivable.              

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AND SUBSIDIARIES

  Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997

(1)  The Company and Summary of Significant Accounting Policies (continued)     

Net Income Per Share                                                            

     Basic EPS is computed  using the weighted  average  number of common shares
outstanding  during the  period.  Diluted  EPS is  computed  using the  weighted
average  number of common and  dilutive  common  equivalent  shares  outstanding
during the period.  Dilutive  common  equivalent  shares consist of common stock
issuable  upon exercise of stock  options  using the treasury  stock method.  In
1997,  common equivalent shares from preferred stock have been excluded from the
computation  of  diluted  EPS  because  the  effect  of the  inclusion  would be
antidilutive.  The  following  is a  reconciliation  of the  shares  used in the
computation  of  basic  and  diluted  EPS (in  thousands  except  for per  share
amounts):                                                                       

                                                                    December 31,
                                                                 ---------------
                                                                  1998      1997
                                                                 -----     -----

Basic EPS -- weighted average number of common                                  
  shares outstanding .......................................     8,004     6,476
Effect of dilutive common equivalent shares-- stock                             
  options outstanding ......................................       549       484
                                                                 -----     -----
Diluted EPS -- weighted average number of common                                
  shares and common equivalents shares outstanding .........     8,553     6,960
                                                                 =====     =====

Stock Based Compensation                                                        

     The Company uses the intrinsic value-based method to account for all of its
employee stock-based compensation plans.                                        

Recent Accounting Pronouncements                                                

     In March 1998,  the  American  Institute of  Certified  Public  Accountants
("AICPA")  issued  Statement of Position  ("SOP") No. 98-1,  "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP No. 98-1
requires that entities capitalize certain cost related to internal-use  software
once certain  criteria  have been met. The Company  expects that the adoption of
SOP No. 98.1 will have no material impact on its financial position,  results of
operations or cash flows. The Company will be required to implement SOP No. 98-1
for the year ending December 31, 1999.                                          

     In April  1998,  the  AICPA  issued  SOP 98-5,  "Reporting  on the Costs of
Start-Up  Activities."  SOP No. 98-5 requires that all start-up costs related to
new  operations  must be expensed as incurred.  In addition,  all start-up costs
that were  capitalized  in the past  must be  written  off when SOP No.  98-5 is
adopted.  The  Company  expects  that the  adoption of SOP No. 98-5 will have no
material impact on its financial position,  results of operations or cash flows.
The  Company  will be  required  to  implement  SOP No. 98-5 for the year ending
December 31, 1999.                                                              

     In June 1998 the Financial  Accounting  Standards Board issued Statement of
Financial  Accounting  Standards  ("SFAS") No. 133,  "Accounting  for Derivative
Instruments  and  Hedging  Activities."  SFAS No.  133  established  methods  of
accounting for derivative  financial  instruments and hedging activities related
to those  instruments as well as other hedging  activities.  Because the Company
currently  holds  no  derivative  instruments  and does not  engage  in  hedging
activities,  the Company  expects that the adoption of SFAS No. 133 will have no
material impact on its financial position,  results of operations or cash flows.
The  Company  will be  required  to  implement  SFAS No. 133 for the year ending
December 31, 2000.                                                              

     In December 1998, the AICPA issued SOP No. 98-9,  "Modification  of SOP No.
97-2, Software Revenue Recognition,  with Respect to Certain  Transactions." SOP
No.  98-9  requires  recognition  of revenue  using the  "residual  method" in a
multiple element software  arrangement when fair value does not exist for one or
more of the delivered elements in the arrangement.  Under the "residual method,"
the total fair value of the  undelivered  elements is deferred and recognized in
accordance  with SOP No. 97-2. The Company will be required to                  

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AND SUBSIDIARIES

  Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997

implement SOP No. 98-9 for the year ending  December 31, 2000. SOP No. 98-9 also
extends  the  deferral  of the  application  of SOP No.  97-2 to  certain  other
multiple-element   software  arrangements  through  the  Company's  year  ending
December 31, 1999.  The Company is evaluating the provisions of SOP 98-9 and the
impact it will have on its  financial  position,  results of  operations or cash
flows.                                                                          

(2)  Financial Statement Details                                                

Inventories                                                                     

Inventories consisted of the following (in thousands):                

                                              December 31,
                                             -------------------
                                             1998           1997
                                             ----           ----

Raw materials ....................           $138           $203
Finished goods ...................            187            230
                                             ----           ----
                                             $325           $433
                                             ====           ====

Property and Equipment, Net                                                     

Property and equipment consisted of the following (in thousands):     

                                                  December 31,
                                                 ---------------
                                                 1998     1997
                                                 ------   ------

Machinery and equipment ......................   $2,968   $3,263
Leasehold improvements .......................      950      950
Furniture and fixtures .......................      444      438
                                                 ------   ------
                                                  4,362    4,651
Less accumulated depreciation and amortization    3,065    2,929
                                                 ------   ------
                                                 $1,297   $1,722
                                                 ======   ======

     Equipment  recorded under capital leases  aggregated  $518,000 with related
accumulated  amortization  of $337,000  and $233,000 as of December 31, 1998 and
1997, respectively.                                                             

Other Assets                                                                    

Other assets consisted of the following (in thousands):               

                                                December 31,
                                               -----------------
                                               1998       1997
                                               ------     ------

Investment in CAC ........................     $2,837     $2,337
Investment in Digimarc ...................      1,500      1,500
Investment in C-Dilla ....................      3,553         --
Prepayment of royalties to C-Dilla .......        872         --
Deposits and other assets ................        148        163
                                               ------     ------
                                               $8,910     $4,000
                                               ======     ======

     In February 1998, Macrovision acquired 247,500 shares (approximately 19.8%)
of the common  stock of  C-Dilla,  a UK  company,  for a purchase  price of $3.6
million.  The  Company  also  entered  into a  Software  Marketing  License  and
Development  Agreement  under which it has  obtained,  for an initial  five-year
term, the world-wide  exclusive  license to market,  in the consumer  multimedia
software market,  C-Dilla's proprietary copy protection technology.  The Company
paid $1.0  million  in  up-front  royalties  subject  to offset  against  future
royalties  and will pay  royalty  payments  to C-Dilla of between  30% to 45% of
revenues from sales of software  products  incorporating                        

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AND SUBSIDIARIES

  Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997

(2)  Financial Statement Details(continued)                                     

C-Dilla's  technology.  During 1998,  the Company  recorded  revenue  under this
agreement of $344,000 and cost of sales of $230,000 of which $143,000 offset the
prepayment of royalties to C-Dilla.                                             

     In 1998, the Company invested $500,000 in CAC in connection with a round of
external  third-party  financing obtained by CAC. This investment by Macrovision
was less than  19.8% of the total  investment  financing  made and thus  reduced
Macrovision's previous 19.8% ownership of CAC to 11.9%.  Subsequently,  CAC paid
in full the note due Macrovision including accrued interest.                    

     In December 1997, the Company  invested $1.5 million in preferred  stock of
Digimarc,  or 6.8%  ownership.  Digimarc is a private company  headquartered  in
Portland,   Oregon.  Its  products  include  proprietary  digital   watermarking
technology  used  in  information  embedding,   enabling  image  identification,
copyright protection and facilitating electronic commerce.                      

Accrued Expenses                                                                

Accrued expenses consisted of the following (in thousands):           

                                                  December 31,
                                                ----------------
                                                1998      1997
                                                ------    ------

         Accrued compensation ..............    $1,810    $1,142
         Accrued professional fees .........       308       409
         Accrued rebates ...................        --        30
         Other accrued liabilities .........       573       609
                                                ------    ------
                                                $2,691    $2,190
                                                ======    ======
Interest and Other Income (Expense), Net                        

     Interest and other income  (expense),  net,  consisted of the following (in
thousands):                                                                     

                                           Year ended December 31,
                                           -----------------------
                                            1998            1997
                                           --------       --------

         Interest income ...............   $ 1,062       $   513
          Interest expense ..............       (11)          (12)
          Other .........................        51           (23)
                                           -------       -------
                                           $ 1,102       $   478
                                           =======       =======

Supplemental Cash Flow Information                                    

     Supplemental  cash  flow  information  related  to  noncash  investing  and
financing activities is as follows (in thousands):                              

                                                         Year ended December 31,
                                                        ----------------------
                                                      1998        1997
                                                      ----      ------

Conversion of preferred stock into common stock ....... $ --      $7,433  
                                                      ====      ======

(3)  Transactions with Related Parties                                          

     The Company and JVC are parties to a Technology Application Agreement dated
November 29, 1988 (the "Application  Agreement"),  a Duplicator  Agreement dated
June 1, 1988 (the  "Duplicator  Agreement") and an Agreement dated July 15, 1994
(the "Video Agreement").  Pursuant to the Application Agreement, JVC has applied
the Company's copy protection process to prerecorded videocassettes manufactured
and distributed in Japan by                                                     

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AND SUBSIDIARIES

  Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997

(3)  Transactions with Related Parties (continued)                              

JVC.  Pursuant to the Duplicator  Agreement,  JVC has applied the Company's copy
protection process to prerecorded videocassettes manufactured and distributed in
Japan by certain of the Company's  licensees.  Pursuant to the Video  Agreement,
JVC  developed a prototype of equipment  to apply a copy  protection  process to
prerecorded videocassettes, and granted the Company exclusive rights to purchase
such  equipment  from JVC for  resale  and to  sublicense  the  copy  protection
technology for use with the equipment. For the years ended December 31, 1998 and
1997,  the Company  recorded  revenue  from JVC of  approximately  $211,000  and
$234,000,  respectively,  and recorded  expenses payable to JVC of approximately
$36,000 and $22,000, respectively under these agreements.                       

     In  January  1997,  the  Company  and JVC  entered  into a Copy  Protection
Technology  Agreement in which the Company has agreed to continue to license its
copy protection technologies to third parties in the event of the acquisition of
the Company by a party other than JVC.  Further,  the Company has granted to JVC
the right to sublicense the Company's copy protection  technologies  with 95% of
the royalties from such  sublicenses  payable to the Company or successor in the
event that the Company fails to make its copy protection  technologies generally
available  for  licensing  to third  parties  following  an  acquisition  of the
Company.                                                                        

     In 1997, the Company entered into several agreements with JVC or its wholly
owned subsidiaries  including a Copy Protection Technology License Agreement,  a
Digital Versatile Disc Player/Digital  Video Cassette Recorder License Agreement
for Anticopy Technology, and a Replicator Agreement. The terms and conditions of
these  agreements  are not more  favorable to JVC or its  subsidiaries  than the
terms offered to other unrelated parties. The Company recorded revenues from JVC
of approximately  $6,000 and $59,000 during the year ended December 31, 1998 and
1997, respectively.                                                             

     In 1998, the Company entered into a Copy Protection Technology  Application
and  Duplicator  Agreement  with JVC and a third party  duplicator  by which JVC
agrees to pay all fees to Macrovision on behalf of the duplicator. The terms and
conditions of such agreements are not more favorable to JVC or its  subsidiaries
than the terms offered to other unrelated  parties.  The Company has recorded no
revenue pursuant to this contract.                                              

     In 1996 and 1997,  the Company  entered into  agreements  with  Matsushita,
which owns  approximately  52% of JVC,  including a Copy  Protection  Technology
License  Agreement,  a Digital  Versatile  Disc  Player/Digital  Video  Cassette
Recorder  License  Agreement for Anticopy  Technology  and a Component  Supplier
Non-Assertion and Technical Services Agreement. The terms and conditions of this
agreement  are not more  favorable to Matsushita  or its  subsidiaries  than the
terms offered to other unrelated  parties.  The Company  recorded  revenues from
Matsushita  of  approximately  $148,000  and  $111,000  during  the years  ended
December 31, 1998 and 1997, respectively.                                       

     In 1998, the Company entered into  agreements with Matsushita  including an
Authoring  and  Replicator  Agreement  and  a  DVD  Copy  Protection  Technology
Application Agreement.  The terms and conditions of such agreements are not more
favorable to  Matsushita  or its  subsidiaries  than the terms  offered to other
unrelated parties.  The Company has recorded no revenue and paid no service fees
pursuant to these contracts.                                                    

     In February,  1998, the Company entered into a Software  Marketing  License
and  Development  Agreement  with C-Dilla  under which it has  obtained,  for an
initial  five-year  term, the  world-wide  exclusive  license to market,  in the
consumer  multimedia  software  market,  C-Dilla's  proprietary  copy protection
technology.  In February, 1998, C-Dilla also agreed to reimburse the Company for
specific marketing related expenses up to $500,000.  As of December 31, 1998 the
Company  had  received  the full  amount  reimbursable,  under the  co-marketing
agreement with C-Dilla.                                                         

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AND SUBSIDIARIES

  Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997

(4)  Stockholders' Equity                                                       

Series A Convertible Preferred Stock                                            

     The Company's Certificate of Incorporation  provides for the issuance of up
to  5,000,000  shares  of  preferred  stock,  of  which  1,376,432  shares  were
designated as Series A. In June 1991,  the Company issued to Pacific Media ( the
"Purchaser")  833,333 shares of Series A convertible  preferred  stock for gross
proceeds of  $4,500,000.  The shares were  converted  into the Company's  common
stock on a one-for-one  basis in connection with its IPO. Each share of Series A
convertible  preferred  stock  entitled its holder to one vote for each share of
common stock into which such shares  could be  converted,  not to exceed  voting
rights equivalent to 49% of the outstanding voting stock.  Cumulative  dividends
at the rate of $.54 per share per year were  payable  quarterly to the holder of
the Series A convertible preferred stock. The holder of the Series A convertible
preferred stock is entitled to $5.40 per share in the event of any  liquidation,
dissolution,  or winding up of the Company, plus an amount equal to all declared
but unpaid dividends, prior and in preference to any distribution to the holders
of common stock.                                                                

     In  conjunction  with the  issuance of the Series A  convertible  preferred
stock and the  convertible  note,  the Company agreed to grant certain rights to
the Purchaser,  which included a first right to purchase a pro rata share of any
equity offering of the Company  excluding shares issued for (a) an IPO or (b) an
acquisition  of  another  corporation,  if such  exclusions  will not reduce the
purchaser's  pro rata  ownership  share of the  Company  below  25%,  (c)  stock
dividend or splits, and (d) stock compensation plans. Further, the purchaser has
entered into an agreement  with the holders of common stock and optionees of the
Company as of June 12, 1991,  giving the  purchaser  the right to acquire all of
their  shares of common stock and options at a  predetermined  price upon notice
from the Company that it has filed a registration  statement in connection  with
an IPO. In January  1997,  the Company and Pacific  Media  entered into a Waiver
Agreement,  pursuant to which Pacific Media waived its right to purchase  shares
of the Company's common stock from stockholders and  optionholders  triggered by
the filing of the  registration  statement  in  connection  with the IPO and any
pre-effective  amendments  thereto  filed  prior  to  April  1,  1997.  Upon the
completion of the IPO, all rights of Pacific  Media to purchase  common stock of
the Company from such persons expired.                                          

Restricted Stock                                                                

     On June 7, 1996,  the Company  issued  58,333  shares of common  stock at a
price of $2.70 per share pursuant to a restricted stock purchase agreement to an
officer of the Company in exchange for a full recourse  promissory  note secured
by the shares in the principal amount of $157,000.  Interest accrues at the rate
of 6.58% per annum.  Principal and accrued interest, if any, are due and payable
on June 7,  2001.  The  Company  has the  right to  repurchase  the stock at the
original sales price upon the termination of the purchaser's employment with the
Company.  The  repurchase  right lapses at a rate of 1/6 after June 7, 1997, 1/3
after June 7, 1998,  and 1/2 after June 7, 1999. As of December 31, 1998,  there
were 29,167 shares subject to the repurchase  right and the remaining  principal
of the note was $78,000.                                                        

Stock Option and Purchase Plans                                                 

     In December 1996, the Company  adopted the 1996 Equity  Incentive Plan (the
"Equity  Incentive  Plan"),  which serves as the successor to the Company's 1988
Stock Option Plan (the "1988 Plan").  Options granted under the 1988 Plan before
its termination  continue to remain  outstanding in accordance with their terms,
but no further  options may be granted under the 1988 Plan.  Nonstatutory  stock
options and incentive stock options granted under the 1988 Plan were exercisable
at prices  not less than 85% and 100%,  respectively,  of the fair  value of the
Company's  common stock on the date of grant,  as  determined  by the  Company's
Board of Directors. The options were generally exercisable over a 3-year vesting
period and expire 7 to 10 years from date of grant.                             

     Pursuant to the Equity Incentive Plan, the Company's Board of Directors has
reserved  1,272,222  shares  of  common  stock for  issuance.  In May  1998,  an
additional  400,000  shares were  reserved by approval of the Board of          

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AND SUBSIDIARIES

  Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997

(4)  Stockholders' Equity (continued)                                           

Directors and stockholders.  The Equity Incentive Plan provides for the grant of
stock options,  stock  appreciation  rights,  and restricted stock awards by the
Company to employees, officers, directors, consultants, independent contractors,
and  advisers of the  Company.  During  1998,  no stock  options were granted to
consultants,  independent  contractors  or advisers of the  Company.  The Equity
Incentive  Plan  permits the grant of either  incentive  or  nonqualified  stock
options at the then  current  market  price.  Options  granted  under the Equity
Incentive  Plan will have a maximum  term of ten years and  generally  vest over
three years at the rate of 1/6, 1/3 and 1/2, respectively.                      

     In  December  1996,  the  Company's  Board of  Directors  adopted  the 1996
Employee Stock Purchase Plan (the "Purchase  Plan") and reserved  140,000 shares
of common stock for issuance  thereunder.  The Purchase Plan was effective  upon
the  Company's  proposed IPO. The Purchase  Plan permits  eligible  employees to
purchase common stock,  through payroll  deductions of between 1% and 20% of the
employee's compensation, at a price equal to 85% of the lower of the fair market
value of the common stock on the first day of the offering period or on the last
day of the purchase  period.  The Company's  stockholders  approved the Purchase
Plan in February  1997. In 1998 and 1997,  the Company  issued 37,039 and 11,646
shares, respectively, pursuant to the Purchase Plan.                            

     In  December  1996,  the  Company's  Board of  Directors  adopted  the 1996
Directors Stock Option Plan (the "Directors Plan") and reserved 60,000 shares of
common  stock for  issuance  thereunder.  The  Directors  Plan  provides for the
initial grant of a nonqualified  option to purchase 5,000 shares of common stock
on the date the eligible  director  first becomes a director and the  additional
grant of a nonqualified option to purchase 3,000 shares of Common Stock annually
thereafter.  Options  will  vest at the rate of 2.08%  per  month so long as the
director  continues  to  serve  on  the  Board  on  such  dates.  The  Company's
stockholders approved the Directors Plan in February 1997. During 1998 and 1997,
the Company granted  options to purchase 9,000 and 15,000 shares,  respectively,
of common stock.                                                                

     The Company uses the intrinsic value-based method to account for all of its
employee stock-based compensation plans.  Accordingly,  no compensation cost has
been recognized in the accompanying  consolidated  financial  statements for its
plans  because the  exercise  price of each option  equaled or exceeded the fair
value of the underlying common stock as of the grant date for each stock option,
except for  options  and  restricted  stock  granted in May and June 1996.  With
respect to the options and  restricted  stock granted in May and June 1996,  the
Company has recorded deferred stock  compensation of $231,000 for the difference
at the grant date between the exercise  price and the fair value,  as determined
by an  independent  valuation,  of the  restricted  stock and the  common  stock
underlying the options.  This amount is being amortized on a straight-line basis
over  the  vesting  period  of the  individual  options  and  restricted  stock,
generally three years.                                                          

     If compensation cost for the Company's  stock-based  compensation plans had
been determined in a manner consistent with the fair value approach described in
SFAS No.  123,  the  Company's  net income and net income per share as  reported
would have been reduced to the pro forma amounts  indicated below (in thousands,
except per share data):                                                         

                                                                [Download Table]

                                                       Year ended December 31, 
                                                      -------------------------
                                                        1998              1997 
                                                      -------           -------
                                                                               
Net income                    As reported ........... $ 6,342           $ 3,821
                              Adjusted pro forma ....   5,091             3,388
Basic net income per share    As reported ...........     .79               .57
                              Adjusted pro forma ....     .64               .52
Diluted net income per share  As reported ...........     .74               .53
                              Adjusted pro forma ....     .59               .46

F-16

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  Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997

(4)  Stockholders' Equity (continued)                                           

     The provisions of SFAS No. 123 are effective for options granted  beginning
January 1, 1996.  Options vest over several  years and new options are generally
granted each year.  Because of these  factors,  the pro forma effect shown above
may not be  representative  of the pro forma  effect  of SFAS No.  123 in future
years.                                                                          

     The fair value of each option is  estimated  on the date of grant using the
Black-Scholes  method  in 1998 and 1997,  with the  following  weighted  average
assumptions for options and the ESPP plan:                                      

                                                   Year ended December 31,
                                                  ------------------------
                                                  1998              1997
                                                  -------           ------
Option Plans:                                                 
       Dividends ............................      None             None
          Expected term ........................   4.34 years       4.56 years
        Risk free interest rate ..............      6.45%            6.07%
        Volatility rate ......................      66.8%            64.7%
ESPP Plan:                                                    
       Dividends ............................      None             None
          Expected term ........................   1.24 years       1.25 years
        Risk free interest rate ..............      5.47%            5.42%
        Volatility rate ......................      62.6%            62.4%

Activity under the Company's option plans is as follows:              

                                                                [Download Table]

                                               Number of      Weighted-average
                                                shares         exercise price 
                                               --------       ----------------
                                                                              
Outstanding as of December 31, 1996 .........   700,565             $2.99     
  Granted ...................................   126,154             11.81     
  Canceled ..................................   (17,034)             4.17     
  Exercised .................................  (111,342)             2.59     
                                               --------                       
Outstanding as of December 31, 1997 .........   698,343              4.62     
  Granted ...................................   206,395             17.12     
  Canceled ..................................   (12,772)            12.95     
  Exercised .................................  (185,336)             3.03     
                                               --------                       
Outstanding as of December 31, 1998 .........   706,630              8.54     
                                               ========                       

                                                                [Download Table]

                                                        December 31,      
                                                 -------------------------
                                                  1998              1997  
                                                 -------           -------
                                                                          
Options exercisable at end of year               348,729           379,042
Weighted average fair value of options granted                            
  during the period                             $  10.00          $   6.87

     The  following  table  summarizes  information  about fixed  stock  options
outstanding as of December 31, 1998:                                  

                                                        [Enlarge/Download Table]

                                  Outstanding                             Exercisable       
                  ---------------------------------------------  ---------------------------
                                   Weighted                                                 
                                    average        Weighted                     Weighted    
  Range of          Number         remaining        average        Number        average    
 exercise prices  of shares    contractual life  exercise price  exercisable  exercise price
 ---------------  ---------    ----------------  --------------  -----------  --------------
                                                                                            
$2.70 - 2.70        354,617        5.93 years      $ 2.70          314,486        $ 2.70    
$7.20 - 15.00       314,113        8.77             13.05           33,057         10.34    
$20.00 - 27.75       37,900        9.68             25.88            1,186         21.35    
                    -------                                        -------                  
                    706,630        7.39              8.54          348,729          3.49    
                    =======                                        =======                  

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AND SUBSIDIARIES

  Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997

(5)  Income Taxes                                                               

Income taxes consisted of the following (in thousands):               

                                                              December 31,
                                                            ------------------
                                                             1998       1997
                                                            -------    -------
Current:                                                          
        Federal .........................................   $ 2,119    $ 2,031
        Foreign .........................................       354        383
        State ...........................................       873        544
                                                            -------    -------
          Total current .................................     3,346      2,958
                                                            -------    -------
Deferred:                                                         
         Federal .........................................       (34)      (554)
         State ...........................................        --       (129)
                                                            -------    -------
           Total deferred ................................       (34)      (683)
                                                            -------    -------
Charges in lieu of income taxes associated with the               
        exercise of stock options .......................       617        138
                                                            -------    -------
                                                            $ 3,929    $ 2,413
                                                            =======    =======

     The Company's  effective  tax rate differs from the  statutory  federal tax
rate as follows (in thousands):                                                 

                                                       Year ended December 31,
                                                       -----------------------
                                                       1998       1997
                                                      -------    -------

    Computed "expected" tax expense ..........        $ 3,492    $ 2,120
    State tax expenses, net of federal benefit            576        274
     Tax credits ..............................           (304)       (87)
    Foreign taxes ............................            192         47
     Exempt interest ..........................           (320)      (144)
    Other ....................................            293        203
                                                      -------    -------
                                                      $ 3,929    $ 2,413
                                                      =======    =======

     The tax effects of the temporary  differences that give rise to significant
portions of the  deferred tax assets and  liabilities  are  presented  below (in
thousands):                                                                     

                                                      December 31,
                                                       -------------------------
                                                       1998               1997
                                                       ------             ------
Deferred tax assets:                                            
          Accrued liabilities and reserves .......     $  826             $  673
          Allowance for doubtful accounts ........        341                272
          Depreciation and amortization ..........        483                707
          Deferred revenue .......................        502                382
                                                       ------             ------
            Total gross deferred tax assets ......      2,152              2,034
Deferred tax liabilities:                                       
          Patents ................................        866                782
                                                       ------             ------
            Net deferred tax assets ..............     $1,286             $1,252
                                                       ======             ======

     Management  believes  that it is more  likely  than not that the results of
future  operations  will  generate  sufficient  taxable  income to  realize  the
deferred tax assets.                                                            

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  Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997

(6)  Commitments                                                                

Leases                                                                          

     The  Company  leases its  facilities  and  certain  equipment  pursuant  to
noncancelable  operating  lease  agreements.  Additionally,  the Company  leases
certain equipment pursuant to a capital lease agreement.                        

     Future minimum lease  payments  pursuant to these leases as of December 31,
1998, were as follows (in thousands):                                           

                                                        Capital    Operating
                                                       lease      leases
                                                        -------    ---------

 1999                                                  $  116       $  507
 2000                                                      78          505
 2001                                                      --          519
 2002                                                      --          307
 2003 and thereafter                                       --          154
                                                       ------       ------
 Total                                                 $  194       $1,992
                                                       ======       ======
Less amounts representing interest                         6            
                                          ------
Present value of minimum capital lease payments          188            
Less current portion of capital lease liability          112            
                                          ------
Capital lease liability, net of current portion       $   76            
                                          ======

     Rent  expense was  $501,000  and $469,000 as of December 31, 1998 and 1997,
respectively.                                                                   

Employee Benefit Plan                                                           

     The Company has a 401(k) plan that allows eligible  employees to contribute
up to 20% of their  compensation,  which  contribution was limited to $10,000 in
1998. Employee contributions and earnings thereon vest immediately.  The Company
is not  required  to  contribute  to the 401(k)  plan and had made no  voluntary
contributions.  The Company made matching contributions to the 401(k) plan equal
to 20% of each  participating  employee's  contribution,  up to a maximum annual
matching  contribution  of $2,000  and  $1,900  in 1998 and 1997,  respectively.
Matching  contributions  aggregated  $60,000  and  $54,000  for the  year  ended
December 31, 1998 and 1997, respectively, and are fully vested after three years
of service.                                                                     

(7)  Segment and Geographic Information                                         

     The Company  operates  in three  industry  segments as follows:  Video Copy
Protection,  Video Scrambling and Computer Software Copy Protection.  Video Copy
Protection licenses  Macrovision's  anti-copy video technologies to customers in
the home videocassette,  DVD and digital pay-per-view markets.  Video Scrambling
licenses and sells products utilizing the Company's  PhaseKrypt video scrambling
technology to manufacturer  analog set-top decoders for sale to cable television
system  operators  in  developing  cable  television   markets,   to  television
broadcasters  for securing  incoming  contribution  circuits to network  control
centers and outbound  rebroadcast  circuits and to the government,  military and
law  enforcement  agencies for covert  surveillance  applications.  The Computer
Software Copy Protection  licenses copy protection  technology in the multimedia
software market.                                                                

     The Company identifies segments based principally upon the type of products
sold. The accounting policies of these reportable segments are the same as those
described in the consolidated  entity.  The Company evaluates the performance of
its segments based on revenue and segment income. In addition,  as the Company's
assets are primarily  located in its  corporate  office in the United States and
not allocated to any specific segment,  the Company does not produce reports for
or measure the  performance  of its segments based on any  asset-based  metrics.
Therefore, segment information is presented only for revenue and segment income.

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  Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997

(7)  Segment and Geographic Information (continued)                             

     The  following  segment  reporting  information  of the Company is provided
(dollars in thousands):                                                         

                                                       Year ended December 31,
                                                       -----------------------
                                                      1998        1997
                                                      --------    --------
Revenue:                                                                    
 Video Copy Protection ............................   $ 22,626    $ 17,412
 Video Scrambling .................................      1,464       2,739
 Computer Software Copy Protection ................        344          --
 Other ............................................         --         189
                                                      --------    --------
 Total ............................................   $ 24,434    $ 20,340
                                                      ========    ========

                                                       Year ended December 31,
                                                       -----------------------
                                                      1998        1997
                                                      --------    --------
Operating Income:                                                           
 Video Copy Protection ............................   $ 17,115    $ 12,509
 Video Scrambling .................................       (504)        309
 Computer Software Copy Protection ................       (126)         --
  Other ............................................       (117)       (665)
                                                      --------    --------
   Segment income .................................     16,368      12,153
 Research and development .........................      2,578       2,248
 General and administrative .......................      4,621       4,149
                                                      --------    --------
   Operating income ...............................      9,169       5,756
 Interest and other income (expense), net .........      1,102         478
                                                      --------    --------
   Income before taxes ............................   $ 10,271    $  6,234
                                                      ========    ========

                                                       Year ended December 31,
                                                       -----------------------
                                                      1998        1997
                                                      --------    --------
Depreciation and Amortization:                                              
 Video Copy Protection ............................   $    311    $    451
 Video Scrambling .................................        221         281
 Computer Software Copy Protection ................         13          --
 Other ............................................         --          73
 Research and development .........................        206         169
 General and administrative .......................        180         182
                                                      --------    --------
 Total ............................................   $    931    $  1,156
                                                      ========    ========

                                                       Year ended December 31,
                                                       -----------------------
                                                      1998        1997
                                                      --------    --------
Information on Revenue by Significant Product Group:                        
Video Copy Protection:                                                  
   Videocassette ..................................   $ 15,770    $ 12,616
   DVD ............................................      3,096       1,084
   Pay-Per-View ...................................      3,760       3,712
Video Scrambling:                                                       
   Video Scrambling Systems .......................        477         756
   Components & Licensing .........................        987       1,983
 Computer Software Copy Protection ................        344          --
 Other ............................................         --         189
                                                      --------    --------
 Total ............................................   $ 24,434    $ 20,340
                                                      ========    ========

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  Notes to Consolidated Financial Statements (continued)
December 31, 1998 and 1997

(7)  Segment and Geographic Information (continued)                             

                                                       Year ended December 31,
                                                       -----------------------
                                                      1998        1997
                                                     -------     -------
Information on Revenue by Geographic Areas:                                 
United States ...................................    $13,563     $10,878
Japan ...........................................      2,738       2,181
Export & Foreign Operations .....................      8,133       7,281
                                                     -------     -------
Total Revenue ...................................    $24,434     $20,340
                                                     =======     =======

     Geographic  area  information  is based  upon  country of  destination  for
products  shipped and country of contract holder for royalties and license fees.
Both the United States and Japan account for over 10% of the Company's  revenues
in both 1998 or 1997.  Revenue  from one  customer of the Video Copy  Protection
accounted for 12% of net revenue for the year ended  December 31, 1998.  Another
customer of the Video Copy  Protection  accounted for 11% of net revenue for the
year ended December 31, 1997. At December 31, 1998 and 1997 receivables from one
customer of the Video Copy Protection represented 16% and 25%, respectively,  of
net accounts receivable.                                                        

(8) Subsequent Events                                                           

     In October  1995,  Joseph Swyt,  one of the Company's  former  officers and
directors,  filed suit against the Company in the Superior Court of the State of
California  alleging  monetary  damages  suffered as a result of alleged  fraud,
misrepresentation  and other  malfeasance in connection  with our grant of stock
options to him.  Mr.  Swyt  maintains  that the  company  induced  him to accept
employment  by  falsely  representing  to him that the  options  granted  to him
eventually would have substantial value.  Between August 1990 and December 1993,
the Company granted to him options to purchase approximately 200,000 shares with
per-share exercise prices of $2.25 or $2.70.  Substantially all of these options
expired unexercised within three months following his departure from Macrovision
in June  1995.  In  December  1996,  the court  ordered  this  matter to binding
arbitration  in  accordance  with a  written  agreement  between  Mr.  Swyt  and
Macrovision.  The  arbitration  agreement  contains  limitations on the types of
damages  available to him and expressly  precludes  punitive  damages.  Mr. Swyt
filed his claim in  arbitration  for this matter with the  American  Arbitration
Association  in June 1997 and  arbitration  hearings were  completed in February
1999.  On March 16,  1999,  a decision in favor of the Company was rendered by a
majority  of the  arbitrators  in the Swyt  litigation,  finding  that we had no
liability  to Mr.  Swyt on any of his claims and that his  claims  were  without
merit.  The  Company is seeking  and  expects to have the  arbitrators  decision
confirmed by the Superior  Court.                                               

Dates Referenced Herein   and   Documents Incorporated by Reference

				Referenced-On Page
This ‘10KSB’ Filing		Date		First		Last			Other Filings
		6/30/02		26					10-Q
		6/7/01		53
		12/31/00		49		50			10-K
		12/31/99		49		50			10-K/A,  10-K405
		6/7/99		53
		5/18/99		1
Filed on:		3/30/99		38
		3/22/99		1		27			DEF 14A
		3/16/99		24		59
		2/1/99		40					4
For Period End:		12/31/98		1		59
		6/23/98		37					10QSB/A
		6/7/98		53
		5/15/98		37					10QSB
		2/19/98		37
		2/17/98		37					8-K
		12/31/97		39		59			10KSB40
		12/15/97		47
		6/7/97		53
		4/11/97		27
		4/1/97		53
		3/17/97		27
		3/13/97		27					424B4,  S-8
		3/12/97		27		37
		2/18/97		37
		2/10/97		37
		1/29/97		37
		1/14/97		37
		1/7/97		36		37			SB-2
		1/6/97		36
		12/31/96		43		55
		12/6/96		36
		9/30/96		36
		7/31/96		36
		7/1/96		37
		6/7/96		36		53
		6/5/96		36
		1/1/96		55
		9/26/95		36
		9/21/95		37
		4/21/95		37
		7/15/94		36		51
		5/26/92		37
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