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Executives

Karen Fisher - VP of IR and Compliance

Kevin Hell - CEO

Dan Halvorson - EVP and CFO

Analysts

Paul Coster - JPMorgan

John Bright - Avondale Partners LLC

Steven Frankel - Brigantine Advisors LLC

Rob Stone - Cowen and Company

Jack Hain - Barrington Research

Justin Cable - Global Hunter Securities

DivX, Inc. (DIVX) Q2 2009 Earnings Call August 4, 2009 4:30 PM ET

Operator

Welcome to the DivX second quarter 2009 operational and financial results conference call. Just a quick reminder today's call is being recorded and now at this time I will turn things over to our host Ms. Karen Fisher, Vice President of Investor Relations. Please go ahead, ma'am.

Karen Fisher

Thank you. Good afternoon and thank you for joining the management team of DivX. I am Karen Fisher, Vice President for Investor Relations and Compliance and with me on the call today is Kevin Hell, our Chief Executive Officer; and Dan Halvorson, our Executive Vice President and Chief Financial Officer. Before we get started I would like to read a brief Safe Harbor statement and then turn the call over to Kevin Hell.

Statements made during this call that are not strictly historical in nature constitute forward-looking statements. Such statements include but are not limited to the growth and earning potential of the DivX business, the company's position in the digital media space, its confidence in its growth prospects and its plans to increase shareholder value, uncertainties contributing to the macro economic climate, the company's outlook for 2009, uncertainties that Google software distribution revenue may not meet company expectations, the company's plans for expanding its core licensing business, expectations for DivX Connected, plans for extending the company's content licensing partnerships and the company's anticipated financial results for the third quarter of 2009.

Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual results to be materially different than those expressed or implied by such forward-looking statements. These factors include but are not limited to the risk that customer use of DivX technology and may not grow as anticipated, the risk that anticipated market opportunities may not materialize at expected levels or at all, uncertainties related to the current macro economic climate, the risk that the Google software distribution or if they may not meet company expectations, the risk that the company's activities may not result in the growth of profitable revenue, the risk that the company's financial performance for the third quarter of 2009 may not meet expectations and other factors discussed in the risk factor section of the company's most recent reports filed with the SEC.

All forward-looking statements are qualified in their entirety by this cautionary statement. DivX is providing this information as of the date of this call and does not undertake any obligation to update any forward-looking statements discussed in this call as a result of new information, future events or otherwise other than as required under applicable securities laws.

For those of you who are not able to stay on the call today an audio webcast will be archived on our website under Events and Presentations at investors.divx.com. In addition this teleconference will be made available via a podcast which can be downloaded from the Investor Relations section on our website.

At this time I’d like to turn the call over to Kevin Hell. Kevin, please go ahead.

Kevin Hell

Thank you, Karen. Hello and thank you for joining us on the call today as we report our second quarter results. I like to start our call by discussing our view on the state of our market today and the opportunity we have in front of us.

We operate in an industry that I believe is at a significant inflection as we move toward a more connected and converged digital landscape. It's therefore important to look at our quarterly results and accomplishments not only in the context of how we are executing and running our business today, but also in light of how we are positioning the company for growth as this exciting new media landscape becomes a reality.

So, let's talk about our future opportunities and our view on their timing. DivX has always had a very strong focus on delivering technology and products that enable consumers to enjoy and experience media in the way that they want. We talk about in terms of the open DivX vision, any content, any device, anytime. When you think about how people are experiencing media today, you're seeing bits and pieces of this vision a wide range environments.

Consumers are watching videos on their mobile phones, they are watching content on their personnel media players, they are streaming video from their netbooks and cable boxes. And all these different devices are converging, but what has not happened yet, what has really not been unleashed is a true conversions that all these devices working interoperability, seamlessly without having to burn discs, use confusing software or put with all the other hassles that exist today.

So what you are seeing throughout the DivX ecosystem are the major OEMs the LG's, Samsung's and the Sony's. Winding up their partners or products in their market strategies for when this opportunity will emerge. Whether it's this Christmas season or the next year or the year after that, it is hard to say that's going to happen and we believe it's going to be huge. What's' important for DivX is being aligned with the key partners. The top OEMs the top content providers the top videos to be in the pole position when this market takes off.

So as I talk about the quarter and I talk about our partners I want you to have that context, think about how far and how rapidly the market position leader has evolved and how instrumental DivX has been in its growth.

Today DivX is the most successful and wealthiest bridge between digital video on the internet and consumer electronics. We started off with PC then moved to the DVD player and have now rapidly expanded to a number of new devices including mobile phones, digital televisions, gaming consoles and even clock radios and personnel navigation devices.

With each step DivX has come closer and closer to its brand promise of true interoperability for the consumer. And now DivX is preparing to lead the way

towards the next major evolutionary step as mass market devices begin to access video directly from the internet, without the need for a physical storage medium such as the DVD disc. Incidentally large libraries of digital content will be one simple click away without having to deal with close distribution systems.

It's a significant opportunity that will transform the face of media distribution and advertising as it exists today. DivX will once again pioneer the way by anticipating customer needs and developing best in class solutions that make sense for its partners and which are simple open and reliable for consumers.

So let me start with a discussion of the quarter and how we are moving along those two tracks. Growing up business for the realities today, but at the same time building relationships and technology solutions for the opportunities to come.

In the second quarter we delivered strong financial and business results and made significant progress for realizing our vision of powering a seamless, high-quality digital media experience on any device. We continue to execute on all areas of the business striking the right balance between managing expenses and investing in a business for long-term growth.

We reported total revenue of $15.2 million comprised of $13.7 million of technology licensing revenue and $1.5 million of media and other distribution and services revenue. In light of the continued pressure on consumer electronics and the broader economy we are encouraged by our second quarter financial and operational results.

I'd like to discuss this quarter's developments in more detail beginning with a brief overview of our expanding DivX ecosystem and then move to review, of our core licensing business and emerging growth areas. I will close the discussion of our DivX Plus coded content and the DivX Connected initiatives.

One of the strengths of the DivX value proposition is the size and breadth of the DivX ecosystem. With more 200 million DivX devices shipped into the market this ecosystem gives consumers the freedom to watch the videos they purchase on any of their devices that carry the DivX logo. The steady proliferation new and different devices that can playback video is fueling the expansion of the DivX ecosystem and driving the [receptation] of our licensing revenues.

Let's review our licensing business in more detail starting with our core DVD market. The traditional DVD player market is shrinking and there is a shift to lower priced models. Despite these trends our global penetration of traditional DVD player market continues to hold relatively steady at approximately 40% for the 12 months ended Q1. While traditional DVD licensing still remains our biggest revenue source for 2009, we are gaining solid traction in several of the emerging product categories including digital televisions, mobile phones and Blu-ray players.

This quarter emerging products increased to 13% of our total licensing revenue and we expect strong momentum here going forward. Although we are dependent on macro economic trends, we anticipate the contribution percentage from emerging products to approximately double by the end of the year. I would like to review our progress in [ETVs] emerging product categories starting with digital televisions.

We have now certified nearly 1,000 Digital TV models from leading OEMs such as LG, Samsung and Toshiba. This represents a nearly 50% increase in just one quarter. Many of these models will be appearing on retail shops in the next few months just in time for the holiday season.

Turning to the Blu-ray category. Blu-ray sales continued to perform solidly despite the broader economic conditions and we remain optimistic about the replacement cycle with DVD players. We have now certified close to 300 Blu-ray players with nearly 80 players capable of high definition DivX playback at 1080p resolution.

In the mobile market we have now certified close to 40 handsets from LG and Samsung, many of which can be [coded] as well playback DivX video. In July, Hantec, the Korean handset maker became one of our new CE partners when they launched their DivX Certified Sciphone'. We are looking forward to working with Hantec on a global basis.

Another recent example of how we are spending our mobile portfolio with the US launch of the new Samsung Mondi, the first DivX certified mobile phones that includes WiMAX technology. The Mondi joined several other handsets, capable of recording DivX video such as LG's Renoir, Secret and Viewty models.

Next, I would like to provide an update on our two H.264 initiatives. DivX Plus HD certification and DivX 7 software. H.264 is a next generation video standard offering improved digital video compression that is well suited for the recording and playback of high definition content and is particularly relevant as we move toward to our larger vision of the Connected home.

Our CE partners continue to raise our DivX plus HD certification program, which adds support for video files in the new H.264 format. Driven by the OEM demand, we have now signed licensing agreements with nine leading chipmakers to enable DivX Plus HD certification including high volumes suppliers like Mediatech, MStar, NXP and [SEMplus].

Our key driver for the demand of our DivX Plus HD program will be the availability of H.264 content created using our new DivX 7 software and community tools. With the successful launch of DivX 7 in January the size and engagement of the global DivX community continues to grow rapidly.

There were approximately 750 million launches of the DivX player and web-player by consumers since January, an increase of almost 70% year-over-year. In addition there were 12.2 million average monthly unique visitors to DivX.com this quarter, an increase of 22% over last year.

The positive growth of the DivX community worldwide, we now offer DivX 7 software in a number of languages including simplified and traditional Chinese, as well as Portuguese. In localizing our offerings we are expanding the debt and breadth of the DivX ecosystem, ensuring that consumers around the world can enjoy high quality digital content.

One of the benefits of the strong and engaged DivX community is our partnership with Google. We began distributing the Google Chrome browser in conjunction with our DivX 7 software bundle this quarter and Google Chrome contributed approximately $1.3 million in total revenue for two months in the second quarter.

The Google Chrome browser is still in its infancy and we are exploring new approaches to increase user acquisition and extend the value proposition of the Google DivX partnership.

Next I would like to update you on our Hollywood content initiatives. We are extremely excited about the new developments in this area having signed two new Hollywood studio partners Paramount and Lionsgate. And several new download to own video sites.

We are pleased that Lionsgate and Paramount Pictures have become the latest Hollywood videos to embrace the quality and portability of the DivX technology and to endorse our robust DivX DRM for secured online distribution. We now have multi-year format agreements with four studios, Sony Pictures, Warner Brothers, Paramount and Lionsgate. With these studios thousands of the top Hollywood titles will be available in the DivX format, including the recent top selling movies such as Paramount’s Iron Man, Sony’s Hancock, Warner Brothers the Dark Knight and Lionsgates' 3:10 to Yuma.

Now that we have a number of Hollywood studios working with us we need to make this content available to consumers. As announced last year the Warner Brothers’ France online store became the first to offer films from the Warner Brothers’ catalogue in the DivX format. Since adding the DivX format the Warner Brothers storefront has reported strong increases in download-to-own transactions.

And is currently promoting DivX on its homepage. Warner Brothers' France has also started using DivX technology to bundle digital copies of several major movies such Dark Knight and Grand Torino along with Blu-ray and DVD discs. French consumers are particularly pleased with the flexible DivX DRM, which enables them to playback the movies they purchased on their DivX certified devices including mobile phones and portable media players. DivX penetration in DVD players in France is approximately 90%. So most consumers already have access to one or more DivX devices in their home.

Joining Warner Brothers' in France, three new European video retail sites will soon offer Hollywood films in the DivX format. Entertainment Retail Group in Benelux, FilmOn in the UK and Play4film in Italy. And we expect a US site to be launched shortly. In addition, our DivX promotion with Philips will soon be launched at US retail locations.

Beginning this month and running through to December consumers will be offered a free Warner Brothers' digital movie in the DivX format with a purchase of a DivX certified Philips device. Once registered consumers can download the movie to their computers and then simply transfer via disc or USB stick to their Philips devices.

As you can see the investment in our Hollywood content offerings has gained real traction this quarter. DivX technology offers film lovers a true cinematic experience that is uniquely transferable across multiple devices enabling to watch their favorite movies at home or on the go and over 200 million DivX devices shipped into the market.

Finally, let me take a few minutes to talk about our DivX Connected initiative. As I discussed at the beginning of the call, we see the mass-market emergence of Internet connected devices to be a key opportunity for us. One that we expect will drive our future growth. We are hard at work developing a next-generation streaming service, which can be embedded in devices such as Connected Digital Televisions, and Blu-ray players and it’s as simple and easy to use as turning on your TV.

With this exciting platform we plan to support a variety of content services including Catch-up TV, news, user generated content, premium Hollywood movies and even offering such as games and Internet radio.

All of these services will have the potential to drive new recurring revenue streams either directly through transactions or indirectly through advertising. Based on a significant worldwide customer base and device footprint our deep OEM and Hollywood content relationships are neutral position in the market, our Google brand and the exciting new technology we are developing. We believe we are well positioned to be the market leader in this space.

Our goal is simple, any content service on any device from any manufacturer. We’re looking to offer a TV like consumer experience that is unrestricted and unlimited, it will be TV unleashed. We are making great progress and we’ll keep you updated as we roll out this new offering.

Now, I would like to hand the call to Dan to discuss our financial results in more detail. Dan?

Dan Halvorson

Thank you, Kevin. On today’s call I will provide a summary review of our second quarter and provide some color as we head in to the third quarter. As I have done in the past quarters, I will quickly remind you of the three key operating principles that drive our strategic and financial decisions.

One, maintain high gross margins, which create the foundation for meaningful operating margin performance. Two, manage expenses tightly at all times, not just when times are tough so that we have the ability to make investments when opportunities present themselves. And three, keep a strong balance sheet to provide both operating leverage and strategic flexibility.

In the current state of the market, I believe these principles provide the foundation of our success. Revenue for the second quarter was slightly ahead of guidance at $15.2 million. Our GAAP EPS for the quarter was a loss of $0.07 per diluted share and our GAAP loss was approximately $2.4 million. Non-GAAP EPS was breakeven well ahead of our guidance and we incurred a small non-GAAP loss of $91,000.

Excluded from our non-GAAP EPS and net income are the following. One, non-cash share based compensation of approximately 2.4 million or 1.6 million or $0.05 per diluted share net of taxes; two, the scheduled amortization of purchased intangible assets related to the acquisition of MainConcept of 532,000 or 370,000 or $0.01 per diluted share net of taxes. Three, foreign exchange benefit from our inter company loan of approximately 287,000, 200,000 or $0.01 per diluted share net of related taxes. And four, a non-cash charge of approximately 460,000 or $0.01 per diluted share related to the write-off of certain deferred tax assets associated with canceled stock options.

Breaking the quarter down further, technology-licensing revenue for this quarter decreased 16% over the same quarter last year to $13.7 million. Technology and licensing to hardware manufacturing partners was approximately 70% of our total revenues for the quarter. Technology licensing for software, which includes our main concept revenue, was 20% of total revenues for this quarter.

We had two over 10% licensing customers. That is Sony and Samsung in the quarter who accounted for approximately 26% of our revenue. Media and distribution revenue for the quarter was $1.5 million reflecting the first quarter of contribution from our new distribution agreement with Google, noting that we earned revenue in two of the three months I this initial quarter launch from Google.

The mixed economies geographies for the quarter was 69% for Asia Pacific, 11% from EMEA and 20% for the Americas. Remember that this year graphic mix represents a location of our licensees to manufacturer products not the locations in to which the products are shipped.

Gross margins were 85% compared to 95% last year. The decline is due to the impact of the H.264 license costs associated with DivX 7 software and the decrease in total revenue in the quarter especially related to software distribution.

Now let me focus my comments on expenses. I will talk about our expenses consistent with the non-GAAP breakout provided in supplemental earnings table in our press release today, detailing share based compensation and other items discussed earlier.

Total operating expenses in this quarter of $16.5 million including core operating expenses of $13.6 million or approximate 89% of total revenue. 2.4 million of share based compensation and the scheduled amortization of purchased intangible asset related to the MainConcept acquisition of 532,000. Included in other income expense is the foreign exchange benefit on the inter company loan to MainConcept of approximately 287,000.

Our second quarter operating loss excluding share based compensation and the intangible asset amortization was 680,000 or 5% of revenue, including share based compensation and the amortization expense we had a GAAP operating loss of $3.6 million. Our interest income for the quarter was 430,000 which compares to interest income of approximately $1.1 million earned during the second quarter last year and reflects dramatically lower interest rates.

For the second quarter, share based compensation expense; net of taxes was approximately $1.6 million or $0.05 per diluted share. We ended the quarter with total cash and short and long-term investments of approximately $140 million or $4.29 per share. This includes $4.1 million of auction rate securities classified as long-term investments. During the quarter, you might note that we reclassified approximately $14.3 million of our auction rate securities to short-term investments as a result of our anticipated sale of these securities, one year out on June 30, 2010 under our rights agreement with UBS.

Cash provided by operating activities was approximately $1.5 million during the second quarter and we generated approximately $900,000 from operations. We did not incur any significant capital expenditures during the quarter. We recorded a GAAP tax expense of $462,000 in the quarter related to a write-off of deferred tax assets associated with cancelled stock options. Excluding this expense, our GAAP blended tax rate for the quarter was approximately 27%. Headcount remained consistent and was 305,000 at June 30th, 2009 which compares to 306,000 at the previous quarter Q1.

Now, let me address guidance. We are projecting revenue for the third quarter to be in the range of $15 million to $16 million with a non-GAAP loss per share ranging from $0.02 to zero or breakeven for diluted share in the third quarter. We anticipate technology licensing revenue will make up approximately 85% to 90% of the revenue for the third quarter and media and distribution revenue is expected to be approximately 10% to 15%, taking into consideration that we will have three full months contribution from Google.

Gross margins in the third quarter are expected to be approximately 85%. GAAP EPS for the third quarter is expected to be in the range of a loss of $0.08 to a loss of $0.06 per diluted share and includes one anticipated non-cash share based compensation of approximately $2.5 million or a nickel per diluted share, $0.05 per diluted share. And two the scheduled amortization of purchase intangible asset related to the acquisition of MainConcept of approximately 500,000 or $0.01 per diluted share net of taxes.

Our weighted average shares outstanding for the third quarter are expected to be approximately 33 million.

With that we'll open the call up for questions, operator?

Question-and-Answer Session

Operator

(Operator Instructions) We'll go first this afternoon to Paul Coster with JP Morgan.

Paul Coster - JPMorgan

With the understanding of the comments around the inflation usually the third quarter is a strongly positive quarter from a sequential perspective, but it looks like you are pointing towards flat to downish. I am sorry this is not revenue again. Okay I will withdraw that part of the comment but what do you mean by an inflection point?

Kevin Hell

Sure this is Kevin. We are still an inflection between DVD players and emerging products. If you look at the DVD market overall worldwide it's down 20% and it continues to be the lion share of our revenue. The emerging products are coming on-line rapidly as I mentioned we have 1,000 digital television models now certified and 300 Blu-ray models and 40 mobile firms, but they are still growing out of a small base. So we are still in this inflection period that obviously is compounded by the economy overall.

The good news, I would say from our perspective we are very well positioned to grow as the economy recovers. And is big wave of digital media hits. We have all the strategic pieces coming into place. We have the emerging products and all the relationships around those. We have the premium content and the acceptance by the studios coming online, our software engagement continues to increase, we are getting deeper and deeper OEM relationships and getting a lot of strategic interest and it's all coming together for what we believe is a huge next big wave for the company, we're very excited about that.

Paul Coster - JPMorgan

As you see this inflection point from new products, emerging products, what is happening to your per unit royalty rate?

Dan Halvorson

Sure Paul this is Dan. As you know we have a long history with the companies. So, historically a lot of contracts are set, two and some three-year contracts. So those contracts are still in good standing. The emerging and as we talked about before and the inflection point that Kevin just talked about, obviously some of the new products have a different ASP, you move into mobile which is going to be lower set top boxes, they are going to be at different rates. So we are seeing, the constant channels negotiations with our partners, the good news is we have a broader offering and then we are entering into areas where the total adjustable market are much larger. So I see the ASP is flat in certain products down in others and we talked about that before relative to mobile is a good example that we are not going to get the same ASP on a handset as we've been in the past what we received for DVD players.

Paul Coster - JPMorgan

Okay Kevin, clearly 2009 has just been the brutal year for everyone involved. But as you look at out to calendar year ‘10, do you think this company will be back on a year-on-year growth path and at what point do you think these many Hollywood arrangements you’ve now got as you translate into kind of accelerate to the adoption?

Kevin Hell

Yes. So I think we are looking at this year overall and actually I think we are putting into place, some great strategic building blocks that are providing growth, a growth platform for the future. We got great traction in the emerging product categories as I mentioned and that lead towards, as we mentioned a doubling of the emerging product contribution by the end of the year, its our expectation. So, I absolutely do see those coming in line and the continued diversification and expansion of our ecosystem goes to our broader strategic goal of driving DivX across every device and enabling every service.

I think having the premium content coming on line is particularly important now as we mentioned on the call, we have three new retail stores that have been announced in Europe and we have another one coming here in the US. This will be in addition to the Warner Brothers', France site that we already launched. This will be the first time where you can buy DivX content full length Hollywood movies and watch it on all different DivX devices that are out there.

So, that's an important new development in the marketplace that we think is going to provide a booster to the overall licensing business for us overall. I should also mention as I did on the call that, we're also particularly pleased with lot of the new used cases that are emerging around the premium content, not just a download to own business, but also the fact that we're seeing digital copy of movies coming out now bundled with physical discs with DVD players, DVD discs and Blu-ray discs in France with Warner Brothers', France and we are also seeing bundling opportunities as I mentioned with Philips and we think all of these things are going to continue to drive increased demand in our licensing business overall.

So, I am very optimistic as we go into 2010 about the impact this is going to have on our business.

Paul Coster - JPMorgan

Okay. Last thing Kevin, I mean 80% approximately of your market cap is in cash and never seems to get a very high multiple, at least even in the last couple of years and it feels like your, there are tons of optionality here in the right place, but wouldn't it be, so it's a big part of a larger branded company in this space. Why don't you just sell the company to a strategic buyer?

Kevin Hell

Well, I think we are making tremendous progress in terms of the number of devices that are out there in the breadth of the DivX ecosystem on our own. As we just updated here we have over 200 million devices shipped into the marketplace this point in time from DivX. We think it's one of the largest ecosystems out there. The same kind of scale as iPod and iPhone added together ultimately. So we are very optimistic about the future and we see this next big wave coming with devices that connect directly to the internet we think there is a huge opportunity there.

We think we are very well positioned given our OEM relations give our technology position, given the neutrality of our brand and what not to take advantage of that. So we are very optimistic about our outlook as a (inaudible) entity.

Operator

Next we'll go to John Bright with Avondale Partners.

John Bright - Avondale Partners LLC

I'll go along the same lines. Well on the guidance Dan. $1.3 million from Chrome in two months if you extrapolate that forward, it does look like the technology licensing might be going down sequentially. Is the transition from red-laser to Blu-ray happening faster than you guys anticipated, maybe emerging is not coming as quick?

Dan Halvorson

Sure I will elaborate on that and I think that is built on to Paul's question and that’s the inflection point. So a couple of things you are right to think about the Google Chrome browsing and the 1.3 and extrapolate that inherent in the guidance in the 10% to 15% as run rate that we are comfortable with relative to the Google Chrome Brower. And then you look at the licensing business. So certainly as Kevin and we talked about before the DVD, core DVD is coming down as we sit here in August, you know over time I heard people say, you have your royalty reports, you kind of know your quarter, interesting enough as we sit here in August. Where I had some royalty reports that are quite solid for the quarter and I have royalty reports that aren’t coming in yet.

So we do know and everything we hear is that DVD and to Kevin remarks and DVD is down 20%. So we do see that and to go in to the inflection and Virgin is coming up it's just how fast as the (inaudible) coming up. We are comfortable with the pace and we are comfortable with the statistics that Kevin said in the prepared remarks between numbers certified DTVs, the number certified Blu-ray, the number of certified handsets, but as you also know we recognized revenue in arrears. So the shipments that were made in Q2 we are going to recognize in Q3 and to use Paul's point, 2009 has been and continues to be brutal.

So I think its two points. I think, as I'll refer to it as the DVDs why you are asking the question is the same-store sales. The same-store sales are down and directionally, we use the 20% mark and the [emerging] is coming up. It just has to come up fast enough. So I think that will help you put to the guidance. Directionally we are pleased, the other part of it is to continue to manage not only the top line which we are not in entire control of giving the macro trends, but we certainly are in control of the levers in the P&L and continue to run this company solid. If you look at cash which is a different topic on Paul's question, his last question there, we were sitting with last quarter with $138 million, we just grew cash to $140 million. We are continuing to be [straight] with the way we were handling the cash and the expenses of the company.

John Bright - Avondale Partners LLC

Kevin, internet or digital TVs are net ready televisions. You signed an LG agreement, I think you mentioned, you may have alluded to Sony as well. What's the market opportunity here for DivX? And is it more the Trojan Horse opportunity for a DivX Connected solution or is that something you see coming out on a set-top box and how are viewing that at this structure?

Kevin Hell

Well, just to be clear on the digital television side, we have agreements and shipping products with several OEMs including Samsung, LG, Panasonic, Philips, Toshiba, (inaudible) and Vestel. So we have quite a few number of the DTV's signed up out there today.

Much of the used case today is allowing you to take a USB stick, for instance on load a DivX video on it and simply stick into the side of the TV and watch your video, it's that easy. And that's the value of proposition today. Increasingly, a number of these devices are getting internet connectivity and we are building the next generation of our DivX connected platform to allow for an embedded solution where you simply turn on the television set and you are able to access internet video live on these devices.

We think it's a huge opportunity. The kind of the high end top of the range of digital television models today are giving internet connectivity built in. We expect that to come down, market relatively quickly and we are building it and discussing partnerships to basically bring internet video directly to these devices without a PC being on in the middle of it, a really simple solution that's as simple and easy as turning on your TV and changing channels. And that's what's we are building towards and we are very excited about the future around that.

John Bright - Avondale Partners LLC

So, do you view the DivX Connected opportunity from a software standpoint as more attractive or do you view the Digital TV opportunity over the next year as more attractive?

Kevin Hell

Well, they are both related at the end of the day. Once in the current model and we expect the current model around digital televisions and we'll call the disconnected model, remove your media to a memory stick and plug it into the device. That's the current model that will essentially drive the licensing in the short-term. Over the longer-term we're building this platform that we think is really the exciting home run for the future. And that's what we're building towards that we think will ultimately replace the used cases having removed your content physically to these devices.

John Bright - Avondale Partners LLC

You mentioned on the Hollywood content discussion US side for downloading shortly. Do you want to expand upon that?

Kevin Hell

In terms of the timing all I can say obviously it's depended on our partners, but this is something that its going to happen relatively shortly. So I'll say at this point in time we are very excited about it. It will have content from number of the studios and it will be the first US site to have that available.

John Bright - Avondale Partners LLC

And would you guys when you look at your usage of cash do you rule out anything for usage of cash right now rule out a buyback at this juncture or are you keeping all the chips on the table?

Dan Halvorson

John that's a good question. We get that from time-to-time and quite often at these levels picking upon the team Paul just mentioned and you are asking. So as you know we did a buyback, actually you and others may have forgotten. We did a $20 million buyback within a year-ago. Of course we spent just under $30 million for the acquisition of MainConcept.

So I think you acquired, the second part the way you asked the question of buyback, or other, you know all the options on the table. I think all the options are on the table and I think you've seen that management is not afraid to use the cash and deploy it appropriately. At this point we continue to look at our options we continue to look at what to do with it and it's very important to protect the balance sheet. But at the same token, the right use of cash is something we look at a management and Board level constantly.

Operator

Next, now to Steven Frankel with Brigantine Advisors.

Steven Frankel - Brigantine Advisors LLC

On the Hollywood content it appears that you talked to players in industry most of the consumer activity today is around VOD. Are you able to modify these studio deals to include VOD in addition to DTL.

Kevin Hell

Today this is primarily around, these deals are really organized around, download-to-own, you see download-to-own today. They certainly contemplate the [impulsive] rental models, but that’s not the design today.

Steven Frankel - Brigantine Advisors LLC

And are they day and date with DVD release?

Kevin Hell

Yes.

Steven Frankel - Brigantine Advisors LLC

Okay. And DivX Plus how quickly would you expect your core CE customers to migrate from DivX to DivX Plus and is critical in your long-term strategic vision?

Kevin Hell

I think its definitely key to have DivX Plus with our major OEMs over time. Clearly a number of the chipsets are moving to supporting H.264. We also see growth of content much of the HD content that is coming out now on the internet is in a (inaudible) format and an MTV container and we support that with DivX Plus. So we think its important to continue to progress we are making with the emerging products to have OEM adoption or our DivX Plus HD program.

Steven Frankel - Brigantine Advisors LLC

When you talk about connected, at one point you were describing it as a way to really save the OEM a lot of handfuls by being the centre piece for a lot of different feeds, but when I look at these internet connected televisions. Today they are already doing that. They have a long list of partners, how does connected add value over what some of these high end TVs are doing today,?

Kevin Hell

They offer a few different offerings but they certainly don’t offer the breadth of content that we essentially are looking to do. So what we are looking to do is create a system that makes it very, very easy for you to add content quickly and expand the content list. If you can look at lot of the offerings that are out there today on many of the OEM devices they are fairly stale, they don’t get updated offering, they are fairly limited.

We are looking at building a system that would allow for a very broad base of content to be managed very seamlessly, very easily or the performance to be vastly improved over what is it today taking our embedded experience, our knowledge of chips and allowing you to have a much more fluid experience around your content. And then of course, we have the breadth of relationships with all the OEMs as well, and so we believe that we will be able to get that out there from a neutrality perspective both on the OEM side as well on the services side.

Steven Frankel - Brigantine Advisors LLC

I know you talk about the emerging technology percentage going up. Would you expect the dollars to go up in the third quarter or just a percentage of a smaller basis the red laser business shrinks?

Kevin Hell

Yes, Steve I have taken pause because that's one way for backing into the Q4 annual guidance, isn't it? It would increase in annual, I think our plan is that, our thought is that both as a percentage and absolute it will increase. The driver is that just without leaving to drive there, I mean there are drivers that we are still excited about my comments earlier, you've got CTVs, you have got the emerging and when you look at, it's not yet but when, when you look at what we've done, what we've delivered and the points that Kevin made just building on each other, when you think about the certified devices that come through are certainly out downstairs.

We've got over 25 people certifying the handsets, the DTVs, the Blu-ray [suits]. So the team that the company is doing a lot of things right and then we're dependent on the consumer and that's what as we look at we think about, if it doesn't happen in Q3, for Q4 revenue, I think we're pretty. Usually you come to know me as pretty measured, but I think we're pretty confident in the Christmas shipments things are going to take off, now to what degree, I am not specifying what happens with the economy, but certainly the Christmas shipments, there is going to be a lot of new emerging to take off.

But I think the direct answer to your question is yes, in terms of percentage and in terms of dollars we expect it to increase but the bigger point for you and potential investors, as we know that we're, we've got the ingredients, we are putting the building blocks in place for success here.

Steven Frankel - Brigantine Advisors LLC

What's your penetration today in Blu-ray devices, relatively. You talked about your red laser penetration, must have the right penetration?

Kevin Hell

Well, it’s still relatively early in terms of giving out a percentage of the penetration numbers. I’ve mentioned, we do have 300 devices out there that have been certified. 78 of those are HD models. We will start to update you on penetration stats but we’re still a little bit early on that market to be able to do that.

Operator

We’ll go next now to Rob Stone with Cowen and Company.

Rob Stone - Cowen and Company

I want to clarify on the US portal that you’re expecting soon. I think you mentioned that it would have content from several studios. The European partners that were announced today still have to [deuce] to your deals. Are you implying that this US announcement is going to come with the studio deal that’s already in hand?

Kevin Hell

Yes. We expect our US launch relatively shortly and if that includes, (inaudible) obviously studio deals have to in hand for that to occur.

Rob Stone - Cowen and Company

Okay. In terms of the next generation connected, two part question here. One, when do you think that will be available and two, how do you expect to address the problem of navigation because opening up everything that might be available out there on the Internet. I agree with you, it’s a large library, but then finding the desired content may not be something that you want to do, trying to browse on a remote control interface for instance?

Kevin Hell

Right. So the first question, that being specific, in terms of the exact timing is. It’s going to be in 2010. Clearly, we’d like to see it on the earlier side of that but we have a lot of things to put in place to make that happen until we get more specifics when we are ready to introduce the product. On the specific question around how you managed discovery and navigation on this. We’ve been putting a lot of work into that specific area, we want to strike the right balance between making a lot of content available but also making it such that it can be leaned back experience, it’s appropriate for television, the remote control. We think we’ve got a platform that will do that quite well, we are not yet ready to unveil that but we are confident that we’ve got a great solution in the works.

Rob Stone - Cowen and Company

Okay. Finally more of a housekeeping question for Dan. Expenses came down a good bit sequentially. Can you comment directionally on, you mentioned one of the principles was keeping expenses tight, what should we expect for Q3 in terms of the expense trend?

Dan Halvorson

Well, interesting enough coming off Q1, we all attend for those what you did, while we reduced it, but you know sequentially, you’re right. Rob, there’s a few things that go on. You’ve got CES, you’ve got marketing expenses, but that said it’s interesting and we can work through the models on more housekeeping. But on the trend, we’re going to continue to watch our expenses and I think directionally as you work through the numbers in the guidance and I’ll try to give you enough guidance.

Headcount, we do have some open reqs, so we’re being careful on our guidance related to open reqs. But then there is other areas that we’re looking at, the studio deals and the execution of the marketing around that and moving forward. I would expect the company to incur some marketing expenses. The other area where although it came down as you know, we have been spending legal costs that as we move forward we’re going to continue watch on some of the litigation that we’ve had, which is minimal.

So I think directionally, we’re going to continue to watch it and I’ll look forward to updating you on the results in the quarter. But there are puts and takes that are going on sequentially. Other areas we’re just seeing, trying to be diligent, smart where we spend our resources.

Rob Stone - Cowen and Company

So without drilling into the sub categories precisely do I sum all what you just said correctly by, inferring that expenses will be flat to up slightly in the third quarter in total?

Dan Halvorson

Yes, that’s the way to think about it. It’s flat, yes directionally flat to up. That’s right.

Operator

We go next now to Jack Hain with Barrington Research.

Jack Hain - Barrington Research

Most of my questions were actually answered already, but I have a couple lingering ones here. And I’m sorry if you have already addressed this. But is there any direct economic benefit for these DTO site deals or is it all sort of indirect through ecosystem growth et cetera?

Dan Halvorson

Well there will still be a combination, we get a very strong and direct benefit immediately from our the negotiations that we do on the licensing side with our OEM partners and it has a huge benefit right away, by validating the technology and showing off the use case and also making it something where they absolutely want to have DivX out there and have it working well. Given the fact that will leave this content out there in the marketplace. In terms of these specific relationships there is a REVshare component to many of these deals and there are also opportunities to drive traffic to these new sites as well. Is it going to be material from a revenue perspective in the early days, no I would not model it such, but there are revenue elements coming from these new deals.

Jack Hain - Barrington Research

Okay, that’s helpful. So I know that ultimately the negotiations for DivX also going to happen between yourselves and the OEM partners. But you know ultimately that’s going to be driven by consumer demand for the technology and I am just wondering if there is any concern on your part that creation of H.264 content with DivX 7 is going to be a bit less robust down with there so much content for the available in the Internet as they compare to their earlier days of MPEG-4/2. I was just wondering if you could can add any color there?

Dan Halvorson

Again as we mentioned in the past we clearly are creating tools sets that will drive, we believe will drive the creation of content that can take advantage. That can be used on our DivX Plus HD devices out there in the marketplace and thereby create demand. We've got a lot of initiatives around that to make sure both to our own software and to third party software that we stimulate the creation of content that would be incompatible with our devices in the marketplace.

In addition we’ve also designed our certification program in such a way that a lot of the content that’s out there in HD format will also work on our devices as well, so that we take advantage of the biggest footprint of content as possible to drive demand for our devices.

We do see positive response from our OEMs. They know and they have experienced the power of our certification process, and the fact that it guarantee is a great experience for consumers and the fact that brand has real value from a consumer perspective. When consumers see the DivX brand, they know it’s just going to work and that’s pretty powerful and its valuable to the OEMs. And what we did for the MPEG-4 market, we’re also being trying to do with H.264 as well.

Jack Hain - Barrington Research

Okay. And I have one last sort of clarificatory question. Kevin you said earlier that about 13% of total revenues in the quarter were from emerging product categories and if that number should double by year-end, I was a little unclear what you meant by that, does that mean that 26% of revenues by year-end will be from emerging product categories? Is that just full year '09 versus full year '08?

Kevin Hell

So, I’m saying by the end of the year the contribution of emerging product categories will be roughly double of the 13%. Yes, so roughly in that range.

Dan Halvorson

That’s based again on the fact that we have so many devices being certified, we have this great relationship and are seeing those products going out into the marketplace. We are of course always dependent on the macroeconomic situation that’s out there. But we feel very comfortable that we’re seeing tremendous traction in all three of these categories, Blu-ray, DTV and mobile phones.

Operator

(Operator Instructions). With that we’ll go next now to Justin Cable with Global Hunter Securities.

Justin Cable - Global Hunter Securities

In terms of your licensing business, I know HD is sort of just getting off the ground right now. Has that yet contributed any revenue or is it simply just getting design wins in this early stage?

Dan Halvorson

No, we’ve seen several products already go out into the marketplace and ship that are HD capable. So it absolutely is already starting to drive real revenue for us. So we expect for the end of this year into the next year for that to increase pretty dramatically.

Justin Cable - Global Hunter Securities

Okay. Then on the last question about doubling the contribution from emerging products. Is this sort of what your expectation is for recognized revenues for Q4 or do you simply hope to get to this level by the end of Q4 in terms of revenue contribution?

Dan Halvorson

That we - on those prepared remarks and then follow-up. It looks like right now what we’re thinking is from shipments and the revenue recognized in that, like Kevin said approximately doubling. So rev req.

Justin Cable - Global Hunter Securities

Okay.

Dan Halvorson

In the fourth quarter, yes.

Justin Cable - Global Hunter Securities

Okay. On the media side, you mentioned that you’re exploring some new approaches with the Chrome distribution, can you elaborate on that?

Dan Halvorson

I can’t. At this point in time. We’ve had a great relationship with Google, we are working with them from 2004 through 2007 and we’ve had a long-standing partnership with them. We are pleased to get to be working with them on Chrome. It’s one of their earliest partnership with Chrome. We are also looking at other ways so we can expand the relationship but we are not yet in a position to describe this in detail.

Justin Cable - Global Hunter Securities

Then on the premium content side in launching this first sight in the US. Are you working with existing download to own sites or are you actually launching a brand new site?

Dan Halvorson

We are not yet at a position to talk about the partner. We will be in the relative near future however, so stay tuned.

Justin Cable - Global Hunter Securities

Okay. With these news deals with Lionsgate and Paramount, was there any up line investments required in [hard] dollar investment made to set up these relationships?

Dan Halvorson

There were, in the other deals we’re probably a size larger these deals. There were, what I think of is kind of marketing expense if you will that will amortize over period, but not large amounts.

Justin Cable - Global Hunter Securities

Then well lastly, looking at the overall tech licensing guidance for Q3 and kind of doing the math, it looks like the assumption is that the year-over-year comparison and technology licensing is going to be down sort of in the 25% to 33% range. I know you mentioned DVD players are down about 20% year-over-year. Is there anything else kind of going on in the channel or is it just basically reflecting your level of conservatism? Is there any additional color you can give us on the year-over-year comparison?

Kevin Hell

No, I think you have got it. I mean the 20 doesn’t exactly fit. It goes to an earlier question I think on ASP and think you’ve got a combination of the levers, but it really is volume driven and then in the number of contracts we have you got a couple that when you go back year-over-year that ASP may not be quite as strong but it’s largely driven by volume Justin.

Operator

Ladies and gentlemen it appears we have no further questions, Mr. Hell I’ll turn it back to you sir, for any closing comments.

Kevin Hell

Okay great well thank you again for joining us today we look forward to talking with you next quarter.

Operator

Thank you gentlemen. That will conclude our conference call. We thank you all for joining us. Again wish you all a great day. Good-bye.

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Source: DivX, Inc. Q2 2009 Earnings Call Transcript
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