DivX Q3 2007 Earnings Call Transcriopt

DivX, Inc.(DIVX)

Q3 2007 Earnings Call

November 5, 2007 4:30 pm ET

Executives

Kevin Hell - CEO

Dan Halvorson - EVP and CFO

Karen Fisher - VP of IR and Compliance

Analysts

John Bright - Avondale Partners

Paul Coster - JP Morgan

Steven Frankel - Canaccord Adams

Darren Aftahi - ThinkEquity Partners

Rowan Wolfstorf - Cowen

Jim Goss - Barrington Research.

Presentation

Operator

Welcome to the DivX Incorporated Third Quarter 2007 Operational and Financial Results Conference Call. As a reminder, today's call is being recorded. At this time, I would like to turn the conference over to Miss Karen Fisher. Please go ahead, Ma'am.

Karen Fisher

Good afternoon and thank you for joining the management team of DivX. I am Karen Fisher, Vice President of Investor Relations and Compliance, and I look forward to working with each of you on a regular basis going forward.

With me on the call today is Dan Halvorson, our Executive Vice President and Chief Financial Officer and Kevin Hell, the Chief Executive Officer for DivX. Before we get started, I would like to read a brief Safe Harbor Statement and then turn the call over to Dan Halvorson.

Statements made during this call that are not strictly historical in nature constitute forward-looking statements. Such statements include, but are not limited to, statements regarding the potential separation of Stage6 into a private company, the anticipated timing and benefits of the transaction, expectations regarding Stage6 expenses for the fourth quarter of 2007, top-line growth and earnings potential of the Core DivX business, the Company's position in the digital media space, the Company's plans for its software bundling partnership with Yahoo, plans for expanding the Company's core licensing business, expectations for DivX Connected, plans for extending the Company's content licensing partnerships and anticipated financial results for the fourth quarter of 2007. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause DivX's actual results to be materially different from those expressed or implied by such forward-looking statements.

These factors include, but are not limited to, the risks that the contemplated separation of Stage6 into a private company may not be completed when expected or at all, risks related to the implementation of the proposed transaction, risks related to any uncertainties surrounding the proposed transaction, the risks that the anticipated benefits of the proposed transaction may not materialize to the extent expected or at all.

The risk that customer use of DivX technology may not grow as anticipated, the risk that anticipated market opportunities may not materialize at expected levels or at all, the risks that the Company's activities may not result in the growth of possible revenue.

The risk that the Company's financial performance in the fourth quarter of 2007 may not meet expectations and other factors discussed in the risk factors section of DivX's most recent quarterly report on Form 10-Q filed with the SEC on August 14th, 2007.

All forward-looking statements are qualified in their entirety by this cautionary statement, and DivX is providing this information as of the date of this call, and does not take 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 are not able to stay on the call today, an audio webcast will be archived on our website under Events and Presentations at www.investors.divx.com.

At this time, I would like to turn the call over to Dan. Please go ahead.

Dan Halvorson

Thank you, and welcome to our third quarter earnings call for 2007. As I get started, I would like to congratulate Kevin Hell on his appointment as Chief Executive Officer and a new board member of DivX.

Our agenda for today's call will be as follows. First, I will provide commentary on our high level financial results and the status of Stage6. Then, Kevin Hell will provide some color about the quarter and talk about near and mid-term objectives and opportunities for the business.

And lastly, I will review the quarter and provide guidance.

Taking a quick look at the financial highlights for the quarter, record revenue for the third quarter was $21.9 million. Our GAAP EPS for the quarter was $0.2 per share, non-GAAP EPS was $0.17 per share and we generated non-GAAP profit of 5.9 million. I am pleased to report that we came in ahead of our Q3 guidance.

Excluded from the non-GAAP EPS is the following. Stock-based compensation net of related taxes accounted for $0.04 per share, this was in-line with our guidance. Our investment in Stage6, net of related taxes accounted for $0.07 per share, again in-line with guidance. And then an impairment charge to intangible asset related to our acquisitions of Veatros that accounted for $0.04 per share. I'll discuss this impairment charge in more detail later in the call.

Before I turn the call over to Kevin, let me provide you with an update on Stage6. As we shared with you during our Q2 earnings call, we continue to believe a vibrant video-echo system driven by content that uses the DivX format adds value to DivX. In order to sort through the various alternatives available to us related to Stage6, we have retained an investment banker to work with us to think through [short-term] alternatives.

I believe, we are well positioned to determine the best strategy for this asset. I am sure many of you will have questions and I look forward to keeping investors appraised to our progress over the coming months.

With that, I will turn the call over to Kevin.

Kevin Hell

Thanks, Dan. I am honored to join you today as the CEO of DivX and I appreciate the recent vote of confidence from our Board of Directors. Seven years ago, the DivX founders had a great vision of the digital media future and built a highly successful company. Going forward, I am excited to lead this company and its talented team, as we continue to make this vision a reality and establish DivX as the de facto standard for high quality digital video across any device.

Now, let's discuss the progress of our business and provide an update on our strategy. In the third quarter, we made significant progress towards our goal of transforming and improving the digital media experience for consumers.

Let's review a couple of the key highlights: We announced our first partner for DivX Connected to D-Link. We'll begin shipping products shortly. We entered into very exciting new partnership with Qualcomm. We signed a multiyear software distribution agreement Yahoo. We increased our market share in the U.S. and global DVD player space, and finally we entered in to an expanded relationship with LG Electronics, covering digital televisions, a new mobile handsets and a multiyear contract renewal.

Let's discuss these developments in context to both, the most recent quarter and our broader strategy of transforming the media experience for consumers.

Last quarter, I discussed three areas of focus for DivX on the earnings call. First: grow our licensing business, second: launch our DivX Connected platform and third: build our content solutions business through a powered by DivX approach.

I am going review our progress in each of those areas starting with our core licensing business. In Q3 we grew our existing DVD market share and continued to penetrate new product categories. The first and largest for those categories is the mobile market, an area where we made significant strides during the quarter.

In September, we announced a strategic relationship with Qualcomm, one of the world’s leading manufacturers of integrated circuits for mobile devices. The licensing agreement will allow Qualcomm to incorporate DivX technology into a range of video-enabled chipsets, with the potential to dramatically increase the number of DivX Certified mobile handsets. Qualcomm is a major player in this space, and we believe the strategic partnership will pay strong dividends, as we penetrate the mobile market.

We announced that LG Electronics has become the second major OEM partner to achieve DivX certification for a mobile handset. The LG [PRADA] phone offers the sleek and stylish multimedia experience and is now on sale in key European markets. We are very excited about this product and the potential volume it represents.

Showing further traction in the mobile space, Samsung announced expanded retail availability of the DivX Certified F500 handset, during the third quarter. Previously for sale only in Europe, this Samsung F500 is now available on a global basis.

These accomplishments show real traction for DivX in the middle market, a market which is over seven times larger than the DVD player category in terms of total unit volume.

DVD remains our largest market opportunity in the short-term, so let's turn to our progress there. While the overall DVD market remains flat, we have continued to increase our share of DVD products among major partners while increasing regional and global penetration.

Over the 12-month period ending June 30th, our worldwide DVD penetration was approximately 37%. This compares to a penetration of 25% during the previous 12 months and represents an increase of 45%. On a regional basis, we maintained our historically high penetration rates for our Western and Eastern Europe, while increasing penetration in the U.S. and other markets. Of particular note in Q3, DivX penetration in the U.S. market grew to 31%, an increase of 53% over the same period last year.

These penetration gains are a direct result of our growing relationships with the key OEM partners, as they react to increasing consumer demand for DivX devices. In Q3, our top 5 OEM partners, taken as a group, increased unit shipments of DivX Certified products by 55% relative to the same period last year. What's more, we are especially pleased that we have been able to achieve this growth while maintaining our historically strong average royalty rates. This trend is consistent with our overall goal of increasing market share while maintaining unit pricing levels in the DVD sector.

I would like to also mention that we signed a multiyear contract renewal with LG Electronics in Q3. LG offers a complete line of DivX Certified DVD players in global markets and is leading the way towards adopting DivX in a variety of emerging product categories. Specifically in August, we announced DivX Certification of the LG Time Machine Series of digital televisions.

That's an overview of our progress in our licensing business. We are experiencing significant traction penetrating new product categories, specifically the mobile market, posting strong growth in our core DVD Player category.

The second area of focus is the DivX Connected, the next step in our mission to transform the digital media express. DivX Connected is an open platform that enables users to easily access content and services from the PC or the Internet on a variety of consumer electronic devices. Over time, DivX Connected has the power to transform our business model and become the operating system of the digital home.

DivX Connected experienced a major milestone in Q3 with the announcement of D-Link as our first OEM partner. The D-Link DSM-330 DivX Connected HD Media Player is slated to launch this quarter in Germany, France and the U.K., at an affordable price point comparable with a high-end DVD Player. The device is available for pre-order now on European retail sites, such as Amazon and we are ramping up marketing and promotional efforts around the upcoming launch and partnership with D-Link.

We recently received extremely positive reviews from a number of press outlets who have tested the device and compared it favorably to competitors in terms of usability, feature support and digital quality. While the D-Link relationship is a major step for our DivX Connected initiative, it's important to note that DivX Connected is a platform, not a single product and we continue to engage with a variety of partners to allow their products to support DivX Connected. We will update the market as we sign additional partners and expand product availability.

We remain confident in the success of DivX Connected, that provides consumers with the high-quality open and affordable media experience that bridges the gap between the PC and the living room.

The third area of focus for DivX is around expanding and broadening content solutions that are powered by DivX approach. The Stage6 website is a good model of a third-party site that can utilize the DivX content solution to deliver a high-quality video experience to consumers.

Our goal is to partner with a variety of publishers and content providers to power the delivery of everything from user generated to premium content. As we said in our last call, we continue to focus on pursuing partnerships with premium content providers such as Hollywood Studios and Broadcast networks.

In addition, we are actively engaging with a number of user-generated content sites who can benefit from the high-quality and interoperability of DivX as a distribution solution. A great example of this can be seen at the popular community site deviantART.

At the end of the third quarter, deviantart.com, which reaches over 17 million unique monthly visitors, launched a high-quality video section, powered by DivX technology.

Before I wrap up, I'd like to briefly discuss another significant new relationship we announced this quarter. In September, we entered into a two-year agreement with Yahoo! to distribute the co-branded Yahoo! toolbar an internet explorer browser with our software. This will replace previous third-party software tools from Google, offered to our consumers for the last few years. We are excited about the Yahoo! relationship, and believe our bundling business validates the continued strength of our software offerings to our global user base.

Our multi-year Google relationship has been valuable to our business, and we are excited to move forward with Yahoo! or continue to explore additional strategic synergies with both companies.

To summarize Q3, we achieved strong operational success by executing on our core vision. During the quarter, we reached significant milestones and continued to work with our partners to build an interoperable ecosystem that allows consumers to enjoy a high-quality digital content experience when and where they choose.

The strength in the existing relationships with major OEM partners bodes new strategic relationships in key growth areas for our business and continued to grow consumer adoption and overall penetration in our core DVD licensing business.

In addition, we put the final pieces in place for the launch of DivX Connected, one of our most important new initiatives. These developments point squarely to the emergence of DivX as a de facto standard for a high-quality digital video experience across any device.

With that I'll turn the call back over to Dan to provide further information on our financial forecast.

Dan Halvorson

Thanks, Kevin. I will recap the quarter, provide an update on Stage6 activity and then walk you through our guidance for Q4.

Quarterly revenue of $21.9 million represents an increase of 42% over the same quarter last year. Technology licensing revenue for this quarter was $17.1 million, representing a 37% increase over the same quarter last year and a 20% increase from the preceding quarter. Similar to Q2, technology licensing revenue in Q3, included a $500,000 payment from Google for the use of our technology in international markets.

We had one hardware license customer LG, which accounted for more than 10% of total revenue. During Q3, we renewed an LG agreement, and recognized revenue from the new agreement as well as the [Bluebird show] of about $500,000 from the old agreement.

Breaking this line item down further, revenue from technology licensing to hardware manufacturing partners was approximately 71% of total revenues for the quarter. Technology license for software was approximately 7% of total revenues for the quarter.

Media and distribution revenue for the quarter was approximately $4.8 million or 22% of total revenue. This approximately 64% more than the same quarter last year, and up sequentially 19% Q2 of '07. Of the 4.8 million media and distribution revenue for the quarter, software distribution revenue represented approximately 21% of total quarterly revenue. Google accounted approximately 23% of total Q3 revenue, 21% of which is in the media and distribution line and the balance is related software licensing revenue.

As Kevin announced earlier in this call, we are pleased to be working Yahoo and anticipate a smooth transition between Google and the newly signed Yahoo agreement with revenues to be recognized in Q4. The mix across geographies for the quarter was 65% Asia-Pacific, 28% Americas and 7% EMEA.

This geographic revenue mix represents the location from which our partners’ great products are now or the products are shipped. Gross margins remain solid at approximately 95% consistent with the second quarter. These high gross margins illustrate, what I believe, is the earnings potential of our technology licensing business which you can see both in our supplementary earnings table and in our guidance.

Now, let me focus my comments on expenses. I will talk about our expenses consistent with the non-GAAP breakup provided in the supplemental earnings tables detailing Stage6 expenses, stock based compensation and our asset impairment. Total operating expenses in the quarter of $21.7 million included core DivX business expense of $13.1 million or approximately 60% of revenue. $4 million from our investment in Stage6, $2.4 million of stock based compensation and a $2.2 million asset impairment charge related to our Veatros, acquisition.

As you may recall we acquired the assets of Veatros in Q2. While we continue to development the Veatros technology of real time digital video processing, the future cash flows of this asset are uncertain. From an accounting perspective, it was necessary to incur impairment charge of $2.2 million during the quarter related to this asset.

Breaking down the line items, SG&A was $15.1 million in the quarter or 69% of revenue, compared to $6.7 million or 43% of revenue in the third quarter last year. SG&A for the core DivX business was $9.5 million or 43% of revenue. The Stage6 SG&A expense was $3.7 million or 17% of revenue. Approximately two-third of the Stage6 expenses in the third quarter was related to bandwidth.

Product development was $4.3 million or 20% of revenue. Stage6 accounted for a small portion of product development expense at approximately $300,000.

Next, let's examine Stage6 metrics and costs in more detail. As we mentioned in the past, the side experience a huge trajectory in 2007 moving from 4 million “uniques” in April to 10 million by July. At the end of October, Stage6 reached 11.7 million unique visitors. Our view is the number of unique could have been higher, but we're limited by infrastructure capacity. To accommodate the increased traffic we have continued to enhance the Stage6 infrastructure.

During the quarter, Stage6 cost were $4 million compared to $4.5 million in guidance we provided on August 9. As we previously discussed, the Board approved plan calls for expense was of to approximately $6 million in Q4 or up to $10 million combined over the second half of the year.

Our core DivX Q3 operating income was $7.8 million or 36% of revenue. Including the investment in Stage6, stock-based compensation and the asset impairment charge for Veatros we had a GAAP operating loss of $800,000.

Our interest income for the quarter was approximately $2 million. Stock-based compensation expense, net of cash for the third quarter was $1.4 million or approximately $0.04 per share compared to $1.2 million in the second of 2007.

I'll now turn to the balance sheet and cash flow statement. We ended the quarter with total cash and investments of approximately $163 million or approximately $4.70 per share. Accounts receivable balances declined to $3.2 million and our day sales outstanding were approximately 22 days. We generated approximately $10.3 million in cash from operations during the third quarter. We invested approximately $800,000 in capital expenditures in the third quarter.

We have a solid financial quarter, both from a revenue and expense standpoint, as well as increased our cash position. Business continued to be profitable and is meeting our expectations. Headcount was down as a result of the Stage6 transition and routine organizational attrition, as well as diligent expense management in a number of areas.

Moving into the fourth quarter, we do anticipate to ramp up in marketing cost, as we expand our core business and prepare for the Consumer Electronics Show in Las Vegas in January. In addition, expenses associated with being a public company such as audit, Sarbanes-Oxley compliance will continue to be significant expense area for the company.

To recap, the Q3 GAAP EPS was $0.02. Stock-based compensation net of related taxes was $0.04. Our Stage6 investment, net of related taxes was $0.07, and the impairment charge related to Veatros' asset was $0.04, net of related taxes.

For Q4, we are reiterating guidance on the top-line and expect revenue of approximately $22 million to $23 million in the fourth quarter. GAAP EPS in the fourth quarter is expected to range between a $0.04 loss per diluted share and $0.02 loss per diluted share, which includes non-cash share-based compensation of approximately $5.6 million, $3.4 million or $0.10per diluted share net of related taxes. And our Stage6 costs of approximately $6 million, which is $3.2 million or $0.10 per diluted share net of related taxes.

Included in our Q4 FAS 123R expense guidance an accounting charge of approximately $3.2 million or $1.9 million or $0.06 per share net of related taxes, which is specific to the settlement and cancellation of our unvested stock options for Jordan Greenhall, a former CEO upon his resignation, as an employee of the Company effective October 1st.

Excluding the effect of these two items, the raising our core business EPS guidance to $0.16 to $0.18 per diluted share is evidence of our commitment to profitable growth.

I hope that this illustrates both the opportunity and profitability that we believe is rooted in our core business.

With that we'll open the call up for questions.

Question-and Answer Session

Operator

(Operator Instructions). We'll take the first question today from John Bright, Avondale Partners.

John Bright - Avondale Partners

Thank you. Good afternoon, gentlemen. Kevin, first for you, if you look out to 2008, how would you characterize the way you see the opportunity out to 2008?

There has been a lot of concern in the marketplace that the DVD market is going to flatten or your penetration will peak. How would you characterize your outlook at this juncture for 2008?

Kevin Hell

John, you always treat us with such a great question. You know, I've been with DivX for five years now John. We're as optimistic as ever about the outlook for the business going forward into 2008.

We continue to have, and see, strong penetration in the DVD markets. We're also seeing now, in this latest quarter, some great traction in emerging product categories.

We've just launched a very exciting product with D-Link, on conducted and we're also very, very optimistic about our continued progress with content solutions and so: Yes, I am very optimistic as we look forward to 2008.

John Bright - Avondale Partners

Okay. On the Stage6 update, Dan, you said you have an investment banker in place. What, are you still reiterating your commitment to having a decision in place by the end of the calendar year?

Dan Halvorson

Yes hi, John. That’s right, that’s fair, and as I indicated in the prepared remarks, there is probably inherently a lot questions around Stage6, but we will have, our plan is to have a decision in place by year end, that’s correct.

John Bright - Avondale Partners

Would you characterize, how would you characterize, the level of interest at this juncture?

Dan Halvorson

I was really hoping not to get in, I just, to some degree for negotiating purposes and others, I think it’s somewhat inappropriate, to get too detail. But, I think, there is a process, it’s moving a pace, and sitting here in the first part of November, I am pleased to think that I have this 60 days runway of executing, but I think there has been a lot of ventures. There has been a process that’s ongoing and I do spend a lot of time on Stage6.

John Bright - Avondale Partners

Okay. I missed the unique visitors, did you provide that numbers?

Dan Halvorson

We did John, in October would be 11.7 million.

John Bright - Avondale Partners

Alright, and then the last question, Kevin this is for you, you have a 10b5 in place and so, a number of investors would have seen the selling take place. Does that 10b5 continue going forward, I mean if so, would you consider maybe changing that?

Dan Halvorson

John no, you won’t be seeing for this sale in that plan, John.

John Bright - Avondale Partners

Okay. Is that something that just took place recently?

Dan Halvorson

That’s right.

John Bright - Avondale Partners

Thank you.

Operator

We’ll take our next question from Paul Coster, JP Morgan.

Paul Coster - JP Morgan

Thank you, a few quick questions. First of all Dan, was there any currency benefit this quarter?

Dan Halvorson

No, Paul. No, significant impact on currency.

Paul Coster - JP Morgan

Can you tell us: what we should we should be thinking in terms of the replacement of Google by Yahoo? Is this straight swap from a financial perspective or is there more to it than that?.

Dan Halvorson

You know, I think from a straight financial perspective, it’s a tough one because I haven't expanded on the guidance and we typically don't give, I guess, what they call a line item or by customer guidance, but it’s certainly a fair question relative to Google and Yahoo. What I would tell you is, on an over arching view, we are pleased to do replacement as all of -- lot of you have talked to us about when I think that one I joined, one of the first question was Dan is new CFO, you have got a contract that's going to come up, is coming up. It is coming up for a new how are you going to fill that gap, and I think that I am comfortable to say that we've filled that gap and replacing Google with Yahoo is something, from a financial perspective, very comfortable with and then as different people have written about it, I think that also expand the opportunities for DivX Copper, if you will, into the ecosystem. So, I am very pleased to be able replace Google with Yahoo notwithstanding Google has been a great partner and is still valuable is the DivX ecosystem.

John Bright - Avondale Partners

Can you still see licensing revenues from Google, what you think?

Kevin Hell

This is Kevin, We are going to continue to explore strategic opportunities with Google going forward, as well as, Yahoo apart from beyond this toolbar. There is nothing that we were prepared to announce at this point in time but we do continue to maintain great and strong relationships with both companies.

John Bright - Avondale Partners

Kevin, in the past you have expressed hope regarding Sony North America to become a licensee, what’s there?

Kevin Hell

You are talking about the Hollywood space?

John Bright - Avondale Partners

No, on the DVD front?

Kevin Hell

In the DVD front. Right, we continue to work with Sony to get our DVD products to the U.S. market. We don't have anything to announce at this time. We are seeing continued strong penetration of the U.S. market overall in terms of DVD penetration. However, Sony has still not launched our product in U.S. market. We will keep you appraised as soon as we get there.

Paul Coster - JP Morgan

In terms of DivX Connected beyond D-Link products, are we would likely to see other OEMs coming onboard in the next three to six months?

Kevin Hell

We are working on both OEMs and IT chip solutions that will allow Connected to come out through broad range of products and our goal is absolutely to have product out from a number of OEMs in 2008.

Paul Coster - JP Morgan

Okay. My last question is really just the statement and I'd like to confirm, which is that, we will see typical seasonality or the first quarter will be reflecting unit shipments from the fourth quarter, to one quarter lag. Is that correct? So that would be the seasonally strongest quarter. Is there any reason to suppose that seasonality is going to be in some moderation in anyway going forward?

Kevin Hell

Well, majority of our revenues still come from the DVD market. To that extent the DVD market follows certain seasonality and so will our revenue streams going forward. So, there is no -- at this point there is nothing that I would see out there that would significantly change that. Obviously, as we move into emerging product categories and also add in other content services, we may see that seasonality change, but that's not likely to have a huge impact in 2008.

Paul Coster - JP Morgan

Great. Congratulations on the new role, Kevin.

Kevin Hell

Thank you.

Operator

Next we'll hear from Steven Frankel, Canaccord Adams.

Steven Frankel - Canaccord Adams

Kevin, I wonder if you might update us on your efforts to secure Hollywood content in the DivX format?

Kevin Hell

Sure. We continue to aggressively pursue Hollywood content and believe that there is a strong rationale for a deal. Of course, these sort of deals take time, particularly with our [opera] products where we're working across the number of different device types and a number of different brands, but we think the rationale isn’t severe and nor the premium content of ours is compelling. We have over 100 million devices out there that are certified. All those devices have [D-Arm] inside and so ultimately we believe that its just matter of time. Once we do get these folks on board, the studios and other premium content owners, we'll then be working with other folks like Amazon or Netflex to enable service for distribution powered by DivX models. So that's absolutely still our goal.

Steven Frankel - Canaccord Adams

Okay. A lot of chatter among investors about H.264. Is there a role DivX can play around H.264?

Kevin Hell

Absolutely, yeah, we are looking at it very closely, I mean H.264 is a great technology, but it's really not well understood by consumers yet. And its also there is lot to competing and permutations across different devices and applications. So it's a really great opportunity for now DivX to step in and with our brand and our OEM relationships and standardize the experience for consumers. So we are working right on H.264 solutions and we'll keep posted once we have a specific product announcement.

I should always say that our goal is really to make formats like H.264 really transparent to the user. We don't want the use to think about what format content is in and we want the content to just work on any device and so our strategy is to build the brand that represent interoperability and high quality video on any devices without worrying about what format the content is in again today. We obviously support FX4, MP3, MP3 surround and number of other formats. We are looking at things like H.264 while we continue to add where we can continue to add format support to our overall brand and our mix, so that we can extend the overall experience for the consumer.

Steven Frankel - Canaccord Adams

Great. And lastly, a couple of conference calls ago, you talked a third digital camera manufacturer coming on is that still in the pipe line?

Kevin Hell

Yeah. That's still in the pipeline. As we talk about that we have two partnerships in product Casio and Pentax. Pentax is now up to 7 skews. There was a, and there is a third additional partner, and we're going to announce that once they actually have products certified, ultimately it's driven by our partners' timelines.

We also do think that going back to Hdot264, that adding Hdot264 will accelerate our progress in the camera market going forward since most of the chips in the camera market now are going in this direction.

Steven Frankel - Canaccord Adams

And can you or the CE partner do Hdot264 in the same chipset that they are doing DivX in today, or does it require change to that building material?

Kevin Hell

It would be fairly expensive to do multiple different implementation, that's why I think when a camera maker looks at going toward Hdot264 architecture, at that point, it likely is going to be that it would be harder for them to be able to do DivX. And so that's why for us as we have Hdot264 we believe our efforts in camera market will be accelerated.

Steven Frankel - Canaccord Adams

Okay, great. Thank you very much.

Kevin Hell

Sure.

Operator

Next we'll hear from Darren Aftahi, ThinkEquity Partners.

Darren Aftahi - ThinkEquity Partners

Hey, guys. A couple of questions. First: can you talk about the Qualcomm relationship’s kind of the expected lead times for handsets licensees in terms of when that would potentially hit the model? And then I have got a couple of follow-ups.

Dan Halvorson

Sure, the agreement with QUALCOMM is to allow QUALCOMM to include DivX technology process in its family of mobile chipsets. And so, like with DVD players, surely the OEMs that ultimately are the ones that pay for DivX. So I see partners like QUALCOMM simply put the DivX into the chip. So, it’s available out there.

In terms of timing, I think it’s important to point out that both the Samsung F500 and F508 phones as well as the LG beauty phone have a day span shift from QUALCOMM. They actually have a two -chip solution that uses a multimedia process or and a day span shift from QUALCOMM.

And so, in terms of time to market, we're seeing a number of acquisitions like that now that will allow our partners to get to market directly with this approach while also looking at phone solutions that do it in software as well. And so, that allows our partners to come more quickly to market with QUALCOMM chips or other chips for the matte.

Darren Aftahi - ThinkEquity Partners

Okay. And then on the connecting side, one -- we're going to see U.S. space device by the end of the year, and how important is having broader studio adoption of negative DivX content for them to be or Connected strategy and then I got one follow-up financial for Dan?

Kevin Hell

Okay. Going to Connected, in the U.S. market, ultimately this is driven our partners and the choices they make like with DVD we expect Connected to take off first in Europe while our brand is strong as, I mean, it really grows from there. As we continue to demonstrate success with Connected with the launch in Europe, we expect it will come to the U.S. I can't be specific about timing, but my hope would be sometime in 2008.

I should also mention that the D-Link product is going on sale on November 12th and it’s going to be sold through a number of outlets, which is Amazon in U.K. and Germany and also Pixmania in France. We are very excited about this launch and the initial part reviews that we've been seeing our there.

In terms of the importance of studio content to Connected, I think Connected in its current form and the sense that it has access to all of your music, your photos and, of course, your video, as well as access to Stage6 and other services is a compelling offering and I believe that its something that solves the problem out there, unlike any other platform that's out there today.

That said, of course, I do see Hollywood content is been accelerated to Connected. So I believe that, that the current product has lot of the value in the market and I think with a Hollywood based service from a blockbuster on Amazon or something like that would really help Connected to continue to grow over time and that would be my expectation is that we eventually do offer those sort of services on Connected.

Darren Aftahi - ThinkEquity Partners

Thanks, and then finally for Dan, it looks like the revenue for the fourth quarter your guidance is flat, but EPS is up $0.03 across the range. Can you just talk little bit about what's going on there?

Dan Halvorson

Sure, with regards to -- I think at this point we had called that guidance, as you say, is flat, flat as it was from -- you're referring to the August 9th guidance, and that's right. We had [upbeat] by 900,000 in Q3 and I talked a little bit about that on the prepared, so at this point I didn't raise the revenue but I am very pleased to be able to increase the EPS guidance by, as you say, the $0.03 and that's a combination of what's going on there and I think coming in and being disciplined, taking a very measured approach to the costs, looking at headcount, recognizing that that's $0.03 is to me is a pretty important increase and it just shows the profitability.

What I had given before would have been about 28% to 30% operating margins and it's clearly above 30%. So I think I've got more comfortable since I have joined in the last few months that I've been in the saddle, to kind of pick the expenses apart and make sure I am comfortable with the expenses and therefore and I am comfortable raising guidance at this point.

Darren Aftahi - ThinkEquity Partners

Great. Thank you.

Operator

From Cowen, we will hear from [Rowan Wolfstorf]

Rowan Wolfstorf - Cowen

Well, gentlemen, thanks very much. My questions have actually been answered. Congrats on the quarter.

Kevin Hell

Thank you.

Dan Halvorson

Thank you.

Operator

(Operator Instructions). Next we'll hear from Jim Goss, Barrington Research.

Jim Goss - Barrington Research.

Well, thanks. A couple of questions. First Dan: on your ownership issues, one with Stage6. As you try to determine the course of action with that, are you trying to do it in a way where you would still be involved in some at least minority ownership and also you left the door open with Google. I was wondering what sort of involvement you think you might have with them going forward? And then I have a couple of others.

Dan Halvorson

Sure. Well, Jim, hi, and this is Dan. I will take the Stage6. With regards to Stage6, we did talked more elaborate about what thoughts were, there with different examples. Obviously, what we do with Stage6.com is something that we want to maximize shareholder value. So as your specific example about keeping minority interest, that's -- there is a variety of ways to look at it, whether if we keep a minority interest, some ownership interest or an outright sale, but, suffice it to say, without giving too detailed in it just because where we at, I don't think it's prudent to take a deep dive with this point with the ongoing discussions. Our intention is to maximize shareholder value with regard to that asset.

Jim Goss - Barrington Research

Okay. And in terms of Google?

Dan Halvorson

Yeah, in terms of the Google relationship, we've had a relationship with Google for a number of years and that was primarily focused around, obviously, the two of our, but we also did license our decoder to Google during that period of time. Ultimately, as you step back, you think about where it can go, I can’t be specific, obviously, but I can talk about where DivX comes in for folks like Google or Yahoo, at a strategic level, which is we really bridge the gap between video that's being distributed on the Internet and allowing that video to reach consumer electronics devices.

So, as these companies look to distribute video, not just a lower quality video to the PC platform, but look to really migrate the content of the PC to devices that are attached to televisions sets, or mobile phones, or what not, we are going to be the logical solution. So, that's what I would point to as the as the possible future as we look towards Google in the future.

Jim Goss - Barrington Research.

And lastly, as you move into this, seven times opportunity beyond DVD with cell phones and other mobile platforms, maybe talk about how you rank those opportunities and also whether you think you can get your branding camera, cell phones etcetera as part of your marketing agreement which would really--?

Dan Halvorson

Yeah, in terms of the overall emerging markets, they are actually, as we look at it right now, ten times larger than DVD market -- the mobile and cell phone market alone is seven times larger in terms of just unit volume alone. In terms of the ranking of those opportunities, I would say, mobile, given its size obviously, is probably the largest. We are also thus seeing DTVs, HDTVs, set top boxes and gaming consoles all being interested to us overtime as well. Cameras, of course, are important not just because it’s a large market, but because it is also a generic content in the DivX format, and as I mentioned I think in addition of Hdot264 to our overall media language will allow us to penetrate that more quickly as well.

Jim Goss - Barrington Research

The branding part is tough itself.

Dan Halvorson

Yes, sorry yes, branding, if you look at the LG Beauty phone today, you would actually see a DivX logo on the front of display. I think it will vary with every OEM in terms of what you they trying to achieve at the end of the day, but we are pretty optimistic that our brand provides a lot of value to consumers, consumers are looking for that brand and so that extent that will appear on these devices.

Jim Goss - Barrington Research.

Alright, thanks very much.

Dan Halvorson

Sure.

Operator

We'll take follow up question from Paul Coster, J.P. Morgan.

Paul Coster - J.P. Morgan

Yes, Kevin, your predecessor, previously spoken of the per unit royalties for the mobile handset, initially is above the corporate average. Is that still the case of volume of sort of agreement is kicking in or how we should we think about the royalty per unit in new product category?

Kevin Hell

Sure. Paul without getting too specific, that's, I guess, I think on one hand, if that's the case, you're pulling up predecessors a tall act to follow in some regard, I guess. I would say that I won't give too much color, but I think as you alluded to it, and as I think about where I came from with total wireless, with the analogy I make with the PC cards, I think that that’s a tough market we're moving in. As Kevin just articulated a much larger market, but I do think the leverage is well. So I am not sure that I follow that. I would think that probably mobile royalty rate is going to be less, directionally less, is what the way I would think about it.

Paul Coster - JP Morgan

And what about DivX Connected?

Kevin Hell

DivX Connected, I would expect our pricing to be higher than what we're seeing today for just home theater playback on a DVD player, given the value that it provides.

Of course, overtime, as we introduce rich services to that platform, we may be able to actually lower licensing to get market share, but at this point in time, I would expect the licensing be significantly higher than what we get right now on a DVD player.

Paul Coster - JP Morgan

Okay, thanks.

Kevin Hell

Sure.

Operator

We'll move back to Darren Aftahi, ThinkEquity Partners.

Darren Aftahi - ThinkEquity Partners

Two follow-up questions, can you give us any sense for CapEx kind of guidance in the fourth quarter, and then the Yahoo! agreement, is there any content relationship piece of the agreement that's kind of come to fruition as we go forward?

Dan Halvorson

Sure. Darren, I'll adjust the CapEx. As it relates to CapEx guidance, you might recall last quarter we talked about, just alone in the second half, for Stage6, we would have $2 million. If you look at the cash flow statement, or you look when we get more cash flow information, CapEx was around $800,000 for Q3.

So in Q4, I would expect CapEx to be have the Stage6 infrastructure cost we've talked about; they are kind of on their way in and plus other, so it's somewhere around $2 million round numbers.

Kevin Hell

And with respect to the content question, [Halvorson] has answered the same way I was answering it for Google. We don't have anything specific to announce this time, but clearly our direction is to work closely with partners such as Yahoo! and Google to help enable the distribution of content from their sites to reach consumer electronic devices.

Darren Aftahi - ThinkEquity Partners

Thanks.

Kevin Hell

Sure.

Operator

And Mr. Halvorson, I cannot see any other questions at this time. So I will turn the conference back over to you for any additional or closing comments.

Dan Halvorson

Great, well look behalf of all DivX employees, we would like to say thank you for your time and interest today with regards to DivX. Thank you.

Operator

Again, that does conclude today conference. I thank you all for joining us.

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