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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 - BarringtonResearch.

DivX, Inc.(DIVX) Q3 2007 Earnings Call November 5, 2007 4:30 PM ET

Operator

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

Karen Fisher

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

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

Statements made during this call that are not strictlyhistorical in nature constitute forward-looking statements. Such statementsinclude, but are not limited to, statements regarding the potential separationof Stage6 into a private company, the anticipated timing and benefits of thetransaction, expectations regarding Stage6 expenses for the fourth quarter of2007, top-line growth and earnings potential of the Core DivX business, theCompany's position in the digital media space, the Company's plans for itssoftware bundling partnership with Yahoo, plans for expanding the Company'score licensing business, expectations for DivX Connected, plans for extendingthe Company's content licensing partnerships and anticipated financial resultsfor the fourth quarter of 2007. Such forward-looking statements involve knownand unknown risks, uncertainties and other factors, which may cause DivX'sactual results to be materially different from those expressed or implied bysuch forward-looking statements.

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

The risk that customer use of DivX technology may not growas anticipated, the risk that anticipated market opportunities may notmaterialize at expected levels or at all, the risks that the Company'sactivities may not result in the growth of possible revenue.

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

All forward-looking statements are qualified in theirentirety by this cautionary statement, and DivX is providing this informationas of the date of this call, and does not take any obligation to update anyforward-looking statements discussed in this call as a result of newinformation, future events or otherwise other than as required under applicablesecurities laws.

For those of you are not able to stay on the call today, anaudio webcast will be archived on our website under Events and Presentations atwww.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 callfor 2007. As I get started, I would like to congratulate Kevin Hell on hisappointment as Chief Executive Officer and a new board member of DivX.

Our agenda for today's call will be as follows. First, Iwill provide commentary on our high level financial results and the status ofStage6. Then, Kevin Hell will provide some color about the quarter and talkabout 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 thequarter, record revenue for the third quarter was $21.9 million. Our GAAP EPSfor the quarter was $0.2 per share, non-GAAP EPS was $0.17 per share and wegenerated non-GAAP profit of 5.9 million. I am pleased to report that we camein ahead of our Q3 guidance.

Excluded from the non-GAAP EPS is the following. Stock-basedcompensation net of related taxes accounted for $0.04 per share, this wasin-line with our guidance. Our investment in Stage6, net of related taxesaccounted for $0.07 per share, again in-line with guidance. And then animpairment charge to intangible asset related to our acquisitions of Veatrosthat accounted for $0.04 per share. I'll discuss this impairment charge in moredetail later in the call.

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

I believe, we are well positioned to determine the beststrategy for this asset. I am sure many of you will have questions and I lookforward 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 ofDivX and I appreciate the recent vote of confidence from our Board ofDirectors. Seven years ago, the DivX founders had a great vision of the digitalmedia future and built a highly successful company. Going forward, I am excitedto lead this company and its talented team, as we continue to make this visiona reality and establish DivX as the de facto standard for high quality digitalvideo across any device.

Now, let's discuss the progress of our business and providean update on our strategy. In the third quarter, we made significant progresstowards our goal of transforming and improving the digital media experience forconsumers.

Let's review a couple of the key highlights: We announcedour first partner for DivX Connected to D-Link. We'll begin shipping productsshortly. We entered into very exciting new partnership with Qualcomm. We signeda multiyear software distribution agreement Yahoo. We increased our marketshare in the U.S.and global DVD player space, and finally we entered in to an expandedrelationship with LG Electronics, covering digital televisions, a new mobilehandsets and a multiyear contract renewal.

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

Last quarter, I discussed three areas of focus for DivX onthe earnings call. First: grow our licensing business, second: launch our DivX Connectedplatform and third: build our content solutions business through a powered byDivX approach.

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

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

We announced that LG Electronics has become the second majorOEM 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 inkey European markets. We are very excited about this product and the potentialvolume it represents.

Showing further traction in the mobile space, Samsungannounced 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 themiddle market, a market which is over seven times larger than the DVD playercategory in terms of total unit volume.

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

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

These penetration gains are a direct result of our growingrelationships with the key OEM partners, as they react to increasing consumerdemand 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 sameperiod last year. What's more, we are especially pleased that we have been ableto achieve this growth while maintaining our historically strong averageroyalty rates. This trend is consistent with our overall goal of increasingmarket share while maintaining unit pricing levels in the DVD sector.

I would like to also mention that we signed a multiyearcontract renewal with LG Electronics in Q3. LG offers a complete line of DivXCertified DVD players in global markets and is leading the way towards adoptingDivX in a variety of emerging product categories. Specifically in August, weannounced DivX Certification of the LG Time Machine Series of digitaltelevisions.

That's an overview of our progress in our licensingbusiness. We are experiencing significant traction penetrating new productcategories, specifically the mobile market, posting strong growth in our coreDVD Player category.

The second area of focus is the DivX Connected, the nextstep in our mission to transform the digital media express. DivX Connected isan open platform that enables users to easily access content and services fromthe 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 theoperating system of the digital home.

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

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

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

The third area of focus for DivX is around expanding andbroadening content solutions that are powered by DivX approach. The Stage6website is a good model of a third-party site that can utilize the DivX contentsolution to deliver a high-quality video experience to consumers.

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

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

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

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

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

To summarize Q3, we achieved strong operational success byexecuting on our core vision. During the quarter, we reached significantmilestones and continued to work with our partners to build an interoperableecosystem that allows consumers to enjoy a high-quality digital contentexperience when and where they choose.

The strength in the existing relationships with major OEMpartners bodes new strategic relationships in key growth areas for our businessand continued to grow consumer adoption and overall penetration in our core DVDlicensing business.

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

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

Dan Halvorson

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

Quarterly revenue of $21.9 million represents an increase of42% over the same quarter last year. Technology licensing revenue for thisquarter was $17.1 million, representing a 37% increase over the same quarterlast year and a 20% increase from the preceding quarter. Similar to Q2,technology licensing revenue in Q3, included a $500,000 payment from Google forthe use of our technology in international markets.

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

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

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

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

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

Now, let me focus my comments on expenses. I will talk aboutour expenses consistent with the non-GAAP breakup provided in the supplementalearnings tables detailing Stage6 expenses, stock based compensation and ourasset impairment. Total operating expenses in the quarter of $21.7 millionincluded core DivX business expense of $13.1 million or approximately 60% ofrevenue. $4 million from our investment in Stage6, $2.4 million of stock basedcompensation 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 digitalvideo processing, the future cash flows of this asset are uncertain. From anaccounting perspective, it was necessary to incur impairment charge of $2.2million during the quarter related to this asset.

Breaking down the line items, SG&A was $15.1 million inthe quarter or 69% of revenue, compared to $6.7 million or 43% of revenue inthe third quarter last year. SG&A for the core DivX business was $9.5million 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 quarterwas related to bandwidth.

Product development was $4.3 million or 20% of revenue.Stage6 accounted for a small portion of product development expense atapproximately $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 2007moving from 4 million “uniques” in April to 10 million by July. At the end ofOctober, Stage6 reached 11.7 million unique visitors. Our view is the number ofunique could have been higher, but we're limited by infrastructure capacity. Toaccommodate the increased traffic we have continued to enhance the Stage6infrastructure.

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 $10million combined over the second half of the year.

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

Our interest income for the quarter was approximately $2million. Stock-based compensation expense, net of cash for the third quarterwas $1.4 million or approximately $0.04 per share compared to $1.2 million inthe 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 $163million or approximately $4.70 per share. Accounts receivable balances declinedto $3.2 million and our day sales outstanding were approximately 22 days. Wegenerated approximately $10.3 million in cash from operations during the thirdquarter. We invested approximately $800,000 in capital expenditures in thethird quarter.

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

Moving into the fourth quarter, we do anticipate to ramp upin marketing cost, as we expand our core business and prepare for the ConsumerElectronics Show in Las Vegasin January. In addition, expenses associated with being a public company suchas audit, Sarbanes-Oxley compliance will continue to be significant expensearea for the company.

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

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

Included in our Q4 FAS 123R expense guidance an accountingcharge of approximately $3.2 million or $1.9 million or $0.06 per share net ofrelated taxes, which is specific to the settlement and cancellation of ourunvested 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 ourcore business EPS guidance to $0.16 to $0.18 per diluted share is evidence ofour commitment to profitable growth.

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

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

Question-and AnswerSession

Operator

(Operator Instructions). We'll take the first question todayfrom 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 theopportunity out to 2008?

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

Kevin Hell

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

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

We've just launched a very exciting product with D-Link, onconducted and we're also very, very optimistic about our continued progresswith content solutions and so: Yes, I am very optimistic as we look forward to2008.

John Bright -Avondale Partners

Okay. On the Stage6 update, Dan, you said you have aninvestment banker in place. What, are you still reiterating your commitment tohaving 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 indicatedin the prepared remarks, there is probably inherently a lot questions aroundStage6, 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, thelevel of interest at this juncture?

Dan Halvorson

I was really hoping not to get in, I just, to some degreefor negotiating purposes and others, I think it’s somewhat inappropriate, toget too detail. But, I think, there is a process, it’s moving a pace, andsitting here in the first part of November, I am pleased to think that I havethis 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 thatnumbers?

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 theselling take place. Does that 10b5 continue going forward, I mean if so, wouldyou 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 - JPMorgan

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

DanHalvorson

No, Paul. No, significant impact oncurrency.

Paul Coster - JPMorgan

Can you tell us: what we should we should be thinking interms of the replacement of Google by Yahoo? Is this straight swap from afinancial 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 typicallydon't give, I guess, what they call a line item or by customer guidance, butit’s certainly a fair question relative to Google and Yahoo. What I would tellyou 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 thefirst question was Dan is new CFO, you have got a contract that's going to comeup, 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 andreplacing Google with Yahoo is something, from a financial perspective, verycomfortable with and then as different people have written about it, I thinkthat also expand the opportunities for DivX Copper, if you will, into theecosystem. So, I am very pleased to be able replace Google with Yahoonotwithstanding Google has been a great partner and is still valuable is theDivX ecosystem.

John Bright -Avondale Partners

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

Kevin Hell

This is Kevin, We are going to continue to explore strategicopportunities with Google going forward, as well as, Yahoo apart from beyondthis toolbar. There is nothing that we were prepared to announce at this pointin time but we do continue to maintain great and strong relationships with bothcompanies.

John Bright -Avondale Partners

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

Kevin Hell

You are talking about the Hollywoodspace?

John Bright -Avondale Partners

No, on the DVD front?

Kevin Hell

In the DVD front. Right, we continue to work with Sony toget our DVD products to the U.S.market. We don't have anything to announce at this time. We are seeingcontinued strong penetration of the U.S. market overall in terms of DVDpenetration. 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 - JPMorgan

In terms of DivX Connected beyond D-Link products, are wewould 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 willallow Connected to come out through broad range of products and our goal isabsolutely to have product out from a number of OEMs in 2008.

Paul Coster - JPMorgan

Okay. My last question is really just the statement and I'dlike to confirm, which is that, we will see typical seasonality or the firstquarter will be reflecting unit shipments from the fourth quarter, to onequarter 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 somemoderation in anyway going forward?

Kevin Hell

Well, majority of our revenues still come from the DVDmarket. To that extent the DVD market follows certain seasonality and so willour revenue streams going forward. So, there is no -- at this point there isnothing that I would see out there that would significantly change that.Obviously, as we move into emerging product categories and also add in othercontent services, we may see that seasonality change, but that's not likely tohave a huge impact in 2008.

Paul Coster - JPMorgan

Great. Congratulations on the new role, Kevin.

Kevin Hell

Thank you.

Operator

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

Steven Frankel - CanaccordAdams

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

Kevin Hell

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

Steven Frankel -Canaccord Adams

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

Kevin Hell

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

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

Steven Frankel -Canaccord Adams

Great. And lastly, a couple of conference calls ago, youtalked a third digital camera manufacturer coming on is that still in the pipeline?

Kevin Hell

Yeah. That's still in the pipeline. As we talk about that wehave two partnerships in product Casioand Pentax. Pentax is now up to 7 skews. There was a, andthere is a third additional partner, and we're going to announce that once theyactually 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 goingforward since most of the chips in the camera market now are going in thisdirection.

Steven Frankel -Canaccord Adams

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

Kevin Hell

It would be fairly expensive to do multiple differentimplementation, that's why I think when a camera maker looks at going toward Hdot264architecture, at that point, it likely is going to be that it would be harderfor them to be able to do DivX. And so that's why for us as we have Hdot264 webelieve 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 aboutthe Qualcomm relationship’s kind of the expected lead times for handsets licenseesin terms of when that would potentially hit the model? And then I have got acouple of follow-ups.

Dan Halvorson

Sure, the agreement with QUALCOMM is to allow QUALCOMM toinclude DivX technology process in its family of mobile chipsets. And so, likewith DVD players, surely the OEMs that ultimately are the ones that pay forDivX. 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 thatboth the Samsung F500 and F508 phones as well as the LG beauty phone have a dayspan shift from QUALCOMM. They actually have a two -chip solution that uses amultimedia process or and a day span shift from QUALCOMM.

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

Darren Aftahi -ThinkEquity Partners

Okay. And then on the connecting side, one -- we're going tosee U.S. space device by the end of the year, and how important is havingbroader studio adoption of negative DivX content for them to be or Connectedstrategy 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 likewith DVD we expect Connected to take off first in Europewhile our brand is strong as, I mean, it really grows from there. As wecontinue to demonstrate success with Connected with the launch in Europe, weexpect 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 onsale 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 aboutthis launch and the initial part reviews that we've been seeing our there.

In terms of the importance of studio content to Connected, Ithink Connected in its current form and the sense that it has access to all ofyour music, your photos and, of course, your video, as well as access to Stage6and other services is a compelling offering and I believe that its somethingthat solves the problem out there, unlike any other platform that's out theretoday.

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

Darren Aftahi -ThinkEquity Partners

Thanks, and then finally for Dan, it looks like the revenuefor the fourth quarter your guidance is flat, but EPS is up $0.03 across therange. 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 calledthat guidance, as you say, is flat, flat as it was from -- you're referring tothe August 9th guidance, and that's right. We had [upbeat] by 900,000 in Q3 andI talked a little bit about that on the prepared, so at this point I didn'traise the revenue but I am very pleased to be able to increase the EPS guidanceby, as you say, the $0.03 and that's a combination of what's going on there andI think coming in and being disciplined, taking a very measured approach to thecosts, looking at headcount, recognizing that that's $0.03 is to me is a prettyimportant 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 morecomfortable since I have joined in the last few months that I've been in thesaddle, to kind of pick the expenses apart and make sure I am comfortable withthe 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 haveactually been answered. Congrats on the quarter.

Kevin Hell

Thank you.

Dan Halvorson

Thank you.

Operator

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

Jim Goss - Barrington Research.

Well, thanks. A couple of questions. First Dan: on yourownership issues, one with Stage6. As you try to determine the course of actionwith that, are you trying to do it in a way where you would still be involvedin some at least minority ownership and also you left the door open withGoogle. I was wondering what sort of involvement you think you might have withthem 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 issomething that we want to maximize shareholder value. So as your specificexample about keeping minority interest, that's -- there is a variety of waysto look at it, whether if we keep a minority interest, some ownership interestor an outright sale, but, suffice it to say, without giving too detailed in itjust because where we at, I don't think it's prudent to take a deep dive withthis point with the ongoing discussions. Our intention is to maximizeshareholder 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 arelationship with Google for a number of years and that was primarily focusedaround, obviously, the two of our, but we also did license our decoder toGoogle during that period of time. Ultimately, as you step back, you think aboutwhere it can go, I can’t be specific, obviously, but I can talk about whereDivX comes in for folks like Google or Yahoo, at a strategic level, which is wereally bridge the gap between video that's being distributed on the Internetand allowing that video to reach consumer electronics devices.

So, as these companies look to distribute video, not just alower quality video to the PC platform, but look to really migrate the contentof 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 wouldpoint 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 opportunitybeyond DVD with cell phones and other mobile platforms, maybe talk about howyou rank those opportunities and also whether you think you can get yourbranding camera, cell phones etcetera as part of your marketing agreement whichwould really--?

Dan Halvorson

Yeah, in terms of the overall emerging markets, they areactually, as we look at it right now, ten times larger than DVD market -- themobile and cell phone market alone is seven times larger in terms of just unitvolume alone. In terms of the ranking of those opportunities, I would say,mobile, given its size obviously, is probably the largest. We are also thusseeing DTVs, HDTVs, set top boxes and gaming consoles all being interested tous overtime as well. Cameras, of course, are important not just because it’s alarge market, but because it is also a generic content in the DivX format, andas I mentioned I think in addition of Hdot264 to our overall media languagewill 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 phonetoday, you would actually see a DivX logo on the front of display. I think itwill vary with every OEM in terms of what you they trying to achieve at the endof the day, but we are pretty optimistic that our brand provides a lot of valueto consumers, consumers are looking for that brand and so that extent that willappear 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 perunit royalties for the mobile handset, initially is above the corporateaverage. Is that still the case of volume of sort of agreement is kicking in orhow 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, Ithink on one hand, if that's the case, you're pulling up predecessors a tallact to follow in some regard, I guess. I would say that I won't give too muchcolor, but I think as you alluded to it, and as I think about where I came fromwith total wireless, with the analogy I make with the PC cards, I think thatthat’s a tough market we're moving in. As Kevin just articulated a much largermarket, but I do think the leverage is well. So I am not sure that I followthat. 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 - JPMorgan

And what about DivX Connected?

Kevin Hell

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

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

Paul Coster - JPMorgan

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 CapExkind of guidance in the fourth quarter, and then the Yahoo! agreement, is thereany content relationship piece of the agreement that's kind of come to fruitionas we go forward?

Dan Halvorson

Sure. Darren, I'll adjust the CapEx. As it relates to CapExguidance, you might recall last quarter we talked about, just alone in thesecond half, for Stage6, we would have $2 million. If you look at the cash flowstatement, 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 Stage6infrastructure cost we've talked about; they are kind of on their way in andplus other, so it's somewhere around $2 million round numbers.

Kevin Hell

And with respect to the content question, [Halvorson] hasanswered the same way I was answering it for Google. We don't have anythingspecific to announce this time, but clearly our direction is to work closelywith partners such as Yahoo! and Google to help enable the distribution of contentfrom 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 thistime. So I will turn the conference back over to you for any additional orclosing comments.

Dan Halvorson

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

Operator

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

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Source: DivX Q3 2007 Earnings Call Transcriopt

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