DivX Inc. Q1 2008 Earnings Call Transcript

May. 5.08 | About: DivX, Inc. (DIVX)

DivX Inc. (DIVX) Q1 2008 Earnings Call May 5, 2008 4:30 PM ET

Executives

Karen Fisher - VP of IR and Compliance

Kevin Hell - CEO

Dan Halvorson - EVP and CFO

Analysts

John Bright - Avondale Partners

Stephen Frankel - Canaccord Adams

Paul Coster - JPMorgan

Rob Stone - Cowen and Company

Darren Aftahi - Think Equity

Bud Leedom - Global Hunter

Jim Goss - Barrington Research

Mark Cluster - Lucent

Operator

Welcome to DivX Inc. first quarter 2008 operational and financial results conference call. (Operator Instructions).

Now at this time, I would like to turn the conference over to Ms. Karen Fisher. Please go ahead.

Karen Fisher

Thank you. Good afternoon. Thank you for joining the Management team of DivX. I am Karen Fisher, Vice President of 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 company's position in the digital media space, its confidence in its growth prospects and its plans to increase shareholder value, the company's focus on 2008, the company's plans for expanding its core licensing business, expectations for DivX connected, plans for extending the company's contact licensing partnerships and the company's anticipated financial results for the second quarter and full-year 2008. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results to be materially different from those expressed or implied by such forward-looking statements.

These statements include, but are not limited to, the unpredictability and volatility of the price of DivX common stock, the risk that customer use of DivX technology may not grow as anticipated, the risk that anticipates market opportunities may not materialize at expected levels or at all. The risk that the company's activities may not result in the growth of profitable revenue, the risk that the company's financial performance in the first quarter and full-year 2008 may not meet expectations, and other factors discussed in the risk factor section of DivX's most recent quarterly report on Form 10-K filed with the SEC on March, 17th, 2008.

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 required under applicable securities laws. For those of you not able to stay on the call today, an audio webcast will be archived on our website under Events and Presentations at http://investors.divx.com.

At this time, I would like to turn the call over to Kevin Hell.

Kevin Hell

Hello, everyone and thank you for joining us on the call today. In the first quarter of 2008, DivX continued to make progress towards delivering on the full promise of digital media for consumers. We realized strong financial results and announced a number of new partnerships and product launches that are critical to our long term strategy.

There is clearly a need for what DivX offers, a real consumer problem that we are working with our partners to solve. There has been an explosion of digital video contents services across the internet, but it is difficult to enjoy this content beyond the PC. Content exists in incompatible formats, with gearing levels of digital quality, making it extremely difficult to enjoy this content on the increasing array of devices that make up the digital lifestyles, DVD players, mobile phones, gaming consoles, in-car devices, digital televisions and more. DivX solves this problem by acting as a bridge between consumers and their content on one end and devices on the other. The DivX brand ensures a high quality video experience that can be seamlessly enjoyed on any kind of device, from any manufacturer.

In the first quarter of 2008, we strengthened this bridge between the consumer and their devices in a number of ways. First an update on our core licensing business, in Q1 we saw strong growth, as we continued grow DVD penetration and gain traction in emerging product categories.

As we discussed in the last call the DVD player market continues to mature and faces pressure from the broader macro-economic environment. Nonetheless, we still have a strong opportunity to grow our overall penetration in this category and strengthen our position in key regions.

Our penetration of the global DVD market for the 12 months period ending Q4, 2007 was 42%, a growth of 27% over the previous 12 months period ending Q4, 2006. We also renewed contracts with major Tier 1 OEM’s, including Philips and Samsung, covering several product categories in addition to DVD players.

Blu-ray is an area where we saw very strong Q1 growth, and we believe we are well positioned to again become a checklist feature in the Blu-ray category as the market matures. Blu-ray has emerged as a high definition successor to the standard DVD player. We have announced a number of DivX certified Blu-ray DVD players from major brands, including Philips, Denon and Panasonic. And we are working to certify additional devices in our lab.

As we discussed last quarter, the best selling Blu-ray device in the world is the Sony PlayStation 3, which already supports DivX playback. According to recent analyst estimates the PS3 alone will account for up to 85% of the Blu-ray device market in 2008. We also recently extended our relationship with Sony too enable PS3 game developers to utilize DivX for in game cinematics, which is another example of the much broader strategic value of this significant platform and the appeal of DivX to the larger game console market. We believe the game console category has enormous potential to increase the reaching impact of DivX throughout the consumer digital media experience.

The mobile market represents another important growth opportunity for our business. We continue to make progress with our mobile certification program in Q1, seeing strong results and consumer demand for existing handsets from LG and Samsung. We recently announced the newest DivX certified handset from LG, the highly anticipated LG Secret, which is a powerful multimedia device and a same thing as a successor of DivX certified LG Viewty model.

Going forward, we expect several additional DivX certified handsets from our partners to hit the market this year. We are also working to extend the reach of DivX in mobile on the chip side through partnerships with Qualcomm, AMD, Chips and Media, and others. By increasing the number of DivX certified chip solutions available to our mobile partners, we expect to significantly speed our progress in this market.

Another compelling growth opportunity for DivX exists in the digital television market, where we've seen strong interest from a variety of OEMs. As we recently announced, we've already certified over 80 television models from partners like LG and HP. And we are working with leading chip providers such as Trident. In fact Trident along with our other chip partners such as AMD and Broadcom account for almost half of the digital television market.

Digital televisions are an important part of the DivX story, not just as standard devices that playback content through USB media, but also as potential client devices for our DivX Connected platform, enabling content and services to stream from the internet and PC directly to the television.

That is a quick overview of the developments in the DivX licensing business, which has continued to grow according to plan and reflects the strong consumer demand for DivX. I believe that we are well positioned to significantly extend the DivX value proposition with the introduction of new services and technologies that continue to solve real digital media problems for consumers.

We talked in previous calls about the importance of H.264 and our acquisition in MainConcept, the leading provider of H.264 video technology. As a quick refresher H.264 is a new standard for new digital video compression that has already become popular online and has emerged as the successor to MPEG-4.

H.264 technology has also has been widely adopted in key device categories, including mobile handsets, high-definition devices and set-top boxes. And it is worth noting that the MainConcept H.264 solution powers the latest versions of w/ Flash Video that is used by a large number of content sites throughout the internet.

Looking forward, a real opportunity exists for DivX to emerge as the consumer face of H.264, serving as a trusted brand for users who don't want to concern themselves with underlying formats or technologies. In fact, the current H.264 market resembles in many ways the early stages of MEPG-4 market.

When they DivX first emerged seven years ago there were number of different and incompatible MPEG-4 implementations available. Through our strong consumer adoption and the creation of the DivX certification program, we were able to simplify the experience for consumers and provide a solution that just works across any device. We plan to repeat that strategy by incorporating broad H.264 support into both our software and consumer electronics offerings under the DivX brand. We are on track to release a new version of our software in 2008 that supports H.264 and then extend that support to consumer electronic devices that are likely to hit the market in 2009. We believe that this development will help move the DivX brand beyond one single format and toward promise of support for any video content, on any device.

Video content of course is the engine that drives our business at the end of the day. We are developing a number of products and services to dramatically extend the availability of content in the DivX format. Going forward our content strategy will follow a two pronged approach. First, we are working to enable premium Hollywood content providers to distribute, secure, high quality titles and empowered by DivX model. And secondly, we will continue to leverage our own software solutions to empower any consumer to easily distribute their video content across the internet. As we discussed last quarter, we have received format approval from Sony Pictures Entertainment that will allow any third party retailer to distribute the Sony Library in the DivX format.

Going forward, we are working to gain format approval from additional Hollywood studios, while simultaneously working with retailers to power sites who will distribute this content. We are encouraged by our progress thus far. Premium Hollywood content, though important, is only one piece of the overall landscape. Millions of consumers are creating, dealing and sharing digital video today across the internet. This has been a strong historical driver of consumer demand for DivX and we see this trend continuing in the future.

Driven by the great user experience offered on Stage6, a large community of content publishers began utilizing our web player technology to publish high quality content on their sites. This is an exciting trend, we believe, speaks to the value of DivX for web based video. We are looking to build on this success by making it as easy as possible for content publishers, big and small, to host high quality content on their sites.

DivX Connected is another initiative that has seen continued moment and is key to our long term growth. In Q1, we announced that our first partner D-Link will begin shipping product in the US from Canada this year. Our second partner, Hauppauge is also on track to begin shipping a DivX Connected device in 2008.

In addition, we recently signed an agreement with Revision3, a hugely popular internet video network with a number of widely viewed original shows and channels to make their content available on DivX Connected. We continue to see a positive response from our community, with many users taking advantage of the openness of the DivX Connected platform to create a variety of plug-ins that allow users to access all kinds of internet content services such as Flickr and digital music service Last.fm among many others. It is important to reiterate that DivX Connected is a long-term initiative. Ultimately we believe DivX Connected has a potential to serve as the standard for seamlessly accessing internet media services in the living room. It is clear that the market is moving in that direction, but it is equally clear the growth of home network in consumer education, availability of content and the penetration of network-enabled devices are all factors that will influence the pace of consumer adoption for DivX Connected.

In summary, we delivered another strong quarter that witnessed real growth for DivX across a number of key areas. I believe we are in a better position than ever before to deliver on a promise on enabling a seamless, high-quality digital video experience for consumers on any device from any manufacturer. I look forward to continuing to update on our progress.

With that I will turn it over Dan to discuss our financial results in more detail.

Dan Halvorson

Thank you, Kevin. On today’s call I will provide a summary review of the first quarter, provide guidance for the second quarter, and update our EPS guidance for full year 2008. Revenue for the first quarter was $25 million, an increase of 24% over the first quarter last year. Our GAAP EPS was $0.07 per diluted share and our GAAP profits was $2.5 million.

Non-GAAP EPS was $0.18 per diluted share, and we generated non-GAAP profit of $6.2 million. Excluded from non-GAAP EPS and net income are the following: One, stock based compensation net of related taxes accounted for $0.03 per diluted share. Two, stage six operating cost net of related taxes, accounted for $0.06 per diluted share. Three, a $0.02 per diluted share asset impairment charge, which is attributable to the write-off of additional milestones related to the Beatrice acquisition, as previously discussed. Four, amortization and purchase intangible assets related to main concepts of $0.01 and $0.05, a $0.01 gain per diluted share representing foreign currency exchange impact on the Euro based inter-company loan between MainConcept and DivX.

Breaking down the quarter further; technology and licensing revenue for this quarter increased 14% over the same quarter last year. Technology and licensing to hardware manufacturing partners was approximately 67% of total revenues for the quarter. Technology and licensing for software, which includes the MainConcept revenue was approximately 9% of total revenues for the quarter.

Let me add here that our overall billings for MainConcept were strong during Q1 and we recognized both revenue and deferred revenue contributing to the increase in our deferred revenue on the balance sheet. We had two licensing customers, Philips and Samsung in the quarter, who accounted for more than 10% of revenue. Media and distribution revenue for the quarter was approximately $5.9 million or 24% of total revenue. This is a 10% increase over the first quarter of last year.

Yahoo! accounted for approximately 22% of total Q1 revenue. We believe the better than expected results for Yahoo! illustrates the strength of our software distribution business in spite of the loss of Stage6.com traffic for one month during the quarter. The mix across geographies for the quarter was 58% for Asia-Pac, 6% for the Americas and $0.36 for EMEA. Remember that this geographic revenue mix represents the location from which our partners create products not where the products are been shipped.

Gross margins remained at a strong 95%. Now let me focus my comments on expenses. I'll talk about our expenses consistent with non-GAAP break-out provided in the supplemental earnings table in our press release today, detailing Stage6 operating cost and stock-based compensation and the other items discussed earlier. Please remember that we closed the MainConcept acquisition in the fourth quarter, so our year-over-year comparisons are impacted by the addition of the MainConcept business.

We are making solid progress in the integration of MainConcept operations to optimize the synergies within DivX. Due to the nature of accounting requirements for revenue recognition, specific billings may be deferred and recognized as certain criteria are met. Consequently, we continue to expect revenue and deferred revenue to fluctuate from quarter-to-quarter as we integrated and adjust the form of MainConcept's customer terms to traditional DivX terms and conditions.

Total operating expenses in the quarter of $22.4 million included DivX business expense of $15.6 million or approximately 62% of revenue, $3.3million for Stage6.com, $2.0 million for stock-based comp, $1 million for the impairment to the intangibles assets that triggers for the write-off with additional milestones related to Beatrice, and scheduled amortization of purchased intangible assets related to MainConcept of approximately 500,000. The DivX Q1 operating income excluding Stage6, stock-based compensation, the impairment charge, and the amortization of intangible assets was $8.3 million or 33% of revenue.

Including Stage6, stock-based compensation, the impairment charge and amortization, our GAAP reporting income was $1.4 million. Our interest income for the quarter was approximately $1.7 million. Stock-based compensation, net of tax for the first quarter was $1.2 million or approximately $0.03 per share. We ended the quarter, with total cash investments of approximately $132 million or approximately $4 per share.

We generated approximately $5 million in EBITDA during the quarter and we invested approximately $700,000 in capital expenses. Our blended tax rate for Q1 was approximately 31%. This included a tax benefit of approximately $300,000 relating to a purchase accounting adjustment for our deferred tax liability associated with the acquisition of MainConcept. Excluding this discreet tax benefit, our blended tax rate was approximately 40% for Q1.

Our largest use of cash in the quarter was for our share repurchase program. During the first quarter, we purchased approximately 1.4 million shares or 4% total shares outstanding. To date a total of 2.5 million have been repurchased or 7% of total outstanding shares. We have used approximately $17.5 million of the $20 million authorized for the repurchase system.

Next, I would like to address our portfolio of auction-rates securities. We have approximately $20 million or 15% of our cash investments in auction-rate securities. We believe our auction-rate portfolio is of high quality as they carry a AAA credit rating with no history of default, and they are collateralized by the federal educational lending program. However, given the current lack of liquidity in the auction market, we concluded the fair value is no longer equal to the part value for these securities, and I recorded an unrealized loss of approximately 900,000 on the consolidated balance sheet.

Additionally, we reclassified these securities from short-term to long-term investments due to the lack of short-term liquidity available for these securities. We feel that this decline in fair value to be temporary based partly on our ability and intent to hold these investments until liquidity returns to the market. Headcount was 353 as of March 31, 2008, which includes 73 employees from MainConcept, compared to just over 380 at the end of the year.

Now let me provide guidance for the second quarter and update our annual guidance. Before getting into the numbers, this should be an appropriate time to announce that after this quarter we are planning to transition to providing only annual guidance. As you know and similar to our peers in the digital media space, we have become more dependent on third party data such as royalty reports as we have evolved our global CE licensing business. This evolution brings with it a challenged divisibility on a quarter-by-quarter basis, thus we believe that forecasting the business model on an annual basis is appropriate.

Now to the numbers, to update 2008 guidance we are reaffirming our previous guidance on the top line and continue to anticipate full year revenue in the range of $95 million to $100 million. Technology and licensing revenue is anticipated to be in range of 75% to 85% of total revenues for the year. Media and distribution services will be between 15% and 25% of total revenue for the fiscal year. We are targeting gross margins for the full year of approximately 95%. Product development expenses in 2008 will increase as a percentage of revenue given our investment in emerging product categories.

Our tax rate guidance for the balance of the year remains unchanged and is anticipated to be approximately 40%. Weighted average shares outstanding for the year are expected to be approximately $34 million, which includes the impact from the share repurchase program. GAAP EPS for 2008 is expected to be in the range of $0.24 to $0.30 per diluted share, which includes one; expected non-cash share-based compensation of approximately $9.5 million or $0.16 per diluted share net of taxes. Two; anticipated Stage6 operating related accruals of approximately $3.3 million or $0.06 per diluted share net of taxes, which was incurred in the first quarter. Three, expected impairment to acquired intangible assets attributable to the write-off of additional milestones related to [Beatrice] of approximately $1.3 million or $0.03 per diluted share; and four, anticipated amortization of purchased intangible assets related to MainConcept of approximately $2.2 million or $0.04 per diluted share net of related taxes, and five, a foreign currency exchange impact on Euro-based intercompany loan between MainConcept and DivX of approximately $500,000 or a gain of $0.01 per diluted share, which was recognized in the first quarter.

Note that no further impact is been assumed for further FX fluctuations at this time. Based on these items, we are increasing the non-GAAP EPS to a range of $0.52 to $0.58 per diluted share for the full year.

Now turning to guidance for Q2; GAAP, EPS is expected to be in the range of $0.03 to $0.05 per diluted share which includes one, expected non-cash share-based compensation of approximately $2.5 million or $0.04 per diluted share. Two, expected impairment of acquired intangible assets attributable to the write-off of additional milestones for Beatrice of approximately $300,00 or a $0.01 per diluted share net of taxes; and three, anticipated amortization of purchased intangibles related to MainConcept of approximately $500,000 or a penny per share net of taxes.

Based on these items, non-GAAP EPS for Q2 is anticipated to be in the range of $0.09 to $0.11 per share. With that we will open up the call up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions). Our first question will come from John Bright with Avondale Partners.

John Bright - Avondale Partners

Thank you, good afternoon. Dan you gave the numbers on Phillips and Samsung 10% type customers. Combined, what were they together?

Dan Halvorson

We do not get that granular as such there. In total they are just over 10 actually each John. So we have got less than just barely over 20.

John Bright - Avondale Partners

Okay

Dan Halvorson

Fairly just the 10. So you have got those two plus of course the Yahoo! That's over 10 percenters.

John Bright - Avondale Partners

Right. And then Yahoo!, I think you mentioned without Yahoo! for one month. Google made up the other month or was there not anything after the one month and then was the behavior of the Yahoo! revenue? Was there a linear behavior over the months?

Dan Halvorson

No, remember that is fair on clarifying. I guess it was. The extra month we did not have was Stage6.com. We shut that site down February 28th. So we wrapped up Google last Q4. So this was all Yahoo! We are very pleased with the performance of the Yahoo! toolbar distribution revenue. And as far with linearity, I think it behaved as good or better. I would say better than we expected, when we were on the call just seven weeks ago.

Part of that was, we were not sure what the behavior was going to be. But as you will in the numbers, we are very pleased in some of Kevin's prepared comments that the DivX ecosystem is strong and healthy, particularly when you see something like this. I think there was global concern about shutting down the Stage6.com website, what it would do, and we see the numbers actually were very steady. That is a testament to the strength of the DivX web player.

Kevin Hell

Typically, John this is Kevin. What we are seeing is several hundred sites did have actually, based on the great experience they saw Stage6 have adopted the DivX web player and that actually translates through our distribution numbers.

John Bright - Avondale Partners

With that said did, I understand the numbers correctly on projecting for 2008 Dan, that you are expecting a greater contribution from the licensing revenue for 2008, looking forward to the next three quarter. So if I look back at the envelope for the first quarter, it was roughly what, 25% of revenue?

Dan Halvorson

It was, what we said is that stay in firm to, what we said or the other way to say, if the licensing was 67 plus software so yeah, it was in the 24% and we have given the guidance so it will be somewhere in the 15% to 25%.

John Bright - Avondale Partners

So you are really expecting the licensing to ramp the remaining portion?

Dan Halvorson

Well it's a combination. The other part, although, Q1 looked and to the comments Kevin just said, we are being measured in this guidance both in terms of the CE licensing but also in terms of, there's still, let's prove out some more. We are very pleased with the strength of the toolbar but let's see what happens given another quarter on your belt, but as we sit here, think the ecosystem, the DivX is healthy.

John Bright - Avondale Partners

What about in the United States, where it is a question we talked about each quarter. Would you discuss DVD penetration thoughts on the United States; DVD player penetration, and then Sony in the United States? Any update there?

Kevin Hell

Sure the US penetration for DVD players is approximately 30% in Q4, that's up 24% year-on-year, so we are seeing some continued nice growth there. The DVDR recorder category was actually closer to 49%. So we are seeing extremely growth from that perspective in the penetration. In terms of OEMs using it, Toshiba, Pioneer, Panasonic, Philips, Thomson, Samsung, JVC and LG, we do not have Sony DVD players in the US market. They continue to be the one holed out from a major OEM perspective.

John Bright - Avondale Partners

Any thoughts on why?

Kevin Hell

Well again as we commented on the last call, Sony really is comprised of a number of atomist decision making bodies and each region makes its own decisions around when and how to launch products. So ultimately that is the call that the US ultimately would be making. And at this point they have not given a green light on DivX, however it's something that we are continuing to work on and we are optimistic about it in the future.

John Bright - Avondale Partners

Kevin if we look forward, two years from now, year and a half, two years or into 2009 timeframe. Help us think about the demand drivers for DivX codec or the DivX licensing initially on different devices. You went through talking about the DVD player devices, Mobile devices, Digital televisions etcetera. What is it that is going to need to be in place, you think to continue to accelerate the demand for DivX licensing?

Kevin Hell

Well the biggest driver of demand on all of these devices ultimately is content, that is what really moves the needle, that what’s historically moved the needle relative to the DVD player market, and that is also what’s going to drive the needle relative to these other devices. And along those lines you have several different forms of content, you have premium content services, Hollywood based content, television content for sale which is something that we are aggressively working to put in place, and I think that’s going to drive adoption in these emerging categories. Then you have the broader base of content that people are distributing across the internet, whether it be web based services or other forms of distribution and content, file sharing etcetera. And we have got initiatives around all of those areas going forward to drive the availability of the content in the DivX format.

In addition, we believe that initiatives around H.264 will also speed our penetrations to these new emerging categories. Many of the key devices that we are going after the set top box category, the DTV category, the mobile category etcetera are moving towards H.264 support. And by adding that into our certification program we believe we can extend the DivX value proposition to beyond just MPEG-4, to suggest support for a much broader variety of formats, including H.264 in the future.

John Bright - Avondale Partners

Yeah. Dan and Kevin for this one, the economy question, visibility, Dan you are giving guidance for the entire year, anything that you are able to draw from the demand that you are seeing today, about how the consumer behavior may or may not be impacting demand for different devices?

Dan Halvorson

John it’s a mix. We hear on the macro-level. We all watch the news and read the Wall Street Journal, but you hear certain things and then you see some of the peers and other people have decent quarters. I think the biggest thing we have talked about is do we take pause and how measured are we with regards to Blu-ray and some of the things that Kevin just hit on. So, it feels like early innings, but I think we just put up, albeit a end line, top line, but I think we are continuing to watch the growth of the top line and then manage this business effectively. So, from the economy we hear the same things, you hear, we are measuring that. We are going to plan accordingly there on the business.

Operator

We will move now on to Stephen Frankel with Canaccord Adams.

Stephen Frankel - Canaccord Adams

Good afternoon. Kevin, I wonder if we might dive into Connected a little more and help us understand what milestones we should be looking for on a hardware side, maybe in terms of chip development or partner announcements over the next couple of months.

Kevin Hell

Sure. As we announced we have two partners now D-Link and Hauppauge, with products coming out this year. D-Link is already in European market, looks like it is going to be in the US market shortly, as well as Hauppauge here in 2008. In addition, we are working on both the chip side, as well as with major OEMs to drive embedded solutions were Connected appears within the DTV's or connected DVD Players or other types of devices that have connectivity to the internet built in. This is what we believe will be the long-term mass market phenomenon that will drive the success of DivX Connected in the future. So, we are aggressively driving for that. That's the big play for DivX Connected that will drive significantly scale in revenue contribution in the future.

In the mean time, it's also important to note, that we are continuing to build value on the platform by continuing to extend the services that are on that platform. And as we just announced today, we are adding Revision3, we have V.I.O and Views and number of others on Connected. As services will be available on Connected, already are available on Connected. And in addition, we are seeing a number of plug-ins emerging as well, with Last.fm, Flickr, Google Maps, Dilbert Cartoons, a range of various plug-ins that extend the value of that platform. So, we are continuing to see that and I think that’s going to add a lot of value to the platform that will further drive the major OEM's to put Connected into their devices going forward 2009 and beyond.

Stephen Frankel - Canaccord Adams

As you look to find retail partners for your Sony agreement, what has been the pushback so far and what's the reasonable time frame to expect this offering to come to market?

Kevin Hell

In terms of time frame, it is hard to specify specific time frame. It depends on getting the contract signed and then actually going through the implementation, getting the service launched. In terms of pushback it's usually an issue of just adding the additional complexity in support of supporting another format to these services. But we believe, in terms of what we offer, in terms of value proposition, we are going to be only games in town to reach over $100 million devices that we have out there today that support our DRM. So, we are working on it aggressively. We do see the interest among retail partners and it's just a matter of making it happen. We also think that when we additional studio libraries to the mix, it will become that much more attractive from a retailer perspective.

Stephen Frankel - Canaccord Adams

Do you have to lay out guarantees to get additional studio interest or that is not something that you have to do may be the retailer has to do?

Kevin Hell

From a minimum guarantee perspective, given we are pursuing a powered-by-model that would be something that he retailer would actually do.

Stephen Frankel - Canaccord Adams

Okay. Great, thank you.

Kevin Hell

Sure.

Operator

Next we go to Paul Coster from JPMorgan.

Paul Coster - JPMorgan

I have a few quick questions, Dan and Kevin. First of all, when you rolled over the Phillips and Sony licensing agreement, how were the terms relative to what you have seen previously from an economic perspective?

Kevin Hell

We can not comment on specific terms, obviously its confidential, but we continue to offer pricing that is reflective of volume. So, we obviously give discounts relative to volume commitment and that's about all I can say. However, the Philips deal was a two year deal and did involve not only DVD Players but several other emerging product categories as well.

Paul Coster - JPMorgan

Okay. The number of sets, just numbers last quarter, because recently you realized, perhaps a bit late that it is going to be an investment year. Do you still see it that way, if so, what are you investing in this year, what's the key investment themes that's happening behind the scenes?

Dan Halvorson

Sure, yes, I wouldn't say that 2008 is definitely an investment year, the investment teams are really around, first H.264, as we talked about it number of times, that's a key initiatives for us and key to our growth going forward. Connected as we have also talked about is another area that we continue to add value to. The mobile category is another area that we are investing in.

Finally, I would also say content services, both on the premium side, as well as on the user generated content side are also areas were we are continuing to make investments in 2008.

Paul Coster - JPMorgan

Do you have any commitments from customers to your H.264 platform. I mean it's otherwise a bit of Hail Mary isn’t it, what visibility do you have into adoption there?

Kevin Hell

We have not announced any specific partnerships yet, we at this point are developing the SDK and the certification kit that would go out to our partners to allow them to incorporate the technology into their chips and then into their products. We just had a number of discussions with our partners around H.264 and our plans there. There is a tremendous amount of interest. I did not at all characterize it as a Hail Mary, because what we are really doing here is we are taking advantage of large amount of H.264 content that is already out in the internet today. So our implementation is looking to take advantage of variety of content that is already, actually, out there on the internet. We believe it will have immediate value and that we really will not be only games in town, in terms of bridging between the internet content that is already out there and these devices that are going into your living room and on the go.

Paul Coster - JPMorgan

Adobe seems to be making some progress with Flash on mobile devices. Can you remind us what is it that MainConcept is doing with the Adobe? Is there any repeat or escalating revenue associated with that? And how should we think of Adobe’s Flash initiative relative to your say H.264 initiative. How do they coexist if at all?

Kevin Hell

Sure and they do coexist, first of all we have a commercial licensing deal, we had Adobe to license the H.264 codec for the latest version of the Flash Player 9. And that’s a commercial licensing deal, I can not go into the details and the terms on that one. In terms of how we think about Flash more broadly, the vast majority of content that is downloaded today is in DivX format or variations of DivX format. So, we do not see that as being a threat in terms of the use case that we are really providing which is high quality content, delivered through the internet, and then played back on a variety of devices. To the extent that Flash starts to get traction in terms of files that are downloaded at high quality, it's based on the terms something that we could actually extend into an offering to our certification program as well that’s what we will be looking to do.

Operator

And Rob Stone with Cowen and Company has our next question.

Rob Stone - Cowen and Company

A question for Dan to begin; what is it mainly that’s driving your increase guidance for non-GAAP EPS given that revenue and gross margins are both the same as before, what are the effects of reduced share count and/or expenses, is that really what's behind it?

Dan Halvorson

Yes, that’s fair; I tried to give some transparency in the share count. So we have repurchased in the tail-end of Q1, little over 2 million shares in April. But basically its going to reduce, we think that was accretive. For the rest of the year that’s $0.02, that’s about sixth-tenths of a $0.01, it's just little over $0.05 per quarter, three quarters less, so penny and a half to $0.02. But the bigger part, Rob, is really driving and in the comments we said, really we are doing a better handle on expenses. There are going to be investments and Paul Coster just said about this investment year, and I do not want to protest too much, I think even with the investment year, our guidance would indicate a model in the high 20s, flirting with the 30% operating income. So, it's really a matter of controlling costs and getting our handle on the cost of the business. The integration of MainConcept, we think there are synergies. We think that acquisition makes sense. So, it's variety of things. But to be clear, the numbers are pretty straight forward relative to the buyback at these levels, and that will be about $0.02 of it.

And the other part that's meaningful in these numbers is new this quarter, I carved out a lot of debits or the hedges like Stage6, like share base. You will see also what I have carved out, is we had a gain. But just to be fair, because that’s were $0.18 reported, it could have been $0.19. I have also carved out a $0.01 gain on a inter-company, because I want to try and get the investors and analyst to really understand this model as transparent as I can. Even with the inter-company debt between MainConcept and DivX. So, the core business is generating 32% operating income and that's a driver of just really trying to watch expenses as judicially as is possible.

Rob Stone - Cowen and Company

A question for Kevin, as you were going through your prepared remarks, you have listed off few of the things that could affect the growth and penetration of Connected devices. Is that just, trying to turn away out of fair case for the timing of the uptake or are you somewhat more or less bullish then before on how soon Connected is going to be a meaningful part of your business?

Kevin Hell

I was really pointing to what I see as being the drivers of the pace and adoption in this specific market. I mean if you are looking at Apple TV today or other Connected devices. Obviously, some of those devices sort of had mix success. And I think it's for a number of reasons around consumer readiness, in terms of the network in their homes, in terms of consumer behavior and et cetera. So I was relaying those out there to make sure there is an understanding of what actually is driving that part of the margin in terms of connectivity in devices. I think it is a given that it will occur, that connectivity in devices is going to occur, it is more complete. The question is really one of timing and how fast does that occur. I think ultimately that’s going to be driven by consumer behavior.

Rob Stone - Cowen and Company

The test with other sites using web players, which I guess is helping your content, your download traffic and with that the media distribution revenue, but it is interesting to me that, the web players proliferating other sites are supporting that. But then several months since the Sony announcement and we still do not see or what we can see from our side, I am sure you guys see stuff you can not tell us about yet, visible signs of premium content moving out. So why do you think one is spreading so readily and the other are taking is longer?

Kevin Hell

Well, it is really an issue of how fast these things can occur. On the community based sites, these are relatively, obviously smaller sites. They can move very quickly. There is less issues with regards to the premium content. There's a number of things that have to occur around getting the deals done, going through the various parts of the organization within the studios and others that we deal with and getting approval, and then working with the retailers to get, essentially sites launched. So, that actually takes more time to occur. But I’m very optimistic on both of those fronts, both on the premium side as well as on the internet user generated site.

Rob Stone - Cowen and Company

Is there any way for you to monetize the user generated sites beyond just driving traffic to your site? Is there some revenue stream that you can get a share of in the future?

Kevin Hell

Well there certainly are various ways we can generate revenue from the sites in the future. I think it would premature at this point to go into details on that, but certainly things that we are looking at around essentially looking some of these sites together and creating value on top of that, but at this point I am going to differ that for later calls.

Rob Stone - Cowen and Company

Thanks very much.

Operator

We will move down to Darren Aftahi from Think Equity.

Darren Aftahi - Think Equity

Good afternoon, just a couple of questions first for Kevin. What kind of traction are you guys seeing in Blue-ray, I know you had some positive comments early in the call, but have you seen any pushback in terms of sell-through because of pricing and I know the players that offer the disc?

Kevin Hell

No, at this point in terms of our penetration in the Blue-ray category we are targeting all of the OEMs that we are currently doing business for standard definition players, and I think we are getting tremendous progress on that front. So I continue to believe that we will see the same kind of progress in the Blue-ray front as we did on the DVD player front.

Darren Aftahi - Think Equity

Okay, and then couple of housekeeping questions for Dan. Can you give us the basic comments Dan of any other quarter? And then did I hear you right that the tax rate was 31% and I guess last quarter you had talked about 40% for the entire year?

Dan Halvorson

Sure. Yes Darren I will give those in order. So the basic around $34.7 million for Q1 and as you will see, you will see the impact as we roll forward. With follow-up we bought back $2 million share, but negligible impact that happened in the tail-end of the quarter. So the shares will be impacted as we move forward. And then with regard to the tax rate, our tax rate is about 40%. There was a purchase price adjustment really around the deferred tax liability for the acquisition of MainConcept discreet item around $300,000 that was booked in the quarter.

So in my prepared remarks, I talked about that that moved the 40% tax rate down on effective tax rate of 31%. The way we should, you know to be clear, the way you should think about it, is around a 40% between the federal and the California tax rate and other parts around taxes, the R&D credit still up in the air. So the best way to think about is 40% unless there are discrete items. And in this case we had the transaction in Q4 and then we settled some of the taxes issues around MainConcept here within Q1. So we ended up with a discrete item that drove that rate from 40 down to 31%.

Darren Aftahi - Thinkequity Partners

Okay. Any sort of pause in terms of increasing the buyback, what are the plans of the cash in the balance sheet?

Dan Halvorson

I know that is a good question, and I think we put effective use with the $20 million, and like I said we are almost, we spend about $17.5 million. That is an interesting one, with new initiatives, the question is what's our capital structure, and right now the Board and management continues to look at uses of the cash and that includes do we increase the buy back. But at this point, we think the $20 million was the right number. And that’s what we are doing thus far.

Darren Aftahi - Thinkequity Partners

Great. Thanks.

Dan Halvorson

Thanks Darren.

Operator

Now we will go to Bud Needham from Global Hunter.

Bud Leedom - Global Hunter

Hi guys, nice quarter. Is there any way to carve out what your revenue, Yahoo! revenue was in the quarter that was based on Stage6 so-say the first two months of the year?

Dan Halvorson

No. we really have not tracked it that way. I mean, I appreciate one of the other questions was and trying to kind of look at that relative to the linear, so we are really haven’t carved it out that way.

Bud Leedom - Global Hunter

Okay.

Dan Halvorson

But what I had said before and last quarter and that's the follow-up question. Bud think of it in terms of pre Stage6.com, that was what we were thinking about on the March call just seven, eight weeks ago and we are still being measured about this is, we are navigating. We have Stage6.com growth throughout '07 and then now it's only been one month in the quarter and now we are moving on to kind of two months with it out. So we are measured on this, but we are seeing some other comments here, that the web player is still solid and so we are very healthy. We have a very healthy eco-system. But, as far as, splitting out between divx.com and Stage6.com, it's something that we haven't done.

Bud Leedom - Global Hunter

Okay. Given the shutdown of Stage6, and now it is obviously aged, is there any hope for, any recovery of any of the assets associated with Stage6, either tangible or intangible?

Dan Halvorson

Now that's a good question. That's was something that, there are still things we work on, and we move. On one hand it's getting dated, but at the same token that was such a successful site that there are certain levels of interest, but at the same token we move. We run the business assuming that it's closed and we continue to figure out. We do get inbound calls but at the same token you know they are vary. So, I mean in that case, we just kind of move on.

Bud Leedom - Global Hunter

Okay. And given the shutdown is there been any softening or anything that you might be able to relate it to UMG in the suite?

Dan Halvorson

I am sorry Bud, with regards to UMG?

Bud Leedom - Global Hunter

UMG?

Dan Halvorson

No, that's status quo. On both the last calls, as well as our 34 Act filing, UMG is very much running the pace now. We last year filed a deck action. The courts are moving the venue so it's kind of wait and see. We will keep you posted on UMG.

Bud Leedom - Global Hunter

Okay. Great, and then just finally on the mobile. Could you give us any ball park at least in terms of may be what you are looking at internally, when this actually becomes a material contribution of revenue? And also may be provide some detail on the Qualcomm integration?

Kevin Hell

Sure, it depends on your definition of material contribution. We are seeing real revenue now from LG and from Samsung. The phones are out there now, like they recently announced LG Secret phone, it is a high volume phone, as well as the LG Viewty phone. And we expect to see more handsets here in 2008. So, we are bullish on the mobile category in general.

In terms of Qualcomm, we are looking at eventually getting to a single chip solution to get to mass market products, that takes time, as I mentioned on the last call, its really more of a 2009 solution that we will see emerging. But in the meantime we do have many phones now that are based on Qualcomm base band chip, like the LG phones and Samsung phones using a multimedia processor. They're higher end phones and more expensive, but they are out there now and that's what are going to be see here in 2008.

Bud Leedom - Global Hunter

Great. Thanks again.

Kevin Hell

Sure. Thanks Bud.

Operator

We will now go to Jim Goss from Barrington Research

Jim Goss - Barrington Research

Thank you. Hulu began to develop on the internet; how does that affect the competitive landscape and are there any co-branding opportunities you might have?

Kevin Hell

Well yeah sites like Hulu are definitely targets for us from a partnership perspective. In the days when we were running Stage6, you might think of that as being some form of competition. But in our current model we are looking to power sites like this. We'd like to see sites like Hulu offering content in the DivX format, to be accessible for download and then playback on a variety of devices in your life that are beyond your PermCath, one. I think Hulu will be a great partner for DivX Connected to be accessible directly on a Connected device, where you do not need to take the content, download it, burn it and walk through other two device or side load it to a device you can just watch it directly on a connected device. So they would be absolutely a key partner for Connected and there is nothing to prevent them from actually been a partner on Connected even with the current size of the structure.

Jim Goss - Barrington Research

Okay so they do not have to be mutually exclusive. You can be involved and somebody can else be involved and it could be unique to you or it could be multiple users.

Kevin Hell

Yes exactly you are seeing a variety sites out there today that are popping upon DivX Connected that we can essentially point to, to add value to that overall experience.

Jim Goss - Barrington Research

With the Yahoo! Microsoft deal and then collapse, was there any impact on any thing you had to do with them from that distraction?

Kevin Hell

No impact at all.

Jim Goss - Barrington Research

Okay. Thank you.

Kevin Hell

Sure.

Operator

We will take a follow question from Paul Coster with JPMorgan.

Paul Coster - JPMorgan

Yes thank you. Set-top boxes at the NAB Show there were proliferation of them that seems to be a major area focus for everyone going into the 2009 holiday season. I know you are on silicon, but are you seeing design wins in that product category that will lead to product instructions this year?

Dan Halvorson

You said set-top boxes?

Paul Coster - JPMorgan

Yes.

Dan Halvorson

Yes, absolutely. As we talked about before, we have had a number of chip relationships that we have established in the set-top box space with STMicro and XP, we certify the Broadcom 7403 chip. We are seeing interest in Europe and in Asia, particularly among the IPTV players and also the retail free-to-air DVB-T boxes. So it's there we are seeing significant interest and we hope to have specific devices and specific OEMs announced shortly.

Paul Coster - JPMorgan

Your DRM is also installed on the 100 million plus devices that are already deployed out there with the DivX certification. How important was that in Sony's decision to use your platform going forward?

Kevin Hell

Well, it is certainly important for any content provider as they look toward endorsing the DivX format, given the scope of devices that are already attached to television sets. Today without requiring you can go out and buy a new device.

Paul Coster - JPMorgan

As you go forward your new platform will be backwardly compatible with the old DRM, the previously deployed DRM's?

Kevin Hell

When you say the new platforms are you saying the H.264?

Paul Coster - JPMorgan

Yes.

Kevin Hell

We will continue to evolve the DRM as we go forward. So with the introduction of the H.264 standard we will be also making upgrades to our DRM as well.

Paul Coster - JPMorgan

Okay. My last question is DivX download activity, how important is that from the perspective of measuring the health of your kind of viral community? Is that a good measure of it or not, because as you know, it kind of goes up and down up with the various software releases you have?

Kevin Hell

It does overall. I think it does talk to the general demand for DivX technology in the marketplace and the general demand for DivX technology among our consumers overall. Also, as we talked about here on the call, with the usage of our web player on many sites out there, it is also a testament to the publishers of content themselves and how they feel about DivX. So it is an extremely important indicator that speaks I think to the health and vitality of the overall ecosystem.

Paul Coster - JPMorgan

Okay. So with that in mind, it is not trending up. I mean it kind of bounces up and down but it is not kind of growing exponentially or even accumulatively is that a fair statement?

Kevin Hell

For what we have seen, we have seen some nice growth in the overall number of software downloads, the visitors to divx.com etcetera on all those categories.

Paul Coster - JPMorgan

Okay

Kevin Hell

Of the $100 million or for instance here is a stats where we have a $100 million player banners per month now. So you know the player's being used quite frequently out there.

Paul Coster - JPMorgan

Yeah thank you.

Kevin Hell

Sure.

Operator

(Operator Instructions). We will hear now from Mark Cluster with Lucent

Mark Cluster - Lucent

Thanks Kevin and Dan. I was wondering to what extent do you guys are pursuing kind of license compliance opportunities particularly internationally, if there is anybody that's using your product without really paying for it?

Kevin Hell

That is an area that we have been working on for many years now to continue to protect our IP in the market. We vigorously do defend our technology and our brand as it is used in the market place. When we do see devices that are using our technology or our brand inappropriately, we pursue that a variety of levels. We talk to retailers make sure that they are aware that they are selling devices that are not licensed from DivX. And we also talk to the suppliers of the chips for those devices as well. So we approach it from both sides.

Mark Cluster - Lucent

Is that pretty diversified in terms of, is it all like really small Tier 2, 3 4, typed CE vendors or are there any larger opportunities out there for you?

Kevin Hell

It generally happens in the smaller Tier 2 players. In most part,

Mark Cluster - Lucent

Okay, great. I apologize for attempting to tie these two together. But how do you view folks that kind of allow some DivX functionality but aren’t specifically certified, may be with respect to the gaming consoles or other PC things, excluding the Sony PlayStation? Is that something you are comfortable with or are you trying to move towards certification?

Kevin Hell

No, certainly not. We will want to move them to full certifications so that they support our DRM. Ultimately those devices do not support our DRM, they also will not support the broad range of types of DivX content that are essentially out there, and they also do not have rights to sue the brand ultimately. So those are all things that we will vigorously pursue and defend ultimately. That is what I would say on that front.

Operator

We have no other questions at this time. Mr. Hell, I will turn the conference back to you.

Kevin Hell

Okay, thanks. Once again I want to thank everyone for joining us on our Q1 earnings call, and for your insightful questions. I also want to acknowledge our employees for another solid quarter. We look forward to updating you on our business during our second quarter conference call. Thanks again.

Operator

Again that does conclude our conference. We do thank you for joining us.

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