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Executives

Karen Fisher - Vice President of Investor Relations and Compliance

Kevin Hell - Chief Executive Officer

Dan Halvorson - Executive Vice President and Chief Financial Officer

Analysts

Steven Frankel - Canaccord Adams

Paul Coster - JPMorgan

Rob Stone - Cowen & Company

Bud Leedom - Global Hunter

DivX, Inc. (DIVX) Q2 2008 Earnings Call August 7, 2008 4:30 PM ET

Operator

Welcome to the DivX Inc. second quarter 2008 operational and financial results conference call. (Operator Instructions) Now at this time, I would like to turn the call over to Karen Fisher.

Karen Fisher

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 for 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 its full-year of 2008.

Such forward-looking statements involve known and unknown risks, uncertainties and other factors which 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 risk that customer use of DivX technology may not grow as anticipated, the risk that anticipated market opportunities may not materialize at expected levels or at all. The risk that the company's activities may not result in the growth of profitable revenue, the risk that the company's financial performance for the full-year 2008 may not meet expectations, and other factors discussed in the risks factor section of DivX's most recent quarterly report on Form 10-K filed with the SEC on March, 17, 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 as 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

DivX delivered strong financial and business results in the second quarter and made significant progress toward achieving our mission of powering a seamless, high quality digital media experience on any device. What is more, we realize key wins in several strategic areas which we believe will drive our business going forward. Specifically in Q2, we continue to expand our core licensing business to new product categories beyond the DVD market with major partners launching new DivX certified products in the mobile Blu-Ray, digital television and gaming consoles categories.

Rolled out the first Beta version of our H.264 video decoder to enthusiastic response from the digital video community, close our first deal with our major online content retailer, Cinema Now and expanded our relationship with Sony Pictures to include access to international content for the paving the way for the secure delivery of high quality Hollywood titles in the DivX format, continue to grow and nature our DivX connected initiative for the launch of the first partner parking in United States and a greatly expanded library of contents, services and plug ins, added a new board member with strong knowledge of the digital video and mobile industries and a skilled sales and marketing executive with extensive experience in industry relationships in the technology and entertainment space.

Let me discuss our quarterly developments in more detail beginning with a brief overview of our core licensing business. In Q2, we saw additional evidence of the global DVD player market is slowing and we expect that trend to continue in the foreseeable future. However, we increase our overall penetration of the global Red Laser DVD player market to 44% for the 12 month ending Q1, a growth of 29% from the previous 12 month period. Looking forward, we see continued opportunities to grow our penetration of the DVD market especially in certain regions but are now focusing much of our sales in business development efforts on emerging product categories.

Let us review our progress to each of these areas starting with the Blu-Ray category. In Q2, we increased our footprint in Blu-Ray devices what we recognized as the high definition successor to standard DVD players. As Blu-Ray gains market traction that replaces standard Red Laser DVD players in the future, we believe that it will be an important source of growth for our licensing business. We announced several new DivX certified Blu-Ray players this quarter including models from Panasonic, Marantz and DENON. We believe the addition of H.264 to our technology portfolio later this year will only increase are already strong traction in the Blu-Ray category.

We have also increased our footprint in the mobile category where we are seeing strong partner interest and consumer demand. Two new DivX certified mobile devices were launched by our customers in the second quarter, the LG Secret and the Samsung Omnia. A third new mobile device, Samsung Innovate, was also certified and will be launched soon. These sleek multimedia phones offer a highly compelling consumer experience and stand strong alternatives to the iPhone. With a high quality, strong compression and interoperability of DivX video technology, consumers can use these phones as portal media centers taking advantage of the TV up feature to view high quality content from their phones in the living room.

Many of these models can also record natively in the DivX video format functioning as high quality mobile video cameras. The adoption of DivX by mobile chip manufacturers is another indicator of our traction in this category. You will recall that we announced an agreement with Qualcomm, a leading mobile chip manufacturer last September and have been working with Qualcomm to certify a number of chip solutions since then. I am pleased to announce that Qualcomm achieved DivX certification on nine of their 7,000 series chip sets in Q2 which represents a critical milestone for the DivX mobile initiative.

These DivX certified Qualcomm chip sets will provide a low cost, single chip solution for DivX playback and are expected to facilitate DivX adoption in this category. We also announced a mobile licensing agreement with AMD, a major chip manufacturer and continue to work towards agreements with a number of other chip companies which should result in additional DivX certified chip sets in the near future. Another critical element in the growth of our licensing business is the set-top box category.

After announcing a number of DivX certified set-top box chips over the last few quarters, I am pleased to report that we recently certified our first set-top box from a major manufacturer LG. Consumers will be able to playback DivX video to the device's internal hard drive or by attaching a USB flash drive to the box. Going forward, we see set-top boxes as a key piece of our DivX Connected and content strategies and we expect to see the certification of additional devices for more OEM in the future.

Digital televisions are another key product category where we saw increased traction in the second quarter. We now have over 100 digital television models certified from major manufacturers including LG and HP and we recently announced the first DivX certified DTV in the Japanese market from ByDesign, a large domestic OEM. We expect to see continued growth in this category as well. In fact we just certified a 7405 chip from leading chip supplier Broadcom which will be used for both DTV and set-top boxes. The Broadcom solution is among the first chips to receive certification for full 1080p DivX HD playback, a significant milestone that should increase our penetration in these important categories.

Turning to the gaming console category, we expanded our relationship with Sony computer entertainment to offer Play Station III game developers the ability to encode cinematic scenes and high quality DivX video. This agreement will expand our licensing revenue in the gaming category. The PS III as you recall is the first gaming console to enable full DivX video playback that remains by far the best selling Blu-Ray device in the world. Our relationship with Sony continues to strengthen and we believe that PS III serves as a valuable extension of the overall DivX device in the system.

So that is an overview of our progress in our core licensing business. We continue to increase our penetration in the DVD player market while making good progress and extending the DivX video strengths to a variety of new devices and platforms. Let me turn now to our H.264 initiatives which will help accelerate our momentum in these emerging product categories.

H.264 is a new standard for digital video compression that has already become ubiquitous online and has been widely adopted in key device categories including mobile phones, high definition devices and set-top boxes. We have been working closely with our MainConcept team to develop an H.264 solution that meets the need of the DivX user base. This quarter we launched the first version of our H.264 decoder technology to an invitation-only data program and the response from the early adopter community was very encouraging.

We are still in the very early stages of productizing our H.264 technology but initial testing and user feedback suggest the quality and performance of our solution as highly competitive. We find to formally release our first H.264 software product to consumers by the end of the year and help to see DivX certified devices supporting the format in late 2009. We will continue to update you here in this area in the upcoming quarters.

Content is another important initiative that is driving continued device penetration and consumer adoption. Our content strategy is focused on our power by DivX model in which we seek the power of broader range of content services of DivX technology. From premium Hollywood sides to personal video blogs and allow those services to be enjoyed on the vast installed base of DivX certified devices.

Our format approval agreements with content providers, our online retailer relationships and our independent publisher solutions based on our web player are all part of our strategy here. Earlier this year, we announced our first format approval agreement with a major premium content provider Sony Pictures television. This quarter we completed an additional agreement with Sony Pictures International which will enable retailers to gain access to a broader library of premium titles in a DivX format both domestically and overseas.

We also announced the milestone agreement with Cinema Now this quarter, the first major internet distributor of premium Hollywood content to adopt the DivX format. With this agreement, we would be providing Cinema Now with all the technology components they need to securely offer consumers high quality movies in the DivX format that could be enjoyed on any DivX certified device. Cinema Now has not yet released a timeline for implementation of the perspective service but we are working closely to support them as they integrate our backend technology solution and finalize streams with Sony Pictures.

The format approval from a major content provider and a complete distribution platform, we are in a position to extend our solution to other content retailers. In parallel, we will also continue to pursue format approval deals with additional content providers to increase the number of premium Hollywood titles available in the DivX format. We acknowledge that it will take time to put all these pieces in place for our premium content initiative but we are pleased with our progress and will continue to provide updates here.

Another key element of our content strategy is to enable the creation and distribution of web based DivX content. As we mentioned last quarter, we have seen strong adoption that the DivX web player by independent content publishers across the internet, a trend that is extremely encouraging as part of our “Powered by DivX content strategy.” In fact, to date, there are thousands of websites across the internet using the DivX web player to deliver high quality content in a browser.

This viral adoption has occurred with virtually no marketing effort or financial resources on our side. We believe the web player solution is a strong asset that enables anyone to offer high definition digital video content online. The broader online DivX community at large remains very healthy and strong. In Q2 we averaged over 10 million monthly unique visitors to divx.com and delivered 250 million player better impressions. A key metric that we enforce is the size and engagement of the DivX user community. This strong traffic and user engagement has resulted in higher software downloads and increase toolbar revenue for our software business.

Another key element of our long-term version as we have discussed in the past is our DivX Connected initiative. Though still in the early stages, DivX Connected is progressing nicely. Thanks to the openness of the platform, we have seen a strong community developed around the project with a wide array of user creative plug ins that enable consumers to access a variety of online content. This open approach leverages the power of the internet and our growing and enthusiastic user community has created over 60 plug ins that let DivX Connected users easily enjoy a variety of internet applications on their televisions including YouTube, Facebook, Flickr, BlastFM, Google Maps, MTV.com and many more.

We also announced the deal with Revision3 and launched the Beta version of the 13:56view service on DivX Connected. DLink our first DivX Connected partner, we simply begin shipping product in the US for the first time and we continue to pursue additional OEM agreements to enable the DivX Connected experience of products from a variety of partners. Before closing, I would like to note a few corporate developments.

We recently added James Brailean to our Board of Directors. As co-founder and Chief Executive Officer of PacketVideo, Jim brings strong strategic guidance and a deep understanding of the mobile video space to DivX. We are glad to have him on board. We also added Eric Rodli to our executive team as EVP of Sales and Marketing. We are confident Eric is the right person to take the reigns of our global Sales and Marketing organization. Eric brings strong experience in the digital media and entertainment industries to his ten years at Macrovision and Kodak and possesses a keen strategic understanding of our unique business model and position in the marketplace.

Before turning the call over to Dan, I would like to reiterate that Q2 was another strong quarter for DivX the solid financial results and meaningful progress across several strategic initiatives. Going forward, we have the right team in placed to execute on our business plan and realize our objectives in a consistent and methodical manner. I believe we are in a better position than ever before to deliver on the promise of digital media enabling consumers to easily create, enjoy and share high quality digital video content and services seamlessly across any device for many manufacture, from the PC to living room and on the cell.

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

Dan Halvorson

On today's call I will provide a summary review on our second quarter and address our EPS and revenue guidance for the full year 2008. To start, I would like to make a quick comment about how we approach our business in the current environment. We are focused on adhering to few key principles. First, maintain our historically high gross margins. Second, manage expenses tightly and invest to generate long-term returns for the business and third, focus on delivering strong cash from operations a key measure of our success. We are pleased to report that in the second quarter, we achieved each of these objectives.

Revenue for the second quarter was $21.3 million, an increase of 17% over the second quarter last year. Our GAAP EPS for the quarter was $0.05 per diluted share and our GAAP profit was $1.7 million. Now, on GAAP EPS was $0.11 per diluted share and we generated non-GAAP profit of $3.5 million. Excluded from the non-GAAP EPS and net income are the following. One, share base compensation net related taxes of $0.04 per diluted share. Two, a $0.01 per diluted share asset impairment charge net of taxes which is attributable to the write off in the final milestone related to the VHS acquisition and three, scheduled amortization of purchase intangible asset, net of taxes related to MainConcept of a $0.01.

Breaking down the quarter further, technology and licensing revenue for the quarter increased 15% over the same quarter last year. Technology and licensing to hardware manufacturing partners was approximately 63% of total revenues for the quarter. Technology and licensing for software which includes the MainConcept revenue was approximately 14% of total revenues for the quarter. We had one licensing customer that is LG in the quarter that accounted for 10% of revenue. Media and distribution revenue for the quarter was approximately $4.9 million or 23% of total revenue. This is a 21% increase over the second quarter last year.

Revenue from our Yahoo! toolbar agreement accounted for approximately 22% of Q2 revenue. The mix across geographies for the quarter was 56% for Asia Pacific, 27% for the Americas and 17% for EMEA. Remember that this year’s graphic revenue mix represents the location from which our licensees manufacture products not the location into which the products are shipped. Gross margins remain strong at 95%.

Now, let me focus my comments on expenses. I will talk about our expenses consistent with the non-GAAP breakout provided in the supplemental earnings table in our press release today, detail and share base compensation and other items discussed earlier. Please remember that we closed the MainConcept acquisition in the fourth quarter of 2007, consequently our year-over-year comparisons for all of 2008 are impacted by the addition of MainConcept. We continue to optimize the synergies between DivX and MainConcept. As noted in our Q1 conference call, we are seeing increase deferred revenue from MainConcept due to the nature of accounting requirements for revenue recognition.

Consequently, we continue to expect revenue and deferred revenue to fluctuate from quarter to quarter as we integrate and adjust the form of MainConcepts’ customer terms to traditional DivX terms and conditions. Total operating expenses in the quarter of $18.2 million included core DivX business expense of $15 million for approximately 70% of total revenue, $2.4 million of share base compensation, $250,000 impairment due to an intangible asset attributable to the write off of the final milestone related to VHS and the scheduled amortization of purchase and tangible asset related to MainConcept of approximately $500,000.

The core DivX Q2 operating income excluding share base comp, the impairment charge and amortization was $5.2 million or 24% of revenue. Including share base compensation, the impairment charge and amortization, we had a GAAP operating income of approximately $2 million. Our interest income for the quarter was approximately $1.1 million which compares to interest income of approximately $2 million earned during the second quarter of last year. The decrease in interest income is primarily due to lower average cash balances in 2008.

The decrease in cash is primarily a result of one, cash used to acquire MainConcept in November of 2007 and two, the cash used to repurchase shares or common stock. For the second quarter, share base compensation expense, net of tax was approximately $1.4 million or $0.04 per share. We ended the quarter with total cash and investments of approximately $180 million or $3.66 per share. We generated approximately $5.6 million in cash from operations during the quarter.

Including working capital changes, cash used in operating activities was approximately $2.7 million primarily due to timing of the $6 million decrease in accrued expenses and payable balances and an increase in our deferred tax asset of approximately $1.6 million. Our capital expenditures were $625,000 during the quarter. From a tax perspective, during the quarter, we updated our tax rate in various geographic regions including Germany and United States. Based on this analysis, we estimate that our overall tax rate for fiscal 2008 will be approximately 41%, up from 40% as noted in previous earnings calls.

As a result, we reconcile the annual effective tax rates in the current quarter resulting in a Q2 non-GAAP tax rate of approximately 45%. For modeling purposes, the second half of 2008 should be estimated at a 41% effective of tax rate. As we mentioned above, our largest use of cash in the quarter was for stock repurchase program. During the second quarter, we used $10.1 million to repurchase approximately 1.4 million shares or 4% of total shares outstanding. To date, a total of 2.8 million shares were repurchased or 9% of shares outstanding. We have now used the 20 million which was authorized by the board of directors for the repurchase program.

Before we move to guidance, I would like to address our portfolio of auction rate securities. We have a par value of approximately $19 million in auction rate securities. We believe our auction rate portfolio is high quality as a 100% carry triple A rating with no history of default and a 100% of these auction rate securities are collateralized by the Federal Educational Lending program. As a result of the continued lateral liquidity in the auction market and fluctuation in interest rate assumptions used to calculate the value of these investments, during the second quarter, we recorded an additional unrealized loss of approximately $300,000.

The total unrealized loss recorded on a consolidated balance sheet for the first two quarters was approximately $1.5 million. We feel this decline in value is temporary, partly base on our ability and intent to hold these investments until liquidity return to the market. It is important to note that during the second quarter, $1.3 million of our auction rate securities were redeemed at par by one of the issuers. This further supports our belief of the temporary nature of these declines in values. Our headcount was 341 at June 30, 2008 which includes 83 from MainConcept. This compares to just over 380 at the end of the year.

Next, let me address guidance, you will recall that last quarter we announced we will provide annual guidance. We are reaffirming our previous guidance and continue to anticipate full year revenue in the range of $95 million to $100 million. Technology and licensing revenue are anticipated to be in the range of 75% to 85% of revenue for the full year. Media and other distribution services is expected to be between 15% and 25% of total revenue for fiscal year. We are targeting gross margins for the full year to be approximately 95%. Product development expenses in 2008 will increase as a percentage of revenue given our investment in new product categories.

Our tax rate guidance for the balance of the year is anticipated to be approximately 41%. GAAP EPS for 2008 is expected to be in the range of $0.24 to $0.30 per diluted share which includes one, anticipated non cash share base compensation of approximately $9.5 million or $0.16 per diluted share net of taxes, two, stage 6 related expenses of approximately $3.3 million or $0.16 per diluted share net of taxes which were incurred during the first quarter, three, impairment of intangible asset attributable to the write off of milestones associated with the acquisition of the interest of approximately $1.3 million or $0.03 per diluted share, four, the scheduled amortization of purchase intangible asset related to the acquisition of MainConcept of approximately $2.2 million or $0.04 per diluted share, five, a foreign currency exchange impact on a euro base inter company loan between MainConcept and DivX of approximately $500,000 which was a gain of $0.01 per diluted share which was recognized in the first quarter.

Weighted average shares outstanding for the year are expected to be approximately $34 million which includes the impact of the share repurchase program.

With that, we will open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Steven Frankel - Canaccord Adams.

Steven Frankel - Canaccord Adams

I wonder if you might start out with what kind of visibility do you have into the back half to give you confidence in this guidance given the current environment.

Kevin Hell

The visibility it is always tough. We gave this, you would like to be in a position, obviously, to adjust not downward but upward and I think we are pretty firm with keeping this. We had put this guidance out originally in March and then we reiterated the top line guidance with a raise on the bottom line in May. As we look at some more contracts and the strength with the relationship as you know Steven and some of the other people on the line, a lot of these contracts have set terms. The price is set. It is all depending on volumes though and that is really the crux to your question but there is some part of the business that although it is getting more complex to model, it does help us.

The Yahoo is an area that we felt like we have strength that we can talk about that a little more but the core CE licensing business is an area that, albeit, we need to sort through the transition as Kevin talked through in his prepared remarks as we moved from standard DVD to Blu-Ray. We still think that there are wallets going down. We have a transition there. You have got Yahoo that we feel like the toolbar, our immediate distribution is solid and then you bring in MainConcept with that. So, while they are removing pieces, we do have, we take enough visibility to reiterate guidance at this time.

Steven Frankel - Canaccord Adams

On the Blu-Ray front, are there of your significant customers that are signaling to use it there not like to put DivX in next generation Blu-Ray devices?

Kevin Hell

No, we are seeing strong and good traction in the Blu-Ray segment. In Q2, we certified eight additional Blu-Ray devices. We are up to I think some 19 total devices to date excluding the PS III and we are giving very good traction with all of our major partners. So, my expectation would be that we would see similar if not greater penetration to Blu-Ray category as we seen in the Red Laser category.

Steven Frankel - Canaccord Adams

And when it is likely to happen to headcount over the next six months? Is it going to be stable or are we growing it?

Dan Halvorson

As you go through some of the initiatives that we have talked about before and Kevin just went through, we would expect to grow. It certainly mixed, we have opportunities now as we have talked about before worldwide both with Germany but San Diego is the main stay. San Diego is important so across the company, we would expect that. The good news is we continue to…, yesterday, we have an internal what we call our all hands meeting and we had various new employees hired. So, there is always…, you can take turn but we would expect headcount to grow.

We cannot really give you a number of about where we are at now but I think headcount will continue to grow.

Steven Frankel - Canaccord Adams

And on the Yahoo front, you feel like you have enough experience now that you can understand how to model that and how to drive traffic there?

Kevin Hell

Yes, Yahoo is driven by our software downloads and we have seen tremendous growth in that category where we probably see come up with stage 6 now but we have seen the web player downloaded 4.7 million times actually in Q2 and that is something that is contributing to overall Yahoo numbers in addition to our main software player bundle that we have out there. So, we got good visibility on that now, in the post stage 6 era and we are confident of that going forward.

Steven Frankel - Canaccord Adams

When is the next major release of the software player? Is that none until you get H.264 integrated or we have something before that?

Kevin Hell

The next major release of the software left of the decimal would be our H.264 release which is scheduled for later this year.

Operator

Your next question comes from Paul Coster - JPMorgan.

Paul Coster - JPMorgan

A few quick questions, so, the global penetration went up 200 basis points sequentially. The guidance that you were calling for the remainder of the year suggests that we are going to see mid-teens to high year on year growth in licensing so against a backdrop of potentially some slowdown in unit shipments from the Red Laser? I could only draw the conclusion that the new product category is starting to sort of move the needle, is that correct? What percentage of revenues came from them this quarter and what percentage for the year?

Kevin Hell

That is correct. I mean the overall shift, as you look toward the back of the year, is increasing penetration of DVD market despite the fact that the broader DVD market is down along with increasing revenues associated with the emerging product categories. We have introduced products in the mobile space, the Blu-Ray space, the set-top box space, the DVD space, the gaming console space and so all those are starting to contribute and we will continue to contribute as it move forward. One of the big announcements that I have made on the prepared remarks was the certification of the nine 7000 series chips from Qualcomm.

Those are chips that are higher volume chips that will allow us to expand in the mobile category in the future so we are very optimistic about that as we move forward. In addition, as I mentioned also you have the Yahoo component to that as well so those were all the things that drive continued growth in the category.

Paul Coster - JPMorgan

Well, it presents the licensing revenue came from along Red Laser DVD products this quarter and for the full year, do you think you will have?

Kevin Hell

Paul, we did not break that out. You mean. traditionally we break that out, at least by my thinking is when it would be significant and that significant is typically in the 10% range and though to extend it is what I call meaningful, we would give an update on that but right now we have not broke that out and it is early earnings on that.

Paul Coster - JPMorgan

Okay you said in your remarks that penetration will be driven forward with certain countries in mind. What countries do you have in mind and how will you address those particularl countries?

Kevin Hell

Sure, we will reduce our markets like the US, markets like Japan, larger Brazil, larger markets where we do not have high penetration today and the way we drive that is a couple of ways. The first is through continued meetings with retailers in those geographies to make sure that they understand the value of DivX and represent that when they meet with their OEM suppliers. And the second way is to have continued progress in the content space that drives consumer demand for these devices whether it be the usage of our web player on the thousands of sites that are out there today, where premium services as we are talking about with Cinema Now. So, those will continue to help drive additional penetration in these different geographies.

Paul Coster - JPMorgan

With respect to the premium content in these DviX cost we aplaud and it is good to see a price set this quarter. Nonetheless, it really feels like you are pushing it at the moment whereas ideally it would be pushed by the premium content raters themselves. Do you see that dynamic particularly with Sony happening any time in the next 18 months?

Kevin Hell

Yes, I would say that we are seeing strong support from our partner, Sony to help drive this with retailers. I think that they would like to see us be successful they believe in direction what we represent the fact that we have this very large eco system, the fact that we are not Apple has certain advantages to the studios as well. So, we do see that Sony is behind us in that way to help drive additional retailers out there above and beyond Cinema Now and of course as we add additional studios in the future, we expect it will be a helpful partner as well in that context.

Paul Coster - JPMorgan

But they did not do anything, at least, for instance to promote DivX on Q3?

Kevin Hell

I know that there has been a number of conversations in retailers for Sony and it has been very helpful in terms of driving and recommending DviX. That is all I can say in that front.

Operator

Your next question comes from Rob Stone - Cowen and Company.

Rob Stone - Cowen & Company

Question relative to sort of understanding the transition slowing overall marketing. In the past, one of the things that you guys used to talk about was essentially moving up across a range of different flavors of the product with increasing capability and of course Blu-Ray is a new family of product as well. So, can you give us a sense as we move to this transition and increase more high definition penetration whether in addition to managing the unit growth that you would expect to see and increase in revenue per unit.

Kevin Hell

Are you talking about specifically the DVD category?

Rob Stone - Cowen & Company

Yes.

Kevin Hell

So, on the Blu-Ray category given these are high power devices as the transition occurs over time between Red Laser to Blu-Ray we would expect to see increased value on a pre unit basis both in terms of DivX HD capability where we are seeing demand right now for 720p playback and 1080p playback on these devices. The addition of H.264 playback on these devices with DivX plus which will be coming out later this year and then of course DivX Connected as well. Many of the Blu-Ray players are getting connectivity and those that are great targets for adding DivX Connected.

So, when you look at a per unit basis, there is truly an opportunity to increase the value on each of these devices relative to what we have seen in the past in Red Laser.

Rob Stone - Cowen & Company

Okay so, are we seeing that trend on Red Laser or…because there was a period of time where it seem like due to the format confusion on next generation devices that manufacturers were looking for ways to differentiate Red Laser devices and perhaps up scaling and offering current high definition capability, what is happening in the, it is like take from your prior answer that Red Laser is still 90%+ of the revenue and licensing, hardware licensing, what is the ASP and future trend that you are seeing within that category?

Kevin Hell

Sure on the Red Laser, there are certain OEMs who are interested in actually having HD playback on those devices as well and that does allow for an increase in the ASP on those specific devices but I think it is relatively temporarily as it make the transition to Blu-Ray devices more broadly overall. In terms of the over broader, overall ASP trend, I would say we continue to hold the line fairly well on ASP. There has been some slight decline in ASPs overall but the trend has been fairly stable.

Rob Stone - Cowen & Company

Second topic if I may on the Cinema Now relationship you mentioned that you are providing the necessary tools to support them, can you just talk a little bit I know you probably cannot go into specifics since you only got one relationship like this but can you give us a sense of in general how that relationship will be monetize? Are we talking about one time revenue to set them up from ongoing revenue? What is going to be the impact can you give us the future?

Kevin Hell

Yes, I cannot go into detail on the specific relationship. There will be no expect to see significant direct monetization from the relationship but we are seeing an immediate impact of this deal actually in the form our licensing negotiations as our partners see this premium content coming both with the Sony relationship and Cinema Now and hopefully others overtime here. We are seeing a very beneficial impact to our licensing negotiations both for the DVD segment as well as for these new emerging product categories. That is having a real material impact today in striving real revenue today.

In terms of how this plays out from a business model perspective on the contents, I think we are still in early innings. I think there could be a blend of upfront keys associated with setting it up as well as potential revenue participation as well but it is still early to say. I cannot tell you that we have been operating a BOD service with smaller players, tier 2 content I will call it long-term content for nearly seven years now and in those models, we do have a revenue share but in the premium content area, it is still early to tell exactly how that is going to play out.

Operator

Your next question comes from Bud Leedom - Global Hunter.

Bud Leedom - Global Hunter

I know you did not mentioned digital camera and I know that was the strength of H.264 and I am assuming once the new software comes on line that would might give some activity there, can you just comment on what you are seeing or what the game plan is on digital camera?

Kevin Hell

I want to point out the fact that two of the mobile phone models that we have already certified actually have cameras inside and they actually does these cameras in terms of the quality of the output. It is actually quite significant. It rival some of the certified cameras we have up there already in terms of the overall quality. So, a lot of where we see it going overtime is toward mobile phone, we see a combination of a camera, a portal media player and a phone really all coming into one. So, from the camera respective, we see a lot of growth from the in code side coming from mobiles phones in the short to medium term.

For mainstream dedicated cameras, as you mentioned it is really a lot of going toward H.264 chip architectures and that is why we had a trouble driving penetration over the last year to year and a half but as we release DivX plus, we hope and expect that to increase our penetration of the digital camera segment

Bud Leedom - Global Hunter

Okay and just a quite note on mobile there, is there a sort of a targeted and selection point? I know we have sort of discuss this with the 2009 event, is there any, just based on the initial revenue ramp that you are seeing there, is there any fervent selection that you might be able to outline in terms of when we would expect to see this as a potential 10% opportunity?

Kevin Hell

I cannot point to specific timeline. It is driven by our partners' schedules and we report revenues a quarter after they ship. So it is hard to predict to specific timeline around that. I can tell you that it is looking very good in this space. We get more optimistic by the day. We have great traction across our OEMs, LG and Samsung. We are seeing the majority of the other major OEMs expressing strong interest in corporate DivX as well. We are in many negotiations on that front. We certified the Qualcomm chip sets. We have certified chips that are from several other manufacturers as well. Handsets are becoming VGA capable. It is all really moving in our direction overall. So we are pretty optimistic about the mobile category and I think as our solution migrates from being a fairly expensive two chip solutions as we have today down to a single chip solution, we are going to be able to reach the larger nash market volume level for mobile phones which will happen sometime going into next year.

Bud Leedom - Global Hunter

Okay, great and then just finally, is there any update on the UMG suit?

Kevin Hell

No, well so we were out with UMG. It is mainly were it was before, no substantial update. It is really procedure in nature, I kind of refer to it as joking around for venue but from our standpoint I would just reiterate but that is a good question. I would just reiterate that our DivX is used that we feel that we are in compliant with the DMCA and we will keep you updated on that in both either separate call or in our 34AC [ph] filings.

Operator

Your last question is a follow-up from Paul Coster - JPMorgan.

Paul Coster - JPMorgan

Yahoo, the role over of that contract, when will the negotiation start for that process?

Kevin Hell

It is a two-year deal and it ends toward the end of 2009.

Operator

It appears there are no further questions at this time.

Kevin Hell

Well, thank you. We would like to thank everyone for joining us today and we look forward to speaking with you when we report our third quarter results. Thank you.

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Source: DivX, Inc. Q2 2008 Earnings Call Transcript
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