DivX, Inc. Q4 2007 Earnings Call Transcript

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DivX, Inc. (DIVX) Q4 2007 Earnings Call March 11, 2008 6:00 PM ET


Karen Fisher – Vise President of Investor Relations & Compliance

Dan Halvorson – Executive Vise President and Chief Financial Officer

Kevin Hell - Chief Executive Officer


John Bright - Avondale Partners LLC

Steve Frankel - Canaccord Adams

Paul Coster – JPMorgan

Rob Stone - Cowen

Darren Aftahi – ThinkEquity

Dave [inaudible] - Pacific Edge

James Goss - Barrington Research

Bud Leedom – Global Hunter Securities


Welcome to DivX, Inc. fourth quarter fiscal 2007 operational and financial results conference call. (Operator Instructions) Now at this time I would like to turn to Miss Karen Fischer.

Karen Fischer

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

Statements during this call there are not strictly historical in nature constitute forward-looking statements. Such statements include but are not limited to: statements regarding the shutdown of Stage6, the company’s repurchase of its common stock and anticipated cash requirements, the company’s is 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 stating the company’s content licensing partnerships and the company’s anticipated financial results for the first quarter and full year 2008.

Such forward looking statements involve known and unknown risks, uncertainties and other factors which may cause the company’s 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 the company’s common stock, the performance and conditions in the United States and world financial markets, the policies and actions of the United States and other governments, the risks that that customers use DivX technology may not grow as anticipated, the risk anticipated markup opportunity may not materialize at the expected levels or at all, the risks 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 the full year 2008 may not meet expectations, and other factors discussed in the Risk Factors section of the company’s most recent quarterly report on Forms 10-Q filed with the SEC on November 14, 2007.

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

For those who will not be able to stay on the call for today, an audio webcast will be archived on our website under events and presentations at investors@divx.com.

At this time I would like to turn the call over to Dan Halvorson.

Dan Halvorson

Welcome to our fourth quarter and year in on this call for 2007. For today’s call we are going to change our format. Given the questions we have received following our announced shutdown of Stage6 we thought it best to give you some additional information in that regard at the beginning of today’s call.

I will then provide a summary review of the fourth quarter results and provide guidance for the first quarter and full year 2008. Following my remarks Kevin will then talk about the business, our near and mid term objectives and our opportunities for continued growth.

To start let me recap some of the background on our decisions to shutdown Stage6.

You will recall in July we publicly announced our plan to increase focus on our core business by seeking to separate Stage6 into its own private company. Over the ensuing months, we have evaluated several proposals. As you might imagine, we conducted the traditional risk-reward analysis.

Among many things we assessed, one, the proposed value of each offer and whether the offer made sense in a long term economic stand point; two, the likelihood that the proposed value will actually be received by DivX; three, the protection to be provided to DivX and its shareholders for any potential downside risk including any potential copyright litigation; and four, the amount of time the DivX team will need to devote to the continuation of Stage6.

In short we conducted what we believed to be a very thorough process. As matter of policy, we will not comment on any specifics financial or otherwise. But let me clearly state that we did not believe that any of our options that were presented adequately addressed our basic criteria or provided a balance of cost reduction and risk mitigation while preserving upside to the overall business.

In the meantime our previous indications regarding the cost of running Stage6 remained accurate. While the traffic to Stage6 did help generate some revenue under the toolbar distribution agreements under Google and in Yahoo, it took and it will have continued to take substantial financial investments to continue operating Stage6. The process itself as you might imagine has consumed significant amounts of time.

As we near the end of 2007 and in the light of recent market and economic conditions which have clearly affected the valuations of video sharing services, we begin to entertain the notion that we would not ultimately receive a suitable offer and we will need to accept a different outcome.

The two most likely alternatives would have been to continue operating stagesix.com which would have been a continued financial and resource drain on the organization or to close the service down. It was with that mind that we announced an extension of our process in December and began evaluating our final options in January and February.

Unfortunately, we again concluded that none of these options adequately addressed our basic criteria or providing a balance of cost reduction and risk mitigation while preserving upside to the overall business.

If we had the limited dollars to spend and low concern for profitability for our shareholders in the core business we could have maintained the site for years, but essential objective for this management team is to deliver consistent financial performance so an alternative solution was required. We believe strongly that our decision was and continues to be in the best long-term interest of our company and our shareholders.

There have been some questions about the timing of the shutdown, specifically why we didn’t wait until this call to announce the shutdown. We had certain contractual obligations related to our content delivery service that required the decision to be made by March 1 or we would have incurred additional expenses for the service.

Since we announced the shutdown of Stage6 we have received a number of new enquiries regarding Stage6 assets. We will continue to assess these offers under the same basic criteria outlined earlier to determine whether any of them strike the appropriate balance of cost reduction and risk mitigation or preserving upside to the overall business.

Switching gears for a second, one of the questions we have heard is how much revenue is attached to the web player downloads from Stage6 and how will that affect 2008 revenue. To provide the most color on that question, during the quarter, Google made up less than 10% of the revenue while Yahoo accounted for approximately 15% of total revenue. Both Google and Yahoo revenue was driven by both websites stagesix.com and divx.com.

In line to the shutdown of Stage6, the mix will shift and look much like it did before we launched Stage6, the media and distribution accounted for 10% -15% of the total revenue. With that background let me move to the numbers. If you have specific questions regarding Stage6, we welcome them during the Q&A session.

Record revenue for the fourth quarter was $24.5 million, ahead of our guidance of $22 to $23 million and an increase of 47% for the fourth quarter last year. Our GAAP EPS for the quarter was $0.11 per diluted share and our GAAP profit was $3.7 million. Non-GAAP EPS was $0.16 per share and we generated non-GAAP profit of $5.6 million.

Excluded from the non-GAAP EPS and net income are the following. One, stock based compensation net of related taxes accounted for $0.11 per diluted share. Two,

Stage6 operating costs net of related taxes accounted for $0.06 per diluted share. Three, a $0.01 per share asset impairment charge which is attributable to the write off of additional milestones related to VHS acquisition we have talked about in the past, and four, amortization of purchased intangible assets related to MainConcept.

These four items were offset by an income tax benefit during the fourth quarter for the release of valuation allowances relating to $0.13 per diluted share.

For the full year, 2007 was very successful. Revenue for the year was approximately $85 million, an increase of 43% over 2006. GAAP EPS for the year was $0.26 per share while non-GAAP EPS was $0.57 per share.

Non-GAAP net income for the year excluding the items outlined earlier increased 97% over 2006 to $20.3 million. GAAP income for 2007 decreased 44% to $9.2 million compared to 16.4 million in ‘06 primarily due to the operating cost related to Stage6, as well as the FAS 123(NYSE:R) charges.

Breaking the quarter down a little more, technology licensing revenue for this quarter increased 37% over the same quarter last year. Technology in licensing to hardware manufacturing partners was approximately 70% of total revenues for the quarter. Technology licensing for software was approximately 5% of total revenues.

Media and distribution revenue for the quarter was approximately $6.1 million or 25% of total revenue. This was up subsequently 27% from Q3 of 2007. Up to $6.1 million media and distribution revenue, software distribution was $5.7 million and represented approximately 23% quarterly revenue.

As we discussed earlier during the quarter we transitioned from Google to Yahoo. During the quarter Google made less than 10% of revenue while Yahoo accounted for approximately 15% of total Q4 revenue. With the shutdown of Stage6, let me provide a little guidance here to help you model this revenue stream going forward.

Q1 is a hybrid in that we have two months of Stage6 revenue. As we said in our press release media and distribution revenue will make up approximately 25% of total Q1 revenue. Beyond that however, the mix will shift and look much as it did before we launched Stage6 when media and distribution accounted for 10-15% of total revenue.

The mix across [inaudible] for the quarter was 58% Asia-Pac, 30% EMEA and 12% in the Americas. Remember that this geographical mix represents the location from which our partners create products, not where the products are shipped. Gross margins remained solid at approximately 94%.

Now let me talk about expenses consistent with the non-GAAP breakout provided in supplemental earnings table in our press release today detailing Stage6 operating cost and stock based comp and other items discussed earlier.

Please remember that we closed the MainConcept acquisition on November 14th so we have approximately 45 days of expenses in the quarter that recognize virtually no revenue from MainConcept in the quarter due to revenue recognition criteria.

Total operating expenses in the quarter of $25.8 million included core DivX business expenses of $15.2 million or approximately 62% of revenue, $3.5 million for Stage6, $6.4 million of stock based comp, $750,000 impairment charge to an intangible asset attributable to the write-off of additional milestones servitures and amortization of purchased intangible assets related to MainConcept of approximately $270,000.

The Q4 core DivX operating income excluding Stage6, stock based comp, the impairment charge, and amortization of intangibles was 32% of revenue. Including Stage6, stock based compensation and the impairment charge we had a GAAP operating loss of $2.7 million.

Our interest income for the quarter was approximately $1.9 million. Stock based compensation expense net of tax for the fourth quarter was $3.8 million or approximately $0.11 per share. You will recall that this amount was higher than normal and includes approximately $0.06 per share charge relating to Jordan Green Hall’s departure during the quarter.

We ended the quarter with total capital cash investments of approximately $141 million or $4 per share in cash. The biggest use of cash in the quarter was just over $20 million related to the acquisition of MainConcept.

In addition we used approximately $800,000 in cash from operations earned during the fourth quarter and we invested approximately $1.5 million in capital expenditures. Our head count was 389 at December 31, which includes the 88 employees from the newly acquired MainConcept.

Now let me address guidance for the first quarter of 2008. We are also introducing guidance for the full year. As you are aware, we have less visibility in the back half of the year and we are therefore taking a measured approach toward our annual guidance but we do expect our non-GAAP projected EBITDA to be in the range of 25-30% for the full year of 2008.

Let me begin with annual guidance, we currently anticipate full year revenue in the range $95 to $100 million which would represent growth of 12-18% over 2007. We expect technology licensing revenue to be between 75-85% for the full year and approximately 75% in the first quarter. Media and other distribution services will be between 15% and 25% for the fiscal year and approximately 25% for the first quarter.

We are targeting growth margins for the full year of approximately 95%. Product development expenses in 2008 are expected to increase as a percentage of revenue given our investment in new emerging product categories.

GAAP EPS for 2008 is expected to be at the range $0.14 to $0.22 per diluted share which includes: one, expected non-cash share based compensation of approximately $10 million or $0.16 per diluted share net of taxes; two, anticipated Stage6 operating costs and related accruals of approximately $4 million or $0.07 per diluted share net of related taxes; three, expected impairment of acquired intangible assets attributable to write-off of additional milestones related to Veatros of approximately $1.3 million or $0.03 per diluted share net of taxes; and, four, the amortization of purchase intangible assets related to MainConcept of approximately $2.2 million or $0.04 per diluted share net of related taxes.

Our 2008 guidance does not include any impact from the company’s recently announced share repurchase program which allows for the company to repurchase up to 20 million of our common stock. Based on these items we are guiding to non-GAAP EPS of $0.44 to $0.52 per diluted share for the full year.

One additional note for the full year, we expect revenue and deferred revenue to fluctuate from quarter to quarter as we integrate and adjust four of MainConcept customer terms to traditional DivX terms and conditions.

Turning to the first quarter of 2008 we expect revenue of approximately $24.5 to $25.5 million.

GAAP EPS in the first quarter is expected to be in the range of a loss of $0.01 to a positive $0.01 per diluted share which includes: one, expected non-cash based compensation expense of approximately $2.5 million or $0.04 per diluted share net of taxes; two, anticipated Stage6 operating costs and related accruals incurred through February 29 of approximately $4 million or $0.07 per share; three, expected impairment of acquired intangible assets attributable to the write-off position of milestone payment related to Veatros of $1 million or $0.02 per share net of taxes; and four, anticipated amortization of purchased intangible assets related to MainConcept of approximately $550,000 or $0.01 per diluted share.

Please note that the total $4 million for Stage6 will be expensed in the first quarter. Excluding the effects of these items we expect our Q1 core business EPS to be in the range of $0.13 to $0.15 per diluted share.

Before turning the call to Kevin let me give you a few house keeping items for your financial models.

As stated in November we expect MainConcept to be accretive in EPS for the second half of the year. In terms of revenue we expect MainConcept to contribute approximately $6-8 million to the technology life in business for the full year.

We also expect MainConcept will add approximately $2 million in operating expense each quarter and approximately 4550,000 each quarter for the intangible amortization related to the acquisition. Please note the expected revenue and operating expenses for MainConcept have been included in our guidance.

We are currently forecasting a 40% effective tax rate for the full year and this will depend on the effective tax rate in various domestic and foreign jurisdictions.

Weighted average shares for the full year outstanding year are expected to be approximately 37 million; this does not include any potential impact from the share we purchased and which we will incorporate as we execute on the buyback program.

I will be happy to answer your questions about guidance during Q&A but first I will turn over the call to Kevin for his commentary.

Kevin Hell

As Dan stated 2007 was a very good year for DivX. We experienced significant growth across all areas of the company and made real strides toward the goal of creating a global standard for high quality digital video on any device.

We are emerging as the open alternative to Apple giving consumers’ freedom and control over how and where they enjoy digital video and I am confident that we are on track to achieve our mission and execute on our strategic plan.

Before I discuss the key highlights of the fourth quarter, I would like to take a moment to provide some color and context around the financial results and guidance that Dan offered. First and foremost the core DivX licensing business remains healthy and profitable with high gross margins and continued global penetration.

Looking forward to 2008 we expect to see continued growth in our licensing business but are developing our forecast with a prudent view of broader industry trends. A global economic slow down could reduce demand for consumer electronic devices that incorporate our technology.

What’s more, many analysts predict a continued slowing of the standard definition DVD player market. And although Blu-Ray recently emerged victorious in the high definition format war, it will remain a relatively small share of the overall market in 2008, given pricing trends in the broader adoption cycle.

We are also seeing early and promising traction in emerging product categories including mobile devices, set-top boxes, digital televisions and connected devices. But we are taking a conservative approach here as well, until we see predictable and meaningful contributions from these new markets.

In some ways you should think of 2008 as an execution year as we work through the transition from a core DVD market to new categories. We are expecting growth in emerging categories but still our forecasting that to be less than 10% of the total revenue for the year.

With our solid business model, continued profitability and diligent management of expenses we are confident that we will continue to offer positive results to shareholders as we make this transition.

We are equally confident that throughout 2008 you will see DixX develop an even stronger leadership position as a true global standard for digital video that gives consumers the freedom to enjoy their content not just on one screen but anywhere they choose, from the PC to the living room and on the go.

With that said let me review a few key high level achievements for the company and then turn to a more detailed discussion of progress in our three areas of focus.

In the fourth quarter of 2007, we signed a milestone agreement with Sony Pictures Television that will enable consumers to purchase and enjoy secure high quality premium content for a major Hollywood studio in a DivX format for the first time. We saw the first development of DivX technology on a major gaming console with the addition of DivX playback to the popular Sony PlayStation 3.

We helped launch the first consumer product powered by the DivX Connected platform, and we announced our first significant acquisition as a public company with the addition of MainConcept, the world’s leading supplier of next generation H.264 video technology.

Now let’s turn to a more in-depth discussion of our progress. As I have detailed in previous calls, we are seeking to grow our business by focusing on three key areas, the expansion of our licensing business, the development of our DivX connective platform, and the launch of our content solutions business.

First, a snapshot of our licensing business, licensing continues to account for a majority of our revenue and last quarter we grew our core DVD player business while making significant progress in emerging product categories beyond DVD. On the DVD front, we continue to solidify our position as a ‘must have checklist’ feature on web laser DVD players for major manufacturers across the world.

We estimate that the overall DivX penetration in the global market rose to 41% in 2007 compared to roughly 30% in 2006. This increase was driven in large part by penetration gains in key markets including the US, Japan and Brazil.

We’ve also successfully renewed or re-negotiated multi-year contracts with key OEM partners including Philips, Samsung and LG, which speaks to the health and vitality of our overall licensing business. The DivX address full market for consumer electronic products now extends well beyond DVD to encompass a wide range of devices capable of playing back and recording digital video.

We continue to make significant strides this quarter in penetrating emerging product categories that will become increasingly important to the success of our business over time.

As I touched upon earlier on the call, the gaming console market opened-up for DivX in meaningful way in Q4 with the Sony PlayStation 3. Over 9 million units of the PS3 have shipped worldwide in 2007, all of which are now able to play DivX video through a simple firmware upgrade.

Our PS3 relationship is significant in another respect given the fact that the device is the best selling Blu-Ray player in the world. As I stated earlier Blu-Ray has emerged as the clear victor in the high definition format war, which is an encouraging development for the industry at large and DivX in particular.

In Q4 we certified the first Blu-Ray chipset from Panasonic and we have since certified several Blu-Ray DVD players for the DivX playback for multiple manufacturers. We recently announced the first of these devices the Panasonic DMPBD30 will go on sale in Europe and Russia this month.

The mobile category represents another significant area of focus for our licensing business. In Q4 we saw very strong sales figures for the LG Viewty. A slick multi-media phone that was among the first to receive DivX certification. The LG Viewty out-sold its predecessor, the popular LG Chocolate phone in key markets and continues to draw a great deal of interest in consumer demand.

We recently announced that the Viewty became the first mobile phone to record high quality video, natively in the DivX format. Essentially functioning as an all-in-one digital camcorder and mobile entertainment device.

Another important emerging product category for DivX is the set-top box market. In Q4 we certified a set-top box chipset from Broadcom, the third such set-top box IT solution from a partner to gain DivX certification. We have progressed in our discussions with a variety of set-top box manufacturers and plan to announce new partnerships shortly.

We are also partnering with Broadcom on chip solutions for the digital television market. And we’ve seen OEM traction in this category as well. In December LG Electronics announced that they had expanded their line of DivX certified digital televisions and we have now certified 14 DTV models from LG with more to come.

Digital televisions have the potential to serve as an important extension in the DivX eco-system, both in terms of stand-alone DivX playback and for our DivX Connected platform. This brings me to a discussion of our second key area of focus, DivX Connected.

An important piece of our overall strategy, DivX Connected is an early stage initiative that enables consumers to stream high quality video, music, photos and Internet services directly to the living room on a portable consumer electronics device from our partners. DivX Connected provides an experience similar to that of Apple TV but is not limited to a stand-alone box. It is an experience that can be embedded to a wide variety of different devices potentially including digital televisions, gaming consoles and others.

Last quarter we saw the first commercial deployment of a DivX Connected partner product, with the European launch of the D-Link DSM-330 DivX Connected HD media player. The product was rolled out to online retailers in three countries, France, Germany and the UK. And we expect the D-Link device to be available in the US and Canadian retail stores in the first half of 2008.

We also made significant strides in adding a variety of service partners for the DivX Connected platform. Signing agreements with video com chip providers including Veoh Networks, Vuze, [Jahman] and Next New Networks. Last week we announced an agreement with Hauppauge, our second DivX Connected OEM partner, with a product release scheduled for the second half of this year.

Consistent with my characterization of 2008 as a transition year for DivX, I’d like to reiterate that we do not expect to see significant volume or associated revenue for DivX Connected this year but are positioning our product for long term success.

Content solutions, a third focus for our business is an area where we saw real progress in the final part of 2007. We signed a milestone agreement with Sony Pictures Television, our first major Hollywood studio. Through this deal content retailers can now securely distribute the entire Sony Pictures television and motion picture digital catalogue to the millions of DivX certified devices from a DVD player in the living room to a mobile phone on the go.

We are working diligently to put those agreements with major retailers and strike similar deals with additional premium content providers as part of our “Powered by DivX” strategy.

I’d like to take a brief moment to update you on two additional corporate developments. We completed our acquisition of MainConcept in November, and have been working throughout the organization to integrate and align product strategy and resources. This process is proceeding well and we expect MainConcept’s H.264 technology to play a critical role in future DivX product rollouts in both software and consumer electronics.

We also recently appointed Markus Moenig, the founder of MainConcept, as our Chief Technology Officer, a position where he can leverage his deep and broad expertise in digital video to guide our technology road map as we transition to next generation platforms and product categories.

Our online team has also been working to enable the transition of our software bundling business based on our agreement with Yahoo, which replaced our previous relationship with Google. We have fully implemented the new Yahoo tool bar into our software download and have seen positive results in terms of revenue and consumer adoption.

In conclusion, 2007 was a momentous year for DivX on a number of fronts as we’ve made significant strides toward achieving our goal of building a global standard for high quality video on any device.

In 2008, we believe we are in a strong position to continue to reap the benefits of our profitable high margin model by weathering macro-economic trends and positioning our business to transition beyond our core DVD market into new product categories in 2009 and beyond.

With that we’ll open-up the call for questions.

Question-and-Answer Session


(Operator Instructions) And the first question comes from John Bright - Avondale Partners LLC.

John Bright - Avondale Partners LLC

Dan on stage6.com you mentioned some assets that might have some value, what are we talking about there in the value of those assets, and are there any associated with Stage6 you might be able to cut in addition to what you are thinking about looking forward.

Dan Halvorson

John with regards to the asset value, there is obviously a few things where we continue to look at. There is the hard server; there is the physical asset; and then there is what we did and what we learned and that’s hard to put a value on the assets that sit here as we shut it down. We also do expenses.

In the remarks and then the guidance we talked about for the quarter through the shutdown and then kind of accruals there’s about $4 million in Q1 and then we expect going forward those expenses to be out of the P&L.

John Bright - Avondale Partners LLC

Dan how much caution have you built in up to your guidance for 2008 given the consumer slow down that we are seeing that we are all seeing and have we seen Sony in the United States yet for DVD players?

Dan Halvorson

So with regards to the level of I guess caution there is a couple of what I think about is imperfect choice when am looking at guidance to give guidance a year out in an economy in a macro-environment like this. But I think it is the right thing to do given when I look out and give you our investors and shareholders some directional guidance.

So we are being measured and I made that in my comments. Kevin came behind and talked about that. We are looking at macro trends, we are looking at standard DVD and then Blu-Ray coming in and just wanting to be cautious with that. To quantify it wouldn’t be prudent but I think that there is a degree of conservatism or certainly being measured on the second half as we think about guidance.

Kevin Hell

Yes just to echo Dan’s remarks on the broader market, we are pacing a slowing economy. We are seeing the DVD market declining in some of the major markets, the developed markets 10-15 % on some cases more generally, not for DivX but overall. And are also are under increasing pricing pressure, so those are some headwinds that we are factoring in.

And to our conservative forecast as we look forward around the DVD market in terms of Sony is certainly in the US. With the PlayStation 3 it’s obviously a very high volume product out there but it’s not in the US market yet with DVD players.

John Bright - Avondale Partners LLC

DivX started out with a great first mover advantage. If we are looking forward you’ve got a good Sony Studios signed on to encode movies in DivX. How are we going to see in the future DivX participate in the market place for video and demand looking forward.

Kevin Hell

We are looking to do a couple of things. First we are looking to continue to expand the number of studios that will shoot content in the DivX format and in addition to that we are also looking at adding additional retailers that can shoot with that content. It’s all part of a power by DivX content strategy where we want to see a number of distributors of content such as Netflix, Amazon and Blockbuster all distributing content in the DivX format to the over 100 million devices that can playback that content.

So, I think the ultimate use case is actually when you can enjoy that content on a device that is sitting in you living room through remote control and that is where really Connected comes in. Connected can be built into a variety of different devices that can be built into your DTV, Connected DVD player, a gaming consul for instance.

And with Connected and these sources for video on demand you will be able to select a movie in you living room and hit play and have it immediately go and that’s the division we are building towards. Connected is important relative to other offers that are out there in the market place in a couple of key ways.

First it works with any OEM in any device, its not limited to just the Apple universe its not limited to just the Apple TV. It can work on any device. Secondly, its low cost. It can be embedded in devices that you already own, it plays back the content that you already have out there not just DivX but other formats as well. And its very open and highly extensible so we believe that its one of the best platforms out there to ultimately win in the space.

John Bright - Avondale Partners LLC

So what should we be looking for to connect those dots together? Should we be looking for more announcements for the additional studios and an additional announcement with folks to distribute that video from DivX? What should we be looking for?

Kevin Hell

Yes, exactly more studios, more distributors and retailers so that that content is available. We do have a number of sites out there that are distributing our content today for instance [INA] in France, GreenCine, [stonecrush] and sited like [inaudible] are using our format in a web player but in terms of actually reaching mainstream with Hollywood content that’s what we are working on right now by both expanding the number of studios and reaching out to retailers.


Your next question comes from Steve Frankel - Canaccord Adams.

Steve Frankel - Canaccord Adams

The way I worked out the numbers roughly you looked like you were talking about 10% licensing growth on apple to apple spaces if I take out MainConcept and I am wondering how much if anything does a decline in ASPs especially if you have just re-up some major customers have something to do with that sort of growth rate.

Kevin Hell

The 10% is directly right, there is puts and calls all through out it and one of the things that make a difference. But these levels last year remember we had the Google decoder that’s sitting up in the CE licensing business. That was a solid $2 million that won’t repeat. I think one of our analysts published about that.

But that said so it moves a 10% to 12% and it moves a higher end. But that said we are being measured kind of through out and measured in terms of we did just re-up we have announced some of the re-ups and that’s a good thing but ASPs are still solid or we probably have to not I said we have 98% gross margins so

ASPs are solid but we are going to be measured in terms of the price and the quantity of units. The part that I would round out is I think with regards to even with the growth slowing from the traditional high 30%, 40% growth is what I still look at the DivX business model and we are being measured with regards to top line growth and obviously that falls down to the bottom line.

But when you get the chance to model it you will pick out what I said in the prepared remarks. We have evened off 30% and we have an operating income even at these levels in the mid-20s. So I still think we have a very solid business model albeit we are being measured on a top line and of course that translate into the bottom line.

Steve Frankel - Canaccord Adams

In the mid-20s operating margin and the pressure on margin does that come in from increased R&D and is that headcount related, is that project related?

Dan Halvorson

No that’s clear Steve. It’s in my prepared much talked about PD and some of the items that Kevin talked on. When you look at our emerging categories we will be making it the transitional investment year. So we will expect PD to go ahead and increase as a percentage in both and absolute dollar and as a percentage for product development and that’s an area where we think that it makes sense to invest.

We are going to continue to focus on SG&A, get the scale there that is appropriate and then continue to integrate MainConcept.

The other thing that I think we shouldn’t get lost on people looking at these models and that we get a chance to study you will get a little more color of until we turn the corner with MainConcept where its accretive and we still stand by that acquisition. It’s a good acquisition. The first couple of quarters aren’t accretive therefore they are dilutive.

So depending also on MainConcept is other area that is something that we think there is up side. But taking that over, looking at the revenue recognition around converting a German based company into both US GAAP and converting the MainConcept contract into the more traditional DivX contract we just have to be measured as we approach this.

We are a little over two to three months into the MainConcept integration. That is going well but at this point for the first two quarters that ends up being dilutive. But as we said in November when we closed our MainConcept and as we reiterated today that transaction will be accretive in the second half on a quarterly basis.

Steve Frankel - Canaccord Adams

And will we see some of the product integration that you talked about when you bought MainConcept this year or is there some kind of delay in timing and we are not going to see those new integration between H.254 and DivX until next year.

Kevin Hell

Yes, you will see that this year we are working to integrate the H.264 technology both into our software and then to our consumer electronics, STKs. And we are devolved to have that in this year with products emerging that incorporate that technology. consumer electronics products. in 2009.

Steve Frankel - Canaccord Adams

Can you give us any color on the pipeline for Connected?

Kevin Hell

We talked about D-Link and that product was launched in UK, Germany and France. It’s now been announced for the US market for Q2. So we should be seeing that shortly. In addition we recently just announced the second OEM that was announced here at [inaudible] which is Hauppauge.

These are still both DMA products, really pilot proof of concept products that allow you to demonstrate the platform and get, user feed back and continue to expand the amount of plug-ins, etc. At the same time we’re working really to imbed the technology into chips. We announced at CES our relationship with Broadcom to do that.

We’re working with other chip vendors as well to incorporate the technology into mass market chips that can be embedded into a number of devices and that’s where you will start to see the significant volumes and where Connected will start to really grow.

Steve Frankel - Canaccord Adams

On Stage6 what kind of plans are there to move some of the specific content to other partner sites?

Kevin Hell

We have a number of content partners that were part of Stage6 where we have been working to migrate their content to other sites like Natgeo, National Geographic, G4 TV, etc. So we are in the process of actually doing that.

But it’s also important to remember that the DivX content universe is vast and although Stage6 was a good source of content there have been over 2 billion video files created into DivX format that existed long before Stage6 came around and that really was what powered and drove our licensing business from the very beginning.


The next question comes from Paul Coster – JPMorgan.

Paul Coster – JPMorgan

On MainConcept, you’re talking of $6 to $8 million of revenue associated with that acquisition and the second sort of back end loaded. What product categories does that relate to and is it in addition to business that you had from you MPEG-4 codec or is it replacing some of that?

Kevin Hell

The MainConcept revenue is primarily commercial licensing revenue to writing a different software partners etc., that incorporate some of their codecs and technology in their products, Vuze for instance to offer Blu-ray discs. By commercial entities it’s used in a variety of software programs etc. So those are primarily commercial licensing revenues associated with integrating that technology into other products.

I should also mention, as you may know that MainConcept’s codec was adopted for the Adobe Flash Player and it is the next generation standard that was adopted for the Flash Player, so that’s obviously a very strategic and important relationship that we now inherit with MainConcept.

Paul Coster – JPMorgan

So this is diversifying your licensing essentially but do you see MainConcept now being ported onto your traditional product line?

Kevin Hell

Yes, absolutely that’s what I was referring to earlier, so in addition to their revenue lines that we are breaking out around commercial licensing. In addition we’re taking the core HF.264 technology and we’re embedding it into our SDKs that we work with our consumer electronics partners that we incorporate that technology into their devices.

So you can also see that as being an important bridge as we expand our emerging product categories in 2009. Our partners will have these SDK’s for the end of this year and will incorporate that technology into devices so that they can support not only MPEG-4 based DivX but also in H.264, a variation DivX in 2009 and we expect that to be a nice growth driver for us as we move forward into 2009 and beyond.

Paul Coster – JPMorgan

You’ve got this business the Sony Pictures now lined up and you’ve also got the Sony PlayStation 3 and yet Sony DVDs North America still do not use your codec. What’s going on there? It doesn’t make any sense really from the outsiders’ point of view.

Kevin Hell

Right and we have a number of OEM’s in the U.S market that are shipping in the major O.E.M’s and, Toshiba, Pioneer, Sony, Phillips, Samsung, JVC, etc. Sony is one of the main holdouts actually in the U.S market just for the DVD group. Each of these divisions really makes their own determination and they arrive at conclusions on their own.

That’s what I would really say there. Obviously the PlayStation 3 is very high volume product but for a variety of reasons, the Sony DVD group in the U.S has decided not to play DivX yet.

Paul Coster – JPMorgan

On viral adoption can you give us any statistics that, for instance download volumes or unique visitors per known site etc. that might help us sort of feel that the viral community is indeed growing and this isn’t just a sort of the see industry blindly adopting without knowing that there is real demand portal out there?

Kevin Hell

We’re jockeying through a couple of statistics and one is that we have approximately 10 million unique visitors to divx.com. And they are coming to divs.com to download our software so that they can use that software to playback content, that’s out there on the Internet. So that’s just a huge number.

We have over 95 million player banners per month that is shown, which means, that our player has been used or started up. So those suggested very, very significant community in scale that continues to exist. In addition we are seeing large gains in our overall software downloads from our website as well. We had over 50 million software downloads in the fourth quarter of 2007.


And the next question comes from Rob Stone – Cowen.

Rob Stone - Cowen

Related to the Sony Content deal, you mentioned working on signing up retailers. It seems puzzling to me since Sony is the one that wants to distribute the content and they’re going to get paid for it. Who is actually doing the work to sign up these retailers and why isn’t Sony pushing out those distribution deals?

Kevin Hell

Well, we’re, actively working with Sony to do that but ultimately we also need to work with the retailers to enable them with our technology. We have a system of video-D platform that we can help them with to allow them to launch their site. So it’s really a multiple set of considerations that really go into it.

The key value proposition at the end of the day for DivX around this is though is reaching consumer electric devices that are in your living room. There is really nobody else out there, putting aside Apple for a moment that can do that. We have a huge footprint of devices and so as these retailers are looking at ways of really going beyond that PC to the living room, we’re really the only game in town. So we are aggressively pursuing these opportunities.

Rob Stone - Cowen

Can you help us understand what that process looks like if we were giving it a traditional selling cycle description. You talk to a site, you ultimately convinced them along with Sony to get it set up and they actually start distributing DivX content. How long does that take?

Kevin Hell

There will be a deal signing phase and the negotiation phase and there will be an implementation phase and there will be a ramp phase. Hard to say how long each of those is going to take they’re going to depend on the specific retailer but obviously we wouldn’t want to put out specific time until we have something to announce.


And the next question comes from Darren Aftahi – ThinkEquity.

Darren Aftahi – ThinkEquity

Around Stage6, did the Universal Music Group lawsuit play into the hands of shutting the business down at all or was the decision even spinning out? You still have some legal liability and now that its shutdown where does that stand with the company and do you think it better positions you to get more of these content deals?

Dan Halvorson

There are a lot of things that weighed into this decision last July to separate. It was the cost of the content delivery, the bandwidth. It was we feel and felt at that time and still feel like we are following the DMCA, the Digital Million Copyright Act, still feel that way. But of course as you bring out and as you and the public know as we have discussed during our 34 Act filing.

We are in litigation with U& P, there’s a degree of jockeying that we’ve filed a deck action, they’ve come back. There is some jockeying going around that, so I can’t tell you that one out weighs the other but certainly the cost of running the website coupled with some question mark around our position around the DCMA’s all comes into play there.

With regards to shutting it down, it does not automatically go away, we’d still I’d say jockeying with that and we’ll keep you posted through either our 34 Act filings or on calls like this.


And the next question comes from Dave [inaudible] - Pacific Edge.

Dave [inaudible] - Pacific Edge

Dan when you joined in this summer and kind of even into the fall you talked about a 30/30 mile as far as revenue growth and operating margins concerned and I was just curious. Obviously your guidance for 2008 is a bit lower on the operating margin end so understanding the top line conservatism, what has happened from a strategic standpoint that, now we are thinking of 2008 as an investment year whereas before it seams like we’d be seeing some leverage with Stage6 coming off.

Dan Halvorson

Yes, I think that’s fair. I think directionally the 30/30 was picked up and talked about the second 30 from an operating income and that’s why am continuing to focus people on it, we’ve had a lot of discussions here. I think we are kind of right there on the cusp by the 30/30. We are a little light at these numbers, and should there be up side, being measured at the top line, should there be up side that’s going to drop right to the bottom line at the 95% gross margin.

So, I think strategically with what’s happened I think you have to look out. And I think also my portfolio, your portfolio between sub-prime, between comments made by Best Buy CEO, by other competitors, comments we’ve made, I think when we see the macro environment, certainly from July when I started and I’ve talked about this, I think that the top line obviously drives the bottom line.

The good news is we’re not talking about a company that’s even with rounding our product development, even with making some investments we are still deep in the 20% range from an operating. So we’re not far from what I think this company ought to generate from an operating income. I think we are right in striking distance and then that top line, I think at this point to give annual guidance its pretty tough to come out too heavy in this overall environment.

And while we are excited about Blu-Ray, I think we need to be measured and see what and when that kicks in. So I think the point is there’s a lot of opportunity with our, Kevin talked about the different strategic areas but at the same token based on even the questions you and colleagues are asking now, there’s a few areas that make us take pause.

And we’ve seen this as a great transition year setting the groundwork for ‘09 and even perhaps even ‘08. But I think the 30/30 is to say I think we are on striking distance. Certainly on the bottom line and then the top line is we’re just going to see what happens with regards to the macro environment.

Dave [inaudible] - Pacific Edge

On the Stage6 front, can you make any comment on the LiveUniverse bid? Obviously the numbers are greater than zero so it seems that it would make sense to explore it?

Dan Halvorson

You can’t talk specifically about any one of them Dave, and I appreciate the question, I honestly do, we’ve had a variety of offers come in. Each one of them needs to stand on their own merits.

You are right intuitively a dollar is better than zero but you have to kind of dig deep and without giving into public forum to talk about a deal that someone else put out publicly, I think I’d just say that the management and Board and special committee with independent legal council was looking at every and any offer that we have and we are going to make the appropriate processing conclusions on that.


The next question comes from James Goss - Barrington Research

James Goss - Barrington Research

I was wondering in terms of the potential for other content deals with other producers, is there any timing we might expect in terms of hearing such deals and with regard to MainConcept are there any new product categories like cameras for example that you think you might be pushing more aggressively into where you might not have without MainConcept?

Dan Halvorson

In terms of the timing of content I think it’s difficult obviously to predict specific timing on that, we are engaged with several of the major studios and we are seeing interest in DivX for the same reason that Sony saw interest in DivX. They like our idea. They like our reach through the consumer electronics companies and the chip companies and what we can essentially do from that perspective. And they like the fact that we have all these new devices out, these hundreds of millions of devices.

So we are pretty competent in our overall value proposition and we think the Sony deal is a good model take forward. I can’t comment on specific timing but we’re optimistic there. In terms of MainConcept, yes, MainConcept is very key for us to bring H.264 technology and allow us to go after a broad range of devices. Mobile, HDTV’s, set-top boxes and digital cameras are all the devices that are seeing an up take of the H.264 technology.

We believe by incorporating MainConcept’s technology, we’ll be in a better position to go after those device categories. Now you won’t see the impact of that until 2009 because in 2008 we are basically building the technology and sharing it with our chip partners and our OEM partners so that they can build the products and incorporate that in which will actually appear in 2009. So you won’t see licensing revenue in 2008, you’ll see that in 2009.

And that goes back to again, the broader theme here, which is, 2008 is an investment year. We got a lot of very exciting products that are going to that transition stage. You’ve got H.264, you’ve got Connected, you’ve got Mobile essentially ramping and all of these things are key technologies that will help drive revenue growth into 2009 and beyond.


And the next question comes from Bud Leedom – Global Hunter Securities.

Bud Leedom – Global Hunter Securities

I know you have touched on this a couple of times just in terms of some of the alternative product categories, but can you provide maybe a little more detail on the ramp that you see and particularly mobile and maybe set-top box. How we may see that play out and becoming more substantial in terms of relativity to the DVD player.

Kevin Hell

On the mobile space, we are seeing good demand not only from the mobile handset vendors but also from the carriers as well particularly in Europe that are looking at triple plays. The way we see the mobile working out is that’s its primarily going to be in high end phones here in 2008 that have two chip solutions and that allows us to go to market more quickly. And then we’ll see single chip solutions which are lower priced for mass market appearing in 2009 and that allows us to grow much quicker so you should see additional handsets here in 2008 with real growth happening in 2009.

In the set-top box category, we have now three certified chip vendors, ST Micro, XP and now Broadcom with the 7403 chip. We plan to announce the first OEM shortly here in Europe and Asia so we do have set-top box manufacturers that are shortly coming to market with product.

The interest in the set-top box base is really a combination of both IPTV and retail free-to-air boxes that you’re seeing primarily in Europe and the buy proposition there is playing DivX content back though a USB interface. So we are seeing, traction in the set-up box base and we’ll expect to see that not only in 2008 but also, of course, in 2009 as it grows.

In addition to that we are seeing traction in the HDTV category for devices. HP has a media smart TV and then LG now has 14 certified models actually with DivX certification. There’s many more in the pipeline there. So we are seeing the LG Time series and their new PG60 line now also certified for DivX, again through USB playback.

So between mobile set-up box and HDTV we’re seeing some great take up. We are also expecting digital cameras to come back onto the scene once we have H.264 solutions out there as well, and then of course you have gaming consoles. We have the Sony PS3 and there are of course two others out there as well. So overall net-net this is a big space. The overall volume of the emerging product categories is much larger than the DVD market overall.


And the next question comes from Paul Coster - JPMorgan.

Paul Coster - JPMorgan

Can I just follow up on the emerging product categories for a moment? The ASP’s on these emerging products, what should we think of as a rule of thumb and are the DVD related ASP’s actually staying pretty flat.

Kevin Hell

So just going through that it varies with each category, Paul. The mobile category we are likely to see ASP’s sort of less than DVD’s. Set-up box, Blu-Ray, HDTV, you’ll see prices probably similar to DVD overall. As we move towards an H.264 and next generation DivX solution we’ll see an opportunity to increase ASP’s also as a go toward DivX HD playback on these devices we’ll see an opportunity to increase ASP’s.

In the broader overall DVD market, you are going to see obviously pressure on ASP’s as we continue to move forward given the market realities that are out there. I think we’ve done a great job for maintaining the ASP’s at relatively consistent levels but over time we will see increasing pressure there.

Paul Coster - JPMorgan

Do you think DivX is disabled from kind of forcing the adoption of the codec and everything else related by the fact that you are such a small company and would it be easier if you were part of a large tech company that is able to force the industry’s hand a bit better?

Kevin Hell

I think considering our size I think that we’ve actually made tremendous strides in actually moving the industry along toward DivX adoption in the DVD market where checklist feature and many other markets around the world now we are getting significant traction. We have major studios behind us with Sony and we are looking at adding additional studios over time here.

So net-net I think stand-alone business we are making great traction. If we are a part of a bigger business could we move faster? Perhaps, it is hard to say but I think we are making great traction on our own.

Paul Coster - JPMorgan

And finally are you likely to do more acquisitions this year?

Kevin Hell

I think Paul getting the MainConcept right and integrated right is going to be something that will be important for that key question. And I think with our balance sheet and stock price well with currency you can never tell if you can ever do more M&A. But I think we can get things set up and we certainly have cash and the stock works, the currency to be set up for some acquisitions but we will continue to keep you posted.


And the next question comes from Rob Stone – Cowen.

Rob Stone - Cowen

A question regarding the Panasonic Blu-ray rollout, without necessarily picking on that licensing particular why would a next generation product like Blu-ray be released for Europe and Russia but not the US? It seems like you would have as many earlier adopters of the Blu-ray in the US as anywhere else.

Kevin Hell

Again it goes back to the way that many of the OEM’s make their products decisions. They are somewhat autonomous in each of the different marketing regions. Clearly in Europe we have DivX as a checklist feature and so the requirement to have them on board is really key. So I can’t speak for Panasonic specifically around that but that’s partially what is driving around that decision right now.

The more broadly I think OEM’s are looking right now to differentiate the Blu-ray models and we are pretty confident that DivX is a real help here and we really help differentiate their products going forwards.

Rob Stone - Cowen

So what is the threshold that gets you to a checklist as in the US?

Kevin Hell

I think its a matter of timing and growth as we already seeing tremendous growth, I think the growth rate is somewhere in the 60 plus range in terms of year-on-year growth in the US market. And so we continue to become and move towards a check list feature.

I went through the list earlier of all the OEM’s that are in the US market and it is a pretty lengthy list over all. And I think obviously when you have also emerging services where you can download premium content in the US that is going to help drive DivX to be on the checklist feature as well.

Rob Stone - Cowen

If we peel off the shutdown of Stage6 influence on the download revenues and so there is a partial quarter of that. And the fact you are adding some revenue for MainConcept it still looks like a quarter to quarter evolution to what would normally be your seasonal strong quarter emerged is a lot less than last year. What is behind that and put some takes on the MainConcept and Stage6?

Dan Halvorson

One of the areas you are getting right on. You’ve got the hybrid as I said in my prepared remarks around the tool bar. But you’ve got that hybrid and then you’ve got some in the MainConcept but the top line in around the rev rec it’s not really going to drive into Q1. But even if you strip that out you’re looking at kind of apples to apples.

And when you look at that apples to apples what’s interesting I can’t recap a year ago and I don’t know how clear the former CFO was. But as I look back and dissect it and wouldn’t even try it my prepared remarks, there was some unusually high icon blue birds going from any seasonally high. I think last year it had gone from Q4 to Q1 was actually even higher [inaudible].

So if I pull those out and put some takes it is still not the traditional spikes that you would see from Q4 to Q1. For instance in Q4 to get a little granular we had one of our top ten OEM’s Q4 this year, the contract ended. We recognized about a million dollars of kind of end contract. As we talk about guide to 22% to 23% and we are at 24.5%, I don’t necessarily call that a blue bird because it is in the numbers hen we get guidance it wasn’t there. So two things are going on.

Last year the spike increase was unusually high and this year we have something in Q4. Just as the quarter we are closing on the number we are [inaudible] that doesn’t repeat. So you’ve got a few as you said puts and takes make it look kind of slower than it actually is. As Kevin said and I would say, it’s healthy. It is just not 38% or 40% quarter over quarter, year over year like it has been for many reasons.

Rob Stone - Cowen

So if we look forward, I know you are not giving guidance for 2009 but you’ve talked about a number of things that should begin to get traction in 2009. Given the fact that this is a transition year would you expect them to see this type of muted seasonality effect heading into the beginning of next year as well.

Kevin Hell

I would not and I don’t want to get trapped into giving some people might go out with ‘09 models. I would not expect to see this muted Q4 to Q1 because Q4 to Q1 is traditionally stronger for a variety of reasons. but the short answer is I would not expect as we roll into ‘09 to have a muted effect.


We have reached the end of the call I will now turn the conference back over to management.

Kevin Hell

Once again I want to thank everyone for joining us on our Q4 and full year 2007 earnings call. We look forward to updating you on our business during our first quarter conference call scheduled for early May.

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