Item 1. Business
DivX overview
DivX was incorporated in Delaware in May 2000. Our principal offices are located at 4780 Eastgate Mall, San Diego, California 92121, and our telephone number is (858) 882-0600.
DivX is a company making media better through the use of technology. We believe that media is undergoing a profound transformation that will change how we get
information, communicate and express ourselves. This transformation changes how we think and who we are. We believe that there are opportunities within this transformationopportunities to generate tremendous value by meeting the needs of the
new media and, more importantly, opportunities to influence its evolution and development. Our successes to date have been the result of creating value with and for a broad community of constituents including software vendors, consumer hardware
device manufacturers, content creators and consumers themselves. Like the evolving markets in which we operate, DivX is open and dynamic.
We create
products and services designed to improve the experience of media. Our long-term goal is to allow creators to have the ability to capture their content in the DivX format using any device or software of their choosing and to allow consumers of such
content to playback and interact with it on any device or platform.
In 2000, the first step towards our goal was to build and release a high-quality video
compression-decompression software library, or codec, to enable distribution of media across the Internet and through recordable media. As a result, we created the DivX codec, which has been actively sought out and downloaded by consumers over
250 million times, including over 80 million times during the last twelve months. These downloads include those for which we receive revenue as well as free downloads, such as limited-time trial versions, and downloads provided as upgrades
or support to existing end users of our products. After the significant grass-roots adoption of our codec, the next step towards our goal was to license similar technology to consumer hardware device manufacturers and certify their products to
ensure the interoperable support of DivX-encoded content. Through December 31, 2007, over 100 million DivX Certified hardware devices have been shipped worldwide. Our customers include major consumer video hardware original equipment
manufacturers. We are entitled to receive a royalty and/or license fee for DivX Certified devices our customers ship. In addition to technology licensing to consumer hardware device manufacturers, we currently generate revenue from software
licensing, advertising and content distribution.
Complementing our organic growth since 2000, in November 2007, we acquired MainConcept AG, a leading
provider of H.264 and other high-quality video codecs and technologies for the broadcast, film, consumer electronics and computer software markets. Through integration, we expect to realize additional opportunities both in our core markets and in
related emerging markets that will help advance our long-term goal.
Our next steps, which we have begun working toward, are to bring together the millions
of DivX consumers with content creators both large and small to build communities around media, including through the development and licensing of media distribution platforms and services for Internet and consumer electronics devices. We are
optimistic about the future and believe the opportunity for DivX is only beginning to be realized.
The DivX solution
DivX has developed a solution to address the opportunity created by the transformation of content. Specifically, we have built the technological platform and galvanized
the community necessary to enable a digital media ecosystem of consumers, content creators, software vendors, hardware device manufacturers and advertisers, allowing all to benefit from the participation of each other.
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The following illustration depicts how DivX provides the foundation and connection for the participants in the digital
media ecosystem, all of whom ultimately work to benefit the consumer:
Specifically, our ecosystem offers the following benefits to these various participants in the content industry:
To content consumers,
the DivX ecosystem provides a high-quality, interoperable digital media format supported by dozens of software products and
over 2,000 models of consumer hardware devices. This allows users to access a diverse range of content from large and small content creators and to play back this content when, where and how they want. Moreover, the widespread availability of
consumer hardware devices, software and services within the DivX ecosystem makes creating and sharing content easier and more fun for a growing community of DivX users.
To content creators,
the DivX ecosystem provides the ability to cost-effectively and securely create and distribute high-quality content to a large market of consumers, and to deliver that content when, where
and how consumers want it. The DivX platform gives content creators access to DivX Certified consumer hardware devices as well as millions of digital video savvy consumers who have demonstrated their willingness and ability to seek out high-quality
content distributed via the Internet.
To digital media software vendors,
the DivX ecosystem allows software vendors to provide
easy-to-use products for the creation and playback of content that is interoperable with all other DivX Certified devices. By doing so, software vendors can differentiate their products by adding DivX media creation and playback functionality, and
thus providing useful products to maintain and augment their position in the face of competition from generic operating system bundles.
To consumer hardware device manufacturers
, the DivX ecosystem provides the ability to offer recording and playback devices that are interoperable with millions of other DivX Certified devices in a high-quality, secure digital media
format that consumers want and use. Manufacturers can thus avoid the cost of supporting many different incompatible formats, allowing them to remain competitive in the face of
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significant price pressures. Use of DivX technologies and association with the DivX brand enables manufacturers to participate in new content business models
from content services provided by others in the DivX ecosystem.
To advertisers
, the DivX ecosystem provides access to a large and
engaged group of DivX users.
Our strategy
Our
strategy is to make media better by supporting the digital media ecosystem. Key elements of our strategy include:
Growing our core licensing
business.
We believe that our software and consumer hardware partners are integral to our success. In hardware, we will focus on increasing the penetration of DivX technologies into the current and next-generation DVD player market, while
simultaneously building on the initial success of DivX technologies in new categories of consumer hardware devices such as digital video recorders, digital still cameras, high definition recording and playback devices, mobile phones, portable media
players and other mobile devices. We also plan to advance our new DivX platform technologies into the consumer hardware device market that will, for example, allow consumers to encode and play back high definition video and access content on
connected networks directly. In software, we plan to enhance the value of the DivX technologies to our existing software partners by adding new features to the DivX media format and to increase partnerships across the software market.
Provide platforms to communities of users centered around content.
We believe it is a fundamental human desire to share experiences and be emotionally connected
with others. This desire is especially strong around media experiences, which leads to the creation of communities of individuals with a shared interest in a specific piece or genre of content. We intend to develop a set of products and services
that will give people a place to meet one another and build strong relationships around content. We believe these communities, centered around online video content, will give content creators the ability to build their content brands and generate
revenue through transactions, subscriptions, advertising and other methods.
Develop services around content and advertising that are valued by DivX
users and economically valuable to the larger DivX ecosystem.
We plan to create services that offer access to content as well as useful and relevant advertising to DivX users in a way that improves the overall media experience. Too often,
advertising detracts and distracts from the content it accompanies. We are optimistic that advertising can be done in a way that will enhance the media experience and be valuable to consumers. We have direct access to millions of users to whom
content can be offered and advertising distributed. We intend to work with content creators and advertisers who share our goal of providing DivX users with services that enhance their experience and respect their privacy.
Expand the DivX ecosystem through partnerships with the community of diverse content creators.
We believe the active engagement of content creators in the DivX
ecosystem is essential to realizing the full potential of the digital media transformation. We plan to continue to develop relationships with premium, mid-tier and individual content creators. We intend to partner with creators based not only on the
economic potential of their content, but also on the potential for DivX to enhance the value of their content through the power of our platform and community. We also plan to support our content partners in their plans to distribute their content in
the DivX format through their own various digital distribution channels.
Strengthen the DivX brand.
We intend to continue building upon the
strength of the DivX brand. We plan to ensure that in the future the DivX brand continues to be associated only with those products and services that offer high-quality media experiences. We may also invest in activities beyond our products that are
consistent with the DivX vision of better media.
Pursue selected complementary acquisitions, investments and strategic alliances.
When the
opportunity presents itself, we intend to pursue selected acquisitions, investments or alliances that complement and further our mission to make media better and improve the media experience for consumers. Our primary objectives in these
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transactions would be to acquire complementary technologies and platforms and expand the consumer and content portions of our ecosystem. Once we have
accomplished such acquisitions, we will spend time and resources integrating them into our businesses.
Our strengths
We believe that the following key strengths uniquely position DivX to continue to enhance and enrich the digital media content experience:
Our demonstrated history of success, innovation and ecosystem creation.
We have a history of technology leadership on which we will continue to build. The success
of DivX has been driven by the grassroots adoption of our technologies by millions of consumers, due in large part to the strength of our technology. We also have a demonstrated ability to build technologies that support an ecosystem of diverse
participants that gain value from their participation.
Our large installed base.
DivX technologies and products have been adopted by millions of
users who have sought it out and chosen to download it. This success encouraged consumer hardware device manufacturers to build support for DivX technologies into their products. Today over 200 consumer hardware device manufacturers and over 20
integrated circuit manufacturers, support DivX technologies in over 2,000 models of consumer hardware devices. Our original equipment manufacturer customers have shipped over 100 million units worldwide. We believe our large user and consumer
hardware installed base places us in a strong position to benefit from the transformation of the content industry and growing digital content distribution. The DivX media platform installed base represents a large addressable market for content
creators interested in commercial digital distribution of their content.
The DivX brand.
The DivX logo appears on products that incorporate DivX
technology and indicates to consumers that the product meets our strict standards of interoperability and delivers a high-quality DivX media experience. We believe that consumers recognize the value of the DivX logo, and that this increases the
value of the DivX brand to all other participants in the DivX ecosystem.
Our neutral media technology platform for software, hardware and content.
Our technology platform for the creation, distribution and consumption of media content is not tied exclusively to any specific consumer hardware device manufacturer, software vendor or content provider. We license our encoding and decoding
technologies to a wide array of such companies. We believe our neutral platform allows us to bring a diverse set of powerful interests together in the DivX ecosystem.
Our ability to understand and partner with various constituents of the digital media industry.
We have a demonstrated ability to work with industries that have very different prerogatives and goals. We are
as comfortable working within the explosiveness of the Internet industry as we are within the planned and deliberate environment of the consumer hardware industry. We believe this ability will serve us well as we work to add even more diverse
participants and industries into the DivX ecosystem.
How we derive revenue
We have four revenue streams. Three of these revenue streams emanate from our technologies, including technology licensing to producers of consumer hardware devices, licenses to independent software vendors and
consumers, and services we provide related to digital media distribution over the Internet. Additionally, we derive revenues from advertising and distributing third-party products on our website.
Consumer hardware technology licensing.
Our technology licensing revenues from consumer hardware device manufacturers comprise the majority of our total
revenues and are derived primarily from royalties and/or license fees received from original equipment manufacturers, although related revenues are derived from other members of the consumer hardware device supply chain. We license our technologies
to original equipment manufacturers, allowing them to build support of DivX technologies into their consumer hardware devices. A majority of our
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original equipment manufacturer licensees pay us a per unit fee for each DivX Certified device they sell. Our license agreements with original equipment
manufacturers typically range from one to two years, and may include the payment of initial fees, volume-based royalties and minimum guaranteed volume levels. To ensure high-quality support of the DivX media format in finished consumer products, we
also license our technologies to those companies who create the major components in those products. These include the integrated circuit manufacturers who supply the integrated circuits, and the original design manufacturers who create the reference
designs, for DVD players, digital still cameras and the other consumer hardware devices distributed by our licensee original equipment manufacturers. One of our original equipment manufacturer customers, LG Electronics, Inc. accounted for
approximately 10% of our total net revenue in the fiscal years 2006 and 2007.
To ensure that our licensees products conform to our quality
standards, we employ a rigorous certification program. Integrated circuit manufacturers, original design manufacturers and original equipment manufacturers are required to have their devices tested and certified prior to distribution. Only DivX
Certified devices are permitted to include our logo as evidence that they conform to our quality standards.
In the fiscal years 2005, 2006 and 2007, we
derived 71%, 72% and 70%, respectively, of our total net revenues from licensing our technology to original equipment manufacturers, original design manufacturers and integrated circuit manufacturers.
Software licensing.
We license our technologies to independent software vendors that incorporate our technologies into software applications for computers
and other consumer hardware devices. An independent software vendor typically pays us an initial license fee, in addition to per-unit royalties based on the number of products sold that include our technology. We also license our technologies
directly to consumers through several software bundles. We make certain software bundles available free of charge from our website. These bundles incorporate a version of our codec technology, and allow consumers to play and create content in the
DivX format. We also make available from our website an enhanced version of the free software bundle, including additional features that increase the quality and control of DivX media playback and creation. This enhanced version is available free of
charge for a limited trial period, which is generally 15 days. At the end of the trial period, our users are invited to purchase a license to one or more components of the enhanced bundle by making a one time payment to us. If they choose not
to do so, they still enjoy playback and creation functionality equivalent to our free software bundle.
In the fiscal years 2005, 2006 and 2007, we derived
11%, 8% and 8%, respectively, of our total net revenues from licensing our technology to independent software vendors and licensing our software directly to consumers.
Advertising and third-party product distribution.
We derive revenue from advertisements or third party software applications that we embed in or include with the software bundles we offer to consumers. For
example, through most of 2007, we had agreed with Google to include and distribute the Mozilla Firefox Browser and certain Google software products with our software products. Google paid us fees based on the number of downloads or activations of
the included software by consumers. This agreement expired on November 30, 2007. Revenues earned under the Google agreement accounted for approximately 15%, 18% and 17% of our total net revenues in the fiscal years 2005, 2006 and 2007,
respectively.
Beginning in November 2007, we switched from distribution of the Google software, to instead include and distribute a co-branded Yahoo!
toolbar and Internet Explorer browser with our software products. Yahoo! pays us fees based on the number of certain distributions or installations of the Yahoo! software by consumers. Yahoo! may terminate the agreement, or the revenue we derive for
such periods will be reduced, if we fail to achieve certain minimum distribution volumes or certain minimum installations of the Yahoo! software for specific periods described in the agreement. This agreement expires on December 31, 2009, and
Yahoo! is under no obligation to renew this agreement.
In the fiscal years 2005, 2006 and 2007, we derived 15%, 18% and 21%, respectively, of our total
net revenues from the inclusion of advertisements and third party software applications in our software products.
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Digital media distribution.
We derive revenue by acting as an application service provider for third party
owners of digital video content. We provide encoding, content storage and distribution services to these third parties in exchange for a percentage of the revenue they receive from sales of digital content to consumers.
In the fiscal years 2005, 2006 and 2007, we derived 3%, 2% and 1%, respectively, of our total net revenues from providing content distribution services to third parties.
Since the acquisition of MainConcept in November 2007, we also have generated revenues associated with MainConcepts licensing deals in areas
complementary to our existing revenue streams, including through MainConcepts focus on the professional sector. MainConcept is the worldwide leading provider of high-quality codec technology for the broadcast, film, consumer electronics,
computer software, medical imaging and security markets. MainConcept solutions are optimized for various platforms including PCs, set-top boxes, portable media players and mobile phones. MainConcept supports a wide range of industry standards,
including H.264.
Geographic information.
We are a
global company with a broad, geographically diverse market presence. For the years 2007, 2006 and 2005, our revenues outside North America comprised 77%, 76% and 78%, respectively, of our total net revenues. In addition, a large number of our
consumer hardware device manufacturers are located in Asia, which comprised 56%, 63% and 59% of our total net revenues for 2005, 2006 and 2007, respectively.
Technologies
Our digital media ecosystem utilizes a series of technologies designed for commercial and consumer users. These technologies
enable users to compress, secure and distribute digital video and otherwise participate in our digital media ecosystem. The following is a description of the core technologies that form the basis for our digital media ecosystem.
DivX media format.
Our DivX media format is our primary commercial technology, and comprises our DivX video compression technology, and the DivX file format
with its advanced media features and digital rights management.
DivX video compression technology.
Our DivX video compression technology
reduces the size of high-quality video to a level that can be efficiently distributed over broadband networks. The technology utilizes a mixture of video compression tools, including some from the MPEG-4 standard, and is capable of producing
high-quality video using only a fraction of the amount of data required by a standard-length DVD. As a result, DivX technology enables a user to store approximately two hours of high-quality video on a standard CD-R. DivX technology is designed to
offer a balance of compression, complexity and speed. Our technology offers superior visual quality at a high level of compression. The computational efficiencies of our technology make it suitable for integration into low-cost consumer hardware
devices and its speed makes it useful in both consumer and professional content creation and editing environments. DivX video technology can be used on video sources with sizes ranging from high definition quality video to video resolutions suitable
for a mobile environment.
DivX file format.
Our DivX file format is designed to hold multimedia data and metadata. It is based on the Resource
Interchange File Format, which by design gives it some compatibility with other Resource Interchange File Format based file formats such as the Audio Video Interleave file format.
DivX advanced media features.
DivX advanced media features enable DivX users to create enhanced digital media files, including features in the files themselves that are normally associated with the
physical media or playback device used, such as DVD-like menus, user-selected multiple-language audio tracks, subtitles, and metadata that allow the content creator to add descriptive information such as title, author and video specifications.
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Digital rights management.
We have developed a digital rights management technology that encrypts and manages
the playback of protected DivX content on personal computers and consumer hardware devices. When implemented, it ensures that digital video is delivered in a secure manner and used in accordance with rules defined by its publisher. Our digital
rights management technology is designed to require minimal system resources, allowing it to be implemented on low-cost consumer hardware devices.
Products and services
Our technologies are incorporated into several software product bundles that we offer directly to consumers, as well
as software development kits that we license to hardware and software companies. We also offer certification services to software and hardware companies, and operate a digital media distribution system in which we act as an application service
provider to third party content owners.
Consumer software
In addition to the third-party consumer software products that our technologies power, we offer several programs to consumers directly. These programs include the following:
DivX for Windows bundle.
Our DivX for Windows bundle includes our DivX community codec, DivX Player and DivX Web Player. The bundle also includes free trial
versions of the Windows versions of the DivX Converter and the DivX Pro video codec.
DivX Pro for Windows bundle.
Like our DivX for Windows
bundle, the DivX Pro for Windows bundle includes our DivX Player, and DivX Web Player. However, instead of our DivX community codec, this bundle includes our DivX Pro video codec and additionally includes the DivX Converter application.
DivX for Mac bundle.
Our DivX for Mac bundle includes Mac OS versions of our DivX community codec, DivX Player and DivX Web Player. The bundle also
includes free trial versions of the Mac OS versions of the DivX Converter and the DivX Pro video codec. The DivX for Mac software bundle does not yet support the advanced media features of the DivX format.
DivX Pro for Mac bundle.
Our DivX Pro for Mac bundle includes all of the components of the DivX for Mac bundle as well as Mac OS versions of the DivX
Converter application and the DivX Pro video codec.
DivX Mobile Player.
Our DivX Mobile Player is available for certain mobile handsets, and allows
users to playback DivX videos on their handsets from a variety of sources, including side-loading from memory cards or downloaded from the Internet, including DivXs own mobile portal.
DivX Author.
Our DivX Author application is available for the Windows OS and allows users to combine and edit multiple videos into a single DivX video, add the
advanced features of the DivX format to enhance digital media files, and create slideshows with videos, photos and music.
Technology licensing for
independent software vendors and consumer hardware device manufacturers
Software development kits.
We typically make our technologies
available to partners via software development kits. For hardware licensees, we have decode and encode software development kits that enable hardware partners to build DivX playback and recording support, respectively, into
their products. For software licensees, we offer several software development kits that allow software vendors to build DivX playback and creation support into their products.
Certification Programs.
Integrated circuit manufacturers, original design manufacturers, original equipment manufacturers and software vendors are required to have their products certified prior to being
marketed as DivX
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Certified or DivX Ultra Certified products. For example, integrated circuit manufacturers typically receive a software development kit and certification kit
from us, which they use to design a DivX Certified integrated circuit. Manufacturers may distribute those integrated circuits to DivX-licensed original equipment manufacturers and original design manufacturers for inclusion in DivX Certified devices
only after those integrated circuits are certified. Similarly, original design manufacturers, original equipment manufacturers and software vendors must have their products certified prior to being marketed as DivX Certified products. We currently
offer the following certification programs:
DivX Certified
The DivX Certified Program certifies hardware devices and software applications for the creation and playback of DivX video. DivX Certified hardware
devices support playback of all versions of DivX video, while DivX Certified software applications support the conversion of digital video into the high-quality, highly-compressed DivX media format.
Profiles for DivX Certified Products
Hardware devices may be certified for DivX decode under the DivX Certified Home Theater, HD 720p, HD 1080p, Mobile, qMobile profiles, or may be certified
for DivX encode. DivX Certified software applications support the conversion of digital video into the various available profiles.
DivX
Ultra Certified
The DivX Ultra Certified Program is a premium certification level that certifies hardware devices and software
applications for the creation and playback of high-quality DivX video with advanced features such as motion menus, subtitles, chapter points and alternate audio tracks. DivX Ultra Certified devices support playback of all versions of DivX video,
including DivX video with advanced features. DivX Ultra Certified software applications support the conversion of digital video into the high-quality, highly-compressed DivX media format as well as the creation of video with advanced features.
Profiles for DivX Ultra Certified Products
Hardware devices may be certified under the DivX Ultra Certified Home Theater profile. DivX Ultra Certified software applications support the conversion
of digital video for DivX Ultra Certified devices and software.
DivX Certified Recorder/Encoder
The DivX Certified Recorder/Encoder Program certifies hardware devices to record video directly in the DivX media format. DivX Certified Recorder/Encoder
devices create DivX video that is compatible with all DivX Certified and DivX Ultra Certified products.
Open Video System
Our Open Video System is a complete hosted service that allows content creators to deliver high-quality DivX video content over the Internet. We use our Open Video System
to provide content and service providers with encoding services, content storage and distribution services, and use of our DivX media format and digital rights management technology. Using the Open Video System, a content service provider can launch
its own web store and sell content online.
DivX Mobile Media
We recently launched a mobile media platform service where users can discover both professionally produced and user-generated video content from a variety of sources. The service is available from certain compatible
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handheld internet-connected devices and provides access to manage accounts and favorites from a computers browser. The service is still in a beta
testing stage and we are not certain what business opportunities we may choose to pursue with respect to this technology.
Stage6
We recently shut down Stage6, our online service that allowed users to publish and download video content.
Sales and marketing
Our sales and marketing team markets our
technologies to a wide range of integrated circuit manufacturers, original design manufacturers, original equipment manufacturers and software developers on a worldwide basis. In addition, members of this team market our products to various consumer
segments at industry tradeshows such as CES and CeBIT, and engage in partner and retailer training, product marketing, sales support and partner co-marketing programs. Members of our sales and marketing team also focus on content and distribution
partnerships, co-marketing transactions, advertising partnerships, brand and product marketing, electronic software distribution, business operations and marketing programs. As of December 31, 2007, our sales and marketing team included 153
full-time employees based in 11 countries.
Product development
We incurred product development costs of approximately $10.3 million, $15.4 million and $18.7 million in fiscal years 2005, 2006 and 2007, respectively, representing 31%, 26% and 22%, respectively, of total net revenue. Our product
development team is based out of our headquarters in San Diego, California and with the acquisition of MainConcept in November 2007 has team members in Germany and Russia. As of December 31, 2007, this team consisted of 184 full-time employees
dedicated to product development and product management, 113 of which were engineers and 14 of which were product managers (the other 57 filling other related roles).
Our product development team focuses on building our technologies into products that meet the needs of our consumers. This team identifies, investigates and analyzes new long-term opportunities, shapes our technology
strategy and provides support for internally developed and externally acquired technologies. Our product development team builds the platform technologies upon which our products are based and conducts our applied research in developing and
improving technologies to compress, secure and distribute digital video.
Competition
We face significant competition in the digital media markets in which we operate. We believe that our most significant competitive threat comes from companies that have the collective financial, technical and other
resources to develop the technologies, services, products, and partnerships necessary to create a digital media ecosystem that can compete with the DivX ecosystem. Those potential competitors currently include Adobe Systems, Apple Computer, Google,
Microsoft, News Corporation, Sony and Yahoo!.
We also compete with companies that offer products or services that compete with specific aspects of our
digital media ecosystem. For example, our digital rights management technology competes with technologies from companies such as Apple Computer, ContentGuard, Intertrust Technologies, Microsoft, Nagra Audio, NDS Group and 4C Entity, as well as the
internal development efforts of certain of our licensees. Similarly, content distribution providers, such as Amazon.com, Apple Computer, CinemaNow, Google, Joost, MovieLink, MySpace.com, a subsidiary of News Corporation, Netflix, Yahoo!, YouTube, a
subsidiary of Google, and subscription entertainment services and cable and satellite providers compete against our content distribution services. Moreover, other video compression technologies, including other implementations of MPEG-4 or
implementations of H.264/AVC such as those from Adobe Systems, Apple Computer, Ateme, On2 Technologies,
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and Sorenson compete with our proprietary compression technologies. Our proprietary video format also competes with other video formats, including those
offered by Apple Computer, Adobe Systems, Microsoft, On2 Technologies and RealNetworks.
We believe that the principal competitive factors that affect our
digital media ecosystem include some or all of the following:
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quality and reliability of products and services;
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technology performance, flexibility and range of application;
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timeliness and relevance of new product introductions;
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the ability to address the needs of all the constituents in the ecosystem;
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brand recognition and reputation;
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relationships with film producers and distributors as well as semiconductor and consumer hardware device manufacturers;
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differences in adoption across countries and regions; and
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We believe that we compete favorably on the
factors described above. However, our industry is evolving rapidly and is becoming increasingly competitive. Larger, more established businesses are increasingly participating in the markets in which our products and technologies compete, and we
cannot assure you that we will continue to compete favorably on these or any other factors.
Some of our current or future competitors may have
significantly greater financial, technical, marketing and other resources than we do, may enjoy greater name recognition than we do, or may have more experience or advantages than we have in the markets in which they compete. For example, companies
such as Apple Computer, Amazon.com, Google, Microsoft, Sony and Yahoo! may have competitive advantages over us because of their greater size and resources and the strength of their respective brand names. In addition, some of our current or
potential competitors, such as Apple Computer, Dolby Laboratories, Microsoft and Sony, may be able to offer integrated system solutions in certain markets for entertainment technologies, including audio, video and rights management technologies
related to personal computers or the Internet, which could make competing products and technologies that we develop unnecessary. By offering an integrated system solution, these potential competitors also may be able to offer competing products and
technologies at lower prices than our products and technologies. Further, many of the consumer hardware and software products that include our technologies also include technologies developed by our competitors. As a result, we must continue to
invest significant resources in product development to enhance our technologies and our existing products and introduce new high-quality technologies and products to meet the wide variety of such competitive pressures.
Significant Customers
A small number of customers account for a
significant percentage of our revenues. In 2007, Google, Inc. and LG Electronics, Inc. accounted for 19% and 10%, respectively, of our total net revenues. In 2006, Google, Inc. and LG Electronics, Inc. accounted for 20% and 10%, respectively, of our
total net revenues. In 2005, Google, Inc. and Philips accounted for 15% and 13%, respectively, of our total net revenues.
Intellectual property
To protect our proprietary rights, we rely on a combination of trademark, copyright, patent, trade secret and other intellectual property laws, employment,
confidentiality and invention assignment agreements with our employees
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and contractors, and confidentiality agreements and protective contractual provisions with our partners, licensees and other third parties.
Trademarks.
As of December 31, 2007, we had over 40 trademark registrations and over 60 pending trademark applications in the U.S. and more than 25
other countries for a variety of word marks, logos and slogans. Our trademarks are an integral part of our licensing program. Licensees are allowed to place our trademarks on their products to inform customers that their products incorporate our
technology and meet our quality specifications only if such products have been DivX Certified. We also require that our licensees adhere to detailed branding guidelines to ensure that usage of our trademarks and logos are consistent and uphold our
image. Our trademarks include, among others, DivX, DivX Certified, DivX Connected and Stage6.
Copyrights.
We have a significant amount of
copyright-protected materials, including among other things, software, codecs and textual material. As an additional layer of protection to the common law copyrights we own in our software and other materials, we have also obtained U.S. copyright
registrations on more than 20 software products as of December 31, 2007.
Patents.
As of December 31, 2007, we had two issued U.S.
patents and one issued foreign patent. We also hold an exclusive license to one additional U.S. patent. We are in the process of applying for additional patent coverage for various aspects of our technology, including technologies for digital rights
management, digital media formats, mobile content delivery, connected devices and video encoding and decoding. As a result, as of December 31, 2007, we had over 30 U.S. and international patent applications on file relating to various aspects
of our technology.
Other proprietary rights.
Many of our consumer hardware licensees and other partners have contractually recognized our
proprietary rights in the file identifiers that identify video content files as encoded using our codec. For instance, a video file encoded using our codec may be identified with a DIVX code that can be read and recognized by a consumer
hardware device or PC video player. Such consumer hardware licensees and partners have also contractually agreed to limit playback of such DIVX-identified files to devices that incorporate our technologies. These contractual agreements
enable us to differentiate DivX devices and video files from non-DivX devices and video files.
In addition, we also seek to maintain certain intellectual
property and proprietary know-how as trade secrets, and generally require our partners to execute non-disclosure agreements prior to any substantive discussions or disclosures of our technology.
MPEG LA technology licenses.
We have entered into a license agreement with MPEG LA, effective January 2000, under its MPEG-4 Part 2 Visual Patent
Portfolio. Under this license agreement, we have a royalty-bearing, worldwide, non-exclusive sublicense of certain patents licensed to MPEG LA relating to MPEG-4 technology. The current version of our video codec incorporates technologies
implementing a portion of the MPEG-4 video standard. Our license agreement with MPEG LA will expire on December 31, 2008, unless the agreement is earlier terminated. We may terminate the license agreement for any reason by providing
30 days prior written notice to MPEG LA. Upon expiration, the license agreement may be renewed by MPEG-LA for successive five year periods upon notice of renewal to us. For the fiscal years 2005, 2006 and 2007, we paid $2.0 million,
$2.5 million, and $2 million, respectively, to MPEG LA under this license agreement. We have also entered into a license agreement with MPEG LA, effective August 2002, under its MPEG-4 Part 10, or AVC, Patent Portfolio. Under
this license agreement, we have a royalty-bearing, worldwide, non-exclusive sublicense of certain patents licensed to MPEG LA relating to H.264 technology. Our license agreement with MPEG LA with respect to this technology will expire on
December 31, 2010, unless the agreement is earlier terminated. We may terminate the license agreement for any reason by providing 30 days prior written notice to MPEG LA. Upon expiration, the license agreement may be renewed by MPEG-LA for
successive five year periods upon notice of renewal to us. We have not been required to pay, nor have we paid, license fees to MPEG LA under this license agreement to date.
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Government regulation
We are subject to a number of foreign and domestic laws and regulations that affect companies that import or export software and technology, including encryption technology, such as the U.S. export control regulations as administered by the
U.S. Department of Commerce.
We are also subject to a number of foreign and domestic laws that affect companies conducting business on the Internet. In
addition, because of the increasing popularity of the Internet and the growth of online services, laws relating to user privacy, freedom of expression, content, advertising, information security and intellectual property rights are being debated and
considered for adoption by many countries throughout the world.
In the U.S., online service providers have been subject to claims of defamation, libel,
invasion of privacy and other data protection claims, tort, unlawful activity, copyright or trademark infringement, or other theories based on the nature and content of the materials searched and the ads posted or the content generated by users. In
addition, several other federal laws could have an impact on our business. For example, the Digital Millennium Copyright Act has provisions that limit, but do not eliminate, our liability for hosting or linking to third-party websites that include
materials that infringe copyrights or other rights, so long as we comply with the statutory requirements of this act. The Child Online Protection Act and the Childrens Online Privacy Protection Act restrict the distribution of materials
considered harmful to children and impose additional restrictions on the ability of online services to collect information from minors. In addition, the Protection of Children from Sexual Predators Act of 1998 requires online service providers to
report evidence of violations of federal child pornography laws under certain circumstances.
In addition, the application of existing laws regulating or
requiring licenses for certain businesses of our advertisers can be unclear. Existing or new legislation could expose us to substantial liability and restrict our ability to deliver services to our users. We also face risks from legislation that
could be passed in the future.
We may be further subject to international laws associated with data protection in Europe and elsewhere and the
interpretation and application of data protection laws is still uncertain and in flux. In addition, because our services are accessible worldwide, foreign jurisdictions may claim that we are required to comply with their laws.
Employees
As of December 31, 2007, we employed 389 full-time
employees, including full-time equivalents. None of our employees is subject to any collective bargaining agreements. We consider our relationship with our employees to be good.
Executive Officers of the Registrant
Our executive officers serve at the discretion of the Board. The names of our
executive officers and their ages, titles, and biographies as of December 31, 2007 are set forth below:
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Name
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Age
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Position
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Kevin Hell
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43
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CEO, Director
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Dan L. Halvorson
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42
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EVP and CFO
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David J. Richter
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39
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EVP, Corporate Development and Legal
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Chris Russell
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41
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CTO
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Kevin Hell
has served as our CEO and a Director since October 2007. From July 2007 to October 2007,
Mr. Hell served as our Acting CEO. Between 2002 and 2007, Mr. Hell held a number of management positions within the Company including Chief Marketing Officer and Managing Director, Chief Operating Officer, the Companys CXO for
Partners and Licensing, and President. Mr. Hell is currently responsible for our corporate strategy and
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overall strategic direction. From July 2001 to May 2002, Mr. Hell served as Senior Vice President of Product Management in the Solutions Group of Palm,
a handheld solutions company. From May 1999 to May 2001, Mr. Hell was Vice President of the Connected Home division and Vice President of Corporate Strategy at Gateway Computer, a personal computer manufacturing company. From May 1991 to May
1999, Mr. Hell worked in the Los Angeles office of the Boston Consulting Group, a management consulting firm. Mr. Hell received an M.B.A. from The Wharton School, and a masters degree in Aeronautics and Astronautics and a B.S. in
Mechanical Engineering from Stanford University.
Dan L. Halvorson
has served as our Executive Vice President and Chief Financial Officer since July
2007. From June 2007 to July 2007, Mr. Halvorson served as our Chief Financial Officer and Senior Vice President. Mr. Halvorson is responsible for investor relations, financial and administrative aspects of our strategic and tactical
goals, and for supplying related support to our operations teams. Mr. Halvorson has served in many senior finance and accounting roles at a number of public companies. Mr. Halvorson held various roles from 2000 to 2007 at Novatel Wireless,
and was named Chief Financial Officer and Chief Accounting Officer in early 2004. From 1998 to 2000, he was Director of Finance at Dura Pharmaceuticals, which was acquired by Elan in 2000. He was also Director of Finance at Alliance Pharmaceuticals
from 1996 to 1998. Previous to his public company roles, Mr. Halvorson spent eight years in public accounting at Deloitte & Touche and PriceWaterhouseCoopers, serving both public and private client companies. Mr. Halvorson is a
Certified Public Accountant and holds a Bachelor of Science from San Diego State University.
David J. Richter
has served as our Executive Vice
President, Corporate Development and Legal since July 2007. From June 2007 to July 2007, Mr. Richter served as our General Counsel and Senior Vice President Corporate Development. From April 2006 to June 2007, Mr. Richter served as our GC,
Legal and Corporate Development. From May 2004 to April 2006, Mr. Richter served as our General Counsel and, in addition, from January 2005 through April 2006, as our Senior Vice President, Corporate Development. Mr. Richter is responsible
for our legal and corporate development efforts. Previously, Mr. Richter worked at Maveron, a venture capital firm, as a Principal from January 2002 through March 2004 and as Director, Business Development from July 2000 through December 2001.
Mr. Richter received a J.D. from Yale Law School and a B.A. in Government from Cornell University.
Chris Russell
served as our CTO, Strategy
and Technology from April 2006 until February 2008. From September 2005 to April 2006, Mr. Russell served as our Vice President and General Manager, Technology and Strategy. From January 2005 to September 2005, Mr. Russell served as our
Vice President of Advanced Technology. From July 2002 to January 2005, Mr. Russell served as Vice President with the Motion Picture Association of America, or MPAA, an association advocating for the motion picture, home video, and television
industries. From July 2001 to July 2002, Mr. Russell served as Chief Technology Officer for Information Technology Alliance, a managed security services company. From June 1996 to December 1998, Mr. Russell served as Director of Software
Engineering, and from December 1998 to July 2001 as Vice President of Technology, with Sony Pictures Entertainment, an entertainment company. Mr. Russell received an M.B.A. from Pepperdine University and a B.S. in Computer Science from
California State Polytechnic University, Pomona.
Available Information
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange
Act of 1934 (the Exchange Act) are available free of charge on our website (www.divx.com) as soon as reasonably practicable after they are filed with, or furnished to, the SEC.
Item 1A. Risk Factors
Before you decide to invest or maintain an interest in our common stock, you should consider
carefully the risks described below, together with the other information contained in this Annual Report on Form 10-K. We believe
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the risks described below are the risks that are material to us as of the date of this Annual Report on Form 10-K. If any of the following risks comes to
fruition, our business, financial condition, results of operations and future growth prospects would likely be materially and adversely affected. In these circumstances, the market price of our common stock could decline and you may lose all or part
of your investment.
Risks related to our business
Our business and prospects depend on the strength of our brand, and if we do not maintain and strengthen our brand, we may be unable to maintain or expand our business.
Maintaining and strengthening the DivX brand is critical to maintaining and expanding our business, as well as to our ability to enter into new markets for
our technologies and products. If we fail to promote and maintain the DivX brand successfully, our ability to sustain and expand our business and enter into new markets will suffer. Maintaining and strengthening our brand will depend heavily on our
ability to continue to develop and provide innovative and high-quality technologies and products for consumers, content owners, consumer hardware device manufacturers and software vendors. Moreover, because we engage in relatively little direct
brand advertising, the promotion of our brand depends, among other things, upon hardware device manufacturing partners displaying our trademarks on their products. If these partners choose for any reason not to display our trademarks on their
products, or if our partners use our trademarks incorrectly or in an unauthorized manner, the strength of our brand may be diluted or our ability to maintain or increase our brand awareness may be harmed. In addition, if we fail to maintain
high-quality standards for products that incorporate our technologies through the quality-control certification process that we require of our licensees, or if we take other steps to commercialize our products and services that our customers or
potential customers reject, the strength of our brand could be adversely affected. Further, unauthorized third parties may use our brand in ways that may dilute or undermine its strength.
If we are unable to penetrate existing markets or adapt or develop technologies and products for new markets, our business prospects could be limited.
We expect that our future success will depend, in part, upon our ability to successfully penetrate existing markets for digital media technologies,
including:
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network connected DVD players;
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high definition DVD players;
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portable media players;
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digital media software applications;
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To date, we have penetrated
only some of these markets, including the markets for DVD players, network connected DVD players, high definition DVD players, portable media players, digital still cameras, smart TVs,
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mobile handsets, digital media software applications, set-top boxes, and video game consoles. Our success depends upon our ability to further penetrate these
markets, some of which we have only penetrated to a limited extent, and to successfully penetrate those markets in which we currently have no presence. Demand for our technologies in any of these developing markets may not grow or develop, and a
sufficiently broad base of consumers and professionals may not adopt or continue to use our technologies. In addition, our ability to generate revenue from these markets may be limited to the extent that service providers in these markets choose to
provide competitive technologies and entertainment at little or no cost. Because of our limited experience in certain of these markets, we may not be able to adequately adapt our business and our technologies to the needs of consumers and licensees
in these markets.
We face significant competition in various markets, and if we are unable to compete successfully, our ability to generate revenues
from our business will suffer.
We face significant competition in the digital media markets in which we operate. We believe that our most
significant competitive threat comes from companies that have the collective financial, technical and other resources to develop the technologies, services, products and partnerships necessary to create a digital media ecosystem that can compete
with the DivX ecosystem. Those potential competitors currently include Adobe Systems, Apple Computer, Google, Microsoft, News Corporation, Sony and Yahoo!.
We also compete with companies that offer products or services that compete with specific aspects of our digital media ecosystem. For example, our digital rights management technology competes with technologies from companies such as Apple
Computer, ContentGuard, Intertrust Technologies, Microsoft, Nagra Audio, NDS Group and 4C Entity, as well as the internal development efforts of certain of our licensees. Similarly, content distribution providers, such as Amazon.com, Apple Computer,
CinemaNow, Google, Joost, MovieLink, MySpace.com, a subsidiary of News Corporation, Netflix, Yahoo!, YouTube, a subsidiary of Google, and subscription entertainment services and cable and satellite providers compete against our content distribution
services.
Our proprietary technologies also compete with other video compression technologies, including other implementations of MPEG-4 or
implementations of H.264/AVC. A number of companies such as Adobe Systems, Apple Computer, Ateme, Google, Microsoft, On2 Technologies and RealNetworks offer other competing video formats.
We also face competition from subscription entertainment services, cable and satellite providers, DVDs and other emerging technologies and products related to content
distribution. Our content distribution platforms and services face significant competition from services, such as peer-to-peer and content aggregator services, which allow consumers to directly access an expansive array of content without securing
licenses from content providers.
Some of our current or future competitors may have significantly greater financial, technical, marketing and other
resources than we do, may enjoy greater name recognition than we do, or may have more experience or advantages than we have in the markets in which they compete. For example, companies such as Amazon.com, Apple Computer, Google, Microsoft, Sony and
Yahoo! may have competitive advantages over us because of their greater size and resources and the strength of their respective brand names. In addition, some of our current or potential competitors, such as Apple Computer, Dolby Laboratories,
Microsoft and Sony, may be able to offer integrated system solutions in certain markets for entertainment technologies, including audio, video and rights management technologies related to personal computers or the Internet, which could make
competing products and technologies that we develop unnecessary. By offering an integrated system solution, these potential competitors also may be able to offer competing products and technologies at lower prices than our products and technologies.
Further, many of the consumer hardware and software products that include our technologies also include technologies developed by our competitors. As a result, we must continue to invest significant resources in product development in order to
enhance our technologies and our existing products and introduce new high-
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quality technologies and products to meet the wide variety of such competitive pressures. Our ability to generate revenues from our business will suffer if
we fail to do so successfully.
We are dependent on the sale by our licensees of consumer hardware and software products that incorporate our
technologies. Our top 10 licensees by revenue accounted for approximately 50% of our total net revenues during the year ended December 31, 2007, and a reduction in revenues from those licensees or a loss of one or more of our key licensees
would adversely affect our licensing revenue.
We derive most of our revenue from the licensing of our technologies to consumer hardware device
manufacturers, software vendors and consumers. We derived 78%, 80% and 82% of our total net revenues from licensing our technology in the fiscal years 2007, 2006 and 2005, respectively. One or a small number of our licensees generally represents a
significant percentage of our technology licensing revenues. For example, in 2007, LG accounted for approximately 10% of our total net revenues, and our top 10 licensees by revenue accounted for approximately 50% of our total net revenues. Our
technology licensing revenues are particularly dependent upon our relationships with consumer hardware device manufacturers. We cannot control consumer hardware device manufacturers and software developers product development or
commercialization efforts or predict their success. Our license agreements typically require manufacturers of consumer hardware devices and software vendors to pay us a specified royalty for every shipped consumer hardware or software product that
incorporates our technologies, but many of these agreements do not require these manufacturers to guarantee us a minimum royalty in any given period. Accordingly, if our licensees sell fewer products incorporating our technologies, or otherwise face
significant economic difficulties, our licensing revenues will be adversely affected. Additionally, certain of our license agreements provide for specific royalties based on our estimations of the volumes of certain units consumer hardware device
manufacturers are likely to ship during a given term; if our estimates are too low, the actual per-unit revenues received may be lower than expected. Our license agreements are generally for two years or less in duration, and a significant number of
these agreements expire in any given quarter. Upon expiration of their license agreements, manufacturers and software developers may not renew their agreements or may elect not to enter into new agreements with us on terms as favorable as our
current agreements.
Our September 2007 software distribution and promotion agreement with Yahoo! is our first distribution agreement with Yahoo!,
and if products from Yahoo! are not as popular as the products of Google (with which we were previously a party to a software distribution agreement), or if Yahoo! products are more difficult to install or distribute than Google products, or if
products from Yahoo! have greater market saturation than Google products, then our revenues may significantly decrease.
Pursuant to our September
2007 agreement with Yahoo!, we agreed to distribute a version of Internet Explorer browser optimized for Yahoo! and a co-branded version of the Yahoo! Toolbar with our software products and Yahoo! will pay us fees based on the number of certain
distributions or installations of the Yahoo! software. Our agreement with Yahoo! also affects our ability to offer our software products with third party web browsers, toolbars, and search services other than those provided by Yahoo!. As a result,
if the Yahoo! products we plan to distribute are not as popular as, or if the have greater market saturation than, the Google products we have distributed in the past, or if they are more difficult to install or distribute, our revenues may
significantly decrease. Any decline in the popularity of our products or Yahoo!s products among consumers or market saturation of those products could result in a decrease in revenue under our agreement with Yahoo!. In addition, if we fail to
achieve certain minimum distribution volumes or certain minimum installations of the Yahoo! software for specific periods described in the agreement, Yahoo! may elect to terminate the agreement.
The success of our business depends on the availability of premium video content in the DivX format.
To date, only one major motion picture studio has agreed to make certain video content available in the DivX video format. If we, and/or our consumer electronics
partners, fail to implement certain technological safeguards mandated under that deal, such format approval deal may be suspended or terminated, either of which could
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negatively impact our business. The implementation of these changes could potentially be viewed negatively by consumers and as a result our business could
suffer. Additionally, the distribution of such DivX-formatted video content is dependent on third party retailers willingness to enter into distribution deals with our studio partner and DivX and ultimately upon the willingness of
consumers to purchase such content from such third party retailers. Finally, our business success depends upon our ability to reach agreement with other major motion picture studios to make their content available in the DivX video format. In the
event that we fail to reach agreement with such studios, the DivX format may become less compelling to consumers and to retailers and potentially to consumer electronics licensees of DivX.
The success of our business depends on the interoperability of our technologies with consumer hardware devices.
To be successful we design our digital media platform to interoperate effectively with a variety of consumer hardware devices, including personal computers, DVD players,
DVD recorders, network connected DVD players, high definition DVD players, digital still cameras, digital camcorders, portable media players, smart TVs, home media centers, set-top boxes, video game consoles, and mobile handsets. We depend on
significant cooperation with manufacturers of these devices and the components integrated into these devices, as well as software providers that create the operating systems for such devices, to incorporate our technologies into their product
offerings and ensure consistent playback of DivX-encoded files. Currently, a limited number of devices are designed to support our technologies. If we are unsuccessful in causing component manufacturers, device manufacturers and software providers
to integrate our technologies into their product offerings, our technologies may become less accessible to consumers, which would adversely affect our revenue potential.
If we fail to develop and deliver innovative technologies and products in response to changes in our industry, including changes in consumer tastes or trends, our revenues could decline.
The markets for our technologies and products are characterized by rapid change and technological evolution. We will need to expend considerable resources on product
development in the future to continue to design and deliver enduring and innovative technologies and products. Despite our efforts, we may not be able to develop and effectively market new technologies and products that adequately or competitively
address the needs of the changing marketplace. In addition, we may not correctly identify new or changing market trends at an early enough stage to capitalize on market opportunities. At times such changes can be dramatic. Our future success depends
to a great extent on our ability to develop and deliver innovative technologies that are widely adopted in response to changes in our industry and that are compatible with the technologies or products introduced by other participants in our
industry. If we fail to deliver innovative technologies, we may be unable to meet changes in consumer tastes or trends, which could decrease our revenues.
Our licensing revenue depends in large part upon integrated circuit manufacturers incorporating our technologies into their products for sale to our consumer hardware device manufacturer licensees and if our technologies are not
incorporated in these integrated circuits or fewer integrated circuits are sold that incorporate our technologies, our revenues will be adversely affected.
Our licensing revenue from consumer hardware device manufacturers depends in large part upon the availability of integrated circuits that incorporate our technologies. Integrated circuit manufacturers incorporate our technologies into their
products, which are then incorporated into consumer hardware devices. We do not manufacture integrated circuits, but rather depend on integrated circuit manufacturers to develop, produce and sell these products to licensed consumer hardware device
manufacturers. We do not control the integrated circuit manufacturers decision whether or not to incorporate our technologies into their products, and we do not control their product development or commercialization efforts. If we fail to
develop new technologies that adequately or competitively address the needs of the changing marketplace, integrated circuit manufacturers may not be willing to implement our technologies into their products. The process utilized by integrated
circuit manufacturers to design, develop, produce and sell their products is generally 12 to 18 months in duration. As a result, if an
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integrated circuit manufacturer is unwilling or unable to implement our technologies into an integrated circuit that it is producing, we may experience
significant delays in generating revenue while we wait for that manufacturer to begin development of a new integrated circuit that may incorporate our technologies. In addition, while the design cycles utilized by integrated circuit manufacturers
are typically long, the life cycles of our technologies tend to be short as a result of the rapidly changing technology environment in which we operate. If integrated circuit manufacturers are unable or unwilling to implement technologies we develop
into their products, or if they sell fewer products incorporating our technologies, our revenues will be adversely affected. In addition, if integrated circuit manufacturers incorporate our technology in new ways that make reporting or tracking more
difficult, it could adversely affect our ability to collect revenues.
Our business is dependent in part on technologies we license from third
parties, and these license rights may be inadequate for our business.
Certain of our technologies and products are dependent in part on the
licensing and incorporation of technologies from third parties. For example, we have entered into license agreements with MPEG LA pursuant to which we have acquired rights to use in our technologies and products certain MPEG-4 and AVC intellectual
property licensed to MPEG LA. Our licensing agreements with MPEG LA grant us sublicenses only to the rights in the relevant intellectual property licensed to MPEG LA. There are other parties who have competing rights to MPEG-4 and AVC intellectual
property, and to the extent that the rights of such other parties conflict with or are superior to the rights licensed to MPEG LA, our rights to utilize MPEG-4 or AVC technology in our technologies and products could be challenged. Our license
agreement with MPEG LA, under its MPEG-4 Part 2 Visual Patent Portfolio will expire on December 31, 2008. MPEG LA has the right to renew the license agreement for successive terms of five years, upon notice to us.
If the technology we license fails to perform as expected, if key licensors do not continue to support their technology or intellectual property because the licensor has
gone out of business or otherwise, if a licensor, such as MPEG LA determines not to renew a license agreement upon expiration or if it is determined that any of our licensors are not entitled to license to us any of the technologies or intellectual
property that are subject to our current license agreements, then we may incur substantial costs in replacing the licensed technologies or intellectual property or fall behind in our development schedule while we search for a replacement. In
addition, replacement technology may not be available for license on commercially reasonable terms, or at all.
In addition, our agreements with licensors
generally require us to give them the right to audit our calculations of royalties payable to them. If a licensor challenges the basis of our calculations, the amount of royalties we have to pay them could increase. Any royalties paid as a result of
a successful challenge would increase our expenses and could impair our ability to continue to use and re-license technologies or intellectual property from that licensor.
We rely on our licensees to accurately prepare royalty reports for our determination of licensing revenues, and if these reports are inaccurate, our revenues may be under- or over-stated and our forecasts and
budgets may be incorrect.
Our licensing revenues are generated primarily from consumer hardware device manufacturers and software vendors who
license our technologies and incorporate them into their products. Under these arrangements, these licensees typically pay us a specified royalty for every consumer hardware or software product they ship that incorporates our technologies. We rely
on our licensees to accurately report the number of units shipped. We calculate our license fees, prepare our financial reports, projections and budgets, and direct our sales and technology development efforts based in part on these reports.
However, it is often difficult for us to independently determine whether or not our licensees are reporting shipments accurately. This is especially true with respect to software incorporating our technologies because software can be copied
relatively easily and we often do not have ways to readily determine how many copies have been made. Licensees in specific countries, including China, have a history of underreporting or failing to report shipments of their products that incorporate
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our technologies. Most of our license agreements permit us to audit our licensees records, but audits are generally expensive and time consuming. We
have initiated, and intend to initiate, audits with certain of our licensees to determine whether their shipment reports for past periods were accurate. Such audits could harm our relationships with our licensees or may result in the cancellation or
termination of our agreements with such licensees. In addition, the license agreements that we have entered into with most of our licensees impose restrictions on our audit rights, such as limitations on the number of audits we may conduct. To the
extent that our licensees understate or fail to report the number of products incorporating our technologies that they ship, we will not collect and recognize revenue to which we are entitled. Alternatively, we have experienced limited instances in
which a customer has notified us that it previously reported and paid royalties on units in excess of what the customer actually shipped. In such cases, the customer requested, and we granted, a credit for the excess royalties paid. If a similar
event occurs in the future, we may be required to record the credit as a reduction in revenue in the period in which it is granted, and such a reduction could be material.
Any development delays or cost overruns may affect our ability to respond to technological changes, competitive developments or customer requirements and expose us to other adverse consequences.
We have experienced development delays and cost overruns in our development efforts in the past and we may encounter such problems in the future.
Delays and cost overruns could affect our ability to respond to technological changes, competitive developments or customer requirements. Also, our technologies and products may contain undetected errors that could cause increased development costs,
loss of revenue, adverse publicity, reduced market acceptance of our technologies and products or lawsuits by participants in the consumer hardware or software industries or consumers.
We conduct a substantial portion of our business outside North America and, as a result, we face diverse risks related to engaging in international business.
We have offices in seven foreign countries as well as sales staff in several others, and we are dedicating a significant portion of our sales efforts in countries outside
North America. We are dependent on international sales for a substantial amount of our total revenues. For 2007, 2006 and 2005, our net revenue outside North America comprised 77%, 76% and 78%, respectively, of our total revenues. We expect that
international sales will continue to represent a substantial portion of our revenues for the foreseeable future. These future international revenues will depend to a large extent on the continued use and expansion of our technologies in
entertainment industries worldwide. Increased worldwide use of our technologies is also an important factor in our future growth.
We are subject to the
risks of conducting business internationally, including:
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our ability to enforce our contractual and intellectual property rights, especially in those foreign countries that do not respect and protect intellectual property
rights to the same extent that the United States does, which increases the risk of unauthorized and uncompensated use of our technology;
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United States and foreign government trade restrictions, including those that may impose restrictions on importation of programming, technology or components to or
from the United States;
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foreign government taxes, regulations and permit requirements, including foreign taxes that we may not be able to offset against taxes imposed upon us in the United
States, and foreign tax and other laws limiting our ability to repatriate funds to the United States;
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foreign labor laws, regulations and restrictions;
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changes in diplomatic and trade relationships;
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difficulty in staffing and managing foreign operations;
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fluctuations in foreign currency exchange rates and interest rates, including risks related to any interest rate swap or other hedging activities we undertake;
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political instability, natural disasters, war and/or events of terrorism; and
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the strength of international economies.
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We
face risks with respect to conducting business in China due to Chinas historically limited recognition and enforcement of intellectual property and contractual rights.
We currently have direct license relationships with over 50 consumer hardware device manufacturers located in China. In addition, a number of the OEMs that license our technologies utilize captive or third-party
manufacturing facilities located in China. We expect this to continue in the future as consumer hardware device manufacturing in China continues to increase due to its lower manufacturing cost structure as compared to other industrialized countries.
As a result, we face many risks in China, in large part due to Chinas historically limited recognition and enforcement of contractual and intellectual property rights. In particular, we have experienced, and expect to continue to experience,
problems with China-based consumer hardware device manufacturers underreporting or failing to report shipments of their products that incorporate our technologies, or incorporating our technologies or trademarks into their products without our
authorization or without paying us licensing fees. We may also experience difficulty enforcing our intellectual property rights in China, where intellectual property rights are not as respected as they are in the United States, Japan and Europe.
Unauthorized use of our technologies and intellectual property rights may dilute or undermine the strength of our brand. Further, if we are not able to adequately monitor the use of our technologies by China-based consumer hardware device
manufacturers, or enforce our intellectual property rights in China, our revenue potential could be adversely affected.
Pricing pressures on the
consumer hardware device manufacturers and software vendors who incorporate our technologies into their products could limit the licensing fees we charge for our technologies and adversely affect our revenues.
The markets for the consumer hardware and software products in which our technologies are incorporated are intensely competitive and price sensitive. For example, retail
prices for consumer hardware devices that include our digital media platform, such as DVD players, have decreased significantly in recent years, and we expect prices to continue to decrease for the foreseeable future. In response, consumer hardware
device manufacturers and software vendors have sought to reduce their product costs, which can result in downward pressure on the licensing fees we charge our licensees who incorporate our technologies into the consumer hardware and software
products that they sell. In addition, we have experienced erosion in the average royalty we can charge for specific versions of our technologies to our OEM partners since the release of these technologies. To maintain higher overall per unit
royalties, we must continue to introduce new, more highly functional versions of our products for which we can charge a higher royalty. Any inability to introduce such products in the future or other declines in the royalties we charge would
adversely affect our revenues.
We do not expect sales of DVD players to continue to grow as quickly as they have in the past. To the extent that
sales of DVD players level off or decline, or alternative technologies in which we do not participate replace DVDs as a dominant medium for consumer video entertainment, our licensing revenue will be adversely affected.
Growth in our revenue over the past several years has been the result, in large part, of the rapid growth in sales of red-laser DVD players incorporating our
technologies. For the years 2007, 2006 and 2005, we derived approximately 70%, 72% and 71%, respectively, of our total net revenues from technology licensing to consumer hardware device manufacturers, a majority of which are derived from sales of
red-laser DVD players incorporating our technologies. However, as the markets for DVD players mature, we do not expect sales of red-laser DVD players to continue to grow as quickly as they have in the past. To the extent that sales of
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red-laser DVD players level off or decline, our licensing revenue will be adversely affected. In addition, if new technologies are developed for use with
DVDs or new technologies are developed that substantially compete with or replace red-laser DVDs as a dominant medium for consumer video entertainment such as high definition DVD or Blu-ray Disc, and if we are unable to develop and successfully
market technologies that are incorporated into or compatible with such new technologies, our ability to generate revenues will be adversely affected.
Digital video technologies could be treated as a commodity in the future, which could expose us to significant pricing pressure.
We
believe that the success we have had licensing our digital video technologies to consumer hardware device manufacturers and software vendors is due, in part, to the strength of our brand and the perception that our technologies provide a
high-quality video solution. However, as applications that incorporate digital video technologies become increasingly prevalent, we expect more competitors to enter this field with other solutions. Furthermore, to the extent that competitors
solutions are perceived, accurately or not, to provide the same or greater advantages as our technologies, at a lower or comparable price, there is a risk that video encoding and decoding technologies such as ours will be treated as commodities,
exposing us to significant pricing pressure.
Current and future government standards or standards-setting organizations may limit our business
opportunities.
Various national governments have adopted or are in the process of adopting standards for digital television broadcasts, including
cable and satellite broadcasts. In the event national governments adopt similar standards for video codecs used in consumer hardware devices, software products or Internet applications, our technology may be excluded from such standards. We have not
made any efforts to have our technologies adopted as standards by any national governments, nor do we currently expect that our technologies will be adopted as standards by any national government in the future. If national governments adopt
standards that exclude our technologies, we will be required to redesign our technologies to comply with such government standards to allow our products to be utilized in those countries. Costs or potential delays in the development of our
technologies and products to comply with such government standards could significantly increase our expenses. In addition, standards-setting organizations are adopting or establishing formal technology standards for use in a wide range of consumer
hardware devices, software products and Internet applications. In the past, we have not participated in standards-setting organizations, nor have we sought to have our technologies adopted as industry standards. As such, participants in the consumer
hardware or software industries or consumers may elect not to purchase our technologies because they have not been adopted by standards-setting organizations or if a competing technology is adopted as an industry standard.
Our business may depend in part upon our ability to provide effective digital rights management technology.
Our business may depend in part upon our ability to provide effective digital rights management technology that controls access to digital content that addresses, among
other things, content providers concerns over piracy. We cannot be certain that we can continue to develop, license or acquire such technology, or that content licensors, consumer hardware device manufacturers or consumers will accept such
technology. In addition, consumers may be unwilling to accept the use of digital rights management technology that limits their use of content, especially with large amounts of free content readily available. We may need to license digital rights
management technology from third parties to support our technologies and products. Such technology may not be available to us on reasonable terms, or at all. If digital rights management technology is not effective, is perceived as not effective or
is compromised by third parties, or if laws are enacted that require digital rights management technology to allow consumers to convert content stored in a protected format into an unprotected format, content providers may not be willing to encode
their content using our products and consumer hardware device manufacturers may not be willing to include our technologies in their products.
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We have offered and we expect to continue to offer some of our products and technologies for reduced prices or free
of charge, and we may not realize the benefits of this marketing strategy.
We have offered and expect to continue to offer some of our products and
technologies to consumers for reduced prices or free of charge as part of our overall strategy of developing a digital media ecosystem and promoting additional penetration of our products and technologies into the markets in which we compete. If we
offer such products and technologies at reduced prices or free of charge, we will forego all or a portion of the revenue from licensing these products, and we may not realize the intended benefits of this marketing strategy.
Our online video communities and distribution services and platforms are rapidly evolving and may not prove viable.
Online video distribution is a relatively new enterprise, and successful business models for delivering digital media over the Internet are not fully tested. We have only
recently launched our efforts to develop a business centered around online content delivery, and we have recently ceased operation of our Stage6 service, which was our first full-scale direct attempt at this business. We have not scaled any of our
other distribution or community services or platforms to a material size. We may fail to develop a viable business model that properly monetizes our technology platforms for online video communities.
Our decision to cease operations of the Stage6 service may result in a negative impact to our brand or to our ability to achieve certain business metrics.
Our decision to shut down the Stage6 service may be viewed unfavorably by users and consumers, who may then opt not to download our software or purchase
products or services offered by DivX. The shutdown of Stage6 may result in users and consumers developing unfavorable opinions about our business, which, in turn, may negatively impact our brand image and our business. Additionally, loss of users
and consumers could impact the perceived demand for DivX Certified products by our licensees, which could negatively impact our ability to generate revenue. Further, as Stage6 was one service offering through which users developed a desire to
download and install our software offerings, we may see slower adoption of our software and a negative impact on our ability to generate revenue from the distribution of third party software, including that from Yahoo!.
We will need to increase the size of our organization, and we may experience difficulties in managing growth.
As of December 31, 2007 we had over 380 full-time employees, including full-time equivalents. We will need to continue to expand our managerial, operational,
financial and other resources to manage our business, including our relationships with key customers and licensees. Our current facilities and systems may not be adequate to support this future growth. We may require additional office space to
accommodate our growth. Additional office space may not be available on commercially reasonable terms and may result in a disruption of our corporate culture. Our need to effectively manage our operations, growth and various projects requires that
we continue to improve our operational, financial and management controls, reporting systems and procedures and to attract and retain sufficient numbers of talented employees. We may be unable to successfully implement these tasks on a larger scale,
which could prevent us from executing our business strategy.
We have experienced recent changes in our senior management, which may disrupt our
operations.
We have recently experienced several changes in our senior management, including the departure of our former Chief Financial Officer,
the appointment of Kevin Hell as our Chief Executive Officer and the addition of Dan L. Halvorson as our Executive Vice President and Chief Financial Officer. In addition, we recently announced that R. Jordan Greenhall, our former Chief Executive
Officer, has resigned as an employee of DivX, Inc. In February 2008 Chris Russell resigned as our Chief Technology Officer and we appointed Markus Moenig as our new Chief Technology Officer. We may experience disruptions in our operations as a
result of these changes and as
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the new members of our management team become acclimated to their roles and to our company in general. If we experience any of these disruptions or a loss of
management attention to our core business, our operating results could be adversely affected.
Our business, in particular our content distribution
offerings and community forums, will suffer if our systems or networks fail, become unavailable or perform poorly so that current or potential users do not have adequate access to our online products and websites.
Our ability to provide our online offerings will depend on the continued operation of our information systems and networks. As our user traffic increases and our products
become more complex, we will need more computing power. We have spent, and may again spend, substantial amounts to purchase or lease data centers and equipment and to upgrade our technology and network infrastructure to handle increased traffic on
our website and to introduce new technologies and products. These expansions may be expensive and complex and could result in inefficiencies or operational failures. If we do not implement these expansions successfully, or if we experience
inefficiencies and operational failures during the implementation, the quality of our technologies and products and our users experience could decline. This could damage our reputation and lead us to lose current and potential users,
advertisers and content providers.
In addition, significant or repeated reductions in the performance, reliability or availability of our information
systems and network infrastructure could harm our ability to provide our content distribution offerings and advertising platforms. We could experience failures in our systems and networks from our failure to adequately maintain and enhance these
systems and networks, natural disasters and similar events, power failures, intentional actions to disrupt our systems and networks and many other causes. The vulnerability of our computer and communications infrastructure is increased because it is
largely located at facilities in San Diego, California, an area that is at heightened risk of earthquake, wildfires and flood. We are vulnerable to terrorist attacks, fires, power loss, telecommunications failures, computer viruses, computer denial
of service attacks or other attempts to harm our systems. Moreover, much of our facilities are located near the landing path of a military base and are subject to risks related to falling debris and aircraft crashes. We do not currently have fully
redundant systems or a formal disaster recovery plan, and we may not have adequate business interruption insurance to compensate us for losses that may occur from a system outage.
Any failure or interruption of the services provided by bandwidth providers, data centers or other key third parties could subject our business to disruption and additional costs and damage our reputation.
We rely on third-party vendors, including data center and bandwidth providers for network access or co-location services that are essential to our
business. Any interruption in these services, including any failure to handle current or higher volumes of use, could subject our business to disruption and additional costs and significantly harm our reputation. Our systems are also heavily reliant
on the availability of electricity, which also comes from third-party providers. The cost of electricity has risen in recent years with the rising costs of fuel. If the cost of electricity continues to increase, such increased costs could
significantly increase our expenses. In addition, if we were to experience a major power outage, it could result in a significant disruption of our business.
Our network is subject to security risks that could harm our reputation and expose us to litigation or liability.
Online commerce
and communications depend on the ability to transmit confidential or proprietary information securely over private and public networks. Any compromise of our ability to transmit and store such information and data securely, and any costs associated
with preventing or eliminating such problems, could impair our ability to distribute technologies and products or collect revenue, threaten the proprietary or confidential nature of our technology, harm our reputation and expose us to litigation or
liability. We also may be required to expend significant capital or other resources to protect against the threat of security breaches or hacker attacks or to alleviate problems caused by such breaches or attacks. Any successful attack or breach of
our security could hurt consumer demand for our technologies and products and expose us to consumer class action lawsuits and other
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liabilities. In addition, our vulnerability to security risks may affect our ability to maintain effective internal controls over financial reporting as
contemplated by Section 404 of the Sarbanes-Oxley Act of 2002.
It is not yet clear how laws designed to protect children that use the Internet
may be interpreted and enforced, and whether new similar laws will be enacted in the future which may apply to our business in ways that may subject us to potential liability.
The Child Online Protection Act and the Childrens Online Privacy Protection Act impose civil and criminal penalties on persons distributing material harmful to minors (e.g., obscene material) over the Internet
to persons under the age of 17, or collecting personal information from children under the age of 13. We do not knowingly distribute harmful materials to minors, direct our websites or services, to children under the age of 13, or collect personal
information from children under the age of 13. However, we are not able to control the ways in which consumers use our technology, and our technology may be used for purposes that violate these laws. The manner in which these Acts may be interpreted
and enforced cannot be fully determined, and future legislation similar to these Acts could subject us to potential liability if we were deemed to be non-compliant with such rules and regulations.
We may be subject to market risk and legal liability in connection with the data collection capabilities of our various online services.
Many components of our online services include interactive components that by their very nature require communication between a client and server to operate. To provide
better consumer experiences and to operate effectively, we collect certain information from users. Our collection and use of such information may be subject to United States state and federal privacy and data collection laws and regulations, as well
as foreign laws such as the EU Data Protection Directive. We post an extensive privacy policy concerning the collection, use and disclosure of user data, including that involved in interactions between our client and server products. Because of the
evolving nature of our business and applicable law, our privacy policy may now or in the future fail to comply with applicable law. Any failure by us to comply with our posted privacy policy, any failure by us to conform our privacy policy to
changing aspects of our business or applicable law, or any existing or new legislation regarding privacy issues could impact the market for our online video community service, technologies and products and subject us to fines, litigation or other
liability.
Improper conduct by users could subject us to claims and compliance costs.
The terms of use and end-user license agreements for our products and services prohibit a broad range of unlawful or undesirable conduct. However, we are unable to block
access in all instances to users who are determined to gain access to our products or services for improper motives. Claims may be threatened or brought against us using various legal theories based on the nature and content of information or media
that may be created, posted online or generated by our users or the use of our technology. This risk includes actions by our users to copy or distribute third-party content. Investigating and defending any of these types of claims could be
expensive, even if the claims do not ultimately result in liability. In addition, we may incur substantial costs to enforce our terms of use or end-user license agreements and to exclude certain users of our services or products who violate such
terms of use or end-user license agreements, or who otherwise engage in unlawful or undesirable conduct.
We may be subject to legal liability for
the provision of third-party products, services, content or advertising.
We have entered into, and expect to continue to enter into, arrangements
for third-party products, services, content or advertising to be offered in connection with our various content distribution offerings. Certain of these arrangements involve the enabling distribution of digital content owned by third parties, which
may subject us to third party claims related to such products, services, content or advertising, including defamation, violation of privacy laws, misappropriation of publicity rights, violation of United States federal CAN-SPAM legislation, and
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infringement of intellectual property rights. We require users of our services to agree to terms of use that prohibit, among other things, the posting of
content that violates third party intellectual property rights, or that is obscene, hateful or defamatory. We have implemented procedures to enforce such terms of use on certain of our services, including taking down content that violates our terms
of use for which we have received notification, or that we are aware of, and/or blocking access by, or terminating the accounts of, users determined to be repeat violators of our terms of use. Despite these measures, we cannot guarantee that such
unauthorized content will not exist on our services, that these procedures will reduce our liability with respect to such unauthorized third party conduct or content, or that we will be able to resolve any disputes that may arise with content
providers or users regarding such conduct or content. Our agreements with these parties may not adequately protect us from these potential liabilities. Investigating and defending any of these types of claims is expensive, even if the claims do not
result in liability. If any of these claims results in liability, we could be required to pay damages or other penalties.
We may be subject to
assessment of sales taxes and other taxes for our licensing of technology or sale of products.
We do not currently directly collect sales taxes or
other taxes on the licensing of our technology, the sale of our products over the Internet, or our distribution of content. Although we have evaluated the tax requirements of certain major tax jurisdictions with respect to the licensing of our
technology or the sale of our products over the Internet, in the past we have licensed or sold, and in the future we may license or sell, our technologies or products to consumers located in jurisdictions where we have not evaluated the tax
consequences of such license or sale. We would incur substantial costs if one or more taxing jurisdictions required us to collect sales or other taxes from past licenses of technology or sales or distributions of our products or content over the
Internet, particularly because we would be unable to go back to customers to collect sales, value added or other taxes for past licenses, sales or distributions and would likely have to pay such taxes out of our own funds. Certain of our licensing
agreements require our partners to pay taxes to applicable taxing jurisdictions as a result of the sale of products that incorporate our technologies. If our licensees fail to pay such taxes, we may become liable for the payment of such taxes.
We also intend to sell content over the Internet to consumers throughout the world in conjunction with certain of our service offerings. We intend to
comply with applicable tax requirements of certain major tax jurisdictions with respect to such sales. However, we may sell content to consumers located in jurisdictions where we have not evaluated the tax consequences of such sale. If we fail to
comply with tax requirements of tax jurisdictions in which we sell content online, we may become liable for substantial costs or penalties.
Inflation and other unfavorable economic conditions may adversely affect our revenues, margins and profitability.
Our consumer
software products, as well as the consumer hardware device and software products that contain our technologies, are discretionary purchases for consumers. Consumers are generally more willing to make discretionary purchases during favorable economic
conditions. As a result of inflation or other unfavorable economic conditions, including higher interest rates, increased taxation, higher consumer debt levels and lower availability of consumer credit, consumers purchases of discretionary
items may decline, which could adversely affect our revenues. In addition, while inflation historically has not had a material effect on our operating results, we may experience inflationary conditions in our cost base due to changes in foreign
currency exchange rates that reduce the purchasing power of the United States dollar, increases in selling, general and administrative expenses, reduced interest rates for our cash positions, and other factors. These inflationary conditions may harm
our margins and profitability if we are unable to increase our license, advertising and content distribution fees or reduce our costs sufficiently to offset the effects of inflation in our cost base. Our attempts to offset the effects of inflation
and cost increases through controlling our expenses, passing cost increases on to our licensees, advertisers and partners or any other method may not succeed.
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Failure to comply with applicable current and future government regulations could limit our ability to license our
technologies, sell our products or distribute content, and expose us to additional costs and liabilities.
Our operations and business practices are
subject to federal, state and local government laws and regulations, as well as international laws and regulations, including those relating to import or export of technology and software, distribution or censorship of content, use of encryption or
other digital rights management software and consumer and other safety-related compliance for electronic equipment. Any failure by us to comply with the laws and regulations applicable to us or our technologies, products or our distribution of
content could result in our inability to license those technologies, sell those products, or distribute content, additional costs to redesign technologies, products or our methods for distribution of content to meet such laws and regulations, fines
or other administrative, civil or criminal liability or actions by the agencies charged with enforcing compliance and, possibly, damages awarded to persons claiming injury as the result of our non-compliance. Changes in or enactment of new statutes,
rules or regulations applicable to us could have a material adverse effect on our business.
If we lose the services of key members of our senior
management team, we may not be able to execute our business strategy.
Our future success depends in large part upon the continued services of key
members of our senior management team. All of our executive officers and key employees are at-will employees, and we do not maintain any key person life insurance policies. The loss of our management or key personnel could seriously harm our ability
to execute our business strategy. We also may have to incur significant costs in identifying, hiring, training and retaining replacements for key employees.
We rely on highly skilled personnel, and if we are unable to retain or motivate key personnel or hire qualified personnel, we may not be able to maintain our operations or grow effectively.
Our performance is largely dependent on the talents and efforts of highly skilled individuals. These individuals have acquired specialized knowledge and skills with
respect to us and our operations. Our employment relationship with each of these individuals is on an at will basis and can be terminated at any time. If any of these individuals or a group of individuals were to terminate their employment
unexpectedly, we could face substantial difficulty in hiring qualified successors and could experience a loss in productivity while any such successor obtains the necessary training and experience.
Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization. In this
regard, if we are unable to hire and train a sufficient number of qualified employees for any reason, we may not be able to implement our current initiatives or grow effectively. We have in the past maintained a rigorous, highly selective and
time-consuming hiring process. We believe that our approach to hiring has significantly contributed to our success to date. However, our highly selective hiring process has made it more difficult for us to hire a sufficient number of qualified
employees, and, as we grow, our hiring process may prevent us from hiring the personnel we need in a timely manner. Moreover, the cost of living in the San Diego area, where our corporate headquarters are located, has been an impediment to
attracting new employees in the past, and we expect that this will continue to impair our ability to attract and retain employees in the future. If we do not succeed in attracting qualified personnel and retaining and motivating existing personnel,
our ability to execute our business strategy may suffer.
Our recent acquisitions, as well as any companies or technologies we may acquire in the
future, could prove difficult to integrate and may result in unexpected costs and disruptions to our business.
We recently acquired all of the
outstanding shares of MainConcept AG, a leading provider of audio and video codecs and software development kits to the broadcast, film and consumer markets. In early 2007 we acquired all of the assets of a limited liability corporation engaged in
developing real-time digital video processing
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technology for the purposes of producing enhanced video search and discovery services. We expect to continue to evaluate possible additional acquisitions of
technologies and businesses on an ongoing basis. Our recent acquisitions, as well as acquisitions in which we may engage in the future, entail numerous operational and financial risks including certain of the following risks:
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exposure to unknown liabilities;
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disruption of our business and diversion of our managements time and attention to developing acquired products or technologies;
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incurrence of substantial debt or dilutive issuances of securities to pay for acquisitions;
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higher than expected acquisition and integration costs;
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increased amortization expenses;
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difficulty and cost in combining the operations and personnel of any acquired businesses with our operations and personnel;
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impairment of relationships with key suppliers or customers of any acquired businesses due to changes in management and ownership; and
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inability to retain key employees of any acquired businesses.
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We have limited experience in identifying new acquisition targets, successfully completing acquisitions and integrating any acquired products, businesses or technologies into our current infrastructure. Moreover, in
the future we may devote resources to potential acquisitions that are never completed or that fail to realize any of their anticipated benefits.
We
may not realize the benefits we expect from the acquisition of MainConcept.
The integration of MainConcepts technology may be time consuming
and expensive, and may disrupt our business. We will need to overcome significant challenges to realize any benefits or synergies from this transaction. These challenges include the timely, efficient and successful execution of a number of
post-transaction integration activities, including:
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integrating MainConcepts technology;
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entering markets in which we have limited or no prior experience;
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successfully completing the development of MainConcepts technologies;
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developing commercial products based on those technologies;
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retaining and assimilating the key personnel of MainConcept;
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attracting additional customers for products based on MainConcepts technologies;
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implementing and maintaining uniform standards, controls, processes, procedures, policies, accounting systems and information systems; and
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managing expenses of any potential legal liability of MainConcept.
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In particular, we may encounter difficulties successfully integrating our operations, technologies, services and personnel with those of MainConcept, and our financial and management resources may be diverted from our
existing operations. For example, as a result of our acquisition of MainConcept we have additional offices in Germany, Russia and Japan. Maintaining offices in multiple countries could create a strain on our ability to effectively manage our
operations and personnel. In addition, the process of integrating operations and technology could cause an interruption of, or loss of momentum in, the activities of one or more of our businesses and the loss of key personnel. The delays or
difficulties encountered in connection with the
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integration of MainConcepts technologies could have an adverse effect on our business, results of operations or financial condition. We may not succeed
in addressing these risks or any other problems encountered in connection with this transaction. Our inability to successfully integrate the technology and personnel of MainConcept, or any significant delay in achieving integration, including
regulatory approval delays, could have a material adverse effect on us and, as a result, on the market price of our common stock.
Our corporate
culture has contributed to our success, and if we cannot maintain this culture as we grow, we could lose the innovation, creativity and teamwork fostered by our culture.
We believe that a critical contributor to our success has been our corporate culture, which we believe fosters innovation, creativity and teamwork. As our organization grows and we are required to implement more
complex organizational management structures, we may find it increasingly difficult to maintain the beneficial aspects of our corporate culture. This could negatively impact our future success.
Risks related to our finances
Our quarterly operating results
and stock price may fluctuate significantly.
We expect our operating results to be subject to quarterly fluctuations. The revenues we generate and
our operating results and the market price of our common stock will be affected by numerous factors, including:
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demand for our technologies and products;
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introduction, enhancement and market acceptance of technologies and products by us and our competitors;
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price reductions by us or our competitors or changes in how technologies and products are priced;
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the mix of technologies and products offered by us and our competitors;
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the mix of distribution channels through which our technologies and products are licensed and sold;
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our ability to successfully generate revenues from advertising and content distribution;
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the mix of international and United States revenues attributable to our technologies and products;
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costs of intellectual property protection and any litigation;
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timing of payments received by us pursuant to our licensing agreements;
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our ability to hire and retain qualified personnel; and
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growth in the use of the Internet.
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As a result of
the variances in quarterly volumes reported by our consumer hardware device manufacturing customers, we expect our revenues to be subject to seasonality, with our second quarter revenues expected to be lower than the revenues we derive in our other
quarters. In addition, a substantial majority of our quarterly revenues are based on actual shipment of products incorporating our technologies in that quarter, and not on contractually agreed upon minimum revenue commitments. Because the shipping
of products by our consumer hardware and independent software vendor partners are outside our control and difficult to predict, our ability to accurately forecast quarterly revenue is substantially limited. Quarterly fluctuations in our operating
results may, in turn, cause the price of our stock to fluctuate substantially. We believe that quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.
We have a history of net losses and only recently achieved profitability on a quarterly basis, and we may not be able to sustain our profitability.
We may not generate sufficient revenue to be profitable on a quarterly or annual basis in the future. In addition, we devote significant resources
to developing and enhancing our technology and to selling, marketing and
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obtaining content for our technologies and products. We expect our operating expenses to increase, as we, among other things:
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develop and grow our community and content distribution platform initiatives;
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expand our domestic and international sales and marketing activities;
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increase our product development efforts to advance our existing technologies and products and develop new technologies and products;
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hire additional personnel;
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upgrade our operational and financial systems, procedures and controls and continued compliance with Section 404 of the Sarbanes-Oxley Act; and
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continue to assume the responsibilities of being a public company.
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In addition, starting January 1, 2006, we adopted SFAS No. 123(R),
Share-Based Payment
, which required that we record stock-based compensation charges in connection with our equity compensation for
employees. As a result, we expect to continue to record significant expenses in future periods and we will need to generate significant revenue to be profitable in the future.
We may require additional capital, and raising additional funds by issuing securities, debt financing or through strategic alliances or licensing arrangements may cause dilution to existing stockholders,
restrict our operations or require us to relinquish proprietary rights.
We may raise additional funds through public or private equity offerings,
debt financings, strategic alliances or licensing arrangements. To the extent that we raise additional capital by issuing equity securities, our existing stockholders ownership will be diluted. Any debt financing we enter into may involve
covenants that restrict our operations. These restrictive covenants may include limitations on additional borrowing, specific restrictions on the use of our assets as well as prohibitions on our ability to create liens, pay dividends, redeem our
stock or make investments. In addition, if we raise additional funds through strategic alliances or licensing arrangements, it may be necessary to relinquish potentially valuable rights to our potential products or proprietary technologies, or grant
licenses on terms that are not favorable to us.
Risks related to our intellectual property
We are, and may in the future be, subject to intellectual property rights claims, which are costly to defend, could require us to pay damages and could limit our
ability to use certain technologies or content in the future.
Companies in the technology and entertainment industries own large numbers of
patents, copyrights, trademarks and trade secrets and they frequently make claims and commence litigation based on allegations of infringement or other violations of intellectual property rights, including those relating to digital media standards
such as MPEG-4, H.264, MP3 and AAC or relating to video or music content. We have faced such claims in the past, we currently face such claims, and we expect to face similar claims in the future. For instance, we have been contacted by third parties
regarding the licensing of certain patents characterized by such parties as being essential to the MPEG-4 visual standard. In this regard, AT&T has offered to license us certain patents it claims are essential to MPEG-4 and our products, and
while we believe we do not need a license from AT&T for these patents, AT&T may pursue their claims. We have also been contacted by LG Electronics regarding a license to certain patents that LG Electronics owns and claims are related to the
MPEG-4 visual standard. LG Electronics is one of our most significant customers in consumer hardware technology licensing and any dispute with LG over intellectual property rights could materially and adversely affect this important commercial
relationship. In the event we determine that we need to obtain a license from any third party, we cannot guarantee that we would be able to obtain such license on commercially reasonable terms, if at all. We may be required to develop
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non-infringing alternative technologies, which could be very time consuming and expensive, and there is no guarantee that we would be successful in
developing such technologies. We have also been asked by content owners to stop the display or hosting of copyrighted materials by our users or ourselves through our service offerings, including notices provided to us pursuant to the Digital
Millennium Copyright Act. For instance, in the recent past several major motion picture studios, record labels, television networks, and trade associations such as the Recording Industry Association of America and the Motion Picture Association of
America have asked us to remove content posted by users of our website which it claims infringe its rights in such content. Among those labels who have asked us to remove content is Universal Music Group, Inc. (UMG), who also asserted
claims of copyright infringement against us arising from the operation of Stage6, our online video community service. As a result, on September 6, 2007, we filed a lawsuit against UMG seeking a declaratory relief judgment against UMG. UMG
responded by filing a lawsuit against us in the Central District of California on October 22, 2007 alleging copyright infringement and seeking monetary damages, and later sought to dismiss or transfer the lawsuit that we initially filed in the
United States District Court for the Southern District of California. On February 5, 2008, the Court in the Southern District of California granted UMGs motion to dismiss the Companys lawsuit. At this time the parties are waiting
for the Court to decide on the Companys currently pending motion to dismiss UMGs action in the Central District. Moreover, content providers may claim that we are contributorily or vicariously liable for third parties use of our
technology or service offerings to infringe the content providers copyrights. Users of our services are subject to terms of use that prohibit the posting of content that violates third party intellectual property rights. We have and will
promptly respond to legitimate takedown notices or complaints, including but not limited to those submitted pursuant to the Digital Millennium Copyright Act, notifying us that we are providing unauthorized access to copyrighted content by removing
such content and/or any links to such content from our websites. Nevertheless, we cannot guarantee that our prompt removal of content, including removal pursuant to the provisions of the Digital Millennium Copyright Act, will prevent disputes with
content providers, that infringing content will not exist on our services, or that we will be able to resolve any disputes that may arise with content providers or users regarding such infringing content. Any intellectual property claims, with or
without merit, could be time-consuming, expensive to litigate or settle and could divert management resources and attention. An adverse determination could require that we pay damages, block access to certain content, or stop using technologies
found to be in violation of a third partys rights, and could prevent us from offering our technologies, products or certain content to others. To avoid these restrictions, we may be required to seek a license for the technology or content from
additional third parties. Such licenses may not be available on reasonable terms, could require us to pay significant royalties and may significantly increase our cost of revenues. The technologies or content also may not be available for license to
us at all. As a result, we may be required to develop alternative non-infringing technologies, or license alternative content, which could require significant effort and expense. If we cannot license or develop technologies or content for any
infringing aspects of our business, we may be forced to limit our technology or content offerings and may be unable to compete effectively with entities that offer such technology or content. In addition, from time to time we engage in disputes
regarding the licensing of our intellectual property rights, including matters related to our royalty rates and other terms of our licensing arrangements. These types of disputes can be asserted by our licensees or prospective licensees or by other
third parties as part of negotiations with us or in private actions seeking monetary damages or injunctive relief. Any disputes with our licensees or potential licensees or other third parties could harm our reputation and expose us to additional
costs and other liabilities.
We may be unable to adequately protect the proprietary rights in our technologies and products.
We have only two issued patents in the United States and one issued patent in foreign jurisdictions, along with exclusive rights to one additional United States patent,
and we generally do not rely upon patents to protect our proprietary rights. In addition, our ability to obtain patent protection for our technologies and products will be limited as a result of the incorporation of aspects of MPEG-4, MP3, and other
standards-based technologies into our technologies and products. We license such technologies from third party licensors and do not own any patents relating to such technologies. As a result, we do not have the right to defend perceived
infringements of patents relating to such technologies. Moreover, the licensors from which we have acquired the right to incorporate MPEG-4 and MP3 technologies into our products are not the exclusive owners of the patents relating
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to such technologies. As a result, our licensors must coordinate enforcement efforts with the owners of such patents to protect or defend against
infringements of patents relating to such technology, which can be expensive, time consuming and difficult. Any significant impairment of the intellectual property rights relating to the MPEG-4 or MP3 technologies we license for use in our
technologies and products could reduce the value of such technologies, which could impair our ability to compete.
Our ability to compete partly depends on
the superiority, uniqueness and value of our technologies, including both internally developed technology and technology licensed from third parties. To protect our proprietary rights, we rely on a combination of trademark, patent, copyright and
trade secret laws, confidentiality agreements with our employees and third parties, and protective contractual provisions. Despite our efforts to protect our intellectual property, any of the following occurrences may reduce the value of our
intellectual property:
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our applications for trademarks or patents may not be granted and, if granted, may be challenged or invalidated;
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issued patents, copyrights and trademarks may not provide us with any competitive advantages;
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our efforts to protect our intellectual property rights may not be effective in preventing misappropriation of our technology or dilution of our trademarks;
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our efforts may not prevent the development and design by others of products or technologies similar to or competitive with, or superior to those that we develop;
or
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another party may obtain a blocking patent that would force us to either obtain a license or design around the patent to continue to offer the contested feature or
service in our technologies.
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Legislation may be passed that would require companies to share information about their digital rights
management technology to permit interoperability with other systems. If this legislation is enacted, we may be required to reveal our proprietary digital rights management code to competitors. Furthermore, if content must be formatted such that it
can be played on a media player other than a DivX Certified player, then the demand for DivX Certified players could decrease.
We may be forced to
litigate to defend our intellectual property rights or to defend against claims by third parties against us relating to intellectual property rights.
Disputes regarding the ownership of technologies and rights associated with digital media technologies and online businesses are common and likely to arise in the future. We may be forced to litigate to enforce or defend our intellectual
property rights, to protect our trade secrets or to determine the validity and scope of other parties proprietary rights. Any such litigation could be very costly and could distract our management from focusing on operating our business.
Our ability to maintain and enforce our trademark rights has a large impact on our ability to prevent third party infringement of our brand and
technologies.
We generally rely on enforcing our trademark rights to prevent unauthorized use of our brand and technologies. Our ability to prevent
unauthorized uses of our brand and technologies would be negatively impacted if our trademark registrations were overturned in the jurisdictions where we do business. Our brand and logo are widely used by consumers and entities, both licensed and
unlicensed, in association with digital video compression technology, and if we are not vigilant in preventing unauthorized or improper use of our trademarks, then our trademarks could become generic and we would lose our ability to assert such
trademarks against others. We also have trademark applications pending in a number of jurisdictions that may not ultimately be granted, or if granted, may be challenged or invalidated, in which case we would be unable to prevent unauthorized use of
our brand and logo in such jurisdiction. We have not filed trademark registrations in all jurisdictions where our brand and logo are used.
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Some software we provide may be subject to open source licenses, which may restrict how we use or
distribute our software or require that we release the source code of certain products subject to those licenses.
Some of the products we support
and some of our proprietary technologies incorporate open source software such as open source MP3 codecs that may be subject to the Lesser Gnu Public License or other open source licenses. The Lesser Gnu Public License and other open source licenses
typically require that source code subject to the license be released or made available to the public. Such open source licenses typically mandate that software developed based on source code that is subject to the open source license, or combined
in specific ways with such open source software, become subject to the open source license. We take steps to ensure that proprietary software we do not wish to disclose is not combined with, or does not incorporate, open source software in ways that
would require such proprietary software to be subject to an open source license. However, few courts have interpreted the Lesser Gnu Public License or other open source licenses, and the manner in which these licenses may be interpreted and enforced
is therefore subject to some uncertainty. We also take steps to disclose any source code for which disclosure is required under an open source license, but it is possible that we have or will make mistakes in doing so, which could negatively impact
our brand or our adoption in the community, or could expose use to additional liability. In addition, we rely on multiple software programmers to design our proprietary products and technologies. Although we take steps to ensure that our programmers
do not include open source software in products and technologies we intend to keep proprietary, we do not exercise complete control over the development efforts of our programmers and we cannot be certain that our programmers have not incorporated
open source software into products and technologies we intend to keep proprietary. In the event that portions of our proprietary technology are determined to be subject to an open source license, or are intentionally released under an open source
license, we could be required to publicly release the relevant portions of our source code, which could reduce or eliminate our ability to commercialize our products and technologies. Also, in relying on multiple software programmers to design
products and technologies that we intend, or ultimately end up releasing in the open source community, we may discover that one or multiple such programmers have included code or language that would be embarrassing to the company, which could
negatively impact our brand or our adoption in the community, or could expose use to additional liability.
Risks related to the securities markets and
investment in our common stock
Market volatility may affect our stock price and the value of your investment.
The market price for our common stock has been and is likely to continue to be volatile, in part because our shares have only recently been traded publicly. In addition,
the market price of our common stock may fluctuate significantly in response to a number of factors, most of which we cannot control, including:
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announcements of new products, services or technologies, commercial relationships or other events by us or our competitors;
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regulatory developments in the United States and foreign countries;
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fluctuations in stock market prices and trading volumes of similar companies;
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variations in our quarterly operating results;
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changes in securities analysts estimates of our financial performance;
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changes in accounting principles;
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sales of large blocks of our common stock, including sales by our executive officers, directors and significant stockholders;
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additions or departures of key personnel; and
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discussion of us or our stock price by the financial press and in online investor communities.
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Shares of our common stock are relatively illiquid.
As of February 29, 2008, we had 34,894,369 shares of common stock outstanding, excluding 89,497 shares subject to repurchase. As a result of our relatively small
public float, our common stock may be less liquid than the stock of companies with broader public ownership. Among other things, trading of a relatively small volume of our common stock may have a greater impact on the trading price for our shares
than would be the case if our public float were larger. We have recently announced a planned buy-back of up to $20 million of our common stock, which may impact the liquidity of our common stock.
Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us, which may be beneficial to our stockholders, more
difficult and may prevent attempts by our stockholders to replace or remove our current management.
Provisions in our certificate of incorporation
and bylaws may delay or prevent an acquisition of us or a change in our management. These provisions include a classified board of directors, a prohibition on actions by written consent of our stockholders and the ability of our board of directors
to issue preferred stock without stockholder approval. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which limits the ability of stockholders
owning in excess of 15% of our outstanding voting stock to merge or combine with us. Although we believe these provisions collectively provide for an opportunity to obtain higher bids by requiring potential acquirors to negotiate with our board of
directors, they would apply even if an offer were considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more
difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.
We do
not intend to pay dividends on our common stock.
We have never declared or paid any cash dividend on our capital stock. We currently intend to
retain any future earnings and do not expect to pay any dividends in the foreseeable future.
We will incur increased costs as a result of changes in
laws and regulations relating to corporate governance matters.
Changes in the laws and regulations affecting public companies, including the
provisions of the Sarbanes-Oxley Act and rules adopted by the SEC and by The Nasdaq Stock Market, will result in increased costs to us as we continue to evaluate the implications of these laws and respond to their requirements. The impact of these
laws and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers. We are presently evaluating and monitoring developments with
respect to these laws and regulations and cannot predict or estimate the amount or timing of additional costs we may incur to respond to their requirements.
If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements could be impaired, which could adversely affect our ability to operate our business and our stock price.
Ensuring that we have adequate internal financial and accounting controls and procedures in place to help ensure that we can produce accurate
financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. We periodically document, review and, where appropriate, improve our internal controls and procedures for compliance with
Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent auditors addressing these assessments. Both we and our
independent auditors periodically test our internal controls in connection with the Section 404 requirements and could, as part of that documentation
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and testing, identify material weaknesses, significant deficiencies or other areas for further attention or improvement. Our networks are vulnerable to
security risks and hacker attacks, which may affect our ability to maintain effective internal controls as contemplated by Section 404. Implementing any appropriate changes to our internal controls may require specific compliance training for
our directors, officers and employees, entail substantial costs to modify our existing accounting systems, and take a significant period of time to complete. Such changes may not, however, be effective in maintaining the adequacy of our internal
controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. In addition,
disclosure regarding our internal controls or investors perceptions that our internal controls are inadequate or that we are unable to produce accurate financial statements may adversely affect our stock price.
For example, in connection with our financial statement close process and our acquisition integration efforts, we identified several control deficiencies at a company we
acquired in 2007 whose operations are primarily foreign. Specifically, there were deficiencies in revenue recognition and the availability of a sufficiently trained workforce in the accounting organization. Ernst & Young LLP, in connection with
their audit for the year ended December 31, 2007, also identified control deficiencies in the revenue recognition and financial statement close processes at this same acquired company. These deficiencies could rise to the level of one or more
material weaknesses once the evaluation of these controls has been completed. We are in the process of implementing a number of measures to remedy these deficiencies including the addition of qualified personnel. We believe the new controls and
procedures will address the deficiencies identified. The evaluation of these controls is expected to be completed subsequent to the date of this report and will be included in our report on internal control over financial reporting for the year
ending December 31, 2008. We plan to continue to monitor the effectiveness of the acquired companys controls, including the operating effectiveness of the newly implemented measures and plan to take further action, as appropriate.
Future sales of our common stock may cause our stock price to decline.
As of February 29, 2008, there were 34,894,369 shares of our common stock outstanding. Excluding 89,497 shares subject to repurchase, substantially all of these shares are eligible for sale in the public market,
although as of February 29, 2008, 3,953,571 of these shares were held by directors, executive officers and other affiliates and will be subject to volume limitations under Rule 144. In addition, as of February 29, 2008 we had
outstanding warrants to purchase up to 175,000 shares of common stock that, if exercised, will result in these additional shares becoming available for sale. A large portion of these shares and warrants are held by a small number of persons and
investment funds. Sales by these stockholders or warrantholders of a substantial number of shares could significantly reduce the market price of our common stock. Moreover, the holders of 6,822,738 shares of common stock at February 29, 2008
have rights, subject to some conditions, to require us to file registration statements covering the shares they currently hold or to include these shares in registration statements that we may file for ourselves or other stockholders.
As of February 29, 2008, an aggregate of approximately 8,590,755 shares of our common stock were reserved for future issuance under our 2000 Stock Option Plan, or
2000 Plan, our 2006 Equity Incentive Plan, or 2006 Plan, and our 2006 Employee Stock Purchase Plan, or 2006 Purchase Plan and the share reserve under our 2006 Plan and our 2006 Purchase Plan are subject to automatic annual increases in accordance
with the terms of the plans. These shares can be freely sold in the public market upon issuance. If a large number of these shares are sold in the public market, the sales could reduce the trading price of our common stock and impede our ability to
raise future capital.