Divx Inc - Quarterly Report (10-Q)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:

Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨

(Do not check if a smaller reporting company)

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934):

Yes ¨ No x

The number of shares of the Registrant’s Common Stock outstanding as of July 31, 2008 was 32,243,854.


		Page No.

PART I.	FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements (unaudited):	3
	Consolidated Balance Sheets as of June 30, 2008 and December 31, 2007	3
	Consolidated Statements of Income for the three and six months ended June 30, 2008 and 2007	4
	Consolidated Statements of Cash Flows for the six months ended June 30, 2008 and 2007	5
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	22
Item 4.	Controls and Procedures	23

PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	23
Item 1A.	Risk Factors	23
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40
Item 4.	Submission of Matters to a Vote of Security Holders	40
Item 6.	Exhibits	42

SIGNATURE		43

2


	June 30, 2008		December 31, 2007
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	28,785	$	14,532
Short-term investments		71,562		126,503
Accounts receivable, net of allowance of $1,759 and $1,909 at June 30, 2008 and December 31, 2007, respectively		16,148		10,397
Income tax receivable		—		857
Prepaid expenses		2,153		2,593
Deferred tax assets, current		4,254		2,699
Other current assets		1,074		1,868

Total current assets		123,976		159,449
Property and equipment, net		5,108		5,402
Long-term investments		17,645		—
Deferred tax assets, long-term		7,499		5,354
Purchased intangible assets, net		14,309		14,261
Goodwill		11,358		11,000
Other assets		5,908		5,422

Total assets	$	185,803	$	200,888

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	1,158	$	2,808
Accrued liabilities		3,616		4,574
Accrued compensation and benefits		2,688		4,011
Accrued patent royalties		884		1,785
Income taxes payable		91		616
Deferred revenue, current		8,679		7,170
Notes payable and capital lease obligations, current portion		53		75

Total current liabilities		17,169		21,039
Notes payable and Capital lease obligations, net of current portion		14		78
Deferred tax liability		2,145		3,119
Deferred revenue, long-term		1,473		1,098
Liability for unvested portion of early stock option exercises		59		114

Total liabilities		20,860		25,448
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.001 par value, 10,000 shares authorized at June 30, 2008 and December 31, 2007; no shares issued and outstanding at June 30, 2008 and December 31, 2007		—		—
Common stock, $0.001 par value, 200,000 shares authorized at June 30, 2008 and December 31, 2007; 32,278 and 34,723 shares issued and outstanding, excluding 59 and 127 shares subject to repurchase at June 30, 2008 and December 31, 2007, respectively		32		35
Additional paid-in capital		163,244		171,400
Accumulated other comprehensive income		182		109
Retained earnings		1,485		3,896

Total stockholders’ equity		164,943		175,440

Total liabilities and stockholders’ equity	$	185,803	$	200,888

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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	Three Months Ended June 30,						Six Months Ended June 30,
	2008			2007			2008		2007
Net revenues:
Technology licensing	$	16,410		$	14,229		$	35,488	$	30,931
Media and other distribution and services		4,909			4,050			10,853		7,566

Total net revenues		21,319			18,279			46,341		38,497
Cost of revenues:
Cost of technology licensing (1)		956			820			1,992		1,668
Cost of media and other distribution and services (1)		186			157			358		418

Total cost of revenues		1,142			977			2,350		2,086

Gross profit		20,177			17,302			43,991		36,411
Operating expenses:
Selling, general and administrative (1)		12,573			13,007			28,550		23,803
Product development (1)		5,366			4,636			10,791		8,792
Impairment of acquired intangibles		250			—			1,250		—

Total operating expenses		18,189			17,643			40,591		32,595

Income (loss) from operations		1,988			(341	)		3,400		3,816
Interest income and expense, net		1,110			2,019			2,767		3,928
Other income (expense), net		(15	)		5			502		(1	)

Income before income taxes		3,083			1,683			6,669		7,743
Income tax provision		1,406			680			2,511		3,080

Net income	$	1,677		$	1,003		$	4,158	$	4,663

Basic net income per share	$	0.05		$	0.03		$	0.12	$	0.14

Diluted net income per share	$	0.05		$	0.03		$	0.12	$	0.13

Shares used to compute basic net income per share		32,399			33,754			33,548		33,454

Shares used to compute diluted net income per share		32,907			35,401			34,132		35,409


(1) Includes share-based compensation as follows:
Cost of revenues	$	—		$	1		$	—	$	2
Selling, general and administrative		1,852			1,562			3,370		2,075
Product development		574			527			1,063		957

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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	Six months ended June 30,
	2008			2007
	(unaudited)
Cash flows from operating activities:
Net income	$	4,158		$	4,663
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,340			1,093
Deferred taxes		(2,738	)		—
Impairment of acquired intangibles		1,250			—
Asset impairment charge		350			—
Share-based compensation		4,433			3,034
Amortization of discount on investments		(448	)		(1,197	)
Tax benefit from stock options exercised		(12	)		—
Foreign currency transaction gain		(486	)		—
Changes in operating assets and liabilities:
Accounts receivable		(5,179	)		(497	)
Prepaid expenses and other assets		1,604			(755	)
Accounts payable		(1,664	)		460
Accrued liabilities		(3,709	)		671
Deferred rent		(276	)		(83	)
Deferred revenue		1,769			204

Net cash provided by operating activities		1,392			7,593
Cash flows from investing activities:
Purchase of investments		(69,359	)		(119,410	)
Proceeds from sales and maturities of investments		105,790			56,516
Purchase of property and equipment		(1,288	)		(1,554	)
Cash paid in Veatros acquisition		(1,750	)		(3,500	)
Cash paid in Main Concept acquisition		(1,205	)		—
Restricted cash		—			270

Net cash provided by (used in) investing activities		32,188			(67,678	)
Cash flows from financing activities:
Proceeds from exercise of stock options		122			1,527
Proceeds from shares issued under the employee stock purchase plan		584			—
Expenses related to initial public offering		—			(467	)
Excess tax benefit from exercise of stock options		12			393
Repurchase of common stock		(19,994	)		—
Repurchase of unvested stock		(16	)		(90	)
Payments on notes payable and capital lease		(90	)		(266	)

Net cash (used in) provided by financing activities		(19,382	)		1,097
Effect of exchange rate changes on cash		55			—

Net increase (decrease) in cash and cash equivalents		14,253			(58,988	)
Cash and cash equivalents at beginning of period		14,532			86,310

Cash and cash equivalents at end of period	$	28,785		$	27,322

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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The accompanying consolidated balance sheet as of June 30, 2008, the consolidated statements of income for the three and six months ended June 30, 2008 and 2007 and the consolidated statements of cash flows for the six months ended June 30, 2008 and 2007 are unaudited. The unaudited consolidated balance sheet as of June 30, 2008 is presented with the audited consolidated balance sheet as of December 31, 2007. These statements should be read in conjunction with the audited consolidated financial statements and related notes, together with management’s discussion and analysis of financial condition and results of operations, contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, or the Annual Report.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. In the opinion of the Company’s management, the unaudited consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements in the Annual Report, and include all adjustments (consisting of normal recurring accruals) necessary for the fair presentation of the Company’s financial information for the periods presented. The results of operations for the three and six months ended June 30, 2008 are not necessarily indicative of the results to be expected for the year as a whole.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes to the financial statements. Actual results could differ from those estimates.

Fair Value Measurements

Effective January 1, 2008, the Company adopted Statement of Financial Standards, or SFAS, No. 157, Fair Value Measurements , or SFAS No. 157. In February 2008, the Fair Accounting Standards Board, or the FASB, issued a staff position that delays the effective date of SFAS No. 157 for all nonfinancial assets and liabilities except for those recognized or disclosed at least annually. Therefore, the Company has adopted the provisions of SFAS No. 157 with respect to its financial assets and liabilities only. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Fair value is defined under SFAS No. 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measure date. Valuation techniques used to measure fair value under SFAS No. 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

See Note 3 for a description of the impact of the adoption of this statement on the Company’s consolidated results of operations and financial condition.

Format Approval Agreement

In June 2008, the Company executed a format approval fee agreement with Sony Pictures Television International, or SPTI, covering the world, excluding the U.S., District of Columbia and Canada. This agreement provides for SPTI to allow online retailers to offer SPTI’s titles for secure download in the DivX format for playback on DivX Certified consumer electronics devices. The total consideration paid by the Company to SPTI was a one-time non-refundable fee of $1.0 million and fully vested warrants to purchase 50,000 shares of the common stock of DivX with a strike price of $9.45 and an exercise period of 18 months. The value of these warrants at the date of issuance was approximately $90,000. The total consideration of $1.09 million was capitalized as an intangible asset and is being recorded against revenues generated from Sony Corporation over the estimated useful life of the format fee approval agreement, which is estimated to be five years.

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Basic earnings per share, or EPS, excludes dilution and is computed by dividing net income or loss attributable to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Potentially dilutive securities are excluded from the diluted EPS computation in loss periods and when their exercise price is greater than the market price as their effect would be anti-dilutive.

The following table sets forth the computation of basic and diluted EPS for the three and six months ended June 30, 2008 and 2007 (in thousands, except per share amounts):


	Three Months Ended June 30,				Six Months Ended June 30,
	2008		2007		2008		2007
Numerator:
Net income	$	1,677	$	1,003	$	4,158	$	4,663

Denominator:
Weighted average common shares outstanding (basic)		32,399		33,754		33,548		33,454
Common equivalent shares from restricted stock units		40		—		29		—
Common equivalent shares from common stock warrants		50		309		54		425
Common equivalent shares from options to purchase common stock and unvested shares of common stock subject to repurchase		418		1,338		501		1,530

Weighted average shares of common stock outstanding (diluted)		32,907		35,401		34,132		35,409

Basic earnings per share	$	0.05	$	0.03	$	0.12	$	0.14

Diluted earnings per share	$	0.05	$	0.03	$	0.12	$	0.13

Potentially dilutive securities, which are not included in the calculation of diluted net income per share because to do so would be anti-dilutive, are as follows (in thousands):
	Three Months Ended June 30,				Six Months Ended June 30,
	2008		2007		2008		2007
Common and preferred stock warrants		150		—		150		—
Options to purchase common stock		3,470		1,553		2,830		1,001

Total		3,620		1,553		2,980		1,001

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	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Commercial paper	$	11,360	$	23	$	(8	)	$	11,375
Corporate bonds		31,748		34		(74	)		31,708
Government		28,447		69		(37	)		28,479

Total short-term investments		71,555		126		(119	)		71,562

Auction rate securities - long-term investments		18,850		—		(1,205	)		17,645

	$	90,405	$	126	$	(1,324	)	$	89,207

The following table summarizes the contractual maturities of the Company’s investments as of June 30, 2008 (in thousands):


Less than one year	$	60,205
Due in one to five years		11,357
Due after five years		17,645

	$	89,207

Asset-backed securities have been allocated within the contractual maturities table based upon the set maturity date of the security. Realized gains and losses on investments are included in interest income (expense), net, in the accompanying consolidated statements of income. The Company recorded no realized gains or losses on its investments during the six months ended June 30, 2008 and 2007.

As of June 30, 2008, the Company had no investments that have been in a continuous unrealized loss position for more than 12 months.

In accordance with SFAS No. 157, the following table represents the Company’s fair value hierarchy for its financial assets (cash equivalents and available for sale investments) as of June 30, 2008 (in thousands):


	Fair Value		Level 1		Level 2		Level 3
Cash equivalents:
Money market funds	$	26,541	$	26,541	$	—	$	—
Short-term investments:
Commercial paper		11,375		11,375		—		—
Corporate bonds		31,708		31,708		—		—
Government		28,479		28,479		—		—
Long-term investments:
Auction rate securities		17,645		—		—		17,645

Total financial assets	$	115,748	$	98,103	$	—	$	17,645

The Company’s long-term investments consist of auction rate securities subject to fair value measurement and the assets valued under the Level 3 hierarchy. Auction-rate securities, or ARS, are long-term variable rate bonds tied to short-term interest rates. After the initial issuance of the securities, the interest rate on the securities is reset periodically, at intervals established at the time of issuance (primarily every 27 to 34 days), based on market demand for a reset period. ARS are bought and sold in the marketplace through a competitive bidding process often referred to as a “Dutch auction.” If there is insufficient interest in the securities at the time of an auction, the auction may not be completed and the rates may be reset to predetermined “penalty” or “maximum” rates.

During the three months ended June 30, 2008, $1.3 million worth of the Company’s ARS were redeemed, which resulted in the reversal of a previously recorded unrealized loss of approximately $60,000. Due to the recent uncertainties in the credit markets, all other scheduled auctions for the Company’s ARS have failed. Consequently, these investments are not currently liquid and the Company will not be able to access these funds until a future auction of these investments is successful, a buyer is found outside of the auction process or the instruments are redeemed. At the time of the initial investment and through the date of this report, all of these ARS remain AAA rated. The assets underlying each security are student loans and municipal bonds. Principal amounts of $2.5 million and $1.6 million are guaranteed by the Federal Family Education Loan Program, or FFELP, at 51% and 81% respectively, and the

9

remaining principal amounts of $14.8 million are guaranteed by FFELP at 99% to 100%. The Company believes it has the ability and currently intends to hold these ARS investments until the lack of liquidity in these markets is resolved. As a result, the Company has re-classified the entire balance of ARS as long-term investments on its consolidated balance sheets. No ARS were redeemed subsequent to June 30, 2008 through the date of this report.

Typically, the par value of ARS investments approximates fair value due to the frequent resets through the auction process. While the Company continues to earn interest on its ARS investments at the contractual rate, these investments are not currently trading and therefore do not have a readily determinable market value. Accordingly, the Company has determined that the par value no longer approximates the estimated fair value of the ARS.

At June 30, 2008, the Company conducted a Level 3 valuation for the ARS investments which indicated a fair value of $17.6 million. The Company’s valuation analysis utilized a discounted cash flow approach to arrive at this valuation. The assumptions used in preparing the discounted cash flow model include estimates for interest rates, timing and amount of cash flows, credit and liquidity premiums, and expected holding periods of the ARS. These assumptions are volatile and subject to change as the underlying sources of these assumptions and market conditions change. They represent the Company’s estimates given available data as of June 30, 2008.

Based on this assessment of fair value, as of June 30, 2008 the Company determined there was a decline in the fair value of its ARS investments of $1.2 million which was deemed temporary. That amount has been recorded as a component of accumulated other comprehensive income on its consolidated balance sheets.

The following table provides a summary of changes in fair value of the Company’s ARS investments (Level 3) as of June 30, 2008 (in thousands):


Balance at December 31, 2007	$	22,300
Purchase of ARS investments		10,150
Sale of ARS investments		(12,300	)
Redemption of ARS investments		(1,300	)
Unrealized loss included in other comprehensive income		(1,205	)

Balance at June 30, 2008	$	17,645

Note 4— Asset Impairment and Accrued Termination Costs

During the first quarter of 2008, the Company shut down Stage6, the Company’s online video community service. In accordance with SFAS, No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets , the Company evaluated the long-lived assets associated with Stage6 for impairment. Based on the Company’s forecasts, the Company concluded that the carrying amount of certain computers and computer equipment, prepaid assets and an intangible asset were not recoverable. As a result, an impairment loss equal to the assets’ remaining carrying amounts of approximately $350,000 was recorded during the first quarter of 2008 in selling, general and administrative expenses in the consolidated statements of income. No impairment loss was recorded in the three months ended June 30, 2008.

In addition, the Company identified several contractual obligations associated with Stage6 that were determined to have no future economic value. As a result, the Company recorded a loss of $477,000 on those contractual obligations during the first quarter of 2008 in operating expenses in the consolidated statements of income. No loss was recorded in the three months ended June 30, 2008.

The following table summarizes the activity and balances of accrued termination costs through June 30, 2008 (in thousands):


	Contractual Obligations			Property and Equipment Impairment			Total
Balance at December 31, 2007	$	—		$	—		$	—
Charged to expense		477			350			827
Non-cash charge		—			(350	)		(350	)

Balance at March 31, 2008		477			0			477
Net cash payments		(291	)		—			(291	)

Balance at June 30, 2008	$	186		$	—		$	186

10

In March 2008, the Board of Directors, pursuant to the 2006 Stock Incentive Plan, granted 377,000 shares of restricted stock to executives and an employee at a fair value of $7.32 per share. The restricted stock awards vest in quarterly increments over a four-year period. The Company estimated the aggregate fair value of this award at approximately $2.8 million which is being amortized and recorded as compensation expense ratably over a period of four years.

Share-Based Compensation under SFAS No. 123(R)

Total share-based compensation expense for the three and six months ended June 30, 2008 and 2007 is as follows (in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2008			2007			2008			2007
Cost of revenues	$	—		$	1		$	—		$	2
Selling, general and administrative		1,852			1,562			3,370			2,075
Product development		574			527			1,063			957

Totals		2,426			2,090			4,433			3,034
Tax effect on share-based compensation		(1,051	)		(844	)		(1,882	)		(1,207	)

Net effect on net income	$	1,375		$	1,246		$	2,551		$	1,827

Effects on earnings per share:
Basic	$	0.04		$	0.04		$	0.08		$	0.05
Diluted	$	0.04		$	0.04		$	0.07		$	0.05

The Company recorded $2.4 million and $2.1 million in share-based compensation expenses during the three months ended June 30, 2008 and 2007, and recorded $4.4 million and $3.0 million in share-based compensation expenses during the six months ended June 30, 2008 and 2007. In addition, for the six months ended June 30, 2008 and 2007, $12,000 and $393,000, respectively, was presented as financing activities to reflect the incremental tax benefits from stock options exercised in those periods. At June 30, 2008, total unrecognized estimated compensation costs related to unvested stock options granted prior to that date was $25.0 million, which is expected to be recognized over a weighted-average period of 3.14 years. At June 30, 2008, total unrecognized estimated compensation costs related to non-vested restricted stock awards granted prior to that date was $2.6 million, which is expected to be recognized over a period of 3.7 years.

On May 8, 2008, the Board of Directors approved an option repricing by the Company. Pursuant to the Board of Directors’ approval, the Company reduced the exercise price of all outstanding non-vested, non-qualified stock options granted to all employees (excluding Section 16 officers) which had exercise prices of $11.00 and above. The exercise price of such options was re-set to $9.79 per share, which was equal to 110% of $8.90, the fair market value of the Company’s common stock as of May 8, 2008. This modification to the existing stock options resulted in an approximately $1.5 million incremental increase in value of the related stock options, the incremental stock compensation cost of which will be recognized by the Company ratably over the remaining life of such stock options. During the three months ended June 30, 2008, the Company recorded approximately $100,000 in additional share-based compensation expenses directly associated with the re-priced stock options.

Note 6—Income Taxes

The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes . Deferred income tax assets or liabilities are recognized based on the temporary differences between financial statement and income tax basis of assets and liabilities using enacted tax rates in effect for the years in which the differences are expected to reverse. Deferred income tax expenses or credits are based on the changes in the deferred income tax assets or liabilities from period to period. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized. The Company records estimated tax liabilities to the extent the contingencies are probable and can be reasonably estimated.

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The Company accounts for uncertain tax positions in accordance with FASB Interpretation, or FIN, No. 48, Accounting for Uncertainty in Income Taxes , an interpretation of FASB Statement No. 109 . FIN No. 48 prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods and income tax disclosures. It is the Company’s practice to include interest and penalties that relate to income tax matters as a component of income tax provision.

Effective May 12, 2008, the Company made certain U.S. tax elections to treat the Company’s wholly-owned subsidiary, MainConcept GmbH, or MainConcept, as a disregarded entity for U.S. income tax purposes. This has the effect of having the income or loss of this foreign subsidiary taxed in the United States as if it were a branch. Further, the U.S. tax elections created tax deductible intangible assets and goodwill. As a result, the Company will receive U.S. tax benefits for the amortization of the purchased intangible assets and tax deductible goodwill, which did not previously exist for U.S. federal income tax purposes. The elections resulted in the recognition of a U.S. deferred tax asset of approximately $2.1 million relating to these future U.S. tax benefits. This deferred tax asset was recorded as a reduction to goodwill during the second quarter of 2008 as part of the finalization of the purchase price allocation during the second quarter of 2008.

The Company also recorded a tax benefit of approximately $300,000 related to the release of the valuation allowance on certain deferred tax assets recorded on the books of the Company’s wholly-owned subsidiary, MainConcept, during the first quarter of 2008.

Income tax provision for the three months ended June 30, 2008 was $1.4 million, or 45.6% of pre-tax income, compared to $680,000 or 40.4% of pre-tax income for the three months ended June 30, 2007. Income tax provision for the six months ended June 30, 2008 was $2.5 million, or 37.7% of pre-tax income, compared with $3.1 million, or 39.8% of pre-tax income for the six months ended June 30, 2007. The difference between the Company’s effective tax rate and the 35% U.S. federal statutory rate for the three and six month period ended June 30, 2008 was primarily due to state income taxes and permanent differences, partially offset by research and development credits. The effective tax rate for the six months ended June 30, 2007 differs from the U.S. federal statutory rate of 35% primarily due to state income taxes and permanent differences, partially offset by research and development credits.

The Company files federal, state and foreign income tax returns in jurisdictions with varying statutes of limitations. Due to net operating loss and research and development credit carryovers from earlier years, the Company is subject to income tax examination by tax authorities from inception to date.

The Company’s U.S. federal income tax return for the 2006 tax year is currently under examination by the Internal Revenue Service. The Company does not expect that the results of this examination will have a material effect on its financial condition or results of operations.

Note 7 — Comprehensive Income

The components of comprehensive income are as follows (in thousands):


	Three Months Ended June 30,					Six Months Ended June 30,
	2008			2007		2008			2007
Net Income	$	1,677		$	1,003	$	4,158		$	4,663
Unrealized gain (loss) on investments		(535	)		42		(1,310	)		38
Unrealized gain on foreign currency translation		11			—		1,379			—

Total comprehensive income	$	1,153		$	1,045	$	4,227		$	4,701

Note 8 — Share Repurchase Program

In March 2008, the Company’s Board of Directors approved a share repurchase program authorizing the Company to repurchase up to $20.0 million of its common stock. During the six months ended June 30, 2008, the Company completed its share repurchase program with the purchases of approximately 2.8 million shares of its common stock for a total purchase price of approximately $20.0 million. Purchases under this program were made through a 10b5-1 program, and open market purchases.

The shares repurchased were retired and additional paid-in-capital was reduced accordingly, to the extent of the average premium with any excess being recorded as a reduction to retained earnings.

12

In July 2007, the Company acquired all of the assets of Veatros, L.L.C., or Veatros, a limited liability company engaged in real-time digital video processing for the purposes of producing enhanced video search and discovery services. At the time of acquisition, the operations of Veatros had been wound down and no development projects were in-process. The acquisition was accounted for as an acquisition of assets in accordance with Emerging Issues Task Force Issue No. 98-3, Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business. The total purchase price for the acquisition was up to $4.3 million comprised of an initial upfront cash payment of $2.0 million, which the Company made in July 2007, and subsequent cash payments of $2.3 million upon the achievement of certain technology related milestones. The Company did not acquire any tangible assets or assume any liabilities as a result of the acquisition. The Company allocated the cash payments of $4.3 million to one identifiable intangible asset, a patented technology license. The asset is being amortized over the remaining life of the patented technology license, or approximately eight years.

In July 2007, subsequent to the asset purchase, the Company’s Board of Directors approved a plan to separate its Stage6 operations into a separate entity, and during the three months ended March 31, 2008, Stage6 was shut down. As a significant portion of the benefit from the acquired patented technology license was originally to be derived from Stage6 future activities, the Company evaluated the intangible asset for impairment in accordance with SFAS No. 144 based on the projected benefits solely attributable to its core consumer electronics business. Based on the Company’s revised forecasts excluding the Stage6 future activities and discounting the cash flows attributable to its core consumer electronics business, the Company concluded that the carrying amount of the asset was not fully recoverable and an impairment charge equal to approximately $3.0 million was recorded in 2007 in the consolidated statements of income for the initial upfront cash payment and for the technology milestones. During the first and second quarter of 2008, the technology milestones equal to $1.0 million in the aggregate were achieved and the technology milestone of $250,000 was deemed payable. As these technology milestones were attributable to Stage6, the milestones were not considered to be recoverable and as a result, the Company recorded an impairment charge of $1.0 million and $250,000 in the consolidated statements of income during the first and second quarter of 2008, respectively.

MainConcept

In November 2007, the Company acquired MainConcept, a German-based provider of audio and video codec technology. In exchange for all outstanding shares of capital stock, the Company paid approximately $22.6 million. The purchase price, including acquisition costs of $200,000, was $16.4 million in cash, 88,940 shares of the Company’s common stock, which were valued at approximately $1.6 million as of the date of the transaction, and outstanding loans extended to MainConcept by one of its shareholders that the Company also purchased for an aggregate amount of approximately $4.4 million. In addition, the purchase agreement provides for additional payments of up to approximately $5.6 million upon the achievement by MainConcept of certain product development goals and certain financial milestones. During the three and six months ended June 30, 2008, $1.1 million and $2.2 million, respectively, in milestones were recorded as additional purchase price and allocated to goodwill. The acquired goodwill will not be amortized for financial reporting purposes, but will be assessed periodically for impairment.

The following table provides a summary of changes in the goodwill balance for the six months ended June 30, 2008 (in thousands):


Balance at December 31, 2007	$	11,000
Product development and financial milestones		2,233
Purchase accounting adjustment related to deferred revenue		(643	)
Impact from “check-the-box” election		(2,145	)
Effect of exchange rate changes		913

Balance at June 30, 2008	$	11,358

Note 10 — Legal Matters

On October 22, 2007, following the filing of a declaratory relief action filed by the Company which was subsequently dismissed, Universal Music Group, Inc., or UMG, filed a lawsuit against the Company in the Central District of California. UMG’s suit alleges copyright infringement and seeks monetary damages related to the operation by the Company of the Stage6 online video community service, which the Company shut down on February 28, 2008. The Company believes it has meritorious defenses to UMG’s claims and will assert them vigorously. Litigation is inherently uncertain and there can be no guarantee as to who will prevail or that this litigation will not have material adverse consequences for the Company; an unfavorable resolution of these proceedings could materially affect the Company’s future operating results or financial conditions in particular periods.

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The Company is also involved in various legal proceedings from time to time arising from the normal course of business activities, including commercial, employment and other matters. In the Company’s opinion, resolution of all of its legal proceedings is not expected to have a material adverse effect on our operating results or financial condition. However, it is possible that an unfavorable resolution of one or more such proceedings could materially affect the Company’s future operating results or financial condition in a particular period.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion and analysis of our financial condition and results of our operations in conjunction with our consolidated financial statements and the notes to those statements included elsewhere in this Quarterly Report on Form 10-Q, as well as our audited consolidated financial statements and notes to those statements as of and for the year ended December 31, 2007 included in our Annual Report on Form 10-K filed with the SEC. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. Our actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed in the section entitled “Risk Factors,” and elsewhere in this Quarterly Report on Form 10-Q.

Overview

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 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. Our customers include major consumer video hardware original equipment manufacturers, or OEMs. We are entitled to receive a royalty and/or license fee for DivX Certified devices that our customers ship. In addition to technology licensing to consumer hardware device manufacturers, we currently generate revenue from software licensing and related support, advertising and content distribution.

Complementing our organic growth since 2000, in November 2007, we acquired MainConcept GmbH, formerly MainConcept AG (“MainConcept”), 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 goals of supporting high-quality video on any device.

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 the Internet and consumer electronics devices. We are optimistic about the future and believe the opportunities for DivX are only beginning to be realized.

Sources of revenues

We have four revenue streams. Three of these revenue streams are derived from our technologies, including technology licensing to producers of consumer hardware devices, licensing to independent software vendors and consumers, and providing services related to content distribution over the Internet. Additionally, we derive revenues from advertising and distributing third-party products on our website.

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 OEMs, although related revenues are derived from other members of the consumer hardware device supply chain. We license our technologies to OEMs, allowing them to build support of DivX technologies into their consumer hardware devices. In the majority of cases, OEMs pay us a per-unit fee for each DivX Certified device they sell. Our license agreements with OEMs 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 companies who create the major components in consumer hardware devices. These companies include integrated circuit manufacturers who supply integrated circuits, and original design manufacturers who create reference designs, for DVD players, digital still cameras and the other consumer hardware devices distributed by our licensee original equipment manufacturers. Because royalties are generated by the shipment volumes of our consumer hardware device customers, and because sales by consumer hardware device manufacturers are highly seasonal, we expect revenues relating to consumer hardware devices to be highly seasonal, with our second quarter revenues in any given calendar year being generally lower than any other quarter in that calendar year.

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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 our free software bundles, including additional features that increase the quality and control of DivX media playback and creation. These enhanced versions are 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. We believe that downloads of this software benefit our business both directly and indirectly. Our business benefits directly from increased revenues when the user downloads a for-pay version. Our business benefits indirectly when free or trial versions are downloaded, as we believe such downloads increase our installed base and therefore the demand for consumer hardware devices that contain our technologies.

We derive revenue from advertisements or third party software applications that we embed in or include with the software packages we offer to consumers. For example, we 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.

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. We also derive revenues by encoding third-party content into the DivX format to allow such content to be delivered more efficiently via the Internet. We report revenue related to content distribution arrangements with consumer hardware OEMs who pay a fee for each copy of DivX-encoded content that is encoded on physical media and bundled with their consumer hardware products. If our content licensing arrangements with consumer hardware OEMs or our online video community services are successful, our content distribution revenues may increase in future periods.

Our wholly owned subsidiary, MainConcept, licenses its codec software applications for professional consumers and sells software development kits for software developers. MainConcept’s licenses typically range in term from one year to perpetual licenses. MainConcept’s customers typically pay us an upfront fee, periodic maintenance and support fees, volume-based royalties and provide minimum guaranteed volume levels. Revenue from these software licensing agreements is recognized upon delivery of the software, which is generally when the software is made available for download, there is persuasive evidence of an arrangement, collection is reasonably assured, the fee is fixed or determinable and vendor-specific objective evidence exists to allocate the total fees to all elements of the arrangement. MainConcept’s licenses generally include maintenance provisions that bundle the license with the related maintenance. Contracts that bundle the software license with software maintenance and technical support are recognized ratably over the contract term.

Cost of revenues

Our cost of revenues consists primarily of license fees payable to providers of intellectual property that is included in our technologies. Generally, royalties are due to our third-party intellectual property providers based on when certain of our products are sold, subject to contractually agreed-upon limits. To a much lesser extent, cost of revenues also includes depreciation on certain computing equipment and related software, the compensation of related employees, Internet connectivity costs, third-party payment processing fees and related overhead. Although this may not be the case in the future, and although we have experienced some variability to our cost of revenue structure in the past, in general our costs of revenues have not been highly variable with revenue volumes. As a result, we generally expect our overall gross margins to fluctuate with revenues.

Selling, general and administrative

The majority of selling, general and administrative expenses consists of employee compensation costs. Selling, general and administrative expense also includes marketing expenses, business travel costs, trade show costs, outside consulting fees and related overhead. Although it fluctuated during the period, our headcount for selling, general, and administrative related personnel, including employees and outside contractors was 189 as of June 30, 2007 and June 30, 2008, as a result of the headcount decrease from the shut-down of Stage6 as offset by headcount increases from our acquisition of MainConcept. We may hire additional employees and outside contractors for our sales and marketing staff and to increase our selling and marketing budget in the future as we attempt to continue to raise awareness of our products and services.

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The majority of product development expense consists of employee compensation for personnel responsible for the development of new technologies and products. Our headcount for product development related personnel, including employees and outside contractors increased by 37 from 118 as of June 30, 2007 to 155 as of June 30, 2008, primarily as a result of our acquisition of MainConcept, offset by our shut-down of Stage6. Product development expense also includes depreciation of computer and related equipment, software license fees and related overhead. We may increase our product development expenses in absolute dollars as we continue to invest in the development of our products and services, though as a percentage of revenues such expenses may fluctuate on a quarterly basis. While we expect to continue to hire additional employees to meet our business needs, if permanent employees are not available for hire, we may use outside contractors to fulfill our labor needs when and as required to accomplish our operating goals.

Impairment of acquired intangibles

In the three and six months ended June 30, 2008, we recorded an impairment charge of $250,000 and $1.3 million, respectively, related to the patented technology license intangible asset acquired in connection with our acquisition of Veatros, L.L.C., a limited liability company, in July 2007. As more fully discussed in Note 9 in the accompanying notes to the unaudited consolidated financial statements, management performed an impairment analysis of the asset in accordance with Statement of Financial Accounting Standards (SFAS) No. 144 , Accounting for the Impairment or Disposal of Long-Lived Assets , and concluded that the asset was not fully recoverable.

Asset Impairment and Restructuring

On February 28, 2008, we shut down Stage6, our online video community service. We evaluated the long-lived assets associated with Stage6 for impairment and concluded that the carrying amount of certain computers and computer equipment, prepaid assets and an intangible asset were not recoverable and an impairment loss equal to the assets’ remaining carrying values of approximately $350,000 was recorded. In addition, we identified several contractual obligations associated with Stage6 that were determined to have no future economic value. As a result, we recorded a loss of $477,000 on those contractual obligations during the three months ended March 31, 2008. No costs associated with the closure of Stage6 were incurred in the three months ended June 30, 2008.

Critical accounting policies

This discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements in accordance with GAAP requires us to use accounting policies and make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies as of the date of the financial statements and the reported amounts of revenue and expenses during a fiscal period. We consider an accounting policy to be critical if it is important to our financial condition and results of operations, and if it requires significant judgment and estimates on the part of management in its application. We have discussed the selection and development of the critical accounting policies with the audit committee of our Board of Directors, and the audit committee has reviewed our related disclosures. Although we believe that our judgments and estimates are appropriate and correct, actual results may differ from those estimates.

Except as noted below, our critical accounting policies are described in the notes to the audited consolidated financial statements as of and for the year ended December 31, 2007 included in our Annual Report on Form 10-K filed with the SEC.

Valuation of financial assets and liabilities. Effective January 1, 2008, we adopted Statement of Financial Standards, or SFAS, No. 157, Fair Value Measurements , or SFAS No. 157. In February 2008, the Fair Accounting Standards Board, or the FASB, issued a staff position that delays the effective date of SFAS No. 157 for all nonfinancial assets and liabilities except for those recognized or disclosed at least annually. Therefore, we adopted the provisions of SFAS No. 157 with respect to our financial assets and liabilities only. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Fair value is defined under SFAS No. 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measure date. Valuation techniques used to measure fair value under SFAS No. 157 must maximize the use of observable inputs and minimize the use of unobservable inputs.

We value our financial assets and liabilities in accordance with SFAS No. 157, utilizing the fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

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Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Future Accounting Requirements

In December 2007, the FASB issued SFAS No. 141 (Revised 2007) (SFAS No. 141R), Business Combinations, or SFAS No. 141R. SFAS No. 141R will change the accounting for business combinations. Under SFAS No.141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS No.141R will change the accounting treatment and disclosure for certain specific items in a business combination. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. SFAS No. 141R will have an impact on accounting for business combinations once adopted but the effect is dependent upon acquisitions at that time.

In December 2007, the FASB issued SFAS No. 160 (SFAS No. 160), Interests in Consolidated Financial Statements—An Amendment of ARB No. 51, or SFAS No. 160. SFAS No. 160 establishes new accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. We are currently evaluating the impact of SFAS No. 160 on our consolidated results of operations and financial condition.

In March 2008, the FASB issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133, or SFAS No. 161, which requires additional disclosures about the objectives of using derivative instruments, the method by which the derivative instruments and related hedged items are accounted for under FASB Statement No.133 and its related interpretations, and the effect of derivative instruments and related hedged items on financial position, financial performance and cash flows. SFAS No. 161 also requires disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. The statement is applicable for all fiscal years beginning on or after November 15, 2008 and will be effective for our fiscal year 2009. We do not believe that the adoption of this statement will have a material impact on our financial statements.

Results of Operations

The following table presents our results of operations as a percentage of total net revenue for the periods indicated:


	Three months ended June 30,				Six months ended June 30,
	2008		2007		2008		2007
	(unaudited)				(unaudited)
Net revenues:
Technology licensing	77	%	78	%	77	%	80	%
Media and other distribution and services	23		22		23		20

Total net revenues	100		100		100		100
Cost of revenue:
Cost of technology licensing	4		4		4		4
Cost of media and other distribution and services (1)	1		1		1		1

Total cost of revenues	5		5		5		5

Gross margin	95		95		95		95
Operating expenses:
Selling, general and administrative (1)	59		71		62		62
Product development (1)	25		25		23		23
Impairment of acquired intangibles	1		—		3		—

Total operating expenses	85		96		88		85

Income (loss) from operations	10		(1	)	7		10
Interest income (expense), net	5		11		6		10
Other income (expenses), net	—		—		1		—

Income before income taxes	15		10		14		20
Income tax provision	7		4		5		8

Net income	8	%	6	%	9	%	12	%


(1) The following table presents details of total stock-based compensation expense included in each functional line item in the unaudited consolidated statements of income above:

Cost of revenues	—	%	—	%	—	%	—	%
Selling, general and administrative	9		9		7		5
Product development	3		3		2		2

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	Three Months Ended June 30,						Change				Six Months Ended June 30,						Change
	2008			2007			$		%		2008			2007			$		%
Net revenues:
Technology licensing
Consumer hardware devices	$	13,411		$	12,498		$	913	7	%	$	30,201		$	27,256		$	2,945	11	%
% of total net revenues		63	%		68	%						65	%		71	%
Software		2,999			1,731			1,268	73	%		5,287			3,675			1,612	44	%
% of total net revenues		14	%		10	%						12	%		9	%

Total technology licensing		16,410			14,229			2,181	15	%		35,488			30,931			4,557	15	%
% of total net revenues		77	%		78	%						77	%		80	%
Advertising and third-party product distribution		4,735			3,878			857	22	%		10,533			7,273			3,260	45	%
% of total net revenues		22	%		21	%						22	%		19	%
Content distribution and related services		174			172			2	1	%		320			293			27	9	%
% of total net revenues		1	%		1	%						1	%		1	%

Total net revenues	$	21,319		$	18,279		$	3,040	17	%	$	46,341		$	38,497		$	7,844	20	%

Technology licensing—consumer hardware devices: The $900,000, or 7%, increase in net revenues from technology licensing to consumer hardware device manufacturers from the three months ended June 30, 2007 to the three months ended June 30, 2008, and the $2.9 million, or 11%, increase in net revenues from technology licensing to consumer hardware device manufacturers from the six months ended June 30, 2007 to the six months ended June 30, 2008 resulted primarily from an increase in net royalty revenues associated with increased shipped-unit volumes of devices that incorporate our technologies reported to us by our licensee partners.

Technology licensing—software : The $1.3 million, or 73%, increase in software licensing revenues from the three months ended June 30, 2007 to the three months ended June 30, 2008, and the $1.6 million, or 44%, increase in software licensing revenues from the six months ended June 30, 2007 to the six months ended June 30, 2008 were primarily due to approximately $1.6 million and $2.4 million of additional revenue from MainConcept acquired in November 2007 for the three- and six-month periods, respectively, offset by a $300,000 and $800,000 decrease in revenue for the three- and six-month periods, respectively, primarily as a result of the expiration of a codec licensing agreement with Google in 2007.

Advertising and third-party product distribution: The $900,000, or 22%, increase in advertising and third-party product distribution revenue from the three months ended June 30, 2007 to the three months ended June 30, 2008, and the $3.3 million, or 45%, increase in advertising and third-party product distribution revenue from the six months ended June 30, 2007 to the six months ended June 30, 2008, resulted primarily from an increase in revenues under our agreement with Yahoo! in 2008 compared to our agreement with Google in 2007. In November 2007, we switched from distribution of Google software, to instead including and distributing a co-branded Yahoo! toolbar and Internet Explorer browser with our software products under agreement with Yahoo!. Pursuant to the agreement, Yahoo! pays us fees based on the number of certain distributions or installations of the Yahoo! software by consumers.

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Content distribution and related services: The $2,000, or 1%, increase in content distribution and related services revenue from the three months ended June 30, 2007 to the three months ended June 30, 2008, and the $27,000, or 9%, increase in content distribution and related services revenue from the six months ended June 30, 2007 to the six months ended June 30, 2008 reflects an increase in sales by our Open Video System (“OVS”) customers and in encoding revenues. Our OVS is a complete hosted service that allows content creators to deliver high-quality DivX video content over the Internet. We use our OVS 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 our OVS, a content service provider can launch its own web store and sell content online.

Gross profit

The following table shows the gross profit earned on each of our revenue streams for the three and six months ended June 30, 2008 and 2007 in absolute dollars and as a percentage of related revenues (in thousands):


	Three months ended June 30,						Change					Six months ended June 30,						Change
	2008			2007			$			%		2008			2007			$		%
Gross profit
Technology licensing	$	15,453		$	13,409		$	2,044		15	%		33,496		$	29,263		$	4,233	14	%
Gross margin %		94	%		94	%							94	%		95	%
Advertising and third-party distribution		4,685			3,841			844		22	%		10,440			7,203			3,237	45	%
Gross margin %		99	%		99	%							99	%		99	%
Content distribution and related services		38			52			(14	)	(27	)%		55			(55	)		110	200	%
Gross margin %		22	%		30	%							17	%		-19	%

Total gross profit	$	20,176		$	17,302		$	2,874		17	%	$	43,991		$	36,411		$	7,580	21	%

Gross margin %		95	%		95	%							95	%		95	%

Technology licensing : The increase in overall gross margin, in terms of absolute dollars, from the three months ended June 30, 2007 to the three months ended June 30, 2008, and from the six months ended June 30, 2007 to the six months ended June 30, 2008, was due primarily to increased royalties from technology licensing to consumer hardware device manufacturers without a corresponding increase in royalty expenses due to our licensors.

Advertising and third-party product distribution : Our cost of advertising and product distribution revenue has remained relatively consistent as a percentage of revenue because the cost of bandwidth associated with product downloads is directly proportional to the volume of downloads.

Content distribution and related services : Our content distribution and related services gross margin has continued to decrease from the three months ended June 30, 2007 to the three months ended June 30, 2008 primarily due to the closure of Stage6, during the three months ended March 31, 2008 resulting in a decrease in Internet connectivity costs. During the six months ended June 30, 2007, revenue from content distribution did not cover costs and related services gross margins were negative due to the high relative fixed cost base which exceeded our content distribution and related services revenue.

Operating expenses

The following table summarizes and analyzes our operating expenses for the three and six months ended June 30, 2008 and 2007 (in thousands):


	Three months ended June 30,						Change					Six months ended June 30,						Change
	2008			2007			$			%		2008			2007			$		%
Operating expenses:
Selling, general and administrative	$	12,573		$	13,007		$	(434	)	(3	)%	$	28,550		$	23,803		$	4,747	20	%
% of total net revenues		59	%		71	%							62	%		62	%
Product development		5,366			4,636			730		16	%		10,791			8,792			1,999	23	%
% of total net revenues		25	%		25	%							23	%		23	%
Impairment of acquired intangibles		250			—			250		100	%		1,250			—			1,250	100	%
% of total net revenues		1	%		0	%							3	%		0	%

Total operating expenses	$	18,189		$	17,643		$	546		3	%	$	40,591		$	32,595		$	7,996	25	%

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Selling, general and administrative : The $434,000, or 3%, decrease in selling, general and administrative expenses from the three months ended June 30, 2007 to the three months ended June 30, 2008 was primarily due to a $1.5 million decrease in Internet connectivity related costs, a $350,000 decrease in patent royalty expenses, and a $300,000 decrease in marketing expenses, all primarily associated with Stage 6, which was closed on February 28, 2008, offset by a $300,000 increase in depreciation expense. In addition, the decreases were offset by approximately $1.6 million of expenses recorded in the three months ended June 30, 2008 that are associated with MainConcept, which was acquired during the fourth quarter of 2007. MainConcept costs primarily include salary and commission expenses, marketing and promotion costs, and amortization of intangibles.

The $4.7 million, or 20%, increase in selling, general and administrative expenses from the six months ended June 30, 2007 to the six months ended June 30, 2008 primarily included: (1) a $1.3 million increase in share-based compensation expense; (2) a $750,000 increase in Internet connectivity related costs primarily associated with Stage6, which was closed on February 28, 2008, resulting in additional connectivity related costs paid to third parties during the first quarter of 2008; (3) an increase of approximately $500,000 for office and equipment rental and utilities; and (4) an increase of $400,000 for travel costs. In addition, the increase includes an approximately $3.3 million of expenses associated with our acquisition of MainConcept which was acquired during the fourth quarter of 2007. MainConcept costs primarily include salary and commission expenses, marketing and promotion costs, and amortization of intangibles. These increases were offset by a reduction of $1.0 million in accrued patent royalty costs after entering a new contract, and an additional reduction of $400,000 in bandwidth related costs resulted from the closure of Stage6.

Product development : The $730,000, or 16%, increase in product development expense from the three months ended June 30, 2007 to the three months ended June 30, 2008 was principally due to an increase of $900,000 associated with our acquisition of MainConcept, which was acquired during the fourth quarter of 2007, offset by a $200,000 decrease in depreciation and amortization expenses. MainConcept costs primarily include salary and commission expenses and outside services costs.

The $2.0 million, or 23%, increase in product development expense from the six months ended June 30, 2007 to the six months ended June 30, 2008 was principally due to an increase of $1.7 million associated with MainConcept, which was acquired during the fourth quarter of 2007, and a $500,000 increase in compensation and benefit expenses, offset by a decrease of approximately $300,000 in depreciation and amortization expenses. Costs associated with MainConcept were comprised primarily of salary and benefits, share-based compensation and recruiting costs. The increase in payroll and benefit expenses is partially attributable to increases in salaries, increased severance payments for terminated employees, increases in share-based compensation expenses, and foreign payroll tax increases.

Impairment of acquired intangibles : In the six months ended June 30, 2008 we recorded an impairment charge of $1.3 million related to the patented technology license intangible asset acquired in connection with our acquisition of Veatros in July 2007, $250,000 of which was recorded during the three months ended June 30, 2008. As more fully discussed in Note 9 in the accompanying notes to the consolidated financial statements, management performed an impairment analysis of the assets in accordance with SFAS No. 144, and concluded that the asset was not fully recoverable and impairment losses were recognized in the first and second quarter of 2008.

Interest income (expense), net : Net interest income decreased from $2.0 million for the three months ended June 30, 2007 to $1.1 million for the three months ended June 30, 2008 and from $3.9 million for the six months ended June 30, 2007 to $2.8 million for the six months ended June 30, 2008, due to lower average cash balances in 2008, which primarily resulted from cash used to acquire MainConcept in November 2007 and cash used to purchase shares of our common stock, as well as lower interest rates compared to the same periods in the prior year.

Other income (expense), net : We recorded other expenses totaling approximately $15,000 for the three months ended June 30, 2008 as compared to other income of $5,000 for the same period in 2007. We recorded other income totaling $502,000 for the six months ended June 30, 2008 as compared to other expense of $1,000 for the same period in 2007. The fluctuations in other income (expenses) were primarily due to foreign exchange gains on our Euro-based intercompany receivable balance which resulted from our acquisition of MainConcept.

Income tax provision : We recorded a provision for income taxes of $1.4 million for the three months ended June 30, 2008, based upon a 45.6% effective tax rate, compared to $680,000 for the three months ended June 30, 2007, based on a 40.4% effective tax rate. For the six months ended June 30, 2008, we recorded a provision for income taxes of $2.5 million, based on a 37.7% effective tax

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rate, compared to $3.1 million for the six months ended June 30, 2007, based upon a 39.8% effective tax rate. The difference between the Company’s effective tax rate and the 35% U.S. federal statutory rate for the three and six month period ended June 30 2008 was primarily due to state income taxes, and permanent differences, partially offset by research and development credits. The effective tax rate for the three and six months ended June 30, 2007 differs from the U.S. federal statutory rate of 35% primarily due to state income taxes and permanent differences, partially offset by research and development credits.

Effective May 12, 2008, we made certain U.S. tax elections to treat the Company’s wholly-owned subsidiary, MainConcept GmbH (“MainConcept”) as a disregarded entity for U.S. income tax purposes. This has the effect of having the income or loss of this foreign subsidiary taxed in the United States as if it were a branch. Further, the U.S. tax elections created tax deductible intangible assets and goodwill. As a result, we will receive U.S. tax benefits for the amortization of the purchased intangible assets and tax deductible goodwill, which did not previously exist for U.S. federal income tax purposes. The elections resulted in the recognition of a U.S. deferred tax asset of approximately $2.1 million relating to these future U.S. tax benefits. This deferred tax asset was recorded as a reduction to goodwill during the second quarter of 2008 as part of the finalization of the purchase price allocation during the second quarter of 2008.

We also recorded a tax benefit of approximately $300,000 related to the release of the valuation allowance on certain deferred tax assets recorded on the books of our wholly-owned subsidiary, MainConcept, during the first quarter of 2008.

The effective tax rate for the six months ended June 30, 2008 is based upon our estimated fiscal 2008 income before income taxes. To the extent the estimate of fiscal 2008 income before income taxes changes, our income tax provision will change as well. The effective tax rate for 2008 is expected to be approximately 43%, excluding discrete items.

Liquidity and capital resources

The following table presents data regarding our liquidity and capital resources (in thousands):


	June 30, 2008		December 31, 2007
Cash, cash equivalents and investments	$	117,992	$	141,035
Working capital		106,807		138,410
Total assets		185,803		200,888
Total debt		67		153

Share Repurchase Program

In March 2008, our Board of Directors approved a share repurchase program, authorizing us to repurchase up to $20.0 million worth of our common stock. During the six months ended June 30, 2008, we completed our share repurchase program with the purchases of approximately 2.8 million shares of our common stock for a total purchase price of approximately $20.0 million. Purchases under this program were made through a 10b5-1 program, and open market purchases.

Cash Flows (in thousands):


	Six Months Ended June 30,
	2008			2007
Net cash provided by operating activities	$	1,392		$	7,593
Net cash provided by (used in) investing activities		32,188			(67,678	)
Net cash (used in) provided by financing activities		(19,382	)		1,097
Effect of exchange rate changes on cash		55			—

Net increase (decrease) in cash and cash equivalents		14,253			(58,988	)
Cash and cash equivalents at beginning of period		14,532			86,310

Cash and cash equivalents at end of period	$	28,785		$	27,322

Cash provided by operating activities : The $1.4 million of cash provided by operating activities for the six months ended June 30, 2008 was primarily the result of net income of $4.2 million, non-cash share-based compensation expenses of $4.4 million and non-cash depreciation and amortization expenses of $2.3 million reflected in net income, offset by a $5.2 million increase in accounts receivable, a $2.7 million increase in deferred tax, and changes in other working capital accounts, primarily decreases in accounts payable and accrued liabilities.

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The $7.6 million of cash provided by operating activities for the six months ended June 30, 2007 was primarily due to net income of $4.7 million, depreciation and amortization of $1.1 million, share-based compensation of $3.0 million, and changes in other working capital accounts, primarily increases in accrued liabilities and accrued compensation and benefits and a decrease in income taxes payable.

Cash provided by (used in) investing activities: The $32.2 million of cash provided by investing activities for the six months ended June 30, 2008 was primarily due to $105.8 million in proceeds from sales and maturities of investments offset by $69.4 million in purchases of investments, $1.8 million of cash paid for our acquisition of all of the assets of Veatros L.L.C., or Veatros, $1.3 million in purchases of property and equipment, and $1.2 million of milestone payments made for the MainConcept acquisition.

The $67.7 million of cash used in investing activities for the six months ended June 30, 2007 was primarily for net short-term investments of $62.9 million, a $3.5 million investment in Veatros and $1.6 million for the purchase of property and equipment, primarily computer hardware and software.

Cash (used in) provided by financing activities : The $19.4 million net cash used in financing activities for the six months ended June 30, 2008 was primarily due to $20.0 million used in the repurchase of our common stock offset by approximately $700,000 in proceeds from the exercise of stock options and shares issued under the employee stock purchase plan.

The $1.1 million of net cash provided by financing activities for the six months ended June 30, 2007 was primarily due to the net proceeds from the sale of $1.5 million of our common stock, principally due to the exercise of stock options and employee stock purchase plan participation, partially offset by the payment of $467,000 of costs related to our initial public offering and $266,000 of payments on our debt obligations.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. We are exposed to market risk primarily in the area of changes in United States interest rates and foreign currency exchange rates as measured against the U.S. dollar. These exposures are directly related to our normal operating and funding activities. We have not used derivative financial or commodity instruments or engaged in hedging activities.

Interest Rate Risk

All of our fixed income investments are classified as available-for-sale and are therefore reported on the balance sheet at market value. The fair values of our cash equivalents and investments are subject to change as a result of changes in market interest rates and investment risk related to the issuers’ credit worthiness. To minimize these risks, we maintain an investment portfolio of various holdings, types and maturities. We have established guidelines relative to diversification and maturities that attempt to maintain safety and liquidity. These guidelines are periodically reviewed and modified, if necessary. We do not utilize financial contracts to manage our exposure in our investment portfolio to changes in interest rates. At June 30, 2008, we had $118.0 million in cash, cash equivalents and investments, all of which are stated at fair value. Changes in market interest rates would not be expected to have a material impact on the fair value of $28.8 million of our cash and cash equivalents at June 30, 2008, as these consisted of securities with maturities of less than three months. A 100 basis point increase or decrease in interest rates over a three month period would, however, decrease or increase, respectively, the remaining $89.2 million of our investments by approximately $900,000. While changes in interest rates may affect the fair value of our investment portfolio, any gains or losses will not be recognized in our consolidated statements of income until the investment is sold or if the reduction in fair value was determined to be other than temporary.

Our long-term capital lease obligations bear interest at fixed rates and therefore we do not have significant market risk exposure with respect to these obligations.

Foreign Currency Exchange Rate Risk

Our wholly-owned subsidiary, MainConcept, incurs costs which are denominated in local currencies. As exchange rates vary, these results when translated into U.S. dollars may vary from expectations and may adversely impact overall expected results.

Additionally, at June 30, 2008, we had a receivable balance denominated in Euros due from MainConcept. Our outstanding receivable balance is translated into U.S. dollars for financial reporting purposes, with unrealized gains and losses included as a component of other income and expense. A 100 basis point increase or decrease in foreign currency exchange rates over a three month period from those in effect at June 30, 2008 would not materially impact our financial position, results of operations and cash flows. During the six months ended June 30, 2008, we recorded approximately $500,000 of foreign currency gains related to our foreign currency receivable denominated in Euros in other income on our consolidated statements of income.

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Evaluation of Disclosure Controls and Procedures: We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by Securities and Exchange Commission Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting. There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1.

Legal Proceedings

On October 22, 2007, following the filing of our declaratory relief action which was subsequently dismissed, Universal Music Group, Inc. (“UMG”) filed a lawsuit against us in the Central District of California. UMG’s suit alleges copyright infringement and seeks monetary damages related to our operation of the Stage6 online video community service, which we shut down on February 28, 2008. We believe we have meritorious defenses to UMG’s claims and will assert them vigorously. Still, litigation is inherently uncertain and there can be no guarantee that we will prevail or that the litigation will not have material adverse consequences for us; an unfavorable resolution of these proceedings could materially affect our future operating results or financial conditions in particular periods.

We are also involved in various legal proceedings from time to time arising from the normal course of business activities, including commercial, employment and other matters. In our opinion, resolution of these proceedings is not expected to have a material adverse effect on our operating results or financial condition. However, it is possible that an unfavorable resolution of one or more such proceedings could materially affect our future operating results or financial condition in a particular period.

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 Quarterly Report on Form 10-Q. We believe the risks described below are the risks that are material to us as of the date of this Quarterly Report on Form 10-Q. 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.

The risk factors set forth below with an asterisk (*) next to the title are new risk factors or risk factors containing changes, including any material changes, from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007, as filed with the Securities and Exchange Commission.

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

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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:

•

DVD players;

•

DVD recorders;

•

network connected DVD players;

•

high definition DVD players;

•

portable media players;

•

digital still cameras;

•

digital camcorders;

•

mobile handsets;

•

digital media software applications;

•

smart TVs;

•

home media centers;

•

set-top boxes; and

•

video game consoles.

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, 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.

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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- 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 53% of our total net revenues during the six months ended June 30, 2008, 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 77% and 80% of our total net revenues from licensing our technology in the six months ended June 30, 2008 and 2007, respectively. One or a small number of our licensees generally represents a significant percentage of our technology licensing revenues. For example, in the six months ended June 30, 2008, Philips accounted for approximately 10% of our total net revenues, and our top 10 licensees by revenue accounted for approximately 53% 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.

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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 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 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.

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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 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 the six months ended June 30, 2008 and for the fiscal years 2007 and 2006, our net revenue outside North America comprised 73%, 74% and 76%, 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.

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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.

We face risks with respect to conducting business in China due to China’s 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 China’s 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 six months ended June 30, 2008 and for the years 2007 and 2006, we derived approximately 65%, 70% and 72%, respectively, of our total net revenues from technology licensing to consumer hardware device

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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 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.

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.

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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 June 30, 2008 we had over 340 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.

In February 2008 Chris Russell resigned as our Chief Technology Officer and we appointed Markus Moenig as our new Chief Technology Officer. In April 2008, Pam Johnston resigned as our Senior Vice President for Sales and Marketing, and in July 2008, we appointed Eric Rodli as our Executive Vice President for Sales and Marketing. We may experience disruptions in our operations as a result of these changes and as 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.

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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 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 Children’s 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 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

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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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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 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 management’s 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 MainConcept’s 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 MainConcept’s 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 MainConcept’s 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 MainConcept’s 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.

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 integration of MainConcept’s 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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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 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.

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

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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 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 UMG, who also asserted claims of copyright infringement against us arising from the operation of Stage6, our online video community service, which we shut down on February 28, 2008. Currently, we are involved in litigation with UMG in the Central District of California, in which UMG has alleged copyright infringement and has sought monetary damages. 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 party’s 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 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:

•

our applications for trademarks or patents may not be granted and, if granted, may be challenged or invalidated;

•

issued patents, copyrights and trademarks may not provide us with any competitive advantages;

•

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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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.

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 us 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 us to additional liability.

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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:

•

announcements of new products, services or technologies, commercial relationships or other events by us or our competitors;

•

regulatory developments in the United States and foreign countries;

•

fluctuations in stock market prices and trading volumes of similar companies;

•

variations in our quarterly operating results;

•

changes in securities analysts’ estimates of our financial performance;

•

changes in accounting principles;

•

sales of large blocks of our common stock, including sales by our executive officers, directors and significant stockholders;

•

additions or departures of key personnel; and

•

discussion of us or our stock price by the financial press and in online investor communities.

*Shares of our common stock are relatively illiquid.

As of July 31, 2008, we had 32,194,941 shares of common stock outstanding, excluding 48,913 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. In addition, in March 2008, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $20.0 million worth of our outstanding common stock. During the six months ended June 30, 2008, we purchased approximately 2.8 million shares of our common stock for a total purchase price of approximately $20.0 million. As of June 30, 2008, the share repurchase program was complete. These repurchases, as well as any future repurchases of our common stock, reduce our public float and may cause our common stock to become less liquid. A reduction in the liquidity of our common stock, as a result of the recent share repurchase or otherwise, could have a greater impact on the trading price for our shares than would be the case if our public float were larger.

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.

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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 registered public accounting firm periodically test our internal controls in connection with the Section 404 requirements and could, as part of that documentation 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 integration of MainConcept, we identified several control deficiencies. Specifically, there were deficiencies in revenue recognition and the availability of a sufficiently trained workforce in the accounting organization. In connection with their audit for the year ended December 31, 2007, Ernst & Young LLP, our independent registered public accounting firm, also identified control deficiencies in the revenue recognition and financial statement close processes at MainConcept. 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 quarterly 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 MainConcept’s controls, including the operating effectiveness of the newly implemented measures and plan to take further action as appropriate. If we fail to identify, assess and remedy these and any other control deficiencies, our operating costs could increase and our ability to operate our business could be materially impaired.

*Future sales of our common stock may cause our stock price to decline.

As of July 31, 2008, there were 32,194,941 shares of our common stock outstanding, excluding 48,913 shares subject to repurchase. Substantially all of these shares are eligible for sale in the public market, although as of July 31, 2008, 4,364,561 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 July 31, 2008 we had outstanding warrants to purchase up to 225,000 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 warrant holders of a substantial number of shares could significantly reduce the market price of our common stock. Moreover, the holders of 3,198,170 shares of common stock at July 31, 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 July 31, 2008, an aggregate of approximately 7,121,208 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.

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Pursuant to the terms of our 2000 Plan, options may typically be exercised prior to vesting. We have the right to repurchase unvested shares from our employees and consultants upon their termination, and it is generally our policy to do so. The following table provides information with respect to purchases made by us of unvested shares of our common stock upon the termination of service of former employees and consultants during the three month period ended June 30, 2008:


Period	Total Number of Shares Purchased (1)	Average Price Paid per Share		Total Value Paid by Company
April 1, 2008 through April 30, 2008 (1)	902	$	0.93	$	842
May 1, 2008 through May 31, 2008	—		—		—
June 1, 2008 through June 30, 2008	—		—		—

(1)

All shares were originally purchased from us by employees and consultants pursuant to exercises of unvested stock options. During the months listed above, we routinely repurchased the shares from our employees and consultants upon their termination of employment pursuant to our right to repurchase unvested shares at the original exercise price under the terms of our 2000 Plan and the related stock option agreements.

On March 4, 2008, we announced that our Board of Directors approved a share repurchase program authorizing us to repurchase up to $20.0 million of our common stock. The following table provides information with respect to purchases made by the Company of its common stock pursuant to the share repurchase program during the three-month period ended June 30, 2008:


Period	Total Number of Shares Purchased (1)	Average Price Paid per Share		Total Value Paid by Company		Maximum Dollar Value of Shares that May Yet Be Purchased Under the Share Repurchase Program
April 1, 2008 through April 30, 2008 (1)	1,082,842	$	6.88	$	7,435,514	$	2,642,717
May 1, 2008 through May 31, 2008 (1)	279,000	$	9.43	$	2,636,543	$	—
June 1, 2008 through June 30, 2008	—		—		—	$	—

(1)

Purchases under this repurchase program were authorized to be made from time to time through 10b5-1 programs, open market purchases, or privately negotiated transactions. 279,000 of the shares listed in the table were purchased in an open market transaction at prices ranging from $9.08 to $9.80 per share and the remaining purchases were made pursuant to a 10b5-1 program. As of June 30, 2008, the share repurchase program was complete.

Use of Proceeds

Our initial public offering of common stock was effected through a Registration Statement on Form S-1 (File No. 333-133855) that was declared effective by the SEC on September 21, 2006. The Registration Statement covered the offer and sale by us of 7,461,538 shares of our common stock, which we sold to the public on September 27, 2006 at a price of $16.00 per share. Our initial public offering resulted in aggregate proceeds to us of approximately $108.2 million net of underwriting discounts and commissions of approximately $8.4 million and offering expenses of approximately $2.8 million.

During the three-month period ended June 30, 2008, we used $10.1 million of the proceeds from our initial public offering in connection with the repurchase of approximately 1.4 million shares of our common stock in the open market. The remaining $62.8 million of proceeds from our initial public offering are invested in auction rate securities, government agency and corporate debt securities and money market funds.

Item 4.

Submission of Matters to a Vote of Security Holders

We held our 2008 Annual Meeting of Stockholders, or the Annual Meeting, on June 4, 2008. At the Annual Meeting, our stockholders:

1.

Elected three Class II directors to hold office until the 2011 Annual Meeting of Stockholders or until their successors are duly elected and qualified; and

2.

Ratified the appointment of Ernst & Young LLP to serve as our independent registered public accounting firm for our fiscal year ending December 31, 2008.

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	For	Against/ Withheld	Abstentions	Broker non-votes
1.a. Election of Frank Creer	19,404,351	3,955,544	Not applicable	—
1.b. Election of Kevin C. Hell	19,955,296	3,404,599	Not applicable	—
1.c. Election of Jérôme J-P. Vashisht-Rota	19,689,630	3,670,265	Not applicable	—
2. Ratification of Appointment of Ernst & Young LLP as our Registered Independent Public Accountants	22,903,499	270,239	186,157	—

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Exhibit Number		Description of Document

3.1(1)		Form of Amended and Restated Certificate of Incorporation as currently in effect.

3.2(2)		Form of Amended and Restated Bylaws as currently in effect.

4.1(1)		Form of Common Stock Certificate.

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32		Certifications of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1)	Incorporated by reference to the exhibit of the same number to the Company’s Registration Statement on Form S-1 (No. 333-133855), originally filed with the SEC on May 5, 2006.

(2)	Filed as an exhibit to the Company’s Current report on Form 8-K filed with the SEC on December 20, 2007.

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Delaware		33-0921758
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification Number)


Supplemental disclosure of non-cash investing and financing activities
Issuance of warrants in connection with format approval agreement	$	87		—
Supplemental disclosure:
Cash paid for income taxes	$	4,871	$	4,871

Cash paid for interest	$	3	$	12


	DIVX, INC.

Dated: August 8, 2008	By:	/s/ Kevin Hell
		Kevin Hell
		Chief Executive Officer

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