DIVX INC - FORM 10-Q - August 6, 2010

DIVX INC - FORM 10-Q - August 6, 2010

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DIVX INC Reports

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EX-32 - CERTIFICATION OF CEO AND CFO - SECTION 906 - DIVX INC	dex32.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - SECTION 302 - DIVX INC	dex311.htm
EX-10.2 - OFFER LETTER - DIVX INC	dex102.htm
EX-10.1 - AMENDMENT NUMBER 1 TO PROMOTION AND DISTRIBUTION AGREEMENT - DIVX INC	dex101.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - SECTION 302 - DIVX INC	dex312.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File Number 001-33029

DivX, Inc.

(Exact name of Registrant as specified in its Charter)


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

4780 Eastgate Mall

San Diego, California 92121

(Address of Principal Executive Offices, including Zip Code)

(858) 882-0600

(Registrant’s Telephone Number, Including Area Code)

N/A

(Former name, former address and former fiscal year if changed since last report)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).

Yes ¨ 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 30, 2010 was 33,209,929.

DIVX, INC.

QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED JUNE 30, 2010

TABLE OF CONTENTS


		Page No.
PART I.	FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements (unaudited):	3
	Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009	3
	Consolidated Statements of Operations for the three and six months ended June 30, 2010 and 2009	4
	Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009	5
	Notes to Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	24
Item 4.	Controls and Procedures	25

PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	26
Item 1A.	Risk Factors	26
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45
Item 6.	Exhibits	46

SIGNATURE		47

PART I — FINANCIAL INFORMATION

Item 1.

Consolidated Financial Statements

DIVX, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)


	June 30, 2010			December 31, 2009
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	29,355		$	14,833
Short-term investments		113,892			125,047
Accounts receivable, net of allowance of $273 and $258 at June 30, 2010 and December 31, 2009, respectively		3,199			2,521
Income tax receivable		2,850			1,011
Prepaid expenses		5,526			3,690
Deferred tax assets, current		1,025			1,025
Other current assets		1,250			1,379

Total current assets		157,097			149,556
Property and equipment, net		1,705			2,143
Long-term investments		3,019			3,779
Deferred tax assets, long-term		13,014			13,178
Purchased intangible assets, net		11,394			13,340
Goodwill		17,153			18,528
Other assets		6,457			7,074

Total assets	$	209,839		$	207,598

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	1,324		$	1,853
Accrued liabilities		2,132			1,654
Accrued compensation and benefits		4,831			2,705
Accrued format approval fee		691			820
Accrued patent royalties		723			725
Acquisition related contingent liabilities		1,483			1,976
Income taxes payable		437			519
Deferred revenue, current		4,600			5,350

Total current liabilities		16,221			15,602
Deferred tax liability		1,704			1,995
Deferred revenue, long-term		911			861
Accrued format approval fee, long-term		736			713
Acquisition related contingent liabilities, long-term		2,105			2,659
Other long-term liabilities		569			593

Total liabilities		22,246			22,423
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.001 par value, 10,000 shares authorized at June 30, 2010 and December 31, 2009; no shares issued and outstanding at June 30, 2010 and December 31, 2009		—			—
Common stock, $0.001 par value, 200,000 shares authorized at June 30, 2010 and December 31, 2009; 33,203 and 32,819 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively		33			32
Additional paid-in capital		184,910			178,319
Accumulated other comprehensive loss		(3,250	)		(641	)
Retained earnings		5,900			7,465

Total stockholders’ equity		187,593			185,175

Total liabilities and stockholders’ equity	$	209,839		$	207,598

See accompanying notes.

DIVX, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2010			2009			2010			2009
Net revenues:
Technology licensing	$	16,877		$	13,725		$	37,818		$	32,331
Media and other distribution and services		2,688			1,509			5,002			1,580

Total net revenues		19,565			15,234			42,820			33,911
Cost of revenues:
Cost of technology licensing (excludes amortization of purchased developed intangibles)		2,283			2,165			4,501			4,576
Cost of media and other distribution and services		115			136			237			312

Total cost of revenues		2,398			2,301			4,738			4,888

Gross profit		17,167			12,933			38,082			29,023
Operating expenses:
Selling, general and administrative(1)		14,122			11,875			26,887			24,584
Product development(1)		6,868			4,633			13,519			9,334

Total operating expenses		20,990			16,508			40,406			33,918

Loss from operations		(3,823	)		(3,575	)		(2,324	)		(4,895	)
Interest income (expense), net		385			432			786			1,026
Other income (expense), net		71			529			(42	)		139

Loss before income taxes		(3,367	)		(2,614	)		(1,580	)		(3,730	)
Income tax provision (benefit)		(546	)		(255	)		(15	)		61

Net Loss	$	(2,821	)	$	(2,359	)	$	(1,565	)	$	(3,791	)

Net loss per share:
Basic	$	(0.09	)	$	(0.07	)	$	(0.05	)	$	(0.12	)

Diluted	$	(0.09	)	$	(0.07	)	$	(0.05	)	$	(0.12	)

Shares used to compute basic net loss per share		33,010			32,589			32,924			32,532

Shares used to compute diluted net loss per share		33,010			32,589			32,924			32,532

(1) Includes share-based compensation as follows:

Selling, general and administrative	$	2,081		$	1,831		$	3,872		$	3,713
Product development		601			524			1,210			841

See accompanying notes.

DIVX, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)


	Six months ended June 30,
	2010			2009
	(unaudited)
Cash flows from operating activities:
Net loss	$	(1,565	)	$	(3,791	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		2,911			3,005
Gain realized on equity interest relating to purchase of MainConcept–Japan		(213	)		—
Accretion of interest expense		44			87
Deferred taxes		111			223
Change in acquisition related contingent consideration liability		378			—
Net recoveries from uncollectible account receivables		(39	)		(272	)
Share-based compensation		5,082			4,554
Accretion of discounts and amortization of premiums on investments		878			341
Excess tax benefit from exercises of stock options		—			(448	)
Realized gain on auction rate securities		—			(141	)
Foreign currency transaction loss		302			26
Changes in operating assets and liabilities:
Accounts receivable		(695	)		5,889
Income taxes payable (receivable)		(1,921	)		(1,918	)
Prepaid expenses and other assets		(1,854	)		(1,844	)
Accounts payable		214			(352	)
Accrued liabilities		767			(283	)
Accrued compensation and benefits		1,669			(760	)
Deferred revenue		(296	)		(523	)
Deferred rent		(11	)		257

Net cash provided by operating activities		5,762			4,050
Cash flows from investing activities:
Purchase of investments		(56,315	)		(78,613	)
Proceeds from sales and maturities of investments		67,012			53,803
Purchase of property and equipment		(442	)		(258	)
Cash paid on format approval agreement obligation		(1,200	)		(200	)
Cash paid in MainConcept – Japan acquisition, net of cash acquired		(228	)		—
Cash paid in AnySource acquisition		(1,425	)		—
Cash paid in MainConcept acquisition		—			(97	)

Net cash provided by (used in) investing activities		7,402			(25,365	)
Cash flows from financing activities:
Proceeds from exercise of stock options		937			22
Proceeds from shares issued under the employee stock purchase plan		573			503
Excess tax benefit from exercises of stock options		—			448
Repurchase of unvested stock		(2	)		(13	)

Net cash provided by financing activities		1,508			960
Effect of exchange rate changes on cash		(200	)		119

Net increase (decrease) in cash and cash equivalents		14,472			(20,236	)
Cash and cash equivalents at beginning of period		14,883			43,442

Cash and cash equivalents at end of period	$	29,355		$	23,206

Supplemental disclosure of non-cash investing activities:
Format approval agreement obligation	$	300		$	—

Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	2,481		$	1,769

See accompanying notes.

DIVX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1—Background and Basis of Presentation

Basis of Presentation

The accompanying consolidated balance sheet as of June 30, 2010, the consolidated statements of operations for the three and six months ended June 30, 2010 and 2009 and the consolidated statements of cash flows for the six months ended June 30, 2010 and 2009 are unaudited. The unaudited consolidated balance sheet as of June 30, 2010 is presented with amounts derived from the audited consolidated balance sheet as of December 31, 2009. 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, 2009, 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. 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, 2010 are not necessarily indicative of the results to be expected for the year as a whole.

Proposed Merger

On June 1, 2010, the Company entered into an Agreement and Plan of Merger, or Merger Agreement, with Sonic Solutions, or Sonic, a Novato, California-based company that develops products and services that enable the creation, management, and enjoyment of digital media across a wide variety of technology platforms. Pursuant to the Merger Agreement, the Company will merge with Siracusa Merger Corporation, a newly formed, wholly owned subsidiary of Sonic, and DivX, Inc. will become a wholly owned subsidiary of Sonic (First Merger). Immediately thereafter, DivX, Inc. will merge with Siracusa Merger LLC, another newly formed, wholly owned subsidiary of Sonic, with Siracusa Merger LLC surviving the merger and immediately changing its name to DivX LLC (Second Merger) (the First Merger and the Second Merger are together referred to as the Proposed Merger). After the Second Merger, the separate corporate existence of DivX, Inc. will cease.

In the Proposed Merger, the Company’s stockholders will receive the merger consideration of 0.514 shares of Sonic common stock and $3.75 in cash for each share of DivX common stock that they own. Sonic shareholders will continue to own their existing shares of Sonic common stock, which will not be affected by the merger. After the close of the merger, current Sonic and DivX, Inc. stockholders are expected to own approximately 65% and 35%, respectively, of Sonic’s outstanding shares. The Proposed Merger is subject to customary closing conditions, and shareholder and regulatory approvals. The Merger Agreement contains customary representations and warranties and pre-closing covenants. It contains termination provisions for each of Sonic and the Company, and provides that in certain specified circumstances, the Company must pay Sonic a termination fee of $8.35 million.

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.

Recent Accounting Pronouncements

With the exception of those stated below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the six months ended June 30, 2010, as compared to the recent accounting pronouncements described in the Annual Report that are of material significance, or have potential material significance, to the Company.

Effective January 1, 2010, the Company adopted the updated guidance related to fair value measurements and disclosures issued by the Financial Accounting Standards Board (FASB), which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. In addition, in the reconciliation for fair value measurements using significant unobservable inputs, or Level 3, a reporting entity should disclose separately information about purchases, sales, issuances and settlements (that is, on a gross basis rather than one net number). The updated guidance also requires that an entity should provide fair value measurement disclosures for each class of assets and liabilities and disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring fair value measurements for Level 2 and Level 3 fair value measurements. The guidance is effective for interim or annual financial reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. Therefore, the Company has not yet adopted the guidance with respect to the roll

forward activity in Level 3 fair value measurements. The Company has updated its disclosures to comply with the updated guidance. However, adoption of the updated guidance did not have an impact on the Company’s consolidated financial condition, results of operations or cash flows.

Effective January 1, 2010, the Company adopted the FASB’s updated guidance for determining whether to consolidate a variable interest entity issued in June 2009. These updated standards amend the evaluation criteria to identify the primary beneficiary of a variable interest entity, or VIE, by replacing the previous quantitative-based analysis with a framework that is based more on qualitative judgments. The new guidance requires the primary beneficiary of a VIE to be identified as the party that both (i) has the power to direct the activities of a VIE that most significantly impact its economic performance and (ii) has an obligation to absorb losses or a right to receive benefits that could potentially be significant to the VIE. The adoption of the updated guidance did not have an impact on the Company’s consolidated financial condition, results of operations or cash flows.

Note 2—Earnings Per Share

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 using the treasury stock method. 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, 2010 and 2009 (in thousands, except per share amounts):


	Three Months Ended June 30,						Six Months Ended June 30,
	2010			2009			2010			2009
Numerator:
Net loss	$	(2,821	)	$	(2,359	)	$	(1,565	)	$	(3,791	)

Denominator:
Weighted average common shares outstanding (basic)		33,010			32,589			32,924			32,532

Weighted average shares of common stock outstanding (diluted)		33,010			32,589			32,924			32,532

Basic loss per share	$	(0.09	)	$	(0.07	)	$	(0.05	)	$	(0.12	)

Diluted loss per share	$	(0.09	)	$	(0.07	)	$	(0.05	)	$	(0.12	)

Potentially dilutive securities, which are not included in the calculation of diluted net loss 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,
	2010	2009	2010	2009
Options to purchase common stock	5,413	5,596	6,696	5,350
Restricted stock awards	340	258	302	269
Common stock warrants	395	545	395	545

Total	6,418	6,399	7,393	6,164

Note 3— Investments and Fair Value Measurements

Investments

The following table summarizes investments by security type as of June 30, 2010 and December 31, 2009 (in thousands):


	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses	Estimated Fair Value
June 30, 2010
Trading securities:
Auction rate securities and put option				$	5,450


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Available-for-sale securities:
Commercial paper	$	2,000	$	—	$	—			2,000
Certificates of deposit		5,350		—		—			5,350
Corporate bonds		63,598		60		(376	)		63,282
Municipal bonds		1,000		1		—			1,001
U.S. government agency notes		36,791		22		(4	)		36,809

Total short-term investments		108,739		83		(380	)		113,892

Auction rate securities - long-term investments		3,300		—		(281	)		3,019

Total investments	$	112,039	$	83	$	(661	)	$	116,911


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
December 31, 2009
Trading securities:
Auction rate securities and put option								$	14,250
Available-for-sale securities:
Commercial paper	$	4,995	$	—	$	—			4,995
Certificates of deposit		4,153		—		—			4,153
Corporate bonds		51,156		130		(41	)		51,245
Municipal bonds		2,005		3		—			2,008
U.S. government agency notes		48,384		31		(19	)		48,396

Total short-term investments		110,693		164		(60	)		125,047

Auction rate securities - long-term investments		4,120		—		(341	)		3,779

Total investments	$	114,813	$	164	$	(401	)	$	128,826

The following table summarizes the contractual maturities of the Company’s investments as of June 30, 2010 (in thousands):


Less than one year	$	90,583
Due in one to five years		23,309
Due after five years		3,019

	$	116,911

Realized gains and losses on investments are included in interest income (expense), net, in the accompanying consolidated statements of operations. During the three and six months ended June 30, 2010, the Company recorded realized gains of $10,000 and $12,000, respectively, on the sale of investments. During the three and six months ended June 30, 2009, the Company recorded realized gains of $14,000 and $28,000, respectively, on the sale of investments. As of June 30, 2010 and December 31, 2009, unrealized losses of $341,000 and $187,000, respectively, were included in accumulated other comprehensive loss in the accompanying consolidated balance sheets.

The Company’s short-term investments consist primarily of commercial paper, certificates of deposit, corporate bonds, U.S. government agency notes, and auction rate securities, or ARS, which are long-term variable rate bonds tied to short-term interest rates. The Company’s long-term investments consist of ARS.

At June 30, 2010, the Company’s holdings of ARS aggregated approximately $8.5 million in fair value (including related put option), $5.5 million of which were included in short-term investments and the remaining $3.0 million included in long-term investments in the consolidated balance sheets. After the initial issuance of the ARS, the interest rate on the underlying 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. In February 2008, auctions began to fail for these securities and each auction since then has failed. As of June 30, 2010, the Company held $8.8 million par value ARS. The underlying assets of the securities consisted of student loans and municipal bonds, all of which were guaranteed by the U.S. government. All of these ARS had credit ratings of AAA by a rating agency. These ARS have contractual maturity dates ranging from 2034 to 2047. The Company is receiving the underlying cash flows on all of its ARS. The principal associated with failed auctions is not expected to be accessible until a successful auction occurs, the issuer redeems the securities, a buyer is found outside of the auction process or the underlying securities mature.

In November 2008, the Company accepted an offer (the Right) from UBS AG (UBS), entitling it to sell at par value ARS originally purchased from UBS at any time during a two-year period from June 30, 2010 through July 2, 2012. In accepting the Right, the Company granted UBS the authority to sell or auction the ARS at par at any time up until the expiration date of the offer and released UBS from any claims relating to the marketing and sale of ARS. During the three and six months ended June 30, 2010, $2.4 million and $5.0 million of ARS held with UBS were redeemed at par by the underlying issuers. In addition, during the three months ended June 30, 2010, UBS redeemed $3.9 million of the Company’s ARS holdings at par. As of June 30, 2010, the remaining ARS held by the Company with UBS amounted to $5.5 million in par value and $5.0 million in fair value, which was classified as short-term investments. In July 2010, the Company exercised its Right under the agreement and sold these ARS holdings of $5.5 million to UBS at par value. The remaining $3.0 million ARS in fair value are held at another financial institution and continued to be classified as long-term investments as of June 30, 2010.

The Company’s Right to sell the ARS to UBS commencing June 30, 2010 represented a put option for a payment equal to the par value of the ARS. As the put option was non-transferable and could not be attached to the ARS if they were sold to another entity other than UBS, it represented a freestanding instrument between the Company and UBS. The Company elected the fair value option and recorded the put option in long-term investments. During the three and six months ended June 30, 2010, the Company recorded in other income (expense), net in the consolidated statements of operations losses of $702,000 and $1.1 million, respectively, representing the changes in the fair value of the put option, and gains of the same amount in the same periods, which represented the changes in the fair value of the ARS. The losses and gains recorded in the three and six months ended June 30, 2010 resulted in a net impact of zero in the Company’s consolidated statements of operations. During the three and six months ended June 30, 2009, the Company recorded in other income (expense), net in the consolidated statements of operations a gain of $253,000 and a loss of $639,000, respectively, representing the changes in the fair value of the put option. During the three and six months ended June 30, 2009, the Company also recorded gains of $35,000 and $779,000, respectively, representing the changes in the fair value of the ARS. The losses and gains recorded in the three and six months ended June 30, 2009 resulted in gains of $288,000 and $140,000, respectively, in the Company’s consolidated statements of operations.

As of June 30, 2010, the Company’s ARS with a fair value of approximately $3.0 million held by another financial institution had been in a continuous unrealized loss position for a period of more than 12 months. As of June 30, 2010, the unrealized losses on these investments were $281,000. The gross unrealized losses on these ARS as of June 30, 2010 were primarily due to their illiquidity. The Company has the ability and intent to hold its non-UBS investments for a period of time sufficient to allow for any anticipated recovery in market value or final settlement at the underlying par value, as the Company believes that the credit ratings and credit support of the security issuers indicate that they have the ability to settle the securities at par value. During the three and six months ended June 30, 2010, $700,000 and $820,000, respectively, of ARS held with this financial institution were redeemed at par. As such, the Company has determined that no other-than-temporary impairment losses existed as of June 30, 2010, and recorded changes in the fair value of these ARS investments of $60,000 in accumulated other comprehensive gain.

Fair Value Measurements

The Company measures its financial assets at fair value on a recurring basis. The fair value of these financial assets was determined based on the following three levels of inputs in accordance with the authoritative guidance for fair value measurements and disclosures, of which the first two are considered observable and the last unobservable, that may be used to measure fair value:

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.

The following table represents the Company’s fair value hierarchy for its assets and liabilities measured at fair value on a recurring basis as of June 30, 2010 and December 31, 2009 (in thousands):


	Fair Value		Level 1		Level 2		Level 3
June 30, 2010
Assets:
Money market funds	$	24,924	$	24,924	$	—	$	—


	Fair Value		Level 1		Level 2		Level 3
Short-term investments:
Commercial paper		2,000		2,000		—		—
Certification of deposit		5,350		5,350		—		—
Corporate bonds		63,282		63,282		—		—
Municipal bonds		1,001		1,001		—		—
U.S government agency notes		36,809		36,809		—		—
Auction rate securities		4,998		—		—		4,998
Put option		452		—		—		452
Long-term investments:
Auction rate securities		3,019		—		—		3,019

Total assets at fair value	$	141,835	$	133,366	$	—	$	8,469

Liabilities:
Acquisition related contingent consideration liabilities
Current	$	1,483	$	—	$	—	$	1,483
Long-term		2,105		—		—		2,105

Total liabilities at fair value	$	3,588	$	—	$	—	$	3,588

December 31, 2009
Assets:
Money market funds	$	9,011	$	9,011	$	—	$	—
Short-term investments:
Commercial paper		4,995		4,995		—		—
Certification of deposit		4,153		4,153		—		—
Corporate bonds		51,245		51,245		—		—
Municipal bonds		2,008		2,008		—		—
U.S government agency notes		48,396		48,396		—		—
Auction rate securities		12,684		—		—		12,684
Put option		1,566		—		—		1,566
Long-term investments:
Auction rate securities		3,779		—		—		3,779

Total assets at fair value	$	137,837	$	119,808	$	—	$	18,029

Liabilities:
Acquisition related contingent consideration liabilities
Current	$	1,976	$	—	$	—	$	1,976
Long-term		2,659		—		—		2,659

Total liabilities at fair value	$	4,635	$	—	$	—	$	4,635

Historically, the fair value of ARS approximates par 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 estimated fair value of the ARS no longer approximates par value. At June 30, 2010, the Company utilized an income approach based on discounted cash flow technique to arrive at this valuation based on Level 3 inputs for the ARS. The assumptions used in preparing the discounted cash flow model include estimates of, based on data available as of June 30, 2010, interest rates, timing and amount of cash flows, credit and liquidity premiums, and expected holding periods of the ARS. The Company valued the put option asset using a discounted cash flow approach including estimates of, based on Level 3 data available as of June 30, 2010, interest rates, timing and amount of cash flow, adjusted for any bearer risk associated with UBS’s financial ability to repurchase the ARS beginning June 30, 2010. The assumptions used in valuing both the ARS and the put option are volatile and subject to change as the underlying sources of these assumptions and market conditions change.

The following table provides reconciliation for all assets measured at fair value using significant unobservable inputs (Level 3) for the six months ended June 30, 2010 (in thousands):


	Fair Value Measurements at Reporting Date Using Significant Unobservable Inputs (Level 3)
	Put Option			ARS
Balance at January 1, 2010	$	1,566		$	16,463
Redemption of ARS investments		—			(9,620	)
Total gains or (losses):
Included in accumulated other comprehensive loss		—			60
Included in net loss		(1,114	)		1,114

Balance at June 30, 2010	$	452		$	8,017

On August 27, 2009, the Company acquired substantially all the assets of AnySource Media, LLC, (AnySource), a technology company developing software and service platforms for Internet-enabled consumer electronics devices. The total consideration for the net assets acquired included contingent consideration of up to $7.5 million upon the achievement of certain technical product development milestones and certain revenue and distribution milestones. On the acquisition date, a liability was recognized for an estimate of the acquisition date fair value of the contingent milestone consideration based on the probability of achieving the milestones and the probability weighted discount on cash flows. As of June 30, 2010, the gross remaining contingent consideration totaled $5.3 million. The Company reassessed the fair value of the remaining contingent consideration at $3.6 million.

This fair value measurement is based on significant inputs not observed in the market and thus represents a Level 3 measurement. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions in measuring fair value. Discount rates considered in the assessment of the fair value of the contingent milestones range from approximately 6% to 23%. Future changes in fair value of the contingent milestone consideration, as results of changes in significant inputs such as the discount rate and estimated probabilities of milestone achievements, could have a material effect on the statement of operations and financial position in the period of the change. During the three and six months ended June 30, 2010, milestone payments of $750,000 and $1.4 million, respectively, were made and total expenses of $102,000 and $378,000, respectively, were recorded in the consolidated statements of operations primarily due to changes in the estimated probabilities and the time effect of the discounting of estimated milestone consideration to be paid in the future. This resulted in a $1.0 million change in the fair value of remaining contingent consideration from $4.6 million as of December 31, 2009 to $3.6 million as of June 30, 2010.

The following table provides reconciliation for the contingent consideration measured at fair value using significant unobservable inputs (Level 3) for the six months ended June 30, 2010 (in thousands):


Balance at January 1, 2010	$	4,635
Payments made		(1,425	)
Expenses recorded due to changes in fair value		378

Balance at June 30, 2010	$	3,588

Note 4—Share-Based Compensation Expense

The Company measures all employee share-based compensation awards using a fair value method and records such expense in the consolidated financial statements. Total share-based compensation expenses for the three and six months ended June 30, 2010 and 2009 are as follows (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2010		2009		2010		2009
Selling, general and administrative	$	2,081	$	1,831	$	3,872	$	3,713
Product development		601		524		1,210		841

Totals	$	2,682	$	2,355	$	5,082	$	4,554

The Company recorded $2.7 million and $2.4 million in share-based compensation expenses during the three months ended June 30, 2010 and 2009, respectively, and recorded $5.1 million and $4.6 million in share-based compensation expenses during the six months ended June 30, 2010 and 2009, respectively. In addition, for the six months ended June 30, 2009, $448,000 was presented as financing activities to reflect the incremental tax benefits from stock options exercised in those periods. No such incremental tax benefit was recorded in the six months ended June 30, 2010. At June 30, 2010, total unrecognized estimated compensation costs related to unvested stock options granted prior to that date was $18.2 million, which is expected to be recognized over a weighted-average period of 2.9 years. At June 30, 2010, total unrecognized estimated compensation costs related to non-vested restricted stock units granted prior to that date was $1.7 million, which is expected to be recognized over a period of 1.8 years.

Stock Options

During the three and six months ended June 30, 2010, the Company granted stock options to purchase approximately 236,000 shares and 2.3 million shares, respectively, of its common stock. During the three and six months ended June 30, 2010, stock options to purchase approximately 170,000 shares and 226,000 shares, respectively, of common stock were exercised and options to purchase 504,000 shares and 875,000 shares, respectively, of common stock were forfeited or expired. As of June 30, 2010, the Company had outstanding options to purchase approximately 7.6 million shares of common stock.

Restricted Stock Units

Approximately 31,000 shares and 52,000 shares of the Company’s common stock vested and were released during the three and six months ended June 30, 2010 pursuant to outstanding restricted stock units. As of June 30, 2010, the Company had approximately 214,000 shares of common stock subject to restricted stock units outstanding.

On February 23, 2010, the Company’s Board of Directors approved the grant to certain employees of approximately 69,000 restricted stock units, which vest quarterly over two years from the date of the grant. The related compensation expense of these restricted stock units is being recognized ratably over the service period of two years.

In addition, on February 23, 2010, the Company’s Board of Directors approved the grant of approximately 104,000 shares of performance based restricted stock units to these employees upon the achievement of certain performance goals in 2010. Upon the achievement of each of the four performance goals, one fourth of these restricted stock units would be granted. These performance based restricted stock units, if granted, will vest quarterly over a two-year period commencing on January 1, 2011. The Company assesses the probabilities of achieving the performance goals and records share-based compensation expenses accordingly at each reporting date, until it is determined whether each of the performance goals is achieved or not pursuant to the Board of Directors’ approval. The Company recognizes the compensation costs related to the performance based restricted stock units ratably over the period from February 23, 2010 through December 31, 2012, once the achievement of the performance goals are considered probable.

The fair value of the performance based restricted stock units is assessed at approximately $350,000 in total as of June 30, 2010, and the Company recorded related compensation expenses of approximately $32,000 and $44,000 during the three and six months ended June 30, 2010, respectively.

The merger agreement entered into between the Company and Sonic Solutions provides that as of immediately prior to the closing of the merger, the performance based restricted stock units issuable to Messrs. Hell, Halvorson and Richter will be granted to such executive officers and the underlying shares of the Company’s common stock will be deemed immediately vested in full. The merger agreement further provides that as of immediately prior to the closing of the merger, the performance based restricted stock units issuable to Mr. Milne will be granted to him, subject to vesting on a quarterly basis over the two-year period following the date of grant, subject to any vesting acceleration to which Mr. Milne is entitled under the terms of the Company’s Change-in-Control Severance Plan.

Warrants

No warrants were issued or exercised during the three and six months ended June 30, 2010. As of June 30, 2010, there were fully vested warrants outstanding to purchase 395,000 shares of the Company’s common stock.

Note 5—Income Taxes

The Company recognizes deferred income tax assets or liabilities 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.

The Company accounts for uncertain tax positions using 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. It is the Company’s practice to include interest and penalties that relate to income tax matters as a component of income tax provision.

The Company recorded an income tax benefit for the three months ended June 30, 2010 of $546,000, or 16% of pre-tax loss, compared to an income tax benefit of $255,000 or 10% of pre-tax income for the three months ended June 30 2009. The income tax benefit for the six months ended June 30, 2010 was $15,000, or 10% of pre-tax loss, compared to an income tax provision of $61,000, or a negative 2% of pre-tax loss for the six months ended June 30, 2009. The income tax benefits recorded during the six months ended June 30, 2010 included discrete items of approximately $400,000 relating primarily to additional expenses recognized for cancelled stock options for which the related deferred tax expense reduced the income tax benefit. Excluding this discrete item, the effective tax rate for the three and six months ended June 30, 2010 was approximately 25%. The difference between the Company’s effective tax rate of 25%, excluding the discrete items, and the 35% U.S. federal statutory rate for the three and six months ended June 30, 2010 was primarily due to the impact of the California tax law change to the Company’s effective tax rate in 2010, state income taxes, permanent differences and California research and development credits.

The income tax provision recorded during the six months ended June 30, 2009 included discrete items of approximately $1.2 million. These discrete items included approximately $750,000 recorded during the first quarter of 2009 relating to a decrease to certain deferred tax assets as a result of a California tax law change that was enacted in February 2009. Excluding these discrete items, the Company’s effective tax rate for the three and six months ended June 30, 2009 was approximately 27% and 31%, respectively. 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, 2009 was primarily due to permanent differences, partially offset by research and development credits and the impact of the discrete items.

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.

Note 6—Comprehensive Loss

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


	Three Months Ended June 30,						Six Months Ended June 30,
	2010			2009			2010			2009
Net loss	$	(2,821	)	$	(2,359	)	$	(1,565	)	$	(3,791	)
Unrealized gain (loss) on investments		(195	)		124			(341	)		339
Unrealized gain (loss) on foreign currency translation		(1,397	)		844			(2,268	)		10

Total comprehensive loss	$	(4,413	)	$	(1,391	)	$	(4,174	)	$	(3,442	)

Note 7—Business Acquisitions and Combinations

MainConcept - Japan

The Company’s wholly-owned subsidiary MainConcept previously had a minority interest in MainConcept-Japan, which functions as a Japanese sales office for MainConcept in consideration for a sales commission. Prior to May 31, 2010, the Company possessed a 38% interest in MainConcept-Japan and did not consolidate MainConcept-Japan as it was not the primary beneficiary of MainConcept-Japan, or any other variable interest entity. On May 31, 2010, for strategic purposes and to gain operational efficiencies, the Company entered into certain share purchase agreements and a trademark assignment agreement with the other shareholders of MainConcept-Japan, pursuant to which the Company purchased the 62% controlling interest and all the rights related to the Japanese MainConcept trademark for a total consideration of approximately $627,000. As a result of, MainConcept-Japan became a wholly-owned subsidiary of MainConcept and its operation results are reflected in the Company’s consolidated financial statements commencing as of May 31, 2010.

The preliminary allocation of the purchase price is as follows (in thousands):


Cash	$	399
Accounts receivable		46
Other assets		26
Identifiable intangible asset, MainConcept – Japan trademark		265
Goodwill		141
Liabilities		(38	)

Total preliminary purchase price	$	839

The preliminary purchase price allocation was based upon a preliminary valuation and the Company’s estimates and assumptions, taking into consideration the control premium included in the purchase price of the remaining equity interest. As a result of this acquisition, the Company recognized a gain of $213,000 during the three months ended June 30, 2010 on its investment in MainConcept-Japan based on the increase in fair value of the minority interest from the historical amount, with such fair value determined based the minority holding. The excess of the purchase price over the identified tangible and intangible assets, less liabilities assumed, was recorded as goodwill. The Company anticipates that the $141,000 goodwill recorded in connection with the MainConcept – Japan acquisition will be deductible for income tax purposes based on a 15 year tax life. In addition, the Company recorded the Main-Concept trademark as an intangible asset with an estimated fair value of $265,000, which is being amortized on a straight-line basis over a useful life of 4.5 years, with no estimated residual value.

AnySource Media

On August 27, 2009, the Company acquired substantially all the assets of AnySource. The Company acquired AnySource as part of its strategy to expand its technology licensing business to the next generation of Internet-enabled consumer electronics devices, and to develop new business models around the new software and service platforms. The results of AnySource’s operations have been included in the consolidated financial statements since the acquisition date.

The total consideration for the net assets acquired is up to $15.0 million, consisting of an initial cash payment of $7.5 million, which the Company made in August 2009, and additional consideration of up to $7.5 million upon the achievement of certain technical product development milestones and certain revenue and distribution milestones. All acquisition costs related to the transaction were expensed as incurred. The total acquisition date fair value of the consideration was estimated at $12.5 million as follows (in thousands):


Initial cash payment to AnySource	$	7,500
Estimated fair value of contingent milestone consideration		4,974

Total consideration	$	12,474

On the acquisition date, a liability was recognized for an estimate of the acquisition date fair value of the contingent milestone consideration based on the probability of achieving the milestones and the probability-weighted discount on cash flows. Any change in the fair value of the contingent milestone consideration subsequent to the acquisition date was and will be recognized in the statements of operations. In 2009, the first two technical milestones were achieved and $1.4 million additional consideration became due, $750,000 of which was paid in 2009, and the remaining $675,000 was paid in January of 2010. During the six months ended June 30, 2010, the third technical milestone was achieved, and an additional $750,000 became due and was paid in the second quarter of 2010. As of June 30, 2010, the gross remaining contingent consideration totaled $5.3 million. The Company reassessed the fair value of the remaining contingent consideration at $3.6 million and recorded in the three and six months ended June 30, 2010 increases of $102,000 and $378,000, respectively, in the fair value of the remaining contingent consideration in selling, general and administrative expenses in the consolidated statements of operations. The changes in the estimated probabilities of achieving the milestones and the time effect of discounting of estimated milestone considerations resulted in a net change of the fair value of the remaining contingent considerations from $4.6 million as of December 31, 2009 to $3.6 million as of June 30, 2010. Immediately prior to the closing of the merger between the Company and Sonic Solutions, any unpaid contingent milestone consideration that could become payable as a result of the achievement of milestones following the closing of the merger shall become immediately due and payable to AnySource.

This fair value measurement of the contingent consideration is based on significant inputs not observed in the market and thus represents a Level 3 measurement. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions in measuring fair value. Discount rates considered in the assessment of the $3.6 million reporting date fair value of the contingent milestones at June 30, 2010 range from approximately 6% to 23%.

On the acquisition date, the Company allocated the total consideration to the following assets (in thousands):


Operating lease security deposit	$	25
In-process research and development (IPR&D) (included in intangible assets)		4,345
Goodwill		8,104

Total consideration	$	12,474

Under the purchase method of accounting, the identifiable net assets acquired and liabilities assumed were recognized and measured as of the acquisition date based on their estimated fair values. In the determination of the fair value of the IPR&D, various factors were considered, such as future revenue contributions, additional licensing costs associated with the underlying technology, and contributory asset charges. The fair value of the IPR&D was calculated using an income approach and the rate utilized to discount net future cash flows to their present values was based on a weighted average cost of capital of approximately 30%. This discount rate was determined after considering the Company’s cost of debt adjusted for a risk premium that market participants would require in an investment in companies that are at similar stages of development as AnySource.

IPR&D will not be amortized until the product is complete, at which time the Company estimates it will be amortized over the estimated useful life of the developed technology of seven years. The useful life of the IPR&D was estimated as the period over which the asset is expected to contribute directly or indirectly to the future cash flows of the Company. Up to the point that the product is complete, the Company will assess the IPR&D annually for impairment, or more frequently if certain indicators are present. The Company performed its annual impairment test of the IPR&D as of December 31, 2009, and concluded that no impairment existed.

As AnySource was in the development stage when it was acquired by the Company, no revenue was generated by AnySource or included in the Company’s consolidated statements of operations since the acquisition date. The expenses incurred by AnySource were included in the Company’s consolidated statements of operations since the acquisition date.

The excess of the fair value of the total consideration over the estimated fair value of the net assets was recorded as goodwill. The Company allocated $8.1 million of the total consideration to goodwill. The Company considers the acquired business an addition to its product development effort and not an additional reporting unit or operating segment. The goodwill recorded for the acquisition of AnySource will not be amortized but tested for impairment at least annually, or more frequently if certain indicators are present. In the event that management determines that the value of goodwill has become impaired, the Company will record an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made. The Company performed its annual impairment test of goodwill as of December 31, 2009, and concluded that no impairment existed. The goodwill will be deductible for tax purposes based upon a 15 year tax life.

Note 8—Legal Matters

On October 22, 2007, following the filing of the Company’s declaratory relief action which was subsequently dismissed, Universal Music Group, Inc. (UMG), filed a lawsuit against the Company in the Central District of California, alleging copyright infringement and seeking monetary damages related to the Company’s operation of the Stage6 online video community service, which was shut down on February 29, 2008. On November 11, 2009, the Company entered into a Settlement Agreement with UMG (UMG Settlement) pursuant to which the Company and UMG agreed to dismiss with prejudice all of the pending claims in the UMG litigation. Under the UMG Settlement, upon the occurrence of certain triggers, the Company may be obligated to pay to UMG either $6 million or $15 million. As of the date of this filing, no amounts are due from the Company to UMG under the UMG Settlement. As the Company does not believe that a loss, if any, under the UMG Settlement is probable, no amounts have been accrued in the accompanying consolidated financial statements.

On June 3, 2010, plaintiff Barry Fagan, filed, on behalf of himself and purportedly on behalf of a class of Company stockholders, a class action complaint in the Superior Court of the State of California, County of San Diego against the Company and its directors, Siracusa Merger Corporation, and Siracusa Merger LLC, challenging the Proposed Merger between the Company and Sonic and alleging that the Company’s directors breached their fiduciary duties by agreeing to the Proposed Merger ( Fagan Suit). The Fagan Suit also alleged that Siracusa Merger Corporation and Siracusa Merger LLC aided and abetted the alleged breaches of fiduciary duty. The Fagan Suit sought to enjoin the Proposed Merger, or if it is consummated, rescission or damages. The Fagan Suit was dismissed without prejudice on July 14, 2010.

On June 21, 2010, plaintiff Rainer Gahlen (Gahlen) filed a stockholder class action suit against the Company and its directors in the Superior Court of the State of California, County of San Diego, challenging the Proposed Merger between the Company and Sonic Solutions and alleging that the Company’s directors breached their fiduciary duties by agreeing to the Proposed Merger (Gahlen Suit). The Gahlen Suit seeks to enjoin the Proposed Merger and requests damages.

On July 16, 2010, plaintiff Warren Pared (Pared) filed a stockholder class action against the Company and its directors, Sonic Solutions, Siracusa Merger Corporation and Siracusa Merger LLC in the Superior Court of the State of California, County of San Diego, challenging the Proposed Merger between the Company and Sonic Solutions and alleging that the Company’s directors breached their fiduciary duties by agreeing to the Proposed Merger (the Pared Suit). The Pared Suit also alleges that Sonic Solutions, Siracusa Merger Corporation and Siracusa Merger LLC aided and abetted the alleged breaches of fiduciary duty. The Pared Suit seeks to enjoin the Proposed Merger, or if it is consummated, seeks rescission or damages. On July 19, 2010, counsel for Gahlen and Pared filed a stipulation to consolidate the Gahlen Suit and the Pared Suit and to appoint co-lead counsel.

On July 16, 2010, plaintiff Mark Chropufka filed a shareholder class action against the Company and its directors, Sonic Solutions, Siracusa Merger Corporation and Siracusa Merger LLC in the Delaware Chancery Court, alleging that the Company’s directors breached their fiduciary duties in agreeing to the Proposed Merger with Sonic Solutions and that Sonic Solutions, Siracusa Merger Corporation and Siracusa Merger LLC aided and abetted the alleged breaches of fiduciary duty (Chropufka Suit). The Chropufka Suit seeks to enjoin the Proposed Merger and requests damages.

On July 20, 2010, plaintiff Diana E. Willis filed a shareholder class action against the Company and its directors, Sonic Solutions, Siracusa Merger Corporation and Siracusa Merger LLC in the Delaware Chancery Court, alleging that the Company’s directors breached their fiduciary duties in agreeing to the Proposed Merger with Sonic Solutions and that Sonic Solutions, Siracusa Merger Corporation and Siracusa Merger LLC aided and abetted the alleged breaches of fiduciary duty (Willis Suit). The Willis Suit seeks to enjoin the Proposed Merger and requests damages.

In addition to the above, the Company is involved in various legal proceedings from time to time arising from the normal course of business activities, including commercial, employment and other matters. In its opinion, resolution of any of these legal matters is not expected to have a material adverse effect on the Company’s 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, 2009 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 were incorporated in Delaware in May 2000 with the purpose of making media better through the use of technology. We believe that media is undergoing a profound transformation that will change how individuals and entities obtain information, communicate and express ideas. We believe that there are opportunities within this transformation—opportunities to generate tremendous value by meeting the needs of users of new media and, more importantly, opportunities to influence the evolution and development of media. Our successes to date have been the result of creating value with and for a broad community of constituents including software vendors, consumer hardware device manufacturers, content creators and consumers. Like the evolving markets in which we operate, DivX is open and dynamic.

Our goal is to create products and provide services that improve the way consumers experience media. The first step toward this goal was to build and release a high-quality video compression-decompression software library, or codec, to enable distribution of content across the Internet and through recordable media. As a result, we created the DivX codec. Since the creation of the first DivX codec, DivX codecs have been actively sought out and downloaded by consumers hundreds of millions of times. These downloads include those for which we receive revenue as well as free downloads, such as limited-time trial versions, and downloads provided as upgrades or support to existing end users of our products. After the significant grass-roots adoption of our codecs, the next step toward our goal was to license similar technology to consumer hardware device manufacturers and to certify their products to ensure the interoperable support of DivX-encoded content. We are entitled to receive a royalty and/or license fee for DivX Certified devices shipped by our customers. In addition to licensing revenue from such licensees, we also generate revenue from software licensing, advertising and content distribution.

One aspect of our long term vision is to allow content 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 the content on any device or platform. We bring together consumers of DivX content with content creators both large and small through the development and licensing of media distribution platforms and services.

In January 2009, we released the DivX Plus codec and then, in March 2010, we released a new DivX Plus software package. DivX Plus technology offers consumers and consumer electronics manufacturers an enhanced version of our codecs for certain implementations, including for high definition and mobile content.

In recent years we completed two strategic transactions to complement our organic growth. In November 2007, we acquired MainConcept GmbH, or MainConcept, a leading provider of an H.264 codec solution and a wide range of other high-quality video codecs and technologies for the broadcast, film, consumer electronics and computer software markets. MainConcept solutions are optimized for various platforms including PCs, set-top boxes, portable media players and mobile phones.

In August 2009 we acquired substantially all of the assets of AnySource Media, LLC, or AnySource, a technology company developing software and service platforms for Internet-enabled consumer electronics devices. We believe the AnySource transaction will help us meet our goal of expanding our business model to encompass licensing and other revenue opportunities relating to Internet-enabled consumer electronics devices.

Our next steps, which we have begun working toward, are to bring together the millions of DivX consumers with content creators both large and small to build communities around media, including through the development and licensing of media distribution platforms and services for Internet and consumer electronics devices.

On June 1, 2010, we entered into an Agreement and Plan of Merger, or Merger Agreement, with Sonic Solutions (NASDAQ: SNIC), or Sonic, a Novato, California-based company that develops products and services that enable the creation, management, and enjoyment of digital media across a wide variety of technology platforms. Pursuant to the Merger Agreement, we would merge with Siracusa Merger Corporation, a newly formed, wholly owned subsidiary of Sonic, and become a wholly owned subsidiary of Sonic. Immediately thereafter, we would merge with Siracusa Merger LLC, another newly formed, wholly owned subsidiary of Sonic, with Siracusa Merger LLC surviving the merger and immediately changing its name to DivX LLC. Following the transaction, our separate corporate existence would cease.

Under the terms of the Merger Agreement, our stockholders would receive merger consideration of 0.514 shares of Sonic common stock and $3.75 in cash for each share of DivX common stock that they own. Sonic shareholders would continue to own their existing shares of Sonic common stock, which will not be affected by the transaction. After the close of the transaction, current Sonic and DivX stockholders would be expected to own approximately 65% and 35%, respectively, of Sonic’s outstanding shares. The transaction is expected to be completed in the second half of 2010, subject to customary closing conditions, and stockholder and regulatory approvals. The Merger Agreement contains customary representations and warranties and pre-closing covenants. It also contains termination provisions for each of Sonic and DivX and provides that in certain specified circumstances, we must pay Sonic a termination fee of $8.35 million.

Sources of revenues

We have four revenue streams. Three of these revenue streams emanate from our technologies, including technology licensing to manufacturers of consumer hardware devices, licenses to independent software vendors and consumers, and services we provide related to digital content distribution over the Internet. Additionally, we derive revenues from advertising and distributing third-party products.

Technology licensing-consumer hardware devices. Our technology licensing revenues from consumer hardware device manufacturers comprise the majority of our total revenues and are derived primarily from royalties and/or license fees received from original equipment manufacturers, although related revenues are derived from other members of the consumer hardware device supply chain. We license our technologies to original equipment manufacturers, allowing them to build support of DivX technologies into their consumer hardware devices. Our original equipment manufacturer licensees pay us a fee based on the quantity of DivX Certified devices they sell. Our license agreements with original equipment manufacturers typically range from one to two years, and may include the payment of initial fees, volume-based royalties and minimum guaranteed volume levels. 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 typically 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.

To ensure high-quality support of the DivX media format in finished consumer electronics products, we also license our technologies to those companies who create the major components in those products. These companies include integrated circuit manufacturers who supply integrated circuits, and original design manufacturers who create reference designs, for DVD players, Blu-ray players, digital televisions, mobile phones, and the other consumer hardware devices distributed by our licensee original equipment manufacturers.

To ensure that our licensees’ products conform to our quality standards, we employ a rigorous certification program. Integrated circuit manufacturers, original design manufacturers and original equipment manufacturers are required to have their devices tested and certified prior to distribution. Only DivX Certified devices are permitted to display our logo as evidence that they conform to our standards of high quality.

Technology licensing—software. 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. Since our acquisition of MainConcept in November 2007, we also have generated revenues associated with MainConcept’s licensing agreements in areas complementary to our pre-existing revenue streams, including through MainConcept’s focus on the professional video sector. We also license our technologies directly to consumers through several software bundles. We make certain software bundles available free of charge from our website. These bundles incorporate a version of our codec technology, and allow consumers to play and create content in the DivX format. We also make available from our website an enhanced version of the free software bundle, including additional features that increase the quality and control of DivX media playback and creation. This enhanced version is available free of charge for a limited trial period, which is generally 15 days. At the end of the trial period, our users are invited to purchase a license to one or more components of the enhanced bundle by making a one time payment to us. If they choose not to do so, they still enjoy playback and creation functionality equivalent to our free software bundle.

Advertising and third-party product distribution. We derive revenue from advertisements or third party software applications that we embed in or include with the software packages we offer to consumers. In March 2009, we entered into a promotion and distribution agreement with Google. Pursuant to this agreement, we distribute Google products, including the Google Chrome web browser, with our software products and Google pays us fees based on successful activations of these products. Pursuant to the terms of the agreement with Google, this agreement expires on February 28, 2011, or upon the achievement of a maximum distribution commitment. From November 2007 through November 2008, we had agreed with Yahoo! to include and distribute the Yahoo! Toolbar software product with our software products. Yahoo! paid us fees based on the number of downloads or activations of the included software by consumers.

Content distribution and related services. We derive revenue by acting as an application service provider for third party owners of digital video content by making available our online video delivery system to content providers in return for a revenue share of the download-for-rental or sales revenue generated from the content provider’s customer using our delivery system. We also provide encoding, content storage and distribution services to content providers. The content partner delivers a video-on-demand movie through its website using our Open Video System. We earn a certain percentage of each transaction with the end consumer renting or purchasing such content based on a pre-negotiated revenue share with the content provider. We also encode the content of certain customers into the DivX format and charge certain of these customers for this service or receive an up-front license fee from certain content partners who use our software to encode their own content.

We record revenue related to content distribution arrangements with consumer hardware original equipment manufacturers, or OEMs, who pay us a fee for each copy of DivX-encoded content that is encoded on physical media and bundled with their consumer hardware products.

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 allocable 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, which include format approval fee amortization expenses, business travel costs, trade show costs, outside consulting fees and allocable overhead. Our headcount for selling, general, and administrative related personnel, including full-time and part-time employees remained relatively consistent at 170 as of June 30, 2010, as compared to 166 as of June 30, 2009. If the need arises, we may hire additional employees or outside contractors for our selling, general and administrative staff as needed and may increase our selling, general and administrative budget to meet future needs.

Product development

The majority of product development expenses consist of employee compensation for personnel responsible for the development of new technologies and products. Our headcount for product development related personnel, including full-time and part-time employees, increased by 33 from 168 as of June 30, 2009 to 201 as of June 30, 2010, including approximately 20 employees added as a result of our acquisition of AnySource Media on August 27, 2009. Product development expense also includes bandwidth expenses, depreciation of computer and related equipment, software license fees and allocable overhead. We expect our product development expenses to continue to increase in 2010 as we continue to expand our product offerings, including the development of DivX TV, a software and service platform for Internet-enabled video devices. While we may 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.

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 reasonable, actual results may differ from those estimates.

Our critical accounting policies are described in the notes to the audited consolidated financial statements as of and for the year ended December 31, 2009 included in our Annual Report on Form 10-K filed with the SEC.

Recent Accounting Pronouncements

With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the six months ended June 30, 2010, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, that are of significance, or potential significance to us.

Effective January 1, 2010, we adopted updated guidance related to fair value measurements and disclosures issued by the Financial Accounting Standards Board, or FASB, which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. In addition, in the reconciliation for fair value measurements using significant unobservable inputs, or Level 3, a reporting entity should disclose separately information about purchases, sales, issuances and settlements (that is, on a gross basis rather than one net number). The updated guidance also requires that an entity should provide fair value measurement disclosures for each class of assets and liabilities and disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring fair value measurements for Level 2 and Level 3 fair value measurements. The guidance is effective for interim or annual financial reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. Therefore, we have not yet adopted the guidance with respect to the roll forward activity in Level 3 fair value measurements. We have updated our disclosures to comply with the updated guidance. However, adoption of the updated guidance did not have an impact on our consolidated financial condition, results of operations or statements of cash flows.

Effective January 1, 2010, we adopted the FASB’s updated guidance for determining whether to consolidate a variable interest entity issued in June 2009. These updated standards amend the evaluation criteria to identify the primary beneficiary of a variable interest entity, or VIE, by replacing the previous quantitative-based analysis with a framework that is based more on qualitative judgments. The new guidance requires the primary beneficiary of a VIE to be identified as the party that both (i) has the power to direct the activities of a VIE that most significantly impact its economic performance and (ii) has an obligation to absorb losses or a right to receive benefits that could potentially be significant to the VIE. The adoption of the updated guidance did not have an impact on our consolidated financial position, results of operations and cash flows.

Results of Operations

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


	Three months ended June 30,				Six months ended June 30,
	2010		2009		2010		2009
	(unaudited)				(unaudited)
Net revenues:
Technology licensing	86	%	90	%	88	%	95	%
Media and other distribution and services	14		10		12		5

Total net revenues	100		100		100		100
Cost of revenues:
Cost of technology licensing	11		14		10		13
Cost of media and other distribution and services	1		1		1		1

Total cost of revenues	12		15		11		14

Gross profit	88		85		89		86
Operating expenses:
Selling, general and administrative(1)	72		78		63		72
Product development(1)	35		30		31		28

Total operating expenses	107		108		94		100

Loss from operations	(19	)	(23	)	(5	)	(14	)
Interest income (expense), net	2		3		1		3
Other income (expense), net	—		3		—		—

Loss before income taxes	(17	)	(17	)	(4	)	(11	)
Income tax provision (benefit)	(3	)	(2	)	—		—

Net loss	(14	)%	(15	)%	(4	)%	(11	)%


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

Selling, general and administrative	11	%	12	%	9	%	11	%
Product development	3		3		3		2

Net Revenues

The following table summarizes and analyzes the revenues we earned for the three and six months ended June 30, 2010 and 2009 (in thousands):


	Three Months Ended June 30,						Change					Six Months Ended June 30,						Change
	2010			2009			$			%		2010			2009			$			%
Net revenues:
Technology licensing
Consumer hardware devices	$	13,401		$	10,740		$	2,661		25	%	$	29,878		$	24,448		$	5,430		22	%
% of total net revenues		68	%		70	%							70	%		72	%
Software		3,476			2,985			491		16			7,940			7,883			57		1
% of total net revenues		18	%		20	%							19	%		23	%

Total technology licensing		16,877			13,725			3,152		23			37,818			32,331			5,487		17
% of total net revenues		86	%		90	%							89	%		95	%
Advertising and third-party product distribution		2,632			1,389			1,243		89			4,898			1,390			3,508		252
% of total net revenues		13	%		9	%							11	%		4	%
Content distribution and related services		56			120			(64	)	(54	)		104			190			(86	)	(45	)%
% of total net revenues		1	%		1	%							0	%		1	%

Total net revenues	$	19,565		$	15,234		$	4,331		28	%	$	42,820		$	33,911		$	(8,909	)	(26	)%

Technology licensing—consumer hardware devices: The $2.7 million, or 25%, increase in net revenues from technology licensing to consumer hardware device manufacturers from the three months ended June 30, 2009 to the three months ended June 30, 2010, and the $5.4 million, or 22% increase in net revenues from technology licensing to consumer hardware device manufacturers from the six months ended June 30, 2009 to the six months ended June 30, 2010 resulted primarily from an increase in royalty revenues associated with increased shipped-unit volumes of devices that incorporate our technologies reported to us by our licensee partners, an increase in royalty revenues due to timing of payments on certain fixed fee commitment arrangements which were renewed during the first quarter of 2010, and the recognition of revenues that had been deferred from the prior year under minimum volume commitment arrangements.

Technology licensing—software: The $491,000, or 16%, increase in net revenues from technology licensing to our software licensing partners from the three months ended June 30, 2009 to the three months ended June 30, 2010 was primarily due to an increase in royalty revenues associated with increased shipped-unit volumes of software that incorporate our technologies reported to us by our licensee partners. Software licensing revenue from the six months ended June 30, 2010 was relatively consistent with the same period in 2009, as the increase in royalty revenues associated with shipped-unit volumes of software reported to us was partially offset by the decrease in revenues generated from our website sales. Revenue generated from our website sales is deferred at the time of sale and recognized as revenue over the period of support. During the six months ended June 30, 2010 and 2009, we recognized additional revenue upon the early termination of the support period over which revenue is being recognized on the then-current version of our website software. The lower revenue from our website sales for the three and six months ended June 30, 2010 compared to the same period in 2009 is primarily due to a lower deferred revenue balance at the time of our decision to terminate support on the then–current version of our website software. This lower deferred revenue balance resulted in lower website sales revenue recorded for the six months ended June 30, 2010 compared to the same period in 2009.

Advertising and third-party product distribution: The $1.2 million, or 89%, increase in advertising and third-party product distribution revenue from the three months ended June 30, 2009 to the three months ended June 30, 2010, and the $3.5 million, or 252%, increase in advertising and third-party product distribution revenue from the six months ended June 30, 2009 to the six months ended June 30, 2010 resulted primarily from our promotion and distribution contract with Google, Inc. which was entered into on March 9, 2009. As such, for the six months ended June 30, 2010 we recognized two full quarters of revenue under this agreement and only one full quarter of revenue for the same period of 2009.

Content distribution and related services: The $64,000, or 54%, decrease in content distribution and related services revenue from the three months ended June 30, 2009 to the three months ended June 30, 2010, and the $86,000, or 45%, decrease in content distribution and related services revenue from the six months ended June 30, 2009 to the six months ended June 30, 2010 primarily resulted from a reduction in reported revenue by our Open Video System, or OVS, partners. Content distribution and related services revenues are the result of sales by our OVS customers and encoding and license revenues.

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, 2010 and 2009 in absolute dollars and as a percentage of related revenues (in thousands):


	Three months ended June 30,						Change					Six months ended June 30,						Change
	2010			2009			$			%		2010			2009			$			%
Gross profit
Technology licensing	$	14,594		$	11,559		$	3,035		26	%	$	33,317		$	27,754		$	5,563		20	%
Gross margin %		86	%		84	%							88	%		86	%
Advertising and third-party distribution		2,537			1,305			1,232		94			4,707			1,203			3,504		291
Gross margin %		96	%		94	%							96	%		87	%
Content distribution and related services		36			69			(33	)	(48	)		58			66			(8	)	(12	)
Gross margin %		64	%		57	%							56	%		35	%

Total gross profit	$	17,167		$	12,933		$	4,234		33	%	$	38,082		$	29,023		$	9,059		31	%

Gross margin %		88	%		85	%							89	%		86	%

Technology licensing: The increase in our technology licensing gross profit and the associated increase in gross margin of $3.0 million, or 26%, from the three months ended June 30, 2009 to the three months ended June 30, 2010, and the increase of $5.6 million, or 20%, from the six months ended June 30, 2009 and the six months ended June 30, 2010 were due primarily to an increase in our technology licensing revenue without a corresponding increase in royalty and license costs.

Advertising and third-party distribution: The increase in our advertising and third-party distribution gross profit and the associated gross margin of $1.2 million, or 94%, from the three months ended June 30, 2009 to the three months ended June 30, 2010, and the increase of $3.5 million, or 291%, from the six months ended June 30, 2009 to June 30, 2010 were primarily due to a relatively fixed cost base and an increase in our advertising and third-party distribution revenue, primarily related to revenue recognized from our promotion and distribution agreement with Google.

Content distribution and related services: Our content distribution and related services gross margin decreased $33,000, or 48% from the three months ended June 30, 2009 to the three months ended June 30, 2010 and $8,000, or 12%, from the six months ended June 30, 2009 to the six months ended June 30, 2010, primarily due to the decrease in content distribution revenue described above.

Operating expenses

The following table summarizes and analyzes our operating expenses for the three and six months ended June 30, 2010 and 2009 (in thousands):


	Three months ended June 30,						Change				Six months ended June 30,						Change
	2010			2009			$		%		2010			2009			$		%
Operating expenses:
Selling, general and administrative	$	14,122		$	11,875		$	2,247	19	%	$	26,887		$	24,584		$	2,303	9	%
% of total net revenues		72	%		78	%						63	%		72	%
Product development		6,868			4,633			2,235	48	%		13,519			9,334			4,185	45	%
% of total net revenues		35	%		30	%						31	%		28	%

Total operating expenses	$	20,990		$	16,508		$	4,482	27	%	$	40,406		$	33,918		$	6,488	19	%

Selling, general and administrative: The $2.2 million, or 19%, increase in selling, general and administrative expenses from the three months ended June 30, 2009 to the three months ended June 30, 2010, was primarily due to: 1) an increase of approximately $1.5 million in compensation and benefits expenses, primarily due to higher fringe and variable compensation costs during the three months ended June 30, 2010; 2) an increase in outside service expense of $1.2 million, due to fees associated with the pending transaction with Sonic announced in June 2010; 3) an increase in share-based compensation expense of $250,000; 4) an increase in travel and entertainment expense of $150,000; 5) an increase in amortization expenses related to our prepaid format fees of $150,000, primarily due to format approval agreements we entered in the second half of 2009; 6) an increase of approximately $100,000 in the fair value of AnySource contingent liabilities; and 7) an increase in marketing and promotion of $100,000. These increases were partially offset by a decrease in legal expense of $1.0 million as we settled our UMG litigation in 2009, and a decrease in depreciation expenses of $200,000.

The $2.3 million, or 9%, increase in selling, general and administrative expenses from the six months ended June 30, 2009 to the six months ended June 30, 2010, was primarily due to 1) an increase of approximately $1.8 million in compensation and benefits expenses, as a result of higher fringe and variable compensation costs during the six months ended June 30, 2010; 2) an increase in outside service expenses of $1.2 million, due to fees associated with the pending transaction with Sonic; 3) an increase of approximately $400,000 in the fair value of AnySource contingent liabilities; 4) an increase in marketing and promotion expenses of $250,000 and travel and entertainment expenses of $200,000, primarily related to our participation in sales conferences and tradeshows; 5) an increase in the amortization expenses of $200,000 associated with our prepaid format fees; 6) an increase in office expenses of $150,000; 7) an increase in share-based compensation expense of $150,000; and 8) an increase in contractor expense of $100,000. These increases were partially offset by a decrease in legal expense of $1.7 million as we settled our UMG litigation in 2009, and a decrease in depreciation expense of $450,000.

Product development: The $2.2 million, or 48%, increase in product development expenses from the three months ended June 30, 2009 to the three months ended June 30, 2010 was primarily due to the increase in costs associated with our acquisition of AnySource in August of 2009. Our product development headcount increased by 20 as a result of the acquisition, which was a primary

contributor to the increase of approximately $1.8 million in compensation and benefits expenses, the increase of $100,000 in share-based compensation expenses, and the increase of $200,000 in office rent, utility and other expenses. In addition, an increase of $100,000 in contractor expenses related to our other software development efforts also contributed to the overall increase in product development expenses.

The $4.2 million, or 45%, increase in product development expenses from the six months ended June 30, 2009 to the six months ended June 30, 2010 was primarily due to the increase in costs associated with our acquisition of AnySource in August of 2009. Our headcount increase as a result of the acquisition was a primary contributor to the increase of approximately $3.1 million in compensation and benefit expenses, the increase of $400,000 in share-based compensation expenses, the $300,000 increase in office rent, utility and other expenses, and the $100,000 increase in travel expenses. In addition, an increase in outside research expenses of approximately $100,000 also contributed to the overall increase in product development expenses as we continue to invest in the development of our software and service platforms for Internet enabled consumer electronics devices.

Interest income (expense), net: We reported net interest income of $385,000 for the three months ended June 30, 2010 compared to $432,000 for the three months ended June 30, 2009. For the six months ended June 30, 2010, we reported approximately $786,000 of net interest income compared to $1.0 million for the six months ended June 30, 2009. The decreases are reflective of lower interest rates compared to the same period in the prior year.

Other income (expense), net: We recorded $71,000 of other income for the three months ended June 30, 2010 as compared to $539,000 of other expense for the same period in 2009. For the six months ended June 30, 2010, we recorded other expense of $42,000 compared to $139,000 of other income for the six months ended June 30, 2009. The fluctuations in other income (expenses), net were primarily due to foreign exchange fluctuations on our Euro-based intercompany receivable balance from our German subsidiary MainConcept.

Income tax provision: We recorded an income tax benefit for the three months ended June 30, 2010 of $546,000, or 16% of pre-tax loss, compared to an income tax benefit of $255,000 or 10% of pre-tax income for the three months ended June 30, 2009. The income tax benefit for the six months ended June 30, 2010 was $15,000, or 1% of pre-tax loss, compared to an income tax provision of $61,000, or a negative 2% of pre-tax loss for the six months ended June 30, 2009. The income tax benefits recorded during the six months ended June 30, 2010 included discrete items of approximately $400,000 relating primarily to additional expenses recognized for cancelled stock options. Excluding this discrete item, the effective tax rate for the three and six months ended June 30, 2010 was approximately 25%. The difference between our effective tax rate of 25%, excluding the discrete items, and the 35% U.S. federal statutory rate for the three and six months ended June 30, 2010 was primarily due to the impact of the California tax law change to our effective tax rate in 2010, state income taxes, permanent differences and California research and development credits.

The income tax provision recorded during the six months ended June 30, 2009 included discrete items of approximately $1.2 million. These discrete items included approximately $750,000 recorded during the first quarter of 2009 relating to a decrease to certain deferred tax assets as a result of a California tax law change that was enacted in February 2009. Excluding these discrete items, our effective tax rate for the three and six months ended June 30, 2009 was approximately 27% and 31%, respectively. The difference between our effective tax rate and the 35% U.S. federal statutory rate for the three and six month period ended June 30, 2009 was primarily due to permanent differences, partially offset by research and development credits and the impact of the discrete items.

Liquidity and capital resources

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


	June 30, 2010		December 31, 2009
Cash, cash equivalents and short-term investments	$	143,247	$	143,709
Working capital		140,876		133,954
Total assets		209,839		207,598

Cash Flows (in thousands):


	Six Months Ended June 30,
	2010			2009
Net cash provided by operating activities	$	5,762		$	4,050
Net cash provided by (used in) investing activities		7,402			(25,365	)
Net cash provided by financing activities		1,508			960
Effect of exchange rate changes on cash		(200	)		119


	Six Months Ended June 30,
	2010		2009
Net increase (decrease) in cash and cash equivalents		14,472		(20,236	)
Cash and cash equivalents at beginning of period		14,883		43,442

Cash and cash equivalents at end of period	$	29,355	$	23,206

Cash provided by operating activities: The $5.8 million of cash provided by operating activities for the six months ended June 30, 2010 was primarily comprised of non-cash share-based compensation of $5.1 million, non-cash depreciation and amortization expenses of $2.9 million, and an increase in accrued liabilities of $1.7 million, partially offset by an decrease in prepaid expenses and other assets of $1.9 million, an increase in income taxes receivable of $1.9 million, and the net loss of $1.6 million.

The $4.1 million of cash provided by operating activities for the six months ended June 30, 2009 was primarily due to a decrease in accounts receivable of $5.9 million, non-cash share-based compensation of $4.6 million, and non-cash depreciation and amortization expenses of $3.0 million, partially offset by net loss of $3.8 million, an increase in prepaid and other assets of $1.8 million, an increase in income taxes receivable of $1.9 million, a decrease in accrued liabilities of $1.0 million, and a decrease in deferred revenue of approximately $500,000.

Cash provided by (used in) investing activities: The $7.4 million of cash provided by investing activities for the six months ended June 30, 2010 was due to sales and maturities of investments of $67.0 million, partially offset by purchases of investments of $56.3 million, cash paid for the AnySource acquisition of $1.4 million, and cash paid for format approval fees of $1.2 million.

The $25.4 million of cash used in investing activities for the six months ended June 30, 2009 was due to purchases of investments of $78.6 million, partially offset by sales and maturities of investments of $53.8 million.

Cash provided by financing activities: The $1.5 million cash provided by financing activities for the six months ended June 30, 2010 was primarily due to proceeds of $937,000 from exercises of stock options, and proceeds of $573,000 from shares issued under the employee stock purchase plan.

The $960,000 cash provided by financing activities for the six months ended June 30, 2009 was primarily due to the proceeds of $500,000 from shares issued under the employee stock purchase plan, and $400,000 from the excess tax benefit from the exercise of stock options.

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 sheets 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, 2010, we had $146.3 million in cash and cash equivalents, and investments, all of which are stated at fair value. A 10 basis point increase or decrease in market interest rates over a three months period would not be expected to have a material impact on the fair value of $29.4 million of our cash and cash equivalents at June 30, 2010, as these consisted of securities with maturities of less than three months.

The weighted-average maturity of our investments excluding ARS as of June 30, 2010 was approximately eight months. A 100 basis point increase or decrease in interest rates over an eight-month period from those in effect at June 30, 2010 would, however, decrease or increase, respectively, the approximately $108.4 million remaining of our investments (excluding ARS and the related put option) by approximately $650,000. 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 operations until the investment is sold or if the reduction in fair value was determined to be other than temporary.

At June 30, 2010, we held approximately $8.8 million of ARS in par value, $3.3 million of which were classified in long-term assets, whose underlying assets are student loans which are substantially backed by the federal government. Since February 2008, these auctions have failed and therefore continue to be illiquid and we will not be able to access these funds until a future auction of these investments is successful or a buyer is found outside of the auction process. As a result, our ability to liquidate our investments and fully recover the carrying value of our investments in the near term may be limited or may not exist. If the issuers are unable to successfully close future auctions and their credit ratings deteriorate, we may in the future be required to record an impairment charge on these investments. A 100 basis point increase or decrease in market interest rates over a three month period would not be expected to have a material impact on the fair value of our ARS holdings.

We believe that, based on our total cash and investments position and our expected operating cash flows, we are able to hold these securities until there is a recovery in the auctions market, which may be at final maturity. As a result, we do not anticipate that the current illiquidity of these ARS will have a material effect on our cash requirement or working capital.

The remaining $5.5 million of our ARS holdings in par value were held with UBS AG, or UBS at June 30, 2010. In November 2008, we accepted an offer from UBS entitling us to sell at par value ARS originally purchased from UBS at any time during a two-year period from June 30, 2010 through July 2, 2012. In accepting this offer, we granted UBS the authority to sell or auction the ARS at par at any time up until the expiration date of the offer and released UBS from any claims relating to the marketing and sale of ARS. During the three and six months ended June 30, 2010, $2.4 million and $5.0 million respectively of ARS held with UBS were redeemed at par by the underlying issuers. In addition, during the three months ended June 30, 2010, UBS redeemed $3.9 million of our ARS holdings at par. As of June 30, 2010, the remaining ARS held by the Company with UBS amounted to $5.5 million in par value and $5.0 million in fair value, which was classified as short-term investments. In July 2010, we sold all of these remaining ARS holdings of $5.5 million to UBS at par.

Foreign Currency Exchange Rate Risk

MainConcept generates revenues and 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, 2010, 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 (expense), net. A 100 basis point increase or decrease in foreign currency exchange rates over a three month period from those in effect at June 30, 2010 would not materially impact our financial position, results of operations and cash flows. During the six months ended June 30, 2010, we recorded approximately $302,000 of foreign currency losses related to our foreign currency receivable denominated in Euros in other income (expense), net on our consolidated statements of operations.

Item 4.

Controls and Procedures

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 June 3, 2010, plaintiff Barry Fagan, filed, on behalf of himself and purportedly on behalf of a class of Company stockholders, a class action complaint in the Superior Court of the State of California, County of San Diego against us and our directors, Siracusa Merger Corporation, and Siracusa Merger LLC, challenging the proposed merger between us and Sonic (the “Proposed Merger”) and alleging that our directors breached their fiduciary duties by agreeing to the Proposed Merger (the “Fagan Suit”). The Fagan Suit also alleged that Siracusa Merger Corporation and Siracusa Merger LLC aided and abetted the alleged breaches of fiduciary duty. The Fagan Suit sought to enjoin the Proposed Merger, or if it is consummated, rescission or damages. The Fagan Suit was dismissed without prejudice on July 14, 2010.

On June 21, 2010, plaintiff Rainer Gahlen filed a stockholder class action against us and our directors in the Superior Court of the State of California, County of San Diego, challenging the Proposed Merger between us and Sonic and alleging that our directors breached their fiduciary duties by agreeing to the Proposed Merger (the “Gahlen Suit”). The Gahlen Suit seeks to enjoin the Proposed Merger and requests damages.

On July 16, 2010, plaintiff Warren Pared filed a stockholder class action against us and our directors, Sonic, Siracusa Merger Corporation and Siracusa Merger LLC in the Superior Court of the State of California, County of San Diego, challenging the Proposed Merger between us and Sonic and alleging that our directors breached their fiduciary duties by agreeing to the Proposed Merger (the “Pared Suit”). The Pared Suit also alleges that Sonic, Siracusa Merger Corporation and Siracusa Merger LLC aided and abetted the alleged breaches of fiduciary duty. The Pared Suit seeks to enjoin the Proposed Merger, or if it is consummated, seeks rescission or damages. On July 19, 2010, counsel for Gahlen and Pared filed a stipulation to consolidate the Gahlen Suit and the Pared Suit and to appoint co-lead counsel.

On July 16, 2010, plaintiff Mark Chropufka filed a shareholder class action against us and our directors, Sonic, Siracusa Merger Corporation and Siracusa Merger LLC in the Delaware Chancery Court, alleging that our directors breached their fiduciary duties in agreeing to the Proposed Merger with Sonic and that Sonic, Siracusa Merger Corporation and Siracusa Merger LLC aided and abetted the alleged breaches of fiduciary duty. The Chropufka Suit seeks to enjoin the Proposed Merger and requests damages.

On July 20, 2010, plaintiff Diana E. Willis filed a shareholder class action against us and our directors, Sonic, Siracusa Merger Corporation and Siracusa Merger LLC in the Delaware Chancery Court, alleging that our directors breached their fiduciary duties in agreeing to the Proposed Merger with Sonic and that Sonic, Siracusa Merger Corporation and Siracusa Merger LLC aided and abetted the alleged breaches of fiduciary duty (the “Willis Suit”). The Willis Suit seeks to enjoin the Proposed Merger and requests damages.

In addition, we are 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, 2009, as filed with the Securities and Exchange Commission.

Risks Relating to the Potential Merger with Sonic Solutions

*Failure to complete, or delays in completing, the merger with Sonic Solutions announced on June 2, 2010 could materially and adversely affect our results of operations and our stock price.

On June 1, 2010, we entered into an agreement with Sonic pursuant to which, if all of the conditions to closing are met, we will merge with a subsidiary of Sonic and become a wholly-owned subsidiary of Sonic. Consummation of the merger is subject to customary closing conditions. We cannot assure you that we will be able to successfully consummate the proposed merger as currently contemplated under the Merger Agreement or at all. Risks related to the failure of the proposed merger to be consummated include, but are not limited to, the following:

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If the merger is not consummated, we would not realize any or all of the potential benefits of the merger, including any synergies that could result from combining the financial and proprietary resources of us and Sonic, which could have a negative effect on our stock price;

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We will remain liable for significant transaction costs, including legal, accounting, financial advisory and other costs relating to the merger regardless of whether the merger is consummated;

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Under some circumstances, we may have to pay a termination fee to Sonic in the amount of $8.35 million if the merger is not consummated;

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The attention of our management and our employees may be diverted from day-to-day operations during the period up to the consummation of the merger;

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Our technology licensing process may be disrupted by customer and salesperson uncertainty over when or if the merger will be consummated;

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Our customers and other third parties may seek to modify or terminate existing agreements, or prospective customers may delay entering into new agreements or licensing our technologies as a result of the announcement of the merger;

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Under the Merger Agreement, we are subject to certain restrictions on the conduct of our business prior to completing the merger, which restrictions could adversely affect our ability to conduct our business as we otherwise would have done if we were not subject to these restrictions; and

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Our ability to retain current key employees or attract new employees may be harmed by uncertainties associated with the proposed merger.

The occurrence of any of these events individually or in combination could materially and adversely affect our results of operations and our stock price.

*Because the Merger Agreement contemplates a fixed exchange ratio, changes in the market price of Sonic common stock could adversely affect the value of the shares of Sonic common stock to be received by our stockholders in the merger.

Under the Merger Agreement, each outstanding share of our common stock will be exchanged for 0.514 shares of Sonic common stock and $3.75 in cash. Because the Merger Agreement contemplates a fixed exchange ratio, changes in the stock price of Sonic common stock in the period leading up to the time the merger is consummated could adversely affect the value of our common stock or the value of the Sonic common stock to be received by our stockholders upon consummation of the merger.

*Lawsuits have been filed against us, the members of our board of directors, Sonic Solutions, Siracusa Merger Corporation and Siracusa Merger LLC challenging the proposed merger, and an adverse judgment in any such lawsuit may prevent the merger from becoming effective or from becoming effective within the expected timeframe, and may result in costs to DivX.

As described above, DivX, Inc., the members of our board of directors, Sonic Solutions, Siracusa Merger Corporation and Siracusa Merger LLC are named as defendants in purported shareholder class action lawsuits brought by several individual DivX stockholders as plaintiffs, challenging the Proposed Merger with Sonic, and seeking, among other things, to enjoin DivX and the other parties to the Merger Agreement from consummating the merger on the agreed-upon terms. One of the conditions to the completion of the merger is that no temporary restraining order, preliminary or permanent injunction or other order preventing the completion of the merger shall have been issued by any court of competent jurisdiction and be in effect. Consequently, if any of the plaintiffs is successful in obtaining an injunction prohibiting the parties from completing the merger on the agreed-upon terms, the injunction may prevent the completion of the merger in the expected timeframe, or at all.

We have obligations under certain circumstances to hold harmless and indemnify each of the defendant directors against judgments, fines, settlements and expenses related to claims against such directors and otherwise to the fullest extent permitted under Delaware law and our bylaws and certificate of incorporation. Such obligations may apply to the lawsuits. Our management believes that the allegations in the lawsuits are without merit and intends to vigorously contest the lawsuits. However, there can be no assurance that we and the other defendants in these lawsuits will be successful in our defenses. An unfavorable outcome in any of the lawsuits could prevent or delay the consummation of the merger, result in substantial costs to DivX or both.

* If the merger is consummated, the combined company may not perform as we or the market expects, which could have an adverse effect on the price of Sonic stock, which our current stockholders will own following the merger.

Even if the merger is consummated, the combined company may not perform as we or the market expect. Risks associated with the combined company following the merger include:

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If the merger does not qualify as a tax-free reorganization under Section 368(a) of the Code, the stockholders of DivX may be required to pay substantial U.S. federal income taxes.

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Integrating two businesses is a difficult, expensive, and time-consuming process, and the failure to integrate successfully the businesses of DivX and Sonic in the expected time frame would adversely affect Sonic’s future results following completion of the merger.

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The merger will significantly increase the size of Sonic’s operations, and if Sonic is not able to effectively manage its expanded operations, its stock price may be adversely affected.

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The new members of the Sonic board of directors and other employees of the resulting entity, which have had limited exposure to each other, may not be able to work together effectively.

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It is possible that key employees might decide not to remain with Sonic after the merger is completed, and the loss of key personnel could have a material adverse effect on the resulting entity’s financial condition, results of operations and growth prospects.

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The success of the resulting entity will also depend upon relationships with third parties and pre-existing customers of Sonic and DivX, which relationships may be affected by customer preferences or public attitudes about the merger. Any adverse changes in these relationships could adversely affect the resulting entity’s business, financial condition and results of operations.

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The stock price of Sonic common stock after the merger may be affected by factors different from those currently affecting the shares of Sonic or DivX.

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If governmental agencies or regulatory bodies impose requirements, limitations, costs, divestitures or restrictions on the consummation of the proposed merger, the combined company’s ability to realize the anticipated benefits of the merger may be impaired.

If any of these events were to occur, the value of the Sonic common stock received by DivX stockholders in the merger would be adversely affected.

Risks Relating to DivX, Including as a Stand-Alone Company

Risks Related to our Business

Our business and prospects depend on the strength of our brand, and if we do not maintain and strengthen our brand, we may be unable to maintain or expand our business.

Maintaining and strengthening the “DivX” brand is critical to maintaining and expanding our business, as well as to our ability to enter into new markets for our technologies and products. If we fail to promote and maintain the DivX brand successfully, our ability to sustain and expand our business and enter into new markets will suffer. Maintaining and strengthening our brand will depend heavily on our ability to continue to develop and provide innovative and high-quality technologies and products for consumers, content owners, consumer hardware device manufacturers and software vendors. Moreover, because we engage in relatively little direct brand advertising, the promotion of our brand depends, among other things, upon hardware device manufacturing partners displaying our trademarks on their products. If these partners choose for any reason not to display our trademarks on their products, or if our partners use our trademarks incorrectly or in an unauthorized manner, the strength of our brand may be diluted or our ability to maintain or increase our brand awareness may be harmed. In addition, if we fail to maintain high-quality standards for products that incorporate our technologies through the quality-control certification process that we require of our licensees, or if we take other steps to commercialize our products and services that our customers or potential customers reject, the strength of our brand could be adversely affected. Further, unauthorized third parties may use our brand in ways that may dilute or undermine its strength.

*We expect the market for DVD players to decline as new products are introduced into the market. To the extent that sales of DVD players 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, 2010, 2009 and 2008, we derived approximately 70%, 72% and 65%, respectively, of our total net revenues from technology licensing to consumer hardware device manufacturers, a majority of which are derived from sales of red-laser DVD players incorporating our technologies. However, as the markets for DVD players mature, we expect sales of red-laser DVD players to decline. To the extent that sales of red-laser DVD players 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 the 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.

If we are unable to penetrate existing consumer electronics markets or adapt or develop technologies and products for new markets, our business prospects could be limited.

We expect that our future success will depend, in part, upon our ability to successfully penetrate existing markets for digital media technologies, including:

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DVD players and recorders;

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MP3 devices;

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Blu-ray players;

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portable media players;

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digital still cameras;

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digital camcorders;

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mobile handsets;

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digital media software applications;

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digital TVs;

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home media centers;

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set-top boxes;

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multi-media storage devices; and

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video game consoles.

To date, we have penetrated only some of these markets, including the markets for DVD players, Blu-ray players, portable media players, digital still cameras, digital TVs, mobile handsets, digital media software applications, set-top boxes, multi-media storage devices 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, 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, Google, Joost, MovieLink, a subsidiary of Blockbuster Inc., MySpace.com, a subsidiary of News Corporation, Netflix, Yahoo!, YouTube, a subsidiary of Google, Hulu, LLC and subscription entertainment services and cable and satellite providers compete with our content

distribution services. In addition, we compete with companies such as Yahoo!, VUDU, Inc., a subsidiary of Wal-Mart Stores, Inc., Boxee, Inc. and Rovi Corporation and with internally developed proprietary solutions developed by hardware device manufacturers and integrated circuit manufacturers in our development and marketing of technologies to enable the next generation of Internet-enabled consumer electronics devices.

Our proprietary technologies also compete with other video compression technologies, including other implementations of MPEG-4 or implementations of H.264/AVC. In addition, a number of companies such as Adobe Systems, Apple Computer, Ateme, Google, Microsoft, and RealNetworks offer video formats that compete with our proprietary video format.

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 brand 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, Yahoo! and Adobe Systems 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 64% of our total net revenues during the six months ended June 30, 2010, 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 88%, 95% and 77% of our total net revenues from licensing our technology during the six months ended June 30, 2010, 2009 and 2008, 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, 2010, Samsung accounted for approximately 14% of our total net revenues, and our top 10 licensees by revenue accounted for approximately 64% 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. Also, certain of our OEM partners have sought to enter into a site license with us, pursuant to which the OEM partner pays a flat royalty fee for use of certain of our technology. If we underestimate the use of our technology by one of our site license partners, the flat royalty rate that we charge may be too low and our revenues may be adversely affected. 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.

*Revenues under our promotion and distribution agreement with Google, entered into in March 2009, represented nearly 10% of our total net revenues in the six months ended June 30, 2010. A termination of our promotion and distribution agreement with Google or our failure to renew or replace this agreement would significantly decrease our revenues.

In March 2009, we entered into a promotion and distribution agreement with Google pursuant to which we distribute Google products, including among others the Google Chrome web browser, with our software products, and Google pays us fees based on successful activations of these products. Since March 2009, we have relied on this relationship with Google for a significant portion of our revenue. Revenue derived from the agreement represented nearly 10% of our total net revenues in the six months ended June 30, 2010. If Google’s products do not prove to be as popular among consumers as we anticipate, if our products decline in popularity among

consumers, or if Google’s products reach market saturation, we may experience a decrease in revenue under our agreement with Google. In addition, our ability to continue to generate revenues under the agreement is limited by a cap on the total amounts payable by Google under the agreement, after which Google is relieved of further obligations to pay us for successful activations or otherwise. If we meet this cap, our revenues in subsequent periods may decrease. This agreement expires upon the earlier of February 28, 2011 or the date upon which we reach the cap on the total amounts payable by Google to us under the agreement, and Google is under no obligation to renew this agreement. If, upon the expiration of our agreement with Google, we fail to enter into a new agreement with Google or a similar partner on substantially the same or more favorable terms, our future revenues will significantly decrease.

The success of our business depends in part on the availability of premium video content in the DivX format.

To date, only five Hollywood motion picture studios have agreed to make certain video content available in the DivX media format. If we, and/or our consumer electronics partners or retail partners, fail to implement certain technological safeguards mandated under those deals, such format approval agreements 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 one or more of our studio partners 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 media 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 and recorders, Blu-ray players, digital still cameras, digital camcorders, portable media players, digital TVs, home media centers, set-top boxes, video game consoles, MP3 devices, multi-media storage devices 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 consumer electronics manufacturers and 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.

Our business is dependent in part on technologies we license from third parties, and these license rights may be inadequate for our business.

Certain of our technologies and products are dependent in part on the licensing and incorporation of technologies from third parties. For example, we have entered into license agreements with MPEG LA pursuant to which we have acquired rights to use in our technologies and products certain MPEG-4 and AVC intellectual property licensed to MPEG LA. Our licensing agreements with MPEG LA grant us sublicenses only to the rights in the relevant intellectual property licensed to MPEG LA. There are other parties who have competing rights to MPEG-4 and AVC intellectual property, and to the extent that the rights of such other parties conflict with or are superior to the rights licensed to MPEG LA, our rights to utilize MPEG-4 or AVC technology in our technologies and products could be challenged. Our license agreement with MPEG LA, under its MPEG-4 Part 2 Visual Patent Portfolio will expire on December 31, 2013. Our license agreement with MPEG LA, under its MPEG-4 Part 10, or AVC, Patent Portfolio will expire on December 31, 2010. MPEG LA has the right to renew each of these license agreements 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 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.

Current credit and financial market conditions could delay, or prevent consumers from purchasing products incorporating our licensed technology, which could continue to adversely affect our business, financial condition and results of operations.

Our operations and performance depend significantly on worldwide economic conditions. Uncertainty about current global economic conditions pose a risk as consumers may postpone spending and our licensees may postpone producing products incorporating our technology in response to tighter credit and negative financial news, which could have a material negative effect on demand for our products. These and other economic factors have impacted our results and may have a significant impact on our financial condition and operating results in the future.

The current financial turmoil affecting the banking system and financial markets and the possibility that additional financial institutions may consolidate or go out of business has resulted in a tightening in the credit markets, a low level of liquidity in many financial markets, and extreme volatility in fixed income, credit, currency and equity markets. There could be a number of follow-on effects from the credit crisis on our business, including the insolvency of our licensees or their key suppliers or the inability of our licensees to obtain credit to finance development and/or manufacture products that incorporate our technology. In addition, due to the recent tightening of credit markets and concerns regarding the availability of credit, the markets for consumer hardware and software products in which our technologies are incorporated may be negatively affected and consumers may be delayed in obtaining, or may not be able to obtain, necessary credit for their purchases of the consumer hardware and software products that incorporate our technologies, which could in turn result in reduction in shipments by our licensees. Such reductions would adversely affect our licensing and other revenue. If conditions become more severe or continue longer than we anticipate, our forecasted demand may not materialize to the levels we require to achieve our anticipated financial results, which could in turn have a material adverse effect on our revenue, profitability and the market price of our stock.

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 eight foreign countries as well as sales staff in 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, 2010, 2009 and 2008, our net revenue outside North America comprised 79%, 86% and 73%, respectively, of our total net revenues. We expect that international sales will continue to represent a substantial portion of our revenues for the foreseeable future. These future international revenues will depend to a large extent on the continued use and expansion of our technologies in entertainment industries worldwide. Increased worldwide use of our technologies is also an important factor in our future growth. We are investing resources into expanding the reach of our technologies into the markets of foreign countries where our technologies have not yet been widely adopted. We may not be successful in our efforts to penetrate new international markets for our products.

We are subject to the risks of conducting business internationally, including:

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our ability to enforce our contractual and intellectual property rights, especially in those foreign countries that do not respect and protect intellectual property rights to the same extent that the United States does, which increases the risk of unauthorized and uncompensated use of our technology;

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United States and foreign government trade restrictions, including those that may impose restrictions on importation of programming, technology or components to or from the United States;

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foreign government taxes, regulations and permit requirements, including foreign taxes that we may not be able to offset against taxes imposed upon us in the United States, and foreign tax and other laws limiting our ability to repatriate funds to the United States;

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foreign labor laws, regulations and restrictions;

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changes in diplomatic and trade relationships;

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difficulty in staffing and managing foreign operations;

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fluctuations in foreign currency exchange rates and interest rates, including risks related to any interest rate swap or other hedging activities we undertake;

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political instability, natural disasters, war and/or events of terrorism; and

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the strength of international economies.

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 many 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.

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 reputation that our technologies have for providing 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. We do not typically participate in standards- setting organizations, nor do we typically seek 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 depends in part upon our ability to provide effective digital rights management technology.

Our business depends 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 not scaled any of our 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.

*We may experience changes in the size of our organization, and we may experience difficulties in managing growth or contraction.

As of June 30, 2010 we had 371 full-time and part-time employees. We may need to expand or contract 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 the correct size to support this future growth or contraction. 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 may experience changes in our senior management which may disrupt our operations.

We may experience disruptions in our operations as a result of changes in our senior management 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.

Our network is subject to security risks that could harm our reputation and expose us to litigation or liability.

Online commerce and communications depend on the ability to transmit confidential or proprietary information securely over private and public networks. Any compromise of our ability to transmit and store such information and data securely, and any costs associated with preventing or eliminating such problems, could impair our ability to distribute technologies and products or collect revenue, threaten the proprietary or confidential nature of our technology, harm our reputation and expose us to litigation or liability. We also may be required to expend significant capital or other resources to protect against the threat of security breaches or hacker attacks or to alleviate problems caused by such breaches or attacks. Any successful attack or breach of our security could hurt consumer demand for our technologies and products and expose us to consumer class action lawsuits and other 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 Children’s Online Privacy Protection Act imposes civil and criminal penalties on persons 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 this or other similar laws. The manner in which such laws may be interpreted and enforced cannot be fully determined, and future legislation similar to this law 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 enabling the 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 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.

Failure to comply with applicable current and future government regulations could limit our ability to license our technologies, sell our products or distribute content, and expose us to additional costs and liabilities.

Our operations and business practices are subject to federal, state and local government laws and regulations, as well as international laws and regulations, including those relating to import or export of technology and software, distribution or censorship of content, use of encryption or other digital rights management software and consumer and other safety-related compliance for electronic equipment. Any failure by us to comply with the laws and regulations applicable to us or our technologies, products or our distribution of content could result in our inability to license those technologies, sell those products, or distribute content, additional costs to redesign technologies, products or our methods for distribution of content to meet such laws and regulations, fines or other administrative, civil or criminal liability or actions by the agencies charged with enforcing compliance and, possibly, damages awarded to persons claiming injury as the result of our non-compliance. Changes in or enactment of new statutes, rules or regulations applicable to us could have a material adverse effect on our business.

If we lose the services of key members of our senior management team, we may not be able to execute our business strategy.

Our future success depends in large part upon the continued services of key members of our senior management team. All of our executive officers and key employees are at-will employees, and we do not maintain any key person life insurance policies. The loss of our management or key personnel could seriously harm our ability to execute our business strategy. We also may have to incur significant costs in identifying, hiring, training and retaining replacements for key employees.

We rely on highly skilled personnel, and if we are unable to retain or motivate key personnel or hire qualified personnel, we may not be able to maintain our operations or grow effectively.

Our performance is largely dependent on the talents and efforts of highly skilled individuals. These individuals have acquired specialized knowledge and skills with respect to us and our operations. Except to the extent otherwise required by the laws of foreign jurisdictions in which we have employees, 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.

In August 2009, we acquired substantially all of the assets of AnySource Media, LLC, or AnySource, a company that develops software and service platforms for Internet-enabled consumer electronics devices. 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.

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 transaction with AnySource.

The integration of AnySource’s technologies 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 AnySource’s technologies with our technologies;

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entering markets in which we have limited or no prior experience;

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successfully completing the development of AnySource’s technologies;

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developing commercial products based on those technologies;

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retaining and assimilating the key personnel of AnySource;

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attracting additional customers for products based on AnySource’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 and any potential legal liability arising from our transaction with AnySource.

In particular, we may encounter difficulties successfully integrating our operations, technologies, services and personnel with those of AnySource, and our financial and management resources may be diverted from our existing operations. For example, as a result of our transaction with AnySource, we have an additional office in Malvern, Pennsylvania. Maintaining offices in multiple locations 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 AnySource’s technologies with our 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 technologies and personnel of AnySource, or any significant delay in achieving integration, including regulatory approval delays, could have a material adverse effect on us and, as a result, on the market price of our common stock.

Our corporate culture has contributed to our success, and if we cannot maintain this culture as we grow, we could lose the innovation, creativity and teamwork fostered by our culture.

We believe that a critical contributor to our success has been our corporate culture, which we believe fosters innovation, creativity and teamwork. As our organization grows and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the beneficial aspects of our corporate culture. This could negatively impact our future success.

Risks related to our finances

Our quarterly operating results and stock price may fluctuate significantly.

We expect our operating results to be subject to quarterly fluctuations. The revenues we generate and our operating results and the market price of our common stock will be affected by numerous factors, including:

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demand for our technologies and products;

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introduction, enhancement and market acceptance of technologies and products by us and our competitors;

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price reductions by us or our competitors or changes in how technologies and products are priced;

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the mix of technologies and products offered by us and our competitors;

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the mix of distribution channels through which our technologies and products are licensed and sold;

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our ability to successfully generate revenues from advertising and content distribution;

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the mix of international and United States revenues attributable to our technologies and products;

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costs of intellectual property protection and any litigation;

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timing of payments received by us pursuant to our licensing agreements;

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our ability to hire and retain qualified personnel;

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growth in the use of the Internet; and

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general economic conditions.

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 may not generate sufficient revenue to be profitable on a quarterly or annual basis in the future.

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.

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.

*Our investments in auction rate securities may not provide us a liquid source of cash.

As of June 30, 2010, we held approximately $8.8 million par value of auction rate securities ($8.5 million estimated fair value, including related put option). During the six months ended June 30, 2010, $6.9 million worth of the Company’s auction rate securities were redeemed at par. During the years 2009 and 2008, approximately $500,000 and $1.3 million, respectively, worth of the Company’s auction rate securities were redeemed. Subsequent to June 30, 2010 and prior to the filing of this quarterly report on Form 10-Q, $5.5 million of the Company’s auction rate securities were redeemed at par. All other auction rate security instruments in our portfolio have failed at auctions since February 2008, and we may not be able to sell these securities in a timely manner to meet a liquidity need. In the event that we are unable to sell the underlying securities at or above our carrying value, or at all, these securities may not provide us a liquid source of cash in the future.

Risks related to our intellectual property

We and our licensees 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 such as AT&T and LG (one of our most significant customers in consumer hardware technology licensing) regarding the licensing of certain patents characterized by such parties as being essential to the MPEG-4 visual standard or other standards. Regardless of the merits of such claims any disputes with third parties over intellectual property rights could materially and adversely impact our business, including by resulting in the loss of management time and attention to our core business, or reducing the willingness of licensees to incorporate our technologies into their products. We have also received notices that various third parties have, on occasion, contacted certain of our licensees alleging that products incorporating our technology require a license under certain patents which they purport to own or have rights in. Our licensees have faced claims such as these in the past, currently face such claims, and may face similar claims in the future. Regardless of the merits of these allegations, this type of contact could materially impact our business by reducing our ability to generate revenue and drive adoption of our technologies and it could also materially impact our relationships with our licensees and their desires to implement DivX technologies. 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 example, we were previously engaged in litigation with UMG, which had requested that we remove materials from Stage6, our online video community service which we shut down on February 29, 2008, and which asserted claims of copyright infringement against us. We settled our litigation with UMG in November 2009. 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 seven issued patents in the United States and two issued patents in foreign jurisdictions, along with exclusive rights to one additional United States patent. Our ability to obtain patent protection for certain of our technologies and products may 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 patents relating to MPEG-4, MP3, and other standards-based technologies from third party licensors. The licensors from whom 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:

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

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

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our efforts to protect our intellectual property rights may not be effective in preventing misappropriation of our technology or dilution of our trademarks;

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our efforts may not prevent the development and design by others of products or technologies similar to or competitive with, or superior to those that we develop; or

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another party may obtain a blocking patent that would force us to either obtain a license or design around the patent to continue to offer the contested feature or service in our technologies.

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 or our customers 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.

If we are not able to maintain our domain names it may negatively impact our brand and our reputation.

We hold the domain name DivX.com as well as other domain names that support our brand and our business. If we are not able to maintain our domain names, consumers may have difficulty accessing our products and services on the Internet. If we are not able to maintain our domain names, other parties who control those Internet sites may engage in activities that damage our brand and our reputation. In addition to maintaining our current domain names, we may not be able to obtain additional domain names to support our brand and our business.

Risks related to the securities markets and investment in our common stock

Market volatility may affect our stock price and the value of your investment.

The current turbulence in the U.S. and global financial markets has caused a decline in stock values across all industries. The market price for our common stock has been and is likely to continue to be volatile. In addition, the market price of our common stock may fluctuate significantly in response to a number of factors, most of which we cannot control, including:

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

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regulatory developments in the United States and foreign countries;

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

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variations in our quarterly operating results;

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changes in securities analysts’ estimates of our financial performance;

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changes in accounting principles;

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

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additions or departures of key personnel; and

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

*Shares of our common stock are relatively illiquid.

The current turbulence in the U.S. and global financial markets could adversely affect our stock price and our ability to raise additional capital through the sale of equity or debt securities. As of July 30, 2010, we had 33,209,929 shares of common stock outstanding. 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 2008, we undertook a share repurchase program, which was completed as of June 30, 2008. Prior 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.

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements could be impaired, which could adversely affect our ability to operate our business and our stock price.

Ensuring that we have adequate internal financial and accounting controls and procedures in place to help ensure that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. We periodically document, review and, where appropriate, improve our internal controls and procedures for compliance with Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent auditors addressing these assessments. Both we and our independent 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.

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

As of July 30, 2010, there were 33,209,929 shares of our common stock outstanding. Substantially all of these shares are eligible for sale in the public market, although as of July 30, 2010, 539,052 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 30, 2010, we had outstanding warrants to purchase up to 395,000 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 207,622 shares of common stock at July 30, 2010 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. Additionally, the current turbulence in the U.S. and global financial markets has caused a decline in stock values across all industries.

As of July 30, 2010, an aggregate of approximately 7,638,083 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.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

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.

As of June 30, 2010, the remaining $62.8 million of proceeds from our initial public offering are invested in auction rate securities, commercial paper, certificates of deposit, corporate bonds, government agency notes, and money market funds.

Item 6.

Exhibits.


Exhibit Number		Description of Document

2.1(1)		Agreement and Plan of Merger, dated as of June 1, 2010, by and among Sonic Solutions, Siracusa Merger Corporation, Siracusa Merger LLC and DivX, Inc.

2.2(1)		Form of Voting Agreement, dated June 1, 2010, by and between DivX, Inc. and certain stockholders of Sonic Solutions.

2.3(1)		Form of Voting Agreement, dated June 1, 2010, by and between Sonic Solutions and certain stockholders of DivX, Inc.

3.1(2)		Form of Amended and Restated Certificate of Incorporation as currently in effect.

3.2(3)		Form of Amended and Restated Bylaws as currently in effect.

4.1(2)		Form of Common Stock Certificate.

10.1*		Amendment Number 1 to Promotion and Distribution Agreement between the Company and Google, Inc. dated May 1, 2010.

10.2+		Offer Letter between the Company and Matthew Milne dated July 15, 2009.

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 Current Report on Form 8-K, originally filed with the SEC on June 2, 2010.

(2)	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.

(3)	Filed as an exhibit to the Company’s Current Report on Form 8-K filed with the SEC on March 1, 2010.

*	Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the SEC.

+	Indicates management contract or compensatory plan.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

DIVX, INC.

Dated: August 6, 2010

/s/ Dan L. Halvorson

Dan L. Halvorson

Chief Financial Officer and Executive Vice President Operations

(Duly authorized officer and principal financial officer)