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Executives

Derrick Nueman - Director, Investor Relations

Thomas S. Rogers - President, Chief Executive Officer, Director

Anna Brunelle - Chief Financial Officer, Vice President, Principal Financial and Accounting Officer

Matt Zinn - General Counsel

Analysts

Alan Gould - Natexis Bleichroeder

David Miller - Caris & Company

Lee Westerfield - BMO Capital

Tuna Amobi - Standard & Poor's  

TiVo Inc. (TIVO) F3Q09 Earnings Call November 25, 2008 5:00 PM ET

Operator

Welcome to the TiVo third quarter fiscal year 2009 earnings conference call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Derrick Nueman. Please go ahead, sir.

Derrick Nueman

Thank you and good afternoon. I’m Derrick Nueman, TiVo's head of investor relations. With me today are Tom Rogers, CEO; Anna Brunelle, CFO; Naveen Chopra, VP of Business Development and Strategy; and Matt Zinn, General Counsel. We are here today to discuss TiVo's financial results for the third quarter fiscal year 2009.

We have just distributed a press release and 8-K detailing our financial results. We have also released a financial key metric summary which is posted on our investor relations website. Additionally, we will be posting a recording of this call later today on the investor relations section of our website.

Today’s prepared remarks should take 25 to 30 minutes and will be followed by a question-and-answer session.

Our discussions today include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to, among other things, TiVo's future subscription, advertising, and research businesses, profitability, operations, and financial performance and guidance, distribution of the TiVo service domestically and internationally, TiVo's current and future service features and product releases, and TiVo's ongoing litigation with EchoStar.

You can identify these statements by the use of terminology such as “guidance”, "believe," "expect," "will," or similar forward-looking terms. We caution you not to put undue reliance on these forward-looking statements as they involve risks and uncertainties that may cause actual results to vary materially from the forward-looking statements.

Factors that may cause actual results to differ materially include delays in development, competitive service offerings, and lack of market acceptance, as well as other factors described under "Risk Factors" in our public reports filed with the SEC, including our latest 10-K and 10-Qs.

Any forward-looking statements made on this call reflect analysis as of today and we have no plans or duty to update them.

Additionally, some of the metrics and financial information provided in today’s call include non-GAAP measures. Please see our third quarter fiscal year 2009 key metric trend sheet for a reconciliation of these items.

With that, I will now turn over the call to Tom Rogers.

Thomas S. Rogers

Thanks, Derrick. Good afternoon, everyone. In the midst of this financial crisis and economic downturn, one thing is clear -- cash is king and companies that are able to operate without debt are highly prized. TiVo is uniquely armed with significant cash assets, no debt, and a subscription business model that has been adjusted EBITDA positive for five consecutive quarters. We have paid close attention to the financial profile of the company and we believe that those efforts will pay dividends during uncertain times. More specifically, we came out of the third quarter with a strong balance sheet, consisting of over $200 million of cash and cash equivalents and no debt. Strengthened by the $105 million award for damages and interest we received from EchoStar, we recorded record profitability.

Even without taking into account the award, once again we beat our guidance on adjusted EBITDA and we are well on our way to delivering our first adjusted EBITDA positive year and with this award, our first net income positive year.

We recognize that no company is immune to the challenges of the current economic environment and we anticipate there will be an adverse effect on consumer electronic sales, including TiVo, during the upcoming holiday season. However, with the many growth drivers we have in place and a subscription based business model which is somewhat less dependent on near-term consumer spending, we believe we are well-positioned for continued growth.

Like most companies, we must take steps to reduce our cost in order to take into account the economic climate and to give us the full runway necessary to play out all the many strategic opportunities at hand. To this end, we announced last week a headcount reduction of approximately 7%.

Now let’s talk about some of the highlights from the quarter, which include solid progress on the litigation front, advances in our mass distribution strategy, new and exciting content deals and further momentum in our advertising and research business.

First in terms of our litigation with EchoStar and defending our intellectual property, as I mentioned at the outset we received nearly $105 million from EchoStar for past damages and interest awarded by the United States district court for EchoStar's infringement of our patent prior to September 8, 2006. Additionally, we are pleased that the U.S. District Court has scheduled a hearing on EchoStar's purported work-around on February 17, 2009. Contrary to EchoStar's recent statement, the court did not rule on TiVo's pending motion for contempt of the injunction. The court will do so after the hearing as well as rule on the amount of damages owed to TiVo, which EchoStar admitted at the September 4th hearing are indeed owed, beyond the nearly $105 million already paid by EchoStar. This is a positive step, particularly the accelerated discovery ordered by the court, toward the ultimate resolution of all issues in the litigation. We remain confident that we will prevail in showing that EchoStar's work-around does not avoid infringement and that the district court will ultimately enforce the injunction and award further damages from EchoStar's continued infringement of our time warp patent.

Now, let’s turn to the significant progress we made on our mass distribution strategy. Our partnership with Comcast is progressing. Comcast CEO Steve Burke recently offered the following comments on their earnings call, and I am quoting here: “We are rolling out TiVo beyond the Boston market test, where things are going quite well and we are going to be introducing other cities probably starting with Chicago in the first quarter next year.”

Comcast is now marketing TiVo in Boston with direct mail, bill inserts, and cross-channel television ads. The first television ad is really worth seeing on YouTube if you have not seen it yet.

We also recently announced a new agreement with DirecTV, a partner with which we have had a very successful history. Expected in the second half of next year, DirecTV will market a version of TiVo built on DirecTV’s broadband enabled HD DVR platform, allowing DirecTV customers to use a TiVo DVR with all of DirecTV’s high definition programming. The agreement also reestablishes DirecTV as a key national marketing and distribution partner for TiVo. Financially speaking, the per-subscriber fees we receive from DirecTV with respect to the new platform are substantially higher than those under the existing deal, which when combined with a significant national marketing commitment from DirecTV, presents an attractive growth opportunity for TiVo.

As you can see, our mass distribution strategy continues to gain momentum as we are now partnered with three of the top five multi-channel operators in the U.S., which in the aggregate reach close to 50 million households and have significant legal momentum against the third largest, EchoStar.

This quarter, we also launched a new PC-based version of TiVo with Nero, a German-based provider of digital media solutions. Using Nero Liquid TV, TiVo PC allows viewers who watch TV through a PC screen to have the TiVo experience and to be able to pause and record live television straight from their desktop and transfer shows between computers, as well as easily create DVDs of their favorite programs. This is an exciting partnership for us because it enables us to access a previously untapped medium for distributing the TiVo service and utilize Nero’s strong online subscriber acquisition activities.

One of the ways Nero is planning to market the product is through free downloadable trials, which is consistent with our view that third-party marketing is a key way to grow TiVo's subscription base without direct expenditure by TiVo.

Turning to the standalone side of the business, our goal of making TiVo a full home entertainment center and the only single-source solution for in-home entertainment is becoming a reality. We continue to expand our content offering to provide our subscribers the ability to easily navigate a sea of infinite television and broadband content and deliver anything they want whenever they want it, right to the TV.

As you know, we recently announced a long anticipated partnership with Netflix, which will soon provide our broadband connected HD subscribers access to thousands of movies right to the TV set for no incremental charge. The timing of this partnership is ideal as it provides consumers, including the 8 million Netflix subscribers a portable entertainment option as they look to cut back on discretionary spending and take part in cheaper in-home entertainment options. For the Netflix subscriber, this is the ultimate way to save money and to get the most out of their television experience as they have access to thousands of movies for no additional costs.

Add to that our recent deal with [Damon], the leading broadband provider of award-winning independent art-house and international films, which movie buffs would otherwise have to travel to theaters in New York or Los Angeles to enjoy. So in this quarter, TiVo has continued to more fully develop the ultimate viewer experience that delivers millions of pieces of content beyond linear television straight to the TV set, an offering that can’t be found anywhere else.

In addition, we announced during the quarter that we would be partnering with Research in Motion, the maker of Blackberry devices, to help develop mobile entertainment services for Blackberry. Netflix and Blackberry joined YouTube, Amazon, Disney, and Rhapsody, among other big brand name strategic partners demonstrating the unique breadth of our broadband offering and its appeal to major industry players.

Also, just like we have transformed the in-home entertainment experience, we are looking to transform the in-hotel entertainment experience. Morgans Hotel Group, the leading boutique hotel chain, is opening the Mondrian in Miami with every room equipped with TiVo. Hotels are known for having a lot less choice than our at-home television -- than your at-home television option, so making sure something good is on when you are traveling is a huge benefit for hotel guests.

We look forward to other hotel distribution opportunities to open up yet one more distribution path for TiVo.

In terms of managing the financials of the standalone business, we continue to closely watch our marketing spend and continue to work to build relationships whereby third parties shoulder a large portion of marketing expenditure on behalf of TiVo. The result has been a steady decline of our quarterly subscription acquisition costs. This quarter, SAC came in at $139, a considerable decrease when compared to SAC of $304 in the year-ago quarter.

As we have mentioned in past quarters, we continue to work with leading retailers and consumer electronic manufacturers to bundle TiVo with HD television sale and believe this can help us drive additional sales at efficient acquisition cost levels. For example, Best Buy is rolling out a holiday promotion to make TiVo an attractive option to bundle with a new HD television set and has been increasing its efforts to amplify within their stores customers’ understanding of TiVo's unique offering to the marketplace. Of course, as I mentioned earlier, we fully anticipate that the current economic turmoil will continue to impact retailers and we have factored that into our near-term expectations of these initiatives, especially as we enter into what will likely be a weak holiday season for the consumer electronics industry.

In terms of our advertising business, TiVo is leading the way in defining what television viewing will mean going forward. We are working with dozens of major television advertisers, advertising agencies, television networks and cable operators on a number of very compelling solutions to help address the issue of commercial avoidance. However, we believe that the industry’s level of urgency is presently inadequate.

In a major address during the annual association of National Advertisers’ Conference last month, we discussed how the impact of commercial avoidance will be even more significant than the impact that the advertising industry will feel from the economy near-term.

The commercial avoidance issue is becoming so pronounced that there is no excuse for the advertising industry not to act. As such, we are taking it upon ourselves to try to instill a far greater sense of urgency, which can also bring about a greater embrace of TiVo's role in the future of television advertising.

In order for television advertising to survive this crisis and come out of it stronger, it must deliver the same accountability and measurability offered by online advertisers today. The existing measurement tools available to the TV industry are simply not useful because they aren’t capable of capturing viewer behavior in a granular sense. Our unique offerings have the ability to do just that. As a matter of fact, during the quarter, we expanded our research panel from 20,000 to 100,000 TV units of our TiVo stop-watch rating service, which compiles second-by-second viewership data. This anonymous sample base is about 25 times larger than Nielsen’s DVR panel and gives us the ability to measure many forms of viewing behavior, including the ability to measure DVR ratings on networks that Nielsen and others currently don’t measure.

Additionally, we knocked down one more domino in the advancement of interactive television announcing the ability to order Domino’s Pizza from the television set. This was yet one more indication that what we are doing for the consumer is of immense press fascination, as this announcement generated over 13 million print and online media impressions, even making David Letterman’s nightly monologue last week.

Finally today, we announced TiVo Mobile, our new phone optimized website that will allow TiVo subscribers and non-TiVo subscribers to browse, search, and discover television shows remotely and from the palm of your hand with the mobile phone.

What’s special about this tool is that it doesn’t require a special phone and works regardless of which mobile platform, carrier, or browser you have, opening up the service to millions of cell phone owners. This adds value to the subscription service of TiVo and does so for free.

In conclusion, this was another solid quarter marked by record profitability, a strong balance sheet, significant progress in mass distribution, new strategic partnerships with content providers and momentum with respect to our valuable intellectual property.

While the current economic climate makes it difficult to know what lies immediately ahead, we believe that we have built a strong financial foundation which provides us the full runway to pursue our longer term growth initiatives.

Before we move to Q&A, I would like to take a moment to introduce our newly appointed CFO, Anna Brunelle. Anna has been an influential force at TiVo for nearly four years, running our accounting, cash management, and financial planning functions, as well as being a key figure behind recent improvements to our financial profile. I would like to particularly thank Anna for recognizing a year ago the need for a conservative cash management approach, which has allowed us to navigate safely through the cash management challenges that other companies have succumbed to. She brings a wealth of financial operations experience and a deep understanding of the industry to the table and we are very happy to have her serving as our new CFO, where she can continue her efforts to improve TiVo financially. Congratulations, Anna -- I will now turn it over to you.

Anna Brunelle

Thank you, Tom and good afternoon, everyone. Let me start out by saying how delighted I am to have this opportunity with TiVo. I am pleased by the work that we are doing to improve our financial performance and the traction we are getting in our key growth areas. I was particularly pleased with our financial performance this past year. It was our fifth straight quarter of adjusted EBITDA profitability and as Tom said, we are now well on our way to our first full year of adjusted EBITDA profitability. Additionally, we continue to effectively manage our cost structure such that our earnings results exceeded guidance and finally our balance sheet was further strengthened by the receipt of cash from the EchoStar litigation.

Before I get into the specifics of the third quarter, let me quickly walk you through how we are accounting for the approximately $105 million in EchoStar damages and interests. Approximately $87.8 million of the award relates to damages and is recognized as litigation proceeds in our operating expenses. The remaining $16.8 million in interest is recognized as interest income. The damages portion of the award will benefit both our net income and adjusted EBITDA while the interest portion will only benefit net income as it is stripped out of our adjusted EBITDA calculation.

With that, let me get into some specifics from the third quarter. Service and technology revenues were $61.7 million. Of that, service revenues were $47.7 million, which was down from the same quarter last year. This was impacted primarily by product lifetime subscriptions becoming fully amortized, thereby no longer contributing revenue, as well as continued decreases in our direct TV subscriber base.

Technology revenues were $4 million, down approximately $1.4 million from last quarter and the same quarter last year. Technology revenues will continue to fluctuate based on the nature and amount of third-party work done for service providers in any given quarter.

Excluding about $700,000 in expenses related to stock-based compensation, cost of service and technology revenues were $12.8 million for the quarter, which included $10.7 million related to cost of service revenues. The service gross margin excluding stock-based compensation was 77%. Our hardware loss was $3.6 million, consisting of two major buckets. The first bucket is our hardware loss’ net cost, which is our margin on boxes sold into retail and through our direct channel. This bucket accounted for $2.3 million of the hardware loss and included a benefit from the utilization of about $1.4 million in standard definition inventory reserve on related boxes sold during the quarter.

The second bucket of our hardware loss consists of rebates, marketing development funds, and revenue share from the retail channels. This accounted for the remaining $1.3 million of the hardware loss.

Operating expenses excluding stock-based compensation as a percentage of service and technology revenues were as follows: sales and marketing expenses were 16%, which is a substantial decrease from the 25% we incurred in the same quarter last year but slightly up sequentially due to typical seasonal marketing activities. The portion of sales and marketing expenses related to subscription acquisition costs represented 4% of service and technology revenues.

Research and development expenses were 27% of service and technology revenues. G&A expenses were 15% and we recorded litigation proceeds of $87.8 million related to the EchoStar award.

As stated previously, we received $16.8 million in interest related to the EchoStar award. We plan to use our NOLs to offset the majority of the tax liability related to the EchoStar awards such that we recorded taxes of only $3.1 million in the quarter. This led to net income for the third quarter of $100.6 million, which again included several items related to the EchoStar litigation -- $87.8 million in litigation proceeds plus $16.8 million in interest income less $3.1 million in tax expense. That aggregates to a total positive impact on net income of $101.5 million.

Without these EchoStar litigation related items, our net income would have been $900,000 in the third quarter. This compares to a net loss of $8.3 million in the year-ago quarter and our guidance of a net loss of $7 million to $9 million. Our net income per share was $0.98 on a diluted basis for the third quarter, which compares to a net loss per share of $0.08 for the same quarter last year. Our diluted net income per share calculation for the third quarter this year was based on 102.6 million weighted average shares.

With stock-based compensation expenses of $6.4 million, interest income of $17.2 million, tax expense of $3.1 million, and depreciation and amortization expenses of $2.4 million, our adjusted EBITDA for the third quarter was $95.3 million, which included $87.8 million in litigation proceeds.

Excluding the EchoStar award, our adjusted EBITDA would have been $7.5 million. This compares to our adjusted EBITDA guidance of a negative $1 million to positive $1 million and to our adjusted EBITDA of $200,000 in the same quarter last year.

Obviously the better-than-anticipated net income and adjusted EBITDA was primarily driven by the receipt of approximately $105 million in damages and interest from EchoStar. However, excluding the EchoStar damages, we would have still outperformed our adjusted EBITDA guidance significantly. The out-performance excluding EchoStar was driven by lower retail sell-ins and lower-than-anticipated operating expenses as we pulled back discretionary spend when it became clear the economy was becoming significantly weaker.

Earlier in my remarks, I commented on our strong balance sheet. We ended the third quarter with approximately $205 million in cash and short-term investments and no debt. Our cash and short-term investments balance has increased by about $105 million year-to-date, the same amount that we received in cash damages from EchoStar, meaning we are approximately cash flow neutral to date. This compares favorably to the $46.3 million decline in cash and short-term investments for the same period as the prior year and ensures that we are well-positioned from a financial standpoint to continue to execute on the core strategic objectives for growing our business. Further, safeguarding our cash and short-term investments remains a key priority and our portfolio is conservatively invested, primarily in treasury.

Now, continuing to our third quarter key pricing and volume metrics, our TiVo owned gross additions were 44,000, compared to 69,000 in the year-ago quarter. During the last quarter, the economy began to deteriorate markedly and we encountered significant headwinds beginning in mid-September as purchases of consumer electronics products slowed. This trend has continued into the current quarter as evidenced by Best Buy recently lowering its sales forecast.

On this note, I wanted to touch briefly on the Circuit City bankruptcy filings. The good news for us is that we have minimal financial exposure to this bankruptcy. The bad news is that we believe we will see less of a contribution this holiday season from our second-largest retail partner, making an already difficult selling season even more difficult.

We also continue to focus on churn reduction and in the third quarter, our churn was 1.4% per month, slightly down compared to last quarter and up from 1.3% in the year-ago quarter. Our efforts will remain focused on getting ahead of the HD upgrade cycle and providing compelling offers to our long-time, single-tuner standard definition subscribers to represent the largest component of churn.

On a net basis, our TiVo owned subscriptions decreased by 28,000 in the quarter and our TiVo owned subscription base ended the quarter at approximately $1.7 million subscriptions.

Our MSO broadcaster subscriber base includes DirecTV, Comcast, Cablevision Mexico, Seven, and other mass distribution relationships and this subscriber base declined by 135,000 sequentially from the second quarter.

As expected, our DirecTV base continued to churn as no new subscriptions are being added and as DirecTV is heavily promoting its HD and owned DVR offerings. Further, the contribution from Comcast has yet to be felt in a meaningful way. Comcast launched its New England market -- excuse me; Comcast launched its New England marketing efforts late in the quarter and we expect to see the benefits of this marketing take hold as Comcast expands to additional markets, beginning with Chicago.

Our overall subscription base stands at approximately 3.5 million subscriptions at the end of October. Our TiVo owned average revenue per user was approximately $8.34, slightly up from last quarter. However, we saw a large year-over-year decrease in ARPU, primarily due to a larger number of fully amortized product lifetime subscriptions that once fully amortized are non-revenue generating.

At the end of the quarter, we had approximately 236,000 TiVo owned product lifetime subscriptions that had reached the end of the revenue amortization period. This represents 37% of our current total product lifetime subscription base, which stands at 655,000 subscriptions at the end of the third quarter.

Now taking a look at acquisition costs for TiVo owned subscriptions, our total acquisition costs were $6.1 million in the third quarter, which included a $1.4 million benefit from the utilization of our standard definition inventory reserve and a $700,000 expense from the write-off of advertising credits we no longer expect to use. This was a significant improvement compared to the year-ago quarter, due in large part to reduced marketing expenses and a lower hardware subsidy. Our SAC in the third quarter of this year was about $139, down compared to $304 in the year-ago quarter.

On a trailing 12-month basis, our SAC was $134, declining for the fourth straight quarter as we have become much more prudent with our marketing spend. We will continue to manage marketing expenses aggressively, yet it should be noted that during the holiday season, we typically spend more on absolute marketing dollars and incur higher hardware costs. The fourth quarter should follow these typical patterns.

Before I get into the specific guidance for the fourth quarter, let me walk you through three factors that will impact our guidance.

First, we will be conducting our annual review on the life of our product lifetime subscriptions during Q4. Similar to last year, there is a possibility that we may have to increase the estimated life and amortization period of our lifetime subscriptions if many of these customers keep their TiVos longer than anticipated.

If this change were to occur, it would reduce our Q4 service and technology revenues and increase net loss and adjusted EBITDA, each by an amount of up to $2 million. We have weighed this potential impact in our Q4 guidance.

Second, as we announced previously, we expect to take a severance and benefit charge of approximately $1 million related to our headcount reduction of approximately 7% of the workforce; and third, we expect to incur substantially higher legal costs than the previous quarter due to the accelerated discovery and bench trial on February 17th relating to EchoStar's purported work-around. As Tom stated, we are pleased with the clear path the district court has set fourth to determine contempt, enforcement of the injunction, and further damages from EchoStar's continued infringement.

With that, for the fourth quarter, we expect service and technology revenues of $47 million to $49 million. We expect to continue to see declines from DirecTV subscription revenue and there will be an increase in our fully amortized lifetime subscription.

We currently expect our fourth quarter adjusted EBITDA loss to be in the range of $2 million to $4 million. We expect a net loss in the range of $10 million to $12 million.

To wrap up, I am extremely pleased about our financial performance for the third quarter and for the first nine months of this year. With over $200 million in cash, no debt, and a year-to-date cash flow neutral financial model, we are well-positioned to continue to focus on the elements of our business that we believe will drive meaningful growth over time.

This concludes my remarks. Thank you for your time and we will now take questions.

Thomas S. Rogers

Before we take questions, let me just hand it over to Anna one second for a quick clarification.

Anna Brunelle

I just realized that a moment ago I said that our net income excluding the EchoStar award would have been approximately $900,000. As the press release says, I wanted to clarify that would be a net loss of $900,000. Thank you.

Derrick Nueman

Let’s take questions now.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first to Alan Gould with Natexis.

Alan Gould - Natexis Bleichroeder

I’m going to try to stretch it to two. Tom, can you just tell the layman out here what the advantages are of having accelerated discovery in the DISH lawsuit? And also I realize cash is king in the current environment but could you give us your thoughts about share repurchases with the stock at the current price?

Thomas S. Rogers

Well, you say for the layman -- you are hardly a layman, Alan.

Alan Gould - Natexis Bleichroeder

Not a lawyer.

Thomas S. Rogers

Why we are pleased with the judge’s ruling in this regard is that accelerated discovery means that the resolution of this will be on a very timely basis, an expedited basis. Less than three months from now, we will be in the hearing in front of the judge for the resolution of the issues related to the contempt, related to injunction, related to -- can take many months, can take in some cases much longer than that and the fact that we have a compressed timetable here to get to that resolution we think is quite important.

The issue of our cash, yes, we like our financial profile right now and we want to just emphasize that point, not having any debt, having over $200 million in cash, having gotten our expenses considerably down over the course of the last year before the economic crisis hit, the additional expense reduction we’ve taken recently to put us in a good position to confront what lies ahead and first and foremost, the cash gives us the runway to be able to know we can play out the many strategic hands we have over the next several months.

At every board meeting we have, we do consider what we might do with that cash and certainly one of the issues that gets regular consideration is the potential use of that cash for repurchasing shares. The board in previous meetings has deferred that issue. I can’t speak in terms of how we might look at that issue going forward. We certainly are in a position to assess options beyond the repurchase of cash in terms of its uses and I would say right now the board’s general disposition has been to be quite conservative to really assess what the circumstances are out there and how the economic conditions may further deteriorate but certainly potential share repurchases will continue to get reviewed.

Alan Gould - Natexis Bleichroeder

Okay. Thank you.

Operator

Our next question will come from David Miller with Caris & Company.

David Miller - Caris & Company

I will also try to stretch it to two, if that’s okay. First of all, is it Ann or Anna? I’m sorry, is it Ann?

Anna Brunelle

Anna.

David Miller - Caris & Company

Anna, sorry about that -- the margin per sub figure of $10, so gross profit was $34.6 million. I think that’s a 12% growth rate year over year, a very nice performance for you guys. That equates to margin per sub of $10 even. Is that a record for the company?

Derrick Nueman

David, why don’t we get back to you on this question offline?

David Miller - Caris & Company

Okay. Second question then is can EchoStar appeal any ruling from the February 17th and 18th hearings and stretch this further into 2009?

Thomas S. Rogers

Matt Zinn, our General Counsel, is on the line with us and Matt, I will hand that over to you.

Matt Zinn

Of course they can appeal anything and everything that they wish and we would expect them to do so if it’s an adverse ruling. But I mean, that’s the way the legal system works and we will continue to plug on and persevere and we expect the damages will accrue at a healthy rate and interest and penalties, so we’ll go forward from there.

David Miller - Caris & Company

Okay. Thank you.

Operator

Our next question comes from Lee Westerfield with BMO Capital.

Lee Westerfield - BMO Capital

Thanks, everyone. Two questions from here as well, if I may, but the first -- and if I missed it in your opening comments, Tom, I apologize but if you can make some comment about where the deployment with Cox currently stands and additionally, what if we can get in a little more specific terms what your holiday expectations are for TiVo owned HD [series threes] in whatever way you want to try to frame that expectation.

Thomas S. Rogers

All right. Thanks, Lee. First let me just amplify Matt’s comments a minute ago -- obviously EchoStar can appeal what it chooses to appeal. The bigger issue there is what tolerance the appeals courts will have for continuing to stay an injunction during the course of any appeal and of course, we will pursue with great aggressiveness the resolution of these issues in a way that hopefully will lead to the imposition of the injunction but I just wanted to make clear that the right to appeal is not one without the ability of the court to handle this situation and bring it to ultimate resolution.

In terms of Cox, Cox is currently planning to be in non-employee households on part of the latest stage form of test trials some time in the next couple of months. There are a whole series of trials that you get through, the last of which is actually getting it into non-employee Cox subscriber homes before release to the public and that’s the phase they are looking to be in in the next couple of months, so we are feeling good about the pace at which Cox is continuing to look to roll out.

In terms of holiday expectations, you know, the issue of what is going to happen to holiday sales for all, particularly as it relates to consumer electronics, is a big question mark, given the macroeconomic environment. I am sure most of you saw what Best Buy said publicly a couple of weeks ago and in terms of their view of the broader environment as it would relate to consumer electronics expecting 5% to 15% year-over-year declines. You know, Best Buy of course is our major distributor. Circuit City, which was our second-largest distributor, is in bankruptcy and as we noted, that certainly creates certain challenges.

On the other hand, we are attaching ourselves to certain trends which we hope will allow us to deal with these cross currents better than some. Certainly the HD TV trend, which will not be as a robust one as a result of what is going on in the macroeconomic environment but should continue to be a trend with some legs and Best Buy, as we noted, is trying to significantly promote the savings that they are making available to buyers who buy an HD TiVo with an HD set, so that is something that we are hopeful about and of course, beyond that just the whole in-home entertainment trend, people saving money, going out less, spending less money in out-of-home entertainment and looking to increase their in-home entertainment options. Certainly TiVo is a very cost-effective way to get literally millions of options, particularly in the film area where there’s just about anything you can imagine, we can now provide an ability for someone to get at their television set at home and messaging the many ways that TiVo can save you money, from saving you money on your cable bill to saving you money on entertainment that would cost you much more if you were to go out, is going to be a critical part of our marketing messaging during the quarter. So those are the many factors that are at play. How that all comes out, we’re being I think appropriately cautious about as we look to the fourth quarter.

Operator

Our next question comes from Tuna Amobi with Standard & Poor's.

Tuna Amobi - Standard & Poor's  

Great. If I can stretch it out to two as well, if you don’t mind -- so the first question is on Tom, I think you’ve been a big believer in the view that the commercial avoidance thing is of mega proportions. I think you’ve actually compared it to for the video industry in terms of the financial crisis that is rocking Wall Street, so I am just trying to understand if you actually believe that the issue is that big and when you spoke to the [4-A] audience, what kind of push-back did you get in terms of that issue?

And separately on the question of the accounting for the litigation, Anna, first I want to congratulate you on your new role. I guess this question is for you -- I was trying to parse your comments in terms of the accounting for that, so in terms of the $88 million, what portion of that was actually used to offset some of the legal costs that you had already cumulatively spent on this litigation? And on the tax part of that same number, what amount of NOLs that you alluded to was used to offset some of that tax liability? So I am basically trying to put some numbers around that. Thank you.

Thomas S. Rogers

I’ll take the first question and then I will hand it over to Anna. On the commercial avoidance issue, we have the data that makes it very clear that with DVR in the household, the amount of television viewing that takes place while viewers are avoiding the commercials. If you have a DVR or you have a TiVo, you’ve experienced this yourself, we -- in the advertising industry, they are among the first to admit that that’s how they watch television and therefore have no problem understanding that that’s how others watch television.

The issue of how big this problem is for the media industry comes down to how much DVR adoption you think there is going to be in the next two to three years, because we know what the behavior is and the question is how big a chunk of American television households are going to have DVRs.

The projections on that are -- revolve around numbers that get you to $50 million and above by a number of analysts in the next few years and consequently I do believe that the crisis that is going to create for networks and advertisers is quite enormous. It’s not hard to see that two-thirds of the households that advertisers most care about reaching will be avoiding the majority of the commercials that are otherwise being transmitted to their television set. And that is why we said in very stark terms as difficult as this financial crisis is going to be for the media industry, the crisis that is coming up behind it is going to be even more significant.

What I analogize to the financial crisis that we are dealing with is that there were elements of the financial crisis that many didn’t see coming. But the advertising crisis we pointed to is crystal clear -- the data is right there. It’s staring us all in the face and therefore nobody really has an excuse to think this is something that came up from behind and bit them. It’s all very clear for the world to see.

So our role is increasingly to evangelize based on very clear data that this is something that has to be dealt with and not only does that mean arming yourself with the data to be able to understand what is going on and also what works and what doesn’t work in this environment but using the advertising solutions which are geared toward getting ads through to viewers who would otherwise look to avoid commercials in the normal context, and both of those are key messaging backbones of our advertising and audience research business.

On the accounting area, Anna.

Anna Brunelle

Sure. The EchoStar award was $104.6 million in total, of which we have recorded $87.8 million in damages to operating expense and $16.8 million in interest to interest income. And then on top of that, we recorded a tax expense of $3.1 million. So the total income statement impact was $101.5 million, of which the interest and tax expense are stripped out for EBITDA purposes, such that the EBITDA impacted only the $87.8 million in damages.

Thomas S. Rogers

So you can see the effective work of our NOLs there in terms of the resulting tax liability.

Operator

(Operator Instructions) Our next question comes from James Dobson with Stanford Group. Mr. Dobson, your line is open. I think Mr. Dobson has hung up. (Operator Instructions) We have a follow-up question from David Miller with Caris & Company.

David Miller - Caris & Company

I just wanted to get my head around once again why there was such a decline in the hardware sales year over year. Did it have to do mostly just with the overall macro backdrop or was there something going on with the Australian business that you guys didn’t address in your prepared remarks? Thanks.

Thomas S. Rogers

Well, hardware sales are mostly a function of what we sell into the channel in a given quarter and we have been controlling the inventory that we sell in much more tightly, given the situation of just the question mark surrounding the consumer spending environment and the macroeconomic environment generally, so we sold in less into the retail channel. We’ve been controlling our inventory situation. You can see how inventories were reduced. Ending quarter inventories were reduced year over year. We continue to control that situation tightly. We’ve gotten even better at understanding the time cycle from order to manufacturing to ship into the channel and so what you are really seeing there is a reflection of those practices.

David Miller - Caris & Company

Okay. Thank you.

Operator

We have a follow-up question from Alan Gould with Natexis.

Alan Gould - Natexis Bleichroeder

Thank you. Tom, are you going to temper your marketing spend and be a little bit more cautious with your SAC in the Christmas quarter than you normally would have been, given the economic environment?

Thomas S. Rogers

We have been, as you well know, pulling back on our SAC generally. I would say that the fourth quarter is one that has some seasonal increase, obviously. There will be some seasonal increase this quarter. The issue of its impact on SAC comes down to what the ultimate sales we get from those expenditures are and they are always somewhat difficult to predict. They have become more difficult to predict in this quarter, so we are certainly looking to limit our marketing expenditures, what the resulting SAC impact of that will be will be a function of how this holiday season plays out, which is a bit too early to tell. We do know that we were tracking quite well in the first six weeks of the quarter in terms of our year-over-year sales and in the last six weeks as the economic crisis began to unfold, sales began to substantially decline so we are being appropriately cautious with our own experience and Best Buy’s cautiousness and what is going on with Circuit City but again, the full impact on SAC will be a function of what those numbers end up being.

Alan Gould - Natexis Bleichroeder

Okay, thanks.

Operator

We have a follow-up question from Tuna Amobi with Standard & Poor's.

Tuna Amobi - Standard & Poor's  

Great. Just a quick question, Tom, on the hotel deal with Morgans Group. I was wondering if that is something that you expected incremental and how that might perhaps be accounted for when you get some traction, or if it’s primarily a promotional avenue for you?

Thomas S. Rogers

No, there is economic value to our distribution and it does open up a new distribution channel for us. It is something that we are looking to expand beyond that. We are very proud to be involved with Morgans, which is really a truly leading boutique firm which we felt would be a great way to start this out. And it was structured in a way that goes beyond the promotional elements.

Tuna Amobi - Standard & Poor's  

Great. Thank you very much.

Thomas S. Rogers

Well, if there are no further questions, I will just wrap up briefly. It is worth noting, particularly against the backdrop of tough economic times, that this was TiVo's most profitable quarter ever, that the financial profile we have in terms of no debt and $200 million in cash and the considerations that we will continue to make relative to the use of that cash puts us in a very strong position. I think that when you even strip away the award that we got this quarter, our improvements in our operating profile, particularly when you just look at our operating cash usage over the course of the -- comparing last year to this, through the first three quarters of the year, we have improved our cash flow from operations by about $46 million, which speaks volumes about our control of expenses, in addition to the work that we did last week as we took the lay-off actions that we thought were necessary. With the financial performance of the quarter, again stripping away the effects of the EchoStar award, we beat guidance substantially, both on the net income and EBITDA. We made real progress on the distribution front, with where Comcast indicated it was going to go with rolling out past Boston to one of their huge markets, Chicago and beyond, with putting the DirecTV deal together, which we think will pay substantial fruit starting next year. Even figuring out how to get to media center viewers who watch television through the PC and getting TiVo PC out there and the continued momentum that we are seeing with all kinds of brand players believing that a relationship with TiVo is something that is very important to their own futures as it relates to television, be it Netflix, be it Blackberry, be it Domino’s -- those are the kinds of ongoing rewards for the innovation and pioneering that we continue to do that we continue to see. And to the point of changing consumption in a whole new environment, what we are seeing out there by way of advertising and audience research opportunities with our taking what was already a novel audience research business and being able to provide our customers with a 100,000 sample, 25 times the size that of which they are getting from the leading television research provider, continues to buoy our feelings that we can make a major contribution to the marketing and advertising future that as I said is going to create a real crisis for the industry.

So we are feeling relative to what is otherwise a very difficult economic situation that we are positioned for being able to play out our many strategic hands and have the cash wherewithal to be able to do just that.

I want to thank everybody for joining us today and wish everybody a very, very happy Thanksgiving. Thanks.

Operator

This concludes today’s conference. We thank you for your participation and have a wonderful evening.

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Source: TiVo F3Q09 (Qtr End 10/31/08) Earnings Call Transcript
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