F1Q07 Earnings Conference Call
May 24th 2006, 5:00 pm EST
Marilyn Lattin - Head of IR
Tom Rogers - CEO
Stuart West - Acting CFO
Matt Zinn - General Counsel
Tony Wible - Citigroup
Alan Gould - Bleichroeder
Brian Coyne - Friedman, Billings, Ramsey
Daniel Ernst - Hudson Square Research
Barton Crockett - JP Morgan
Gordon Hodge - Thomas Weisel Partners
Richard Baldry - First Albany Capital
David Miller - Sanders Morris Harris
Rob Sanderson - American Technology Research
Lee Westerfield - Harris Nesbitt
Michael Kelman - Susquehanna Financial
Good day, and welcome to TiVo's first quarter fiscal year 2007 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Marilyn Lattin, TiVo's Head of Investor Relations. Please go ahead.
Thank you, operator. With me today are Tom Rogers, Chief Executive Officer; Stuart West, Acting Chief Financial Officer; and Matt Zinn, General Counsel.
We're here today to discuss TiVo's financial results for the period ending April 30th 2006, which is the first quarter of fiscal year 2007. About an hour ago we distributed a press release detailing these financial results. We have also released some visuals designed to guide you through the call.
Additionally, within a few hours, we will release a recording of this call, both in a streamlined on-version format and through a downloadable MP3 podcast. You can access all of these through our Investor Relations website. The prepared remarks will last about 40 minutes, and then we will leave the remainder of the call for questions and answers.
Before we begin, I'd like to note that our discussions today will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that relate to TiVo's future financial results, partnerships, products, and other factors that may affect future earnings or financial results. You can identify these statements by the use of terminology such as guidance, believes, expect, will, or similar forward-looking terms. You should not rely on these forward-looking statements, as they involve risks and uncertainties that may cause actual results to vary materially from the forward-looking statements.
We describe these risks in TiVo's recent SEC filings, including our annual report on Form 10-K and our quarterly report on Form 10-Q. I'd like to note that any forward-looking statements made on this call reflect analysis as of today, and that we have no plans or obligations to update them.
I will now turn the call over to Tom Rogers.
Thank you. Good afternoon. Thanks for joining us today to discuss TiVo's fiscal first quarter 2007 earnings. Today I will discuss the following topics: I will provide an overview of the highlights of the quarter; I will then provide an update on our sales and marketing efforts; I will discuss our continued progress differentiating our product with new and innovative features; I will talk about distribution and our plans with MSOs and then about some of our initiatives in advertising; I will give an update on the recent lawsuit victory against EchoStar; and, finally, I will turn the call over to Stuart West for a detailed discussion of the quarterly financials as well as our guidance for Q2 '07. We will then take your questions for the rest of the time allowed.
TiVo continues to make progress in a number of areas, some of which is evident in our first quarter performance. While we are generally pleased with the effort, and our results are tracking nicely against our internal plans, we fully recognize that there's still a lot of work to do to overcome some of our marketplace challenges. We are fully committed to this task.
We continue to be the only brand of any significance in an industry that is exploding in growth, estimated to grow from 13.7 million DVRs today to over 54.7 million by the end of 2010, according to Jupiter Research. TiVo stands for, by far, the best DVR functionality, providing the best way to watch television there is.
When it comes to our standalone retail growth, we're the only answer for analog cable subs. There is no other significant DVR available without becoming a digital subscriber.
When it comes to the higher-end digital subs, we are putting in place a world of direct delivery of broadband video to the television set in ways that other DVRs will not address.
When it comes to our mass distribution business, we have unshackled our growth by eliminating the need for dedicated hardware. With Comcast and other cable operators we are looking to sign up, we are a software upgrade that transforms the generic DVR into TiVo.
Because of that, we are actually very excited by the number of generic DVRs the cable industry is looking to roll out, because each of those boxes, as additional cable deals are done, becomes a potential TiVo home with both a subscriber and advertising revenue elements. This creates a powerful business model, beyond the one that exists for our standalone retail business.
Just like HBO cheered on basic cable connections as the key to opening up more homes for their premium service, we, too, view the increase in the number of households taking generic DVRs as a significant new opportunity for us.
This quarter was marked by a very high degree of activity on all fronts. TiVo demonstrated its leadership position across the board, including intellectual property, interactive advertising, distribution partnerships and alliances, digital device integration, and broadband video distribution. I will provide you with some detail on these over the course of my comments.
Looking at the financial highlights for the quarter, we reported higher revenue and a smaller loss than we had anticipated. Our service and technology revenue, which includes recognition of Comcast development revenue, was up 38% year-over-year, and 17% sequentially.
As to our subscription base, at the end of the first quarter, total cumulative subscriptions were just over 4.4 million, representing 33% growth over the first quarter of last year. We had a net gain of 51,000 TiVo-owned subscriptions during the quarter. In the first quarter we added 91,000 total standalone or TiVo-owned gross subscriptions.
We also saw strong momentum with accessory sales, selling out our TiVo-branded wireless adapter inventory within the first two weeks of the quarter. We expanded distribution through retail, and continue to see strong sales of this high-margin item.
I am pleased to note continued progress on our efforts to regain sales and marketing momentum. For the second quarter in a row, we showed a sequential improvement in year-over-year trends in gross adds. The third quarter of last year was 23% below the third quarter of the prior year with respect to gross sub adds. The fourth quarter of last year was 20% below the prior fourth quarter, while the first quarter of this year improved to 13% below last year.
With the introduction of our pricing plans and new offerings, including our dual tuner product, we believe that we will continue to show momentum in these year-over-year comparisons.
Now I'm going to update you on our sales and marketing efforts. We continue to refine our marketing programs to drive subscription growth, ensure that the value of each sub that we bring on is higher, and improve our ability to reach new consumers online.
However, we continue to keep our consumer advertising powder relatively dry until we develop the most effective way to drive a higher volume of subscription acquisition. In this regard, we also recognize that we must work on the challenge posed by our currently having a totally different pricing scheme online versus what is available in retail.
We rolled out new bundled pricing halfway through the quarter in our online channel through TiVo.com, offering two new options different than how TiVo is sold at retail. One optional allows for paying nothing up front with a higher monthly fee, depending on the number of years for which a subscription commitment is made. The other allows for paying up front for one, two, or three-year subscription and includes the box.
As a result of the new offer, with the same level of online media spend, we saw traffic to our main purchasing page of our website increase by more than 50%. Results are not conclusive, but we did see online sales grow as a percentage of our overall sales. The 29% of online sales as a percent of total sales is even higher than the high level of 27% of total sales achieved in Q4.
An interesting point is that we are beginning to see more diversity in our subscription base thanks to our new pricing. We are seeing an increase in somewhat lower-income customers which, as you know, is a key target for our standalone sub growth because we are the only real DVR offering in the analog cable household market.
The combination of new pricing and the new dual tuner product increased online sales toward the end of the quarter, up significantly from what we were seeing prior to the new pricing going into effect. That trend continued to hold during the month of May.
As a reminder, our online sales drives increased value for TiVo in two respects: an increased number of sales where there is not a retailer margin; and secondly, where the revenue per sub on these new zero-up-front pricing plans increases the net present value of the subs over previous levels.
As I have mentioned before, the critical improvement in the quality of our subscription base is driven by the fact that all new subs are on a minimum of a one-year contract. This is contributing to our standalone churn rate declining 0.5%, yet still rounding to the already low 0.9% per month.
The next topic I want to discuss is product differentiation. We continue to offer a number of major features which are truly differentiated from generic DVRs in the market. At the end of April, we announced the launch of the TiVo dual tuner DVR. This is the first standalone dual tuner DVR with TiVo service and features. We have seen a promising early response from customers to the product. Frankly, I wish TiVo had had this product out in the market earlier, given the fact that it is a critical feature to consumers, but I am glad that we have it out there now. We look forward to the introduction later in the year of our high-end, high-definition multi-tuner unit.
A truly critical differentiating feature we announced this quarter is TiVo KidZone. Currently on track to be available in June, TiVo KidZone will launch with the support of Commonsense Media, the Parents Television Council, and the Parents' Choice Foundation, three leading children’s television groups that between them, have members in excess of 4 million. By providing concerned parents the freedom and flexibility to choose specific television programming appropriate for their families, TiVo KidZone creates the first real answer to the 50-year-old question of how to provide the right television environment for children in the home.
When we announced this new feature in Washington, it received loud praises on both sides of the aisle, ranging from the Republican Chairman of the House Subcommittee On Telecommunications and the Internet, Representative Fred Upton to Democratic Senator Barack Obama.
This week we launched TiVo Guru Guide recommendations, an exclusive feature for TiVo subscribers that allows users to discover exciting programming and automatically record shows based on recommendations from editorial experts at some of the nation's most authoritative brands. Sports Illustrated, Star Magazine, Entertainment Weekly, Automobile, Billboard, and other leading brands will offer program recommendations based on popular television categories.
Each TiVo Guru Guide offers several hours of programming per week and are updated at least once per month to ensure that subscribers always receive the freshest, latest and most interesting program recommendations on television.
TiVo will increasingly stand for the key way to bring broadband-delivered video to the TV screen. We recently announced an agreement that will enable broadband video published through Brightcove to be distributed directly to TiVo subscribers. Through this new partnership, the process of delivering Internet-based video to TiVo users will be significantly facilitated. Brightcove and TiVo plan to phase in a number of content partners and new downloading capabilities.
The partnership will provide a method for many publishers of broadband video to distribute content to TiVo subscribers. It also opens the possibility of monetizing the distribution through advertising, subscription plans or pay-per-view. Initially, all content will be offered for free to TiVo subscribers and may carry advertising within the content.
Again, where TiVo will clearly make its mark in this area is taking the Wild West of web video and bringing it to the television set, thus making all those options as easy to record and navigate as any prime-time television show.
We also announced earlier in the quarter an agreement that will continue to differentiate TiVo from its competitors when it comes to integration with other digital devices. The agreement will allow Verizon Wireless to debut the new TiVo Mobile application that lets TiVo subscribers schedule recordings directly from their mobile handset. This partnership allows the growing base of TiVo users to integrate control of their TV life with the most widespread piece of consumer electronics, their cell phone.
Next, I want to discuss our distribution developments. Regarding our DIRECTV relationship, as many of you know, last month we signed an amendment to our existing agreement with DIRECTV, extending the service commitment to our existing DIRECTV-TiVo customers for three years beyond the end of the current agreement in February '07. We are pleased to have reached this agreement, which will allow to us continue to provide our service to approximately 2.9 million DIRECTV-TiVo subscriptions. This amendment with DIRECTV reflects TiVo's popularity among their subscribers, and, importantly, respects the value of our intellectual property as well.
As to Comcast, we continue to work toward the commencement of a rollout at the end of the year. We are satisfied with our progress, and believe we will be able to take the development work from this project and apply it to the development agreements we are currently negotiating with other MSOs. In addition, the strides we are making in very substantially differentiating our product from generic DVRs are also contributing to the progress being made in those discussions.
As we had previously spoken about, starting later in the year RadioShack will be offering TiVo units in its stores. This is a great family-oriented environment for potential subscribers to learn about the TiVo product and specifically, the KidZone feature. We expect to be in around 3,000 stores by mid to late summer. Adding these stores substantially increases the number of storefronts offering our standalone TiVo DVRs.
Now, I want to update you on our initiatives in advertising. We have a very substantial momentum with advertisers. TiVo has just announced a comprehensive advertising deal with one of the world's largest advertising holding companies, Interpublic Media. This clearly demonstrates the perception among ad agencies that there is a high enough demand among multiple clients for advertising inventory on TiVo to justify putting in place agency-wide deals.
In addition, we launched TiVo Product Watch, with 100 brands and 75 advertisers -- many of whom had never advertised on TiVo before -- opening up possibilities for multiple new advertising relationships. With this service, TiVo is leading the way in terms of what advertising is going to be like in the future. At launch General Motors, Sony Pictures, Lending Tree, and Kraft Foods will be included as the premium advertisers for their respective advertising categories.
We are continuing to create new forms of advertising inventory. We have gone from new ways of providing long-form material and tagging of commercials to quite revolutionary techniques so that television can be used as a product search tool.
Moreover, we have created advertising options where the content can be manipulated by the consumer, creating a whole new level of interactivity. As an example, we announced the Lexus Car Configuration Tool, which allows viewers to build their own car on the television set and opens up a whole new world of advertising possibilities.
Moving to the litigation front, as you are well aware, the almost $74 million jury award in the EchoStar trial was an important decision for us, as it recognizes that our intellectual property is valuable and provides further incentive for other companies to enter into commercial arrangements with TiVo, in addition to the other benefits TiVo has to offer. We are actively pursuing damages for willfulness, as well as an injunction. There is no indication as to when the judge will rule, but we have a high level of confidence in our ability to continue to prevail at all phases of this litigation.
Our position on the litigation is that we are confident in our case and are going to continue to fight it out in court, where we have been successful thus far. We are aware that we will be met with a lot of spin from EchoStar. Though they may feel that this is an effective way for them to pursue their interest, it has very little to do with the substance of the case.
We do not plan to share our legal strategic thinking or the analysis of this case publicly, but for Q&A, I have asked our General Counsel Matt Zinn, to join us to respond to questions as to where the process currently stands.
So in conclusion, I'll recap the highlights of the quarter. We are make progress in growing our standalone subscriptions, and we are continuing to refine the right sales and marketing approach before we significantly take up advertising spending there.
We continue to differentiate the product in very substantial ways that leave generic DVRs in the dust. We feel that TiVo is well on its way to regaining its mantel as the most innovative Company defining the television landscape. As I stated before, we are rooting for the roll out of generic cable DVRs, as each one in the field creates an opportunity for a TiVo software upgrade.
The momentum on the advertising side is quite significant. We have already booked, year-to-date, more ad revenue than all the ad revenue booked in calendar 2006. We are highly cognizant of the challenges that we have and we will continue to work to overcome them. I hope this gives you some good insight on the significant progress that we made during the quarter.
I will now turn it over to Stuart to provide some details on the financials.
Thanks, Tom. Good afternoon, everyone. As this is my first time presenting on a TiVo earnings call, I'd like to start by thanking Tom and the Board for giving me this great opportunity. I've been here at TiVo in various roles for over five years now and can easily say there has never been a more exciting time for this Company.
There's so much momentum around our business now: momentum in the television industry around distribution of DVRs, momentum in the advertising community around our new highly-targeted capabilities, and momentum within TiVo around new service and product offerings.
Equally important and particularly relevant from my role is our growing financial momentum, as our recurring revenue base and new subscription additions continue to demonstrate the strength of our business model. This kind of across-the-board momentum puts us in a great position to attack wide-ranging challenges we face as we build TiVo's role in the television and video entertainment industries.
With that aside, on to my comments for the quarter. I'll cover three topics today: first, I'll address a few housekeeping items related to this quarter's results; second, I'll touch on select financial and operational highlights; and, finally, I'll provide some guidance on our expectations for Q2.
Let me start with a few housekeeping items. Please turn to Slide 12 to see a summary. First as expected, we implemented FAS 123R during the quarter. As a result, we began expensing the fair value of stock options granted to employees. During Q1 this effect was approximately $3 million.
Second, as mentioned when we gave guidance in March, we made a voluntary change in accounting policy during the quarter to reflect across the board expensing of hardware costs associated with our bundled pricing plans. We did, however, end up with a different accounting treatment than anticipated in March.
Here's a recap. Last year we started offering bundled pricing, in which consumers pre-paid for both the hardware and service. Because we received cash upfront, we amortized the recognition of the hardware expense over the contract period. This quarter we began offering new bundled pricing plans that involve zero upfront payment.
For these plans, we believe it appropriate to expense the related hardware costs immediately. This created an inconsistency, in that we deferred hardware costs for pre-paid plans but expensed them for zero upfront plans. To resolve this, we made a voluntary change to account for all bundled plans on a most conservative basis, expensing the cost of hardware.
When we gave guidance in March, we mentioned the potential of taking the cumulative effect of this change as a write-off during Q1. Upon further review, we and KPMG determined that we should apply a recently-issued accounting standard, SFAS 154, which calls for the retrospective application of these kinds of voluntary changes in accounting policy. As a result, we did not take a charge in Q1 and instead have reflected the impact of the accounting policy change in our historical financials. The total effect of this was $2.6 million, which affects primarily Q2 and Q4 of last year.
One notable result to this change in policy is that our net income in Q2 of last year, when adjusted for comparison purposes, will go from a slight positive to about $1 million negative. It's also worth noting that this shift in treatment of the accounting change is part of the reason that net loss this quarter came in better than the guidance we gave in March.
On to the third and final housekeeping detail. As we had previously disclosed, we passed an important milestone with Comcast during the quarter when we signed the statement of work related to our advertising platform. For the past few quarters, while we have been doing development work, we have deferred both the revenues and costs associated with our Comcast relationship. Now that we have finalized the details of this additional work, we can recognize these items.
As with some of our development projects, this effort will be accounted for on a zero-margin basis during the first few years of intensive development work. As a result, during Q1 we recognized approximately $7.2 million of technology revenues and $7.2 million of cost of technology revenues. Of that $7.2 million, $4.6 million related to work performed in prior periods, while $2.6 million related to work performed during Q1.
With those housekeeping items aside, I'll turn to my second topic for today and comment on a few of the more important financial and operational metrics for TiVo. Please turn to Slide 13. As you can see, Q1 was another significant quarter of improvement in service and technology revenues. In Q1, service and tech revenue was $55 million, an increase of 38% compared to $40 million in Q1 of last year, and up 17% sequentially. The two drivers of this increase were the growth in our sub base and the Comcast revenues I just mentioned.
Spending on sub acquisition was $21.1 million, versus $15.6 million in Q1 of last year. This total consists of sales and marketing expenses, rebates, revenue share, and other payments to channel, plus the profit or loss generated by hardware sales.
Let me remind that you we take a conservative approach to the measurement of our acquisition spending. Our calculation encompasses all of our spending on sales and marketing related areas, including discretionary items like advertising; non-discretionary items, like overhead; and even stock option expenses for employees on our sales and marketing teams. Other companies often exclude these items from their acquisition cost calculations.
There are two items within acquisition costs I'd like to comment on. The first is an accounting-related item from Q1 of last year. As you may remember, last year we experienced lower-than-expected redemption of holiday season rebates that generated a one-time benefit of approximately $5 million. As expected, we did not see a similar one-time benefit in Q1 of this year, due to improvements in our forecasting of rebate redemption rates.
So while a direct comparison to year-over-year results suggests an increase of $5 million in total acquisition spending, when you note this one-time benefit, Q1 was at similar levels to last year.
I should also note that acquisition spending was less than we expected when we gave our guidance in March. This was driven by two factors. First, we shipped less volume of our new dual tuner product into the channel than expected due to a short delay in the timing of retail roll out. As a result, we accrued less rebate cost than expected.
Also, as Tom mentioned, we didn't ramp up advertising expenses of our new packaged bundles as much as we had initially planned to at the beginning of the quarter.
R&D expense was generally in line with last year, especially when you consider option expenses are included in this Q1 number. G&A rose significantly, from $6 million of Q1 last year, to $15 million in Q1 this year. The primary driver of this increase were peak levels of litigation costs related to our trial with EchoStar during March and April. These increases were offset by ongoing efforts to drive cost savings throughout our business. For example, we recently renegotiated and extended our largest real estate lease, and I'm pleased to report we achieved expense savings of about $1 million per year.
Net loss for the quarter, as you can see on the slide, was $10.7 million. We ended the quarter with approximately $92 million of cash and investments. We do remain comfortable with this cash balance in light of our anticipated growth and cash flows going forward.
Now let me move on to a discussion of some of our key operating metrics. Please turn to Slide 14 for a summary. In Q1, we added 91,000 total standalone, or TiVo-owned, gross subscriptions. For the second quarter in a row, as Tom mentioned, we improved the year-over-year trend in gross sub additions. Standalone churn was 0.9% per month, for a total of 40,000 subs during the quarter. The combination of gross adds and churn resulted in a net gain of 51,000 new TiVo-owned subscriptions.
With our DIRECTV sub base, we are seeing the trend we expected. We continue to add a small number of new DIRECTV sub additions, primarily those using the TiVo high-definition product that is current DIRECTV's only HD DVR. However, churn on the DIRECTV sub base was roughly equal to these new additions, leading to a small net gain of new subs of 2,000 in the quarter.
Our acquisition spending per gross add, or SAC, was just over $230 in the quarter, compared to $150 last year. This increase in year-over-year SAC can be attributed to several factors. First, last year's Q1 had the one-time benefit of the $5 million rebate reversal I just mentioned. That reduced SAC by just under $50. The remainder of the increase results from the higher per-sub acquisition cost associated with our new bundled pricing plans.
Now let me discuss average revenue per unit, or ARPU. Before I get into the specifics, let me take a moment to address an important point around seasonality. As you know, ours is a seasonal business, due to the tremendous popularity of the TiVo service as a holiday gift. This seasonality has a well-known impact on our subscription additions, but there are other seasonality effects as well.
Advertising revenue, for example, follows the patterns of the broad advertising industry, with a peak in Q4 and a drop in Q1. As you know, we include advertising revenues in our ARPU calculations, because they are a core part of the value generated by our subscription base. Because of the rapid growth in our advertising revenue, this seasonality effect will have an increasingly noticeable impact on Q4 to Q1 sequential ARPU trends.
Here's some detail. TiVo service ARPU was $8.54, a sequential decline from $8.82 in Q2 of last year. In addition to the effect of advertising revenue seasonality I just mentioned, our recently-canceled product lifetime pricing option contributed to this decline.
Just over four years ago, we had a strong holiday season, which included a large number of lifetime sub additions. In the spring of 2001, we also saw a spike in lifetime sub adds just prior to an increase in lifetime pricing we rolled out at that time.
The effect of these two items four years later was an unusually large number of lifetime subs reaching the end of the four-year period over which we amortize lifetime fees. This increase in lifetime subs that passed the four-year mark, and therefore generate no revenues, contributed to lower ARPU.
DIRECTV ARPU was $0.93 for the quarter, a sequential decline from $1.14 in Q4 of last year. In addition to the effect of the advertising revenue seasonality, our recently-signed contract amendment with DIRECTV had an accounting impact which contributed to the sequential decline. While DIRECTV is paying us the same monthly fees going forward, we do have certain additional maintenance obligations under the new deal.
We are taking a conservative approach to the accounting here, and deferring a portion of the monthly fees until the end of the relevant maintenance period. I want to point out that the factors contributing to these declines in ARPU are largely seasonal or accounting-driven in nature.
There are other important trends that we expect to drive cash and improved ARPU during the upcoming year. For example, our new pricing plans should drive increases in standalone ARPU. Most of the subs added through our online channel, which Tom discussed, drove 29% of sales during Q1, were at an ARPU higher than $12.95, and we expect this group of subscriptions to grow significant over the next few quarters.
Additionally, our advertising business is posting impressive year-over-year gains in revenues, and we expect this trend to drive additional ARPU increases, both for standalone subs as well as DIRECTV subs during the year.
Now, I'll address my third and final topic, our expectations for Q2's financial performance. Please turn to Slide 16. We currently expect service and tech revenues of $50 million to $53 million in the second quarter. Unlike Q1, we do not expect a lump of technology revenues from our Comcast development program, and more broadly, expect to see smoother revenue recognition from this contract during the year.
We currently expect a net loss of $12 million to $15 million. This expected net loss includes the anticipated effects of rebates surrounding expanded retail channel distribution of our dual tuner DVR; higher marketing spend, driven by the impact of new pricing models; expensing of stock options; and costs resulting from our ongoing patent litigation.
While we do not give subscription guidance, I will remind that you Q2 is typically among our slowest sub growth quarters each year. As Tom mentioned, we have seen a few quarters now of improving year-over-year trends, with just a 13% decline in year-over-year gross adds in Q1. While we do not expect to exceed our gross add performance of last year, we do believe that with the consumer demand for our new bundled pricing plans and the recent introduction of our dual-tuner product, we will continue to see momentum in these year-over-year comparisons.
On DIRECTV subs, we expect to see negative net adds each quarter, as DIRECTV'S focus for new deployment continues shifting to other DVR platforms.
I'd like to close with a comment on the evolution of the TiVo business model. You have heard from Tom that we have made progress on many different fronts. The changes he's walked you through have an important and deliberately crafted impact on our business model. With bundled pricing and service contracts, we drive higher ARPU and reduced churn, resulting in a higher net present value per subscription. By improving product differentiation, we increase market penetration and drive pricing leverage.
With our cable distribution software model, we eliminate the need for capital-intensive, low-margin hardware sales and provide extensive distribution for advertising. With a renewed DIRECTV agreement, we provide significant cash flow for the next four years. With our high margin advertising revenues, we drive increased ARPU and margin. Finally, with our jury victory against EchoStar, we provided a convincing demonstration of the strength and value of our intellectual property portfolio.
These are just a few of the examples of how we are driving improvements to our business model and positioning TiVo for long-term success. I look forward to reporting back to you on our progress throughout the year.
That concludes my prepared remarks for today.
Thanks, Stuart. I am sure there are a lot of questions on the patent litigation, so as we move to Q&A now, I'd like to help guide this part of the call by having Matt Zinn, our General Counsel, first put this area in some context for us.
Thanks, Tom. Good afternoon, everyone. As Tom said earlier on the call, we are confident in our case. We are pursuing enhanced damages for willfulness, supplemental damages for ongoing infringement, prejudgment interest, and an injunction. We do not think it is wise to publicly share the details of our strategic thinking about this case. I will, however, give you a sense of the process that we expect to unfold in the coming weeks and months.
The judge has scheduled June 26th through June 28th for a bench trial on EchoStar's remaining defenses, including inequitable conduct and a hearing on other issues such as the amount of prejudgment interest; supplemental damages and enhanced damages; whether EchoStar will be required to pay TiVo's attorneys' fees; and an injunction. We are filing for enhanced damages tomorrow, and I will speak to the injunction request in a moment.
At that time or sometime thereafter, the judge will enter judgment. If judgment is entered for TiVo, at that time or sometime thereafter, the judge will then rule on the injunction.
EchoStar can also be expected to appeal any judgment for TiVo to the United States Court of Appeals for the Federal Circuit. The appellate process includes briefing by the parties, followed in most cases by a hearing and then a decision. The appeals process typically takes 18 months, but your actual models may vary significantly.
Earlier this month, the Federal Circuit issued a ruling addressing the Court's order for EchoStar to produce certain documents to TiVo. We have witnessed a huge amount of spin about this ruling by our opponent concerning the preclusion of evidence at trial. This order concerned a relatively minor procedural issue, which we won and we believe has no impact on the jury's verdict or is likely to result in a new trial.
Having said that, here are the facts. The Federal Circuit did not issue any ruling about any evidence EchoStar wanted to introduce at trial but that the judge disallowed. Rather, the ruling addressed whether EchoStar improperly withheld documents. The Federal Circuit agreed with the District Court that at least some of the documents that EchoStar withheld should have been produced, meaning the Court ruled that EchoStar did improperly withhold documents from TiVo.
As a result, on May 19th, 2006, EchoStar produced to TiVo many of the documents that it had been wrongly withholding. We believe that EchoStar's mischaracterized the Federal Circuit's ruling, but more importantly, we do not believe that it will have any impact on the jury's verdict.
Now, as many of you know, EchoStar filed with the United States Patent and Trademark Office to re-examine the TiVo patent at issue in the litigation. We are pleased to state that the Patent Office issued its first office action re-examination. The patent office re-examined all 61 claims set forth in our patent, confirming the validity of most of the claims, including two of the claims that EchoStar has been found to have willfully infringed, and rejecting some of the other claims. In the office action, the Patent Office expressly rejected all of the invalidity arguments put forward by EchoStar.
Now the next step in the re-examination process provides TiVo the opportunity to discuss and distinguish the prior [art] relied upon by the Patent Office as to the rejected claims and to present new claims. This is not an opportunity the patent holder gets until the Patent Office issues its office action. EchoStar is not permitted to participate further in the re-examination proceedings.
In other words, with respect to the claims re-affirmed by the Patent Office this is the end of the process and EchoStar has no right to appeal.
With respect to the rejected claims, this is the beginning of the process which now affords TiVo the opportunity to participate and discuss the prior [art] with the Patent Office. Patent claims that come out of re-examination are often stronger than before, since their validity has been re-affirmed over the additional prior [art]. Importantly, even if the Patent Office were to make a determination final with respect to the rejected claims -- which we believe will not be the case after we have the opportunity to respond -- TiVo believes that such a determination should not impact the jury verdict against EchoStar given that the Patent Office confirmed the validity of two claims of our patent that the jury found were willfully infringed by EchoStar.
Now to the injunction. After the bench trial, if the judge rules in our favor, at that point judgment should be entered for TiVo. TiVo believes that if judgment is entered for TiVo, TiVo will be entitled to an injunction. In light of the recent Supreme Court decision in eBay versus MercExchange, we think we have a compelling set of facts for the issuance of an injunction under the four-part test laid out by the decision and there's now Supreme Court law in support of our case for an injunction. TiVo further expects that EchoStar will seek a stay of any such injunction pending the outcome of the appeal. This is an issue to be addressed by the Court.
On Monday, TiVo filed its request for a permanent injunction. Specifically, we are asking the Court to order first no more making use, sale, offer for sale, or importation of all products the jury found to infringe, as well as products that are no more than cosmetically different than those products -- in other words, just a change of the DVR name.
Second, to recall all products the jury found to infringe that are sitting at distributors and retailers.
Third, to disable the DVR functionality in all but 192,708 of the infringing units placed with customers. TiVo was awarded lost profits on 192,708 units. As to the other 4,179,253 units, TiVo was awarded a reasonable royalty through the end of March 2006.
So that sums up where we are to date and what we expect to see in the coming weeks and months. We'll now open it up for questions.
Thanks, Matt. Now that we've put some of these procedural developments in context, I just want to say that I think an objective observer can easily see that EchoStar has been making misleading and incomplete statements which totally mischaracterize what has really gone on here.
We will certainly update investors as to material developments as they occur, but we do not plan to respond to each and every misleading PR statement spinning the matter, which in the end, will be decided and fully resolved by the courts.
So with that to help guide questions here, we're on to Q&A.
(Operator Instructions) The first question comes from Tony Wible with Citigroup.
Tony Wible - Citigroup
Good afternoon. I don't know quite where to start, but since I'm pretty certain we'll have legal questions to come, I guess I'll go to DIRECTV. Stuart, in your commentary, I think you indicated briefly, you said you were expecting negative DIRECTV adds. Can you elaborate on that?
A second part of the DIRECTV question is that the $0.93 you saw this quarter is that weighted average number? In other words, if we look to the second quarter and the fact that the DIRECTV was only in part of this quarter, should we see that weight down into the second quarter?
This is Tom. I'll take the first part and let Stuart take the second part. Nothing new in terms of the DIRECTV subscription situation. We've been pointing to for awhile that their marketing efforts are switching to their new platform. Our deal with DIRECTV, of course, covered our existing base of subscribers, so we are continuing to see some sales of TiVo-DIRECTV units, largely high-definition units. Those are, in this quarter, largely offset by churn in the DIRECTV base.
Going forward, we would expect that would continue to be a factor where there's some high-def boxes of TiVo's that are continuing to be sold and continue to see some churn as they move to a new platform.
Overall, we think that will continue to show a decline in terms of any additional DIRECTV subs. We expect, of course, that the substantial base of existing DIRECTV customers that were the subject of our renewal agreement will be intact.
On your question around the going forward ARPU. Tony, as you know, we obviously don't give guidance around ARPU, but I will reference my comment that the ARPU number with DIRECTV is an average across all of our DIRECTV subscriptions of both the fees we get from DIRECTV as well as the fees we get from advertising to DIRECTV customers.
Given the seasonality of our advertising revenues, I think you can probably draw some conclusions about what might happen in the quarters that are coming up.
Our next question comes from Alan Gould - Bleichroeder.
Alan Gould - Bleichroeder
Thank you. I've got two questions, please. First, with respect to the lawsuit, is the Federal Circuit Court of Appeals the last stop? Or after that average 18-month process, could it go further?
Theoretically, it could go to the Supreme Court, but they don't take many patent cases.
Alan Gould - Bleichroeder
Tom, you did reference how the jury victory has helped with you negotiations with other MSOs. Has there been a marked improvement in their receptiveness to your negotiations?
Well, I think the MSOs are looking at a number of factors in terms of our discussions, not the least of which is the brand and increasingly, the number of differentiating features that we are putting forward that distinguish us from generic offerings. Of course, intellectual property is part of that. As the value of our intellectual property is enhanced by the court decision, certainly that contributes to the overall nature of the discussions.
I don't want to characterize the weight of that relative to all the factors but certainly, we view that it enhances the perception of us in terms of why people will look to do deals with us.
Our next question comes from Brian Coyne - Friedman Billings Ramsey.
Brian Coyne - Friedman Billings Ramsey
I was wondering if you could help me think about the Comcast development revenue. Obviously, $7.2 million from them; tech cost of sales also has the amount, so it's a wash. Obviously, everyone sort of looks at you guys on the basis of your hardware revenues and your costs separate from service and technology. Why shouldn't we be doing the same thing with the development revenues?
Brian, I guess it all depends on how you want to look at the business. For us, what's most important is to zero in on the recurring revenues, but we do have a fairly regular stream of revenues that come out of our development work for some of our distribution partners, so we feel like that's an important metric to contribute and consider when you're looking at overall revenues.
Our next question comes from Daniel Ernst - Hudson Square Research.
Daniel Ernst - Hudson Square Research
Yes. Good afternoon. Thanks for taking the call. If you look at the developments over the last few months, a lot of strategic highlights. Maybe you could help us focus in on one or two things that you think have the highest likelihood of contributing to operating results over the next 18 to 24 months. Is it the launch of Comcast? Is it the launch of new pricing plans? Or is it the high likelihood of another MSO deal in that 18 to 24-month period?
Well, I think we have two focal points to our business: one is standalone sales, one are mass distribution arrangements with other distributors. On the standalone sales front, it's a combination of new pricing and packaging options; new emphasis in terms of certain differentiating features and the combination of all of that and how we continue to refine that messaging, which we think is the core of those efforts in driving standalone sales volume going forward while continuing to prove the net present value of a sub is the thrust of one major set of efforts.
The other is the roll out of TiVo across mass distributors. The Comcast development work and the roll out of Comcast beginning at the end of this year is the most critical element in that particular thrust of the business. So between those two areas those are the highlights that we most focus on.
Our next question comes from Barton Crockett – JP Morgan.
Barton Crockett - JP Morgan
A question about the advertising growth. I wanted to first confirm, did I hear you correctly that you said that you've had year-to-date more advertising than in all of calendar '06? I assume you meant fiscal, but just to clarify what I heard there.
Secondly, I guess we have to assume now that advertising is still below the 5% threshold of materiality but probably pretty soon getting to the point where it might exceed that. Can you give us any color on when that might likely be material enough that you'll start giving us what those numbers are so we can get a better read on what's happening with the seasonality that you're describing? Thank you.
Sure, Barton. Let me address both of those. First, I believe what we said is that we have booked more revenue thus far this year compared to last year, and that was a comparison to last fiscal year. That doesn't mean we have necessarily recognized all that revenue, but we have signed the contracts that lead to us believe it's going to happen.
With respect to disclosure, we regularly monitor the appropriateness of our disclosure and think about when is the right time. I don't think we are going to make any predictions about when that may or may not happen, but we will certainly make sure to bring this information out in our disclosure at the right time.
Our next question comes from Gordon Hodge - Thomas Weisel Partners.
Gordon Hodge - Thomas Weisel Partners
Yes, thanks. Good afternoon. This is a follow-up to that last question. Just curious what sort of reach you're selling to advertisers? I assume it's the full 4.4 million deployed units that you have, but I'm curious under the DIRECTV deal, does some of that inventory go away?
Then, with the Interpublic deal, I'm curious how much inventory you sold and if there was any exclusivity involved with that? Then, how you're getting paid, whether it's a CPM basis or a performance-based compensation? Thanks.
Well, in terms of our advertising revenue, we continue to have rights with respect to the sale of advertising the across the DIRECTV sub base, and that element of our deal was part of our deal renewal with DIRECTV. So our revenues are largely a function of selling across our entire base.
I will say some of the newer features that we have introduced, ones that in particular require broadband connectivity in order to make available to consumers are only available on our standalone base Going forward, the more subscribers that connect to broadband, the greater our ability to derive revenue from those features.
With respect to the Interpublic deal that we announced, we haven't indicated the level of revenue that represents. We generally do not sell on a PTM basis. We sell on a basis that involves a number of variables, not the least of which has been, for returning clients, the extent of the effectiveness of our ad sales which they can increasingly measure through the direct response mechanism that we have. I wouldn't characterize them as being priced on a performance basis, per sae, but obviously the effectiveness is one of those variables.
When it comes to one of our new advertising offerings known as Product Watch, where you can download a specific ad that a customer has sought out, that actually will be priced largely on a per-download basis, so there's an element of performance not that terribly different from pricing of certain Internet advertising search-based product that will enter in there. There is nothing from an Interpublic company point of view that has exclusivity attached to it.
Our next question comes from Richard Baldry - First Albany Capital.
Richard Baldry - First Albany Capital
Thanks. If you looked at the G&A line in the quarter, excluding stock comp, it's up about $2 million sequentially and almost double the year-ago level. Assuming some of the sequential is the lawsuit that just got completed, can you talk about what a normalized G&A line should look like on a go-forward basis? Thanks.
Sure, Rich. I think your conclusions are correct, as I mentioned in my comments, that the peak periods of litigation costs around the trial down in Texas really drove Q1's G&A results to be up sequentially and year-over-year.
In terms of a go-forward level, it's somewhat difficult to try and address that without getting too deep into the specifics, but I think if you look back to the period before when the litigation really started to pick up, in Q3 and Q4 of last year, you can get a sense of the kind of G&A levels that are an appropriate baseline for us.
There's been no significant change to G&A other than what we're seeing through our litigation cost. So I think that's the right way to try and do your analysis.
Our next question comes from David Miller - Sanders Morris Harris.
David Miller - Sanders Morris Harris
Good afternoon. Tom or Stuart, of the 53,000 net subs added, 51,000 originated from the standalone side. In last year's Q1, TiVo acquired 72,000 standalone subs on what appears to be 0.6 million less in marketing spending.
So given that, Tom, are you comfortable with the new pricing structure as it stands right now, or do you feel that you have to tweak that given those results?
Remember, Stuart pointed out in his comments that there was a rebate reversal in the first quarter of last year that does not have a comparable element in this year's financials. So in overall total acquisition spending, there was really a relative equivalence.
We did have fewer net subs, but remember net subs is a function of churn and the higher churn is a function of a higher base, where as I indicated, we've actually seen an ongoing improvement in churn reduction.
So the more appropriate measure to look at in terms of subscriber acquisition are gross adds, where the number last year was 104,000; relative to this year, was 91,000, against what was similar levels of acquisition spending. Remember, we spent considerably less than we had planned to, which was one of the key reasons our net income came in where it did on advertising related to our new plan.
So the difference in subscriber acquisition cost was really not in total acquisition spending but in per subscriber acquisition cost, was a function of the zero-based pricing option that we put into place. Obviously with no hardware cost upfront; that involves a higher SAC cost.
What all that means in terms of our new pricing plans is that we have seen some good activity from that, particularly when it comes to people checking it out. We've driven, at the same level of ad spending, relative to prior to the new pricing going into effect, we've seen a 50% increase in the number of people checking out TiVo.com offers and for the service.
We also did see an increase over what was already high levels at the end last year in the percentage of Internet sales compared to our total sales, which is another indication of the strength of our new offerings since, of course, it's only available on the Internet.
I think probably the best measure of how the new pricing is going, was once the dust settled relative to a somewhat confusing period when we first introduced it when our lifetime offering was still available for people who acquired TiVo through retail and created some confusion, both as to pricing and, therefore, somewhat difficulty for us to truly ascertain the popularity of the new pricing.
When that all got sorted out toward the end of the quarter, we were seeing significant increases on the combination of the new pricing with the new dual tuner product. And as I said, that has continued into May. So I hope that puts in context the different pieces you were pointing to there.
Our next question comes from Rob Sanderson - American Technology Research.
Rob Sanderson - American Technology Research
A quick housekeeping and then a follow up. Is it correct that the DIRECTV results this quarter do not yet reflect the new terms of the new deal? When does the new deal kick in?
I can answer that one quickly. The results actually do reflect the economic terms of the new deal. I mentioned in my remarks the idea that we have some maintenance obligations and as a result we're deferring some of our sub fees, even though the cash payments from DIRECTV remain the same. So that amendment went into place, I believe, in mid-April.
Our next question comes from Lee Westerfield - Harris Nesbitt.
Lee Westerfield - Harris Nesbitt
Thanks. Two quick questions, hopefully. First Stuart, could you give us an update about financing alternatives for the new sales initiative, especially as we go into the Series2 and later on Series3 selling seasons?
Secondly, with regard to broadband and broadband video, I guess it's understood, of course, that Ethernet capability is required for the TiVo-owned boxes. What, in the MSO universe for either Comcast or others that might come up in terms of boxes that your software would be installed, what among that universe would have broadband capability to integrate the broadband video and the Brightcove relationship?
I'll take the second question and hand the first one on financing back over to Stuart. We are making available in our feature set, if MSOs should want it, features that will allow for a DVR to accept and display broadband delivered programming.
For the time being, I think it would be unlikely that MSOs will want to see their DVRs serve that kind of function, although that may change over time. There are other elements of the standalone TiVo that provide a richer feature set, with broadband connectivity that don't have to do with the display of broadband video, that we think, very much, will be a part of the MSO TiVo offering.
So when it comes to broadband video and the display of that on TV sets, that, I think, will be a unique feature, for the time being, of the standalone TiVo offering. I think over time, an increasingly important differentiator of the standalone TiVo offering that gives us a lot of new programming opportunities and marketing opportunities that flow from that.
On the financing topic, Lee, I think as you can see from our balance sheet, over $92 million in the bank. At present, we certainly don't view ourselves as being cash limited in any way. As we look at various options for the rest of the year, if we want to put our foot on the accelerator and really drive sub growth at a faster level, we have looked at a variety of options, and, fortunately, we've got a variety to choose from.
I think all I'll say now is that if and when we solidify some plans, both on the marketing acceleration side and on any related financing side, we'll let you know.
Our next question comes from Rob Sanderson - American Technology Research.
Rob Sanderson - American Technology Research
The main question I wanted to ask was just looking back at -- how the quarter trended versus your initial expectation, and if we're excluding the Comcast NRE, it looks like you came in just a hair below the low end of your revenue guidance, which means you probably would have tracked towards the high end of your loss, meaning you significantly beat by about $11 million or so.
Now, Stu, you mentioned the $2.6 million gain from the accounting treatment on the restatement, and you also talked about the timing the on the rebate accounting. Can you refresh us just how the rebate works on the timing of recognition of the costs versus the sub activation?
The second part is we have to assume the rest of the upside came from, probably, lower subscribers. So did you miss your internal subscriber expectations for the quarter? That's it.
Sure, Rob, I'm happy to address that. To hit the mechanics of rebate accounting, the way that works is when we sell hardware into the channel, it's at that point that we estimate the rebate costs associated with those hardware sales.
So what you might see is an increase in rebate expense around the time that we are, say, rolling out a new product or rolling out distribution with new retailers. As I mentioned in my comments, some of our expectations for what would happen in late April were actually deferred just a few weeks, and as a result, that didn't happen in Q1 as we had expected it to. So that was one of the real drivers.
Then in terms of other upside expectations, I think it really comes down to sub growth, and the cost of sub growth. I'm pleased that from the standpoint of our internal expectations around sub growth, we met those; but we were able to do it at a more efficient marketing and acquisition spending level, in part due to some of the rebate issues, but also due to some conscious decisions on our part to spend a bit less on advertising until we optimize our new marketing programs. So that's the other real driver of what was going on there.
Moreover, I think it's fair to say if you take out the Comcast revenue, whether that which is not attributable directly to the quarter, or all the Comcast revenue, that we hit the range of guidance that we had pointed to in terms of overall revenue for the quarter.
Our next question comes from Michael Kelman - Susquehanna Financial.
Michael Kelman - Susquehanna Financial
Thanks. Back onto the Comcast development revenue. I just wanted to get a sense of how much development revenue you expect to recognize from Comcast prior to your launch of the service?
Also, that $2.6 million that was attributed to the current quarter, is that a good run rate to assume going forward?
After your product is launched with Comcast later in the year, will you still receive development revenue, or will all of your economic interests be completely driven by service and then advertising revenue from that product?
Yes, Mike, I can address that. I think the $2.6 million that was related to development work performed in Q1 is probably a good baseline to look at. Certainly it is better than the $7.2 million, which is due to the deferral from prior periods we recognized during the quarter. There's quite a bit of variability, though, in terms of milestone delivery schedules and timing. So you might see that number be within that range to a few million higher as you look at this intensive development period between now and launch at the end of the year.
Once we do launch, the economic interest really becomes more driven by the recurring fees that Comcast is paying us. As you well know and we've talked about in the past, the accounting for complex relationships like this might mean that things are a little bit more complicated than you might think. But, certainly, as we get past the development period and past the launch, we'll try and give you a better sense of what the accounting impact will be.
But, again, your point on the economics is right. The real driver for us at that point is much more around driving deployment and the recurring fees.
Our next question comes from Tony Wible - Citigroup.
Tony Wible - Citigroup
Could you comment on the popularity of the new pricing plans as far as what percentage of the plans signed up are pre-paid versus recurring fee? What was the most predominant length of time that people chose to commit for?
All of our online sales were a function of some kind of bundle, either people buying with the zero-pricing option or people buying with an all upfront option. In addition to retail, when people purchased, they have the opportunity to pay under a contract for a monthly fee or also can obtain an upfront payment or pay upfront across a one, two, or three-year period.
I would say the most popular option is the one-year option, but we'd had a substantial number of multi-year options, where I guess it's fair to say the three-year option is more popular than the two-year option.
Within that, we are looking at how to optimize those plans, how to optimize the approach we take there. Clearly, the upfront buying provides a source of cash for us, which is important and that we like to see, particularly as we've discontinued the lifetime option. It's fair to say that we've had a very healthy showing in the percentage of overall sales that are beyond a one-year commitment.
I think we have time for just one more question.
We'll take our final question from Alan Gould - Bleichroeder.
Alan Gould - Bleichroeder
Yes. With respect to the lawsuit, I believe there were nine patent claims that the jury found EchoStar guilty of; seven hardware claims and two software claims. Which ones were re-examined by the U.S. Patent Office? All nine or just a few of them?
The Patent Office re-examined all 61 claims of the Timer Warner patent.
Alan Gould - Bleichroeder
But with respect to the nine that EchoStar was found guilty of?
They were all re-examined. The hardware claims were rejected, and the software claims were re-affirmed.
Alan Gould - Bleichroeder
Ladies and gentlemen, that does conclude today's Q&A session. At this time, I'd like to turn the conference back over to Mr. Tom Rogers for any additional or closing comments at this time.
I want to thank everybody for joining us. I hope that we were able to give you a sense of the kind of progress that we are making on any number of fronts. We believe that we have some solid momentum here with solid results, and look forward to continue to keep you updated. Thanks, very much.
Ladies and gentlemen, that does conclude today's conference call. At this time we'd like to thank you for your participation. You may now disconnect. Thank you, and have a great afternoon.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!