TiVo Inc. F2Q07 (Qtr End 7/31/06) Earnings Call Transcript (TIVO)

Aug.30.06 | About: TiVo Inc. (TIVO)


F2Q07 (Qtr End 7/31/06) Earnings Conference Call

August 30, 2006 5:00 pm ET


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

Steven J. Sordello - Chief Financial Officer, Senior Vice President

Stuart West - Acting Chief Financial Officer

Derrick Nueman - Investor Relations


Tony Wibel - Citigroup Smith Barney

Alan Gould - Natexis Bleichroeder

Dan Ernst - Soleil-Hudson Square

David Miller - Sanders Morris Harris Group

Barton Crockett - J.P. Morgan Chase

Lee Westerfield - BMO Capital

Steve Frankel - Conaccord Adams

Todd Mitchell - Kaufman Brothers

Rob Sanderson - American Technology Research

Richard Baldry - First Albany

David Miller - Sanders Morris Harris Group

Alan Bezoza - Oppenheimer & Company


Good day, everyone, and welcome to the TiVo second 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 Derrick Nueman. Please go ahead, sir.

Derrick Nueman

Thank you and good afternoon. I am Derrick Nueman, TiVo’s head of investor relations. With me today are Tom Rogers, Stuart West, Steve Sordello, our new Chief Financial Officer, and Matt Zinn, our General Counsel.

We are here today to discuss TiVo’s financial results for the period ending July 31, 2006, which is the second fiscal quarter of 2007.

About an hour ago, we distributed a press release detailing our financial results. We have also released some visuals designed to help guide you through the call. Additionally, within a few hours, we will release a recording of this call that you can access on our investor relations website. The prepared remarks will last about 30 minutes today and will be followed by a question-and-answer session.

Before we begin, I would like to note that our discussion 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, believe, expect, will, or similar forward-looking terms.

You should not rely on these forward-looking statements, as they involve risk 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 would like to also 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.

At this time, I will now turn over the call to Tom Rogers.

Thomas S. Rogers

Thanks very much. Good afternoon. Thanks for joining us today to discuss TiVo's fiscal second quarter 2007 earnings.

Today I will discuss the following topics: I will provide an overview with the highlights of the quarter. I will then provide an update on the progress of our sales and marketing efforts. I will then discuss where we stand on the distribution front. I will talk about our continued progress differentiating our product. I will give you a very quick update on our ongoing litigation with EchoStar, and finally, I will turn the call over to our new CFO, Steve Sordello, who will say a few introductory words. After that, Stuart West, who has performed with distinction as our acting CFO, will provide a detailed discussion of the quarterly financials, as well as our guidance for Q307, and we will then open up the call for your questions.

On to the quarter -- our progress on a number of initiatives during the quarter helped us to solidify our undisputed standings as the only brand name in the DVR marketplace, the only DVR-based advertising solution, and the only DVR to offer users a totally differentiated set of features relative to the generic DVRs that are currently on the market.

In the second quarter, we delivered better than guided results for both revenue and net income. We generated these results despite the typical slower consumer electronics environment during the summer, and without any exceptional marketing or advertising spend in a very competitive environment.

Service and technology revenues increased 30% to $52.9 million, compared to $40.7 million for the same period last year. Our better-than-expected net loss for the quarter was $6.4 million compared to a net loss of $0.9 million for the second quarter last year. The higher year-over-year net loss was due primarily to the cost associated with our successful patent litigation, more up-front hardware costs from the change to the zero up-front pricing, and the expensing of stock options.

We continued to build momentum on the sales front. TiVo owned subscription gross additions were 74,000 compared to 77,000 in the second quarter of last year. This is a slight 4% decline from the second quarter of last year, but is the third straight quarter we showed a positive trend in which the percentage of new subscriptions compared to a year ago have improved.

As we mentioned on last quarter’s call, the third quarter of last year was 23% below the third quarter of the prior year. The fourth quarter of last year was 20% below the prior fourth quarter. The first quarter of this year improved to 13% below last year. We are very pleased with this trend.

Another indicator of our continued progress is the net number of total new boxes we actually sold during the quarter through our direct and retail channel. For the first time in five quarters, this metric increased from the previous year. This is a very strong indicator of the vitality and robustness of the TiVo brand at retail, our continued product enhancements, the broad popularity of our newly introduced dual tuner unit, which represented approximately 54% of all sales to subscribers this quarter, certainly leads us to believe that these positive trends will continue.

During the quarter, TiVo recorded 30,000 new net TiVo-owned subscriptions. The decrease in net sub adds were primarily due to the impact of a relatively constant churn rate measured against a higher subscriber base. This resulted in an additional 7,000 absolute churn customers compared to last year.

Further, as expected, there was a net decline in the number of DirecTV TiVo subscriptions during the period, though several thousand per month of new TiVo subscribers were still being added by DirecTV during the quarter.

As you know, we rolled out new bundled pricing halfway through the first quarter in our online channel through tivo.com, offering two new options that are different from the way TiVo is sold in retail. One option allows for paying nothing up front with a higher monthly fee, depending on the number of years for which a subscription commitment is made, and the other allows for paying up-front for a one-, two-, or three-year subscription, and includes a receiver.

We also made recent pricing changes to the three-year bundle offer, and have substantially increased the number of subscribers electing this option, delivering significantly higher up-front cash and locking in these subscribers for at least the full three years. We continue to see strong results from the online channel, which we attribute to these new pricing options.

For the second quarter, online sales increased sequentially as a percentage of total sales from 29% in the previous quarter to 33%, despite the increase in monthly service rates for a customer that this represents over TiVos that are purchased in a store.

The shift in the sales mix has helped to improve margins by leveraging this very efficient sales channel while also providing a higher net present value per subscriber.

It is important to note that all of our new subs are now on a minimum of a one-year contract, and this has contributed to the significant improvement of the quality of our subscriber base, the net present value of each new subscriber, and has clearly kept our already low churn of 0.9% per month flat sequentially versus last quarter.

Next, I want to discuss our distribution development.

During the second quarter, and continuing this month, we launched our program with RadioShack to provide TiVo DVRs to 3,000 RadioShack stores nationwide, almost doubling our retail presence. As I have said before. RadioShack offers a great family-oriented environment for potential subscribers to learn about the TiVo product and specifically, our acclaimed KidZone feature.

With this expanded retail footprint, continued strength from our online pricing and packaging, and the multitude of TiVo features clearly differentiating it from the other DVRs on the market, we are closer to determining when to implement a meaningful national advertising campaign. Specifically, we are refining our messaging with respect to how the new TiVo suit features will resonate with key market segments. You will likely see the rollout of these marketing strategies as the holiday season gets closer.

Meanwhile, we will continue to hold back discretionary advertising spend until we believe that we have all the necessary components in place to successfully drive a campaign.

As to negotiations with cable operators, as you know, we recently announced a deal with Cox Communications. We are very excited about this, as it significantly expands our presence in the cable industry and is a big step forward in our strategy to distribute our premium service to more consumers through DVRs within cable set top boxes. With a simple software upgrade, Cox will be able to provide its subscribers with a TiVo DVR and its many differentiated features.

Additionally, we are excited by the opportunity to expand the reach of our advertising solutions on the Cox platform, enabling advertisers to reach more consumers and providing Cox consumers with access to advertising features that enhance their viewing experience.

We remain highly engaged in discussions with various other MSOs. The negotiations are complicated, involving recurring monthly fees, advertising components that are similar to programming deals, and software development that relates to an engineering deal. Because of this, we are proceeding in a very deliberate manner and will not settle for just any deal -- it must be the right deal.

We are happy with our Comcast relationship and how it is progressing, as is Comcast. Comcast believes we are on track to have the product available in trial before the end of 2006. We wanted to pass along some comments from a recent conversation with Mark Coblitz, the Senior Vice President at Comcast, responsible for the development of video products, and who is charged with bringing the TiVo Comcast product to market.

Mark told us, and I am quoting him here:

“Comcast is highly committed to this project. We are extremely pleased with all this very significant work that TiVo has accomplished in bringing this project toward its final stages. The work has been incredibly complex, particularly the integration work with our middleware provider, because the middleware is being completed at the exact same time. This has made for a more time-consuming undertaking than would otherwise be the case. It is still our plan to deliver TiVo capability before the end of 2006. Both companies want to ensure that we launch with a high quality experience. Our joint thinking is we are more oriented toward pre-deployment trials in 2006, followed by broader market deployment in early 2007. Being able to deliver the TiVo application to our set top boxes via a software upgrade is a tremendous technical innovation. We remain excited to roll out the TiVo service to our subscribers so that we can provide Comcast customers with the best way to watch television.”

That is a closed quote there. That entire passage I just read being from Mark Coblitz at Comcast.

Additionally, our development work in this deal will serve us well as we take key learnings and apply them to the development agreements we are currently negotiating with other MSOs. In fact, this was extremely helpful in securing the right to deal with Cox.

In this arena, we recently entered into our first deal with a DSL provider, BellSouth, which will offer the TiVo standalone unit in service to its customers. It is important to note that these are the types of marketing arrangements that we are aggressively pursuing, if we think there are partners other than cable operators who will provide us with a good opportunity to mass distribute TiVo.

The next topic I want to discuss is product differentiation. The second quarter was a significant period of activity for TiVo, where we announced and released a number of key product features and initiatives that continue to differentiate TiVo from its generic competition.

Our innovative new service enhancement designed to help parents provide high-quality programming for children, TiVo KidZone, is now completely available to all current and new subscribers. With the support of Common Sense Media, the Parent’s Television Council, and the Parent’s Choice Foundation, three leading children television groups, our involvement at the new America Foundations distinguished panel of policy makers and industry representatives for a policy roundtable in Washington, D.C., and continued endorsements from political and importantly, as well as from key religious leaders, TiVo KidZone continues to be the only real solution for providing appropriate television programming for kids, with total ease for the parents.

The second quarter also saw the successful announcement and launch of TiVoCast, a one-of-a-kind service which delivers broadband video directly to the television sets of TiVo subscribers. TiVo continues to transform the television experience by bringing the rapidly expanding array of video content on the Internet into the living room.

Turning web video into television by bringing top broadband content now only available on the PC to the TV set, TiVoCast provides niche networks and broadband content suppliers, for which the economics of television distribution might not make sense, a way to connect with audiences in the living room via the TV.

Video content providers, including the National Basketball Association, New York Times, Heavy, iVillage, and CNET, among others, were all part of the initial launch of TiVoCast. You have heard me say that it is not TiVo unless it is on the TV -- TiVoCast makes web content TV for our subscribers.

We also rolled out the previously announced 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 provide program recommendations based on popular television categories. Each TiVo Guru Guide recommendation offers several hours of programming per week, and is updated at least once per month, ensuring subscribers always receive the freshest, latest, and most interesting program recommendations on television.

These enhancements, combined with our TiVoToGo, TiVo Desktop, and the seamless integration of TiVo with other digital devices, including offerings as well from Yahoo! and Intel, are other clear examples of how TiVo is distinctly differentiated from other generic DVRs.

We not only provide a number of major features which are truly differentiated from generic DVRs in the market, but we are delivering the products and services that customers demand. As I mentioned earlier, we saw significant interest in the first standalone dual tuner DVR with TiVo service and features. Moving forward, we will continue to deliver enhanced product offerings, such as our high-end high definition, multi-tuner unit, which will be released before the critical holiday buying season.

Now on to our initiatives in advertising.

What is clearly the hottest issue in television advertising is the growing number of DVRs and the impact that the fast-forwarding of advertising content is having on networks and advertisers. TiVo is the only true DVR-based advertising solution, and the only provider today of second-by-second commercial ratings information in the market place. This combination puts us at the center of the key trends and dynamics in the television industry. Even at our current subscriber level, we are finding ourselves extremely involved in this issue, giving us a high degree of confidence in the significant level that this revenue stream will mean to TiVo in the future.

Specifically during the quarter, we rolled out new inventory, substantially increasing year-over-year advertising sales, recognizing double the revenue that we had recognized in the same period a year ago, and we are on track for significant increases later this year. Just today, we announced our second agency-wide partnership agreement with one of the world’s largest advertising holding companies, Omnicom Media Group. We now have such deals with two out of three of the largest advertising holding companies. This deal again demonstrates that advertising agencies recognize the value of TiVo's unique advertising solutions and are increasingly positioning their clients to capitalize on TiVo's reach with consumers and ability to target messages in a highly effective and innovative manner.

Further, we created a new division named TiVo Audience Research and Measurement. ARM offers research products to advertisers and marketers, such as second-by-second analysis of commercial viewing, as I just referred to.

Importantly, we are not only providing commercial ratings information of what people see but we will be providing a demographic overlay in conjunction with panels we will be conducting with other research entities to provide highly unique television viewing data. Ultimately, this will be combined with transactional data and will provide an enormous amount of insight into not only what consumers watch but how they use this information to make purchasing decisions.

Recently, we held the inaugural meeting of the TiVo Advisory Advertising Council. Participation in the council was extraordinary, including agencies which taken together represent as much as 95% of all TV advertising buying in the U.S. These senior level advertising executives across the entire advertising industry agreed to participate to help TiVo shape the future of television advertising. The event was further proof that the decision-makers in the advertising industry are enthusiastic about working with us to determine how the DVR will ultimately impact television advertising.

We were also able to clearly demonstrate that TiVo is the only truly DVR-based advertising solution today.

In terms of our litigation with EchoStar, we are confident in our case and the positive news that has come out in the past several weeks certainly supports that we will ultimately prevail in all phases of this litigation. Most notably, two weeks ago, District Court Judge David Folsom granted our motion for permanent injunction to prevent EchoStar from making, using, offering for sale or selling in the United States their DVR products at issue in the case. This was soon followed by a decision by the Federal Circuit Court of Appeals in Washington to temporarily block the injunction.

We are very pleased with Judge Folsom’s decision, and I just want to make clear that the decision by the Federal Circuit Court is not based on a consideration of the merits of EchoStar’s request and is simply entered to preserve the status quo while the court considers the paper submitted by both parties as to whether a stay should or should not be in effect for the duration of the appeals process.

Also recently, United States Magistrate Judge Caroline Kraven entered an order granting our motion to stay the litigation EchoStar filed against TiVo pending the outcome of the patent office reexamination proceedings. It should be noted that the reexamination request that we submitted to the patent office detailed how a large number of prior [part] references that the patent office did not previously consider raise substantial new questions regarding the validity of the claims EchoStar asserted and why those claims are invalid.

We will provide you with further updates as they arise. Should you have additional questions, Matt Zinn, our general counsel, is on the call to provide answers.

In closing, we have a lot more work to do in order to realize the full potential of this business, but we believe we are putting the right pieces in place to get there. While our DirecTV sub-base is diminishing a bit, and Comcast is not today yet deployed, we have accomplished quite a bit by adding Cox to our list of distributors, refining our TiVo standalone sales strategy, releasing a wide number of new TiVo features to users, developing unique co-marketing deals, expanding our retail footprint, providing distinctive advertising solutions and research products, making substantial progress in our litigation to protect our intellectual property, and continuing to aggressively negotiate with other cable operators.

We know what the challenges are and we are focused on them, and we have great confidence that we will overcome them.

Before Stuart covers the financials, I wanted to thank Stuart again for his exemplary service to TiVo over the years and his fine work and great dedication in stepping in as acting CFO.

In addition, I just wanted to say a few words about our new CFO, Steve Sordello. We are excited that Steve has joined TiVo, and believe he will bring a great deal of expertise and value to the finance and investor relations functions here. He has a proven track record and brings with him a wealth of hands-on experience in building strong finance organizations. Steve was the CFO at Ask Jeeves from 2001 until the company was acquired by IHD Interactive in 2005. Prior to Ask Jeeves, Steve held senior finance positions at Adobe Systems and Syntex.

With that, I will turn it over to Steve for a few words. Steve.

Steven J. Sordello

Thanks, Tom, and good afternoon. I am pleased to be joining TiVo. I believe that I will bring very relevant experience in the new media and advertising space to the company. I am looking forward to working with the investment community to more widely disseminate the TiVo story, which as you know has become significantly enhanced over the last several months.

TiVo is redefining the future of television landscape and there is much to be done in terms of translating the operating progress of the company into a model that the investment community can easily digest and support. I know my background and experience will be very relevant here.

Before turning the call over to Stuart, I would like to personally thank him for all of his help and support during this transition period. With that, I will turn it over to Stuart to review the details of the quarter.

Stuart West

Thanks, Steve, and good afternoon, everyone. I will touch on three topics today. First, I will address a few housekeeping items related to this quarter’s results. Second, I will touch on select financial and operational highlights, and finally, I will provide some guidance on management’s expectations for the third quarter.

Let me start with a few housekeeping items. First, we reported stock-based compensation expenses of $3.4 million during the second quarter. The expense primarily related to FAS-123R, expensing the fair value of stock options granted to employees.

Second, I would like to note an item important for understanding sequential trends in service and technology revenues, a key metric for us. As we discussed last quarter, Q1’s technology revenues of $8.2 million included $4.6 million of one-time catch-up of technology revenues and costs related to Comcast development work performed in prior periods. Q1 itself included $2.6 million of technology revenues related to work performed in that quarter.

In the second quarter, we reported a slight increase from this level to $3.0 million in Comcast development work. This range of approximately $2.5 million to $3.5 million is a good baseline for quarterly revenues from our Comcast agreement during the intensive development period.

With those housekeeping items aside, I will 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 12 for some background.

As you can see, Q2 was another significant quarter of improvement in service and technology revenues. In Q2, service and tech revenue was $52.9 million, an increase of 30% compared to $40.7 million in Q2 of last year. The three primary drivers of the year over year increase were growth in our subscription base, Comcast development revenues, and our advertising revenues.

Spending on subscriber acquisition was $23.7 million versus $16.6 million in Q2 of last year. This total consists of sales and marketing expenses, rebates, revenue share and other payments to the channel, plus the profit or loss generated by hardware sales. Let me point out that we do take a conservative approach to the measurement of acquisition spending. Our calculation encompasses all of our spending on sales and marketing related areas, including discretionary items like advertising and non-discretionary items like overhead, and even includes stock-option expenses for employees on our marketing and sales teams. Other companies often exclude these items from their acquisition cost calculations.

R&D expense was $13 million, which was approximately $3 million higher than Q2 of last year due to increases in headcount and stock option expenses. G&A was $11.1 million, up from $8.4 million in Q2 of last year but down significantly from just over $15 million reported in Q1 of this year.

The primary difference between this quarter and Q1 were the peak levels of litigation costs related to our trial with EchoStar, which as you will recall happened during March and April.

Net loss for the quarter was $6.4 million. EPS was a loss of $0.07, and the share count for the quarter was about $86 million. These results were better than the guidance we gave in May for three reasons. First, we stocked the retail channel a little less than we had originally planned, as some of that activity shifted into Q3. Second, our legal expenses were lower than expected, given some of our procedural victories against EchoStar. Third, we continue to carefully manage our discretionary marketing spend.

Finally, I will note we ended the quarter with approximately $75 million of cash and short-term investments.

Now let me touch on some of our key operating metrics. You can turn to slide 13 to see a summary of these.

In Q2, we added 74,000 standalone or TiVo owned gross subscriptions. As Tom mentioned, we are pleased that the rollout of our new pricing plans and a wide range of new products has driven three quarters in a row of improvement in year-over-year gross add trends. For example, this quarter we saw a 4% year-over-year decline from Q2 of last year. In Q1, we saw a 13% year-over-year decline, while in Q4 of last year, we saw a 20% decline. In a moment, I will address our expectations for continued improvement in this sequential trend.

Our standalone churn was consistent with the prior quarter, but slightly lower than the year-ago period at 0.9% per month, for a total of 44,000 subs churned during the quarter. The combination of our gross add number and churn resulted in a net gain of 30,000 new TiVo owned subscriptions.

In our DirecTV sub-base, we are seeing the trends we expected and discussed on our last call. We continue to add a small number of new DirecTV subscriptions, primarily those using the TiVo high definition product. However, churn on a larger DirecTV sub-base was slightly higher than these new additions, resulting in a net loss of 29,000 DirecTV subs in the quarter.

Our acquisition spending per gross add, or SAC, was $320 in the second quarter, compared to $216 last year. On slide 14, we have a chart that shows these trends. This increase in year-over-year quarterly SAC can be attributed to three factors. First, as we have previously discussed, our new bundled pricing plan drives a higher per sub acquisition cost while delivering higher ARPU and subscriber net present values. Second, the expansion of our retail channel to include over 3,000 RadioShack stores drove an increase in hardware sales and the associated rebate expense, as RadioShack built up its baseline inventory of our products. Third and finally, during Q2 of last year, we did not consistently offer a rebate, which resulted in lower SAC last year.

As a reminder, we do recognize rebate expense when retailers take possession of our boxes, not when the consumer purchases the box or activates service. This leads to a dynamic where we take a rebate expense prior to adding a gross new sub add.

Going forward, we expect there will be year-over-year SAC increases, but anticipate they will be at lower levels than we saw in Q2.

Now let me discuss average revenue per unit, or ARPU. You can turn to slide 15.

In line with our expectations, TiVo service ARPU improved on a sequential basis to $8.88, up from Q1 levels of $8.54. This was driven by increased ad revenue per sub and the impact of our new bundled pricing plans, which were consistently available through our direct channel during the quarter.

DirecTV ARPU was $0.96 for the quarter, a sequential increase from $0.93 in Q1 of this year, but down year over year. As we discussed last quarter, our recently signed contract amendment with DirecTV has an accounting impact which contributed to the year-over-year decline. While DirecTV is paying us the same monthly fees going forward, we do have certain additional maintenance obligations under the new deal, and 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 there are several factors influencing ARPU going forward. First, our new pricing plan should drive increases in standalone subs. Most of the subs added through our online channel, which Tom discussed, drove a third of our sales during Q2. We are at an ARPU higher than $12.95 and we expect this group of subscriptions to grow significantly 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 ARPU improvements, both for standalone subs as well as DirecTV subs during the year.

I will now address my third and final topic -- our expectations for Q3’s financial performance. Please turn to slide 16.

We currently expect service and tech revenues of $54 million to $56 million. It is our expectation that technology revenue from our Comcast development program will be roughly in line with Q2 levels.

We are currently expecting net loss of $12 million to $17 million for Q3. This expected net loss includes the anticipated effects of rebates surrounding expanded retail channel distribution of our dual tuner DVR, increased shipping to retail in preparation for the holiday season, higher marketing spending driven by the impact of new pricing models, expensing of stock options, and costs related to our ongoing patent litigation.

Before we take questions, I would like to close by repeating in public what I have told many of you before. I really believe this is one of the most exciting times in TiVo’s history. On the eve of the rollout of the series III, and as momentum around KidZone builds, TiVo’s major strides in product differentiation are driving increased distribution through critical partners such as RadioShack and Cox. A powerful new revenue stream from advertising is posting impressive growth numbers, and we now have advertising oriented distribution agreements with Cox, DirecTV, and Comcast -- three of the largest multi-channel operators in the U.S. This increased distribution comes at the same time it is becoming clear that TiVo's DVR advertising solution truly addresses the needs of television advertisers. With the enormous attention on the delivery of broadband video, TiVo is also uniquely positioned to deliver this exploding new form of content to the television.

Finally, our recent intellectual property victories over EchoStar show the value of our patent portfolio and suggest real opportunity to build relationships even more broadly throughout the television industry. I am excited about these opportunities and I do believe Tom and Steve are the right team to drive value for this company and its shareholders going forward.

I would like to close by thanking Tom and the board for an amazing six years here at TiVo. I look forward to remaining involved in an advisory role to both Steve and Tom through the end of the year and helping this company and this team achieve its promise.

Of course, I would also like to thank you, our institutional investors and research analysts, for the past few years of insightful commentary, pointed questions, and never-ending challenges.

Speaking of, that concludes our prepared remarks for today and we are now ready to take questions. Operator.

Question-and-Answer Session


(Operator Instructions)

We will go first to Tony Wibel with Citigroup.

Tony Wibel - Citigroup Smith Barney

I was hoping we could start off by just addressing I guess the revenue and costs per box for the TiVo owned subscribers. It looks like it is tweaking up a little bit in the second quarter. What is the driver behind that?

Stuart West

Tony, if you are focused on ARPU, I think we discussed some of the drivers there in terms of the new pricing and the impact the new pricing is having. There is also some seasonality around advertising revenues. We mentioned we saw a particularly strong quarter when it came to advertising revenues.

Tony Wibel - Citigroup Smith Barney

Actually, I was targeting the hardware revenue and hardware costs.

Stuart West

I think we also touched on some of those items on the call. Really, the increase in retailer demand as RadioShack and others really started to load their channels for the holidays and for the summer, I think that drove a lot of the increase in demand on the hardware side.

On a cost side, you saw a corresponding increase that tracked pretty closely with the increase in hardware revenues. Then, there was a delta there, and you will recall an accounting policy change we made in the first quarter where we now expense the cost of hardware associated with our bundled pricing, so that is driving a little bit of the margin impact you may be noting between hardware revenues and costs of hardware revenues.


To ensure that all participants are able to ask a question, please limit yourself to just one question. We will go next to Alan Gould with Bleichroeder.

Alan Gould - Natexis Bleichroeder

Thank you. I was wondering two things. Tom, could you be a little clearer on what the advertising cost is going to be in terms of your marketing spend? Should we assume that does not come in the third quarter but comes in the fourth fiscal quarter? If you could clarify the advertising in the Comcast and Cox boxes, when they go out, will you be able to get TiVo advertising in all Motorola boxes or only the DVRs which are upgraded with a software download to TiVo boxes?

Thomas S. Rogers

Thank you. On the first question, which is the advertising spend, we have been keeping our powder pretty dry in terms of major advertising spending in terms of our driving retail awareness of the product. We have been focused on getting our new features out into the marketplace. We have been focused on refining our pricing strategies, doing some testing and connecting what of those features are going to best resonate in terms of connecting them with specific elements of the television audience.

We have been mindful of the fact that while we have made a lot of our pricing changes have focused on our online sales, our online activity, and we have driven some good increases there, that the action in retail happens around the holiday season and will be focused on probably the moving forward on advertising a little bit toward the end of the third quarter, but most of that will probably be hitting in November and December. Certainly there will be some of that that begins to hit as the third quarter comes to a close.

In terms of advertising in terms of us as an advertising platform, and your question on Comcast and Cox, as you will remember, we have the right in the Comcast deal to provide an advertising platform for their generic DVRs beyond those that have the TiVo experience in them. Our current thrust is to get out the TiVo experience so we have that software upgrade for the generic boxes. Sometime relatively shortly after that, the advertising capability for those TiVo upgraded boxes will come forward.

The key thing is that we do have the rights to have our advertising platform in both the Comcast and the Cox boxes, and that is a critical piece of the overall cable model we have in terms of driving revenue against the mass distribution that we get from those providers.


We will take our next question from Rob Sanderson with American Technology Research. Mr. Sanderson, your line is open. Please go ahead.

Thomas S. Rogers

I do not think anybody is there, Operator.


We will go next to Daniel Ernst with Hudson Square Research.

Dan Ernst - Soleil-Hudson Square

Good evening. Thanks for taking the call. Two questions, if I might. First, on the ad revenue, given that it doubled in the quarter versus overall service tech revenue up 30% year on year, are we now approaching that being a 10% contributor? Then, Tom, if you look out kind of big picture where you see this going in terms of revenue. I know on the partner subs, TiVo has talked in the past about this being maybe 50% of the revenue might get out of partners like Comcast. If you look at it across the entire company, where do you think ad revenue is going to be as a percentage of revenue?

Then, for Stu, maybe you can help us normalize CPGA, break out or match the hardware expense, rebates plus expensing hardware to the gross adds versus those that were for the channel ship? Thank you.

Thomas S. Rogers

On the ad revenue side, we are clearly seeing some progress and some nice year-over-year movement that we expect to continue to build through the third and fourth quarters. I am not going to make any statements here in terms of when we will consider this material for purposes of disclosing what those numbers are, but obviously we do over time consider this to be a revenue stream that will be quite material.

The kind of progress we are making in the ad community I think may be best pointed to by a session we had over the course of the quarter with the CEOs of the largest buying agencies, advertising buying agencies around the country, advertising buying groups that may be represented as much as 95% of all of television advertising spend. We see those people come together in a room with TiVo to try to figure out the future of television advertising as it relates to the biggest issue confronting advertisers, which is fast-forwarding through ads, and how do you come up with solutions for that.

Finding ourselves right in the middle of that debate, finding ourselves right in the middle of the issue of ratings information on a second-by-second basis for commercials which we have the ability to uniquely provide, we think we not only have turned relationships with the advertising industry, which another good indication of is the announcement we made today with the Omnicom group, but the tools that we have to do that with and certainly over a reasonably near-term timeframe, we expect this to grow to something that we will be giving you more detail about.

On the issue of how will advertising relate as an overall percentage of the company’s revenues, we are not going to lay out a specific model for that today, or a specific percentage of that, but the guts of the cable model, and coming right on the heels of the Cox announcement, it is probably worthwhile pointing to this, there are two great benefits we get from mass distribution cable deals. One is that we do not bear the marketing costs of acquiring a sub the way that we do in terms of subscriber acquisition expense when it comes to our standalone subscribers.

The second is that because it is mass distribution, which can get to much bigger numbers than standalone distribution might, evidence the DirecTV relationship, that with that brings a disproportionate impact on what our advertising revenues can be and grow to. So lower marketing and advertising spend, higher advertising revenue -- again, over time we will begin to lay that out in greater detail, but that goes to the guts of what we think the strength of our future business plan is. Stuart.

Stuart West

On your acquisition costs question, Dan, you should think that about half of the increase in SAC that we saw year over year was driven by the up-front costs associated with our new bundled pricing, and the remaining half was due to the other factors we mentioned.

I will definitely note that while the up-front costs of our new bundled pricing do affect SAC immediately, the benefits, which are the increased revenue and therefore increased overall ARPU, do play out over the next couple of years. We are very confident that we are going to get a return on this increased investment and up-front costs.

Next question.


We will go next to David Miller with Sanders Morris Harris.

David Miller - Sanders Morris Harris Group

Just one quick question -- Stu, of the 44,000 subs that you guys lost via churn in the quarter, how much would you contribute that to, or how much would you assign that to just straight churn? You know, folks who just decided for whatever reason they just did not want the product anymore? How many would you assign to the subs that have reached the end of the 48-month period that you guys use to recognize lifetime sub revenue? Thank you.

Stuart West

Good question, David, and I will give you a high-level answer. We tend not to get that deep into the detail on these items. I think the main thing I would point out is the 0.9% monthly churn level that we saw, which is consistent or better than the prior year and the prior quarter, is a baseline that we are certainly aiming for in terms of driving and maintaining. Certainly the majority of those do come from monthly subs that are rolling off and a small portion of that comes from lifetime.

I will probably leave it at that because we do not get too much into the detail, but certainly the majority of that churn is what you might typically think of as churn, and a fairly small portion comes from the lifetime subs.

I might also point out that lifetime, as a program that we recently eliminated, should really start to cut down on that impact hitting our churn.


We will go next to Barton Crockett with JP Morgan.

Barton Crockett - J.P. Morgan Chase

Thank you for taking my question. I wanted to get some more color on the Cox and Comcast relationships and the impact on your business. In particular, I am concerned about the potential for these cable distribution deals to take subs away from the standalone business in that it would seem that the most natural user of the cable DVR is going to be someone that has a TiVo standalone subscription, so can you give us some way to gauge that risk? In other words, how many TiVo standalone subs do you have in Cox and Comcast territories? How many of those subs have a digital cable subscription?

Then, in a related note, can you give us any sense of the pricing for the TiVo service relative to the generic DVRs, and any way to gauge the uptake? Will it be a majority of their DVR sub sales, or a small sliver? You know, those are crucial questions to gauge this, and I was hoping you could start to tip your hand a bit on that. Thank you.

Thomas S. Rogers

On the Cox and Comcast relationships, I think you have to look at this in terms of there being different buckets of subscribers. There is still a substantial number of analog subs that these cable operators serve. Over 50% today of our standalone subs are coming from analog and I would not expect that this will largely be cannibalization, if you want to call it that, of the integrated digital cable offering relative to an analog sub, because that is a whole different set of decisions that the analog sub would face in terms of whether or not they want to upgrade to digital cable and all the costs associated with it.

Similarly, on the upper end, particularly when we release our high-end high def cable card product, which will be a cable integrated product through the use of a cable card, and will also have the full array of TiVo features, such as the ability to get broadband content up on your television set, some of which cable operators, at least initially, are not likely to have. I can see for people who are TiVo subscribers and want the full array of TiVo features that even though the availability of the cable product through digital cable offerings is there, that the standalone offering is something that they would find preferable.

In the middle is our digital cable customers that may have TiVos today and may have a digital offering. Again, there are certain benefits that come from having a standalone service. I would expect, with respect to new customers, that the cable offering will be far more persuasive in terms of the up-front cost issue in terms of the attractiveness of having it on an integrated basis through cable.

So in terms of the ability to get to a digital customer who is not again on the high-end, is not an analog customer of course, I would say that customer, on a newly acquisition basis will be the most effective in terms of our standalone sales relative to the cable offering.

In terms of how that will be priced relative to generic DVRs, neither Comcast or Cox have set that at this point, so I do not have anything to share with you. I will say that their incentives are to see this widely distributed because it would be incremental revenue. It is an advertising solution. It is a level of stickiness that they are looking to get, a level of uniqueness relative to what the satellite service providers may offer. For all those reasons, modest as opposed to significant up-charges in terms of the cost of getting TiVo as your DVR is what I think is being targeted, but specifics on that will have to wait their setting of their marketing plans.


We will go next to Lee Westerfield with BMO Capital.

Lee Westerfield - BMO Capital

Thank you. Good evening. Two quick questions, I hope. First, Tom, with regard to the advertising and the relationship with Cox and with Comcast, does TiVo retain exclusively the information about TiVo audience behavior? Is that shared with the cable operators? How is that information parsed out?

The second question relates to the upcoming Series III launch ahead of the holidays. Tom, at this stage, to the extent you can answer it, how are you looking at the promotion of the product and also, more importantly, the pricing and subsidization price points?

Thomas S. Rogers

On your data question, we certainly look to include as part of our overall anonymous composite data panels the information that can be garnered from the TiVo subscribers that come through cable operators. I am not going to speak to the issues of what other relationships, if any, the cable operators have there, but what we are finding is the data that we collect is pretty unique. Certainly with breadth that comes from additional distributors, we think that information will have that much more value. We are looking to enhance that data with other ways that we can combine it and enhance it that we think will be that much more significant in terms of a research offering.

So yes, the cable activity that the data has generated will play a role within our overall research product.

On the high-end offering, it is a high-end offering. It is obviously going to be a significantly higher cost -- I should say price -- for a TiVo unit that is a high-def TiVo unit than our current SKUs. It is not going to be a unit that we look to subsidize the way that our current subscriber acquisition spending subsidizes the units for our current SKUs. We do think this will be a product certainly initially that the home theatre crowd, the media room crowd, people who are really looking for the best TV experience in the home with the integration with cable, the high-def experience, the multi-tuner offerings, the full array of feature sets that TiVo has, that that is going to be something that the high-end user is going to seek.

In terms of how we promote it, that brings with it a certain different approach than our current average -- I should say our current marketing efforts and how we may market our other SKUs for the holiday period. There are certain places that you would go to for that high-end consumer electronics consumer that are a very different kind of marketing approach than the more general mass consumer electronics offering, and we plan to pursue our marketing initiatives through a few of those.


We will go next to Steve Frankel with Conaccord Adams.

Steve Frankel - Conaccord Adams

Two questions. One, if you might give us some sense for what the likely increase in ad spending this holiday season is versus last holiday season, especially given you have the series III to roll out. Two, is the pricing disparity likely to remain for the standard def unit between your web sales and retail through the holidays?

Thomas S. Rogers

As to your first question, I think that we will begin to advertise I said toward the end of the quarter, and more heavily in November and December. Given those time periods, the issue of how much advertising we put into the market place will in part depend on the answer to your second question, which is the ability to unify some of the pricing there to get some efficiencies from national advertising. That has been one of the issues that we have been challenged to overcome with a very different pricing and offer on the Internet and the various bundles and prepay arrangements that are available on the Internet versus how the product is sold and made available at retail.

Our efforts to reconcile those, to the extent we are more successful in being able to do that, we may increase somewhat our spend because we think the efficiencies of doing so will be worthwhile. To the extent that does not come together quite as neatly as we would like, that may dictate a somewhat different spend in terms of what we would be able to yield from that spend.

So it is something that we are continuing to test and assess now. As a result, I cannot give you a clear directional answer at this point.


We will go next to Todd Mitchell with Kaufman Brothers.

Todd Mitchell - Kaufman Brothers

Thank you. Just a quick question on -- you said that you had 33% of the ads through the new model. What does that correlate with the higher-priced new boxes?

Thomas S. Rogers

The higher-priced new boxes, if you are referring to the high definition…

Todd Mitchell - Kaufman Brothers

No, sort of -- you said 54% of your boxes were the dual tuner and you said 33% were -- are we seeing -- in that direct channel, is that primarily the dual tuner boxes, or is there an even split between the two?

Thomas S. Rogers

The dual tuner product, which is slightly higher, you are correct, is also showing somewhat higher sales online. As a percentage of online sales, the dual tuner product is a higher percentage than is the case overall, or at retail. We are seeing that is a highly popular item that gets further boosted by the pricing plans that are available online.

Todd Mitchell - Kaufman Brothers

Do you expect that to increase as a percentage of the retail?

Thomas S. Rogers

I would say dual tuner will certainly increase in popularity, particularly because it is increasing as the amount of product that we ship into the channel and the single tuner product and that SKU becomes an increasingly lower amount of the inventory available at retail.


We will go next to Rob Sanderson with American Technology Research.

Rob Sanderson - American Technology Research

Good afternoon. Can you hear me this time?

Thomas S. Rogers


Rob Sanderson - American Technology Research

Okay, thank you. I just want to go back to something, Tom, I think you said in your prepared comments that you are seeing a substantial shift to the three-year bundle and the significantly higher up-front cash that goes along with that. First, did I hear that correctly? Then, if so, how can I reconcile about a $10 million decrease in deferred revenue?

Thomas S. Rogers

Well, I will let Stuart handle the deferred revenue question. We are definitely seeing a substantial jump as we brought our three-year pricing down to what lifetime was previously available for. We jumped from a rather minor percentage of prepaid sales on the Internet representing the three-year option to about half of those sales representing the three-year option. Consequently, we demonstrated to ourselves that the pricing increasing we are doing can have very substantial impact on results in terms of sales volume, not to mention a very substantial impact on our cash generating capabilities up front, where of course the lifetime option did previously yield a fair amount of cash, and this has the ability to generate a very substantial amount of up-front cash as well. Obviously with one-year options representing the other 50% of that, there is less up-front cash that comes from those, relative to a lifetime.

Stuart, as that relates to deferred revenues.

Stuart West

Yes, I think that is one of the two drivers of the different performance of deferred revenue this quarter compared to last year. One, as Tom mentioned, is the average amount of prepayment cash we are getting now is lower compared to lifetime, which was a single $300 price point. So we are getting a bit less cash up-front related to prepayment plans, but the other driver of that account, as I know you know, Rob, because we have talked about it before, is the size of the lifetime base. We have a bigger lifetime base this year than we did one year ago, so that means that revenues are coming out of that count and being recognized at a higher rate.

So it is really those two factors which contribute to that drop in the deferred revenue change this year.


We will go next to Richard Baldry with First Albany Capital.

Richard Baldry - First Albany

Thank you. In the past, your cash cycle has typically bottomed in the third quarter before rebounding in the fourth quarter. I wonder if you want to quantify where you feel your comfort levels are with the cash and whether maybe with these new pricing plans, you think that actually that cycle might change, could there actually be a flattening ahead of the third quarter before rebounding in the fourth quarter? Thank you.

Thomas S. Rogers

I do not think we really want to give you any cash projections here, relative to third and fourth quarter. Obviously the zero pricing elements involve a certain amount of increased cash, given the subsidies. As we have said, the overall look at that going out, not a single quarter’s approach to SAC, which those have cash implications, is a fair view of what SAC is over a 12-month period, and how subscriber acquisition costs tend to smooth over a 12-month period. I think I would leave it at that without specifically talking about third or fourth quarter cash.


We will go next to David Miller with Sanders Morris Harris.

David Miller - Sanders Morris Harris Group

Just a quick follow-up. Tom, you talked about a trial period for the Comcast platform occurring before the end of the year with sort of a broader rollout in calendar Q1 of ’07. Can you give us any sort of sense of timing for the Cox situation? Thank you.

Thomas S. Rogers

The Cox situation, we are roughly targeting for first-half of ’07. I will caveat that by saying that we have not gotten deeply into the Cox infrastructure yet, and that first half of ’07 is premised on not only the hardware and middleware similarities with Comcast being what they are, but the infrastructure necessary to deploy are also similar enough that it does not involve any significant delays. Obviously if Cox wanted some significantly different feature set beyond what Comcast had, that might also create additional timing issues. I would say as a rough matter, assuming the features are about the same, assuming that the middleware and hardware configurations have the similarities that we have scoped, and assuming the infrastructure does not pose any unique challenges that we did not face at Comcast, that is what we are targeting.

Derrick Nueman

We have time for one more question.


We will take our last question from Alan Bezoza with Oppenheimer & Company.

Alan Bezoza - Oppenheimer & Company

Stu, congratulations on the move. Hopefully we will see you soon. I want to talk to you first about your SAC and how that levels off. If you look at the increased up-front cost from the box and seeing the SAC increase steadily, where does that level off with this new pricing plan?

My second question is regarding Cox and Comcast, or any other cable operator who may end up signing up. As you think about, we have all been trying to figure out what percent penetration you will have as opposed to new DVR customers or total DVR customers. In your minds, where do you think this levels off as far as penetration rates at cable outlets?

Thomas S. Rogers

Taking your second question first, I would say that is going to be something that is going to require some rollout experience with cable operators for any of us to firmly answer. I think the expectation when cable operators do a deal with us is that this is something they are going to heavily market, because of the user interface, the brand name, the uniqueness relative to satellite, the distance of advertising solutions, the lack of any incremental hardware expense the software upgrade allows, that all of that suggests that their incentive is to have broad rollouts and to market in a way that accomplishes broad penetration.

How that actually plays out, whether it takes some time before the desired penetration levels are achieved, whether the word of mouth from cable subscribers is something that needs some time to work in the marketplace -- as we have found from TiVo that word of mouth was a huge seller of this -- the time it may take to now make very clear that there is a real difference between a generic DVR and TiVo, which is something we obviously want to hit harder and harder as that distinction may not be as clear to cable people who do not have TiVo as we want it to be -- all of those things I think we are going to see what that period of time is.

Over time, taking a long-term view, we think that households become much more dependent on DVRs, that the virtues and features of TiVo become overwhelmingly compelling, that the incentive here and the target of the operators is to have this priced in a way that is a modest up-charge relative to what the generic DVR is, all of those in our mind point to high levels of penetration.

As to SAC, there is a tradeoff with SAC. The tradeoff is that we are raising our service pricing and our revenue per sub, and the net present value of a subscriber as we spend more cash by making a pricing plan available that does not drive, that does not have any up-front costs.

We tested this a long time ago. Now that we have had some pure looks with some of the year-over-year, quarter-over-quarter fuzziness taken out, it looks like those pricing elements in terms of online subs where it has been available truly does drive incremental volume, incremental subs with healthy improvements to ARPU and net present value that we want to drive.

Now, there are different types of offerings, as we mentioned, where a high-end box would not have that kind of subsidy. We also talked about prepaid bundles, which we have now bound, as we said, with a three-year plan, a way to really boost the increase of those where up-front subsidy is not the issue because you are getting a prepaid bundle of a significant amount of cash up-front.

How those all meld as we approach retail with that is one of the significant questions that we are grappling with in terms of what the overall marketing spend is as we grow our sub base. I will say that overall, we do expect SAC for the year to be on a 12-month period, which is the way we look at it, to be above last year’s levels. It is clearly going to be well below where it came in for this quarter, and the mix of the various variables I just pointed to in the end of the day will determine what that trend actually looks like.

I think with that, I would just like to sum up a minute here.

I think the best way for me to look at the opportunity, and I hope for you to look at the opportunity in front of us, is to look at what I call our list of onlys. We have to remember that we are the only brand in a marketplace that is booming and is going to grow from 12 million to 14 million to 50 million to 60 million subs in terms of DVR households in the next four or five years.

Being the only brand, we are also the only truly DVR based ad solution where the biggest single issue in the television industry today in terms of its economics is who is watching ads and how do you deal with people fast-forwarding through them? We have the only truly based solution to deal with that.

The biggest new issue in terms of programming in the television arena is broadband distribution of content and we are the only way today to get broadband content up on your television set, and that is a big deal in terms of how people find and search, navigate, menu their television offerings going forward.

We are the only way for analog subs to get a DVR, and we do believe that analog subs want DVRs just like digital subs. As we said, over half now of our subs are coming from the analog space. We think that continues to be a very interesting market for our standalone business to focus on.

We are the only way to have a DVR that transfers your programming to the portable device of your choice, be it an Apple or an iPod or a Sony PSP, we now have put the software in the marketplace that allows for overnight syncing to the portable device of your choice and as mobility, a close second to broadband content, is a theme that for certain demographics becomes bigger and bigger, we are the only way to really create that consumer choice.

We are the only real solution for children’s television. I know you have heard us talk about this, and I think from an investor or research analyst point of view, it tends to sound like a promotional language that goes right by everybody’s head because it sounds like a feature we are spending too much time on, but if you could see the amount of support we are getting from conservative religious circles, that we are getting from political circles, that we are getting from grassroots parents and children’s advocacy groups, it is really something after 50 years to see people celebrate a product that can really discern what quality programming is for kids, get it in the living room, and make it a turnkey simple solution for parents. It is something that we think we are the only players on for something truly unique.

Of course, we are the only core tested DVR intellectual property that has really shown that we have something out there that has real strength in terms of our intellectual property position.

You put all that together and I think our future looks good. We have some challenges. We know that the interplay of our subscriber acquisition costs relative to taking on subs, our need to drive new mass distribution relationships, our need to clarify for some of you what all these pieces that we have begun to put in place looks like by way of a financial model that you can project out more clearly than some of the data available to you today, are all challenges clearly in front of us and ones that we think we can tackle.

We feel very, very good about what we have been able to accomplish over the last several months and look forward to continuing to unveil the story for you in the weeks and months ahead. Thanks very much.


Thank you, everyone. That does conclude today’s conference. You may now disconnect.

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