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TiVo Inc. (NASDAQ:TIVO)

F3Q07 Earnings Call

November 29, 2006 5:00 pm ET

Executives

Derrick Nueman - Investor Relations

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

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

Analysts

Daniel Ernst - Hudson Square Research

Tony Wibel - Citigroup Smith Barney

Michael Kelman - Susquehanna Financial Group

Kunal Madhukar - Bear Stearns

Barton Crockett - JP Morgan

Murray Arenson - Ferris, Baker Watts, Inc.

Lee Westerfield - BMO Capital Markets

Presentation

Operator

Welcome to the TiVo third quarter fiscal year 2007 earnings conference call. Today’s conference is being recorded. The speakers for today’s conference are going to be Mr. Tom Rogers, Mr. Steve Sordello, and Mr. Derrick Nueman. At this time, I would like to turn the conference over to Mr. 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 is Tom Rogers, CEO, and Steve Sordello, CFO. We are here today to discuss TiVo's financial results for the period ending October 31, 2006, which is the third quarter of the fiscal year 2007.

About an hour ago, we distributed a press release detailing our financial results. We have also released a financial and key metrics sheet designed to guide you through the call, which is posted on our investor relations website.

Additionally, within a few hours, we will release a recording of this call that you can access on our investor relations website.

Today’s prepared remarks will last approximately 30 to 40 minutes, 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 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 would also like to note that any forward-looking statements made on the call today 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

Good afternoon. Thank you for joining us today to discuss TiVo's fiscal third quarter 2007 earnings. Today I will discuss several topics. I will first provide an overview of the performance of the business and the highlights of the quarter. I will then provide an update on our sales and marketing efforts. I will discuss our continued progress in reinforcing our differentiated product in the market. I will talk about new steps we have taken in our emerging advertising business, and I will give you a quick update on our ongoing litigation with EchoStar. Finally, I will turn the call over to our CFO, Steve Sordello, for a detailed discussion of the quarterly financials, as well as our guidance for the fiscal fourth quarter 2007. We will then take your questions for the rest of the time.

This quarter, we continued to make progress against our strategies, as gross addition growth for our TiVo-owned business was positive for the first time on a year-over-year basis in six quarters, up 10% year over year. That is gross additional subs.

This was a continuation of a positive trend beginning a year ago where we recorded gross sub adds of 23% below the prior year quarter. Overall, TiVo-owned subscriptions were up 24% year over year to more than 1.6 million.

Our improving TiVo-owned subscription metrics speak to the vitality of our business and improve the overall financial strength of the subscription base by adding much more valuable TiVo-owned subs as DirecTV subs declined to some extent.

We are also seeing continued success in the value we are generating from our newest subscriptions, as the average monthly price of new subscriptions in the quarter increased significantly year over year.

Further, we recorded a better-than-expected net loss of $11.1 million, which compares to last year’s net loss of $14.2 million. While our net loss improved relative to last year, losses for the fourth quarter are expected to be larger as we are extending the full hardware rebate program to retail stores, and this year concentrating all of our broader consumer advertising in the fourth quarter.

Our service and technology revenues for the quarter increase 22% to $52.6 million.

Now, let me update you on our sales and marketing efforts. We continued to see strong results from our online channel, which we believe are directly attributable to the pricing changes we made in the first quarter of this year, our ability to market more efficiently online, and the introduction of new products and features over the last year.

Online sales increased sequentially as a percentage of total sales, from 33% last quarter to 43% this quarter.

On November 5th, we introduced new pricing available at all retail stores nationwide that provides no up-front charge for the single tuner hardware, and a reduced fee for the dual tuner hardware, with new subscription plans that range from $19.95 for a one-year service plan, $14.95 for two years, and the current $12.95 service, which can still be purchased under a three-year plan.

At the same time, we have created uniform subscription pricing across online and retail store customers to enable us to nationally advertise in print, radio and television. This began in mid-November.

The free after rebate offer in the online channel has given us the confidence to move forward in evaluating whether such an offering in retail stores will create a large enough surge in subscription additions to maintain this approach going forward. Additionally, it provides us with an opportunity to reduce inventories on the single tuner box, a product on which we will not put much focus on in the future.

There are many reasons why the implementation of a 100% rebate in retail stores may well generate a very different response than the no-cash up-front approach that has been available on line, not the least of which is at retail stores, a consumer must shell out over $200 up-front.

Following the holiday period, we will be evaluating the success generated by this kind of hardware pricing approach versus an approach where there is less rebate on hardware and a greater proportion dedicated to advertising the TiVo product. Steve will give a more in-depth explanation of why our expectations here are somewhat tempered by the differences on those two retail environments.

Also during the quarter, we continued to differentiate the product in very substantial ways that increasingly leave generic DVRs in the dust. I am sure many of you have seen our television, radio and print advertising campaign which broke about 10 days ago. This advertising and promotion that we are implementing will for the first time be about making clear that TiVo is very different from the generic alternatives, and that it is not TiVo unless it is a TiVo.

For more than 10 years, people have talked about the TV set and Internet coming together, and this dramatic expansion of video options is being driven by the amount of video now available by the power of broadband distribution. Not a week goes by without an announcement about some studio network, studio or network or programmer or Internet company providing yet even more video content online.

TiVo provides the only approach that brings it all -- broadcast, cable, broadband -- together into a seamless experience for the viewer. TiVo is providing one holistic viewing experience where you will be able to find what you want when you want it, no matter whether the content comes from broadcast, cable, or the Internet. This theme is encapsulated by our motto in this area that it is not TV until it is on the TV, which underscores the point that the wild west of broadband video is not really television for most viewers until it is on the TV set.

During the quarter, we made several announcements in this area. First, using TiVo and our partner, One True Media, viewers will now be able to send home movies to friends and family and have it received right on their TV sets.

Second, now with TiVo, viewers will be able to take non-rights-protected video coming into their PC off the Internet and have it played on their TV sets as if it is just another TV program.

Third, we announced earlier this year a number of media and Internet companies that will send their broadband content directly to TiVo units. Known as TiVoCast, we announced a group of new content providers, including our first such program deal with a television network, CBS.

Fourth, with all the new video options available because of the explosion in broadband delivered video, TiVo is creating a system of unified search, discovery and menuing across all programming so it is seamless to the viewer whether content is delivered by broadcast, cable, or broadband.

Finally, with all this new choice, viewers will increasingly look to key ways to locate choice and filter choice. TV is all about being entertained, and when you talk about entertainment search, the most important key word, so to speak, are those of the celebrities and talent that create a lot of the identity through which viewing entertainment choices are made.

A recent announcement with International Creative Management, ICM, one of the world’s largest talent agencies representing many of the top artists in the entertainment industry, illustrates how TiVo is seen as a unique means by which celebrity brand names can create a direct relationship with viewers, increasing the ease with which consumers can find and discover their favorite options for television viewing, while also giving talent a way to expand their business opportunities.

Over the last year, through deals we have done with satellite and cable providers, advertisers, ad agencies, programmers, networks, Internet content companies, magazines, and even consumer television watchdog groups, and now a major player representing talent and artists, TiVo has made major strides weaving its way into the fabric of the media industry.

Beyond feature enhancements, we continued our push in product development by introducing the Series 3 High Definition Digital Media Recorder, the first stand-alone TiVo product that is HD-compatible. While still in the early days, we have received positive consumer feedback on the product, with Series 3 sales meeting our expectations.

At the same time, the TiVo Series 2 dual tuner box, which we launched in the second quarter, represented approximately 58% of all sales, highlighting the continued popularity of this product.

While TiVo is focused on the cutting edge of the newest technologies, we continue to serve the very important analog cable customer. In the quarter, approximately 47% of our TiVo-owned subscriptions came from this analog cable customer market, where we remain the only DVR solution for these customers.

Now, regarding distribution, we are pleased to announce that we have entered into a major international distribution agreement with Cablevision Mexico, the largest cable operator in Mexico City, owned by Televisa -- the country's dominant broadcast company, which is one of the largest cable distributors in Latin America. This is a very significant development from our standpoint.

Our confidence that there are many international opportunities for TiVo distribution is steadily growing, and we believe you should begin to define the relevant market for TiVo as being well beyond the US alone.

Further, we are happy with how our relationships with Comcast and Cox are progressing. Both of these initiatives will significantly expand our presence in the cable industry, and offers us a highly scalable way to deliver our service and the best way to watch television to a much broader audience.

The following is a quote from a conversation I recently had with Steve Burke, the Chief Operating Officer of Comcast, who summarizes nice and succinctly how our relationship is moving forward. Steve says: “We’re excited about the TiVo product and feel we are on track to begin trials in the near future. We plan to market the product such that getting TiVo is an easy decision for our customers.”

I should add Steve is particularly excited about integrating VOD into the TiVo user interface. We look forward to showcasing the Comcast product at the upcoming CVS show.

Specific to Cox, we have engaged with them in very productive meetings, as we are making progress toward refining the scope of the product for that MSO, and we continue to have conversations with other cable operators and, as I have stated before, we are not unhappy with the rollout of additional generic cable DVRs, as each one creates an opportunity for a TiVo software upgrade that transforms the generic DVR into TiVo.

Now, on to our initiatives in our advertising business. The momentum in terms of the mind share we get in the advertising community continues to be significant. While we saw slightly softer ad sales than anticipated, we expect to see this revenue stream build in the fourth quarter and beyond.

We recognize that we need to continue to build out our sales team, create more inventory options for advertisers, and work with advertisers to create economical long-form advertising spots. We continue to believe that this area of our business presents a strong strategic opportunity for us.

Specifically, we announced yesterday that we were introducing a new advertising product called program placement, which gives advertisers the ability to offer an ad at the end of a television show, when consumers are asked if they want to save or delete a program, providing a whole new access point for TiVo-enhanced commercials.

We have developed various other forms of new inventory that provide advertisers with a way to engage with viewers as they navigate through the TiVo interface. Additionally, this quarter we signed yet another agency-wide advertising agreement with WPP's GroupM network of agencies, further demonstrating the value that advertisers see in TiVo's unique advertising solutions.

In the audience research and measurement business, we made significant progress in how we are helping advertisers, ad agencies and even networks analyze and measure the effectiveness of advertising campaigns by offering second-by-second viewer data, as well as research in TiVo households related to consumer purchase decisions.

Recently, we sent an open letter to key executives at ad agencies, top advertisers, and networks, and have received positive feedback on how we can further help them in this area. For example, our IRI TiVo consumer insights provides information on how advertising is viewed, processed, and then acted upon in terms of purchasing behavior by TiVo subscribers. No other research solution can deliver such detailed insight analysis on what ads are being watched and what effect they then have.

I wanted to touch quickly on our pending litigation with EchoStar, specifically the stay of the injunction that was issued by the U.S. Court of Appeals for the Federal Circuit in early October. In patent cases such as ours, it is not unusual for the Federal Circuit to grant stays of injunctions, so we were not surprised by the decision on the stay, particularly given the injunction order would require EchoStar to cut off DVR service to several million installed set-top boxes.

Even though we strongly disagreed with the court’s decision, it should be noted that there are two standards the Federal Circuit could have referenced in staying the injunction. One standard is a finding that EchoStar had a “strong likelihood of success” on the merits, or failing that, a second standard based on a substantial case on the merits, provided that the equities of a temporary stay [inaudible].

The Federal Circuit chose the lesser of the two standards in its decision to stay the injunction, which is the lowest standard that can be applied. The Federal Circuit expressly stated that its decision was without prejudice to the ultimate determination of the case, which will in fact be decided by a different panel of Federal Circuit judges than the panel that decided to stay the injunction.

In terms of process here, on November 27th, the District Court judge in Texas denied all post-trial motions filed by EchoStar. This helped clear the way for the appeals of the injunction and judgment to proceed, and we will be looking to the Federal Circuit to rule as quickly as possible.

With that, I will turn the call over to Steve.

Steven J. Sordello

Thanks, Tom, and good afternoon, everyone. To begin, let me provide you with our third quarter financial results, followed by a look at the metrics, and then finally, our business outlook.

For the third quarter, service and technology revenues were $52.6 million, advancing 22% compared to the year-ago period. Service revenues were $49 million, up 16%, driven primarily by an increase of 317,000 net subscriptions in our stand-alone base versus the third quarter of last year. Technology revenues were $3.6 million compared to $900,000 in the year-ago period. The increase here reflects the development work related to Comcast.

Our service and technology revenues fell short of our guidance range as certain advertising revenue deals did not close in the quarter, and some key advertisers substantially passed their overall ad budget.

Excluding expenses related to stock options, cost of service and technology revenues were $13.5 million, which consisted of $10.7 million related to service revenues. The gross margin on our service revenues were 78%.

Operating expenses as a percentage of service and technology revenues were as follows:

  • Sales and marketing, 18%;
  • Research and development, 20%; and
  • G&A, 16%.

G&A expenses were down $3.4 million compared to the year-ago quarter, due to lower litigation costs.

Stock-based compensation expenses were $4.1 million, and interest income for the quarter was $1.2 million, leading to a net loss of $11.1 million.

Bottom line performance was better than expected, as marketing spend was shifted to the fourth quarter and we benefited from the timing of retail selling. Our loss per share was $0.12 in the quarter, based on 92 million weighted shares outstanding. Note our share count partially reflects the impact of the roughly 8.2 million shares we issued on September 7th.

In an effort to give you more insight into our operating results, we will also begin to report adjusted EBITDA. Our adjusted EBITDA calculations adjust for depreciation, amortization, interest income, and stock-based compensation.

In addition to the stock-based compensation and interest income numbers just provided, we reconcile from net loss to EBITDA excluding $2.2 million of depreciation and amortization in the quarter. This results in an EBITDA loss of $6 million for the quarter, and this compares favorably to the year-ago EBITDA loss of $13.2 million.

I will now touch briefly on the highlights of the balance sheet. We ended the quarter with approximately $107 million in cash and cash equivalents. This number includes the $65 million from our stock offerings, the typical cash outflows to build inventory ahead of the holiday season, and the cash payment to IBM to license its patent portfolio.

Following the holiday period, we typically see an improvement to our cash position as we collect on the receivables generated during that period.

Turning to our key pricing and volume metric, our TiVo stand-alone gross additions were 101,000, representing a 10% increase over the year-ago quarter. As Tom mentioned earlier, this is the first time in six quarters that gross additions have been up on a year-over-year basis.

Churn against our growing base was 1%, leading to 53,000 net stand-alone additions in the quarter, and our stand-alone subscription base now stands at 1.63 million, which is up over 300,000 from the year-ago period.

Our TiVo service average revenue per user was $8.65, down 2% from the year-ago quarter. In the quarter, we saw a lift from service plans associated with the new pricing in the online channel. This was offset by a larger number of lifetime users that have been fully amortized. These amortized lifetime users do not contribute to revenue, but remain in our subscription base, negatively impacting our ARPU calculations.

In the quarter, we had approximately 138,000 cumulative lifetime subscriptions that have reached the end of the 48-month period TiVo uses to recognize lifetime revenue. Compared to the third quarter of last year, fully amortized subscriptions were up roughly 50,000.

As we no longer offer lifetime to new subscribers, all new subscriptions are now on a contract, and therefore we continue to have ongoing revenue against each subscription.

In discontinuing our lifetime offer, we have been focused on increasing both the value and quality of each acquired subscriber. To that end, the average monthly price paid on a new sub was approximately $13, up about 30% compared to the year-ago quarter. Further, in the quarter we saw a healthy percentage of new subs choosing either the three-year monthly or prepaid plan, with the up-front cash generated from the three-year prepaid providing a considerable amount of up-front cash, but not quite at the level of the lifetime offer.

Finally, since we introduced our new pricing plans in early November, we have seen approximately 60% of new gross additions choosing either the three-year prepaid or the three-year monthly plans. Going forward, we expect to see ARPU benefit from the higher monthly service pricing plans and churn benefit by longer-term commitments.

Turning to subscriber acquisition costs, our SAC in the quarter was $287, down about 7% from the year-ago quarter. The lower SAC was impacted by higher gross adds in the quarter, the timing of selling of inventory to the retail channel, and the fact that we spent less on advertising media relative to the year-ago period.

As we previously discussed, this is a fully loaded metric, including both variable and fixed cost elements, including stock option expenses.

With our DirecTV sub base, we are seeing the trend we expected. We added a small number of new DirecTV subs early in the quarter. However, that tapered off as DirecTV rolled out its non-TiVo DVR HD box. The churn on the large DirecTV sub base was higher than these new additions, resulting in a net loss of 37,000 DirecTV subs in the quarter. The DirecTV ARPU was $0.89 for the quarter, and this ARPU excludes the monthly fees we defer until the end of the relevant maintenance period.

Before I get into the specific fourth quarter guidance, I would like to make a few comments.

As we look at the model, one of the fundamental questions that I have been focusing on since I came on board relates to the subsidization of hardware in our stand-alone business, and whether this is the most effective way to grow long-term value.

Over the last six months, we have done testing on pricing in the online channels, and we have learned a lot. We have seen positive results from our online pricing, where we have increased the up-front subsidy but also increased the monthly service fees, and in doing so, increased subscription volume.

This quarter, we have chosen to evaluate the effectiveness of similar pricing in the retail store channel, and we will be making a decision following the holiday period to see if this is an effective way to accelerate growth in the retail channel.

While we have seen significant increase in subscriptions through our online channel since we have introduced the new pricing plans online, there are a few points I want to make on our free offer in retail stores.

First, a 100% rebate in retail is different than our free offer on TiVo.com, as a customer pays for hardware up-front and then mails in for the rebate.

Second, when we implemented free online, it took several months for the pricing changes to lead to increasing momentum in sales.

Third, a portion of our sales during the holidays involves gifting, and a free rebate is not necessarily relevant to the person gifting.

Finally, our testing of the free rebate is limited to our single tuner product, which is a smaller SKU of our overall holiday inventory and will not receive much focus going forward.

Through it is still early, I want to provide you with an update on our holiday sales strategy. As expected, we are working through our single tuner inventory as consumers are taking advantage of our special free offer. Again, the single tuner product only represents about one-third of our inventory, with the dual tuner product representing the majority of that inventory.

We made a conscious decision to increase the value of subscribers compared to last year by charging 40% more for our primary SKU, as well as by significantly increasing our service pricing. For instance, the one-year plan now costs $19.95 per month, compared to $12.95 per month last holiday season.

As one would expect, these price increases, while improving the net present value of dual tuner subs, will in all likelihood decrease volume relative to last year, when looking across all of our SKUs on a combined basis.

Coming out of the holidays, we intend to evaluate the attractiveness of sales volume velocity of free service offering versus offering the product on a less subsidized basis in terms of overall subscriber growth and profitability.

If it appears offering a product on a less subsidized basis is optimal, then increasing the advertising will be fully considered. We are continuing to approach the whole issue of the stand-alone market thoroughly, so that we safeguard cash resources and best define the stand-alone model going forward.

Finally, now that we have been successful in introducing features that differentiate TiVo from the generic competition, we are in a position to much more effectively engage in brand marketing to consumers, starting with the message that it is not TiVo unless it is a TiVo. In other words, as we have grappled with the issue of subsidy versus advertising, we are in a stronger position to do the latter.

Turning to the specific guidance for the fourth quarter, we expect service and technology revenues of $54 million to $55 million. We expect technology revenues to be approximately $3.5 million, roughly in line with the third quarter.

We currently expect an adjusted EBITDA loss of $28 million to $33 million, and a net loss of $33 million to $38 million. As I stated earlier, our fourth quarter results will be impacted by increased levels of marketing, higher rebate expenses due to timing of selling, and the rebate expense due to the free after rebate offer in retail stores.

Compared to the year-ago period, we expect to incur an additional $16 million in marketing and rebate expenses as a result of these new programs.

Last year, advertising media spend and retail store selling were allocated more evenly between the third and fourth quarter, while this year, they are more concentrated in the fourth quarter. As you compile your financial models, I would not necessarily extrapolate this guidance beyond the fourth quarter, since we will be assessing our sales strategy going forward.

As we prepare to enter a new phase of distribution of TiVo through multi-service operators, we continue to assess the best balance between hardware subsidies, advertising expenditures, and different pricing plans. We think it is a good sign and a strength of the business that with less media advertising expenditures relative to last year and more expensive monthly service plans, we have been able to add more gross subs this quarter than the year-ago quarter.

As I look forward, I would like to stress a few key points. In our stand-alone business, we are continuing to grow stand-alone subs while increasing service fees, with a majority of contracts at the three-year commitment since our recent pricing changes. We are more focused than ever on marketing TiVo's differentiated features. Our ad sales and audience research businesses have much potential and we continue to add new products and inventories. Finally, as we look towards Comcast and Cox rollouts, we are excited about how these deals provide a cost-effective way to grow our TiVo sub base.

This concludes my remarks. Thanks for your time, and I will now turn it back over to Tom.

Thomas S. Rogers

Thanks, Steve. In closing, let me just sum up a minute. Our efforts in differentiating our product in substantial ways is clearly paying off, highlighted by the increase in gross subscription additions year over year, the increase in overall TiVo-owned subscriptions, and our ability to bring in higher revenue per new subscription.

Our broadband capabilities are going to enable us to lead the way in responding to the exploding demand for access to more and more unique web video content and to get it to the TV set.

We continue to see momentum in our advertising business, and took some innovative steps to help advertisers engage with viewers and measure the effectiveness of those campaigns.

Our distribution programs with major cable operators are progressing well, and our international deal in Mexico underscores the fact that we see the international part of our business accelerating.

With the announcement of a major talent stable in our corner, we are truly weaving our way into the future fabric of the media industry.

We continue to see growth from our online channel and will now evaluate whether a free after rebate offering in retail stores will create an increase in subscription additions that warrant maintaining this approach going forward, or not. We will have to evaluate this very carefully coming out of the holiday season.

While we understand there are additional challenges to overcome, we believe that we have all the pieces in place to be able to be a leading force in the future of television worldwide.

With that, we will now take some questions.

Question-and-Answer Session

Operator

(Operator Instructions)

We will take our first question from Daniel Ernst, Hudson Square Research. Please go ahead.

Daniel Ernst - Hudson Square Research

Thanks for taking the call. Two questions, if I might. First, could you just comment on the advertising revenue falling a little bit short on expectations? Obviously the timing of a deal is one thing, but the second point on a couple of key advertisers cut their budgets. Could you give us a little color on that? Is that a temporary thing? Are these advertisers pulling out of the program, or is there a macro, they are cutting their ad budgets overall and TiVo is just a part of that?

Second question on Comcast, do you still expect to see the trials to begin here in the fourth quarter? Thank you.

Thomas S. Rogers

Thanks very much. On the first question on ad revenues, the reference that was made to advertisers cutting budgets was more of a macro point in terms of a few advertisers that made some significant cut-backs that involved a number of outlets, and TiVo was not singled out in that sense.

Secondly, on the Comcast front, this is in Comcast’s hands, not ours, in terms of the trials themselves. We would expect to see some kind of trial, not necessarily a public trial but trials of our fully developed product some time in this year, and trials to continue next year. Our expectation is to see some deployment beginning early next year, public deployment, that is.

That continues to look as if we are progressing as we want to be with Comcast, and as I said in my comments, the excitement level with Comcast I think it is fair to say has only grown as we get near to the point of being able to get this out to the public.

Back on the advertising point, I would not make too much of the revenue shortfall that was pointed to by Steve on the advertising side. We are still seeing very substantial interest and momentum on the part of advertisers. The program placement announcement we made earlier this week and the advertisers that were part of it continue to show that these are often relatively long cycle discussions, and are in the stage of this relatively nascent business. Having predictability as to what is going to close when is not quite something that we have down as well as I would like.

There are issues that we still grapple with in terms of some advertisers who very much want to go forward with us not yet having some of the longer form material that is most effective for TiVo at the point that we and they had hoped they would be able to go forward. There are some things in the advertising sales process that as the business continues to gain momentum, I am sure they will work their way out, so I would not over-emphasize that at all.

Operator

We will take our next question from Tony Wibel, Citigroup. Please go ahead.

Tony Wibel - Citigroup Smith Barney

I was hoping you could start by highlighting what the MPV value is on a new contract sub as compared to the old pricing. How much higher is that MPV? Tied to that question, should we now be modeling for a slightly higher ARPU on the incremental subscribers with the service contracts?

Steven J. Sordello

We do not publicly disclose the MPV number, but one of the things that we really tried to do as a company is attract higher value and higher quality sub base. We talked about the average price of a contract rising to $13 this last quarter. That is up 30% from the year-ago quarter, so we are attracting a higher contract price, which we believe will benefit ARPU over time, while locking folks into longer term commitments.

Tony Wibel - Citigroup Smith Barney

What is the most popular plan that people are moving to?

Steven J. Sordello

Lately it has been the three-year prepaid plans.

Thomas S. Rogers

The combination of the three-year prepaid and the three-year monthly together are close to the majority of our overall subscriptions at this point. It is very heartening to see that as part of what we have done here in coming up with new kinds of commitments and pricing offerings, that we are getting those kind of longer term commitments.

Let me just take an opportunity to talk to this point a little more generally, because I am not sure in the midst of a lot of the individual different moves here, the fundamental shift that we have been able to achieve has clearly resonated as much as we think it should. When you look at the commitments and the pricing and the MPV and the sub growth, we really have a number of pieces here moving in the right direction.

What we have done in the last year is move everybody to contracts. To get TiVo service now as a new subscriber going forward, you have to enter into a contract, one- to three-year contracts. As I said, we have about 50% of our subs now taking three-year commitments. We have gotten out of our lifetime offering, which is coming back to bite us a little bit in terms of the fact that it existed in the past, because what we see happening now is those lifetime subs are on but they are not contributing any revenue as they became fully amortized, and that is clearly a drag on ARPU.

It is clearly just underscoring the fact that moving away from lifetime was a good thing to do, but the question that we got along the way here, we have gotten it on earnings calls over the last few quarters, has been what about the cash that generated? What are you going to do as you look toward modeling this business from a cash point of view with the lifetime subscription no longer being there?

We now offer the three-year up-front commitment at the $299 price, which was the same price as a lifetime commitment. So now the question is what are we seeing from subscribers in terms of the popularity of that three-year deal. If current percentages hold, and this is obviously a snapshot, so we will have to continue to look at this over time, but if current percentages hold, we are actually seeing now the same level of cash coming in from those up-front commitments on a three-year deal that we were seeing on lifetime, so that is a really important piece of progress that we have made there, as you look at how those pieces come together.

Now, Steve said along the way here, we have also been able to look at the monthly price that a new subscriber is coming in and paying, and we were looking at before what was in the $9.50 range to something that is about $13 a month in terms of that average price that a new subscriber is now coming in and paying on a monthly basis, which is obviously a very substantial increase, and along the way included in that present value of those subs, going to the essence of your question, is improving.

Now, you look at all that and in this quarter, with all that going on and the improvement in the quality of that sub, we were able to increase year-over-year subs, gross additions, for the first time in six quarters with a lot less advertising than we spent in the third quarter a year ago. All of that is quite heartening.

The essence of what we are doing over the holidays is taking all of that learnings and saying okay, let’s take a look at the retail store environment. The retail store environment, let’s see what it means to have some kind of free offer in the retail stores. We know we are dealing with a different animal there because 100% rebate is very different when you have to shell out the cash up-front than the offer online where you do not have to shell out anything.

We are also, as Steve said, the majority of our SKUs now, our major SKU is not having a free offer attached to it. In fact, the up-front price for the dual tuner is about 40% above what the up-front holiday price was in last holiday season. We actually moved on that SKU, which again is the majority of our product available to an overall higher up-front at the same time as we are moving the subscription fees higher.

Higher up-front with higher subscription fees for the majority of our offering is clearly going to have some downward pressure on our volume, the number of subs that we think we will add in the fourth quarter, but again, what we are trying to balance here while we measure this free offer in the retail store environment, we are trying to come up with an overall balance of quality of sub, net present value of sub increasing and improving, and to get a better handle on at the same time does free really accelerate things at a retail environment the way it does online, or should we consider a different approach going forward that has less subsidy and put more of our marketing dollars into advertising and the leverage that we might be able to derive from that.

Particularly given all the differentiation that we have now worked hard to accomplish, we really think that there is a credible basis to think about advertising benefiting TiVo and not just educating people about DVRs in general, where we would not necessarily see the benefit in TiVo sales of that increased advertising spend.

That is I hope helpful context in terms of how all the pieces come together and gear us toward what we are assessing now in the fourth quarter.

Tony Wibel - Citigroup Smith Barney

Very helpful. Last housekeeping question, is the Cablevision Mexico, how many subs do they have? How many are digital? When should that start?

Thomas S. Rogers

Well, it is about 500,000 subs that Cablevision Mexico has. It is a largely digital plan. Digital means something a bit different in that country than it does here, but it is a largely digital plan. They are looking to start by the middle of ’07. It is something we are looking to implement in relative short order.

Tony Wibel - Citigroup Smith Barney

Great. Thank you.

Operator

We will take our next question from Michael Kelman, Susquehanna Financial Group. Please go ahead.

Michael Kelman - Susquehanna Financial Group

Thanks. I just wanted to get a clarification on something Steve mentioned earlier. The $16 million you referenced with regard to incremental sales and marketing spend in the fourth quarter, is that incremental to the $11 million that was spent in last year’s fourth quarter, so that would mean somewhere around $27 million? Or would you expect sales and marketing to actually trend around $16 million this quarter?

Just to touch on something that Tom just elaborated on, is it my understanding that you would expect the positive trend in gross adds that you experienced this quarter to reverse itself next quarter, given the changes you are making in the retail?

Thomas S. Rogers

Just taking that second question last, the fourth quarter is far more geared toward retail store sales than online, for somewhat obvious reasons, given the amount of push that it gets in the retail environment and the stacks of TiVo boxes out there and all, and for just the reasons that I said in terms of the mix and the wait, a ramp that is heavily not a free offer in terms of our overall inventory and the pricing associated with that, yes, overall for this quarter, we would not expect to see gross subs for this quarter exceed last year’s gross subs.

I would not extrapolate from that, trying to give a very clear picture one, why the fourth quarter is different, and two, why we are going to assess the outcome here in terms of where we put our marketing dollars going forward and how that will relate to accelerating our gross subs, but that is for purposes of a snapshot of the fourth quarter, your conclusion is correct.

Steven J. Sordello

In terms of your question on the $16 million increase, it is not necessarily an increase in the sales and marketing line item. It is really a function of some of it is media advertising, where we are really pushing hard this Q4 relative to last Q4, and some of it is timing of our second-half media spend. Then, a lot of it is related to the rebate, the free offer, and along those lines, the timing of the selling related to the rebate.

You cannot just look at the sales and marketing line. You have to look at the composite of some of our subscriber acquisition costs together.

Michael Kelman - Susquehanna Financial Group

Thank you, and one other question, to elaborate a little bit on the Comcast rollout. Obviously there is only a month or so left in the calendar year. Has Comcast already earmarked certain markets that they would like to initially roll out, whether it is on a beta test or kind of early markets for commercial rollout? Also, maybe you could talk a little more qualitatively about what type of metrics you will be looking at with Comcast to determine if it is a successful early launch, and then how you will proceed on a wider scale commercial deployment?

Thomas S. Rogers

In terms of the first question, yes, Comcast is very much focused on where introduction may first occur and where it may roll out from there. That is not for me to talk about, though.

When it comes to evaluating up-take, I think they will certainly look at -- compare it to other kinds of premium offerings that are out there, will compare it both in terms of new subs, will compare it meaning new DVR subs, compare the take rate on existing DVR subs that are looking for the upgrades, will look at it as a way to win over satellite subs and we will evaluate it on that basis.

I would say those three categories will be the key ones that we will both be looking at in terms of the effectiveness, all against whatever relative metrics there are in terms of the adoption rate of premium services and how TiVo adoption compares to some of those and whatever the points of distinction one might expect there to be.

Michael Kelman - Susquehanna Financial Group

Thanks very much.

Operator

We will take our next question from Kunal Madhukar with Bear Stearns. Please go ahead.

Kunal Madhukar - Bear Stearns

Thanks for taking my question. A couple of things. One is on the three-year plan, under the prepaid option, which I guess is probably the most popular plan, the ARPU is significantly lower than what you have been reporting in the past. How is it that you intend to make up for that ARPU shortfall?

Thomas S. Rogers

Well, there are a couple of things to note there. We said that the combination of the up-front three-year commitment with the month-to-month three-year commitment is the most popular offering. Obviously the month-to-month commitment provides revenue at a higher level than the up-front offer does. When you amortize that up-front offer over three years, then you have to add in the number of people who buy on a one-year basis, particularly the month-to-month one-year basis, where pricing has gone up to $19.95.

The combination of those things is where we came up with an average incremental sub pricing compared to average incremental sub pricing a year ago is where you get this $3 or so lift from the $9.50 type range where we were at previously to the closer to $13 range where we are now. It is blending all the up-front and monthly together into what is certainly an overall increase. That does not mean that certain commitments do not have certain incentives to them that come in below the average.

Steven J. Sordello

The other factor is one you saw for the lifetime offer, which was a relatively significant piece of our business. That ARPU average when you amortize it, about $6.23, so you can see how even the prepaid scenarios we are doing now are significantly above that number.

Kunal Madhukar - Bear Stearns

Thank you. A question on the Comcast rollout. My understanding is your software, the software that you would be installing for the DVR, basically writes on the middleware, which Comcast has yet to deploy. Have you gotten any sense from Comcast as to how quickly or how aggressively they would want to deploy that middleware, particularly if there is anything wrong that would impact consumer experience?

Thomas S. Rogers

Well, the middleware that we write on top of is something that we have been very involved with the development of it that relates to TiVo. That is one of a number of engineering and technical issues which are dependencies for the TiVo rollout.

As I have said before, the rollout is not by any means totally a function of our development work and readiness. There are various things here that must be in place.

As I said, the kind of trials that I believe Comcast contemplates engaging in this year are not public trials in terms of public availability and the kind of trial that we will be going through will clearly be a function of testing TiVo's interaction with the middleware and the other components of the system. Then, as they move toward public trials next year, and then eventually public deployment, obviously all the pieces of the chain have to work together to make sure that the product is optimized, and that is a lot of what the trial work, both non-public and public, will involve.

Kunal Madhukar - Bear Stearns

Great. The last question relates to international opportunities that you talked about. One of the negating factors I understand is that the information, the program data may not be available in a lot of countries. How big is this international market opportunity that you are targeting over the next few years?

Thomas S. Rogers

International opportunity in terms of, your concern is the limitation on program guide data?

Kunal Madhukar - Bear Stearns

Yes, given that there is a limitation in program guide data in a lot of countries.

Thomas S. Rogers

We are talking to people in a number of international markets, and the program guide data availability is certainly one of the issues that we focus on as we develop these international offerings. The markets where we are engaged, we have undertaken to make sure that some of the partners that we are involved with would be able to go about accessing the data so that TiVo can work.

Obviously that data is a dependency. I do not think it is a question of whether the data can be put together. The question is does it come from a different kind of source, and is it accessed differently than the kind of relationship that we may have, relative to Tribune data that we access here for purposes of our guide.

Operator

We will take our next question from Barton Crockett, JP Morgan. Please go ahead.

Barton Crockett - JP Morgan

Great, thanks for taking my question. I want to ask a question about the churn rate. That ticked up a little bit, 1% from 0.9%, yet I thought more people were locked into these long-term commitments. I would have thought if anything, it would have been flattish or down. Is that noise, or the beginning of a trend there?

Secondly, in your statement of cash flow, it looks like there was a large number in expenditures in cap-ex, $15 million or so number. I was wondering what was behind that, because it was much larger than what we saw in the other couple of quarters. I think I will leave it there. Thank you.

Steven J. Sordello

The thing that had the biggest impact on our churn rate, again with ex our lifetime, follow-up of lifetime users, we have lifetime users that remain a sub but the revenue falls off, and then we have lifetime users where the box dies and they fall off. That was the biggest component of our churn this quarter, or the biggest change in our churn rate.

In terms of the cash utilization, in this quarter, this is a quarter where we really build up inventory for the holiday period. That was the biggest chunk of cap usage. We also had in addition to that the purchase of the IBM cross license patent, so those were the two biggest elements of cash utilization this quarter.

Barton Crockett - JP Morgan

Okay, and that flows through into investing, like a $10 million, $12 million, the IBM patent?

Steven J. Sordello

Correct.

Barton Crockett - JP Morgan

Okay. One other thing, just to make sure I understand this. You guys expect a cash contribution in the fourth quarter. Is that a negative net income, but positive cash flow from operations? Is that what you are looking for? Or is it negative net income to non-negative on your cash flow from operations, because of the working capital offset?

Steven J. Sordello

I do not think we want to predict our cash flow for the quarter, but typically what we see, it is a very seasonal business. The way the accounting works and the way the cash flow comes in across this quarter, and so as you build up your receivables and before the holiday period, you typically collect on those receivables following the holiday period. You are not building inventory as heavily at that time as you are in the third quarter, so Q4 tends to be a much more favorable cash flow quarter than other quarters.

Barton Crockett - JP Morgan

Okay. I will leave it there. Thanks a lot.

Operator

We will take our next question from Murray Arenson, Ferris, Baker Watts. Please go ahead.

Murray Arenson - Ferris, Baker Watts, Inc.

Thank you. Good afternoon. Just a couple quick questions. On the lifetime subscribers, can you tell us how many of those are left in the pipeline and what we should expect in this coming quarter as far as attrition?

Steven J. Sordello

In terms of the number, I do not think we have broken out our sub base and I do not think we want to start breaking out those metrics. But what we expect to see on a year-over-year basis, probably the impact in terms of revenue is between $1 million and $1.5 million impact. Some of that would be offset obviously by our growing subscriber base, but that is a lifetime impact quarter to quarter.

Murray Arenson - Ferris, Baker Watts, Inc.

You have also talked a lot about comparing the different approaches to marketing here. I wondered if maybe you could coral that question in terms of subscriber acquisition costs, and maybe give us your thoughts on what the target levels are there, taking into account obviously some seasonal aspects.

Thomas S. Rogers

That goes to the heart of the question that we are going to be looking at in terms of subsidized versus advertise, which is what a lot of this comes down to.

I do not think it is well understood that if we wanted to hold our growth in this business to say 250,000 to 300,000 gross subs a year, we could be profitable. This is a company that in terms of our cost of operations, outside of a cost of acquiring new subs, generates sufficient revenues to cover our operations and some decent levels of subscriber growth.

At the same time, if we wanted to, we could subsidize all SKUs and have three offers on everything, and lower our subscription contract prices back to the kind of levels they were as opposed to where we took them out, and we could drive subscribers on a much more aggressive basis than we have.

In between what I would call more modest sub growth that could run this business as profitability, and more accelerated sub growth that would drive a lot more cash outflow, we end up in a -- what we are trying to do is come up with that right level of growth that responsibly manages our cash, comes up with the highest quality net present value of a sub, and accelerates our growth somewhat beyond what it would be if we were to run the business for profitability today.

It is that balance coming out of the holiday season that we are going to address in looking at whether we did get an acceleration out of the free rebate oriented offer in retail stores versus how we look at our volume on the other SKUs, and whether the volume in the other SKUs should instead be driven further by a more extensive advertising campaign that really begins to hit the differences that TiVo offers.

To answer your question on SAC, it is very much going to be something that we have to come back to as we look at these holiday results.

Murray Arenson - Ferris, Baker Watts, Inc.

Okay. Last question, if I could. Looking at the advertising portion of the business, could you talk a little bit about your partnerships there? Is their involvement still -- would you characterize it at the experimental stage of things, or are you starting to see a model develop, by which you can extrapolate how the spending is going to come in the door in the advertising front? Could you just give a sense of where that is at?

Thomas S. Rogers

Sure. I would not call them partnerships. What we did is we wanted to signal to as broad an array of agency buyers and clients as possible that dealing with TiVo was a fine thing to do. Remember, going back a year or more, we were viewed primarily as a great disruptor in the advertising business that was undermining the existing advertising model and it was not winning us a lot of friends or followers.

We had spent a lot of time over the last year educating advertisers who I think generally came around to say with or without TiVo, fast-forwarding of ads is going to happen, and with or without TiVo, this is a major strategic issue. At least TiVo has a solution, the only solution that is built into the DVR, that can begin to get people to watch commercials and look at ads when they are otherwise dealing with an opportunity to avoid them altogether.

We did deals with the three major advertising holding companies as a way to signal the fact that hey, we are a friend, not foe, which was quite effective.

To answer your question in terms of whether we are an experiment or whether we are a well-established advertising outlet, I would say we are somewhere in between. We certainly are still an experiment to some group of advertisers who come in and want to understand certain things, and to another group of advertisers, they provide ongoing recurring business that are negotiating and are re-upping and have re-upped in the past. For that group, we are more an established play going forward.

I think we certainly do not have enough predictability into the revenue stream yet, as much as we would like, but what we do find is that the engagement with us only has more and more momentum in terms of every month that goes by, there seems to be more concern about what the future of television advertising is when people can fast-forward through ads that people do expect 50 million to 60 million DVRs in homes in the next four years or so, which will turn what is today an interesting area into an area that is of overwhelming importance to the future of that business. With that, and as we introduce new forms of inventory, we seem to find new assurance to different approaches that we set forward.

But it is nowhere near as grounded as we hope it to be in the next year or two, and it is still very much a developing business.

Murray Arenson - Ferris, Baker Watts, Inc.

Thanks very much.

Operator

We will take our next question from Lee Westerfield with BMO Capital Markets. Please go ahead.

Lee Westerfield - BMO Capital Markets

I just wanted to get further refinement on the question about how the impact on ARPU is behaving with the roll-off of lifetime subs. Can I make sure I have these details correct -- lifetime subs, $6.47 did you say, Steve? I wanted to understand that in contrast to the $13, which is for the blend of various three-year plans.

Steven J. Sordello

Our lifetime offer was $299, and we recognized that revenue over a four-year period, so if you look at that on a monthly basis, it is about $6.23 a month. We have gotten revenue from those subscribers. It is non-cash revenue, because the cash was taken up-front.

What we are saying here is we are having a fall-off. As these things become fully amortized over the 48-month period, they remain a sub but there is no revenue associated with it, so it has a negative impact on our ARPU.

What we have been doing for the last year or so as we look to acquire subs that are higher value, higher quality, we have eliminated the lifetime offer and we have raised our service pricing to the point now where the average monthly price this last quarter was $13. We see that ultimately benefiting our ARPU as we go forward.

As we look forward, there are some things that are negatively impacting ARPU and falling off. Those happen to be non-cash related ARPU, and there are contracts coming on at higher prices that will benefit ARPU going forward.

That, along with locking them in for commitment periods so that you do not have someone having a box into perpetuity, is a healthier sub and that is what we have been really focused on doing.

Thomas S. Rogers

Lee, just to clarify -- the $13 is not just a blend of the three years. That is a blend of all the new pricing programs, one-, two- and three-years that exist. I just wanted to clarify that.

As Steve said, we get bitten by lifetime two ways. One, we get bitten because they are fully amortized and therefore not contributing any revenue, yet still in the sub base, so that brings down ARPU. Then, those that continue to amortize, as Steve said, are in the $6 or so range in terms of the level at which we amortized them. Even when they are in there, relative to our new pricing, they continue to provide a drag on ARPU.

Lee Westerfield - BMO Capital Markets

That is a helpful clarification, and just one further question, if I can. Steve, make sure I understood this a little more clearly as well, in the in-store sales channel, in so far as there are rebates being offered in the fourth quarter here, you mentioned that -- actually, I think Tom mentioned, but that some of the impact here would be lessened based upon gift-giving. My question here is how are you budgeting for the rebate offering through the retail channel, in so far as it is not yet totally clear what degree of demand will be from that particular channel?

Steven J. Sordello

It is an estimate and we do our best based on prior experience with changes to our rebate policy. The one challenge this particular quarter, it is a holiday season, and when people gift, the breakage of the rebate in terms of people’s actual taking the rebate tends to fall off. It is an estimate. We hopefully are being conservative here, but that is the best that we can do.

Thomas S. Rogers

We have been pretty good at being able to estimate what the breakage will be on rebates, and my only point was the obvious one that while 100% rebate is a stimulant in some cases, when somebody is giving a gift, they will not necessarily be the one redeeming the rebate. It is not necessarily much of an incentive there. That is a different set of facts than what we are dealing with online. Remember online really, anyway you buy it, it is free. That is the only way it has been available when it comes to that lowest end SKU.

Lee Westerfield - BMO Capital Markets

Thank you.

Operator

At this time, I would like to turn the conference back over to Mr. Tom Rogers for any additional or closing remarks.

Thomas S. Rogers

Thank you for staying with us. A lot of good and new news to come in the future and we will keep you updated. Thanks very much.

Operator

That does conclude today’s presentation. We thank you for your participation and you may disconnect at this time.

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Source: TiVo F3Q07 (Qtr End 10/31/06) Earnings Call Transcript
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