TiVo CEO Discusses F3Q2011 Results - Earnings Call Transcript

Nov.23.10 | About: TiVo Inc. (TIVO)

TiVo Inc. (NASDAQ:TIVO)

F3Q2011 (Qtr End 10/31/2010) Earnings Call Transcript

November 23, 2010 5:00 pm ET

Executives

Derrick Nueman - Head of IR

Tom Rogers - CEO

Anna Brunelle - CFO

Naveen Chopra - SVP of Business Development & Corporate Strategy

Matt Zinn - General Counsel

Analysts

Bridget Weishaar - JPMorgan

Tony Wible - Janney

Barton Crockett - Lazard Capital Markets

Rich Tullo - Albert Fried and Company

Edward Williams - BMO Capital Market

Mark Argentino - Craig-Hallum Capital

Todd Mitchell - Kaufman Brothers

Doug Reid- Stifel Nicolaus

Operator

At this time I would like to welcome everyone to the TiVo third quarter fiscal 2011 conference call. (Operator Instructions) I would now like to turn the conference over to Derrick Nueman, Head of Investor Relations.

Derrick Nueman

Thank you and good afternoon. With me today are Tom Rogers, CEO; Anna Brunelle, CFO; Naveen Chopra, SVP of Business Development & Corporate Strategy; and Matt Zinn, our General Counsel.

We are here today to discuss TiVo’s financial results for third quarter ending October 31, 2010. We have just distributed a press release and 8-K detailing our financial results. We have also released a financial and key metrics summary, which is also posted on Investor Relations web site. Additionally, we will post a recording of this call later today on our Investor Relations web site.

The prepared remarks today should take about 30 minutes and will be followed by a question-and-answer session.

Our discussion today includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relates upon other things, TiVo’s future subscription, advertising and research businesses; profitability, operations, and financial performance and guidance, including future marketing in holiday pricing plans, R&D, litigation and other operating expenditures; distribution of TiVo service domestically with DIRECTV, RCN, Suddenlink, Comcast and Cox; and internationally with Virgin Media, U.K.; ONO in Spain; Canal Digital in Scandinavia; and Seven HTS in the Australia and New Zealand.

TiVo’s current and future service features and product releases as well as TiVo's ongoing litigation with EchoStar, AT&T, Verizon and Microsoft.

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

Factors that may cause actual results to differ materially include delays in development, competitive service offerings and lack of market acceptance, as well as other factors described under Risk Factors in our public reports filed with the SEC, including our latest 10-K and 10-Q. Any forward-looking statements made on the call today reflect analysis as of today, and we have no plans or duty to update them.

Additionally, some of the metrics and financial information provided in today’s call, include non-GAAP measures. Please see our third quarter 2011 key metrics trend sheet for reconciliation of these items.

With that, I'll now turn over the call to Tom.

Tom Rogers

Thanks, Derrick good afternoon, everyone. You may hear some background noise from the outside, and if you do, I apologize. Before we get into the details of the quarter, let me briefly touch on our ongoing litigation with EchoStar.

Two weeks ago, we presented our argument to the United States Court of Appeals for the Federal Circuit, as to why the District Court was correct in holding EchoStar in contempt for violating the Court's injunction in multiple ways. It is important to reiterate. This case will determine whether in practice District Court and enforce injunctions against determined infringers, who overstate the significance of minor changes with the aim of requiring the pattern holder to institute a whole new trial.

Allowing EchoStars position to prevail would create an endless cycle of new trials based on dressed-up work around claims, turning pattern litigation into even more of an enormous terrain on judicial resources. We remain confident in our legal and policy positions and the outcome, and expect the decision in the next several months.

Additionally, it is worth pointing out that the United States PTO recently affirmed the validity without amendment or narrowing of all claims of our time or pattern at issue for the third time, making our pattern even stronger. We believe this action will benefit us in all of our ongoing litigations involving the patterns.

Now to the quarter. The television world is changing faster than you can find an (inaudible) television show or YouTube video on a TiVo premier box. That's pretty fast. But we're staying ahead of the new world order of television where consumers are increasingly looking for a simple way to bring content from pretty much anywhere directly to the TV.

Today, we are the only ones out there that offer a true advance television solution, that seamlessly marries linear and operator video on demand, with the vast new world of broadband content in one box with one search and one user interface. And the consumer in the operator communities have taken noticed.

You might respond to that statement by asking, what about the rise of all those retail gadgets and specialty devices like Apple TV and Google TV. They claim to have the answer to bring in internet content to the television. The answer, they only address a small component of the future television experience.

The device is out today are all essentially fighting for what we call input 2 on the TV set. None of them deliver and marry the complete spectrum of content from traditional linear channels, which still account for some 99% of all TV viewing, to cable video on demand and internet content, nor do any of them give you the ability to search across all this content at the same time. For our part, TiVo is happy to own input 1 where we uniquely tie in the new TV options to the traditional one.

In the meantime, multichannel operators have been "flat-footed" with no viable solution of their own to address this growing trend. To make matters worse, there is a user interface that’s hopelessly outdated, putting the operator in real danger of ceding the market share to more nimble and innovative competitors.

As a result, they are seeking answers to how they can bring more choice to customers, including over-the-top content and a much better experience. TiVo has the only real answer to take multichannel operators' interfaces out of the 1980s. RCN, Suddenlink, Cox, DIRECTV, Virgin Media and ONO and more recently Canal Digital are among the leading operators who have recognized the benefits of working with TiVo, and we are confident that others will follow their lead.

Our deal with RCN exemplifies how an operator is quickly embracing TiVo to gain an immediate competitive advantage and to address the growing broadband television trend. We’re encouraged to say that RCN deployment thus far has exceeded expectations in both subscription volume and customer satisfactions, while competitors like Time Warner Cable are finding their DVR deployment substantially slowing.

Additionally, Suddenlink with whom we announced the deal four months ago is nearing launch in its first market. Our partnership with Suddenlink demonstrates just how efficiently a TiVo solution can be deployed by taking our retail product and provisioning it as a cable box with modifications to incorporate the operator's video-on-demand service.

We’re also seeing a significant interest from other small and medium-sized U.S. service providers and believe we’ll be able to capitalize on the success we’ve seen from RCN and Suddenlink. Our efforts with the larger service provider are also moving forward as both Cox and DIRECTV are progressing towards launch next year.

Concurrently, momentum is building on the international front as well. We’re moving even closer to launch with Virgin Media in the near term. We believe that Virgin offering will be one of the best on the market and will include the seamless integration of traditional television, video-on-demand and broadband catch-up television.

Echoing the excitement we are seeing for this product to launch, Cindy Rose, the Executive Director of Digital Entertainment at Virgin Media, said in a recent press statement detailing the upcoming TiVo launch that the next-generation connected TV service will blow other connected TV products out of the water.

For those of you who are interested, Virgin is having an Analyst Day in the next week or so where they will show off the new TiVo-powered device. We couldn’t be happier to be moving closer toward bringing the TiVo experience to millions of subscribers across U.K. and look forward to sharing additional details as the launch nears.

Separately, in Spain, our work with ONO, the country’s largest cable operator, is progressing as we drive towards deployment there next year. Additionally, last week we announced yet another distribution deal to deploy the TiVo solution in Europe with Canal Digital, the largest satellite operator in Scandinavia.

This is a very important deal, not only because it brings TiVo into a sizeable and attractive international market, but because it gives us a foundational international satellite platform which can be a basis for extending TiVo to other satellite operators, a significant asset given that direct broadcast satellite remains the dominant medium for provision of pay television service outside the U.S.

This deal will take advantage of some valuable development work we have been doing with Conax under the deal we announced with them last year. It's a perfect example of how we can leverage relationships with conditional access and third-party hardware vendors to secure additional distribution deals.

These two exclusive international deals with Virgin and ONO, along with Canal Digital, are expected to make the TiVo experience available to up to 7 million households in Western Europe over the next several years and will help bolster our position as the clear leader in the fastest growing segment of pay TV, the integration of linear and broadband content.

It was thought to be hard to build a great interface 10 years ago. Well, it's even harder now due to the complexity of integrating so much more content from numerous sources and formats and usage models. We’ve been able to leverage the credibility of our retail product to the great benefit of the operator community.

Moreover, TiVo has proven capable developing flexible operator solutions. So the different approaches of various operators can be accommodated. Most importantly, we have the technological expertise to understand design-around, the complex plumbing associated with each individual operator. The combination of these skill sets and our ability to constantly innovate ahead of the curve is what we believe sets TiVo apart.

Coupled with our ability to quickly move on bringing software capabilities to market, such as iPad integration, which I will expand on in a minute, this momentum shows that we are able to keep operators at the cutting edge of innovation. We believe that the work that we are doing and the distribution deals we have in place will become apparent in our financials over time and will also change the trajectory of our subscriber base in a meaningful way in the relative near term, particularly with an opportunity to realize millions of new subscriptions given the operator relationships that TiVo already has in place.

Moving to the TiVo-Owned side of the business now, we're highly focused on finding ways to drive incremental subscription volumes, while maintaining or even enhancing the financial model associated with new subscriptions. As such, I want to provide some more details around our recent holiday pricing move.

As we looked ahead to what we could accomplish for the upcoming holiday season, we tested in our direct channel possible new pricing options. The results showed that lower upfront pricings combined with higher monthly fees drove significant increases in volume and therefore increases in ARPU and increases in service revenues, while also lifting subscription profitability. As a result, we made the decision to more widely deploy these pricing options for the holiday season.

Beyond the positive results that the test revealed, our decision was also made possible by the fact that our current hardware costs are lower than they have ever been with past products. Even so, the lower upfront cost will lead to a near-term impact on earnings; however, we do expect that the holiday pricing change will have a long-term positive impact on our financial results and strengthen the TiVo-Owned business model.

Our efforts to drive more leverage from our TiVo-Owned business are only enhanced as we continue to improve the capabilities and innovation of our products in meaningful ways. As an example, we will be launching our iPad app in a few weeks.

Now, while many others in the market have announced iPad app, we believe these are nothing more than glorified remote controls. However, the TiVo iPad app will be an experience that is context-aware and works uniquely in tandem with what you are doing on the television screen at the same time. Brining this app to life was by no means an easy thing to do and was only made possible by investments over the course of several years in moving considerable capabilities to the cloud, while allowing simultaneous interaction between the local DVR and the cloud-based services, an effort which is simply not easily replicable.

Everyone knows not all user interfaces are created equal. And believe me when you see how it works, you will clearly understand that not all iPad tie-ins to the television screens are created equally. We really suggest you check this out either on your iPad or on YouTube page. And I am sure you will find it to be very core.

I saw an article yesterday, and I am quoting, "If you've got a TiVo Premiere or you're an iPad owner thinking about getting a TiVo, the TiVo Premiere app for iPad might be enough to get you to buy the one you don't have."

Our innovation and the user experience base is not limited just to applications or device integrations. As video choices expand exponentially, driven in large part by growth of over-the-top streaming, we continue to add content to the millions and millions of pieces of content already available on TiVo.

For example, we recently announced that TiVo Premiere subscribers will gain access to the full array of Hulu Plus content streamed instantly to their TVs. This move is a huge win for TiVo subscribers who will be able to access another major piece of the content, making TiVo truly the most complete television viewing experience on the market today. Additionally, for music fans, we've expanded our audio offering with Pandora now available on all broadband-connected TiVo Premiere boxes.

Finally on the TiVo-Owned front, we are very encouraged by a recent Federal Communications Commission action updating its rules to among other things ensure that retail cable card devices have access to all linear cable channels delivered using switch digital video technique, providing discounts on cable bundles to subscribers who bring their own retail box and providing a table card self-installation option so that retail customers do not need to wait around for a cable installer.

The FCC expressed its intention to strictly enforce its cable card rules, and we believe these updates will help make our TiVo-Owned products even more attractive to consumers. We also think this will make it easier for our cable card customers to deal with issues at the point-of-sale.

This quarter, we also continued to enhance TiVo's audience research and measurement capabilities, broadening our ability to play a vital role for advertisers, brands and networks as they try to navigate the maze of an increasingly fragmented TV audience landscape.

Among a host of new offerings, we are now able to showcase the effectiveness of promos in driving audiences to view shows, and we are also in the process of increasing the size of our PowerWatch opt-in panel from 25,000 to 100,000 TiVo households, making it the largest second-by-second demographic, psychographic and segmentation characteristics sample derived from set-top box data.

In conclusion, as we move toward the end of the year, we believe momentum is building around the elements of our business that will drive future growth. We have showcased to the pay TV world that we have a unique advanced television solution that's ready to be deployed today. As a result, the number of signed domestic and international distribution deals continues to grow. We have also continued to successfully protect our intellectual property and believe that we are steps closer to a final decision in our litigation with EchoStar. We believe that all of these catalysts will help to improve the distribution and financial trajectory for the company.

And with that, I'll turn it over to Anna.

Anna Brunelle

Thank you, Tom, and good afternoon everyone. We are pleased with the progress we have been making on our key distribution and product initiatives, and we believe the investments in those areas will help to drive long-term subscription and financial growth.

Service and technology revenues were $41.3 million. Of that, service revenues were $34.3 million and technology revenues were $7 million. Total stock-based compensation expenses for the quarter were $6.4 million. Excluding the related stock-based compensation expenses, cost of service and technology revenues were $13.1 million.

Our hardware loss was approximately $4 million, impacted by approximately $2 million related to the change in pricing for the holiday season that Tom alluded to and which I'll talk to in just a moment. Hardware loss consisted of $2.1 million in loss related to net hardware sales and $1.9 million of cost related to the retail channels.

Operating expenses, excluding stock-based compensation, as a percentage of service and technology revenues were as follows. Non-SAC sales and marketing, 12%; subscription acquisition cost, 3%; research and development, 45%, which increased as accelerated our investment in developing advanced television offerings in line with our guidance; and G&A, 33%, up from the prior quarter due to increased litigation cost.

Additionally, our interest income net of taxes was approximately $350,000. This led to a net loss for the third quarter of $20.6 million which compared to net loss of $6.4 million in the year-ago quarter. Our net loss per share was $0.18 for the quarter using an average of 114 million shares outstanding.

Adjusted EBITDA loss for the third quarter was $12.2 million. In addition to excluding stock-based compensation interest and taxes, our adjusted EBITDA excluded $2.3 million in depreciation and amortization.

Both net income and adjusted EBITDA were impacted by the $2 million in price protection related to the holiday pricing. It is worth noting that had we not made the decision to go ahead with the new pricing for the holiday season, which wasn’t contemplated when we provided third quarter guidance, both net income and adjusted EBITDA would have exceeded the high end of our guidance.

We ended the quarter with $227 million of cash and short-term investments, down from the prior quarter. Our cash utilization was a little higher than adjusted EBITDA this quarter due to the typical seasonal spend leading into the holidays and due to the engineering development expenses related to new deals that we'll recoup later through guaranteed future financial commitments.

Again, it is worth reiterating that we continue to believe that winning of new distribution deals and development of advanced products remains the best near-term use of cash. Finally, if the outcome of the en banc proceeding is positive, we expect to receive well in excess of the $300 million in previously awarded sanctions and damages.

Now turning to our third quarter key metrics, we continue to see strengthening trends in our TiVo-Owned subscription additions, as they were up 7% year-over-year to 35,000. Churn was 2%, similar to the prior quarter. And on a net basis, our TiVo-Owned subscriptions decreased by 45,000 in the quarter and ended the quarter at approximately 1.3 million subscriptions.

Our MSO/Broadcasters subscription base declined by 67,000 from the prior quarter, and we expect to see a significant change in this trend once key distribution deals such as DIRECTV, Virgin, ONO and others launch. Is it also worth noting that our recently announced deal with Canal Digital could reach up to 2 million homes in Scandinavia, which builds on the 5 million homes we expect to reach between Virgin and ONO.

With that said, our overall subscription base stands at approximately 2.3 million subscriptions at the end of October, and we had approximately 282,000 TiVo-Owned product lifetime subscriptions that had reached the end of the revenue amortization period, representing 48% of our current total product lifetime subscription base.

Our TiVo-Owned average revenue per subscription was $7.59, and it is our expectation that we'll see a material increase in Q4 due to the holiday pricing plans as our incremental APRU is expected to be significantly higher. TiVo-Owned total acquisition cost was $6.2 million, while SAC was $178 compared to $165 in the year ago quarter; however, excluding the $2 million of price protection, our SAC was well below last year’s level reflecting the lower cost of manufacturing our box.

Before I get into the specific items for the fourth quarter let me walk you through some factors that are impacting our guidance. First, we’re focused on leveraging our TiVo-owned assets to drive up side. To that end during the third quarter we performed testing in our direct channel to determine whether potential pricing changes for our retail offering, the TiVo Premiere DVR could drive increased TiVo-Owned volume, while still maintaining the subscription profitability characteristics associated with our current model.

The result showed that lower upfront pricing combined with higher monthly fees drove significant increases in volume, and with expected increases in ARPU therefore lifting revenues, while also rising expected subscription profitability. And we believe ultimately strengthening our business model is successful.

As a result as Tom mentioned we determined that it was in our best interest to more widely deploy this pricings for the holiday season. However it is important to note that this pricing structure means that we bear significant costs upfront which leads to a near-term impact on earnings before becoming additive over time.

As such, we expect the holiday pricing change will impact fourth quarter earnings by about $8 million to $10 million. Assuming holiday results near our direct channel testing, we will explore the possibility of continuing with this pricing strategy.

Second, as Tom discussed, we’re continuing to invest more in R&D to take advantage of the opportunity in the rapidly evolving television world specifically investing and distribution deals in product that we expect to begin to rising revenue in the not to distant future. And finally, we continue to budget higher legal expenses due to our ongoing patent litigation that is accessible as a significant payback potential.

With that, for the fourth quarter, we expect service and technology revenues of $40 million to $42 million and we expect adjusted EBITDA to be in the range of negative $24 million to negative $26 million and our net loss in the range of negative $32 million to negative $34 million.

The increase in adjusted EBITDA loss and net loss compared to the third quarter is largely attributable to the mechanics of our holiday pricing and the typical seasonal increase in marketing spend, also it is worth highlighting we currently expect our fiscal year 2012 adjusted EBITDA to be well below the fourth quarter run rate.

To summarize we believe we're putting in place the building blocks for a significant payback and strong long-term returns by investing in our distribution and product development, protecting our intellectual property and instituting programs that are aimed at achieving higher subscription volumes from our existing product offerings, while adding to the subscription profitability.

This concludes my remark. Thank you for your time. And we will now take question.

Derrick Nueman

Real quickly, before we take our first question. I just wanted to make a quick clarification point on our guidance for fiscal '12. And that would be, if you look at our fourth quarter run rate it would be an overstatement to think that will be our last for fiscal '12.

With that, we can take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Bridget Weishaar with JPMorgan.

Bridget Weishaar - JPMorgan

Looking at the guidance for the EBITDA loss going into next year, I think I have a big confuse because I figured as these new partnerships rolled out that margins would improve. So I know some of its legal and some of it is the discount hardware and some of it is the upfront cost with the MSO deals. But can you give us any color and specifically what portion of the increase is due to each component? And what other components are involved in this?

Tom Rogers

Well for purposes of the holiday pricing and currently we're just offering that as a holiday opportunity. So until we see the impact of it and assess it further, we aren't making any view as to any impact next year. As to our R&D efforts, while we don't see significant increases from our current levels at the same time as we said before, we believe it's our best use of cash. And we are finding and we are accelerating our distribution opportunities by our focus on that.

At the same time, we're going to begin to have some significant distribution deals take in next year in terms of the distribution. And the revenue that flows back on the MSO line from that for those deals beginning to have deployment. And so we will certainly see EBITDA contribution from those deals that we currently don't have.

On the legal front that's hard to predict quarter-to-quarter, but obviously next quarter we see substantial increase from the previous year relative to the impact of legal expense on EBITDA. And next year, particularly with AT&T and Verizon activity heating up, as we get into the second quarter of next year we see that that will continue to be an ongoing major expense. So that's the context I'd give you for next year without giving you any specific guidance as to next year.

Bridget Weishaar - JPMorgan

So that would basically imply that the additional revenue you're going to receive from these MSO partnerships will be much more than offset with the increase in the cost with the new deals rolling out? If you're doing those run rate negative EBITDA?

Anna Brunelle

I think our plan is that you'll eventually see revenue growth outpace the R&D growth. But I think what Tom diluting to is that we're in a really exciting time right now with a lot of momentum on the operator front. And given where we're at in that evolution of operators choosing high-risk solution, I just don't want to guide to that right now. But that is where our focus is at and I'm always focused on making sure that we see good returns from these investments.

Operator

Your next question comes from the line of Tony Wible with Janney.

Tony Wible - Janney

I was hoping if we could start off by just looking at the ARPU contribution on the MSOs. It's been improving and we saw another improvement this quarter. How much of that is a mix shift within DIRECTV of old subs and new subs within this DIRECTV versus a mix shift across all of your MSOs, meaning more of a contribution from RCN, Comcast, Cox. And then I had one other quick question on the legal, if I can?

Anna Brunelle

I think in terms of the mix shift question that you're asking about, we don't specifically guide to individual ARPUs for each of our operator deal. So I'm not sure that there is a lot of additional comments we can make there.

Tom Rogers

Obviously some of our newest deals are helping there, but the biggest driver remains contractual momentum with some of our large partners.

Tony Wible - Janney

And there's been a lot of people opining about their views on litigation (inaudible). Can you guys put in your view as to how long you think the various scenarios could play out? In other words, if on one extreme there's a remand and a new trial, how long that would go? And middle ground scenario in the case if there's a remand and a quick summary judgment. And then obviously the timeline should you win, how long for the injunction or a timing on Supreme Court appeal by Dish.

Tom Rogers

Well Tony, I've seen a lot of scenarios commented on out there. I think the first point is that we have a high degree of confidence in the Court of Appeals and this (inaudible) proceeding, bringing this to a conclusion. The decision from the Court of Appeals should be the final word on a patent case and I think that’s where our head is and that's where our anticipation lies.

Obviously people have commented on the possibility of other scenarios, you point to summary judgment on a remand, and summary judgment is a quick proceeding. If there was a new trial, look we're not starting from scratch, discovery, and other things have largely taken place. It would be much accelerated from something that was a start from scratch proceeding.

If we win in enforcement of an injunction, I think this District Court Judge here has seen this case hang around long enough. And we would anticipate that he would move with great dispatch. But all of those are scenarios with the exception and the last thing that I mentioned, our view is that the Court of Appeals is going to give us a victory here. And we are going to be able to implement that victory with speed.

Operator

(Operator Instructions) Your next question comes from the line of Barton Crockett with Lazard Capital Markets.

Barton Crockett - Lazard Capital Markets

I wanted to make sure I understood the guidance for 2012, because it's just a little bit confusing to me. And maybe I'm not alone, but I read in the press release is that you are expecting 2012 adjusted EBITDA to be well below your fourth quarter run rate. And then Derrick, you said something about the fourth quarter run rate not being indicative of the 2012 loss. I'm fairly confused.

Tom Rogers

If you take the midpoint of our Q4 adjusted EBITDA guidance of $24 million to $26 million, and $25 million and you run rate it out you get a $100 million. We expect the loss to me much smaller than not. So better than that number, makes sense.

Barton Crockett - Lazard Capital Markets

Now it makes sense, I appreciate that clarification there. And then also to understand in your guidance for next year, you're not including any incremental expenses from the some promotion that you're doing here in Christmas, that something where you kind of see if you want to extend it, after the fourth quarter, is that correct?

Tom Rogers

We haven't guided to next year. We simply didn't want people to take our run rate as indicative of what our EBITDA for next year would be. But correct, we have made no decision obviously on the effectiveness of holiday pricing, if it works, as did in testing and we see substantially increased volumes and with that the increase in overall revenues, the increase ARPU, the increase in profitability and sub. There maybe a basis for us to decide that its worth making the upfront cash investment for those improvements in the business model. But we're not making any such decisions and we're focused on that being holiday a promotion for lot of obvious reasons related to the holiday.

Derrick Nueman

And just to be clear Barton, if we were to decide to go forward with this pricing, you can't take the Q4 run rate of what this is costing us. Because what occurs is we start getting the benefit of all the ARPU. And the impact narrows and narrows to the point where we start actually becoming additive or this actually helps our earnings and really helps our revenue. So again, if we decide to go for this you can't run rate the Q4 numbers.

Barton Crockett - Lazard Capital Markets

I know you expect revenue contribution to accelerate for the third party MSOs, what about subscribers? I think Tom you were suggesting that there will be a change in the trajectory of subscribers you lost MSO subs this quarter. You have the Virgin deal that's on the (inaudible) of kicking in, you have a new box coming direct from DIRECTV, you have some of these other deals. Could you just update us on the timing of when these deals you think will not kick in including DIRECTV, and when we might start to see a turn North in MSO third party subs?

Tom Rogers

Well it's a general matter that these things kick in next year those are significant deals that kick in next year. Their continued contributions that will kick in next year from smaller deals and smaller MSOs and we think all of that will contribute to change in the trajectory. Obviously the loss of subs on the MSO line has been improving and with the increase in subs that we hope to see from these newer deals kicking in, we hope to see further improvement next year.

The issue of the mass distribution subs is something that as well as deals come on board from places like Virgin, where they are exclusive in nature in the sense that any new sub getting an advanced television offering is going to be a key TiVo sub. There is an acceleration factors there toward our sub trajectory build, which isn't present in number of deals that we’ve talked about in the past. So that’s a major help in that regard.

Barton Crockett - Lazard Capital Markets

But to be clear, there's nothing in the fourth quarter that's going to meaningfully affect the MSO as potentially Virgin would kick in there?

Tom Rogers

Barton, I think that obviously in terms of meaningful impact it is going to take sometime, even although the product launches are very near term. And it will take some time before you see numbers that are going to be meaningful on the radar screen.

Operator

Your next question comes from the line of Rich Tullo from Albert Fried & Company.

Rich Tullo - Albert Fried & Company

You had mentioned cable card at the top of the call, when does that go into effect and when will you be able to monetize that opportunity if at all?

Tom Rogers

Well we are the key providers of a service (inaudible) on cable cards out there and we’ve been quite active with DFCC making sure that the issues of friction for consumer got solved and in the last few weeks the SEC took on the issue head on improved rules relative to it and its intention to enforce those rules.

Rich Tullo - Albert Fried & Company

Where do you expect CapEx in 2012? Sounds like you have a lot going on in development next fiscal year what do you expect the CapEx run rate cost to look like is it going to look like the fourth quarter of this year or something less?

Anna Brunelle

We don’t actually guide the CapEx run rate, but I think basically we’ve been pretty flat historically and if you are building your model I’d take that into consideration.

Derrick Nueman

I think its fair to say that the new distribution opportunities that we are taking on while they do cause us to incur some incremental R&D expenses they don’t tend to have a significant impact on CapEx.

Operator

(Operator Instructions) Your next question comes from the line of Edward Williams with BMO Capital Market.

Edward Williams - BMO Capital Market

Can you talk a little bit about what conversion rates you have seen for TiVo Premiere from your existing boxes and also maybe come in a little bit on what level of over the top usage you’ve seen for your new interface so far?

Tom Rogers

Well we get a substantial number of TiVo subs that are great to the premiere box and that’s obviously a significant element of where we market to, but the new pricing we’re introducing for the holidays is really intended to go well beyond the existing base that no other products. We want to make sure that people who haven’t been exposed to TiVo or referred one of issues with TiVo was the upfront price of becoming a subscriber that the accessibility of the product is made very clear. And given how we tested that’s with new subscribers that’s very much the aim there in terms of our over the top product we are seeing still consistently in the 85% or higher range of subscribers connecting when they buy a new box to broadband right away.

And much of that is a function of people wanting to immediately take advantage of the broadband content operating switch is as good a collection as you can get out there of everything from television, and movies, and music from multiple providers and multiple plans and approaches for consumer so that continues to be a key draw. The unique draw of course of the product is that it’s a combination of linear channels in that broadband in a single interface. So everything is provided for in a seamless single integrated solution for consumers then that obviously is the biggest draw of all.

Operator

Your next question comes from the line of Mark Argentino with Craig-Hallum Capital.

Mark Argentino - Craig-Hallum Capital

When you are thinking about the holiday pricing a little bit more specifically and you did mention it’s going to hit your I think it’s the adjusted EBITDA about $10 million for the quarter. Can you just talk little bit about the box economics there so what kind of payback period assuming you discount the box. Do you expect to break even and what are some of the gaining factors to maybe may be gone forward with this type of model?

Tom Rogers

Well when you mention the box and one of the reasons that we could do this now and distinguishes from past periods is that when we introduced our new box earlier in the year a lot of cost reduction went into that box much more sophisticated box, much more sophisticated interface first implementation of a (inaudible), but the cost substantially came down.

So, while the retail price being what it is, there was a substantial improvement in the cost and we basically recapture that cost well within a lifetime of the sub and when you look at the lifetime of the sub we are improving the overall revenue and overall profitability of the sub so that’s why we are feeling that this is got little downside to it if it actually does drives volume. It strengthens the business model strengthens the ARPU, and the profitability the payback is there. And the issue is the use of upfront cash that does hit EBITDA as you said but given the other benefit of what it may provide for us we looked that it is a work while thing to do for the holidays.

Mark Argento – Craig-Hallum

I guess more specifically and I was just online it looks like you are selling a box at least the one offer I saw for roughly $100, and we got $20 monthly is that model you guys are going to go with?

Naveen Chopra

Yes that’s the new pricing. And so you get the substantial increase on your monthly ARPU relative to what people were paying previously and that’s a more than made up for well within the lifetime of the sub and over the lifetime of the sub it’s a nice increase.

Mark Argento – Craig-Hallum

When you are thinking about the lifetime of sub are you thinking about that kind of 2% term rate is that what kind of lifetime values are you thinking through this?

Derrick Nueman

We given a specific light, but we are relatively conservative on that and could be in excess of what we actually think.

Mark Argento – Craig-Hallum

The high level of thinking here is if you are $20 a month a box and say your cost of the box $300 you are getting 100 upfront maybe you got to split the retail. I mean you guys should be get your payback period on the box should be better part of a year I must say and might often that thinking?

Derrick Nueman

Well, I was giving you an exact estimate on that it is well within the life of the sub and it is a relatively short period for purposes of looking at that payback.

Mark Argento – Craig-Hallum

And then you’re shifting gears to the more the MSO’s and some of those satellite deals, and a price deals. When you saying it about these deals that you strike although you don’t quantify your CapEx but if I had to think about your kind of the project values some of these relationships, and how much capital are you guys deploying in terms of upfront the R&D but also the integration work.

And kind of back to my other question I can’t take back period there as well. Do you think from signing the deal then implementing it that means actually achieving a positive return and if you think you can get a positive return after a couple of years, what’s just kind of that the time the money on some of these deals. I know every deal is unique but I just be a little helpful there so we can think really either talking about new deals and could we got some momentum along these lines so it will be helpful to understand that.

Naveen Chopra

So I think your comment there is important that obviously every deal is unique, and so I am always cautious about trying to describing things generically. But I think it's fair to say that we obviously approach these deals with a great deal of diligence such that to the extent we are making upfront investments. And it's not the case that in all deals we do, in many cases I think the distributor is actually funding all over the vast majority of the upfront development effort. There are some cases as we have described for you more recently, where we contribute to that.

But it is always done on the basis of a distribution commitment that can be translated to revenue that we believe will manifest in a reasonable period of time that more than offsets any investments that we're making from an R&D perspective. And that’s something were able to do because the nature of the deals, as Tom described for you earlier, are such that there are commitments around TiVo being the either exclusive or primary platform that these operators are distributing. So it’s relatively easy both for us and them to forecast with that distribution and deployment looks like over some period of time.

Mark Argento – Craig-Hallum

So when you're going into these deals of course you have an idea on the number of potential sub. But you get some level of commitment from the service provider that to be able to get to certain levels, and I am assuming there's no guarantee here.

Naveen Chopra

There are guarantees and in deals where we are making investments in the R&D. Those guarantees tend to be quite substantial.

Tom Rogers

And as indicated a number of the deals that we've done recently are exclusive and that brings with it a certain degree of certainties to the level of distribution we're going to get beyond any guarantees. So it’s overall a formula where we get substantial return in sub fees for anything that we've invested upfront on the R&D front.

Naveen Chopra

I think it is worth highlighting that those dynamics are fundamentally different than the context of our mass distribution deals two or three years ago. I think there was more uncertainty and less predictability about that kind of deployment. But if you think about what has transpired over the last 12 months, we've put in place deals with Verizon, with Suddenlink, with ONO, with Canal Digital. We've hit the market with RCN, we'll soon be hitting the market with Verizon. And so it is a very different mode of distribution and what we haven’t had in the past with operators who had multiple solutions in the market at the same time.

Operator

Your next question comes from the line of Todd Mitchell with Kaufman Brothers.

Todd Mitchell - Kaufman Brothers

Not to believe where the point, but I want to go into some of the perhaps which you can tell on the accounting of these deals. So these are all gross add deals and there is I am assuming the way we should model this is based upon some sort of ASP per gross add as these guys build out their subscriber base. Now can you tell us that you have a minimum commitment from these operators does the minimum commitment start at the upfront of the deals or should we model on a stable ASP that gross out with their with their subscriber base.

Tom Rogers

First to make sure that everyone is clear when we say a gross add deal, the key distinction there is that we are not going back into somebody’s install base of boxes. And upgrading software on those so our deployment is a function of how quickly they deploy their next generation boxes, but I want to be clear that that does not mean we are solely dependent on the operators ability to add new subscribers, because the vast majority of these operators are replacing boxes at a pretty healthy clip and obviously the broader dynamics of broadband television, multi room etc. etc. are I think accelerating that pace. So you see many operators that are replacing as much as 25% of their set top base on an annual basis. And that’s something that we get the benefit of under these deals.

Todd Mitchell - Kaufman Brothers

Fair enough gross DVR adds but my question is you have a minimum commitment from an operator and you start to scale lets say in the second or third quarter you do twice as many units as you did in the first quarter are we going to see the ASP jump around or are you going to match the revenues with the subs as they come online is that the way to model this from our prospective?

Tom Rogers

I think you may see in the early stages of deployment with some of these operators because of the nature of the minimum guarantees then obviously they are actual deployments. They take a little while to catch up with their minimum guarantees but once we pass the guarantees, I think you should see a correlation between growth on revenue and subs.

Naveen Chopra

Not all deals are the same. There are different ways that this is constructed based on different approaches to different components of the economics from different operators.

Tom Rogers

And clearly operators get the benefits of volume. So operators drive a lot of volume and are getting benefit for that.

Todd Mitchell - Kaufman Brothers

And then in terms of your deployment cost, and integration cost do you get to, and truly I just don’t know this. Do you get to capitalize a part of that so that you can match them with the revenue stream as it grows? And just so I think some other people are trying to get up. Is there an upfront, basically you're going to have eat some of it, so the yields go from being dilutive to accretive to the basic EBITDA.

Tom Rogers

I think we actually have some flexibility on a deal-by-deal basis in terms of how we recognize the revenue on the cost of those. I don't obviously want to comment on any of them, specifically, but the upfront losses that were taking are pretty modest for most of those, and in most cases we're able to match it with revenue.

Todd Mitchell - Kaufman Brothers

When we think about these deals, again, in our models, we should think about there's an ASP and then there is a contribution margin. Is that correct or shouldn't be modeling basically, there's a ASP which a licensing fee and then there is a chunk of R&D to get spin upfront for that future licensing. We can match them going forward and if that’s the case, what is the kind of level of contribution margin that these types of deals should give you?

Derrick Nueman

I mean we really haven't broken out the contribution margins of these mass distribution deals. I mean again, we believe they have very high contribution margins, just given once you do the development work. Each incremental sub is upside, but it's planning on something we really for competitive reasons won't to share.

Todd Mitchell - Kaufman Brothers

I mean you use to talk about this kind of in the context of your core business kind of having, 70%, 75%.

Naveen Chopra

I would tell you the incremental margins on that business are very good and that hasn't changed.

Operator

Your next question comes from the line of Doug Reid with Stifel Nicolaus.

Doug Reid- Stifel Nicolaus

Most of my questions have been answered. I did want to get some color you might be able to share on differences in dynamics in the European market from that of North America, given the strength and are saying there are a number of new operators just signing up there. Could you help us understand, what comparative dynamics exist there that are supporting some of that growth rate now. And how sustainable you might believe that growth could be, given the rapid pace at which you're seeing new alternative offerings at the market.

Tom Rogers

One key distinction is that we've gone to a way of DVR deployment in this market and while there's been some DVR deployment in Europe. The wave of DVR deployment with broadband over the top content to the set-top combined with the improvement of an advanced user interface are kind of all hitting in the European market as one. So somebody who can provide a consumer solution that integrates to all that. And then is sufficiently skilled to be able to take all of that and build that into the unique plumbing of each individual environment there, which there are very many and so the operating logistics of the network architectures of these distinctive operators create a whole different level of expertise.

The combination of all that coming together has put us in a unique position as a provider. I think we'll also view it as the guidance that have the only broadband linear integrated solution that's actually been implemented in the marketplace. So we view to somebody who not only has a solution, but has proven that they have a solution that can be implemented. And that puts us in a different category in terms of our perception there.

Derrick Nueman

I would add to that that there are not a lot of context outside the United States, meaning it is a much more competitive multi-channel environment or you have smaller players, very few of them have the capability to develop in absolution. Obviously, some of the biggest operators in the United States still rely very heavily on in house solution. You don't see that in places like Europe at a substantial degree.

So you have a lot of operators who need capable vendors and who are looking to differentiate their service, and I think those are very good dynamics for us, coupled with the fact that you have a broadband infrastructure. And I think a very nascent market in terms of broadband television in which we can play a very big role.

Tom Rogers

I think the last issue that's distinct of this that in the U.S. market, the box manufactures have had because of their roles conditional access providers. And you need to hold in decisions related to the set-top box. And what we're seeing internationally is that those variables are very different over there in the decision. First and foremost is being made as to what kind of user experience, what kind of user interface you need and the box, and other decisions following from that and obviously being you as the leader in user experience, in user interface, putting us at the lead of that decision making tree is a very helpful place to be.

Operator

Your final question comes from line of Tony Wible with Janney.

Tony Wible - Janney

I have a quick follow-up. I guess when we did or now looking at this holiday pricing is kind of a preview. We noticed that the box was sold out on Best Buy subsequently, now has being restocked ahead of Black Friday. Is there any kind of a qualitative early data you could share suggesting that you would expect to see an increase in the subs. Because it seems like a lot of the focus of the questions here have been on the trade-off of having bigger hit upfront in exchange for a bigger service fee. But I was hoping, if you can look at the other dynamic which is the potential to sell more boxes. And on the early data you could share that suggested that's happening would be helpful.

Tom Rogers

Well we've certainly had excitement from retail partners and certainly it looks promising. Its obviously too early to tell how the holidays will do, because we really aren't in the throes of it yet. But certainly based on feedback that we've gotten, it appears promising and we would expect based on our own view that our year-over-year comparison of subs will not only be better than last year’s fourth quarter, but better than the improvement we saw this quarter relative to the last third quarter.

Operator

I would now like to turn the conference over the Tom Rogers for closing remarks.

Tom Rogers

Thank you very much. I'd say that beyond all the issues that we discussed, we see on the distribution front just continuing to win deal, Canal Digital being the latest example of that. On the innovation leadership front, something we discussed in our comments, but didn’t discussed in the questions is the iPad implementation that we did. You're hearing a lot about this from a lot of providers.

Again I urgently go out and see it, this is really high to the television experience and enhances the television experience, is about taking a very rich user interface and putting in your hands in a way that very much expands the whole usability of a rich interface. We think we continue to win in terms of innovation leadership there.

And on the pattern front the key win for the quarter being the upholding of our patent validity for the third time by the patent office strengthens that patent in terms of the long-term perception of the value of our intellectual property. I don’t want to leave that out as a major win. So against this backdrop, we are very excited to go into the holiday season. And continue to believe that the unique role we play is taking what the cable box has and the DVR attached to that box with no broadband content, take with this specialty device guides and have with no linear channel delivery and no DVR, and only broadband content.

And put both of those sides of the equation into a combination of cable-box linear channel delivery DVR and all the broadband content anybody would want into a single offering, is the right place to be this holiday season, as broadband content finally comes to the floor is something that we think is a mainstream consumer choice.

We’ll look forward to telling you all how it goes. And thanks very much, for being with us. Happy Thanksgiving.

Operator

Thank you for joining today’s conference call. You may now disconnect.

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