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TiVo, Inc. (NASDAQ:TIVO)
F1Q08 Earnings Call
May 30, 2007 5:00 pm ET
Derrick Nueman - IR
Tom Rogers - CEO
Steve Sordello - CFO
Matt Zinn - General Counsel
Tony Wible - Citigroup
Kunal Madhukar - Bear Stearns
Daniel Ernst - Hudson Square Research
Alan Gould - Natexis Bleichroeder
Barton Crockett – JP Morgan
Ingrid Ebeling - JMP Securities
Michael Kelman - Susquehanna Financial Group
Alan Bezoza - Oppenheimer
Richard Baldry - First Albany Capital
David Miller - SMH Capital
Welcome to the TiVo first quarter fiscal year 2008 earnings 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'd like to turn the conference over to Derrick Nueman. Please go ahead, sir.
Thank you and good afternoon. I'm Derrick Nueman, TiVo's Head of Investor Relations. With me today are Tom Rogers, CEO; and CFO Steve Sordello. We are here today to discuss TiVo's financial results for the period ending April 30 2007, which is the first quarter of fiscal year 2008.
About an hour ago, we distributed a press release detailing our key financial results. We have also released a financial and key metric summary which is posted on our investor relations website, and filed with the SEC. Additionally, within a few hours we will release a recording of this call that you can access through our investor relations section on our website.
The prepared remarks today should last about 30 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, litigation 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.
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 forward-looking statements. We describe these risks in TiVo's recent SEC filings, including our most recent annual report on Form 10-K and our quarterly reports on Form 10-Q.
I'd also like to note that any forward-looking statements made on this call reflect analysis as of today and that we have no plans or obligation to update them. Additionally, some of the metrics and financial information provided in today's call include non-GAAP measures. Please see our FY08 key metric trend sheet for more information and a reconciliation of these items.
With that, I will now turn over the call to Tom Rogers.
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Thank you. Good afternoon. I will first take you through the operational and financial highlights of the first quarter. I will then discuss in some detail the ways in which TiVo continues to significantly differentiate itself from generic DVR alternatives. Next, I will provide an update on the advertising front. Finally, I will provide you with an update on the five key engines outlined on our last call that we believe are crucial to driving TiVo's growth going forward.
The first quarter was all about steady progress across many areas of our business. In this context, it was very exciting to note that this was a period during which we continued to develop and bring to market additional key features to our TiVo service. One of the most important tenets driving TiVo forward today is the idea that we will continue to define and introduce new and compelling features that further position and differentiate TiVo from generic DVR alternatives, and do so in a way which will connect with a mass TV audience. This quarter was no exception and I will expand on that later.
Also, very importantly, we improved our financial profile, posting both positive adjusted EBITDA and net income. This improved financial performance, our first advertising campaign in years, continued progress with our mass distribution opportunities that we have with Comcast, Cox, and now the seven networks of Australia, along with a new set of very distinctive and compelling features recently introduced with more coming over the next few months, we believe combined to get fiscal 2008 off to a good start.
In the first quarter, we delivered better than guided results for both net income and adjusted EBITDA, posting net income of $835,000 and adjusted EBITDA of $6.7 million. We are quite pleased with these results and we continue to make progress toward our objective of getting closer to adjusted EBITDA breakeven for fiscal year 2008, assuming gross subscription addition levels similar to those achieved in fiscal year 2007. Service and technology revenues came in slightly above the high end of our expectations, at $58.1 million.
We believe these results validate our approach to driving standalone business forward in a way that substantially improves the company's business model. Moreover, there are many factors in front of us to increase that momentum: the long-term impact of our mass distribution strategy, increasing advertising industry support, international opportunities, enhancing the brand through our marketing campaign, and the ability to better leverage our intellectual property.
Moving to sub results, TiVo-owned subscription growth additions for the first quarter were 57,000 and churn fell sequentially to 1.1%. This led to a slight increase in the overall TiVo-owned subscriptions, which now stand at over $1.7 million. Similar to the previous period, DirecTV TiVo subscriptions declined during the period, as DirecTV is no longer deploying TiVo boxes.
Growth additions this quarter were impacted by three factors:
First, in an effort to reduce hardware subsidies, we increased the effective upfront box price of our standalone units, while maintaining service pricing in the $12.95 to $16.95 range.
Second, we did not have a lower-priced mass appeal HD offering. As we indicated last quarter, given the price of our Series 3 unit, we have not been able to meaningfully participate in the HD wave in retail.
Third, our marketing campaign did not begin until the beginning of the second quarter. As we have said before, our objective has been to increase not only the size of our subscription base, but also the value of each new subscription brought on, and we will continue to work toward that goal. During the quarter, we had record TiVo-owned ARPU of $9.06. In addition, new TiVo-owned subs were added in the first quarter at an average monthly subscription fee of approximately $13, up from about $10 15 months ago.
TiVo continues to be at the forefront of how people watch and get television, especially as our differentiated feature set continues to improve and expand. In the last three months, we have continued our leadership in defining the future of television consumption. Our customers expect this from us and we continue to set the bar high in feature-friendly innovations.
Here are some highlights:
First we launched Amazon Unbox on TiVo which provides TiVo subscribers with the ability to rent or purchase movies and television shows from leading studios and networks, including Fox Entertainment, Paramount Pictures, Universal Studios, Warner Brothers, Lionsgate, CBS and Sony Pictures and deliver them directly to the television. Amazon Unbox currently has about 10,000 titles available to TiVo subscribers. We continue to work toward introducing ordering on the TV screen functionality for Amazon Unbox, where subscribers will be able to purchase and download premium broadband content directly from the TiVo user interface using the remote control. We expect that this feature will be available in the near future.
Second, we recently launched Universal Swivel Search, the first truly TV-centric onscreen search tool, allowing subscribers to explore and discover not only broadcast and cable content but broadband content as well. With programming coming in from hundreds of digital cable channels combined with movies, TV shows, high-quality video through TiVo Cast and Amazon Unbox on TiVo, broadband TiVo users have tens of thousands of immediate choices at any given time.
With Universal Swivel Search, subscribers can search using the way they intuitively think about television. That is, by starting with a program they currently enjoy, and using elements of that program to find more of what they like. The age of on-demand, a la carte television is just beginning. We are defining that experience and making it really easy for viewers to enjoy it rather than be overwhelmed by it.
Third, we launched TiVo Home Movie Sharing which empowers subscribers to share home movies directly through their TiVo service. Perhaps you have seen one of our new television spots where a grandmother wipes her tears away with a TiVo antenna as she watches her grandson directly on her television using the TiVo user interface. This is an excellent example of a way we believe a non-tech-savvy audience connects to one of TiVo's many differentiated features.
Fourth, we launched TiVo Mobile from Verizon Wireless which allows subscribers to see what's on TV and schedule TiVo recordings from almost anywhere using their mobile device.
Our strategy to differentiate the TiVo product and service from other DVRs on the market was best highlighted in a recent New York Times front page business story. David Pogue wrote in his column about TiVo leading the way in connecting broadband content to the TV --and I'm quoting here -- "if TiVo's aim was to differentiate itself, it's been successful. As you probably noticed, not everything worth watching these days originates on TV. But thanks to these unheralded and unadvertised improvements, the TiVo is the first set-top box to present all the good stuff on a single screen… the one across from your couch."
All I would add to this is to say with our new marketing campaign, our differentiated feature set won't be unadvertised improvements for long.
Beyond feature enhancement, we continue to make strides in weaving our way into the fabric of the media industry. Our audience research measurement business has emerged as the only provider of second-by-second commercial ratings data for DVR households for the multibillion dollar television advertising industry. Our proprietary data is increasingly becoming an important element in the evaluation of advertising purchases.
What is becoming very clear is that purchasing behavior in DVR and non-DVR households is significantly different from one another. Marketers are both going to have to understand how to deal with this clear fact from the standpoint of both audience research and advertising buys. Consequently, we are now offering a subscription-based product with a recurring revenue stream rather than simply a one-time research report.
To that end, during the quarter, we launched our TiVo StopWatch syndicated second-by-second programming and commercial DVR rating service and announced that two very large shops -- Interpublic and StarCom -- became the first purchasers of the product.
Last quarter we outlined five new growth engines we believed would drive measurable success in fiscal year 2008. During the first quarter, we achieved a number of milestones against each of these growth engines. I'll now take you through a brief rundown of the highlights in these five areas.
First, in the area of broadband content, as I mentioned earlier we successfully launched Amazon Unbox on TiVo. We will continue to innovate in this area and have several new initiatives in the broadband content arena that we expect to announce later this year.
Second, we have made significant progress on work related to the Comcast product. The trials are progressing well and will include limited subscriber deployment between now and the early summer. We're also excited to update you on the date and location for the commercial launch. Comcast's plan, and I'm now quoting Comcast directly, the Comcast TiVo trials will continue into early summer with a commercial launch plan for August. The commercial launch will be in parts of our New England division, including Metro Boston, Southeast Massachusetts and New Hampshire.
Additionally, work on Cox is progressing well, and it continues to be our expectation that Cox would roll out toward the end of the year.
On the international front, in addition to our deal with Cablevision Mexico which is currently in beta testing, we announced yesterday a very important deal with Seven Network Limited, Australia's leading broadcast company, where Seven will market and distribute TiVo products and services in Australia and New Zealand. The Seven relationship is meaningful because it is a partnership with the most significant media company and leading broadcaster in the Australian market. It would be like having CBS and NBC promote TiVo adoption in the U.S. and Australia is one of the most significant English-speaking television markets in the world. We believe that a large broadcaster driving TiVo advertising solutions into the market should be a real catalyst to our advertising platform being adopted in that market and we hope elsewhere in the world.
In addition, Seven is a company that has led the way in defining Australia's media landscape, having a highly successful joint venture with Yahoo! As a result, Seven fully understands the power of TiVo's broadband application.
What is even more exciting about this is that the hardware will be based on the digital terrestrial DVD-T platform that has emerged as a major worldwide standard, having already been adopted to date in 30 countries and on its way to representing more than 100 million homes by 2009. We believe that development work on DVD-T will be highly leveragable across many more significant international markets and this will give us significant economies and efficiencies for driving TiVo's international business in the future.
Third of our five engines, we continue to make progress toward a lower-priced, mass appeal, high definition unit, which will become available later this year, and will complement the important role that TiVo is playing in working with retailers to offer high definition products and services to consumers. Additionally, the TiVo Series 3 high definition digital media recorder, which is the first standalone TiVo product that is HD-compatible, continues to receive great reviews for its functionality.
Fourth, we launched our advertising campaign, as I mentioned earlier, in early May after the first quarter ended, which is intended to educate the marketplace on the unique and distinct elements of TiVo and highlight TiVo's advantage over generic DVRs. The tag line for the campaign is, "My TiVo gets me", which works on several levels.
First, TiVo goes out and gets programs and records what the viewer wants. Second, TiVo personalizes the TV experience so well that it's clear it gets who the viewer is and what a viewer cares about. Third, there's such passion about TiVo that it's clear it gets people in the heart and the gut. This campaign is focused on branding versus direct response, so we anticipate the campaign will build momentum over time.
Fifth, as we indicated previously, through this advertising campaign, we are moving in a direction where we are reducing hardware subsidies. We believe that this will not only be a better use of our resources but will also significantly enhance the overall financial position of TiVo.
To that end, we are beginning to see the impact of this shift materialize as we delivered better-than-expected adjusted EBITDA performance for the quarter, this positions us well to meet our objective of getting closer to adjusted EBITDA breakeven for fiscal year 2008.
Now, before I turn the call over to Steve, I wanted to touch quickly on our pending litigation with EchoStar. Our case against EchoStar is progressing and we are moving closer to resolution at the Federal Circuit Court of Appeals. EchoStar has filed its initial brief which we believe did not include any surprising argument. We filed our appellate brief today; hence, the two additional steps that we expect to occur before a ruling from the Circuit Court will be a reply brief from EchoStar and an oral argument, which we currently expect to occur in the late summer or early fall timeframe.
The other interesting development in this case is that AT&T recently attempted to file an Amicus brief supporting EchoStar which speaks to how others perceive the importance of this case. We are gratified, though, that the Federal Circuit denied AT&T permission to file the brief.
As a footnote, in the interest of streamlining the appeal and expediting the process, we dismissed our cross-appeal with respect to the judge's decision not to award us enhanced damages. We remain confident in our position and we look forward to the Federal Circuit ruling soon. I should also add that we are actually pleased with EchoStar's recent victory in another patent case, the Forgent litigation. I say pleased because Echo Star side cited as a key defense one of TiVo's important patents.
In conclusion, this quarter marked steady progress for our business. We introduced key features that further position and differentiate TiVo from generic DVR offerings, we improved our financial profile, we continued to solidify our standing as the only DVR platform with a comprehensive advertising solution with the launch of a syndicated DVR rating service. We continue to make significant progress toward rollout of our mass distribution strategy. We ushered in a new era of delivering premium broadband content directly to the television set and our litigation proceedings with Echo Star are progressing well. All of these are good signs of the strength of our business and we are excited that we now have the right pieces in place for additional growth.
With that, I will turn it over to Steve.
Thanks, Tom and good afternoon, everyone. As Tom said earlier, we are pleased with our first quarter performance. The financial highlights of the quarter were strong, as we exceeded expectations for service and technology revenues and reported a profitable quarter on both the net income and an adjusted EBITDA basis.
I'll now quickly touch base on the first quarter 2008 results. Service and technology revenues were $58.1 million, with service revenues up $54.2 million, up 15% year-over-year, driven by an increase in net subscription and increased revenue from new subs in our TiVo-owned base over the course of last year, as well as nice year-over-year growth in our advertising business. This growth rate is consistent with the last couple of quarters.
Technology revenues were $3.9 million, roughly in line with last quarter and down from the approximately $8.1 million in the year-ago period. In the year-ago period we had recognized approximately $4.6 million of deferred revenue related to Comcast development work completed in the prior fiscal year that was deferred until we had completed the statement of work.
Excluding expenses related to stock-based compensation, cost of service and technology revenues were $13 million for the quarter, which consisted of $10 million related to service revenues. The gross margin on our service revenues were 81%, up from 78% in the year-ago quarter. Our hardware margin, which adjusts for hardware revenue and hardware costs as well as expenses related to rebates, revenue share and other expenses associated with our retail channel, was negative $8.4 million. Contributing to the negative margin was $3.7 million related directly to hardware and $4.7 million related to rebates, revenue share and other expenses associated with our retail channel.
Excluding stock-based compensation, operating expenses as a percentage of service and technology revenues were as follows:
Sales and marketing, 18%. Although we incurred some production expenses related to our current television advertising campaign, our campaign didn't kick off until the beginning of the second quarter. Sales and marketing expenses related to subscription acquisition costs represented 10% of revenues.
Research and development represented 22% of revenues and G&A 16%. G&A expenses were down $4.4 million compared to the year-ago quarter, due to lower costs associated with the EchoStar litigation. Stock-based compensation expenses were $4.6 million and interest income for the quarter was $1.3 million, leading to net income of $835,000.
Our earnings per share was $0.01 for the quarter compared to a loss of $0.13 in the year-ago period. Our first quarter EPS was based on 98 million fully diluted weighted shares outstanding. The increase in our share count reflects the inclusion of slightly more than $1 million in common stock equivalents, such as in the money stock options as we achieved net income profitability.
Our adjusted EBITDA was $6.7 million, which compared favorably to the loss of $6.9 million in the year-ago period and to our guidance of our profit between $1 million and $5 million. In addition to stock-based compensation and interest income, our adjusted EBITDA calculations adjust for $2.6 million of depreciation and amortization in the quarter. The contributors for the better-than-expected adjusted EBITDA results include stronger top line results driven primarily from growth in subscriptions and continued improvements in monthly service fees from new subs, and reduced rebate expenses associated with a planned reduction in rebate subsidy. On that note, as of February 15, we reduced our rebate by $30 on our dual tuner and by $50 on our single-tuner products.
I'll now touch briefly on the highlight of the balance sheet. We ended the quarter with about $102 million in cash, cash equivalents and short-term investments. As we discussed on our last call, we expected cash levels to be down in the first quarter due to the payments of rebates associated with holiday sales and supplier payments.
Turning to our key pricing and volume metrics, our TiVo-owned gross additions were 57,000 representing a 37% decrease compared to the year-ago quarter. As Tom previously discussed, we believe the year-over-year decline was a combination of several factors, including: increased upfront pricing on both the box and subscription service, not having a lower price mass market high-def product, and the fact that our marketing campaign didn't launch until May.
Churn was 1.1% per month, slightly down from the prior quarter and up relative to the year-ago period. On a net basis, we generated approximately 1,000 net TiVo-owned additions in the quarter. Our TiVo-owned sub base now stands at approximately 1.73 million, which is up 185,000 from the year-ago period.
For the first quarter, our average revenue per user was a record $9.06. In the quarter, we saw a lift from our new subscriptions which continued to come in at average contract prices that exceed our current ARPU. These improvements in ARPU were partially offset by a larger number of lifetime users that have been fully amortized. As we discussed last quarter, these amortized lifetime users do not contribute to revenue but remain in our sub base, negatively impacting our ARPU calculation.
At the end of the quarter, we had approximately 179,000 cumulative lifetime subscriptions that had reached the end of the 48-month period TiVo uses to recognize lifetime revenue. This represents 25% of our current total lifetime base, which stands at about 700,000 subscriptions.
The average monthly price paid on a new TiVo-owned sub remained at solid levels at approximately $13, well above last year and roughly equivalent to last quarter's level. While ARPU will be impacted quarterly by the seasonality of the ad sale business, we expect to continue to see ARPU benefit from higher monthly service pricing plans.
Before getting into specific acquisition costs, it should be noted that we have realigned our definition of both total acquisition costs and SAC to provide a clearer picture of the costs directly related to acquiring new subs. Historically we included all sales and marketing costs, meaning items such as stock option expenses, headcount and even all the expenses related to our ad sales team were included in our reported SAC.
Going forward, SAC will include two elements. First, hardware margin, which is the net profit or net expense we incur after recognizing all aspects related to hardware, including revenue and expenses, and this includes costs related to hardware such as rebates, revenue share and MDF.
Second, sales and marketing subscription acquisition costs, which are expenses associated with acquiring subs that include expenses related to purchasing and producing advertising spots in all mediums, as well as other promotional type expenses.
It is important to note that the change does not alter trends of prior periods or provide the more accurate representation of our true subscriber acquisition costs. We have included the updated SAC information for the past two years in the metric sheet posted on our investor relations website.
Our total acquisition costs were $14.1 million, compared to $16.2 million in the prior year. Our SAC in the quarter was $248 under the new calculation, up about 39% from the year-ago quarter due primarily lower gross additions and higher rebate redemptions. With our DirecTV sub base, we are seeing slightly higher declines in last quarter as our DirecTV subs decreased by 103,000 in the quarter. As a reminder, DirecTV no longer has the right to market and distribute TiVo.
Turning to the guidance for the second quarter, we expect service and technology revenues of $57 million to $59 million. Of this, we expect technology revenues to be roughly in line with first quarter levels. We currently expect our adjusted EBITDA results to be in a range of a loss of $3 million to breakeven and we expect a net loss in the range of $8 million to $5 million. The change in net loss and adjusted EBITDA on a sequential basis is primarily due to the launch of our marketing campaign and increased R&D.
To wrap up, on our last earnings call, I highlighted three elements of our business model that we view as important business drivers in fiscal 2008.
First, we have begun to shift to subscription acquisition towards an approach more focused on advertising versus subsidizing, which shows financial benefits this quarter and we expect to continue this shift going forward.
Second, our mass distribution efforts are progressing as Comcast is close to launching its first market. This should give us the opportunity for efficient mass sub growth. Additionally, we expect international deals such as Seven and Cable Vision Mexico to ultimately allow us to efficiently reach a significant number of television viewers that haven't had the opportunity to get TiVo before.
Finally, our advertising business showed nice year-over-year growth and our audience research measurement business took a significant step forward with the launch of our syndicated ratings service. This is not only a great product for advertisers, ad agencies and networks but it provides TiVo with another predictable recurring revenue stream. We expect the momentum in advertising and audience research and measurement to continue as mass distribution growth kicks in and we continue to scale and invest in these businesses.
This concludes my remarks. Thanks for your time, and we will now take questions.
(Operator Instructions) The first question comes from Tony Wible - Citigroup.
Tony Wible - Citigroup
I was hoping to start by talking about Seven. Can you go over some of the specifics there about how that will affect revenues, costs and taxes? Is this a pure software service or is there some kind of hardware component associated with it as well?
Thanks, Tony. Seven is a significant deal in a number of ways. It's not only a major English-speaking market but it's one where we are partnering with a very major player in the market; a player that has all kinds of new media activity in it beyond its core business which is broadcasting. It has a significant number of the top shows in the market, it's the ratings leader in the market.
This is a TiVo partnership that will involve standalone TiVo hardware. It will be built to this digital terrestrial standard which, as I noted, is a standard gaining substantial momentum around the globe and 2009 conservative estimates are there will be about 100 million households worldwide that will be served with this standard of television distribution.
The nature of the deal, and we're not talking about the financial specifics but it's one that will deliver to us a recurring revenue stream. From a subscriber fee point of view, it will give us a share of the advertising revenues. We're quite enthusiastic about the prospects for how our advertising platform can be adopted in that market because we have the leading broadcaster with the leading ratings, and obviously a major player with over $1 billion in advertising sales driving that standard forward.
It has a deployment distribution commitment, so this is something that we know we can count on seeing a decent level of activated subs in the market. This is not an arrangement under which we will bear the SAC costs. So in that sense, it is somewhat like our mass distribution deals in the United States market but it will not be a software upgrade as we are pursuing here, but will be based on dedicated consumer hardware.
Tony, just to add, most of the development work is being funded by Seven on top of it. We bear some of it. So this is something that benefits TiVo going forward to leverage the platform to other markets based on some of the work that's being funded by Seven.
Your next question comes from Kunal Madhukar - Bear Stearns.
Kunal Madhukar - Bear Stearns
Hi, a quick question on Comcast and what's happening there. Our understanding was that the service launch or the commercial launch would be sometime in the spring. What is Comcast looking for in the technical trials that would get it up to levels at which Comcast says okay, I'm comfortable launching a commercial service?
Well, I should say that there are a number of dependencies that TiVo has in terms of the rollout of TiVo to Comcast that goes beyond the completion of our software development work for Comcast. I'm not at liberty to discuss those, but there are other things beyond TiVo's work here which need to come together for purposes of the rollout. I think it's fair to say that Comcast wants to make sure that all elements of the system necessary to roll out and support this type of application are fully looked at and fully tested.
They are very hard at work making sure what I call the rocket science phase of this project, which is the translation into software of the TiVo applications in a way that they can run on somebody else's box, a box that we did not devise, that the rocket science elements have been achieved and now Comcast is making sure that all of this can be implemented. Trials are going well. Between now and early summer, there will be a limited number of subs that will have this made available to them, a growing number of limited subs, and then the official launch Comcast is pointing to in August.
I think the short answer to the question is they want to make sure that all elements of the system in their infrastructure are fully ready to support the TiVo launch.
Your next question comes from Daniel Ernst - Hudson Square Research.
Daniel Ernst - Hudson Square Research
Good evening, thanks for taking the call. Two questions, if I might, on the differentiation front. First, on the finance side, R&D's up about $3 million quarter on quarter and year on year and you indicated it's going to head up a little bit more this next quarter. Can you talk about the trajectory of that for the rest of the year? Will the headcount or outside projects where after you've finished a few things this will come back down to where it had been?
Secondly, the output of R&D projects, a lot of the broadband features, you announced the Swivel Search, the Amazon, et cetera. Can you talk a little bit about what you're seeing on usage of various advanced features? What percent of your stand alone base is using features, how often are they using them, how many features is the average feature-user using? Is there something you can give us to put our teeth around to say that this is working out from a business perspective? Thanks.
Sure. We have spoken last quarter that we expected R&D to increase and we expected it to modestly increase throughout this year. We have a number of projects we're working on, a number of them you have mentioned in terms of the feature set with Amazon or Buy On Box or things of that nature, as well as some of the NRE projects we're working on which have somewhat funding components, Comcast and Cablevision Mexico that hit our R&D line. So I guess the short answer is we expect it to modestly increase from this point, but not to the levels that you saw from the Q4 to Q1 jump.
In terms of broadband application usage, we see usage across all the features. Obviously, different features have different appeal to different subscribers. We're not at liberty to release the Amazon Unbox usage but I will say we're very pleased with the high proportion of that usage that is a result of TiVo subscribers.
I think probably the best way to gauge the broadband interest is to talk about the number of subscribers that connect to TiVo by broadband. We've seen a steady increase there. We have almost 60% of the entire dual tuner base that is connected by broadband. We have over 80% of our Series 3 users that connect by broadband. We're seeing over half of our overall new subscribers connect by broadband. That involves some desire to use one or more of the broadband features. We continue to see that broadband connectivity increase.
Your next question comes from Alan Gould - Natexis Bleichroeder.
Alan Gould - Natexis Bleichroeder
Tom, if you can clarify one thing on the litigation. You said that you have taken out the enhanced damages portion of the case. Could you explain that? Can you tell us a little bit of what was in your reply document?
Well, we have our general counsel Matt Zinn here, and I'll let Matt explain that.
Our cross appeal concerned the judge's decision not to award us enhanced damages due to the jury's finding that EchoStar's infringement of our patent was willful, we decided well dismiss the cross appeal because we wanted to simplify the issues in the case and speed up the timing of the resolution of the case.
So in terms of timing, we now expect the briefing to be complete in the middle of next month with oral arguments probably scheduled for late summer or early fall, and a decision from the Federal Circuit either later this year or worst case, early next year. So we think timeliness is more important than trying to persuade the Federal Circuit to find that the judge made a clear error in not granting us enhanced damages.
Your next question comes from Barton Crockett – JP Morgan.
Barton Crockett - JP Morgan
Great, thank you very much. I was wondering if you could talk a little bit about how you see TiVo stacking up competitively to Apple? After the close, Steve Jobs is quoted saying that he sees Apple TV as the DVD player of the future in the living room. It would seem, as you look at the big picture longer term, you guys are looking at a similar space in terms of TV and web integration. They obviously don't have a DVR right now, but looking at their skill at marrying hardware and software, one might think that they might want that in the future, either on their own or potentially in competition with you or potentially a partnership with you.
On the topic of Apple, where do you see that evolving? Is there a potential for them to be a competitor or a partner and has there been any discussion and any potential openness to partnering with you? Thanks.
I think there are a lot of people that are focused on video distribution to the home and broadband's role in video distribution. I can't comment on Apple's future plans or Apple's future strategy. Relative to Apple TV in its current form, I think the way that we look at that is it's basically an appendage to the computer where it takes certain video that you may have resident on your computer and streams it across to your television set.
I think that's in stark contrast to what TiVo does, which is to provide a unified experience in terms of all your television, whether it's coming via broadcast, cable, broadband. Probably the best indication of how we integrate that experience is the search product that we unveiled a couple weeks ago, known as Universal Swivel Search, where we've taken TiVo's interface and brought that into the broadband world with an approach to being able to find content regardless of how it's coming to the television set and being able to unify all of your television inputs into a single menu; a single way to navigate, a single way to record or download everything in a seamless, unified package.
Apple, I think, is really just taking content from your computer and taking it over to the TV set. I know at least today we have many more movie studios in terms of the availability of content that are making content available to the Amazon-TiVo relationship than are currently available for purposes of Apple TV distribution.
So there will be many people that I suspect will look at how to use broadband delivery to get video into the home. Today, so much of that is based on a PC approach and we just don't think that's the guts of what's going to make broadband television interesting. It's going to be interesting because it goes to the television set where people want to watch it and then the question is going to be ease of use, interface, and the integration of the entire video experience in one place.
Your next question comes from Ingrid Ebeling - JMP Securities.
Ingrid Ebeling - JMP Securities
How should we look at modeling sales and marketing costs in Q2 versus Q1? What kind of ramp could we expect to see for the rest of the year, particularly around your pretty aggressive advertising campaigns?
Second question is, will the Universal Swivel Search feature be available to the Comcast subscribers? Thanks.
Well, in the initial launch of the Comcast product, while there are significant search features to the TiVo product that will include the ability to search their Video OnDemand offerings and provide a degree of integration between their broadcast and cable and VOD offerings that Comcast has not been able to offer before, Universal Swivel Search itself will not be available in that initial rollout.
In terms of marketing quarter over quarter without getting into specific numbers, we had a limited amount of advertising buys in this quarter because we had not launched our campaign. Those advertising purchases, advertising buys will increase in the second quarter as we launched our marketing campaign in early May and will continue through Father's Day with significant advertising buys. So quarter over quarter, there will be increases. Steve, anything further you want to add to that?
I think the point to add it's we do plan on increasing our level of marketing. But when you look at what we call our total acquisition costs and the shift relative to what's coming out of the rebate subsidy, it is much greater than what we're planning on putting incrementally into marketing. So I think when you look at the whole picture and what we're trying to do in creating leverage and acquiring new subs, you need to look at in its totality and we're anticipating bringing down rebates at a greater degree.
Your next question comes from Michael Kelman - Susquehanna Financial Group.
Michael Kelman - Susquehanna Financial Group
Now that we have the timing and the location of the Comcast launch, I wanted to see if you can give us a little bit more of a glimpse as to how the product will be priced as well as marketed? Also, has Comcast discussed whether or not TiVo will be included in any of their packages or bundles?
Well, Comcast has done a lot of thinking in that regard, both as to price and how it will be offered and we are consulting with them on various aspects of that marketing. I'm not at liberty to disclose that now, that will be part of what they introduce as part of the major commercial launch. I would say that it will be a very attractive way to be able to get the TiVo service when the monthly price is known.
Your next question comes from Alan Bezoza - Oppenheimer.
Alan Bezoza - Oppenheimer
First on Comcast, do you feel the addition of Comcast will more than offset your losses you're seeing at DirecTV? Certainly looks like that has picked up. Similar economics, we just want to understand how that will transgress.
My second one goes to what I asked you last quarter as well. Again you talk about the differentiation and the strength and how pleased you are in the quarter yet this is probably one of the worst gross adds you had in two years, your second-worse cancellation quarter ever and your adds were very weak. I want to understand, do you really feel like you're going to get on to that target of having the same amount of gross adds this year as last year? Is that still in place?
Well, a couple things. On the gross addition front, I think the key thing to recognize is that we did not have any kind of meaningful marketing campaign over the course of the quarter while we were significantly increasing the price of TiVo hardware. Remember, we originally brought the price of TiVo box down, one offer, of course, was for free, and we're simultaneously bringing up the monthly and package pricing of TiVo.
What we have done now is basically keep that service pricing where it was when we brought the hardware down, and now brought the hardware pricing up. We're going to continue to bring up that hardware pricing this quarter. So as you increase price and don't significantly market, that is usually not a recipe for increasing sales. We were quite cognizant of that. We are now beginning to market the product.
I think that, as we said in our comments, without having a mass appeal priced HD unit to participate in the real key trends that you want to see in consumer electronics today, it's difficult and until we have that product later this year, I'm not sure we're going to get the full bang from the brand marketing we are doing. So that's a key piece of the puzzle. It also relates to just how much retailer shoulder we would expect to see where we would expect to see that shoulder against TiVo increase as they have a HD popular-priced product to move.
So all of those, I think, explain why this was certainly not a quarter of aggressive sub growth and I think as we look out over the next several months as those factors come together, we would expect to see substantial growth. I will say we never guided to last year's sub numbers for purposes of this year and just for clarification, what we did indicate was that moving much closer to adjusted EBITDA was assuming a level of subscribers equivalent to what we had last year, which I realize is a subtle distinction but just to make clear we weren't guiding to a specific sub number over the course of the present year.
Alan Bezoza - Oppenheimer
You are guiding then towards positive adjusted EBITDA which would mean that you would have flat of year-over-year gross adds. If you could answer that Comcast question as well, if you don't mind.
What we guided to was that our adjusted EBITDA would be significantly closer to break even than it was last year, which obviously means significant progress toward moving the dial toward a breakeven number. But we did not guide to breakeven. To give that some context in terms of looking at a model that we weren't disclosing, you have to make some assumption as to what your subs are along the way there, since SAC costs are a critical component of how we move toward adjusted EBITDA breakeven.
What we said was assuming the same number of subscribers as last year we would be moving substantially closer to adjusted EBITDA. I just want to clarify in terms of how we said that last year and not lead you to think that we were making certain guidance or other predictions we hadn't made.
Your Comcast question again, I'm sorry.
Alan Bezoza - Oppenheimer
It was guidance on Comcast subs versus DirecTV churn.
Certainly over time we would hope and expect that the level of Comcast subscribers that we gain is greater than the DirecTV churn that we face. The question is how long it will take the Comcast rollout in multiple markets to occur and from there, the uptick that we would hope would follow. So we don't have any prediction as to when Comcast gains will offset DirecTV losses, but certainly upon introduction that won't be the case.
Your next question comes from Richard Baldry - First Albany Capital.
Richard Baldry - First Albany Capital
Service costs actually went down, I think year-over-year maybe if the first time in quite a while I was wondering if you can go through the components of that and talk about whether that's sustainable or not.
There have been a number of international geographies discussed over time from Mexico and Australia, I think U.K. and Asia as well. To what extent those will be able to actually contribute meaningfully to revenue, sort of what you see, qualitatively or quantitatively in the ramp there. Thanks.
Before commenting on the international situation, that first question you asked, I don't think we heard.
Richard Baldry - First Albany Capital
Service costs actually declined in the quarter on a year-over-year basis, I think that's the first time that's ever happened. Looking at the components in that, how sustainable that is or where that advantage was gained.
When you say the service margin, you mean service margin increasing year over year?
Richard Baldry - First Albany Capital
Clearly I think the biggest driver in improving our margin over the course of last year was our improvements in ARPU when we talk about signing additional contracts at roughly $13 relative to our ARPU level, which has been between $8 and $9 this last quarter, going over $9, that's the biggest driver there. We're constantly looking at areas of cost-effectiveness in our customer service areas and things of that nature. I think the biggest lever we've seen this last year was the improvement in ARPU. Hopefully, we expect that to continue going forward.
The final question today will come from David Miller - SMH Capital.
Before that final question, let me answer the international question that was asked. The opportunities overseas, I think, are going to be a significant area of growth for TiVo over time. What we are seeing is an increasing number of major players in both Seven in Australia, Cablevision of Mexico, are certainly major players in their respective markets, looking to partner with us in a way that gives us an opportunity to have very limited risk in the distribution of TiVo in those markets, but yet participate in recurring revenue streams.
We have tried to undertake deals where we believe the basic development that we need to undertake is leveragable in markets beyond those that we've announced partners in and that's certainly the case with the Australia deal that we announced yesterday.
It's a different model than when TiVo initially launched a major international effort in Asia through a joint venture that we're a significant minority owner in called TGC that operates in China and Taiwan, where there was not an approach by us to work with a major player in those markets, but instead to undertake TiVo distribution through a separate entity for Asia not unlike what TiVo does here in the United States.
I think we need to consider the pluses and minuses of both models, but I would say right now we are highly focused on finding a major player in a market, working with them to bring to us the types of advantages that we see in structuring the kind of relationships we have and being able to really rely on the marketing prowess and capability of superb major player in a foreign market to market TiVo for us.
Mr. Miller, please go ahead.
David Miller - SMH Capital
I believe on your three-year deal, correct me if I'm wrong, the one that's priced at $12.95 per month or $299 prepaid, are you still giving away the third year free? If so, how long do you anticipate doing that?
Well, we are currently pricing the $299, three-year package in a way that it was promoted as the same price as the two-year package. We are continuing to price it on that basis. It seems to be working quite well in terms of driving new subscribers. I think we're finding about 54% or so of our prepay subs are three-year subscribers, meaning taking the three-year package. So it seems to be a good incentive, it certainly gives us opportunity to take in cash up front that overcomes the cash we used to take in from lifetime subs that bought upfront.
In fact, we've basically been able to take that $299 type price and take in the subs on that basis without giving away subscriptions forever. So it both helps the net present value of the sub, it gives us cash up front, it seems to be an attractive offer to lock people in for three years.
Great. Thank you for joining us today and feel free to call us if you have any questions.
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