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Executives

Derrick Nueman - Investor Relations Professional

Anna Brunelle - Chief Financial Officer, Principal Accounting Officer and Vice President

Matthew Zinn - Chief Privacy Officer, Senior Vice President and General Counsel

Naveen Chopra - Senior Vice President of Corporate Development & Strategy

Analysts

Brian Patrick Fitzgerald - UBS Investment Bank, Research Division

David W. Miller - Caris & Company, Inc., Research Division

Alan S. Gould - Evercore Partners Inc., Research Division

Daniel Ernst - Hudson Square Research, Inc.

Clark Lampen

Edward S. Williams - BMO Capital Markets U.S.

James C. Goss - Barrington Research Associates, Inc., Research Division

Richard Tullo - Albert Fried & Company, LLC, Research Division

Michael Cohen

TiVo (TIVO) Q4 2012 Earnings Call February 23, 2012 5:00 PM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the TiVo Fourth Quarter Fiscal Year 2012 Earnings Call. [Operator Instructions] I would now like to turn the conference over to Mr. Derrick Nueman, Head of Investor Relations.

Sir, you may begin your conference.

Derrick Nueman

Thank you, and good afternoon. I'm Derrick Nueman, TiVo's Head of Investor Relations. Welcome TiVo's fourth quarter ending December 31, 2011 earnings call. With me today are Tom Rogers, CEO; Anna Brunelle, CFO; Naveen Chopra, SVP of Business Development and Corporate Strategy; and Matt Zinn, our General Counsel.

We have just distributed a press release and 8-K detailing our fourth quarter and full year financial results. We also posted a fourth quarter key metric trend sheet on our Investor Relations website. You may access a recording of this call on our website during the next 2 weeks. Our prepared remarks today will last about 30 minutes and will be followed by a question-and-answer session.

Our discussion today includes forward-looking statements about TiVo's future business and growth strategies, including domestic and international deployment, future revenue and subscription growth and expenditures relating to research and development and litigation. We caution you not to put undue reliance on these forward-looking statements as they involve risks and uncertainties that may cause our actual results to vary materially from forward-looking statements. Factors that may cause our actual results to differ materially are described in Risk Factors in our annual, quarterly and current reports with the SEC. Any forward-looking statements made on the call today reflect the analysis as of today, and we have no plans or duty to update them.

Additionally, some of the metrics and financial information provided on today's call are non-GAAP metrics. Please see our fourth quarter fiscal year 2012 key metric trend sheet on our Investor Relations website for a reconciliation.

With that as remarks, I'll now give it over to Tom.

Anna Brunelle

Thank you, Tom, and good afternoon, everyone. This was a great quarter and fiscal year for TiVo. In the fourth quarter, our service and technology revenue grew 21% year-over-year. We exceeded adjusted EBITDA and net income guidance and our total subscription base grew approximately 11% year-over-year.

For the full year, we posted close to $150 million in adjusted EBITDA and over $100 million in net income on the heels of our intellectual property settlement.

Before getting into the financials, let me quickly walk you through the details of the AT&T settlement from an accounting standpoint. In the fourth quarter, we recognized $54.4 million related to past damages and we'll recognize at least $6 million a quarter through mid-2018 with expected upside as AT&T U-verse subscribers continue to grow. Excluding all legal-related benefits and expenses in the fourth quarter, which includes the $54.4 million in past damages we just spoke of, $2 million of licensing fees in January and the 1x settlement accruals of roughly $16 million relating to our incentive payments, mostly to our outside counsel, we would have beat our adjusted EBITDA guidance.

Now getting into the quarter. Service and technology revenues were $50 million, which included $2 million of AT&T licensing revenue and a $600,000 impact on subscription revenue as we extended product lifetime amortization from 60 months to 66 months. Our cost of service and technology revenue was $13.2 million. Our net hardware loss was $3.9 million, which was driven by typical negative hardware margin in our retail channel.

Operating expenses were $21.3 million and as discussed earlier, this included a $54.4 million benefit from litigation proceeds and $16 million of related legal settlement expenses. Additionally, in line with our expectations, both litigation and R&D spend increased slightly from the previous quarter.

Interest, taxes and other expenses were roughly $4.4 million. This led to a net income for the fourth quarter of $7.2 million or earnings per share of about 6% of both the basic and diluted basis. This used a basic share count of approximately 118 million shares and a diluted share count of about 122 million shares.

Fourth quarter adjusted EBITDA was $21 million and even excluding the 1x AT&T settlement benefit of $54.4 million and settlement-related cost of $16 million, we would have still exceeded our guidance of a loss of negative $21 million to negative $23 million.

Turning to the balance sheet. We ended the quarter with approximately $619 million of cash and short-term investments, which was up due to the AT&T settlement. Additionally, we continue to assess the opportunity to repurchase shares but did not choose to do so during the fourth quarter.

Quickly updating our tax position, we ended fiscal year '12 with $445 million in federal NOLs. Note that our NOLs offset the vast majority of tax liability related to the AT&T and DISH past damages.

Now turning to our fourth quarter subscription metrics. As noted earlier, we grew our total subscription base by 11% year-over-year to about 2.3 million subscriptions. The growth was driven by our newer distribution deals such as Virgin, RCN, Suddenlink and for the first time, ONO. This was offset by continued churn in our DIRECTV standard definition base and we're hopeful we'll begin to see better results since our new HD DIRECTV product has just become available on a nationwide basis.

Quickly touching on our TiVo-Owned business. We saw roughly half of the net subscriber loss since we saw on the year-ago quarter, and the lowest net subscriber loss in close to 3 years as our absolute churn decreased on a year-over-year basis, and our churn rate was down over 40% in that same period. What's even more encouraging about this is that we eliminated much of our promotional activity in Q4 aimed at new subscriptions, spending about half of our Q4 spend a year ago as we were cautious about the impact of hard disk drive availability and also needed to be sure that the hardware demand from our operator client was met.

Our supply concerns ended up being less of an issue that we feared, but our cautious approach led to lower gross stats than we had anticipated in our initial plan. And to that end, total acquisition cost decreased by roughly $6 million compared to the same quarter in the prior year and $1.5 million sequentially.

Both TiVo-Owned and MSO ARPU were impacted this quarter by a decline in add-on revenue. TiVo-Owned ARPU was also impacted by roughly $0.18 due to the increase of product lifetime amortization from 60 to 66 months. Going forward, we expect TiVo-Owned ARPU to increase due to higher incremental ARPU from new subscribers.

Finally, on the topic of hard disk drive availability. To date, we've been able to secure the inventory we need with a relatively modest financial impact. Looking forward, we don't anticipate that hard disk drive supply issues will grow insignificant for us. Now getting into our first quarter guidance.

We expect service and technology revenues of $53 million to $55 million. Our net loss in the range of negative $18 million to negative $20 million and adjusted EBITDA to be in the range of negative $8 million to negative $10 million, which compares to adjusted EBITDA in the first quarter of last year of $149.4 million, which included $175.7 million relating to past damages from the DISH Network settlement.

With that, let me provide you with a few key items that are impacting Q1 guidance.

First, we will be recognizing a full quarter of AT&T licensing revenue versus just one month. Second, we expect R&D to be roughly in line with Q4 levels and then for it to start declining later in the year, leading to a lower annualized run rate as we exit fiscal year '13, as compared to the ending fiscal year '12 annualized run rate. Third, we expect litigation expenses to decrease significantly in Q1 compared to the roughly $12 million we spent in Q4, excluding the 1x AT&T settlement cost. For the full year, we're currently expecting the Verizon-Motorola litigation to cost materially less than the combined AT&T, DISH, Verizon, Microsoft and Motorola spend of last year.

Finally, I wanted to build on the comments Tom made earlier around how TiVo plans to achieve adjusted EBITDA profitability in the future. In fiscal year '13, we expect adjusted EBITDA to significantly benefit from higher licensing revenue and more subscriber fees from our current deals. As a result, we expect to make significant progress this year toward breakeven adjusted EBITDA, excluding litigation spend. Combine this progress with continued efforts to sign new distribution, potential upside from litigation and our expected lower R&D annualized run rate as we exit this fiscal year, and we believe we will be on the right path towards sustained profitability.

We'll leave with that. Let's now take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Brian Fitzgerald of UBS.

Brian Patrick Fitzgerald - UBS Investment Bank, Research Division

Given the positive press from partners like Virgin, we're wondering if you're seeing increased activity around signing potential new distribution deals. And you've talked about Asia and Latin America as potential areas of opportunity for future growth, any updates there?

Operator

The next question comes from the line of David Miller of Caris & Company.

David W. Miller - Caris & Company, Inc., Research Division

I actually have a few questions. Tom, on the tables/DBS line, with regards subscribership, are you willing to break out how many -- or how much of that gain was DIRECTV? Because it looks like it's mostly V Med, if not all V Med. But I'd be curious to know how much of that is DIRECTV or the DIRECTV, TiVo combo box. And then, on the litigation proceeds, it looks like -- I see the $54.4 million as litigation proceeds, which is essentially a contra entry. But then below that in other expenses, you've got a $5.4 million entry. Is that -- I guess I'm not sure I understand, is that the bonus payout to the attorneys or is that $5.4 million something else? And then I have a couple of follow-ups.

Anna Brunelle

On the second question, you said $5.4 million, but I think you actually mean $4.4 million on the non-off interest in taxes line?

David W. Miller - Caris & Company, Inc., Research Division

Yes, that's correct.

Anna Brunelle

Actually, it consists primarily -- there's a few things in there, the main one being we had about $2 million in interest expense, about $1 million in interest income and then the reason for the jump this time is we had about a $3.4 million write-off of an investment. This is the only investment of that type that we have on our balance sheet, so I don't foresee any future write-offs of a nature like that to be happening, it's a one-time thing.

David W. Miller - Caris & Company, Inc., Research Division

Okay, great. And if your legal counsel is on, could you talk about what happened at the status conference today, and whether or not you have a court date against Verizon?

Matthew Zinn

Yes, so there was a status conference today. I wouldn't say that the affirmed date has been set but we're planning for a trial toward the end of the year, and we're optimistic that a claim construction will be coming our way by mid next month.

Operator

The next question comes from the line of Alan Gould of Evercore Partners.

Alan S. Gould - Evercore Partners Inc., Research Division

I've got 2 questions. First, with respect to the standalone service revenue. I was wondering why -- excuse me, on the MSO service revenue, I was wondering why we aren't seeing a bigger increase? Does some of that revenue come in to other accounts for some accounting reason at first on the V Med revenue?

Alan S. Gould - Evercore Partners Inc., Research Division

Tom, when will all the V Med revenue be going to the service revenue line, should that occur sometime this fiscal year?

Alan S. Gould - Evercore Partners Inc., Research Division

Okay. And then Anna, can you quantify how much less you think litigation costs will be in fiscal '13 versus fiscal '12?

Anna Brunelle

Well, I think what we've said is that we expect it to be significantly less just because the number of actions that we're dealing with right now is significantly less. So certainly, in Q1, for building out your model, I would assume a significant reduction.

Alan S. Gould - Evercore Partners Inc., Research Division

Okay. How much was litigation cost in the past year?

Anna Brunelle

Excluding the 1x cost that we had for the positive AT&T settlement, it was $36 million.

Operator

The next question comes from the line of Daniel Ernst of Hudson Square Research.

Daniel Ernst - Hudson Square Research, Inc.

Two questions, if I might. And the first one, maybe is kind of 2-part. If you look at the retail business where you're getting sort of contra growth and there's a significant, though not as big as it used to be, cost in marketing and in hardware subsidies. And I assume there's some portion of R&D that's going towards the retail business. And now that the MSO business is taking off so well and the profitability there where you don't have to subsidize, the box is so strong. Are we at a point where we might revisit the idea that we had back in '07, '08 to make the retail business either start to trend down or make it sort of neutral to earnings and don't subsidize the business, but let people who want it, pay for it and not lose money on that effort so we could still look at this on a cleaner earnings basis from all the progress you've made? And then second, just kind of revisiting the DTV question about marketing. Do you have an ability to influence that marketing if you're not happy with what they're doing that might be able to accelerate that growth, particularly to the people that are long-term fans of YouTube DTV that just didn't have the option of the HD box until now?

Daniel Ernst - Hudson Square Research, Inc.

Great. Also just one other follow-up question. Given the success you've had in the, we'll call it litigation investments in protecting your intellectual property, we're all happy to see the litigation expense go down as we move down to the one active case in Verizon. But there are a couple of other decent-sized players domestically and quite a number internationally that are not payers for the service and the technology. Is there a potential that we might look to invest in other litigation markets?

Operator

The next question comes from the line of Barton Crockett of Lazard Capital Markets.

Clark Lampen

This is Clark Lampen in for Barton. I apologize if I missed this earlier. I was just curious if you guys could give a little bit of clarity around why we saw the dip in the MSO ARPU this quarter? And what we might expect for improvements going into fiscal 1Q? And then I had one quick follow-up.

Anna Brunelle

Sure. I think our MSO ARPU dipped for a combination of factors. The one we've touched on in the past that impacted us again this quarter is that the DIRECTV minimums will continue to cause fluctuations in the ARPU numbers. And then, as Tom mentioned earlier, some of our newer deals are flowing through tech revenue right now, that's impacting our ARPU. But based on all of that, I think we expect ARPU to continue to trend back towards the mean, so we'll have some fluctuations from time to time, but I'd continue to think about the mean.

Clark Lampen

Okay, and then just second one real quick. Could you guys quantify exactly what the ONO net adds were in the quarter?

Operator

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

Naveen Chopra

Yes. So Tony, to the second part of your Pace question, I think it's certainly part of the impetus. Obviously, a significant part of the development in any one of these projects is the -- according to the relevant set-top platform. And so the fact that we're able to do that in advance with Pace gives us efficiencies, not just in terms of cost, but perhaps even more importantly, in terms of speed to market, which, as you know well, is one of the major reasons why a lot of operators are turning to TiVo as an advanced video platform where we've been able to get these things into the market well in advance to most of our competitors. So we like what Pace can do to continue that trend. In terms of the broader question around R&D expense and how it scales with new deals, we have made some, I think, highly valuable investments over the course of the year to better be able to leverage the work that we are doing with each of these operators. So while there is, obviously, always some incremental expense involved in taking on a new deal, I think the cost for each of those deals going forward is materially lower than what we've seen in the past. So I think the money we spent today is likely to be well leveraged.

Naveen Chopra

Yes, and one last point I would actually add on that, is, as you may know, although it's not something that's super visible, is the fact that we don't provide our own hardware platform outside of the United States. And so anything that we do in terms of bringing on additional hardware partners, I think, is a good sign about the international growth prospects.

Operator

The next question comes from the line of Edward Williams of BMO Capital Markets.

Edward S. Williams - BMO Capital Markets U.S.

Just a couple of questions. Looking at Comcast for a moment, can you talk a little bit about the timing as to when that may roll out in San Francisco and other markets? And then also, how significant do you see that being this year? And then as a follow-up to that, could we see others participating in that -- this calendar year?

Edward S. Williams - BMO Capital Markets U.S.

Then the R&D -- I assume there was some software R&D required to create the software that's going to run Xfinity. Is that something that is subsidized by TiVo or is that something that's subsidized by Comcast?

Edward S. Williams - BMO Capital Markets U.S.

And then lastly, just going back to the question with regards to where the Virgin Media revenue is that's sitting in technology, is the -- if we look at ONO, is ONO following the same sort of a direction where the revenue is primarily showing up in technology before it gets into service revenue? Or is the investment required for the follow-on providers after Virgin Media, and now after ONO, less significant, so therefore the revenue falls more quickly into the service revenue?

Operator

The next question comes from the line of Jim Goss of Barrington Research.

James C. Goss - Barrington Research Associates, Inc., Research Division

Regarding the Virgin comments, which are obviously very encouraging, could you describe the process and time frame over which that rollout might occur? I think that they said they're at about 12% now. But is it going to be basically a replacement over a 5-year period or -- what are you expecting, what are they expecting?

James C. Goss - Barrington Research Associates, Inc., Research Division

And given your comments about hardware issues not outside the United States, it's basically a software solution with them?

James C. Goss - Barrington Research Associates, Inc., Research Division

Great. With the G&A breakdown, given that there was a fair amount of litigation effort or dollars in there this year, do you have a certain run rate you expect there to be on a quarterly basis, the share recognizing that the current quarter will already include some extra litigation costs related to the [indiscernible] efforts?

James C. Goss - Barrington Research Associates, Inc., Research Division

Okay. And maybe this is just a net for Anna. But I noticed the annual diluted share -- average share base was $136.3 million, which I thought was higher than any of the 4 quarters I'd seen, I was just wondering how you're -- arrived at that figure?

Anna Brunelle

Well, I think that the difference there is that since we're net income positive, we're using diluted shares, and we do have our convertible debt to consider where if the income per diluted share is higher than the interest per the -- if converted share is included. If not, if it's anti-dilutive, it's not included, so we included those shares in Q1, but not in Q4.

Operator

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

Richard Tullo - Albert Fried & Company, LLC, Research Division

I have one for Tom and one for Anna. My question for Tom, the IP-based set-top box, you said by the summer, is that going to be a second quarter event or a third quarter event? And should we be looking at that product as the replacement or a adjunct to the consumer retail product? And what's it called?

Richard Tullo - Albert Fried & Company, LLC, Research Division

And if memory serves me correctly, this is the jewel box-sized TiVo, right, so it's a little guy, right?

Richard Tullo - Albert Fried & Company, LLC, Research Division

And when we talk about Comcast, you said full VOD and OTT, does that mean they won't have the same kind of authentication conflicts that other MSOs might have in regards to Hulu and Netflix?

Naveen Chopra

You had a question for Anna?

Richard Tullo - Albert Fried & Company, LLC, Research Division

Oh yes, absolutely. When we're talking about the $36 million for last year on legal expenses, $12 million distributed in the fourth quarter, does that mean we should be thinking about a number in the range of $18 million to $24 million for this year, or is that going to be a little higher or a little lower?

Anna Brunelle

We just aren't going to comment on that, it's not something that we feel we can get into based on the timing of when these actions come to fruition. It's just not cohesive for us to give you a quarterly number, quarter-after-quarter. That being said, I think the guidance that we gave for Q1 was significantly down.

Richard Tullo - Albert Fried & Company, LLC, Research Division

Okay, fair enough. And in regards to R&D, should we be thinking about that as a second half step-down, or at some point during the third quarter or during the fourth quarter?

Anna Brunelle

We said we expect our ending fiscal year '13 run rate to be lower than our ending fiscal year '12 run rate, and we haven't given additional color on that.

Operator

The next question comes from the line of Michael Cohen of MDC Financials.

Michael Cohen

Tom, I was wondering if you could just give us a little bit of color about the current relationship you have with Comcast?

Operator

We've reached the allotted time for today's Q&A session. I will now turn the conference back over to Mr. Tom Rogers for any closing remarks.

Operator

Thank you. This concludes your conference. You may now disconnect.

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