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TiVo Inc. (NASDAQ:TIVO)
F2Q08 Earnings Call
August 29, 2007 5:00 pm ET

Executives

Derrick Nueman - Investor Relations
Tom Rogers - Chief Executive Officer, President
Cal Hoagland - Interim Chief Financial Officer

Analysts

Tony Wibel - Citigroup Smith Barney
Dan Ernst - Hudson Square Research
Kunal Madhukar - Bear Stearns
Barton Crockett - J.P. Morgan Chase
Alan Gould - Natexis Bleichroeder
Ingrid Ebeling - JMP Securities
Lee Westerfield - BMO Capital
Brian Coyne - Friedman Billings Ramsey

Presentation

Operator

Thanks so much for holding, everyone and welcome to the TiVo second quarter fiscal year earnings 2008 conference call. Just a reminder, today’s conference is being recorded. The speakers for today’s conference are going to be Mr. Tom Rogers, Mr. Cal Hoagland, and Mr. Derrick Nueman. At this time, I will turn the call over to Mr. Derrick Nueman. Please go ahead, sir.

Derrick Nueman

Good afternoon. I am Derrick Nueman, TiVo’s head of investor relations. With me today are Tom Rogers, CEO; and Cal Hoagland, CFO, as well as Matt Zinn, our General Counsel. We are here today to discuss TiVo’s financial results for the period ending July 31, 2007, which is the second quarter of fiscal year 2008.

Within the last hour, we distributed a press release and 8-K detailing our financial results. We will also release a financial and key metric summary, which is posted on our investor relations website. Additionally, within a few hours we will release a recording of this call that you can access on our investor relations website.

The prepared remarks will 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. These statements relate to, among other things, TiVo’s future profitability and financial guidance, future growth of subscription additions to the TiVo-owned service; TiVo’s ability to get closer to adjusted EBITDA break even for the fiscal year 2008; distribution of the TiVo service with Comcast, Cox, CableVision in Mexico and Australia’s Seven Network; growth in innovation in TiVo's advertising and audience research measurement business; TiVo's ability to participate in the HD market; the status of ongoing litigation with EchoStar; TiVo's ability to develop and leverage the DVB-T platform; the introduction of new product features, such as progressive downloading; and financial performance.

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 the forward-looking statements. Factors that may cause actual results to differ materially include delays in development, competitive service offerings, and a lack of market acceptance, as well as other potential factors described under risk factors in the company’s public reports filed with the Securities and Exchange Commission, including the company’s annual report on Form 10-K for the fiscal year ended July 31, 2007, and subsequent reports filed with the SEC.

I would 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 obligations to update them. Additionally, some of the metrics and financial information provided on today’s call include non-GAAP measures. Please see our second quarter fiscal year ’08 key metric trend sheet for a reconciliation of these items.

With this, I will now turn over the call to CEO Tom Rogers.

Tom Rogers

Thanks very much. Good afternoon, everybody. I am going to first take you through our operational highlights, beginning with the rollout of our new HD box and then the progress we have made with our Comcast relationship. Next I will provide you with some context around the financials. Following that, I will discuss the significant progress we have made over the past six months on several areas of our business that we believe will have a substantial impact on the growth prospects of TiVo. I will then provide you with an update on our litigation with EchoStar and then turn the call over to our Interim CFO, Cal Hoagland, for a detailed discussion of the quarterly financials as well as our guidance for the fiscal third quarter 2008. Finally, we’ll take your questions.

Our business is now entering a new phase. Our continued progress in driving new subscriptions by virtue of our new popularly priced HD box and our mass distribution strategy, specifically our very strong relationship with Comcast, will characterize our success going forward.

In addition, our significantly differentiated feature set, especially as it relates to bringing broadband content directly to the television, as well as our audience research measurement business, our advertising business, and our work to capitalize on the many international opportunities out there will also define our future results, specifically our ability to deliver subscription growth, which is one of our foremost goals.

However, this quarter’s results were defined by a standard definition product that will no longer be the SKU that receives our primary attention and an operating retail store environment that is overwhelmingly focused on high definition televisions. Accordingly, we do not believe that this quarter provides a view of how TiVo should be assessed going forward.

It was, however, a critical quarter in terms of establishing our new distribution opportunities. Let me take a few moments now to discuss two of the critical areas driving our future growth; our new HD box and our mass distribution strategy.

First, we rolled out to a very strong initial reception from retailers our new popularly priced TiVo HD box. Last quarter we had told you that we were working towards making this available by the end of the year. Well, we were able to accelerate our development work around this very important product launch, getting the product out ahead of our most optimistic timeline and can now more significantly participate in the current retailer movement away from the sale of standard definition televisions and accessories to one almost solely focused on HD.

This transition has progressed at a pace that surprised many in the industry, including us. Retailers such as Best Buy and Circuit City are extremely enthusiastic about our new HD product, as it is first a best-in-breed DVR; second, a complete media set player; and third, a replacement for the cable box through its cable card compatibility, which by the way allows us to strengthen our relationship with both retailers and cable operators.

As a result, retailers are embracing TiVo in new and unique ways, including better merchandising, improved floor placement, demos for customers, and more aggressive positioning of the unit as a critical component to a consumer’s home media experience. Additionally, another example of strong retailer sentiment is that Sears, Costco and key regional chains, none of which offered TiVo products in their stores in recent times, will now be offering the HD product.

While it is still very early on, it is clear from retailers that there is strong interest to build a sales channel for this product, which is in stark contrast to the lack of retailer support of the standard definition product in recent months.

One of the key reasons for the retailer support was our ability to bring this product in at a $299 retail price, $500 below our high-end HD offering. Moreover, we were able to accomplish this by re-engineering TiVo HD so that it involved almost no hardware subsidy when sold through the direct channel, and in retail with a reduced subsidy in comparison to the standard definition product. This is right in line with our marketing strategy to redirect investment from hardware subsidies toward a more advertising-centric approach.

On the mass distribution side of the business, the TiVo on Comcast service continues to progress well and Comcast states, and I’m quoting here: “We will commence the TiVo rollout process shortly, which will continue rolling out throughout the fall in Comcast’s New England division, including metro Boston, southeast Massachusetts, and New Hampshire.”

Very importantly, Comcast has just agreed to fund significant additional development work to bring the TiVo service to other Comcast platforms, including Scientific Atlanta set-top boxes. This is a substantial and ongoing commitment to further develop the TiVo on Comcast service and increase the distribution opportunities that TiVo will have available.

Also on the distribution front, during the quarter we announced a deal with DIRECTV to develop a software upgrade to enhance the user experience for DIRECTV customers who have DIRECTV DVRs with the TiVo service. This also highlight’s TiVo's ongoing value to DIRECTV, which indicated in the announcement is looking to explore additional opportunities with TiVo.

Now let’s move on to the financials. During the second quarter, we recorded a net loss of $17.7 million, which included a combined inventory write-down and inventory purchase commitment charge of $11.2 million, for a total net loss of $0.18 per share. The inventory-related charge primarily relates to long lead time dual tuner series II standard definition DVR long lead time parts and related non-tangible purchase commitments.

Our adjusted EBITDA for the second quarter was $11.2 million, including the $11.2 million inventory related charge. For context, second quarter adjusted EBITDA guidance was a loss of $3 million to break even. But to reiterate, our results included an $11.2 million related charge, which is something that we did not contemplate or anticipate when we provided second quarter guidance.

Additionally, earlier this year we introduced the goal of getting closer to adjusted EBITDA break even for fiscal 2008 as compared to last year. An $11.2 million inventory related write-down of standard definition parts was not anticipated at the time we made this projection for the year. Nonetheless, the goal remains in place and thus going forward, we continue to expect that a shift away from hardware subsidies toward a more advertising-centric marketing approach will continue to have a positive impact on our financial profile, as it has over the past two quarters.

Now let me provide you with a bit more context on this inventory-related charge. We were surprised by the speed, as I said, at which retail store activity on television sets became overwhelmingly HD-based and consequently, how quickly retailers have accelerated their HD marketing efforts.

Retailers have fully directed their attention to sales of high definition television and components that support HD. Because we believe that the retailer trend toward HD and away from standard definition will continue, we decided that it was most prudent to charges related primarily to long lead time parts inventory that are uniquely used in the standard definition product.

Let me add that while we took the write-down on these parts based on accounting guidance, considering our current sales performance related to the standard definition product, we do believe there is an opportunity that is uniquely TiVo's to reach the approximately 30 million analog basic cable homes, many of which will not be in the market near-term for an HD television set.

We are not abandoning this space but we certainly have to refocus our marketing efforts to reach this consumer more directly, since retailers are now focused on HD. This could include limited promotions with key business partners.

Moving on, service and technology revenues increased 7% to $56.5 million, compared with $52.8 million for the same period last year. Service and technology revenues were impacted by lower-than-expected technology revenue due to the timing of some of our development work, mostly relating to DIRECTV and our international projects.

Service revenues were $53.4 million while technology revenues were $3.1 million, down $800,000 sequentially and well below our expectations. Hal will provide further color on this.

Moving to sub results, TiVo-owned subscription gross additions for the second quarter were 41,000. Gross additions were impacted by the accelerated pace of the HD trend at retail, as has been the case in recent quarters. Churn was 1.2% for the quarter, leading to a small decline in TiVo-owned subscriptions in the quarter. Overall, TiVo-owned subscriptions were 1.71 million, compared to 1.57 million from the year-ago period.

As expected, TiVo reported a net decline in DIRECTV TiVo subscriptions during the period, as DIRECTV is no longer deploying new TiVo boxes.

In addition to the introduction of the new HD box and the continuing commitment to TiVo by Comcast, during the first half of this year, four additional major areas for our business became a reality. We believe that they will significantly accelerate TiVo's growth going forward. Let me walk you through each now.

First, we continue to achieve a number of milestones against our strategy to differentiate the TiVo product and the service from other DVRs on the market. Specifically, we have made it clear that we are the leader in providing broadband content directly to the television set. Amazon Unbox on TiVo has gained even more traction with our subs, especially now that we made it possible this quarter for subscribers to buy and rent directly from their television sets, movies and TV shows from leading studios and networks, including Fox, Paramount, Universal, Warner Brothers, and Sony Pictures.

I want to emphasize that the ability to deliver broadband content directly to the TV has been a major focus for many industry players out there. For TiVo, it is a reality now. Additionally, many companies are looking to provide this functionality directly to the PC or through an appendage to the PC, which is in stark contrast to what TiVo does, which is to provide a unified television experience straight to the TV set, whether it is coming via broadcast, cable or broadband.

What is also exciting here is that Amazon continues to encode thousands of new titles each month, which are all integrated into our universal swivel search functionality. With the addition of progressive downloading on our HD platforms, which will allow for real on-demand viewing later this year, subscribers will be able to easily and quickly find and download the content that they want when they want.

Second, we continue to make strides in weaving our way into the fabric of the media industry. Our audience research measurement business has quickly become the only provider of second-by-second commercial ratings data for DVR households. This proprietary data is increasingly becoming a crucial element to more critically evaluating advertising purchases.

During the quarter and over the past month, we publicly announced three more clients, Media IQ, MPMA, and Crispin Porter & Bogusky, adding to an already impressive list of clients. We also signed on multiple clients to the TiVo IRI suite of products, which combine DVR viewing behavior with purchase data in DVR households.

Third, we continue to work to develop unique advertising solutions aimed at the increasing number of DVR households that fast forward through television advertising. As an example of how TiVo has become a key ally of the advertising industry, we recently had yet another impressive turnout at our TiVo advisory advertising council meeting, where CEOs from major ad companies representing an enormous portion of the television ad-buying industry, along with certain key creative shops, discuss the future direction of interactive advertising.

The strong support we continue to receive from these ad buyers gives us the confidence that we can grow this business as we develop new and unique ways to help marketers create better, more entertaining and more engaging advertisements without really pushing the consumer control that is so important to DVR users.

Fourth, we have made strong progress on the international front. Our Seven deal continued to generate buzz in Australia, with numerous discussions in the press about how this may alter the Australian television landscape. This quarter we took another important step in our relationship with Seven Network by signing a statement of work. As I have said before, we are confident that the hardware we develop for this platform will be highly leverageable across many more significant international markets, giving us the framework to drive TiVo's international business going forward.

Separately, we anticipate CableVision Mexico will begin distributing TiVo to its customers within the next week or two. Also, it is important to point out that CableVision Mexico will be launching a dedicated TiVo marketing campaign, including television, print, radio and outdoor at the time of launch.

In addition to these important developments, we also made some key hires this quarter that significantly strengthens our management team. First, we brought on Clent Richardson as our Chief Marketing Officer. Clent has directed successful marketing campaigns that have transformed high profile consumer and technology brands, such as Apple and T-Mobile. We are excited for what he will bring to the table in terms of how we will drive greater standalone distribution, as well as insight on our mass distribution efforts.

We also brought on board Karen Bressner as the head of advertising sales headquartered in New York City. Karen was formerly Senior Vice President of National Advertising Sales for some of Viacom’s most well-known brands. Her 25 years of experience in developing strategies for integrated sales efforts across national cable television broadcast and online will certainly add a tremendous amount of value as we come up with unique ways to better reach the fast forwarding viewer.

Finally, we brought on Cal Hoagland as our Interim Chief Financial Officer, who you will hear from in just a minute. Cal brings a great deal of experience to the finance function and we are already very pleased with the value that he has brought to TiVo.

Also, I wanted to congratulate Mike Ramsay, one of the founders of TiVo, who has joined New Enterprise Associates as a venture partner. NEA was one of TiVo's early investors and already has representation on our board. As a result, we expect Mike will be stepping off our board shortly but we are pleased that he will continue to provide services to us as a consultant, focused on technology and other issues in a similar capacity to what he’s done over the past two years.

Additionally, this move will spark some additional non-cash stock-based compensation expense in the third quarter, which Cal will provide more detail on.

Quickly touching on our pending EchoStar litigation, the appeal has been fully briefed and all arguments have been scheduled for October 4th of this year, with a decision to follow sometime thereafter. We remain confident in our position on appeal.

There has been some discussion in the press regarding a recent communication from the U.S. patent and trademark office concerning certain claims of our time-warp patent, and I want to set the record straight on that.

To begin with, the patent office has reaffirmed the validity of the majority of our claims subject for reexamination, 34 out of 61 claims, including two of the claims that the jury determined EchoStar to have infringed. We need to prove infringement of only one claim to prevail on our claim of patent infringement, so this is good news.

Second, this patent office communication is part of the normal reexamination process and is not final with respect to the remaining claims. We expect that the reexamination process will continue for quite some time. We are continuing our efforts to convince the patent office that our remaining claim should be upheld.

While this lengthy process plays out at the patent office, however, all claims of this patent continue to be presumed valid until the reexamination process is complete. In short, the ongoing reexamination process should have no impact on our current litigation against EchoStar.

In closing, the first half of the year marked yet additional progress for our business. We introduced our new HD unit. We made good progress on our mass distribution strategy through an even more significant relationship with Comcast. We have engaged further development work for DIRECTV. We are educating the market on TiVo's differentiated future, especially in the area of broadband. Our audience research measurement business continues to gain momentum. Our advertising business continues to develop ways to help advertisers reach fast-forwarding viewers. We continue to move forward with development work that will help us capitalize on significant international opportunities, and we have made progress on our strategy to redirect investment from hardware subsidies toward a more advertising-centric approach, which over time will improve the financial profile of the company and significantly improve our adjusted EBITDA performance this year.

All of these important elements are coming together to strengthen our position as the leading force in the future of television. With that, I will turn it over to Cal.

Cal Hoagland

Thanks, Tom and good afternoon, everybody. I’ve enjoyed my time here at TiVo and it is exciting to be here as the company moves toward its key goals and potential, especially with the release of the new HD box and Comcast on the verge of being broadly distributed.

As Tom mentioned earlier, this quarter was defined by our standard definition product, which has faced increasingly strong headwinds for the past several quarters, as retailers have quickly transitioned into an HD world.

Because of this rapid transition by retailers into the HD world, we felt it was prudent to record an inventory-related write-down for our series II dual tuner product inventory, the majority of which with long lead time parts on hand and on order under purchase commitments. This inventory-related write-down aggregates $11.2 million and is a substantial component of the $17.7 million net loss and the $11.2 million negative adjusted EBITDA operating results for the quarter.

Again, I would like to reiterate Tom’s comments -- we are not abandoning the standard definition market, but because of the levels of inventory it was prudent to reserve against these inventory-related items.

I will now summarize and provide additional highlights about our most recent second fiscal quarter operating results.

Service and technology revenues were $56.5 million, a 7% increase compared to last year’s fiscal second quarter. We saw lower-than-expected technology revenue due to timing of development work. We had expected roughly another $1 million in technology revenue. Thus, we generated slightly less than expected sub revenues, which were also impacted by our subscription results.

Service revenues were $53.4 million, up 8% for the second quarter year over year, primarily driven by an increase in net subscriptions and increased revenue from new subscriptions in our TiVo-owned base over the course of the last year.

Technology revenues were $3.1 million, down $800,000 from the first quarter of this fiscal year and down from the approximate $3.4 million in the year-ago second fiscal quarter. Again, technology revenues were weaker-than-anticipated, due to the timing of development work, primarily related to DIRECTV and Australia’s Seven.

Excluding expenses related to stock-based compensation, cost of service and technology revenues were $13.1 million for the quarter, which consisted of $9.9 million related to service revenues. The services gross margin, excluding stock-based compensation, was 81%, flat with the year-ago second fiscal quarter.

Looking at hardware, our margin, which consists of hardware revenue and hardware costs, including expenses related to rebates, revenue share, inventory reserves, and other expenses associated with our retail channel, was a negative $22.1 million. Contributing to the hardware negative margin was $11.2 million related to the inventory write-down, $7 million related to the hardware sold, and $3.9 million related to rebates, revenue share, and other expenses associated with our retail channel.

Operating expenses excluding stock-based compensation as a percentage of service and technology revenues were as follows: sales and marketing was 25%. The increase here is on both a sequential and a second fiscal quarter year over year basis, and is primarily related to the commencement of our marketing campaign. The portion of sales and marketing expenses related to subscription acquisition costs represented about 16% of revenues. Research and development was 23%, and G&A was 14%, where G&A expenses were down $1.7 million compared to second fiscal quarter a year ago, due primarily to lower costs associated with the EchoStar litigation.

With the $11.2 million inventory write-down and the aggregate stock-based compensation expense of $5.2 million, net loss was $17.7 million, including interest income of $1.3 million. This compares to our net income guidance of a loss of $5 million to $8 million, which did not contemplate the inventory related write-down.

Our net loss per share was $0.18 for the second quarter this fiscal year, which compared to a net loss per share of $0.07 for the second quarter of last fiscal year. Our net loss per share calculation for the second quarter this fiscal year was based on a 97.1 million weighted shares outstanding calculation.

Our adjusted EBITDA loss for the second quarter of this fiscal year, including the $11.2 million inventory related write-down, was a loss of $11.2 million. Again, this adjusted EBITDA loss of $11.2 million includes the $11.2 million inventory related write-down. This compares to an adjusted EBITDA loss of $2 million in the year-ago second fiscal quarter, and to our adjusted EBITDA guidance of break even to a loss of $3 million for the current quarter just ended, which did not contemplate an inventory related write-down.

In addition, stock-based compensation of $5.2 million and interest income of $1.3 million, our adjusted EBITDA calculations adjust for the $2.6 million of depreciation and amortization in the quarter.

Finally, we ended the quarter with about $98 million of combined cash. That is cash plus cash equivalents plus short-term investments.

Now, turning to our key pricing and volume metrics, our TiVo-owned gross additions were 41,000, representing a 44% decrease compared to the year-ago second fiscal quarter. As Tom previously discussed, we believe the second fiscal quarter year over year decline was due to the increasing popularity and momentum of HD products in the retail channel. We anticipate that our standard definition product will continue to face headwinds in the retail environment. However, with the introduction of our popularly priced HD box, we presently believe that we will see sequential improvements in TiVo-owned gross additions in the third quarter.

Churn was 1.2% per month, slightly up from our first fiscal quarter this year and up relative to the second fiscal quarter a year ago. We believe the increase in churn was in part driven by the HD wave and the fact that we didn’t have a low-priced, mass market appeal HD DVR.

On a net basis, our TiVo-owned additions decreased by 19,000 in the quarter. Our TiVo-owned subscription base now stands at approximately 1.7 million, which is up 136,000 from a year ago.

For the second quarter, our TiVo-owned average revenue per user was $9.08. In the quarter, we saw ARPU increase from our new subscriptions, which continued to come in at an average contract price that exceeded our current ARPU. These improvements in ARPU were partially offset by a larger number of lifetime users that had become fully amortized. As we discussed last quarter, these fully amortized lifetime users do not contribute to revenue but remain in our subscription base, negatively impacting our ARPU calculation.

At the end of the quarter, we had approximately 180,000 cumulative active lifetime subscriptions that had reached the end of the 48-month period that TiVo uses to recognize lifetime revenue. This represents 26% of our current total lifetime base, which stands at about 700,000 subscribers.

The average monthly price paid on a new TiVo-owned subscription remained at a solid level of approximately $13. While ARPU will be impacted quarterly by the seasonality of the ad sales business, we expect to continue to see ARPU benefit from the higher monthly service pricing plans in excess of our average ARPU.

Getting into specific acquisition costs, our total acquisition costs were $31 million, including the $11.2 million inventory related write-down, compared to $18.2 million in the second fiscal quarter of the prior year.

Our SAC in the second quarter fiscal quarter of this year was $758, with $274 relating to the inventory related write-down. This compares to SAC of $245 in the year-ago second fiscal quarter. The increase on a second fiscal quarter year-over-year basis is due to the inventory related write-down, the commencement of our marketing campaign, and lower-than-anticipated gross adds.

Looking to the next half of this fiscal year, we expect a lower SAC as we reap the benefits of the nominal subsidy of our TiVo HD box and as we anticipate the holiday season increase in gross adds.

With our DIRECTV sub base, we are seeing slightly higher declines versus last quarter as our DIRECTV subs decreased by 126,000 during the quarter. Just as a reminder, DIRECTV no longer has the right to market and distribute TiVo.

Turning to our guidance for the third quarter, we expect service and technology revenues of $56 million to $57 million. Of this, we anticipate service revenues will face headwinds from continued DIRECTV churn, but will benefit from sequential increases in advertising revenues. We also anticipate technology revenues to be slightly increased compared to the second quarter.

We currently expect that our third quarter fiscal 2008 adjusted EBITDA results to be in the range of a negative $5 million to a negative $8 million. We also anticipate better adjusted EBITDA in the fourth quarter compared to the fourth quarter of the prior year.

We expect a net loss in the range of $14 million to $17 million. The change in net loss and adjusted EBITDA on a sequential basis is primarily due to costs of stocking the retail channel with inventory ahead of the holidays, as well as increased marketing spend ahead of the holidays. Additionally, our net income guidance for this third fiscal quarter of this year includes an estimated incremental $3 million in non-cash, stock-based compensation which relates to the expected transition and consulting agreement for Mike Ramsay, which is expected to be effective September 1, 2007. We do not expect to incur non-cash stock-based compensation expenses related to this agreement beyond the current quarter.

Let’s take a look at where we stand on our goal to get closer to break even adjusted EBITDA. The first quarter’s adjusted EBITDA was a positive $6.8 million. Our second quarter’s adjusted EBITDA was a negative $11.2 million, which included an inventory related write-down of $11.2 million, and that $11.2 million inventory related write-off was not contemplated in our guidance. Our guidance for the third quarter is a negative $5 million to a negative $8 million, and for the fourth quarter, we anticipate an adjusted EBITDA improvement over the fourth quarter of the prior year.

This compares with last year’s adjusted EBITDA of a negative $7 million for the first quarter, a negative $2 million for the second quarter, and a negative $6 million for the third quarter.

As you can see, we are on pace to make considerable improvements to adjusted EBITDA in this fiscal year compared to last year, despite the $11.2 million inventory related write-down impact on adjusted EBITDA.

To wrap up, I am excited about three elements of our business model that we view as important business drivers during the last half of this year and into next fiscal year. First, this is when the shift subscription acquisition towards an approach that is more focused on advertising versus subsidy. This is very evident with our new TiVo HD box, which has almost no subsidy in the direct channel and a much reduced one compared to our prior products in the retail channel.

Second, our mass distribution efforts are progressing at Comcast, as they are close to launch in its first market. This should give us the opportunity for efficient mass subscription growth.

Additionally, we expect international deals, such as Seven and CableVision Mexico, though they may allow us to effectively reach a significant number of television viewers that haven’t had the opportunity to TiVo before.

Finally, our advertising business continues to show potential. We have high hopes going forward and our audience research measurement business takes significant steps forward as we continue to add customers.

Again, this was a quarter that was defined by our standard definition products, while going forward, our results will be characterized by new distribution, specifically related to our HD product and Comcast.

This concludes my remarks. Thank you for your time and we will now take questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first now to Tony Wibel at Citigroup.

Tony Wibel - Citigroup Smith Barney

Just talking about Comcast and the number of subscribers that are implied in your third quarter guidance, and also update us on Cox. We’ve heard a lot about Comcast, but any update on the timeline with Cox?

Tom Rogers

No, there’s nothing meaningfully attuned in terms of our quarter-to-quarter guidance on the Comcast front. I think that the Comcast focus will be New England and beginning to roll out there, as their quote said shortly and moving on throughout the New England region throughout the fall, and we’ll look to additional markets from there.

On the Cox front, as you know we have pointed a long time to the about a six-month interval we believe between when Comcast would begin its rollout and Cox would begin to make things available. Having said that though, we are still trying to see if things can be kicked off some time this year with Cox and that’s our current focus.

Tony Wibel - Citigroup Smith Barney

Great, thanks.

Operator

(Operator Instructions) We’ll go next now to Dan Ernst at Hudson Square Research.

Dan Ernst - Hudson Square Research

Good evening. Thanks for taking the call. On the Comcast side, could you just give us a little bit of color on what constituted the delay? Because we had expected August, and you had previously said, or earlier you thought a substantial number of markets could launch that year. Could you update us on that assumption?

Lastly, on the partner side, does the renewed deal, or the update of software at DIRECTV potentially foreshadow an opportunity to renew growth of subs at DIRECTV? Thanks.

Tom Rogers

On the Comcast front, Comcast is still focused on the potential of additional markets rolling this year past the New England market, the New England market being their biggest market and their initial market is one getting a great deal of focus. As that progresses, I think we will be to give you a greater update on what those other markets might look like as Comcast continues to focus in on that.

On the DIRECTV front, I think the announcement this quarter that we are working on additional features for DIRECTV and the accompanying quote of theirs in the statement from them about this, indicating potential for looking to build further relationships with TiVo, is an indication of what it is, an interest in opportunities for us to potentially work with them going forward.

I know that they did e-mail and voice-mail blasts to their existing TiVo subscribers, talking to them about the new feature developments coming, and so it is certainly getting some renewed focus from them, from a marketing point of view. Obviously they are facing a change of ownership and that might bring with it as well some opportunity for renewed relationship with DIRECTV.

So I would say that all of that points us into a direction that there is greater focus there on both sides than there has been in the past.

Dan Ernst - Hudson Square Research

Great, and then just the color on the Comcast delay?

Tom Rogers

The Comcast -- I didn’t hear the last word.

Dan Ernst - Hudson Square Research

Comcast, we had hoped that would launch in August and if you could give some color on why that hasn’t happened yet?

Tom Rogers

Not a lot of color to add there, other than they really are in a position to move on this shortly. A very, very senior Comcast person said to me in the last few days you’ll see some real action in September and even more action in October on the rollout front, and I think that kind of speaks for itself in terms of how short the timeframe is in terms of their looking to roll here.

I think equally significantly from a distribution point of view from Comcast is our new agreement with them, which has with it a bunch of additional distribution opportunity. As you know, the development work with Comcast has focused on the Motorola box population. They have I think about 25% of their subscribers that have Scientific Atlanta boxes, and this new platform agreement with them and additional development work that it will involve includes developing TiVo for that box population as well, and obviously that brings with it some additional distribution potential for us, so all in all, we feel quite good about the Comcast relationship progress we’ve made, where they are in terms of timing for the rollout and where it puts us in terms of continuing to work very closely with them on the development front.

Dan Ernst - Hudson Square Research

Great. Looking forward to it. Thanks.

Operator

We’ll go next now to Kunal Madhukar at Bear Stearns.

Kunal Madhukar - Bear Stearns

Thanks for taking the call. A quick question on Comcast -- when do you expect that TiVo service will be fully rolled out across the entire network, the entire Comcast footprint?

Tom Rogers

Well, that’s a little hard for me to estimate because we are just beginning the development work on the Scientific Atlanta front which, as I said, represents a decent chunk of their overall subscribers. That development work will take us into next year, and then the rollout of markets related to SA will take some period of time from then.

I think the thing to focus on is they are looking to begin to roll not only in this large market, but following this market other larger markets for them and as they continue to roll it, they intend through next year to be focused on major pockets of subscriber concentration for them that I think will demonstrate a real commitment to getting this to large portions of their base through the course of next year, but I can’t give you a timeframe in terms of when the entire unit base will be reached.

Kunal Madhukar - Bear Stearns

Thanks, Tom. A quick question on the advertising part; there has been discussion on using DVRs as a way to offer targeted commercials. There has been less discussion on the TiVo conference calls for the past couple of calls. What is happening on the front now that the current is moving to [D-plus-3] and there is a lot more discussion and awareness of what DVRs are doing to advertising on TV? When do we start seeing those kinds of, you know, the revenue dollars starting to flow?

Tom Rogers

Well, it’s a good question and there certainly is an enormous amount of focus for us on that, because we consider it a real future opportunity for us. It is one of the givens in the advertising world that people get DVRs and fast-forward through commercials. And it is right now clear that the only DVR-based ad solution out there is the TiVo ad solution.

We spent a good chunk of time with the leading advertising buying firms and some key creative shops in August, getting together, getting their input in terms of where all this needs to go in terms of the future direction of the ad business. And it is clear we are getting an enormous amount of mine share, not to mention getting the opportunity to work with all kinds of major clients who are continuing to give us advertising buys that continue to grow our ad sales business.

I would say though in terms of that business really taking off and being a significant contributor to TiVo's top line requires sub growth, and I think that the sub growth there is something that is our foremost mission. Whether we get it on the standalone basis from the new HD offering, whether we get it from Comcast and Cox and other mass distribution offerings, driving that distribution will be the single biggest catalyst, and as it comes, we feel quite strongly that the advertising business will follow.

In the meantime, we have developed very strong roots in that regard and feel good about the fact that the ARM business, the audience research and measurement business, which is also one that we’ve spent a lot of time with with the major integrated ad shops, some key marketing companies that you saw from the announcement today. One of the truly leading creative shops out there, Crispin Porter, that all sides of the equation are beginning to look to that data and it’s important. And we have more than enough subscribers for purposes of delivering a product there that is more robust than anything else out in the marketplace. So that one we do feel is one that can begin to contribute into next year without having a major pop in distribution.

So both of those are getting substantial attention from us.

Kunal Madhukar - Bear Stearns

Thank you, Tom.

Operator

We’ll go next now to Barton Crockett at J.P. Morgan.

Barton Crockett - J.P. Morgan Chase

Great, thanks for taking the question. Since we are limited to one, I just wanted to get into the topic of the gross additions of subscribers. I wanted to be clear on this point; implicit in your guidance for the third quarter and also for the full year, are you guys saying that you expect year-to-year growth in gross additions in the third quarter and in the fourth quarter? Or is it not in the third but in the fourth? And within that, can you give us some sense of what the mix is of standard definition versus HD this year versus a year ago, so we get a sense of the lump that you are trying to replace in terms of the standard definition? Thank you.

Tom Rogers

Well, as the gist of our script and the gist of our, this discussion here today outlined, we are really at a turning point, I think, in terms of the retail environment. Our present quarter numbers were all based on the standard definition product. Obviously we’ve had a high-end, high-def product out there that continues to do fine but it is a very high-end product. And the retail environment has drastically changed in terms of supporting standard definition product.

Our HD product is one that we feel quite good about. It’s gotten a good retail embrace. We got it in at the price point that retailers were looking for. We got it in ahead of when most people thought it would come to the market, meaning most were expecting it later in the year, and we’ve been able to increase our footprint, not only substantially within Best Buy and Circuit City but now picking up major retailers like Costco and Sears.

Having said that, it’s a $299 product. Last year in the third quarter, we were offering a free box and the dual tuner product at a $69 price point, and that’s an apples-to-oranges type comparison. So I think we’ve got to establish a fresh base in terms of what HD growth is going to look like.

The retail embrace has been quite good. We know we have work in front of us in terms of educating people as to the price of TiVo and the value proposition there. We know we’ve done some of the work already with the marketing campaign about the differentiated features. We have work to do there in terms of continuing to educate people on the differentiated features.

But I’m hesitant to make any kind of year-over-year comparisons to an SD product offered at a very different price point versus a new HD $299 price point.

I think we’ve said it but it’s worth saying again; while we took the write-off on the unused parts on the standard definition inventory, which was dictated by accounting based on the current pace of our standard definition sales, that is a market that we continue to believe we own.

We are the only player in the standard definition product market, really. You can’t get TiVo otherwise but retailers aren’t going to support it. So we have to find a new way to be able to market to that target and find a way to do that efficiently, and that too brings with it a new set of metrics in terms of approach, because we are not looking for the retail channel to be able to support that product and we are going to find new ways to market it.

I would say we are looking to drive our subs going forward in a way that will contribute to growth in both Q3 and Q4, so that we are adding subs going forward but the mix of that and the trajectory for that is, at this point, premature to discuss.

Barton Crockett - J.P. Morgan Chase

Okay. Thank you.

Operator

We’ll go next now to Alan Gould at Bleichroeder.

Alan Gould - Natexis Bleichroeder

Thank you. Hi, Tom. A couple of quick questions; first, the inventory, if you net out the write-down, went up another $4 million in the quarter. Was that simply more high-def inventory put in there?

Tom Rogers

Give me that one more time, Alan.

Alan Gould - Natexis Bleichroeder

The inventory went from $30 million in April to $23 million now. If you knock out the $11 million write-down, the April goes to $19 million, so the 19 to 23 was up $4 million. Is that new inventory, mostly high-def?

Tom Rogers

That is mostly high-def inventory going in.

Alan Gould - Natexis Bleichroeder

Okay, and secondly, the comment about Comcast funding the development on the SA and other platforms, typically Comcast usually does not -- is not that magnanimous that they typically just start funding other people’s projects for them. Was there any quid-pro-quo in there?

Tom Rogers

Well, on the macro level, the quid-pro-quo is they think they get a great brand, a terrific user interface with an integration of all kinds of VOD and other functionality and the ability to have a competitive advantage in the marketplace.

Were there some modest trade-offs here and there in the nature of our relationship with Comcast? Yes, but I think it is fair to say that this is a major funding commitment from them and one that drives us forward into yet a whole new phase of development work for Comcast as we begin to roll out on the first phase. And we continue to work on the advertising solutions phase of our work with them, which is another significant undertaking as well.

I think it is in their interest, in our interest, and everybody is feeling quite good about it.

Alan Gould - Natexis Bleichroeder

Okay, thanks a lot.

Operator

We’ll go next now to Ingrid Ebeling at JMP Securities.

Ingrid Ebeling - JMP Securities

Thank you. So from your comments on the series II DVRs, are we safe to assume that there is no potential for further write-downs in the third quarter? And will they no longer be available in the retail channel, such as Best Buy?

Tom Rogers

Well, there will be some limited availability because the retailers do have some inventory that is already in the channel for the standard definition product. The difference is that the kind of floor space, the kind of placement, the kind of demos, the kind of packaging opportunities that might be available to consumers will basically the shoulder behind the product will relate to the HD side, as that’s the vast amount of effort that they are putting into their own retail space on the television parts of their store.

In terms of further write-downs, we don’t contemplate any at this point. As I’ve said in my statement, there may be some limited promotion opportunities with certain business partners for our standard definition product but we really are going to focus on how do you reach that 30 million analog base that is not in the market for an HD set that does want a DVR? We know it is not a hypothetical part of the equation because we are getting just under 50% of our subs today from the basic analog segment of the television audience. It is about a third of all television households, and it is a different marketing equation for us because it is not one through the retailer.

We do have a decently robust online sales presence that’s our direct sales presence. It had about, responsible for about 40% of our sales over the last quarter and working from that space and finding ways to target to that audience, we think there’s substantial opportunities to penetrate it at less than 1% of homes that are out there today and be able to actually fully utilize those unused inventory parts. But as I said, accounting dictates that we take the write-down based on where we are today.

Ingrid Ebeling - JMP Securities

Okay. Thank you.

Operator

We’ll go next now to Lee Westerfield at BMO Capital.

Lee Westerfield - BMO Capital

Thank you. Tom, three, sorry about this, but three hopefully very quick questions; first, just to clarify in the third quarter guidance for EBITDA, for a slight single digit millions of losses. Are there inventory write-downs again that are incurred in the third quarter? I think not but I just wanted to clarify that.

Tom Rogers

No, we don’t contemplate any.

Lee Westerfield - BMO Capital

Great. Second, and this might help better understand the performance of ARPU on TiVo-owned subscribers. You provided the detail, 180,000 subscribers beyond the lifetime contract recognition period. Since that is an easily forecastable number internally, what was that say a year ago and what will that be in six and 12 months, so that we can better understand the underlying ARPU for paying subscribers?

And then third, a quick question here; if Comcast is funding the R&D on Scientific Atlanta boxes, who is managing the R&D on those, on that box base?

Tom Rogers

That last one, I’m sorry, who is what-ing?

Lee Westerfield - BMO Capital

Who is managing the R&D on TiVo in terms of platforming on Scientific Atlanta boxes? They are funding it. Who is doing the R&D?

Tom Rogers

On the ARPU question related to the fully amortized subs, the 180,000 was about 50% higher than the corresponding amount last year for this quarter. We had some 700,000 or so additional lifetime subs that have not yet been fully amortized that will continue to roll off in terms of their full amortization hitting up at some point in the future.

The key issue on ARPU is that our new subscribers are coming on at much more substantial levels than was the case last year. We’ve been able to move the new subscriber annual -- I’m sorry, monthly fee to an average of about $13, which is way up from where it was over a year ago. And that’s really having a major contribution on increasing the ARPU.

On the R&D front with Comcast, that work will be managed by the same team that has been managing this incredible work that went into the Motorola development work. It was real rocket science to crack the code on how to take everything that makes TiVo code simple and elegant and port it to somebody else’s hardware.

What we have to do by way of Scientific Atlanta development work is nowhere near as much rocket science, having cracked the code on the essence of how to do that. But it is the same team headed by our senior vice president overseeing the mass distribution area, Jeff Klugman will be managing that.

Lee Westerfield - BMO Capital

Tom, thank you for taking the questions. I appreciate it.

Operator

We do have time for one further question and we’ll take that now from Brian Coyne at Friedman Billings.

Brian Coyne - Friedman Billings Ramsey

Hey, guys. Again, thanks for taking my question. Just following up from an earlier one, you said you are looking obviously for stronger gross adds in the October quarter. Clearly it is net adds that drive your business, so I am just sort of wondering if you expect your net adds to turn positive in October or to continue to be negative.

And related to that in terms of churn, what can you really do to address the rise and the rate here beyond just launching the HD box? I mean, I guess there has to be several reasons why subscribers are going to churn, only one of which is HD. What is -- can you give us a sense as to your strategy around that? Thanks.

Tom Rogers

Well, those questions are obviously very related because being net sub positive is, no small part of that is what your churn factor is for the quarter.

Again, in terms of our growth, we are looking at how we move forward from here with the tools that we have in front of us. Again, the comparisons to last year with very different price offerings are not the relevant ones. We are looking going forward at much more sequential type of comparisons for purposes of evaluating our sub growth.

On the net sub issue, we are not making a projection now but obviously it relates to your second question, which is what is the churn rate? We do think our churn has been creeping up in large part because of subscribers seeking a high-def offering, where TiVo does not have an adequate product to satisfy that. That continually shows up as a reason people go to cable DVRs and move away from TiVo. And so that we do think will be substantially helped by having a new HD product in the market.

Again, the speed and trajectory of how HD at the $299 price gets accepted in the marketplace is something that we know that we have education work to do and getting people fully up to speed on the price value proposition and all, how you can actually by using a cable card reduce the cost of your cable service and how you can actually get TiVo on a three-year up-front basis that comes out on a monthly basis to something that is often cheaper than what the cable offering is, et cetera. It is going to take some time to get there but if we do that right and now that we do have the HD product, we do think we’ll see a beneficial impact on churn and our net income sub growth should -- I mean our net sub growth should be positive.

Operator

Mr. Rogers, I would like to turn the conference back to you for any closing or concluding remarks.

Tom Rogers

Well, thanks, everybody. I know this is a pre-holiday week and getting your focus for this time during it, we really appreciate. We really think we have a quarter in front of us that has a lot of exciting attributes to it, having a new HD product, having Comcast beginning to roll, continuing to build the momentum on several other initiatives. We know we are coming out of a quarter where we have had a standard definition product where the retail environment has moved on. I think we’ve put that into context for you so you can understand it, both financially and from our own point of view in terms of where we see our growth coming from going forward. And we look at all that and we say we got product and we got distribution arrangements that we think will serve us quite well in the future.

With that, I will bid you all a good afternoon and thanks again for joining us.

Operator

That does conclude our conference call. Again, thank you all for joining us. Wish you all a great remainder of your day. Goodbye.

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Source: TiVo F2Q08 (Qtr End 7/31/07) Earnings Call Transcript
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