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Rovi (NASDAQ:ROVI)

Q2 2012 Earnings Call

August 02, 2012 5:00 pm ET

Executives

Chris Keller

Peter C. Halt - Chief Financial Officer and Chief Accounting Officer

Thomas Carson - Chief Executive Officer, President and Director

Analysts

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Michael J. Olson - Piper Jaffray Companies, Research Division

Heather Bellini - Goldman Sachs Group Inc., Research Division

Todd T. Mitchell - Brean Murray, Carret & Co., LLC, Research Division

James Medvedeff

Andy Hargreaves - Pacific Crest Securities, Inc., Research Division

Edward Maguire - Credit Agricole Securities (NYSE:USA) Inc., Research Division

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

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Rovi Corporation Second Quarter Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Thursday, August 2, 2012.

I would now like to turn the conference over to our host, Mr. Chris Keller, Vice President of Investor Relations. Please go ahead, sir.

Chris Keller

Good afternoon, ladies and gentlemen, and thank you for joining us today. I'm joined today by Tom Carson, our President and CEO; and Peter Halt, our Chief Financial Officer.

Before we discuss our second quarter results, which were released earlier today, I would like to start with some housekeeping items. First, I would like to remind you that all statements made during our conference call that are not statements of historical fact, including, but not limited to, statements regarding the company's forecasts of future revenues, expenses and earnings, as well as business strategies and product plans, constitute forward-looking statements, and are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results could vary materially from those contained in these forward-looking statements. Factors that could cause actual results to differ materially from those in the forward-looking statements are described in our Form 10-Q for the period ended June 30, 2012, and other filings with the SEC that are filed from time to time.

Second, our results released earlier today, as well as our discussion on this call, include non-GAAP adjusted pro forma information, which exclude, as applicable, noncash items and items that impact comparability. Examples of such items include amortization, equity-based compensation and discrete tax items and the tax effect of all non-GAAP adjustments. Depreciation expense, while a noncash item, is included in adjusted pro forma operating results as a proxy for capital expenditures to demonstrate recurring cash-based earnings. Adjusted pro forma combined company information assumes the Sonic Solutions acquisition and the Roxio consumer software disposition were both effective on January 1, 2010. Adjusted pro forma reconciliations for historical results, including Sonic Solutions and excluding the Roxio consumer software business, are in our press release.

We have presented and are discussing adjusted pro forma combined company information because this is how we have and will evaluate our business. We believe that this presentation may be meaningful to our investors in analyzing the company's results of operations. This presentation is not intended to be a substitute for our financial results, presented in conformity with generally accepted accounting principles in the United States, and investors and potential investors are encouraged to review the reconciliation of adjusted pro forma financial measures included in our earnings press release.

And as the final piece of housekeeping, the webcast of this conference call will be available on our Investor Relations webpage at www.rovicorp.com.

Now I would like to turn the call over to Peter.

Peter C. Halt

Thanks, Chris. Good afternoon, everyone. Hopefully, you've had a chance to see the press release we issued today with our results for the second quarter ended June 30, 2012.

As we disclosed a couple of weeks ago, the second quarter was a disappointment to us. Adjusted pro forma revenues were down approximately $21 million or 12% from the second quarter of 2011, primarily due to a drop in revenues in our CE vertical. CE was down this quarter by $21 million or 24% from the second quarter of 2011.

As we said when we announced preliminary results, softness in CE was primarily due to anticipated declines in ACP revenues, which we've been talking about for a number of quarters now. Remaining decline was mostly due to the lack of new CE licensing deals during the quarter. But we had hoped to sign at least one of the CE manufacturers that is out of license. It did not happen in the quarter for reasons Tom will discuss. By comparison, in the second quarter of 2011, we've benefited from entering into a license agreement with Toshiba.

Our CE products were also adversely impacted by the macroeconomic factors that appears have been headwinds for many companies involved with the CE industry. Many device manufacturers reported a year-over-year reduction in royalty-bearing unit sales, and some of our CE partners have been incorporating next-generation guides more slowly than we anticipated.

Additionally, activations for connected devices are not meeting either our expectations or, we understand, expectations of the device manufacturers. We believe the lower-than-expected activations also reflect the macro environment as CE device makers are not currently making the kind of investments in marketing that would encourage consumer awareness and activation. As a result, our anticipated advertising revenues were impacted by the resulting smaller-than-anticipated guide footprint in CE.

Additionally, DivX revenues, while slightly up on a year-over-year basis, did not grow as anticipated. DivX growth was impacted by the CE industry's headwinds, as well as by delays in our rolling out new content creation solution software. We are actively addressing such delays as Tom will discuss.

Service provider revenues were up 4% from the second quarter of 2011. Growth came primarily from subscriber growth among our patent licensees and from an increase in subscribers and rates for our guide products. We had 16 agreements for our existing service provider products up for renewal this quarter. Everyone of them was renewed. However, the level of growth, though [ph], did not meet our expectations for the quarter, as the service provider segment was significantly impacted by delays in completing guidance patent licenses.

In addition to not signing an out-of-license CE manufacturer, as I referred to earlier, we experienced delays signing up certain service providers who have not traditionally licensed IP, such as web portals, who need a license for the TV Everywhere field of use, and service providers in certain European markets.

These delays accounted for the majority of our second quarter revenue shortfall. Candidly, these were agreements we hoped to complete even late in Q2, but the parties who we're negotiating with we're looking for discounts beyond what we felt was commercially reasonable. We expect to realize these revenues later this year or in 2013. And as Tom will discuss, we do not believe the delays reflect any change in the value of Rovi's IP.

Additionally, advertising growth in our service provider segment was slower than anticipated due to the overall softness in interactive TV advertising, as well as a lower-than-expected contribution from our online properties. We expect more significant growth in this category by the end of 2013 once the delayed licensing agreements come in and once our MSO partners begin total guide deployment.

The growth in revenues from service providers was offset by decline in revenues in our other vertical. Just down $3 million or 16% in the second quarter of 2011, due primarily to the anticipated decline in the ACP revenues for entertainment. These results were also lower than our expectations due to delays in launching new Rovi Entertainment Store retail partners.

In terms of adjusted pro forma profit measures, SG&A cost was $33.7 million in the quarter, down $1.2 million or 3% from the period a year ago. R&D expenses, however, increased to $35.1 million compared to $33.7 million a year ago due to higher R&D headcount than 1 year ago, partially offset by lower bonus expenses. Our cost of goods sold increased by $4.9 million to $30.1 million when compared to Q2 a year ago.

Contributing to this increase were greater patent litigation and prosecution costs, as well as increased bandwidth and storage charges for the Rovi Entertainment Store. Our patent litigation and prosecution costs were up year-on-year. They were less than we had expected due to the timing of certain litigations. Adjusted pro forma operating income from continuing operations, less depreciation expense, represented 38% of revenues for the quarter. This margin is not acceptable to us, and Tom will describe what we are going to do to return Rovi's margin to more acceptable levels in 2013.

Turning to our outlook for fiscal 2012. We have adjusted our revenue expectations based on the issues I have just discussed, as well as the issues Tom will speak about in more detail later. Approximately half of the reduction expectations for fiscal 2012 relates to deferring our expectations for certain IP license arrangements to 2013.

In order to readdress our 2012 expectations, we performed a thoughtful bottoms-up buildup with the sales team. And the only licensing agreements included in the revised 2012 outlook are ones that we feel have a high probability of getting signed this year. As such, we feel confident that we will meet the revised expectations that we announced 2 weeks ago, adjusted pro forma revenue between $650 million and $680 million and adjusted pro forma earnings per share between $1.60 and $1.90.

Looking to 2013, we expect 5% to 10% growth, depending on when the delayed licensing deals we discussed are finalized. To the extent the deals get signed in 2012, growth will be at the lower end of the range in 2013. To the extent they're delayed into 2013, our growth will be at higher end.

In terms of our balance sheet, in Q1, we took advantage of a market window to refinance existing debt and expand our debt facility at very favorable rates. We were pleased to get these favorable rates while also obtaining very reasonable covenants. The principal amount of our debt was $1.5 billion at June 30. We have reviewed our various debt covenants, in light of our revised expectations for 2012, and these new expectations do not cause us any concerns under those covenants.

Our cash and investments at the end of the quarter were approximately $950 million, giving us a net debt position of approximately $550 million. Rovi continues to have significant cash flow, and we are taking a very thoughtful and disciplined approach to this deployment. Importantly, we do not feel any pressure to be doing an M&A deal, although we will remain strategic and opportunistic with respect to possible acquisitions. We will be disciplined in deploying capital, focusing only on areas that fit Rovi's strategic focus and core DNA.

We also continue to be intently focused on returning value to our stockholders as a key part of our capital allocation framework. In the second quarter, we repurchased 2.1 million shares for approximately $50 million. Looking ahead, with $313 million remaining under our existing share repurchase authorization, we expect to be opportunistic in buying back more stock. And we look forward to providing more details about our repurchase plans after our trading blackout window reopens.

With that, let me turn the call over to Tom.

Thomas Carson

Thanks, Peter, and thank you to everyone joining us today on this call. We have had the chance to speak with many since we announced preliminary results 2 weeks ago. We have found these calls to be very constructive. We have really appreciated your candor and the open dialogue.

We understand the strategic and operational challenges facing the business today, and we are tackling them head on. We continue to be extremely enthusiastic about Rovi's market position and long-term prospects. I'm confident that we have the right plan and the right team in place to once again drive strong revenue growth at appropriate margins.

Before I talk about the detailed operational reviews that we have just completed and our strategic plan going forward, I want to spend a few minutes taking you through the business the way we look at it from an operating perspective. This is slightly different than Peter's financial presentation, which was focused on our sales verticals.

I realized that historically, the number of product lines and initiatives we're involved in may have sounded overwhelming and created some confusion for our investors trying to understand Rovi. The way we view it, is in fact, pretty simple. We view our businesses as comprised of 3 strategic pillars: one, discovery; two, advertising; and three, delivery and display. Hopefully, my discussion of our operations in this fashion will help you better understand our offerings.

First, let's discuss our discovery business. The discovery business is comprised of our IP licensing business and our guide products. A licensing negotiation typically consists of 2 phases: first, we discuss the applicability of our portfolio to the use case and then economics. We believe that we have a strong momentum in our negotiations with a number of parties, and as I mentioned, in some cases, we're negotiating right up until the end of the quarter.

However, as we have previously explained, we strongly believe that we should not sacrifice the overall economics of a deal and its ultimate benefit the stockholders just to generate revenue in a given quarter. For each agreement, we target a price range based on past metrics and what is fair to other licensees. And we always evaluate whether it's more advantageous to take the deal, continue negotiating or litigate.

With regards to the contracts we did not close this quarter, we made the decision not to accept the terms that we did not feel represented appropriate value to Rovi. We are continuing to pursue all of these agreements. We believe we will ultimately agreed to terms acceptable to Rovi and that the value of our IP portfolio will not be impaired.

As we mentioned in our letter to stockholders, we expect these deals, once signed, will include catch-up payments to make Rovi whole for the pre-license period of use. We therefore view the revenue associated with these anticipated agreements as delayed, not lost. While not our preference, we will pursue litigation if commercially reasonable terms cannot be reached within a reasonable amount of time. However, even in those instances where we pursue litigation, full litigation is rarely required. Far more frequently, we find that we can reach agreement after the parties have had a chance to better understand Rovi's IP for this discovery process and to evaluate the potential costs and risks of litigation. We typically maintain parallel negotiations while litigating, and we have a great track record of coming to favorable negotiated terms. The resolution of deals with Sharp and Toshiba last year are excellent examples.

One point I want to make very clear. We do not believe these delays signal any fundamental change in how we need to do business, let alone in the value of Rovi's IP. Our portfolio of more than 5,200 patents and applications worldwide, is widely respected and recognized throughout the digital entertainment ecosystem. The portfolio has broad applicability, including guidance and advertising applications, various DVR functionalities, filters such as parental control and search and discovery functions.

We are also constantly growing the portfolio by generating invention disclosures, filing new patent applications and receiving additional patent grants. We filed more disclosures in the first half of 2012 than at any prior period in the past 10 years. Our core licensing business is very much intact.

Underscoring the strength and relevance of our portfolio, we have licensing agreements in place with almost every major service provider in North America. We have approximately 50% of Western European pay TV market under license by digital subscribers, including the 3 largest service providers in Europe. We have also licensed many of the leading service providers in key Asia-Pacific countries such as Australia, Japan and Korea.

We also have licensing agreements in place with 5 of the top 7 CE manufacturers worldwide. Only LG and VIZIO are out of license. We believe these companies are under significant margin pressure in the current macroeconomic environment, and that the negotiations with them broke down over economic, not over the use case. We're actively pursuing all our options to reach agreements with both companies. Additionally, we signed a number of new deals this quarter, including with Funai, JVC and a large U.K. retailer for its house brands.

Aside from those manufacturers, the delays we have experienced are not with our core group of licensees, and in a certain newer areas in which we are expanding our licensing footprint. Specifically, some agreements are simply taking longer than expected with certain European service providers, while relatively new to the IP licensing business and with some of the big web portals in the TV Everywhere space, who are less knowledgeable about our use case.

Importantly, we have great momentum in our licensing business among both European service providers and within the TV Everywhere field of use. In Europe, following on the heels of last quarter's extension with NDS, we recently entered into an extension of our deal with SKY Italia. In respect to TV Everywhere, major players like Comcast, NDS, Apple and Sony, who are accustomed to the licensing IP, understand our use case outside of television and are under license.

Since our last earnings call, we've entered into new license agreements covering the television and TV Everywhere field of use with Cogeco and with Google, for its high-speed Internet and television service offering in Kansas City, Missouri and Kansas City, Kansas.

I also want to make clear that the recent delays and recent litigation have not negatively impacted our customer relationships or our negotiations with our current partners. Additionally, we have a full pipeline of discussions taking place with prospective licensees, including first-time licensees, and we look forward to providing updates on these agreements in the future.

Moving on to our guide products. We renewed all of the agreements for service provider products that came up this quarter. Additionally, the TotalGuide solution for service providers is resonating very well. The product is doing well in lab tests and field trials, and we anticipate deployment in the first half of 2013 at Bend, Cogeco, Buckeye, Armstrong, Blue Ridge and Mediacom.

From the CE front, we were impacted by the global softness in consumer electronic device sales, as Peter described. Additionally, while many of our CE customers are under fixed-fee arrangements with us, we still need to go out and sell their product teams on incorporating our guide product. They've already paid for their product and in many cases, just need education on incorporating key elements within their own offerings. This is an example of an area of execution we're working on. Still, we're optimistic that growth in TotalGuide for CE or key elements of TotalGuide will improve when the global device market revives.

We're also optimistic that our flat fee deals with a number of the largest CE manufacturers will combine with follow-up sales efforts with their various product teams to encourage greater incorporation. We entered into these deals with a strategic goal of incorporating TotalGuide's advertising platform, and we still like our long-term strategy of expanding our CE footprint to drive advertising revenues.

Turning to our advertising business. After many quarters of strong growth in a number of conventional advertisers, we experienced the sharp falloff as conventional advertisers spent less on interactive TV advertising during the second quarter. Ad budgets are tight and this particular form of advertising is still nascent. That said, we still expect solid growth here, although more likely in the range of 25% to 30% as opposed to last year's 2x growth. We are also optimistic that when their economy and ad budgets come back, we'll be in a great place to capitalize on the opportunity.

Now let's discuss our delivery and display business, which has 2 key aspects: Rovi Entertainment Store and DivX. As Peter mentioned, the launch dates for the Rovi Entertainment Store have slipped as we have continued to work to achieve carrier-class performance and scalability. This has reduced our revenue expectations for the year.

That said, there are a lot of positives to report around the Rovi Entertainment Store. Demand is, in fact, very strong. The need for content distribution technology is large and growing, and there is great enthusiasm for our offering, particularly among retailers and studios.

We currently have retail partners in the U.S., U.K., Germany and Canada, and we continue to see interest in other parts of the world. Content providers in particular have developed a new appreciation for our offering. We are perceived as the leader in this space, and we are making a lot of progress in terms of our technology offering and our cost structure. For example, we have made improvements in uptime and reduced our customer service tickets relative to transaction volume, demonstrating that we're making continued improvements to the infrastructure while we continue to ramp global deployment.

We also made significant operational improvement by putting the Rovi Entertainment Store back into its own business unit. Candidly, this was a much needed change. Some of the issues the Rovi Entertainment Store has experienced since we acquired the business arose from trying to force it into a functional organization. Putting the Rovi Entertainment Store back into a business unit has significantly improved accountability and responsiveness. Customer feedback to this reorganization has been very positive.

We also have some excellent customer developments to report. In last quarter's call, we told you that the barometer for progress with this business will be our ability to onboard 2 major retailers. I'm very pleased to announce that we have accomplished that. We'll be powering the store for Toys"R"Us in the United States. We also anticipate announcing a major European retail partner in the next couple of weeks. Both are the sorts of retail partners we want to have onboard. Both have strong loyalty programs and the marketing skills and resources to drive storefront activation and consumer purchases.

Long term, we think the Rovi Entertainment Store has great potential to provide Tier 2 and Tier 3 service providers a much more robust video-on-demand offering as a plug-in to our next-generation guides. There's also a strong interest from retailers in focused content and supported over-the-top channels. But that this the future. Today, we still have much work to do in terms of on-boarding new retail partners, proving our services to our existing partners and tightening up the periods required to launch new stores and new devices.

Importantly, we have also been focused on improving the economics of this business. Our retail partners and studio content providers are coming to realize the critical role we can play in digital distribution, as well as the implications if we were to step out of this business. As a result, during the quarter, we improved the economic terms with one of our existing storefronts and several major content providers. We've also been focused on organizational efficiencies, and we believe we can take out over $5 million in costs in the second half of the year that burdened this business in the first half of 2012, with more to come. We will continue to manage the business closely, but we're optimistic about where it stands.

Last, turning to DivX. While the business grew year-over-year, as Peter mentioned, it did not grow at the pace we anticipated. This is in part because of the economic headwinds impacting the CE industry and in part also because of poor execution. One of the things I learned as I conducted a series of operational reviews this past quarter is that we have not given enough priority to updating our DivX content creation software. This is critical to maintaining demand, and we are now fully focused on having an updated offering out before the end of this year.

We've also experienced delays in rolling out DivX Plus Streaming. There's a lot of interest in this project and getting it into distribution will let it be the growth driver we anticipate. We are taking steps to ensure such delays do not occur in the future.

I would also like to call out the synergistic benefits of owning both DivX Plus Streaming and the Rovi Entertainment Store, which I think are underappreciated. Most major Hollywood studios have now agreed to use DivX Plus Streaming as a DRM in order for their content to be in the Rovi Entertainment Store. RES is also the vehicle for getting DivX Plus Streaming used as the primary player for over-the-top video distribution offerings. DivX Plus Streaming can provide the Rovi Entertainment Store and its retail partners cost efficiencies around ingestion and storage. This synergistic relationship allows us to drive demand for the player, above and beyond the demand for its advanced feature set alone, allows us to create demand from CE device manufacturers in a way other technology providers cannot.

I'm also pleased to report that we recently announced the deal with Panasonic to integrate our DivX Plus Streaming technology in their digital television and Blu-ray-integrated circuit solutions. We also continue to see good traction in terms of getting DivX on to mobile devices and tablets.

Let me shift gears now for a few minutes and talk about our execution and strategy going forward. Rovi's vision has been to use our industry-leading position in guide technology, drive opportunities in advertising and advanced video services. We are not changing this vision or strategy. We continue to believe that the opportunities being created by the shift towards cloud-based entertainment delivery and network connected devices are enormous and that we have the right approach to capitalize on these powerful trends.

However, we need to rightsize the business and improve our execution. As I mentioned earlier, we've undertaken comprehensive product-by-product operational reviews across our business and identified a number of areas where Rovi can be more efficient, as well as areas that are ripe for investment and innovation. Our management team is committed to getting under the hood and making the organizational and technical improvements necessary to successfully carry the vision.

In addition to reorganizing the Rovi Entertainment Store into its own business unit, we are streamlining our product management function and aligning it with sales and marketing. This will make our product teams more directly responsive to customers and directly accountable for our product introductions.

We're also renewing our emphasis on individual accountability throughout the organization. We're making fewer people more directly accountable for initiatives and objectives. We are working to optimize the parts of our business that haven't been integrated as well as they could have been over the past few years. We have historically been tremendously successful at integrating back-office and general and administrative departments into our functional organization while cutting out costs. In fact, because of our success here, we've overachieved our past synergy targets, and our G&A cost structure is favorable to our peers.

That said, we have been historically given the same level of focus to integrating the operations of the various businesses we have acquired. And we are focusing on creating greater efficiencies and more accountability in our R&D organization as well. Streamlining this organization will improve our cost profile and free up funds to invest in new development opportunities.

As Peter said, margins have fallen below acceptable levels, and we have put in place a road map to improve Rovi's adjusted pro forma EBITDA. As mentioned earlier, we are taking $5 million in costs out of the Rovi Entertainment Store, but our efforts won't end there. Our executive team will be making targeted cost reductions in lower growth and declining businesses also.

We ultimately expect to remove more than $20 million in run rate costs by no later than the end of 2013. This exercise has just begun, and I look forward to updating you on its progress, including providing our expectations on our next call for costs we can pull out immediately, as well as those by year’s end.

We also hosted an off-site 2 weeks ago with the top 100 leaders in the company to discuss these initiatives. There's a great deal of excitement throughout the company around the strategic vision and a real eagerness to improve efficiency and accountability throughout the organization.

I would also like to discuss the strategic plan we presented to our board earlier this week. The plan includes a number of initiatives aimed at building on our core strengths and assets and instilling a higher level of discipline across our operations. To prepare this plan, we began with the deep assessment of the markets in which we do business. We see particularly significant growth and expansion prospects in the service provider category, where many of our customers have strong core business economics and are being driven to evolve and expand their services.

The integration of mobile devices with entertainment and content services is providing to be an increasingly important extension of the entertainment value chain. Additionally, virtual service providers are expanding this category and motivating the traditional operators. Ultimately, we expect to see more nontraditional service provider offerings such as over-the-top and TV Everywhere, under the same strong service provider economic model that exists today. Our focus will be on service providers. We see many opportunities to bring the same core technologies, products and services to consumer electronics and mobile markets.

So what does this mean to where we will invest to drive organic growth? We envision investing in 3 growth areas: First, the discovery and delivery related products to help service providers keep up with the shift from legacy delivery of content to Internet protocol delivery. We're seeing a demand for IP-based guidance and video services as service providers seek to deliver robust pay TV offerings to consumer electronic devices in order to reduce their capital investment and facilitate a rapid geographic expansion of services.

Second, in discovery and delivery related products enable an integrated multiscreen experience. We see demand from our customers in virtually every segment of our business to enable an integrated, multiscreen experience, with a focus on video service delivery and monetization.

And third, in products that drive the monetization of content and services through highly relevant, Internet-delivered advertising on all screens, underpinned by intelligent real-time analytic data.

The plan we presented to the board includes a number of initiatives aimed building on our core strengths and assets while leveraging the higher level of discipline we are instilling across our operations to act on this strategic opportunities. I look forward to speaking more about the specifics in the future as we develop our product road maps to pursue these opportunities.

Our focus over the next 12 to 18 months will be on driving meaningful cost reductions, streamlining our operations, increasing accountability and delivering in the 3 areas where Rovi can best address the opportunities created by the conversion of entertainment technology and with discovery, delivery and display and advertising. We run the businesses we have in a more focused fashion, create organic growth in these 3 areas that I have highlighted, avoid distractions created by doing things that don't fit. We have the opportunity to deliver strong stockholder value. You have my commitment and the commitment of my team that we will do just that.

With that, we have time for a few questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Sterling Auty with JPMorgan.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

I'll ask one question, one follow-up, and I'll move back into the queue. On the 16 renewals in service provider during the quarter, can you give us a sense of what the run rate change was like you did when you reported the same metric last quarter?

Peter C. Halt

Sterling, we averaged over 20% on the renewals.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Okay, great. And the second one is when you look at the R&D spend now, it's been a particular area of conversation that I've had. Can you give us a sense as to how much that R&D spend right now is being focused on the Rovi Entertainment Store front versus your efforts in CE versus your efforts in service provider?

Peter C. Halt

So Sterling, one of the projects we're going through right now, and this has been kind of a result of being in a functional organization, is that we haven't done as great a job historically as we should on aligning up our cost with where it's working. That said, kind of if you look at the year-on-year increase in R&D dollars, I'll tell you about 20% came from the Rovi Entertainment Store. We've also been investing in some areas that we're looking at around our other products and businesses.

Thomas Carson

The other thing I was going to say is if -- I guess if you take a look at the overall R&D spend in others, a couple of segments there are heavy users of R&D. Certainly, RES is one of those. I'd probably put service provider in that category as well. Frankly, our data businesses is also a pretty big user of that as well. Probably DivX will be after that and then CE guide will be last on the list.

Operator

Our next question comes from the line of Mike Olson with Piper Jaffray.

Michael J. Olson - Piper Jaffray Companies, Research Division

Pete, you said that 2012 revenue guidance is now based on only deals that you have very high confidence in. Does the 5% to 10% for 2013 revenue guidance incorporate deals that fall into the kind of online video category like Netflix, Hulu, et cetera, or would those kinds of deals be incremental to that 5% to 10%?

Peter C. Halt

We do have deals in the TV Everywhere space with portals [ph] incorporated. So one of the comments that I made at the close of my remarks was that to the extent that we pull forward any of these deals we've taken out of our guidance, we'd be at the lower range for next year, to the extent that they slip into next year, then we'd be at the upper range.

Michael J. Olson - Piper Jaffray Companies, Research Division

Okay. And then you mentioned VIZIO specifically. Can you just explain what the situation is with them? There was a deal signed with them back in May of '09. But obviously, they're not licensees now. Did that deal expire? Did they just never start paying you or did they stop paying you at some point or what changed there?

Thomas Carson

We don't really get into the details of those kinds of things. They -- you're right. They were a licensee at one point. And basically, the agreement expired and basically, we've had just difficulty getting them to re-up. From our perspective, they clearly violated our intellectual property. So that's kind of where we are right now. So we're pursuing it.

Operator

Our next question comes from the line of Perry Huang with Goldman Sachs.

Heather Bellini - Goldman Sachs Group Inc., Research Division

This is Heather Bellini in for Perry. I had 2 questions for you. I was wondering if -- of the year-over-year decline in the CE segment in the quarter, how much was related to the expected decline in analog revenue in the quarter? And for the first half of the year, how much has analog revenue declined year-over-year? And then I have a follow-up.

Peter C. Halt

So for the total year, we're anticipating a decline in our analog revenues of the 45 to 50 range. That's about $5 million to $10 million less than we had anticipated that one [indiscernible].

Heather Bellini - Goldman Sachs Group Inc., Research Division

And what about for the first half?

Peter C. Halt

The first half of the year, we're looking at roughly 2/3 of the analog revenue coming through in the first half of the year and 1/3 in the second half.

Heather Bellini - Goldman Sachs Group Inc., Research Division

Okay. All right, great. And then, I guess, the second question would be for the Rovi Entertainment Store. How do we think about the rollout going forward? I mean, I heard the comments, some of the comments you gave but [indiscernible].

Thomas Carson

Sorry the question was breaking up. Was it basically commentary about the rollout of the Rovi Entertainment Store?

Heather Bellini - Goldman Sachs Group Inc., Research Division

Yes. I'm just wondering how -- what's the timing of when you expect to reach the performance goals, you can get it kind fully deployed and rolled out?

Thomas Carson

Yes. I mean, it's a great question. So just kind of looking back a little bit on the Rovi Entertainment Store. When we first acquired that business from Sonic, there were a couple of issues. One was with the -- just uptime of the system, and it was with a number of customer tickets that were taking that were pretty high and then just very late deployments. As we progressed, particularly into the last 3 or 4 months, we're getting very close right now to the kind of uptime we want, which is 99-plus percent of the time. The number of customer tickets are down very significantly, which is another good sign. And while we're still delayed in rollout, we're much better. So we're feeling that we've at least turned the corner from where we were. Demand for Rovi Entertainment Store is still very, very high. As we mentioned in our prepared remarks, we have the Toys"R"Us deal that we just recently did. We're expecting another one coming out here very soon with a major European retailer, and that's significant for us. So I would -- for us, as a company, the next 6 months are pretty critical to a lot of deployments or deals that we have signed or will be signing in the not-too-distant future. So the next 6 months are pretty key in a lot of the deployments.

Operator

Our next question comes from the line of Todd Mitchell with Brean Murray.

Todd T. Mitchell - Brean Murray, Carret & Co., LLC, Research Division

I have 3 quick things I'd like to focus in on. First of all, in regards to your comments about the Rovi Entertainment Store, you basically alluded to the fact that you've gone back to -- both the content providers and the distributors you're working with and are seeking better economics. Could we look at that in terms of the fixed component of the upfront setup? Or is that looking at sort of the tail end on your share of gross revenue from these stores?

Peter C. Halt

What we're looking at are things that both impact our cost of goods sold, as well as things that do impact the revenue in terms of such items as our regular monthly service fee.

Todd T. Mitchell - Brean Murray, Carret & Co., LLC, Research Division

Okay. So could be a little bit of both?

Peter C. Halt

Absolutely, yes.

Todd T. Mitchell - Brean Murray, Carret & Co., LLC, Research Division

Okay. Secondly, legal. You guys don't give a lot of visibility to what your legal spend is. And I understand the rationale for that. But I guess, there's 2 things. I guess, can you give us some sort of qualitative or preferably quantitative information in that area? And also, you alluded to the fact that it's a big component of the OpEx. But I also see in your disclosure that -- is there also a component of that, that fits into the gross margin? And how can we think about how legal is going to impact kind of both those levers sort of in an incremental or absolute fashion?

Thomas Carson

Yes. So I think the -- it's a fair question, particularly given our intellectual property business. And I think we're mostly talking about offensive litigation from a legal expense perspective. So first, it's part of kind of the ongoing nature of our business. I think we said in the past that we are up slightly more this year than what we had last year, but it's well within our budget guidelines. We certainly have increased over last year. I would expect our number going into next year to be either at the level we are now or slightly down.

Todd T. Mitchell - Brean Murray, Carret & Co., LLC, Research Division

Okay, okay. And does it impact both the gross margin and the OpEx? Is there some above the gross margin line?

Peter C. Halt

It all flows to cost of goods sold for us.

Todd T. Mitchell - Brean Murray, Carret & Co., LLC, Research Division

And lastly, in terms of the last question I had was -- looking at these over-the-top service providers that you're adding. You've given us some visibility in terms of what your -- loosely what your rate card is for service providers and just the licensing no code, licensing with code, TotalGuide and then TotalGuide with sort of a over-the-top component to it. Some of these over-the-top service providers have -- will they have reoccurring models? They don't have as much ARPU to work with or it's not necessarily in a subscription base. Should we think -- I mean, how do we think about -- how they think or how you think they should think about the monetary value of this licensing? Is it, in fact, closer tied to what the incremental would be if I was to add over-the-top component to my TotalGuide license as opposed to my entire TotalGuide license? Does that make sense as a question? I'm sorry.

Peter C. Halt

It does. It's a bit difficult to answer because we go and look at every over-the-top provider. We look at the offering and which aspects of guidance they're providing. We'll come to them with what we think is an appropriate rate for them to pay. We haven't really given any economics on the over-the-top providers and going away from the DVSs and your MSOs for pricing reasons.

Operator

Our next question comes from line of James Medvedeff from Cowen and company.

James Medvedeff

So I wanted to circle back to the gross margin issue or question. And I noticed it's down 270 basis points from the first quarter. And I'm just wondering what -- I understand legal may be part of that, but I'm wondering what else may be impacting it? Is it mix? Is it a particular business that had some unusual cost in there or could you just flesh that out a little bit?

Peter C. Halt

It's a combination for us in terms of the strain on margins. It's a combination absolutely of mix, and it's also a function of where we've been investing and bringing some additional resources then in the R&D area. Those are probably our 2 biggest drivers outside of what we've already talked about in terms of litigation.

James Medvedeff

Right. I meant above the expense lines. I mean just pure gross margin, just from cost of goods sold so...

Peter C. Halt

The cost of goods sold is a combination of mix to the extent that we get more revenue on the RES side. There's a fair amount of cost that go against the revenue in there, and then our litigation costs go through there, too.

James Medvedeff

So the combination of those 2 things accounts for the bulk of this drop?

Peter C. Halt

Those are the 2 largest drivers, yes.

James Medvedeff

So then, going forward, how should we think about that if RES is going to be growing as a part of the business or shrinking as part of the business?

Peter C. Halt

The Rovi Entertainment Store will be growing. And then it will be driven depending upon who our customer is at the Rovi Entertainment Store and depending upon the nature of the range that we have with them and whether they're recognized on a gross or net basis.

James Medvedeff

Okay. And then finally, on the $20 million cost-out plan, that's a run rate number by the end of next year. Is that correct?

Peter C. Halt

Correct, and that's on target.

James Medvedeff

And that's an absolute drop from this year's level or a drop against what growth might have been?

Peter C. Halt

That's a drop against what our run rate is.

James Medvedeff

Today?

Peter C. Halt

Correct.

Operator

Our next question comes from the line of Andy Hargreaves with Pacific Crest Securities.

Andy Hargreaves - Pacific Crest Securities, Inc., Research Division

Just wanted to see if you could give us any more detail on the Google announcement from this morning. Is that mentioned on the call specific to Kansas City? Is the deal itself specific to Google Fiber or does it cover everything they do? And then 2 follow-ups on that. Was it in the guidance? And I assume it was since you didn't change it. But would it cover the OEMs that you use Google TV?

Thomas Carson

This was a deal that was -- again, I've got to be careful a little bit about talking about the details of this thing. But generally, it was associated with that particular use case. And yes, it was in our guidance. But initially, keep in mind here that it follows kind of the traditional model that our normal service provider licensing business follows. So it's based on per-subscriber approach, so it's going to be dependent on how quickly they roll out.

Andy Hargreaves - Pacific Crest Securities, Inc., Research Division

Okay. And then, separately, on the service provider business, in general, and it being down quarter-over-quarter. Can you give us any more granularity there? Because obviously, the company has been talking about 20% and 30% price increases on renewals for quite a while now. Subscribers didn't decline. So how is it possible that the business actually declined?

Thomas Carson

So you have a couple of things that go through the service provider line in terms of the overall revenue. So it's a combination of our service provider licensing business. You also have service provider product that goes through there, and you also have advertising through there. When you look at our pure service provider product business, which is our guidance and those types of applications and metadata, basically, that business is still very solid. The number of subscribers continues to go up. We continue to renew them at rates kind of in excess of 20% or so in terms of the subscriber rate. So that business is still feeling very strong to us. I'd say it's more on the licensing side and also the advertising side in terms of any softness.

Andy Hargreaves - Pacific Crest Securities, Inc., Research Division

Okay. Was there actually customers that dropped out in Q2?

Thomas Carson

No, there wasn't a drop out of customers. But what we always had and we talked about in our prerelease announcement is there's always customers that we're adding. And when we add customers, there's an element of catch-up in the business. And that's been a recurring revenue stream from us, although it's nonrecurring with that individual customer. And we had kind of a drop in that contribution because we didn't onboard any new players.

Operator

Our next question comes from line of Ed Maguire with CLSA.

Edward Maguire - Credit Agricole Securities (USA) Inc., Research Division

I was wondering if you could comment a bit. Tom, you mentioned doing a strategic review and I was wondering to the extent that you need to make some reallocations of costs, what areas are you looking to kind of pull back investment? And are you also looking to accelerate investment in research and development in other areas? And I guess I'm just trying to get a sense of how your allocation of investment may shift over the next few months?

Thomas Carson

Yes, I think there's a couple of things. First, on the process itself, I think, was a pretty important one for Rovi in terms of taking a very hard look at each one of our businesses and look where we want to spend our time. And really, there's 2 kind of broad statements I'll make. I guess, first is that when you look at what came out of the processes, when you look at our 3 strategic pillars, there's certainly a lot of what I would say tactical types of things that we feel like we are going to do and need to do over the next 12 to 18 months, and that's going to consume a lot of time and attention on our part. Aside from that, I think there was some pretty interesting opportunities that came out of the process for us. When we look at it, things like the service provider space and what's happening with Internet protocol, seems like that could be an interesting opportunity and area for us to spend some more time looking at. One of the other area is some the technology that we've recently acquired relative to being able to have a multiscreen display experience. Utilizing tablet or cell phone in the big screen is also an interesting area for us to drive on. And then probably, the last one has to do with advertising and analytics. Most people don't realize that Rovi collects a lot of data on how people are actually using the guide experience, whether it's on a set-top box or whether it's outside of the set-top box and in connected TV. And we typically use that for our ad business, but we think there could be some longer term opportunities for us to monetize that as well. Again, I'd say, our near-term focus next 12 months, 18 months is going to be on trying to optimize the businesses we have because, frankly, we've acquired a lot of businesses and try to do some more diligence on those other strategic initiatives.

Edward Maguire - Credit Agricole Securities (USA) Inc., Research Division

Great. And just a follow-up. You had been -- you mentioned that you're not looking to do any major acquisitions. But what's your stance in terms of uses of cash to either shore up your patent portfolio or purchase additional patents?

Thomas Carson

I would say that, that's probably the same as it would be for any kind of an acquisition, I mean, with probably the important caveat that when we look at an acquisition, whether it's a company or whether it's additional patents, it has to fit within the strategic profile of what we're really trying to do. And again, I think that was one of the positive things coming out of the strategy review process. And the other thing is going to have to be an accretive component to it as well.

Operator

Our next question comes from the line of Jim Goss with Barrington research.

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

I was wondering if there are a number of patents you've either developed or have had that you have not really implemented yet that you think will be a part of the program over the next year or 2?

Thomas Carson

The way -- you have to look at the way we license is generally, we do not license on a patent-by-patent basis. Generally, we license the entire portfolio and that's basically the approach. Generally speaking, when we look at somebody that might be infringing our intellectual property, we'll take, pick a number, 6 to 10 patents that we believe in that particular use case maybe infringing. And that's what we talk to the potential licensee about. So we don't we really do a patent-and-by patent licensing type of approach. The only other thing I'd say is keep in mind that the portfolio continues to evolve while there are certainly some expirations that happen every year. We continue to have a significant number of invention disclosures and patent issues. So patent portfolio continues to grow and allows us to kind of have an approach where you can take a certain number out for the actual licensing discussion.

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

Just as a follow-up, do you find some time that the people you the approach are surprised that there is even a patent in certain of those applications, where they might have been working on something themselves? Or is that part of the review process they necessarily need to do with their legal team before they approach certain of the businesses?

Thomas Carson

I would say probably the reaction we get in what I would consider our standard core businesses of consumer electronics and service provider, there are really no surprises there. We're pretty well entrenched in that particular use case. I'd say you get a little bit more of that in some of the newer fields of use where people are looking at our portfolio and trying to understand the applicability. Ultimately, they get it but it usually takes a little bit more discussion.

Operator

Ladies and gentlemen, that's all the time we have for questions for today. I'd like to turn the conference back to management for any closing remarks at this time.

Thomas Carson

First, I'd like to thank everybody for being with us today. We're very appreciative of everybody's time, and we look forward to talking to everybody over the next couple of months. So thank you very much.

Operator

Thank you. Ladies and gentlemen, that does conclude the Rovi Corporation Second Quarter Earnings Conference Call. Thank you for your participation. You may now disconnect.

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