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ROVI CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[July 30, 2014]

ROVI CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) This quarterly report on Form 10-Q and other reports filed by the Company from time to time with the U.S. Securities and Exchange Commission (collectively, the "Filings") contain or may contain forward-looking statements and information that are based upon beliefs of, and information currently available to, the Company's management as well as estimates and assumptions made by Company's management. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. When used in the Filings, the words "anticipate," "believe," "estimate," "expect," "future," "intend," "plan," or the negative of these terms and similar expressions as they relate to the Company or the Company's management identify forward-looking statements. Such statements reflect the current view of the Company with respect to future events and are subject to risks, uncertainties, assumptions, and other factors. Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ significantly from those anticipated, believed, estimated, expected, intended, or planned. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance, or achievements. Except as required by applicable law, including the securities laws of the United States, the Company does not intend to update any of the forward-looking statements to conform these statements to actual results.



The following commentary should be read in conjunction with the financial statements and related notes contained in our Annual Report on Form 10-K for the year ended December 31, 2013 as filed with the Securities and Exchange Commission.

Overview We are focused on powering the discovery and personalization of digital entertainment. We provide a broad set of integrated solutions that are embedded in our customers' products and services, connecting consumers with entertainment. Content discovery solutions include interactive program guides ("IPGs"), search and recommendations, cloud data services and our extensive database of Metadata. We also offer advertising and analytics services. Our advertising services are primarily sold in guides we provide or where a service provider allows us to sell advertising. Our analytics services utilize our proprietary data and data we acquire to offer service providers and advertisers the opportunity to optimize their television advertising and promotional efforts. In addition to offering IPGs developed by us, our customers may also license our patents and deploy their own IPG or a third party IPG. We have patented many aspects of content discovery, DVR and VOD functionality, multi-screen functionality, as well as interactive applications and advertising.


We have historically licensed this portfolio for use with linear television broadcast. However, there is an emerging industry transition to Internet platform technologies which is enabling new video services for television in homes as well as on multiple screens such as tablets and smartphones. We believe this transition presents new opportunities to license our intellectual property portfolio for different use cases and to different customers, as well as to develop, market and sell products and services which enable such functionality. Building upon this, we are establishing broad industry relationships with the companies leading the next generation of digital entertainment. Our strategy includes developing products and services that complement our intellectual property and address the opportunity presented by this industry transformation. Our solutions are deployed globally in the cable, satellite, consumer electronics, entertainment, media and online distribution markets.

We group our revenue into the following categories - (i) service providers, (ii) consumer electronics ("CE"), and (iii) Other. We include in service provider revenues any IPG patent or product revenue related to an IPG deployed by a service provider in a subscriber household whether the ultimate payment for that IPG comes from the service provider or from a manufacturer of a set-top box.

Revenue related to an IPG deployed in a set-top box sold at retail is included in CE manufacturers. We also include in service provider revenues in-guide advertising revenue, analytics revenue and revenue from licensing our Metadata to service providers. CE includes license revenue received from consumer electronics companies for our IPG products, IPG patents, Metadata and advertising revenue from our CE IPGs or the Rovi Ad Service. Other revenue consists primarily of revenue generated from our legacy ACP, VCR Plus+, connected platform and media recognition products.

Costs and Expenses Cost of revenues consists primarily of employee compensation and benefits, patent prosecution, patent maintenance and patent litigation costs and an allocation of overhead and facilities. Research and development expenses are comprised primarily of employee compensation and benefits, consulting costs and an allocation of overhead and facilities costs. Selling and marketing expenses are comprised primarily of employee compensation and benefits, travel, advertising and an allocation of overhead and facilities costs. General and administrative expenses are comprised primarily of employee compensation and benefits, travel, accounting, tax and corporate legal fees and an allocation of overhead and facilities costs.

19 -------------------------------------------------------------------------------- Table of Contents Results of Operations The following tables present our condensed consolidated statements of operations compared to the prior year (in thousands).

Three Months Ended June 30, 2014 2013 Change $ Change % Revenues: Service provider $ 102,695 $ 92,845 9,850 11 % CE 29,839 26,058 3,781 15 % Other 4,528 10,248 (5,720 ) (56 )% Total revenues 137,062 129,151 7,911 6 % Costs and expenses: Cost of revenues 24,769 19,754 5,015 25 % Research and development 28,933 29,555 (622 ) (2 )% Selling, general and administrative 38,765 38,175 590 2 % Depreciation 4,550 4,045 505 12 % Amortization of intangible assets 19,330 18,781 549 3 % Restructuring and asset impairment charges 3,505 1,319 2,186 166 % Total operating expenses 119,852 111,629 8,223 7 % Operating income from continuing operations 17,210 17,522 (312 ) (2 )% Interest expense (13,196 ) (15,023 ) 1,827 (12 )% Interest income and other, net 1,597 1,059 538 51 % Debt modification expense - (1,047 ) 1,047 (100 )% (Loss) income on interest rate swaps and caps, net (4,701 ) 7,489 (12,190 ) (163 )% Loss on debt redemption - (2,761 ) 2,761 (100 )% Income from continuing operations before taxes 910 7,239 (6,329 ) (87 )% Income tax expense 3,624 1,553 2,071 133 % (Loss) income from continuing operations, net of tax (2,714 ) 5,686 (8,400 ) (148 )% Income (loss) from discontinued operations, net of tax 74 (79,760 ) 79,834 (100 )% Net loss $ (2,640 ) $ (74,074 ) 71,434 (96 )% 20-------------------------------------------------------------------------------- Table of Contents Six Months Ended June 30, 2014 2013 Change $ Change % Revenues: Service provider $ 200,730 $ 180,443 20,287 11 % CE 59,379 64,524 (5,145 ) (8 )% Other 19,403 16,953 2,450 14 % Total revenues 279,512 261,920 17,592 7 % Costs and expenses: Cost of revenues 55,955 48,325 7,630 16 % Research and development 54,490 57,199 (2,709 ) (5 )%Selling, general and administrative 74,985 75,842 (857 ) (1 )% Depreciation 8,951 8,276 675 8 % Amortization of intangible assets 38,020 37,436 584 2 % Restructuring and asset impairment charges 5,682 1,933 3,749 194 % Total operating expenses 238,083 229,011 9,072 4 % Operating income from continuing operations 41,429 32,909 8,520 26 % Interest expense (26,759 ) (31,184 ) 4,425 (14 )% Interest income and other, net 1,835 1,688 147 9 % Debt modification expense - (1,351 ) 1,351 (100 )% (Loss) income on interest rate swaps and caps, net (7,336 ) 6,445 (13,781 ) (214 )% Loss on debt redemption - (2,761 ) 2,761 (100 )% Income from continuing operations before taxes 9,169 5,746 3,423 60 % Income tax expense 10,200 992 9,208 928 % Income from continuing operations, net of tax (1,031 ) 4,754 (5,785 ) (122 )% Loss from discontinued operations, net of tax (55,874 ) (104,561 ) 48,687 (47 )% Net loss $ (56,905 ) $ (99,807 ) 42,902 (43 )% Service Providers Revenue For the three and six months ended June 30, 2014, revenue from service providers increased by 11% compared to the same periods in the prior year. These increases were primarily due to an increase in IPG patent license revenue due to continued growth in the number of subscribers for which we receive a patent license fee, as well as an increase in IPG product and advertising revenue. Acceptance of our Passport guide product for deployment in multiple countries with a major Latin American service provider contributed to the IPG product revenue growth. We expect our service provider revenue to continue to grow in the future due to growth in product revenues driven by recent product deals and growth in revenue from products such as DTA guides, xD, in-guide advertising and analytics. We expect this increase to be partially offset by a decline in revenue from patent license agreements that included catch-up payments to make us whole for the pre-license period of use.

CE Revenue For the three months ended June 30, 2014, revenue from CE manufacturers increased by 15% compared to the same period in the prior year. This increase was primarily due to new agreements that included catch-up payments to make us whole for the pre-license period of use and an increase in data revenue. For the six months ended June 30, 2014, revenue decreased by 8% compared to the same period in the prior year. This decrease was primarily due to a decline in revenue from license agreements that included catch-up payments to make us whole for the pre-license period of use as compared to the same period in the prior year. We expect our CE revenue to be down to flat in 2014 as increases in CE data revenue are offset by a decline in revenue from patent license agreements that included catch-up payments to make us whole for the pre-license period of use.

Other Revenue For the three months ended June 30, 2014, Other revenue decreased compared to the same period in the prior year primarily due to the anticipated decrease in ACP product revenue. For the six months ended June 30, 2014, Other revenue increased as compared to the same period in the prior year primarily due to a new license agreement which allows one of our 21 -------------------------------------------------------------------------------- Table of Contents licensees to incorporate our ACP technology in specified device types in perpetuity. We expect other revenue to decline in the future as our customers continue to decrease their use of analog copy protection.

Cost of Revenues For the three and six months ended June 30, 2014, cost of revenues increased compared to the same periods in the prior year primarily due to an increase in employee and consulting costs, which has been driven primarily by the international expansion of our Metadata offering as well as the timing of patent litigation costs. We expect patent litigation costs to decrease in the second half of 2014 as compared to the first half of 2014.

Research and Development For the three and six months ended June 30, 2014, research and development expenses decreased compared to the same periods in the prior year. This decrease was primarily due to a decrease in stock compensation expense, partially offset by an increase in spending on our cloud-based platform and the acquisition of Veveo in the first quarter of 2014.

Selling, General and Administrative For the three months ended June 30, 2014, selling, general and administrative expenses increased compared to the same period in the prior year. This increase was primarily due to an increase in consulting expense related to planning for the upcoming major service provider renewals, partially offset by a decrease in stock compensation expense. For the six months ended June 30, 2014, selling, general and administrative expense decreased compared to the same period in the prior year. This decrease was primarily due to a decrease in stock compensation expense partially offset by an increase in consulting expenses.

Restructuring and Asset Impairment Charges In conjunction with the disposition of the Rovi Entertainment Store and DivX business and our narrowed business focus on discovery, we are conducting a complete review of our product development, sales, data operations and general and administrative functions to create cost efficiencies for the Company. As a result of this analysis, we took cost reduction actions that resulted in a restructuring and asset impairment charge of $3.5 million being recorded to the Company's continuing operations during the three months ended June 30, 2014 and $5.4 million during the six months ended June 30, 2014. Included in the restructuring charge for the three months ended June 30, 2014, is $1.5 million of severance charges, $1.2 million to accrue for the present value of lease payments for abandoned office space and $0.8 million of asset impairment charges. Included in the restructuring charge for the six months ended June 30, 2014, is $2.9 million of severance charges, $1.2 million to accrue for the present value of lease payments for abandoned office space, $1.1 million in asset impairment charges and $0.2 million in contract termination costs. This review is ongoing and we anticipate recording additional charges in the second half of 2014. In addition, during the three months ended March 31, 2014, we also recorded $0.3 million in expense related to the present value of lease payments for abandoned office space related to the restructuring action described below.

During the first half of 2013, we completed the review of our operations that began in the third quarter of 2012 (see Note 11 to the Condensed Consolidated Financial Statements). As a result of this analysis, we took additional cost reduction actions, which resulted in a restructuring charge of $1.3 million during the three months ended June 30, 2013 and $1.9 million during the six months ended June 30, 2013.

Interest Expense For the three and six months ended June 30, 2014, interest expense decreased compared to the same periods in the prior year primarily due to a decrease in average debt outstanding.

Interest Income and Other, Net For the three and six months ended June 30, 2014, interest income and other, net increased compared to the same periods in the prior year primarily due to the release of a $1.2 million contingent liability which was acquired in a prior acquisition. This benefit was partially offset by a decrease in investment income due to a decrease in our average investment balances.

Loss on Debt Redemption and Debt Modification Expense On April 9, 2013, we entered into a Refinancing Amendment and Joinder Agreement (the "Refinancing Amendment") to the Amended and Restated Credit Agreement. The Refinancing Amendment provided for a new tranche of term loans ("Term Loan B-3") in the aggregate principal amount of $540.0 million. We used the proceeds from Term Loan B-3 to 22 -------------------------------------------------------------------------------- Table of Contents refinance in full all outstanding Term Loan B-2 amounts (as defined below). We accounted for the issuance of Term Loan B-3 and subsequent repayment of Term Loan B-2 as a partial debt modification, as a significant number of Term Loan B-2 investors reinvested in Term Loan B-3, and the change in the present value of future cash flows between Term Loan B-2 and Term Loan B-3 was less than 10%.

Under debt modification accounting, $3.6 million in unamortized debt issuance costs related to Term Loan B-2 investors who reinvested in Term Loan B-3, are being amortized to Term Loan B-3 interest expense using the effective interest method. In addition, $0.1 million in Term Loan B-3 debt issuance costs, related to new investors in Term Loan B-3, are being amortized to Term Loan B-3 interest expense using the effective interest method. Debt issuance costs of $1.0 million relating to the issuance of Term Loan B-3 to Term Loan B-2 investors, have been recorded as debt modification expenses for the three months ended June 30, 2013.

In addition, during the three months ended June 30, 2013, we realized a loss on debt redemption of $2.8 million related to writing off the unamortized Term Loan B-2 debt issuance costs related to investors who did not reinvest in Term Loan B-3 and the unamortized debt discount on Term Loan B-2.

Loss on Interest Rate Swaps and Caps, Net We have not designated any of our interest rate swaps or caps as hedges and therefore record the changes in fair value of these instruments in our Consolidated Statements of Operations (see Note 7 to the Condensed Consolidated Financial Statements). We generally utilize interest rate swaps to convert the interest rate on a portion of our floating rate term loans to a fixed rate. As under the terms of these interest rate swaps we receive a floating rate and pay a fixed rate, when there is an increase in expected future LIBOR rates we will have a gain when marking our interest rate swaps to market. When there is a decrease in expected future LIBOR rates we will have a loss when marking our interest rate swaps to market.

Income Taxes We recorded income tax expense from continuing operations for the three and six months ended June 30, 2014, of $3.6 million and $10.2 million, respectively, which primarily consists of foreign withholding taxes, foreign income taxes, state income taxes, and the net change in our deferred tax asset valuation allowance. Due to the fact that we have a significant net operating loss carryforward and we have recorded a valuation allowance against our deferred tax assets, foreign withholding taxes are the primary driver of our income tax expense.

We recorded an income tax expense from continuing operations for the three and six months ended June 30, 2013, of $1.6 million and $1.0 million, respectively, which primarily consists of foreign withholding taxes, foreign income taxes and state income taxes. The six months ended June 30, 2013, also benefited from a reduction in the Company's deferred tax asset valuation allowance resulting from the Company's acquisition of IntegralReach.

Discontinued Operations Discontinued operations for the three months ended March 31, 2014, includes the DivX and MainConcept business and the Nowtilus business. Loss on discontinued operations for the three and six months ended June 30, 2014, is primarily due to the loss on the sale of the DivX, MainConcept and Nowtilus businesses.

Discontinued operations for the three and six months ended June 30, 2013, includes the DivX and MainConcept business, the Rovi Entertainment Store business, the Consumer Web business and expenses we recorded for indemnification claims related to another former Software business which was disposed of in 2008 (see Note 4 to Condensed Consolidated Financial Statements). The loss in discontinued operations for the three months ended June 30, 2013, is primarily due to recording a $57.1 million impairment charge to the assets of the Rovi Entertainment Store business and recording a $6.8 million impairment charge to the goodwill and intangible assets of the Consumer Web business. The loss from discontinued operations for the six months ended June 30, 2013, is primarily due to recording a $73.1 million impairment charge to the assets of the Rovi Entertainment Store business and recording a $6.8 million impairment charge to the goodwill and intangible assets of the Consumer Web business. (see Note 4 to the Condensed Consolidated Financial Statements).

Critical Accounting Policies and Use of Estimates The discussion and analysis of our financial condition and results of operations are based upon our Condensed Consolidated Financial Statements. These Condensed Consolidated Financial Statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, equity-based compensation, goodwill and intangible assets, impairment of long lived assets and income taxes. Our estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.

23 -------------------------------------------------------------------------------- Table of Contents There have been no significant changes in our critical accounting policies during the three months ended June 30, 2014, as compared to those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013.

Liquidity and Capital Resources We finance our operations primarily from cash generated by operations. Net cash provided by our continuing operating activities increased to $122.1 million for the six months ended June 30, 2014, from $101.7 million in the prior year. This increase was primarily due to the Company receiving a significant upfront payment in the first quarter of 2014 related to a multi-year licensing deal signed in the fourth quarter of 2013. The availability of cash generated by our operations in the future could be affected by other business risks including, but not limited to, those factors referenced under the caption "Risk Factors" contained in our 2013 Annual Report on Form 10-K.

Net cash provided by investing activities from continuing operations increased to $150.7 million for the six months ended June 30, 2014, from $39.9 million in the prior year. The six months ended June 30, 2014, included $172.1 million in net marketable securities sales or maturities and the receipt of $50.3 million from the sale of the DivX and MainConcept business, partially offset by $10.2 million in capital expenditures and the $60.7 million payment for the Veveo acquisition. Included in 2013 investing activities was $57.0 million in net marketable securities sales or maturities partially offset by $7.1 million in capital expenditures and $10.0 million used for the acquisition of IntegralReach. We anticipate that capital expenditures to support the growth of our business and strengthen our operations infrastructure will be between $19.0 million and $24.0 million for the full year 2014.

Net cash used in financing activities of continuing operations decreased to $161.5 million for the six months ended June 30, 2014, from $207.1 million in the prior year. During the six months ended June 30, 2014, we made $50.0 million in debt principal payments and repurchased $123.1 million of our common stock.

These uses of cash were partially offset by us receiving $11.6 million from the exercise of employee stock options and sales of stock through our employee stock purchase plan. During the six months ended June 30, 2013, we made $110.3 million in net debt payments and repurchased $107.1 million of our common stock. These uses of cash were partially offset by us receiving $10.3 million from the exercise of employee stock options and sales of stock through our employee stock purchase plan.

As of June 30, 2014, we owed $864.0 million under the Predecessor Credit Agreement (See Note 5 to the Condensed Consolidated Financial Statements). On July 2, 2014, the Company, as parent guarantor, and two of our wholly-owned subsidiaries, Rovi Solutions Corporation and Rovi Guides, Inc., as borrowers, and certain of our other subsidiaries, as subsidiary guarantors, entered into a new Credit Agreement (the "Credit Agreement"). The Credit Agreement provides for (i) a five-year $125 million term loan A facility (the "Term Loan A Facility"), (ii) a seven-year $700 million term loan B facility (the "Term Loan B Facility" and together with the Term Loan A Facility, the "Term Loan Facility") and (iii) a five-year $175 million revolving credit facility (including a letter of credit sub-facility) ("the Revolving Facility" and together with the Term Loan Facility, the "Senior Secured Credit Facility"). We used the proceeds of the Term Loan Facility, together with cash on hand, to repay existing loans under the Predecessor Credit Agreement and to pay expenses related thereto. The term loans under the Term Loan A Facility will amortize in annual installments in an aggregate annual amount equal to 5% of the original principal amount thereof, with any remaining balance payable on the final maturity date of the Term Loan A Facility. The term loans under the Term Loan B Facility will amortize in equal quarterly installments in an aggregate annual amount equal to 1% of the original principal amount thereof, with any remaining balance payable on the final maturity date of the Term Loan B Facility. Loans under the Term Loan A Facility bear interest, at our option, at a rate equal to either the LIBOR rate, plus an applicable margin equal to 2.25% per annum, or the prime lending rate, plus an applicable margin equal to 1.25% per annum. Loans under the Term Loan B Facility bear interest, at our option, at a rate equal to either the LIBOR rate, plus an applicable margin equal to 3% per annum (subject to a 0.75% LIBOR floor) or the prime lending rate, plus an applicable margin equal to 2% per annum. Loans under the Revolving Facility will bear interest, at our option, at a rate equal to either the LIBOR rate, plus an applicable margin equal to 2.25% per annum, or the prime lending rate, plus an applicable margin equal to 1.25% per annum, subject to reduction by 0.25% or 0.50% based upon the Company's total secured leverage ratio (as defined in the Credit Agreement).

The Credit Agreement contains customary representations and warranties and customary affirmative and negative covenants applicable to the Company and its subsidiaries, including, among other things, restrictions on indebtedness, liens, investments, mergers, dispositions, prepayment of other indebtedness, and dividends and other distributions. The Term Loan A Facility and Revolving Facility contain financial covenants that require that we maintain a minimum consolidated interest coverage ratio and a maximum total leverage ratio. The Term Loan B Facility does not contain a minimum consolidated interest coverage ratio or a maximum total leverage ratio covenant. Beginning with our fiscal year ending December 31, 2015, we may be required to make an additional payment on the Term Loan Facility each February. This payment is a percentage of the prior year's Excess Cash Flow as defined in the Credit Agreement.

24 -------------------------------------------------------------------------------- Table of Contents As discussed in Note 5 of the Condensed Consolidated Financial Statements, in March 2010, we issued $460.0 million in 2.625% convertible senior notes due in 2040 at par. The 2040 Convertible Notes may be converted, under certain circumstances, based on an initial conversion rate of 21.1149 shares of common stock per $1,000 principal amount of notes (which represents an initial conversion price of approximately $47.36 per share). As of June 30, 2014, $291.0 million par value of the 2040 Convertible Notes remains outstanding. Holders have the right to require us to repurchase the 2040 Convertible Notes on February 20, 2015, 2020, 2025, 2030 and 2035 for cash equal to 100% of the principal amount of the notes to be repurchased, plus accrued interest to, but excluding, the repurchase date (See Note 5 to the Condensed Consolidated Financial Statements for additional details). Given the conversion price, we anticipate that holders will require us to repurchase the 2040 Convertible Notes in February 2015. We anticipate funding this repurchase with cash from our balance sheet and by drawing on our Revolving Facility.

In October 2013 our Board of Directors authorized the repayment of up to $250.0 million of our debt outstanding. This repayment authorization includes any amounts which were outstanding under previously authorized debt repurchase programs. During the six months ended June 30, 2014, we made a voluntary debt prepayment of $50.0 million to reduce loans outstanding under the Amended and Restated Credit Agreement under the October 2013 authorization which, as of June 30, 2014, has been fully utilized.

In April 2014, our Board of Directors authorized the repurchase of up to $200.0 million of our common stock. This authorization included amounts outstanding under the previously authorized stock repurchase program. During the quarter ended March 31, 2014, we repurchased 5.0 million shares of our common stock for $123.1 million. As of June 30, 2014, we had $200.0 million remaining under our existing stock repurchase program.

As of June 30, 2014, we had $266.1 million in cash and cash equivalents, $175.8 million in short-term investments and $137.6 million in long-term marketable securities. Of these amounts, $224.0 million is held by our foreign subsidiaries. Due to our net operating loss carryforwards, we could repatriate the cash and investments held by our foreign subsidiaries back to the United States with a minimal tax impact.

We believe that our current cash, cash equivalents and marketable securities and our annual cash flow from operations will be sufficient to meet our working capital, capital expenditure, debt and operating requirements for at least the next twelve months.

Impact of Recently Issued Accounting Standards See Note 2 to the Condensed Consolidated Financial Statements.

Off Balance Sheet Arrangements None.

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