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TIVO INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion and analysis in conjunction with the condensed consolidated financial statements and the accompanying notes included in this report and our most recent annual report on Form 10-K filed on March 14, 2014, the sections entitled "Risk Factors" in Item 1A of our most recent annual report on Form 10-K and Part II, Item 1A of this quarterly report, as well as other cautionary statements and risks described elsewhere in this report and our most recent annual report on Form 10-K filed on March 14, 2014 before deciding to purchase, sell or hold our common stock. Company Overview We are a global leader in next-generation television software services and innovative cloud-based Software-as-a-Service solutions that enable viewers to consume content across all screens in-home and outside-of-the home. The TiVo experience provides an all-in-one approach for navigating the 'content chaos' by seamlessly combining live, recorded, on-demand, and over-the-top (e.g. NetFlix, Hulu, YouTube) television into one intuitive user interface with simple universal search, discovery, viewing and recording from any device, creating the ultimate viewing experience. We distribute our software, technology, and services through an increasing variety of consumer electronic applications and devices, such as television set-top boxes with and without DVR functionality, smartphones, and tablets. We offer a full whole-home solution that includes 4-Tuner and 6-Tuner DVRs/gateways, non-DVR IP set-top boxes (STBs), and software to enable streaming to mobile and tablet iOS devices (with Android devices coming in the future) through features such as What to Watch Now, Season Pass® recordings, integrated search (including content from both traditional linear television, cable VOD, and broadband sources in one user interface), access to broadband video content, TiVo Online/Mobile Scheduling and applications on third-party devices such as tablet computers and smartphones. As of July 31, 2014, there were approximately 4.8 18-------------------------------------------------------------------------------- Table of Contents million subscriptions to the TiVo service through our TiVo-Owned and MSO businesses. In our TiVo-Owned business, we distribute the TiVo DVR through consumer electronics retailers and through our on-line store at TiVo.com. Additionally, in our MSO business, we generate service, and, in some cases hardware revenues by providing the TiVo service through agreements with leading satellite and cable television service providers and broadcasters on MSO provisioned STBs (both through TiVo supplied and third-party supplied STBs) and other devices. We also generate technology revenues through engineering professional services in connection with the development and deployment of the TiVo service to our MSO customers. On February 14, 2014, we acquired Digitalsmiths Corporation, one of the Pay TV industry's most broadly adopted cloud-based search and recommendation services. We believe this acquisition will broaden our product and service portfolio and increase our opportunities among Pay TV operators, consumer electronics manufacturers, and content providers. Additionally, we generate advertising and audience research and measurement revenues by providing innovative advertising and audience measurement solutions for the television industry. We are focused on enhancing long-term shareholder value, and will continue to evaluate opportunities to grow our business organically and/or through acquisitions. On August 26, 2014, we announced that our board of directors had authorized a new $350 million share repurchase program to replace the prior authorization that had $85.8 million remaining. This new $350 million share repurchase program expires on January 31, 2017, with $100 million in initial share repurchases under this new program intended to be completed in the fiscal year ending January, 31, 2015. As of July 31, 2014 we had purchased a total of 17,939,094 shares of common stock under the prior program at a weighted average price of $11.94 per share for an aggregate purchase price of $214.2 million. We have engaged in significant intellectual property litigation with certain television service and technology providers in the United States to protect our technology from infringement. To date, we have received cash and future technology revenue payment commitments totaling over $1.6 billion from intellectual property litigation. Executive Overview Fiscal year 2015 In the fiscal year ending January 31, 2015, we plan to continue to be focused on our efforts to build leading advanced television products, enter into new distribution agreements, engage in development work for existing distribution customers, and continue deployment activities for our existing distribution customers. Additionally, we have been and plan to continue to actively protect our intellectual property. We will continue to focus on the following priorities: •We expect to continue our efforts to increase our subscription base by adding new subscriptions through our mass distribution relationships both in the U.S. and internationally as well as our TiVo-Owned direct and retail sales with the roll out of new products, such as our TiVo Roamio product line (an all-in-one approach to live, recorded, on demand, and over-the-top television). We expect to further grow our MSO subscription base during the fiscal year ending January 31, 2015. However, we expect that net subscription growth in our installed base of MSO subscriptions will likely be slightly offset by further declines in our net TiVo-Owned subscriptions. •We believe giving operators a choice of hardware platforms is critical to attracting new MSO customers, and driving increased penetration in current MSO customers to increase our MSO service revenues in the long term. As a result, we expect MSO hardware revenues and margins to likely decline in future quarters as U.S. MSO customers transition to third-party hardware such as Pace and other products which can support our TiVo service. Although we lose hardware margin in the short term from decreased hardware sales, we believe we gain additional subscribers through MSOs that would not otherwise be willing to sell the TiVo service. •We expect to see revenue growth from our acquisition of Digitalsmiths. Digitalsmiths currently has business relationships with seven of the top ten U.S. Pay TV operators as well as various consumer electronics manufacturers and content providers. Most of these relationships are at the early stages of deployment and we expect increased penetration will drive further growth. Additionally, we are focused on signing additional distribution customers for Digitalsmiths both in the U.S. and internationally as well as launching new Digitalsmiths' products and services in the future. •We believe that our investment in research and development is critical to remaining competitive and being a leader in advanced television solutions. Therefore, we expect our annual research and development spending in fiscal year 2015 to continue to be significant but to be at lower levels than the fiscal year ended January 31, 2014 as we continue to launch and pursue new product developments 19-------------------------------------------------------------------------------- Table of Contents including enhanced cloud-based services such as network DVR, a more personalized user experience, expanded mobile applications, out-of-home and expanded multi-room streaming capabilities, data analytics, and a variety of back-office enhancements which increase our operational capacity to handle more operator deployments. •We will continue our efforts to protect our technological innovations and intellectual property. However, we expect our litigation expenses to be significantly lower during the fiscal year ending January 31, 2015 as we have no material ongoing patent enforcement actions. •We expect to continue our development efforts under our existing MSO deployment arrangements. As part of these arrangements, we typically receive some payments upfront and a portion over time that is a recoupment of costs to develop. As such, to the extent that our development costs exceed upfront development fees from such arrangements, but the recovery of such development costs through future service fees from these MSOs is reasonably assured, we will defer such development costs and start expensing them in our Statement of Operations later upon deployment with the MSO. As of July 31, 2014 we had deferred costs of approximately $22.6 million related to development work, largely related to Com Hem, ONO, and Charter Communications Operating, LLC (Charter). However, despite the deferral of these development costs, we do incur cash outflows associated with these development efforts resulting in potentially higher cash usage in the near term. Also for international MSOs, when related revenues from service fees are received, they are first recognized as technology revenues until the previously deferred costs of development of such arrangements are expensed. Based on the contractual commitments or recent MSO activities, full recovery of the deferred costs must be reasonably assured. However, we face the risk of unexpected losses if we are forced to recognize these deferred costs early if we don't successfully complete the developments and deployments with the MSO partners or these partners default on future guaranteed service fees or are otherwise able to terminate their contracts with us. Key Business Metrics Management periodically reviews certain key business metrics in order to evaluate our operations, allocate resources, and drive financial performance in our business. Management monitors these metrics together and not individually as it does not make business decisions based upon any single metric. Subscriptions and Households. Management reviews these metrics, and believes they may be useful to investors, in order to evaluate our relative position in the marketplace and to forecast future potential service revenues. Below is a table that details the change in our subscription base during the last eight quarters. The TiVo-Owned Subscription lines refer to subscriptions sold directly or indirectly by TiVo to consumers who have TiVo-enabled devices (such as a DVR or TiVo Mini) and for which TiVo incurs acquisition costs. The MSO Subscription lines refer to subscriptions sold to consumers by MSOs such as Com Hem, ONO, RCN, Suddenlink, Virgin, among others, and for which TiVo expects to incur little or no acquisition costs. Additionally, we provide a breakdown of the average subscriptions for the quarter, the total MSO households and the MSO average households for the quarter, the number of fully amortized active lifetime subscriptions, and percent of TiVo-Owned 20-------------------------------------------------------------------------------- Table of Contents Subscriptions for which consumers pay recurring fees as opposed to a one-time prepaid product lifetime fee. Three Months Ended (Subscriptions and Jul 31, Apr 30, Jan 31, Oct 31, Jul 31, Apr 30, Jan 31, Oct 31, Households in thousands) 2014 2014 2014 2013 2013 2013 2013 2012 TiVo-Owned Gross Additions: 27 32 49 33 20 24 35 30 Net Additions/(Losses): TiVo-Owned (20 ) (9 ) 6 (21 ) (26 ) (22 ) (13 ) (15 ) MSOs 283 341 313 295 238 277 222 240 Total Net Additions/(Losses) 263 332 319 274 212 255 209 225 Cumulative Subscriptions: TiVo-Owned 937 957 966 960 981 1,007 1,029 1,042 MSOs 3,867 3,584 3,243 2,930 2,635 2,397 2,120 1,898 Total Cumulative Subscriptions 4,804 4,541 4,209 3,890 3,616 3,404 3,149 2,940 Average Subscriptions: TiVo-Owned Average Subscriptions 946 961 962 974 994 1,018 1,035 1,050 MSO Average Subscriptions 3,727 3,420 3,072 2,775 2,514 2,261 2,011 1,771 Total Average Subscriptions: 4,673 4,381 4,034 3,749 3,508 3,279 3,046 2,821 Total MSO Households 3,391 3,172 2,912 2,664 2,410 2,222 1,980 1,782 MSO Average Households 3,283 3,036 2,785 2,535 2,318 2,104 1,884 1,668 TiVo-Owned Fully Amortized Active Lifetime Subscriptions 159 161 171 169 176 181 194 208 % of TiVo-Owned Cumulative Subscriptions paying recurring fees 49 % 50 % 50 % 51 % 52 % 52 % 53 % 54 % We define a "subscription" as a contract referencing a TiVo-enabled device such as a DVR or TiVo Mini for which (i) a consumer has committed to pay for the TiVo service and (ii) service is not canceled. Each TiVo-Owned Subscription represents a single TiVo-enabled device (as defined above) and therefore one or more TiVo-Owned Subscriptions may be present in a single household. MSO Subscriptions are a count of the number of devices that connect to the TiVo service and one or more devices may be present in a single household. Subscriptions do not include soft-clients (i.e. iPad application or web portal) or digital tuning adapter users. We count product lifetime subscriptions in our subscription base until both of the following conditions are met: (i) the period we use to recognize product lifetime subscription revenues ends; and (ii) the related TiVo-enabled device has not made contact to the TiVo service within the prior six month period. Product lifetime subscriptions past this period which have not called into the TiVo service for six months are not counted in this total. We define a "household" as one or more devices associated with the same contract or customer number. We currently do not report TiVo-Owned households as we currently receive incremental revenue for each new TiVo-Owned Subscription in the TiVo-Owned business whereas, in some cases, our MSO customers pay us on a per household basis. We calculate average subscriptions for the period by adding the average subscriptions for each month and dividing by the number of months in the period. We calculate the average subscriptions for each month by adding the beginning and ending subscriptions for the month and dividing by two. We calculate Average MSO Households for the period by adding the average households for each month and dividing by the number of months in the period. We calculate the average households for each month by adding the beginning and ending households for the month and dividing by two. We are not aware of any uniform standards for defining subscriptions or households and caution that our presentation may not be consistent with that of other companies. Additionally, the fees that our MSOs pay us are typically based upon a specific contractual definition of a subscriber, subscription, household or a TiVo-enabled device which may not be consistent with how we define a subscription or household for our reporting purposes nor be representative of how such fees are calculated and paid to us by our MSOs. Our MSOs Subscription and MSO Household data is dependent in part on reporting from our third-party MSO partners. TiVo-Owned Subscriptions declined by 20,000 subscriptions during the three months ended July 31, 2014, as compared to a decrease of 26,000 in the same prior year period. The improvement in net TiVo-Owned Subscription losses of 6,000 subscriptions was largely related to increased gross subscription additions. The TiVo-Owned installed subscription base decreased to 937,000 subscriptions as of July 31, 2014 as compared to 981,000 as of July 31, 2013. We believe the year over year decrease in total TiVo-Owned Subscriptions was largely due to continued pressure on subscription gross additions resulting from increased competition from DVRs 21-------------------------------------------------------------------------------- Table of Contents distributed by cable and satellite companies as we continued to have fewer TiVo-Owned Subscription gross additions than TiVo-Owned Subscription cancellations. Our MSO installed subscription base increased by 283,000 subscriptions during the three months ended July 31, 2014, to approximately 3.9 million subscriptions as of July 31, 2014. The increase in cumulative MSO Subscriptions of 1.2 million subscriptions as of July 31, 2013 is due to subscription growth from a variety of partners including Com Hem, ONO, RCN, Suddenlink, Virgin, and others. This subscription growth is largely related to international MSO subscriptions though domestic MSO subscription growth has increased as a contributer. We expect continued growth in our MSO installed subscription base through continued growth from existing distribition and as additional MSO distribution deals launch. TiVo-Owned Churn Rate per Month. Management reviews this metric, and believes it may be useful to investors, in order to evaluate our ability to retain existing TiVo-Owned Subscriptions (including both monthly and product lifetime subscriptions) by providing services that are competitive in the market. Management believes factors such as service enhancements, service commitments, higher customer satisfaction, and improved customer support may improve this metric. Conversely, management believes factors such as increased competition, lack of competitive service features such as high definition television recording capabilities in our older model DVRs or access to certain digital television channels or MSO Video On Demand services, as well as increased price sensitivity, CableCARDTM installation issues, and CableCARDTM technology limitations, may cause our TiVo-Owned Churn Rate per month to increase. We define the TiVo-Owned Churn Rate per month as the total TiVo-Owned Subscription cancellations in the period divided by the Average TiVo-Owned subscriptions for the period (including both monthly and product lifetime subscriptions), which then is divided by the number of months in the period. We calculate Average TiVo-Owned subscriptions for the period by adding the average TiVo-Owned Subscriptions for each month and dividing by the number of months in the period. We calculate the average TiVo-Owned Subscriptions for each month by adding the beginning and ending subscriptions for the month and dividing by two. We are not aware of any uniform standards for calculating churn and caution that our presentation may not be consistent with that of other companies. The following table presents our TiVo-Owned Churn Rate per month information: Three Months Ended (Subscriptions in Jul 31, Apr 30, Jan 31, Oct 31, Jul 31, Apr 30, Jan 31, Oct 31, thousands) 2014 2014 2014 2013 2013 2013 2013 2012 Average TiVo-Owned subscriptions 946 961 962 974 994 1,018 1,035 1,050 TiVo-Owned subscription cancellations (47 ) (41 ) (43 ) (54 ) (46 ) (46 ) (48 ) (45 ) TiVo-Owned Churn Rate per month (1.6 )% (1.4 )% (1.5 )% (1.8 )% (1.5 )% (1.5 )% (1.5 )% (1.4 )% TiVo-Owned Churn Rate per month was 1.6% and 1.5% for the quarters ended July 31, 2014 and 2013, respectively. The increase in our Churn Rate per month is a result of slightly higher number of subscription cancellations combined with a lower average TiVo-Owned subscription base, as compared to the same prior year period. Included in our TiVo-Owned Churn Rate per month are those product lifetime subscriptions that have both reached the end of the revenue recognition period and whose DVRs have not contacted the TiVo service within the prior six months. Conversely, we do not count as churn product lifetime subscriptions that have not reached the end of the revenue recognition period, regardless of whether such subscriptions continue to contact the TiVo service. Subscription Acquisition Cost or SAC. Management reviews this metric, and believes it may be useful to investors, in order to evaluate trends in the efficiency of our marketing programs and subscription acquisition strategies. We define SAC as our total TiVo-Owned acquisition costs for a given period divided by TiVo-Owned subscription gross additions for the same period. We define total acquisition costs as sales and marketing, subscription acquisition costs less net TiVo-Owned related hardware revenues (defined as TiVo-Owned related gross hardware revenues less rebates, revenue share and market development funds paid to retailers) plus TiVo-Owned related cost of hardware revenues. The sales and marketing, subscription acquisition costs line item includes advertising expenses and promotion-related expenses directly related to subscription acquisition activities, but does not include expenses related to advertising sales. We do not include third-parties' subscription gross additions, such as MSOs' gross additions with TiVo subscriptions, in our calculation of SAC because we typically incur limited or no acquisition costs for these new subscriptions, and so we also do not include MSOs' sales and marketing, subscription acquisition costs, hardware revenues, or cost of hardware revenues in our 22-------------------------------------------------------------------------------- Table of Contents calculation of TiVo-Owned SAC. We are not aware of any uniform standards for calculating total acquisition costs or SAC and caution that our presentation may not be consistent with that of other companies. Three Months Ended Jul 31, Apr 30, Jan 31, Oct 31, Jul 31, Apr 30, Jan 31, Oct 31, 2014 2014 2014 2013 2013 2013 2013 2012 (In thousands, except SAC) Subscription Acquisition Costs Sales and marketing, subscription $ 1,212 $ 1,505 $ 6,038 $ 2,628 $ 1,996 $ 1,859 $ 3,471 $ 1,560 acquisition costs Hardware revenues (25,232 ) (21,058 ) (22,301 ) (35,597 ) (23,104 ) (20,786 ) (23,129 ) (21,072 ) Less: MSOs-related hardware 20,234 15,896 12,634 25,759 20,103 16,002 16,834 13,051 revenues Cost of hardware revenues 22,524 19,764 23,163 33,017 21,957 18,496 21,847 23,434 Less: MSOs-related cost of (14,805 ) (11,961 ) (9,650 ) (20,530 ) (15,384 ) (11,079 ) (11,036 ) (11,841 ) hardware revenues Total Acquisition Costs $ 3,933 $ 4,146 $ 9,884 $ 5,277 $ 5,568 $ 4,492 $ 7,987 $ 5,132 TiVo-Owned Subscription Gross 27 32 49 33 20 24 35 30 Additions Subscription Acquisition Costs $ 146 $ 130 $ 202 $ 160 $ 278 $ 187 $ 228 $ 171 (SAC) Twelve Months Ended Jul 31, Apr 30, Jan 31, Oct 31, Jul 31, Apr 30, Jan 31, Oct 31, 2014 2014 2014 2013 2013 2013 2013 2012 (In thousands, except SAC) Subscription Acquisition Costs Sales and marketing, subscription acquisition costs $ 11,383 $ 12,167 $ 12,521 $ 9,954 $ 8,886 $ 9,262 $ 8,660 $ 6,509 Hardware revenues (104,188 ) (102,060 ) (101,788 ) (102,616 ) (88,091 ) (76,116 ) (68,591 ) (61,890 ) Less: MSOs-related hardware revenues 74,523 74,392 74,498 78,698 65,990 52,583 45,849 40,656 Cost of hardware revenues 98,468 97,901 96,633 95,317 85,734 78,208 78,183 76,704 Less: MSOs-related cost of hardware revenues (56,946 ) (57,525 ) (56,643 ) (58,029 ) (49,340 ) (39,355 ) (38,435 ) (36,811 ) Total Acquisition Costs $ 23,240 $ 24,875 $ 25,221 $ 23,324 $ 23,179 $ 24,582 $ 25,666 $ 25,168 TiVo-Owned Subscription Gross Additions 141 134 126 112 109 117 117 114 Subscription Acquisition Costs (SAC) $ 165 $ 186 $ 200 $ 208 $ 213 $ 210 $ 219 $ 221 As a result of the seasonal nature of our subscription growth in the past, total acquisition costs have varied significantly during the year. Management primarily reviews the SAC metric on an annual basis due to the timing difference between our recognition of promotional program expense and the subsequent addition of the related subscriptions. For example, we have historically experienced increased TiVo-Owned subscription gross additions during the fourth quarter; however, sales and marketing, subscription acquisition activities occur throughout the year. During the three months ended July 31, 2014, our total acquisition costs were $3.9 million, a decrease of $1.6 million, as compared to the same prior year period. This decrease was primarily due to decreased sales and marketing subscription acquisition costs of $784,000. This decreases in sales and marketing subscription acquisition costs was the result of significant promotions in the prior year period that were not present in the current period. Also reducing the total acquisition costs was the decrease in the hardware gross margin loss of $851,000 which is a result of the better margins attained on our current product offerings. During the three months ended July 31, 2014 our SAC decreased by $132 to $146 from $278 in the same prior year period. This decrease in SAC was largely a result of the decreased total acquisition costs combined with the increased subscription gross additions for the three months ended July 31, 2014 as compared to the same prior year period. During the twelve months ended July 31, 2014 our total acquisition costs were $23.2 million, an increase of $61,000 compared to the same prior year period. This increase was largely related to a decrease in the hardware gross margin loss of $2.4 million offset by an increase in TiVo's sales and marketing, subscription acquisition costs of $2.5 million, as compared to the same prior year period. The lower hardware gross margin loss was largely driven by increased hardware unit sales with improved economic margins on the Roamio DVRs. The decrease in SAC of $48 for the twelve months ended July 31, 2014 as compared to the same prior year period was largely a result of an increase in the number of TiVo-Owned Subscription gross additions. 23-------------------------------------------------------------------------------- Table of Contents TiVo-Owned Average Revenue Per Subscription or ARPU. Management reviews this metric, and believes it may be useful to investors in order to evaluate the potential of our subscription base to generate service revenues. Investors should not use ARPU as a substitute for measures of financial performance calculated in accordance with GAAP. Management believes it is useful to consider this metric excluding the costs associated with rebates, revenue share, and other payments to channel because of the discretionary and varying nature of these expenses and because management believes these expenses, which are included in hardware revenues, net, are more appropriately monitored as part of SAC. We are not aware of any uniform standards for calculating ARPU and caution that our presentation may not be consistent with that of other companies. We calculate TiVo-Owned service revenues by subtracting MSOs'-related service revenues and Media services and other service revenues (includes Advertising, Research, and Digitalsmiths revenues), from our total reported net Service revenues. The table below provides a more detailed breakdown of our Service revenues, and reconciles to our total Service revenues in our Statement of Operations as reported: Three Months Ended Jul 31, Apr 30, Jan 31, Oct 31, Jul 31, Apr 30, Jan 31, Oct 31, Service Revenues 2014 2014 2014 2013 2013 2013 2013 2012 (in thousands) TiVo-Owned-related service revenues $22,388 $22,510 $22,975 $23,462 $24,120 $24,280 $25,116 $25,412 MSOs'-related service revenues 10,328 9,950 10,498 7,734 7,555 7,279 7,429 6,767 Media services and other service revenues 4,193 3,435 2,844 2,330 3,255 2,503 3,029 3,049 Total Service Revenues $36,909 $35,895 $36,317 $33,526 $34,930 $34,062 $35,574 $35,228 We calculate ARPU per month for TiVo-Owned Subscriptions by taking total reported net TiVo-Owned service revenues and dividing the result by the number of months in the period. We then divide the resulting average service revenue by Average TiVo-Owned subscriptions for the period, calculated as described above for churn rate. The following table shows this calculation: Three Months Ended TiVo-Owned Average Jul 31, Apr 30, Jan 31, Oct 31, Jul 31, Apr 30, Jan 31, Oct 31, Revenue per Subscription 2014 2014 2014 2013 2013 2013 2013 2012 (In thousands, except ARPU) TiVo-Owned-related $ 22,388 $ 22,510 $ 22,975 $ 23,462 $ 24,120 $ 24,280 $ 25,116 $ 25,412 service revenues Average TiVo-Owned 7,463 7,503 7,658 7,821 8,040 8,093 8,372 8,471 revenues per month Average TiVo-Owned 946 961 962 974 994 1,018 1,035 1,050 subscriptions per month TiVo-Owned ARPU per month $ 7.89 $ 7.81 $ 7.96 $ 8.03 $ 8.09 $ 7.95 $ 8.09 $ 8.07 The decrease in TiVo-Owned ARPU per month for the three months ended July 31, 2014 as compared to the same prior year period was due primarily to a percentage increase in sales of service for TiVo Mini, which typically has a lower monthly fee or amortized payments than for DVRs. Critical Accounting Estimates In preparing our condensed consolidated financial statements, we make assumptions, judgments and estimates that can have a significant impact on our revenue, operating income (loss) and net income (loss), as well as on the value of certain assets and liabilities on our condensed consolidated balance sheets. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. At least quarterly, we evaluate our assumptions, judgments and estimates and make changes accordingly. Historically, our assumptions, judgments and estimates relative to our critical accounting estimates have not differed materially from actual results. Other than the critical accounting estimates noted below there have been no other changes to our critical accounting estimates from our Form 10-K for the fiscal year ended January 31, 2014. Business Combinations 24-------------------------------------------------------------------------------- Table of Contents We apply the acquisition method of accounting for business combinations, including our acquisition of Digitalsmiths on February 14, 2014. Under this method of accounting, all assets acquired and liabilities assumed are recorded at their respective fair values at the date of the completion of the transaction. Determining the fair value of assets acquired and liabilities assumed requires our management's judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, intangibles and other asset lives, among other items. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). Market participants are assumed to be buyers and sellers in the principal (most advantageous) market for the asset or liability. Additionally, fair value measurements for an asset assume the highest and best use of that asset by market participants. As a result, we may have been required to value the acquired assets at fair value measures that do not reflect our intended use of those assets. Use of different estimates and judgments could yield different results. Any excess of the purchase price over the fair value of the net assets acquired is recognized as goodwill. Although we believe the assumptions and estimates we have made are reasonable and appropriate, they are based in part on historical experience and information that may be obtained from the management of the acquired company and are inherently uncertain. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates, or actual results. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our Condensed Consolidated Statements of Operations. Recent Accounting Pronouncements On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on February 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting. Results of Operations Net Revenues. Our net revenues for the three and six months ended July 31, 2014 and 2013 as a percentage of total net revenues were as follows: Three Months Ended July 31, Six Months Ended July 31, 2014 2013 2014 2013 (In thousands, except percentages) Service revenues $ 36,909 33 % $ 34,930 35 % $ 72,804 33 % $ 68,992 38 % Technology revenues 49,717 44 % $ 42,056 42 % $ 99,823 46 % $ 69,781 38 % Hardware revenues 25,232 23 % $ 23,104 23 % $ 46,290 21 % $ 43,890 24 % Net revenues $ 111,858 100 % $ 100,090 100 % $ 218,917 100 % $ 182,663 100 % Change from same prior year period 12 % 53 % 20 % 37 % Service Revenues. The increase in Service revenues of $2.0 million and $3.8 million for the three and six months ended July 31, 2014, as compared to the same prior year periods was related to an increase in MSO-related service revenues of $2.8 million and $5.4 million, respectively due to the increased subscription base. This increase was combined with an increase in Media service and other revenues of $938,000 and $1.9 million, respectively, largely related to the acquisition of Digitalsmiths. These increases were partially offset by decreases in TiVo-Owned subscription revenues of $1.7 million and $3.5 million, respectively. Technology Revenues. Technology revenues for the three and six months ended July 31, 2014 increased by $7.7 million and $30.0 million, respectively, as compared to the same prior year periods primarily due to the settlement and license agreements with Verizon and Google/Motorola Mobility and Cisco, additional licensing 25-------------------------------------------------------------------------------- Table of Contents revenues in excess of contractual minimums, and to a lesser extent the timing of revenue recognition related to various technology related projects. Revenue and cash from the contractual minimums (i.e. the following amounts do not include any additional revenues from our AT&T agreement) under our licensing agreements with EchoStar, AT&T, Verizon, and Cisco and Google/Motorola Mobility through July 31, 2014 have been: Technology Revenues Cash Receipts Fiscal Year Ended January 31, (in thousands) 2012 $ 35,275 $ 117,679 2013 76,841 86,356 2014 136,532 464,725 Six month period from February 1, 2014 to July 31, 2014 84,740 58,456 Total $ 333,388 $ 727,216 Based on current GAAP, revenue and cash from the contractual minimums under all our licensing agreements with EchoStar, AT&T, Verizon, and Cisco and Motorola is expected to be recognized (revenues) and received (cash) for the remainder of the fiscal year 2015 and on an annual basis for the fiscal years thereafter as follows: Technology Revenues Cash Receipts (in thousands) Six month period from August 1, 2014 to January 31, 2015 $ 84,902 $ 25,123 Fiscal Year Ending January 31, 2016 171,563 83,579 2017 173,129 83,579 2018 174,411 83,579 2019 88,629 31,139 2020 - 2024 8,193 - Total $ 700,827 $ 306,999 Hardware Revenues. Hardware revenues, net of allowance for sales returns and net of revenue share and marketing development fund payments for the three and six months ended July 31, 2014 increased by $2.1 million and $2.4 million, respectively as compared to the same prior year periods. While the majority of our hardware revenues related to our MSO business, the increases in net hardware revenues during the three and six months ended July 31, 2014 were largely related to the increased number of hardware units sold in our consumer business. Cost of service revenues. Three Months Ended July 31, Six Months Ended July 31, 2014 2013 2014 2013 (In thousands, except percentages) Cost of service revenues $ 13,750 $ 11,408 $ 27,600 $ 22,213 Change from same prior year period 21 % 29 % 24 % 29 % Percentage of service revenues 37 % 33 % 38 % 32 % Service gross margin $ 23,159 $ 23,522 $ 45,204 $ 46,779 Service gross margin as a percentage of service revenues 63 % 67 % 62 % 68 % Cost of service revenues consists primarily of telecommunication and network expenses, employee salaries, service center, credit card processing fees, and other expenses related to providing the TiVo service and amortization of acquired developed technology associated with our acquisitions. Cost of service revenues increased by $2.3 million and $5.4 million for the three and six months ended July 31, 2014, as compared to the same prior year periods. These increases were largely comprised of headcount related costs and amortization of developed technology, a portion of which is associated with the acquisition of Digitalsmiths. 26-------------------------------------------------------------------------------- Table of Contents Service gross margin as a percent of service revenues decline by 4% and 6% for the three and six months ended July 31, 2014, respectively. These declines are largely related to the Digitalsmiths revenues which currently provide little to no gross margins. Cost of technology revenues. Three Months Ended July 31, Six Months Ended July 31, 2014 2013 2014 2013 (In thousands, except percentages) Cost of technology revenues $ 5,669 $ 11,867 $ 10,213 $ 15,578 Change from same prior year period (52 )% 213 % (34 )% 55 % Percentage of technology revenues 11 % 28 % 10 % 22 % Technology gross margin $ 44,048 $ 30,189 $ 89,610 $ 54,203 Technology gross margin as a percentage of technology revenues 89 % 72 % 90 % 78 % Cost of technology revenues includes costs associated with our development work primarily for Virgin, Com Hem, ONO, and our other international and domestic projects. Cost of technology revenues decreased by $6.2 million and $5.4 million, respectively for the three and six months ended July 31, 2014, as compared to the same prior year periods. This decrease in cost of technology revenues for the three and six months ended July 31, 2014 was related primarily to the lower number of ongoing technology projects and the timing of recognition of revenues for those projects during the period. The three and six months ended July 31, 2013 included $6.9 million of costs associated with the completion of our ONO development work during the prior year periods. In certain of our distribution deals, TiVo is not being paid in full for the upfront development cost. However, in exchange, TiVo is receiving guaranteed financial commitments over the duration of the distribution deal. If we are reasonably assured that these arrangements as a whole will be profitable (assuming successful completion of development), we do not expense the development costs that exceed cash payable for the development work as incurred but rather we defer those costs and recognize these costs later when we receive service fees. However, despite the deferral of these development costs, we do incur cash outflows associated with these development efforts resulting in potentially higher cash usage in the near term. As a result, a portion of service fees used to recover the initial development costs would be classified as technology revenues and timing of recognition of these costs and revenues may differ from when these costs are actually incurred. In accordance with our revenue recognition policies, we have deferred costs of approximately $22.6 million related to development work, largely related to Com Hem, ONO, and Charter and these costs are recorded on our Condensed Consolidated Balance Sheets under deferred cost of technology revenues, current and deferred cost of technology revenues, long-term at July 31, 2014. In instances where TiVo does not host the TiVo service, these costs (up to the amount billed) will be recognized when related revenues are recognized upon billing our customers, as specified in the agreement. In instances where TiVo hosts the TiVo service, starting upon deployment, these costs will be amortized to cost of revenues over the longer of the contractual or customer relationship period. Cost of hardware revenues. Three Months Ended July 31, Six Months Ended July 31, 2014 2013 2014 2013 (In thousands, except percentages) Cost of hardware revenues $ 22,524 $ 21,957 $ 42,288 $ 40,453 Change from same prior year period 3 % 52 % 5 % 23 % Percentage of hardware revenues 89 % 95 % 91 % 92 % Hardware gross margin $ 2,708 $ 1,147 $ 4,002 $ 3,437 Hardware gross margin as a percentage of hardware revenue 11 % 5 % 9 % 8 % Cost of hardware revenues include all product costs associated with the TiVo-enabled DVRs and non-DVRs we distribute and sell, including manufacturing-related overhead and personnel, warranty, certain licensing, order 27-------------------------------------------------------------------------------- Table of Contents fulfillment, and freight costs. We sell this hardware primarily as a means to grow our service revenues and, as a result, generating positive gross margins from hardware sales that are linked with the sale of TiVo-Owned service is not the primary goal of the consumer business. Our cost of hardware revenues for the three and six months ended July 31, 2014 increased as compared to the same prior year periods as we sold more units into both our MSO and Consumer channels as compared to the same prior year periods. Hardware gross margin for the three and six months ended July 31, 2014 increased by $1.6 million and $600,000, respectively as compared to the same prior year periods largely due to mix units sold and the channel in which they were sold during the period as compared to the same prior year periods. Our MSO partner margins are likely to decline in future quarters as MSO partners continue to transition to third-party hardware such as the Pace DVR and non-DVR product. Research and development expenses. Three Months Ended July 31, Six Months Ended July 31, 2014 2013 2014 2013 (In thousands, except percentages)Research and development expenses $ 25,051 $ 26,305 $ 51,398 $ 52,767 Change from same prior year period (5 )% (11 )% (3 )% (12 )% Percentage of net revenues 22 % 26 % 23 % 29 % Our research and development expenses consist primarily of employee salaries, related expenses, and consulting expenses related to our development of new technologies and products, such as whole home DVR technology and new features and functionality as well as investments in creating an integrated software code base across our product lines to increase the efficiency of our product development efforts in the future. Our research and development expenses decreased by $1.3 million and $1.4 million for the three and six months ended July 31, 2014 as compared to the same prior year period. These decreases were largely related to decreased headcount and headcount related costs. We expect our annual research and development spending in fiscal year 2015 to continue to be significant but to be at lower levels than the fiscal year 2014. Sales and marketing expenses. Three Months Ended July 31, Six Months Ended July 31, 2014 2013 2014 2013 (In thousands, except percentages) Sales and marketing expenses $ 10,284 $ 9,069 $ 20,599 $ 17,576 Change from same prior year period 13 % 25 % 17 % 31 % Percentage of net revenues 9 % 9 % 9 % 10 % Sales and marketing expenses consist primarily of employee salaries related expenses, consulting expenses and amortization of acquired intangibles. Sales and marketing expenses for the three and six months ended July 31, 2014 increased by $1.2 million and $3.0 million as compared to the same prior year periods. These increases are largely related our acquisition of Digitalsmiths. Amortization of acquired customer relationship intangibles was $1.0 million and $1.9 million for the three and six months ended July 31, 2014, respectively, as compared to $117,000 and $235,000, respectively for the same prior year periods. Sales and marketing, subscription acquisition costs. Three Months Ended July 31, Six Months Ended July 31, 2014 2013 2014 2013 (In thousands, except percentages) Sales and marketing, subscription acquisition costs $ 1,212 $ 1,996 $ 2,717 $ 3,855 Change from same prior year period (39 )% (16 )% (30 )% 6 % Percentage of net revenues 1 % 2 % 1 % 2 % Sales and marketing, subscription acquisition costs include advertising expenses and promotional expenses directly related to our efforts to acquire new TiVo-Owned subscriptions to the TiVo service. Sales and marketing, subscription acquisition expenses for the three and six months ended July 31, 2014 decreased by $784,000 and 28-------------------------------------------------------------------------------- Table of Contents $1.1 million, respectively, as compared to the same prior year periods due to decreased advertising spending during the current periods. General and administrative expenses. Three Months Ended July 31, Six Months Ended July 31, 2014 2013 2014 2013 (In thousands, except percentages) General and administrative $ 15,760 $ 23,225 $ 31,114 $ 45,011 Change from same prior year period (32 )% (9 )% (31 )% 8 % Percentage of net revenues 14 % 23 % 14 % 25 % Litigation expense (included in total general and administrative costs above) $ 1,235 $ 10,667 $ 2,310 $ 21,545 Change from same prior year period (88 )% (16 )% (89 )% 19 % Percentage of net revenues 1 % 11 % 1 % 12 % General and administrative, net of litigation expense $ 14,525 $ 12,558 $ 28,804 $ 23,466 Change from same prior year period 16 % (1 )% 23 % - % Percentage of net revenues 13 % 13 % 13 % 13 % General and administrative expenses consist primarily of employee salaries and related expenses for executive, administrative, accounting, and legal and professional fees. During the three and six months ended July 31, 2014, general and administrative expenses decreased by $7.5 million and $13.9 million, respectively, as compared to the same prior year periods. These decreases for the three and six months ended July 31, 2014 were primarily related to decreased legal fees of $9.4 million and $19.2 million, respectively, and were associated with litigation expenses related to our patent enforcement cases. These were offset by increases in G&A expenses, net of litigation, in the amount of $2.0 million and $5.3 during the three and six months ended July 31, 2014 as compared to the same prior year periods. These increases were related largely to headcount related expenses. Interest income. Interest income for the three and six months ended July 31, 2014 decreased by $535,000 and $214,000, respectively as compared to the same prior year periods. During the three and six months ended July 31, 2013 interest income included $752,000 of interest related our settlement of Google/Motorola Mobility settlement and the interest associated with their past infringement. These decreases were offset by interest that was largely attributed to a higher average cash and short-term investment balance held during the three and six months ended July 31, 2014 as compared to the same prior year periods. Interest expense and other. Interest expense and other income for the three and six months ended July 31, 2014 was relatively flat as compared to the same prior year periods and consists primarily of interest expense associated with our convertible senior notes. Benefit (provision) for income taxes. Three Months Ended July 31, Six Months Ended July 31, 2014 2013 2014 2013 (In thousands, except percentages) Benefit (provision) for income taxes (7,299 ) 167,039 (13,723 ) 166,924 Effective tax rate 44 % (164 )% 44 % (182 )% The provision for income taxes for the three and six months ended July 31, 2014 differs from the U.S. statutory tax rate of 35% primarily due to the tax impact of non-deductible executive based compensation, stock based compensation and state taxes. The provision for income taxes for the three and six months ended July 31, 2013 differs from the U.S. statutory tax rate of 35% primarily due a release of valuation allowance against our deferred tax assets. Liquidity and Capital Resources We have financed our operations and met our capital expenditure requirements primarily from the proceeds from the sale of equity securities, issuance of convertible senior notes, litigation proceeds, and cash flows from operations. Our cash resources are subject, in part, to the amount and timing of cash received from our license agreements, subscriptions, deployment agreements, and hardware customers. As of July 31, 2014, we had over $782.6 million of cash, cash equivalents, and short-term investments. We also have $172.5 million in outstanding 29-------------------------------------------------------------------------------- Table of Contents convertible senior subordinated notes, which are due on March 15, 2016. The notes are unsecured senior obligations of the Company and the Company may not redeem these notes prior to their maturity date although investors may convert the notes into TiVo common stock at any time until March 14, 2016 at their option. We believe our cash, cash equivalents and short-term investments, provide sufficient resources to fund operations, capital expenditures, future repurchases of TiVo shares in connection with our previously announced share repurchase authorization, and working capital needs through the next twelve months. Statement of Cash Flows Discussion The following table summarizes our cash flow activities: |