TiVo Beats on Patent Settlement

A developer of advanced television services including digital video recorders (DVR), TiVo Inc. ( TIVO - Analyst Report ) reported earnings per share (EPS) of $1.04 per share in the first quarter of 2012, comprehensively beating the Zacks Consensus Estimate of a loss of 31 cents and the loss of 13 cents per share in the prior-year quarter.

The better-than expected results were primarily driven by litigation proceeds of $175.7 million in the quarter that TiVo received related to the patent settlement with DISH Network ( DISH - Analyst Report ) .

Operating performance

TiVo reported first quarter 2012 net income of $140.1 million compared with a net loss of $14.2 million in the prior-year quarter. Net income includes litigation proceeds of $175.7 million and $2.9 million in related interest income.

Gross profit decreased 21.0% year over year to $15.4 million, due to declining revenue growth. However, gross margin expanded 250 basis points (bps) to 46.1% in the reported quarter, primarily attributable to lower service and hardware costs.

Operating expenses, excluding litigation proceeds, escalated 38.7% year over year to $57.3 million. Research & development (R&D) expenses surged 46.2% year over year to $27.2 million in the quarter.

TiVo reported an operating income of $139.5 million compared with a loss of $14.5 million in the prior-year quarter. Including the litigation proceeds, adjusted EBITDA came in at $149.4 million.

Revenue

Revenues decreased 25.4% year over year to $45.8 million in the first quarter and were also below the Zacks Consensus Estimate of $54.0 million. The weakness in year-over-year comparison was primarily due to an 8.0% decline in Service revenue, 21.0% decline in Technology revenue and 62.0% decline in Hardware revenue during the quarter.

TiVo-owned subscription gross additions for the quarter were 27,000 compared with 33,000 gross additions in the year-ago quarter. Churn rate increased to 2.3% in the quarter. Subscription acquisition costs, however, decreased 8.4% year over year.

Balance Sheet and Cash Flow

At the end of the first quarter, cash, cash equivalents and short-term investments were $351.2 million versus $209.4 million at the end of fourth quarter 2011.

Cash flow from operations was a negative $24.0 million in the quarter compared with a negative $12.7 million in the previous quarter.

Legal Updates

TiVo, DISH Network and EchoStar Corporation ( SATS ) entered into an agreement to settle their long-running patent dispute over TiVo’s time warp patent.

Under the terms of the settlement, TiVo will allow DISH Network and EchoStar to use its time warp patent. In return, DISH Network and EchoStar will pay TiVo $500.0 million, including an initial payment of $300.0 million with the remaining $200 million distributed in six equal annual installments between 2012 and 2017.

EchoStar also granted TiVo a license under certain DVR-related patents for TiVo-branded, co-branded and ingredient-branded products. Additionally, TiVo will help DISH Network promote the Blockbuster digital video service going forward.

TiVo agreed to dismiss all pending litigations and dissolve all injunctions against DISH Network and EchoStar.

In the recent past TiVo also won a couple of stay orders against Microsoft Corp. ( MSFT - Analyst Report ) and AT&T Inc. ( T - Analyst Report ) . This will allow TiVo to focus on the upcoming claim construction hearings against AT&T, Microsoft and Verizon Communications Inc. ( VZ - Analyst Report ) .

Guidance

TiVo expects Service and Technology revenues to range between $46.0 million and $48.0 million. Management expects net loss in the range of $25.0 million to $27.0 million in the second quarter. Adjusted EBITDA is expected at between ($14.0) million and ($16.0) million for the second quarter of 2012.

For fiscal 2012, TiVo expects the patent settlement with DISH to reduce legal expenses by approximately 20.0%. TiVo believes that the recurring stream of high-margin licensing revenue from DISH and declining expenses will boost adjusted EBITDA for fiscal 2012 and beyond.

Our Take

Recently, TiVo announced the availability of Hulu Plus retail Premier DVRs. TiVo also entered into an agreement with Comcast Corp. ( CMCSK - Snapshot Report ) , which allows subscribers to access Comcast's robust library of Xfinity TV On Demand content on TiVo Premiere set-top boxes.

We continue to believe that new partnerships with leading companies coupled with new customer wins, product launches and international expansion will drive top-line growth.

The biggest positive, in our view, is the settlement of the patent suite against DISH and EchoStar. This has not only reduced legal expenses but also provided a recurring revenue stream for TiVo over the long term. We believe TiVo’s financial position will also improve due to the settlement.

Moreover, we believe that this settlement has enhanced TiVo’s reputation justifying the aggression with which it has been defending its intellectual property.

However, the company continues to see patent litigation issues against Microsoft, AT&T and Verizon. Going forward, any negative outcome from these lawsuits will have a negative impact on the shares, in our view.

Moreover, increasing competition from cable and satellite providers will hurt profitability over the long term.

TiVo remains committed to developing new technologies and is spending handsomely on research and development (R&D), which is expected to increase in the range of $25.0 million to $30.0 million for fiscal year 2012 ($81.6 million in 2011).

The increased expenses will no doubt impact earnings, unless there is a corresponding pickup in sales. We therefore prefer to take a wait-and-see approach.

We have a Neutral recommendation on TiVo over the long term (6-12 months). Currently, TiVo has a Zacks #2 Rank, which implies a Buy rating in the short-term (1-3 months).