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TiVo Inc’s (TIVO - Analyst Report) fourth quarter 2012 earnings of 6 cents per share fared very well compared with the Zacks Consensus Estimate of a loss of 25 cents as well as the year-ago quarter loss of 30 cents. The better-than-expected result was driven by higher revenue based on strong subscriber growth and licensing revenue growth resulting from the AT&T Inc. (T - Analyst Report) settlement.

Quarter Details

Revenues increased 19.1% year over year to $66.5 million in the fourth quarter and surpassed the Zacks Consensus Estimate of $65.0 million. Revenues for the quarter were positively impacted by Services and technology revenue, which jumped 21% to $50.0 million and was in line with the higher end of management’s guided range of $48 million-$50 million. Moreover, hardware revenue also jumped 13.8% year over year to $16.4 million.

Net subscription additions for the quarter were 234,000 compared with 223,000 subscription loss in the year-ago quarter. Churn rate was negative 1.7% in the quarter versus  negative 3.0% posted in the prior-year quarter. Subscription acquisition costs (SAC) increased 3.1% year over year to $234.

Gross profit soared 114.1% year over year to $32.9 million and gross margin expanded to 49.5% in the reported quarter, primarily due to higher revenues and significantly lower technology, service and hardware costs.

Operating expenses decreased 57.4% year over year to $21.3 million. Research & development (R&D) expense surged 28.5% year over year, while general & administrative expense (G&A) shot up 118% during the reported quarter. However, this was fully offset by a 9.3% decline in sales & marketing (S&M) expense and a 40.4% downside in sales & marketing expense related to subscriber acquisition costs. Litigation proceeds related to the AT&T settlement were $54.4 million.

Operating income was $11.6 million compared with a loss of $34.6 million in the year-ago quarter. Adjusted EBITDA was $21.0 million compared favourably with a loss of $25.8 million in the year-ago quarter. Adjusted EBITDA easily surpassed management’s guided range of ($23.0) million to ($21.0) million. TiVo reported fourth quarter 2012 net income of $7.2 million compared with a net loss of $34.4 million in the year-ago quarter.

TiVo exited the fourth quarter with cash, cash equivalents and short-term investments of $618.8 million versus $604.3 million in the previous quarter.

Guidance

For the first quarter of 2013, TiVo expects service and technology revenues in the range of $53 million to $55 million. TiVo expects net loss in the range of ($20.0) million to ($18.0) million and an adjusted EBITDA loss in the range of ($10.0) million to ($8.0) million.

For the first quarter, TiVo expects R&D expense to remain flat sequentially. For the full year, R&D is expected to decline on a year-over-year basis. TiVo expects litigation expenses to decrease significantly for the first quarter from $12.0 million in the fourth quarter. TiVo expects to spend much less in litigation costs compared with fiscal 2012.

TiVo expects adjusted EBITDA to significantly benefit from higher licensing revenue and subscriber fees. Management expects adjusted EBITDA to breakeven for full year 2013.

Our Take

We remain optimistic about TiVo’s long-term growth potential due to new partnerships, product launches and international expansion. We believe that TiVo will continue to witness strong subscriber growth based on its partnerships with Virgin Media Inc. ), RCN, ONO, Charter Communications, Suddenlink and DIRECTV going forward.

TiVo is also expected to benefit from the back-to-back settlements with DISH Network (DISH - Analyst Report), EchoStar Corp. (SATS - Snapshot Report) and AT&T as it will enhance the company’s reputation of aggressively defending its intellectual property.

We believe that the out-of-court settlements recognize the value of TiVo’s intellectual property and provide incentive for other companies such as Comcast Corp. (CMCSA - Analyst Report) to enter into commercial arrangements with TiVo. In addition to the immediate cash payoff, the legal wins also open up major new markets and licensing opportunities for TiVo. Moreover, the settlements will also bring down the litigation expenses that TiVo incurs every quarter owing to these ongoing patent disputes.

However, pending patent litigation issues, rising subscription acquisition costs and higher R&D expenses are expected to impact TiVo’s profitability over the next few quarters. Increasing competition from cable and satellite providers could also hurt profitability over the long term. Thus, we have a Neutral recommendation on TiVo over the long term (6-12 months).

We believe that TiVo remains significantly undervalued despite its growth potential. Currently, TiVo has a Zacks #2 Rank, which implies a Buy rating for the short term (1-3 months).

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