Gemstar-TV Guide International, Inc., a Delaware corporation (“Gemstar” or the “Company”), is a media, entertainment and technology company that develops, licenses, markets and distributes technologies, products and services targeted at the television guidance and home entertainment needs of television viewers worldwide.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the accounting policies described in the Company’s 2005 Annual Report on Form 10-K and the interim period reporting requirements of Form 10-Q. Accordingly, certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.
The accompanying interim financial statements are unaudited but, in the opinion of management, reflect all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the consolidated financial position of the Company and its results of operations and cash flows for such periods. Operating results for any interim period are not necessarily indicative of the results that may be expected for the full year.
The Company’s Consumer Electronics (“CE”) Licensing Segment revenues tend to be the highest in the first quarter, when CE manufacturers report their fourth quarter sales. The Publishing and Cable and Satellite Segments historically have higher revenues in the second half of the year.
Certain financial statement items for the prior period have been reclassified to conform to the 2006 presentation.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued a revised SFAS No. 123, Share-Based Payment (“Statement 123R”), which the Company adopted as of January 1, 2006. See Note 9 for a description of Statement 123R.
On December 1, 2005 the Company sold its SkyMall in-flight catalog business to a private equity group for $43.3 million in cash. Under the terms of the sale, the Company retained approximately $4.0 million of SkyMall liabilities and approximately $12.0 million of SkyMall’s cash, cash equivalents, and marketable securities. The operations of the SkyMall business are shown as discontinued operations in the accompanying condensed consolidated statements of operations. Revenues of the SkyMall business were $11.3 million for the three months ended March 31, 2005.
On March 1, 2004, the Company entered into an agreement with EchoStar Communication Corporation and certain of its subsidiaries (“EchoStar”) whereby EchoStar acquired substantially all of the operating assets and certain liabilities of the Company’s SuperStar/Netlink Group LLC, UVTV distribution services and SpaceCom Systems businesses (collectively the “SNG Businesses”). Costs associated with this disposal were estimated at $5.9 million, and consisted principally of contractual acceleration of certain liabilities, employee-related transfer costs necessitated by the deal structure (asset purchase), and other transaction costs. As of March 31, 2006, $4.9 million of these costs remain unpaid and are included in accrued expenses in the accompanying condensed consolidated balance sheets. These costs are expected to be paid this year.
The following material developments in the Company’s legal proceedings occurred in the quarter ended March 31, 2006. The Company intends to vigorously defend or prosecute all pending legal matters unless specified otherwise below.
In the Matter of an Application for a Temporary Order Pursuant to Section 1103 of the Sarbanes-Oxley Act, Securities and Exchange Commission v. Gemstar-TV Guide International, Inc., Case No. CV-03-3124 MRP (PLAx), in the United States District Court for
GEMSTAR-TV GUIDE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED
(3) Litigation and Other Contingencies (continued)
the Central District of California. On May 5, 2003, the Securities and Exchange Commission (“SEC”) filed a proceeding pursuant to Section 1103 of the Sarbanes-Oxley Act seeking an order requiring the Company to maintain approximately $37.0 million in segregated, interest-bearing bank accounts (“1103 funds”). The Company had originally set those funds aside for payment to its former chief executive officer, Henry C. Yuen, and its former chief financial officer, Elsie Leung, in connection with the Company’s November 2002 management and corporate governance restructuring. On May 9, 2003, after a hearing, the Court ordered the Company to retain the 1103 funds in those segregated accounts preventing the Company from paying any portion of those funds to Mr. Yuen or Ms. Leung, absent further order of the Court. No further orders have been received from the Court with respect to the 1103 funds because the SEC’s civil enforcement case against Mr. Yuen (discussed below) has not been finally resolved, though the proposed relief sought by the SEC in the enforcement proceeding includes a prohibition against Mr. Yuen seeking to obtain any portion of the 1103 funds. Further, the Company has challenged Mr. Yuen’s and Ms. Leung’s assertions of entitlement to the 1103 funds in conjunction with their respective arbitration proceedings which are still pending.
Securities and Exchange Commission v. Henry C. Yuen, et al., Case No. 03-CV-4376 MRP (PLAx), in the United States District Court for the Central District of California. On June 19, 2003, the SEC filed a complaint alleging violations of federal securities laws against Mr. Yuen, Ms. Leung and certain other of the Company’s former executives. The Company is not a party in this proceeding. On November 21, 2005, Ms. Leung reached a settlement with the Pacific Regional Office of the SEC in Los Angeles, which was approved by the SEC Commissioners in Washington, D.C. On February 23, 2006, Ms. Leung’s settlement was approved and a final judgment of permanent injunction and other relief was entered by the Court. On March 16, 2006, the Court issued its findings of fact and conclusions of law with respect to the SEC’s charges against Mr. Yuen, finding Mr. Yuen liable for securities fraud, reporting violations, record-keeping violations, internal control violations, and lying to the Company’s audit committee and auditors. On March 27, 2006, the SEC filed its proposed judgment against Mr. Yuen requesting, among other things, that the Court order Mr. Yuen to relinquish his claims to approximately $30.3 million of the 1103 funds. The Court has allowed Mr. Yuen and the SEC to file additional briefs regarding the form of the proposed judgment and has not issued a final judgment in the case.
Claims Under the Company’s Directors and Officers Liability Insurance Policies
On July 6, 2005, the Company filed a complaint against its former insurance carriers in a case captioned Gemstar-TV Guide International, Inc. v. National Union Fire Insurance Company of Pittsburgh, PA, Federal Insurance Company, et al., in the United States District Court for the Central District of California, Case No. 05-CV-05719 NM, alleging that the issuers of the Company’s directors and officers liability insurance policies, with aggregate policy limits of $50 million, for the 1999-2002 policy periods, breached their obligations under these policies by, among other things, failing to pay defense costs related to: the SEC’s previous investigation into accounting and financial reporting; various related shareholder and derivative actions; and the action entitled Securities and Exchange Commission v. Henry C. Yuen, et al. (discussed above) which alleges violations of federal securities laws. The Company seeks declaratory relief, monetary damages plus interest, attorneys’ fees and costs. On March 30, 2006, the Company dismissed its second complaint in this matter, without prejudice, pursuant to an agreement to participate in mediation with its former insurance carriers. The Company has not recorded a contingent receivable with respect to this matter in the accompanying condensed consolidated financial statements.
Other Litigation
On January 18, 2006, the Company terminated Brian D. Urban, its former chief financial officer, for cause under the terms of his employment agreement. In April 2006, Mr. Urban filed a complaint with the U.S. Department of Labor pursuant to Section 806 of the Sarbanes-Oxley Act. In his complaint, Mr. Urban seeks reinstatement, back pay, with interest, other compensatory damages, exemplary and punitive damages, costs and reasonable attorneys’ fees. Mr. Urban alleges that he was terminated in retaliation for reporting matters which he believed were material weaknesses in the Company’s internal controls. Mr. Urban’s claim that he was terminated in retaliation for reporting matters relating to the Company’s internal controls is without merit and the Company intends to defend itself vigorously.
The Company’s audit committee, with the assistance of independent counsel and accounting experts, investigated Mr. Urban’s allegations regarding the Company’s internal controls. The Company also investigated these allegations. Both the Company and the audit committee concluded that these allegations were without merit.
In addition to the items listed above, the Company is party to various legal actions, claims and proceedings as set forth in its Form 10-K for the year ended December 31, 2005, as well as other actions, claims and proceedings incidental to its business. Additional information regarding certain of the matters discussed above is contained in that filing.
6
GEMSTAR-TV GUIDE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED
(3) Litigation and Other Contingencies (continued)
The Company has established loss provisions only for matters in which it has determined that losses are probable and can be reasonably estimated. However, the Company may be required to incur expenses or costs in these and other incidental litigation matters in aggregate amounts that may have a material adverse effect on its financial condition or results of operations.
(4) Post-Employment Compensation
In accordance with the terms of Mr. Yuen’s and Ms. Leung’s respective employment agreements, the Company is obligated to pay salary and benefits to Mr. Yuen and Ms. Leung until an arbitration panel concurs that each of them was properly terminated. Ms. Leung’s employment agreement expired in November 2005. Combined payments totaled approximately $0.5 million and $0.7 million for the three months ended March 31, 2006 and 2005, respectively, and are included in operating expenses in the condensed consolidated statements of operations. In April 2006, the Company discontinued paying Mr. Yuen’s salary and benefits, pending further rulings on this matter by the arbitration panel.
Pursuant to a Patent Rights Agreement with Mr. Yuen, the Company recognized costs totaling $0.8 million for each of the quarters ending March 31, 2006 and 2005. These costs are included in operating expenses in the condensed consolidated statements of operations.
(5) Guarantees
The Company guarantees from time to time the obligations and financial responsibilities of different subsidiaries incidental to their respective businesses.
The Company provides indemnification of varying scopes and amounts to certain of its licensees against claims made by third parties arising out of the incorporation of the Company’s products, intellectual property, services and/or technologies into the licensee’s products and services, provided the licensee is not in violation of the terms and conditions of the agreement and/or additional performance or other requirements for such indemnification. The Company’s indemnification obligation is typically limited to the cumulative amount paid to the Company by the licensee under the license agreement. Other license agreements, including those with our largest multiple system operators (“MSOs”) and digital broadcast satellite (“DBS”) providers, do not specify a limit on amounts that may be payable under the indemnity arrangements. In the second quarter of 2005, the Company received notice of an indemnification claim from one of its largest licensees under an indemnity arrangement which does not specify a limit on the amount that may be payable. Additionally, the Company has agreed to reimburse another one of its licensees for legal expenses and liabilities in connection with certain pending claims in an aggregate amount not to exceed $3.5 million. The Company evaluates estimated losses for such indemnifications under SFAS No. 5, Accounting for Contingencies, as interpreted by Financial Accounting Interpretation No. 45. The Company considers such factors as the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss.
In connection with the Company’s sale of its SkyMall in-flight catalog business, the Company has indemnified SkyMall and certain of its affiliates for various matters that are typical for transactions of this type, subject in certain instances to a negotiated basket and/or cap.
In conjunction with the assignment of a lease held by TV Guide Interactive, Inc. (“Interactive”) to Guideworks, LLC, a 49% owned joint venture (“Guideworks”) Interactive and the Company’s co-venturer jointly and severally guaranteed the obligations of Guideworks under the lease. Interactive’s guaranty obligations continue as long as the Company is a member of Guideworks.
The Company also has agreements to indemnify and/or advance costs to a number of its former and current officers and directors against losses incurred by them as a result of their service as an officer and/or director of the Company. In particular, the Company has certain agreements to indemnify and/or advance costs to individuals for legal fees and expenses incurred in connection with certain litigation and investigatory proceedings. Among the former officers and directors with whom the Company has such agreements are Mr. Yuen, Ms. Leung and Craig M. Waggy. The litigation and investigatory proceedings to which these agreements relate include, but are not limited to, the SEC enforcement case described above, the shareholder and derivative litigation in which the Company was also named as a party, and the American Arbitration Association (“AAA”) arbitration proceedings between the Company and Mr. Yuen and Ms. Leung. The Company recorded approximately $1.2 million and $1.3 million in legal expenses incurred by its former officers and directors in the three months ended March 31, 2006 and 2005, respectively, which are included in operating expenses in the condensed consolidated statements of operations. As of March 31, 2006 and December 31, 2005, the Company had accrued expenses of $3.6 million and $2.4 million, respectively, for such amounts, which are included in accrued liabilities on the condensed consolidated balance sheets.
7
GEMSTAR-TV GUIDE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED
(5) Guarantees (continued)
The Company maintains directors and officers (“D&O”) liability insurance with respect to liabilities arising out of certain matters, including matters arising under securities laws. This insurance is subject to limitations, conditions and deductibles set forth in the insurance policies.
(6) Income Taxes
The provision for income taxes as a percentage of income from continuing operations before income taxes was 34.2% for the three months ended March 31, 2006.
The provision for income taxes as a percentage of income from continuing operations before income taxes was 168.1% for the three months ended March 31, 2005. The Company’s effective tax rate in 2005 was impacted by a valuation allowance required for a deferred tax asset arising from the taxable income created by the advance payments received in the multi-year patent and license distribution agreements with EchoStar and Comcast Corporation (“Comcast”), which were entered into in 2004. While these advances were received during 2004, a substantial portion of these advances became taxable to the Company during 2005 under current tax regulations.
(7) Related Party Transactions
As of March 31, 2006, News Corporation beneficially owned approximately 41% of the Company’s outstanding common stock and four of the Company’s directors are also officers of News Corporation.
The Company charged entities controlled by News Corporation $3.3 million and $3.9 million for advertising and other services during the three months ended March 31, 2006 and 2005, respectively. During those same periods, the Company acquired programming from News Corporation-controlled entities of $0.3 million and $0.4 million, respectively.
The Company also provides advertising and other services to a third party that is the beneficiary of a media services commitment from News Corporation. News Corporation pays the Company for the services provided to the third party, and accordingly reduces News Corporation’s obligation to this third party. Under this arrangement, the Company charged News Corporation $0.2 million for each of the three months ended March 31, 2006 and 2005.
The Company reimburses News Corporation for facilities and other general and administrative costs incurred on the Company’s behalf. Expenses associated with these costs approximated $1.1 million and $1.2 million for the three months ended March 31, 2006 and 2005, respectively. News Corporation also began providing the Company with the services of the Company’s current chairman of the board of directors starting in December 2004. Expenses associated with these services approximated $0.1 million for each of the quarters ending March 31, 2006 and 2005.
During the third quarter of 2004, the Company entered into a long-term capital sublease with News Corporation for a transponder to be used in its Cable and Satellite operations. Related amortization and interest expense recognized under this capital sublease was $0.5 million for each of the three months ended March 31, 2006 and 2005. The total obligation under this capital lease was $13.1 million at March 31, 2006 and $13.3 million at December 31, 2005.
The Company transmits interactive program guide (“IPG”) data in the vertical blanking interval of television broadcast stations owned and operated by an affiliate of News Corporation. In exchange, the affiliate’s stations are entitled to a preferred position on the IPG in their designated market areas. In addition, the Company purchases paper through a paper procurement arrangement with News Corporation at negotiated prices with paper suppliers based on the combined paper requirements of the two organizations.
As of March 31, 2006 and December 31, 2005, the Company had receivables due from News Corporation-controlled entities totaling $1.0 million and $1.4 million, respectively, and payables due to News Corporation-controlled entities totaling $0.1 million and $0.2 million, respectively.
The Company has included in the amounts discussed above transactions with News Corporation and all known entities in which News Corporation has an interest greater than 50%. In addition, the Company has transactions with entities in which News Corporation owns, directly or indirectly, 50% or less.
8
GEMSTAR-TV GUIDE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED
(8) Segment Information
The Company’s segments are organized along three industry lines, in addition to a segment comprising certain corporate functions and related expenses.
The Cable and Satellite Segment offers technologies, products and services to consumers and service providers in the cable and satellite industry. The business units in this Segment include TV Guide Channel, TV Guide Interactive, TVG Network, TV Guide Spot and TV Guide Mobile Entertainment.
The Publishing Segment consists of TV Guide magazine, TV Guide Online and TV Guide Data Solutions.
The CE Licensing Segment licenses video recording technology currently marketed under the VCR Plus+ brand in North America and under other brands in Europe and Asia, and IPGs marketed under the TV Guide On Screen brand in North America, under the G-GUIDE brand in Japan and under the GUIDE Plus+ brand in Europe. This Segment also has licensed certain IPG patents to manufacturers of set-top boxes for the DBS industry and continues to license certain IPG patents to interactive television software providers and program listings providers in the online, personal computer and other non-television businesses. In addition, the CE Licensing Segment incurs costs associated with patent prosecution and litigation related to the enforcement or defense of patent claims.
The Corporate Segment includes corporate management, corporate legal, corporate finance and other functions, and related costs such as certain litigation and insurance costs. The Corporate Segment also includes the Company’s business development and product development and technology groups’ costs, to the extent that these costs support company-wide initiatives or to the extent they represent preliminary expenditures against initiatives that have not yet been assigned to a business segment.
The Company’s reportable industry segments are strategic business units that offer distinct products and services and compete in distinct industries. The Company’s chief operating decision maker uses an adjusted EBITDA (as defined below) measurement to evaluate the performance of, and allocate resources to, the industry segments. Intersegment revenues and expenses have been eliminated from segment financial information as transactions between reportable segments are excluded from the measure of segment profit and loss when reviewed by the Company’s chief operating decision maker. Balance sheets of the reportable segments are not used by the chief operating decision maker to allocate resources or assess performance of the businesses.
Segment information for the three months ended March 31, 2006 and 2005 is presented and reconciled to consolidated income from continuing operations before income taxes as follows (in thousands):
| Three Months Ended
March 31,
|
|---|
| 2006
| 2005
|
|---|
| Cable and Satellite Segment: | | | | | |
| Revenues | | $ 71,812 | | $ 64,813 | |
| Operating Expenses(1) | | 45,178 | | 44,513 | |
|
| |
| |
| Adjusted EBITDA(2) | | 26,634 | | 20,300 | |
|
| |
| |
| Publishing Segment: | | | | | |
| Revenues | | 38,369 | | 71,005 | |
| Operating Expenses(1) | | 52,018 | | 79,458 | |
|
| |
| |
| Adjusted EBITDA(2) | | (13,649 | ) | (8,453 | ) |
|
| |
| |
| CE Licensing Segment: | | | | | |
| Revenues | | 33,851 | | 28,250 | |
| Operating Expenses(1) | | 12,949 | | 14,719 | |
|
| |
| |
| Adjusted EBITDA(2) | | 20,902 | | 13,531 | |
|
| |
| |
| Corporate Segment: | | | | | |
| Operating Expenses(1) | | 17,876 | | 15,429 | |
|
| |
| |
| Adjusted EBITDA(2) | | (17,876 | ) | (15,429 | ) |
|
| |
| |
| Consolidated: | | | | | |
| Revenues | | 144,032 | | 164,068 | |
| Operating Expenses(1) | | 128,021 | | 154,119 | |
|
| |
| |
| Adjusted EBITDA(2) | | 16,011 | | 9,949 | |
| Stock compensation | | (312 | ) | (25 | ) |
| Depreciation and amortization | | (7,961 | ) | (6,924 | ) |
|
| |
| |
| Operating income | | 7,738 | | 3,000 | |
| Interest income, net | | 5,169 | | 3,214 | |
| Other income, net | | 118 | | 261 | |
|
| |
| |
| Income from continuing operations before income taxes | | $ 13,025 | | $ 6,475 | |
|
| |
| |
9
GEMSTAR-TV GUIDE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED
(8) Segment Information (continued)
| | (1) | Operating expenses means operating expenses, excluding stock compensation, depreciation and amortization and impairment of intangible assets. |
| | (2) | Adjusted EBITDA is defined as operating income (loss), excluding stock compensation, depreciation and amortization and impairment of intangible assets. The Company believes adjusted EBITDA to be relevant and useful information as adjusted EBITDA is the primary measure used by our chief operating decision maker to evaluate the performance of and make decisions about resource allocation to the industry segments. |
(9) Stock-Based Employee Compensation
The Company adopted Statement 123R as of January 1, 2006. Statement 123R requires the Company to expense, in its consolidated statement of operations, the estimated fair value of employee stock options and similar awards. The Company adopted the provisions of Statement 123R using the modified prospective transition method and therefore has not restated prior periods’ results. Under this transition method, all awards granted prior to, but not yet vested as of, January 1, 2006, are included in stock compensation expense using the compensation cost calculated for pro forma disclosure purposes under SFAS No. 123, Accounting for Stock-Based Compensation (“Statement 123”). Stock compensation expense for all share based payment awards granted after January 1, 2006, is based on the grant-date fair value estimated in accordance with the provisions of Statement 123R. The Company recognizes compensation costs for shares that are expected to vest, on a straight-line basis over the requisite service period of the award, which is generally the option vesting term of four years. For the three months ended March 31, 2006, the Company recorded $0.3 million of stock compensation expense in its condensed consolidated statement of operations.
Prior to January 1, 2006, the Company followed the disclosure-only provisions of Statement 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of Statement 123. The Company measured compensation expense for its stock option awards under the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”) and related interpretations. APB 25 required compensation expense to berecognized based on the excess, if any, of the quoted market price of the stock at the date of the grant and the amount an employee must pay to acquire the stock.
The pro forma table below reflects net loss and basic and diluted net loss per share for the three months ended March 31, 2005, had the Company determined compensation cost based on the fair value at the grant date for its stock options under Statement 123 (in thousands, except per share data):
| Three Months Ended,
March 31,
2005
|
|---|
| Net loss as reported | | $(3,749 | ) |
| Add: Stock-based compensation cost included in reported net loss, net | |
| of related tax effects | | 25 | |
| Less: Stock-based compensation cost, net of related tax effects | | (7,575 | ) |
|
| |
| Pro forma net loss | | $(11,299 | ) |
|
| |
| Basic and diluted loss per share: | | | | | |
| As reported | | $ (0.01 | ) |
| Pro forma | | (0.03 | ) |
The above pro forma disclosure includes $4.6 million due to the accelerated vesting of stock options, in accordance with the employment agreements, of certain former executives who left the Company in the first quarter of 2005.
10
GEMSTAR-TV GUIDE INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED
(9) Stock-Based Employee Compensation (continued)
The fair value of options granted during the three months ended March 31, 2006 and 2005, was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
| Three Months Ended March 31,
|
|---|
| 2006
| 2005
|
|---|
| Risk-free interest rate | | 4.6 | % | 4.1 | % |
| Expected volatility | | 49.5 | % | 45.0 | % |
| Expected life (years) | | 6.3 | | 6.5 | |
| Expected dividend yield | | - | % | - | % |
The per share weighted-average fair value of stock options granted during the three months ended March 31, 2006 was $1.72. The Company’s volatility estimate, for each of the three months ended March 31, 2006 and 2005, was based on the Company’s historical daily volatility from April 1, 2003 (the day after the Company restated its 2002 and prior financial results) as well as the implied volatility of the Company’s exchange traded options. The estimated expected term was determined based on the formula described in Staff Accounting Bulletin No. 107 for estimating the expected term of “plain vanilla” options.
The following table summarizes information about the Company’s stock option transactions (options in thousands):
|
Shares
(in thousands)
| Weighted
Average
Exercise
Price
| Weighted-
Average
Remaining
Contractual
Term
(in years)
| Aggregate
Intrinsic
Value
(in thousands)
|
|---|
| Outstanding at December 31, 2005 | | | | 33,839 | | $ | 7.32 | | | | . | | | |
| Granted | | | | 4,206 | | | 3.19 | | | | | | | |
| Exercised | | | | (14 | ) | | 2.80 | | | | | | | |
| Cancelled | | | | (1,533 | ) | | 5.38 | | | | | | | |
|
| | | | |
| Outstanding at March 31, 2006 | | | | 36,498 | | $ | 6.91 | | | 4.2 | | $ | 367 | |
|
| | | | |
| Vested and expected to vest at March 31, 2006 | | | | 35,405 | | $ | 7.02 | | | 4.1 | | $ | 320 | |
|
| | | | |
| Exercisable at March 31, 2006 | | | | 31,405 | | $ | 7.52 | | | 3.4 | | $ | 132 | |
|
| | | | |
As of March 31, 2006, $6.7 million of total unrecognized compensation cost related to stock options is expected to be recognized over a weighted average period of 3.8 years.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with our MD&A included in our Annual Report on Form 10-K for the year ended December 31, 2005 filed with the Securities and Exchange Commission (“SEC”) on March 8, 2006 and all other filings, including current reports on Form 8-K, filed with the SEC after such date and through the date of this report. This MD&A should also be read in conjunction with the condensed consolidated financial statements and notes that appear elsewhere in this report.
Overview
Gemstar-TV Guide International, Inc. (“Gemstar” or the “Company”) is a media, entertainment and technology company that develops, licenses, markets and distributes technologies, products and services targeted at the television guidance and home entertainment needs of television viewers worldwide.
For the three months ended March 31, 2006, we generated revenue of $144.0 million (compared to $164.1 million in the same period in 2005), recorded net income of $8.6 million (compared to a net loss of $3.7 million in the same period in 2005) and had cash flow from operations of $28.5 million (compared to $(23.6) million in the same period in 2005).
The Company’s segments are organized along three industry lines, in addition to a segment comprising certain corporate functions and related expenses.
Cable and Satellite Segment.Our Cable and Satellite Segment includes the operations of TV Guide Channel, TV Guide Interactive, TVG Network, TV Guide Spot and TV Guide Mobile Entertainment. For the three months ended March 31, 2006, the Cable and Satellite Segment generated 49.9% of our total revenue. The Cable and Satellite Segment generates revenue primarily from affiliate and advertising fees received by TV Guide Channel, licensing revenue received by TV Guide Interactive and wagering and licensing fees received by TVG Network.
TV Guide Channel is an entertainment network that offers television guidance-related programming as well as program listings and descriptions. TV Guide Channel offers multiple system operators (“MSOs”) and digital broadcast satellite (“DBS”) providers a customized and localized television network, continuously delivering updated entertainment information that promotes the provider’s networks and services. During the quarter we continued our focus on improving the quality of our programming as the TV Guide Channel premiered 157 episodes, compared to 75 episodes during the same period in the prior year.
As of March 31, 2006, TV Guide Interactive domestic cable and satellite subscribers that receive either our interactive program guide (“IPG”) or another party’s IPG provided under a patent license for which we are paid increased by 20.8% as compared to March 31, 2005. This increase was primarily a result of increased digital penetration among our major MSO licensees and an increase in the number of DirecTV subscribers for which we are paid. This increase does not necessarily exactly correlate to increases in our IPG licensing revenue, due to the terms of certain license agreements.
TVG Network is a television network that combines live horse racing from many of the premier horse racetracks in the United States and other countries with the convenience of interactive wagering from home from certain states. For the three months ended March 31, 2006, TVG Network handled approximately $71.6 million in wagers, a 16.1% increase over the same period in the prior year. During April 2006, TVG Network launched its redesigned Web site (www.tvg.com), which provides convenient access for customers to establish an account, place wagers from certain states and take advantage of features such as free odds and results, an online handicapping store and up to the minute live race schedules.
TV Guide Spot is our on-demand service designed to entertain consumers while helping them navigate their ever-expanding programming choices. TV Guide Spot features short-form, originally-produced entertainment programs that guide consumers to the most compelling fare on TV each week. TV Guide Spot is now available to approximately 15.8 million Comcast, Insight and Time Warner digital cable subscribers. TV Guide Spot is also available to broadband users on TVGuide.com and to TiVo subscribers with stand-alone set-top boxes. TV Guide Spot will also be available to Cox Communications, Charter, Adelphia and Cablevision digital cable subscribers during 2006.
TV Guide Mobile Entertainment is our business unit focused on distributing our content and technology on mobile devices, including video enabled cell phones and personal digital assistants. In February 2006, TV Guide Mobile Entertainment began offering Cingular Video subscribers the opportunity to access a mobile, on demand version of TV Guide Channel.
Publishing Segment.Our Publishing Segment consists ofTV Guide magazine, TV Guide Online (www.tvguide.com), and TV Guide Data Solutions. For the three months ended March 31, 2006, our Publishing Segment generated 26.6% of our total revenue. Our Publishing Segment generates revenue primarily through subscription and newsstand sales ofTV Guide magazine and advertising revenue received byTV Guide magazine and TV Guide Online.
12
The first quarter of 2006 was the first full quarter of results for the full-sized, full-color,TV Guide magazine. The reformattedTV Guide magazine’s content is centered on TV-related news, feature stories, TV celebrity photos, behind-the-scenes coverage, reviews and recommendations and national television listings. The reformattedTV Guide is family-focused and targeted towards women ages 30 to 54. Weekly total circulation for the first quarter of 2006 averaged 4.1 million, exceeding the magazine’s advertising rate base of 3.2 million copies by 27%. We believe the new full-sizedTV Guide magazine is an enhanced, more targeted product for today’s television enthusiasts and is designed to yield higher subscription prices and higher advertising CPMs.
TV Guide Online (www.tvguide.com) is a TV information and guidance destination that provides consumers with a combination of entertainment news, TV programming, celebrity information, localized channel listings, editorial guidance, and community features. During the first quarter of 2006 we launched our new TV Guide Online search service. This TV search engine provides consumers with a uniquely comprehensive experience by fully integrating online video with the breadth and depth of TV Guide’s database of listings, show and episode descriptions, news, reviewers, ratings, podcasts,TV Guide magazine covers, and other contextual information, as well as video clips from certain networks. We also added over 3,000 new partner videos and added video clips from over 60 different shows from the major networks and cable as part of our daily editorial coverage. In addition, in April 2006 we launched an entertainment blog community. Over 60 entertainment blogs, primarily created and maintained by ourTV Guide magazine and TV Guide Online editorial staff, are now live on the site and every user can create his or her own blog using TVGuide.com’s simple blogging tools.
TV Guide Data Solutions is a data collection and distribution business that gathers and distributes program listings and channel lineups.
Consumer Electronics Licensing Segment.Our CE Licensing Segment earns revenue from licensing our proprietary technologies and services to the CE manufacturing industry. For the three months ended March 31, 2006, the CE Licensing Segment generated 23.5% of our total revenue. The CE Licensing Segment licenses video recording technology currently marketed under the VCR Plus+ Brand in North America and under other brands in Europe, Japan and Asia, and IPGs marketed under the G-Guide brand in Japan, under the Guide Plus+ brand in Europe and TV Guide On Screen brand in North America.
Our VCR Plus+ business continues to contribute a meaningful amount of revenue to the CE Licensing Segment. The life of our VCR Plus+ business has been extended by the incorporation of our VCR Plus+ technology in certain mid to low-end digital recorders.
Our CE IPG business continues to be strong in Japan. In Japan we also continue to see a transition for our IPG from primarily a recording feature in digital recorders to a guidance feature in television sets. In the first quarter of 2006, 76% of the 21 CE products incorporating our IPG released in the Japanese market were television sets. We believe this transition will continue throughout 2006.
In Europe, nine CE products incorporating our IPG were released in the first quarter of 2006. All of these products were digital recorders with hard drives. For the remainder of 2006, we believe we will see the number of products in Europe incorporating our IPG increase, as our IPG is integrated into a broader base of products with our key licensees.
In the North American market, eight CE products incorporating our IPG were released in the first quarter of 2006. The North American market differs from the Japanese and European markets in that our IPG is being incorporated primarily in high-end television sets as opposed to digital recorders. Of the eight products launched in 2006, six were high-end television sets, which typically have lower sales volumes than lower-priced devices.
Corporate. Our Corporate Segment includes corporate management, corporate legal, corporate finance and other functions and includes related costs such as certain litigation and insurance costs. Our Corporate Segment also includes our business development and product development and technology groups’ costs, to the extent that these costs support company-wide initiatives or to the extent they represent preliminary spending related to initiatives that have not been assigned to business segments.
13
Consolidated Results of Operations
The following table sets forth certain financial information for the three months ended March 31, 2006 and 2005 (in thousands):
| Three Months Ended
March 31,
| |
|---|
| 2006
| 2005
| Change
|
|---|
| Statement of Operations Data: | | | | | | | | | | | |
| Revenues | | | $ | 144,032 | | $ | 164,068 | | $ | (20,036 | ) |
| Operating expenses: | | |
| Operating expenses, exclusive of expenses shown below | | | | 128,333 | | | 154,144 | | | (25,811 | ) |
| Depreciation and amortization | | | | 7,961 | | | 6,924 | | | 1,037 | |
|
| |
| |
| |
| | | | | 136,294 | | | 161,068 | | | (24,774 | ) |
|
| |
| |
| |
| Operating income | | | | 7,738 | | | 3,000 | | | 4,738 | |
| Interest income, net | | | | 5,169 | | | 3,214 | | | 1,955 | |
| Other income, net | | | | 118 | | | 261 | | | (143 | ) |
|
| |
| |
| |
| Income from continuing operations before income taxes | | | | 13,025 | | | 6,475 | | | 6,550 | |
| Income tax expense | | | | 4,459 | | | 10,882 | | | (6,423 | ) |
|
| |
| |
| |
| Income (loss) from continuing operations | | | | 8,566 | | | (4,407 | ) | | 12,973 | |
| Discontinued operations: | | |
| Income from discontinued operations | | | | -- | | | 419 | | | (419 | ) |
| Income tax benefit | | | | -- | | | 239 | | | (239 | ) |
|
| |
| |
| |
| Income from discontinued operations | | | | -- | | | 658 | | | (658 | ) |
|
| |
| |
| |
| Net income (loss) | | | $ | 8,566 | | $ | (3,749 | ) | $ | 12,315 | |
|
| |
| |
| |
| Other Financial Data: | | | | | | | | | | | |
| Net cash provided by (used in): | | |
| Operating activities | | | $ | 28,536 | | $ | (23,642 | ) | $ | 52,178 | |
| Investing activities | | | | (4,596 | ) | | (7,572 | ) | | 2,976 | |
| Financing activities | | | | (95 | ) | | 1,278 | | | (1,373 | ) |
Discussion
For the three months ended March 31, 2006, revenues were $144.0 million, a decrease of $20.0 million, or 12.2%, compared to the same period in 2005. Revenues for our Publishing Segment decreased by $32.6 million. This decrease was partially offset by a $7.0 million and a $5.6 million increase in revenues for our Cable and Satellite Segment and CE Licensing Segment, respectively. Segment activities are discussed in greater detail in the “Segment Results of Operations,” elsewhere in this MD&A.
For the three months ended March 31, 2006, operating expenses were $128.3 million, a decrease of $25.8 million, or 16.7%, compared to the same period in 2005. The decrease was primarily due to a $26.8 million decrease in operating expenses at TV Guide magazine. Segment activities are discussed in greater detail in the “Segment Results of Operations,” elsewhere in the MD&A.
Interest income, net
For the three months ended March 31, 2006, interest income was $5.2 million, an increase of $2.0 million from the same period in 2005. This increase is due to higher prevailing interest rates.
Legal and Other Loss Contingencies
A significant amount of management estimation is required in determining when, or if, an accrual should be recorded for a contingent matter and the amount of such accrual, if any. Due to the uncertainty of determining the likelihood of a future event occurring and the potential financial statement impact of such an event, it is possible that upon further development or resolution of a contingent matter, a charge could be recorded in a future period that would be material to our consolidated results of operations and financial position.
Liabilities related to contingent matters at March 31, 2006 and December 31, 2005 were $24.3 million and $23.1 million, respectively.
Outside legal expenses were $6.2 million and $6.5 million for the three months ended March 31, 2006 and 2005, respectively. We expect outside legal expenses to continue to be significant for the foreseeable future.
Income Taxes
We have income both from foreign and domestic sources. In the preparation of our financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate, including estimating both our actual current tax exposure and assessing temporary differences resulting from differing treatment of items for tax and accounting purposes.
The overall effective tax rate we report in any single period is impacted by, among other things, the country in which earnings or losses arise, applicable statutory tax rates and withholding tax requirements for particular countries, the availability of net operating loss carryforwards and the availability of tax credits for taxes paid in certain jurisdictions. Because of these factors, our current and future tax expense or benefit as a percentage of income or loss before income taxes may vary from period to period.
14
To the extent that we have deferred tax assets, we must assess the likelihood that our deferred tax assets will be recovered from taxable temporary differences, tax strategies or future taxable income and to the extent that we believe that recovery is not likely, we must establish a valuation allowance. In the future, we may adjust our estimates of the amount of valuation allowance needed and such adjustment would impact our provision for income taxes in the period of such change.
The provision for income taxes as a percentage of income from continuing operations before income taxes was 34.2% for the three months ended March 31, 2006.
The provision for income taxes as a percentage of income from continuing operations before income taxes was 168.1% for the three months ended March 31, 2005. The Company’s effective tax rate in 2005 was impacted by a valuation allowance required for a deferred tax asset arising from the taxable income created by the advance payments received in the multi-year patent and license distribution agreements with EchoStar and Comcast Corporation (“Comcast”), which were entered into in 2004. While these advances were received during 2004, a substantial portion of these advances became taxable to the Company during 2005 under current tax regulations.
Segment Results of Operations
Our business segments are organized along three industry lines, in addition to a segment comprising certain corporate functions and related expenses. Intersegment revenues and expenses have been eliminated from segment financial information as transactions between reportable segments are excluded from the measure of segment profit and loss reviewed by the chief operating decision maker. Segment information for the three months ended March 31, 2006 and 2005 is presented and reconciled to consolidated income from continuing operations before income taxes in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, in Note 8 of the condensed consolidated financial statements. Discussion relating to operating expenses for our segments uses the definition of operating expenses included in Note 8.
Cable and Satellite Segment
For the three months ended March 31, 2006, revenues for this segment were $71.8 million, an increase of $7.0 million, or 10.8%, compared to the same period in 2005.
The following table shows the breakdown of revenues in the Cable and Satellite Segment by business unit (in thousands):
| Three Months Ended
March 31,
|
Change
|
|---|
| 2006
| 2005
| Dollars
| Percent
|
|---|
| Cable and Satellite Segment: | | | | | | | | | | | | | | |
| TV Guide Channel | | | $ | 35,397 | | $ | 32,805 | | $ | 2,592 | | | 7.9 | % |
| TV Guide Interactive | | | | 25,958 | | | 23,578 | | | 2,380 | | | 10.1 | % |
| TVG Network | | | | 10,426 | | | 8,409 | | | 2,017 | | | 24.0 | % |
| Other | | | | 31 | | | 21 | | | 10 | | | 47.6 | % |
|
| |
| |
| | | |
| Total | | | $ | 71,812 | | $ | 64,813 | | $ | 6,999 | | | 10.8 | % |
|
| |
| |
| | | |
For the three months ended March 31, 2006, TV Guide Channel advertising revenue increased $2.3 million, primarily due to improved advertising inventory management and higher unit rates. We believe our advertising revenues will continue to grow due to our efforts to increase viewership by continuing to improve the quality of our programming.
Affiliate revenues increased by $0.3 million or 6.0%. Future TV Guide Channel revenue growth will be largely dependent on our ability to grow advertising revenues, as the majority of our affiliates are contracted under long-term agreements with only cost-of-living increases available under certain contracts.
For the three months ended March 31, 2006, TV Guide Interactive revenues increased by $2.4 million, or 10.1%, when compared to the same period in 2005. This increase was primarily due to a $3.3 million or 15.0% increase in licensing revenue due to an increase in the number of domestic cable and satellite subscribers that receive either our IPG or another party’s IPG provided under a patent license for which we are paid.
In the first quarter of 2006, we entered into a service agreement with Cox Communications to deploy our IPGs in the future. We anticipate recognizing revenue from the deployment of our IPGs pursuant to this service agreement beginning in the second half of 2007. In addition, in April 2006, we extended our relationship with Charter Communications (“Charter”) by entering into a long-term agreement to deploy i-Guide. Charter will deploy i-Guide in Motorola set-top boxes and in Scientific Atlanta set-top boxes when i-Guide is available on that platform. This is anticipated to occur in the second half of 2007. After taking into account the revenue increase resulting from these two agreements, due to the fact that we have licensed our IPG technology to most major domestic cable and satellite providers, our future revenue growth will largely depend upon the overall growth in domestic digital cable and satellite subscribers. In addition, penetrating international markets could provide additional growth opportunities.
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IPG advertising revenues for the three months ended March 31, 2006 decreased by $0.9 million or 56.4%, as compared to the same period in 2005. This decrease is due to the MSO that provided us with the majority of our advertising carriage in the first quarter of 2005 not carrying IPG advertising on the majority of its systems in 2006. Our ability to provide IPG advertising is generally at the discretion of the MSO and DBS providers if they deploy their own IPG or a third party IPG, which is the case for the majority of subscribers for which we are paid a license fee. Our ability to increase advertising revenue in future periods is largely dependent on the development of an IPG advertising platform that is accepted by MSOs and DBS providers, advertisers and consumers.
For the three months ended March 31, 2006, TVG Network, our interactive cable and satellite television network focused on horseracing, increased revenues by $2.0 million or 24.0%, as compared to the same period in 2005. This growth reflects increased wagering volumes for both our wagering operations and the wagering operations of our licensees. Our wagering operations and the wagering operations of our licensees have benefited from our continued growth in household distribution. As of March 31, 2006, TVG Network was available in approximately 18.1 million domestic cable and satellite homes, an increase of 20.7% as compared to March 31, 2005. Additionally, TVG Network is carried on Fox Sports Net in approximately 5.0 million southern California homes for two hours or more, five days a week.
Operating expenses in this segment were $45.2 million for the three months ended March 31, 2006, an increase of $0.7 million, or 1.5%, from the same period last year. This increase was primarily due to a $2.2 million increase in TV Guide Channel programming and marketing expenses.
Additional Cable and Satellite Segment Operating Statistics
| As of
|
|---|
Subscriber Data (in thousands) (1)
| March 31,
2006
| Dec. 31,
2005
| March 31,
2005
| Dec. 31,
2004
|
|---|
| | | | |
|---|
| TV Guide Channel | | 77,954 | | 77,353 | | 76,911 | | 76,667 | |
| Cable and Satellite Technology Licenses | | 41,699 | | 39,372 | | 34,511 | | 32,659 | |
| TVG Network | | 18,100 | | 18,000 | | 15,000 | | 14,300 | |
(1) Subscriber data represents:
| • | | Nielsen households for the domestic TV Guide Channel |
| • | | Cable and Satellite Technology Licenses reported by domestic cable and satellite subscribers that receive either our IPG or another party’s IPG provided under a patent license for which we are paid |
| • | | Households for TVG Network, based primarily on information provided by distributors |
Publishing Segment
For the three months ended March 31, 2006, revenues for this segment were $38.4 million, a decrease of $32.6 million, or 46.0%, compared to the same period last year. The decrease was primarily due to decreases in revenues associated with the reformattedTV Guide magazine, which was relaunched in October 2005.
The following table shows the breakdown of revenues in the Publishing Segment by business unit (in thousands):
| Three Months Ended
March 31,
|
Change
|
|---|
| 2006
| 2005
| Dollars
| Percent
|
|---|
| Publishing Segment: | | | | | | | | | | | | | | |
| TV Guide magazine | | | $ | 35,480 | | $ | 68,981 | | $ | (33,501 | ) | | (48.6 | )% |
| TV Guide Online | | | | 2,731 | | | 1,933 | | | 798 | | | 41.3 | |
| Other | | | | 158 | | | 91 | | | 67 | | | 73.6 | |
|
| |
| |
| | | |
| Total | | | $ | 38,369 | | $ | 71,005 | | $ | (32,636 | ) | | (46.0 | )% |
|
| |
| |
| | | |
The first quarter of 2006 was the first full quarter of results for the full-sized, full-color,TV Guide magazine. During the comparable quarter for 2005, we were publishing our digest formatTV Guide. It is difficult to make meaningful comparisons between the financial results of the legacy digest and the new full-sized magazine, given the significant differences in the products and their business models.
16
The reformattedTV Guide magazine’s content is centered on TV-related news, feature stories, TV celebrity photos, behind-the-scenes coverage, reviews and recommendations and national television listings. The reformattedTV Guide is family-focused and targeted towards women ages 30 to 54. The magazine is published as one national edition, with either an Eastern/Central or a Pacific time zone designation. The reformattedTV Guide magazine is produced with a shorter editorial cycle than its predecessor, the digest formatTV Guide. This enables the magazine to be more timely and topical. The newsstand cover price is now $1.99. The reformattedTV Guide is designed to be a publication that can command a higher CPM from program and conventional advertisers due to its enhanced format, improved circulation mix, and more focused and relevant demographic. The reformattedTV Guide magazine’s advertising rate base, the volume of circulation guaranteed to advertisers, is 3.2 million.
By comparison, during the first quarter of 2005, we published approximately 140 local editions of the digest formatTV Guideand offered it at a newsstand cover price of $2.49. The digest formatTV Guide was focused on grid listings and had substantially less feature content. While there were more ad pages per copy, the digest formatTV Guide appealed to conventional advertisers seeking to reach a very large circulation base and mass audience at low CPMs, as well as to networks for localized black and white tune-in advertising that benefited local affiliates. Our rate base was 9 million and included approximately 2.9 million in sponsored copies. Due to the efficiencies in reaching our mass audience, our largest sources of conventional advertising were from the packaged goods and pharmaceutical industries as well as direct response advertisers.
The decrease inTV Guide magazine’s rate base from 9.0 to 3.2 million has been by design. Since the October 2005 relaunch, we have eliminated most of our non-contributing sponsored copies. We have also eliminated many subscription offers and sources that do not support our new pricing model and circulation strategies, such as the use of heavily discounted promotional offers and certain agent sources. While we over delivered on our circulation base during the first quarter of 2006, we anticipate we will manage down our average weekly total circulation to 3.2 million by the end of 2006 as we continue to focus on improving the quality of our subscriber file.
As a result of our efforts to manage down our circulation base, subscriber revenues for the three months ended March 31, 2006, declined by $10.6 million or 29.3%, when compared to the same period in the prior year. Our average weekly-paid subscribers during the three months ended March 31, 2006, decreased by 35.4% compared to the same period in the prior year. However, the impact on revenue from the decrease in average weekly-paid subscribers was partially offset by a 9.4% increase in subscriber revenue per copy. We believe this result is an indication that our new circulation strategy is working. We also believe that our subscriber revenue per copy will continue to rise as a result of our on-going focus on improving subscriber quality.
Newsstand revenues, for the three months ended March 31, 2006, decreased by $4.8 million or 88.4%, as compared to the same period in the prior year. This decline was primarily due to our lower cover price ($1.99 vs. $2.49 for the digest) as well as $2.3 million in initial placement order (“IPO”) fees associated with acquiring new rack space for the full-sizedTV Guide. Emerging Issues Task Force Issue No. 01-09: Accounting for Consideration Given by a Vendor to a Customer requires certain consideration given by a vendor to a customer to be recorded as a reduction in revenue. As a result, TV Guide magazine revenues have been reported net of rack costs, retail display allowances, distribution fees and IPO fees.
Advertising revenues, for the three months ended March 31, 2006 compared to the same period in 2005, decreased by $17.8 million or 67.1%. A steep decrease in rate base, significantly increased CPMs, and the time necessary to gain advertiser consideration and acceptance of the new full-sizedTV Guidemagazine all contributed to the anticipated decrease in ad revenue and ad pages. While ad revenues declined, we have been able to successfully increase our CPM’s. Our goal is to increase ad page volume while maintaining strong CPMs. We anticipate that advertising revenues in the second quarter of 2006 will be consistent with the first quarter of 2006. We believe our ad page volume and advertising revenue will begin to increase in the third and fourth quarters of 2006, as the fall preview TV season gets underway and we are able to demonstrate our circulation and audience projections to the advertising community.
We anticipate that we will incur operating losses in conjunction with TV Guide magazine operations of approximately $30 million to $36 million during the remainder of 2006. Included in these losses are the anticipated costs of new rack acquisitions, consumer marketing and promotion programs. We incurred approximately $14 million in operating losses for the three months ended March 31, 2006.
We believe the reformattedTV Guide magazine will begin to contribute positively to the Publishing Segment’s adjusted EBITDA in the latter half of 2008.
TV Guide Online derives revenues primarily from advertising. For the three months ended March 31, 2006, advertising revenues increased by $0.8 million, or 40.6%, compared to the same period in 2005. These increases were driven by increases in both program and conventional advertising. During the three months ended March 31, 2006, TV Guide Online increased its unique users by 23% as compared to the same period in the prior year. We believe we can continue to increase our unique users by expanding our content offerings and syndicating our content to third party Web sites.
Operating expenses in this segment were $52.0 million for the three months ended March 31, 2006, a decrease of $27.4 million from the same period last year. This decrease was primarily due to a $16.7 million decrease in TV Guide magazine production costs, primarily due to a decrease in printed copies, and a $10.1 million decrease in TV Guide magazine operating costs associated with the reformattedTV Guide magazine.
17
Additional Publishing Segment Operating Statistics
| March 31,
2006
| Dec. 31,
2005 (3)
| March 31,
2005 (4)
| Dec. 31,
2004 (4)
|
|---|
| (in thousands) |
|---|
| TV Guide magazine circulation (1) | | | | | | | | | |
| Newsstand (2) | | 307 | | 401 | | 311 | | 349 | |
| Subscriptions | | 3,747 | | 4,575 | | 5,799 | | 5,707 | |
| Sponsored/arrears | | 17 | | 604 | | 2,921 | | 2,996 | |
|
| |
| |
| |
| |
| | | 4,071 | | 5,580 | | 9,031 | | 9,052 | |
|
| |
| |
| |
| |
(1) Average weekly circulation for the three months ended.
(2) Current period numbers include an estimate for returns. Prior period numbers are updated to reflect actual returns.
(3) Includes two issues of the digest formatTV Guide magazine.
(4) Results are for the digest formatTV Guide magazine.
Consumer Electronic Licensing Segment
For the three months ended March 31, 2006, revenues in this segment were $33.9 million, an increase of $5.6 million, or 19.8%, compared to the same period in 2005.
The following table shows the breakdown of revenues in the CE Licensing Segment by product (in thousands):
| Three Months Ended
March 31,
|
Change
|
|---|
| 2006
| 2005
| Dollars
| Percent
|
|---|
| CE Licensing Segment: | | | | | | | | | | | | | | |
| VCR Plus+ | | | $ | 15,740 | | $ | 14,112 | | $ | 1,628 | | | 11.5 | % |
| CE IPG | | | | 16,855 | | | 11,444 | | | 5,411 | | | 47.3 | % |
| Other | | | | 1,256 | | | 2,694 | | | (1,438 | ) | | (53.4 | )% |
|
| |
| |
| | | |
| Total | | | $ | 33,851 | | $ | 28,250 | | $ | 5,601 | | | 19.8 | % |
|
| |
| |
| | | |
Our VCR Plus+ business includes technology, marketed under the VCR Plus+ brand in North America, the G-Code brand in Japan and Asia and the Video Plus+/ShowView brand in Europe, which is incorporated in CE products. For the three months ended March 31, 2006, revenues increased by $1.6 million, or 11.5% compared to the same period in 2005. Contributing to this increase was a new agreement with a large CE manufacturer who had not had a VCR Plus+ agreement with us for over a year. Under a new multi-product agreement, subject to certain limitations, we have granted the CE manufacturer a license to incorporate VCR Plus+ and certain of our other products and technologies into an unlimited number of CE devices over a fixed period of time. We will recognize revenue under this agreement on a straight line basis, with revenue allocated among our product lines based on the licensee’s unit shipments during the prior quarter. Also contributing to this increase was the recognition of $1.6 million of minimum revenue guarantees in 2006, compared to $0.6 million for the same period in the prior year. Minimum revenue guarantees are recorded when the guarantee period expires. Although VCR Plus+ revenues have stabilized, we anticipate that some time in the future consumers will demand more advanced guidance and recording technologies in digital devices as the cost of these technologies decreases. While this will likely decrease the demand for VCR Plus+, we believe this demand will increase our CE IPG revenues and offset the decrease in VCR Plus + revenues.
Our CE IPG business includes (i) our IPG incorporated in CE products under the TV Guide On Screen brand in North America, G-GUIDE brand in Japan and GUIDE Plus+ brand in Europe; and (ii) IPG patent licenses with third parties other than cable and satellite service providers. Revenues from our IPG incorporated in CE products increased by $2.0 million or 42.2% as compared to the same period in the prior year. This increase was primarily driven by increases in revenues from the incorporation of our IPG in CE products sold in Europe and North America. We believe we will see the majority of our revenue growth for the remainder of 2006 from the incorporation of our IPG technology in products sold in Europe and Japan. The North American IPG market is dominated by DBS and MSO provided IPGs. While we believe in the long term prospects of the North American CE IPG market, the low take up rate for cable cards and the prevalence of alternative IPGs (generally licensed by us and recognized in the Cable and Satellite Segment) means that growth in our North American CE IPG business will be slower to materialize. Revenues from IPG patent licenses with third parties other than cable and satellite service providers increased by $3.1 million or 51.0%, as compared to the same period in the prior year. This increase was primarily due to revenues from set-top box shipments by Scientific Atlanta, Inc., which did not occur in the prior year, as well as an allocation of revenues from the new agreement referred to above. Revenue from IPG patent licenses also includes the continued amortization of up-front payments received under long-term patent licenses; $4.3 million for each of the quarters ending March 31, 2006 and 2005.
18
For the three months ended March 31, 2006, operating expenses in this segment were $12.9 million, a decrease of $1.8 million, or 12.0%, when compared to the same period in 2005. This decrease is primarily due to $1.3 million in severance costs being recorded in the prior year’s quarter.
Corporate Segment
For the three months ended March 31, 2006, corporate expenses were $17.9 million, an increase of $2.4 million or 15.9% as compared to the same period in the prior year. The increase in corporate expenses was primarily due to an increase in consulting costs related to strategic initiatives, such as implementing Oracle as our centralized financial system and an increase in general compensation and related expenses.
Liquidity and Capital Resources
As of March 31, 2006, our cash, cash equivalents and marketable securities were $498.3 million. In addition, we had restricted cash of $39.7 million maintained in segregated, interest-bearing accounts. Of this amount, $38.7 million relates to the November 2002 management and corporate restructuring, which is described in Note 3 of the condensed consolidated financial statements.
Net cash flows provided by operating activities were $28.5 million for the three months ended March 31, 2006 compared to cash used of $23.6 million for the same period last year. The increase was primarily due to us receiving $52.4 million in income tax refunds during the three months ended March 31, 2006.
We anticipate that we will incur operating losses in conjunction with TV Guide magazine operations of approximately $30 million to $36 million during the remainder of 2006.
Net cash flows used in investing activities were $4.6 million for the three months ended March 31, 2006 compared to $7.6 million used in the same period last year. The decrease is primarily due to a $5.0 million reduction in net marketable securities purchases.
We intend to pursue various strategic initiatives to better position ourselves as the leading consumer brand for video guidance across multiple platforms. We anticipate that these initiatives will result in additional operating and capital expenditures. For the remainder of 2006 we plan to make capital expenditures of approximately $37.0 million to $42.0 million. This spending primarily relates to enhancing our data infrastructure, building a digital content infrastructure, increasing production infrastructure for TV Guide Channel and upgrading our systems and information technology infrastructure, including implementing Oracle. In addition to these capital expenditures, we anticipate operating expenses associated with these initiatives, and for additional research and development activities, of approximately $15 million to $20 million, for the remainder of 2006. As with our business development and product development and technology groups’ costs, to the extent that these costs support company-wide initiatives or to the extent that they represent preliminary spending related to initiatives that have not been assigned to business segments, these costs will likely be included in operating expenses in our Corporate Segment.
Net cash flows used in financing activities were $0.1 million for the three months ended March 31, 2006, compared to cash provided of $1.3 million for the same period last year. The decrease in cash provided from finance activities is due to a $1.4 million decrease in proceeds from the exercise of stock options.
We receive nonrefundable prepaid license fees from certain licensees. Prepaid subscriptions and license fees are included in deferred revenue on the condensed consolidated balance sheets. As of March 31, 2006, current and long-term deferred revenue totaled $541.5 million. Our liability for prepaid magazine subscriptions is limited to the unearned payments in the event customers cancel their subscriptions. Our liability for other payments is limited to a refund of unearned payments in the event that we are unable to provide service. No material refunds have been paid to date.
We anticipate reducing deferred revenues by approximately $75.0 million to $85.0 million in 2006 primarily from the recognition of deferred revenue. Included in the estimate above is a $15.0 million to $20.0 million reduction in TV Guide magazine’s deferred subscription revenues due to the planned decline of the paid subscriber base during 2006.
The IRS is currently examining our U.S. federal tax returns for years 2002 and 2003. The results of this and future IRS examinations may result in the recognition of significant amounts of income or significant cash outlays in future periods. We believe that adequate reserves have been made for any adjustment that might be assessed for open years.
We do not engage in any off-balance sheet financing arrangements. In particular, we do not have any interest in so-called limited purpose entities, which include special purpose entities and structured finance entities.
Based on past performance and future expectations, we believe existing cash, cash equivalents and marketable securities balances will be sufficient to satisfy our expected working capital and capital expenditure requirements in the foreseeable future.
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Critical Accounting Policies and Estimates
This MD&A is based on our condensed consolidated financial statements, which have been prepared in conformity with U.S. generally accepted accounting principles. The preparation of our financial statements requires management to make estimates and assumptions in applying certain critical accounting policies. Certain accounting estimates are particularly sensitive because of their significance to our consolidated financial statements and because of the possibility that future events affecting the estimates could differ markedly from our current expectations.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur could materially change the financial statements. Management believes there have been no significant changes during the three month period ended March 31, 2006 to the items that we disclosed as our critical accounting policies and estimates in the MD&A in our Annual Report on Form 10-K for the year ended December 31, 2005.
Cautionary Statement for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995
Our MD&A section and other portions of this Form 10-Q contain various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent the Company’s expectations or beliefs concerning future events. Statements containing expressions such as “may,” “will,” “continues,” “believes,” “intends,” “anticipates,” “estimates,” “plans” or “expects” used in the Company’s periodic reports on Forms 10-K, 10-Q and 8-K filed with the SEC are intended to identify forward-looking statements. The Company cautions that these and similar statements included in this report and in previously filed periodic reports including reports filed on Forms 10-K, 10-Q and 8-K are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements, including, without limitation, those referred to below in “Certain Risks Affecting Business, Operating Results and Financial Condition” and elsewhere in this Form 10-Q. Such statements reflect the current views of the Company or its management with respect to future events and are subject to certain risks, uncertainties and assumptions including, but not limited to those discussed below. Such factors, together with the other information in this Form 10-Q, should be considered carefully in evaluating an investment in the Company’s common stock. The cautionary statements contained or referred to in this section should be considered in connection with any subsequent written or oral forward-looking statements that the Company or persons acting on the Company’s behalf may issue. The Company undertakes no obligation to revise any forward-looking statements to reflect events or circumstances after the date of this report.
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CERTAIN RISKS AFFECTING BUSINESS,OPERATING
RESULTS AND FINANCIAL CONDITION
This section highlights some specific risks affecting our business, operating results and financial condition. The list of risks is not intended to be exhaustive and the order in which the risks appear is not intended as an indication of their relative weight or importance.
We face risks arising from the transformation of our TV Guide magazine publishing business.
Prior to the re-launch ofTV Guidemagazine in a full-sized, full-color format in October 2005, the operating results of our magazine publishing business had deteriorated over a period of several years due to significant declines in the digest formatTV Guide magazine’s newsstand sales, contribution per copy, and advertising revenue. Prior to the re-launch, we sought to reverse such declines through a variety of different initiatives, including editorial changes and aggressive promotional offerings. However, those efforts were unsuccessful. Consequently, during the fourth quarter of 2005 we transformed ourTV Guide magazine from a digest-sized, listings oriented format to a more contemporary full-sized, full-color magazine, filled with more features and photos and targeted at a younger demographic. However, several other widely circulated magazines and other media outlets seek to appeal to this market segment and there can be no assurance that the transformed magazine will appeal to or be accepted by this market segment or the advertisers who seek to reach it. A business initiative of this scale is inherently risky and there can be no assurance that our assumptions are valid or that our circulation goals can be achieved. Additionally, the cost of transforming the magazine will be substantial, and that should this effort fail, the cost of pursuing other alternatives will be significant. We cannot assure that we will be successful in transforming the magazine or that the transformed magazine or our magazine publishing business will achieve profitability.
We face risks arising from our TV Guide Channel strategy.
Revenues at TV Guide Channel consist of affiliate fees and advertising revenues; however, since the majority of our affiliates are contracted under long-term agreements with only cost-of-living increases available under certain contracts; we do not expect significant growth in affiliate revenues in the future. Accordingly, the results at TV Guide Channel are highly dependent upon advertising revenue. Advertising revenue at the TV Guide Channel is primarily dependent on the extent of distribution of the network, viewership ratings, such as those published by Nielsen, and continuing advertising strength in the marketplace. While TV Guide Channel has benefited, to a certain degree, from the expanded distribution that we have achieved, a significant portion of the expanded distribution has been to DBS subscribers, who did not previously have TV Guide Channel as a programming choice. Digital cable and DBS homes also have many more channels and generally use an IPG for listing information. As such, the viewership of TV Guide Channel in digital cable and DBS homes has been minimal to date. We have been investing in new programming and marketing initiatives at the TV Guide Channel with an expectation that the additional investments that we are making in programming and marketing will, in the future, result in increased viewership in both cable and DBS homes. If our viewership ratings do not improve sufficiently or we are unable to maintain broad distribution of the TV Guide Channel, our increased programming and marketing costs could have a material adverse effect on our Cable and Satellite Segment results of operations. Also, certain of the long-term agreements with MSOs for the TV Guide Channel allow for the migration to exclusively digital carriage. If the MSO elects to migrate TV Guide Channel earlier than we currently expect, the Company will experience a significant reduction of TV Guide Channel subscribers resulting in reduced license fee revenue and potentially reduced advertising revenue. We cannot assure you that we will be successful in implementing our programming and marketing initiatives, or that such initiatives will result in increased viewership ratings and advertising revenues for TV Guide Channel or that any initial increase in viewership ratings will be sustainable over time.
TV Guide Spot may be unsuccessful and may adversely affect our results.
We recently launched TV Guide Spot, an on-demand, cross-platform network featuring originally-produced sponsored, short-form video entertainment programs that provide television guidance. The success of the network is largely dependent on factors such as the extent of distribution of the network as well as market and advertiser acceptance of sponsored short-form on-demand entertainment. We cannot assure you that we will be successful in our initiative or that such initiatives will generate significant revenues or ultimately be profitable.
The market for interactive program guides may not expand rapidly.
The market for IPGs is rapidly evolving and is increasingly competitive. Demand and market acceptance for IPGs are subject to uncertainty and risk. We cannot predict whether, or how fast, this market will grow, how long it can be sustained, or how it may expand or change. For our CE IPGs, the deployment rate depends on the strength or weakness of the consumer electronics industry, and in particular, the sale of television sets, DVD recorders and DVRs. Purchases of CE products and digital cable and DBS subscriptions are largely discretionary and may be affected by general economic trends in the countries or regions in which these products or subscriptions are offered. For TV Guide Interactive, which is deployed primarily through domestic digital set-top boxes, due to the fact that we have licensed our IPG technology to most major domestic cable and satellite providers, our future revenue growth will largely depend upon the overall growth in domestic digital cable and satellite subscribers. If the market for our IPGs, and those of our licensees, develops slowly or becomes saturated with competitors, our operating results could be adversely impacted.
The market for IPG advertising may not develop.
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Our ability to provide IPG advertising is at the discretion of the MSO and DBS providers who have entered into license agreements to deploy their own IPG or a third party IPG. Our ability to increase the revenues that we derive from the sale of advertising on IPGs distributed by our cable and satellite licensees will depend on the implementation of IPG advertising by such licensees, as well as on increased acceptance of IPG advertising by consumers and advertisers. The market for IPG advertising is at an early stage of development and we cannot assure you that we will succeed in our efforts to develop IPG advertising as a widely accepted advertising medium. The MSO that provided us with the majority of our advertising carriage in 2005 is no longer carrying IPG advertising on the majority of its systems.
Our business may be adversely affected by fluctuations in demand for consumer electronics devices incorporating our technologies.
We derive significant revenues from manufacturer license fees for our VCR Plus+ and CE IPG technologies based on the number of units shipped. We do not manufacture hardware, but rather depend on the cooperation of CE manufacturers to incorporate our technology into their products. Generally, our license agreements do not require manufacturers to include our technology in any specific number or percentage of units, and only a few of these agreements guarantee a minimum aggregate licensing fee. Demand for new CE devices, including television sets, integrated satellite receiver decoders, DVRs, DVD recorders, personal computers and Internet appliances, may be adversely impacted by increasing market saturation, durability of products in the marketplace, new competing products and alternate consumer entertainment options. As a result, our future operating results may be adversely impacted by fluctuations in sales of CE devices employing our technologies.
VCR Plus+ revenues have declined over time and may decline further.
The worldwide shipment of VCRs has, and is expected to continue to decline as VCRs are replaced by digital recording devices such as DVD recorders and DVRs. Although VCR Plus+ is now being incorporated into some lower price point digital recording devices, there is no assurance that this practice will become widespread or continue. Furthermore, in order to encourage the incorporation of our IPG in CE products, we are offering certain large CE manufacturers the opportunity to bundle both our IPG and VCR Plus+ technology at a significant discount beginning with sales reported in fiscal 2005. While we believe this will ultimately accelerate the incorporation of our IPG to our benefit, there can be no assurance that this will be the case. In addition, there can be no assurance that we will be able to renew our existing VCR Plus+ agreements as they expire, upon terms as favorable to us as those contained in prior contracts, or at all.
We face competition in many areas and the competition could negatively impact our operating results.
We face competition from a wide range of other companies in the communications, advertising, media, entertainment, publishing, information, Internet services, software and technology fields. The competitive environment could, among other results, require price reductions for our products and services, require increased spending on marketing and development, limit our ability to develop new products and services, limit our ability to acquire rights to produce and/or display content that is popular among our targeted audience, limit our ability to expand our customer base or even result in attrition in our customer base. Any of these occurrences could negatively impact our operating results. Many of our competitors have greater financial and human resources than we do. As a result, these competitors can compete more effectively by offering customers better pricing and other more favorable terms and conditions. Our IPGs face competition from companies that produce and market program guides as well as television schedule information in a variety of formats, both print and electronic. Several products and services on the market offer simplified VCR programming functions that compete with our VCR Plus+ system.TV Guide magazine competes with general entertainment and other magazines at newsstand and for subscribers. The TV Guide Channel competes with general entertainment channels for television viewership and carriage on cable and DBS systems. TV Guide Online competes with general entertainment Web sites for visitors and will compete with established online search providers. Each ofTV Guide magazine, TV Guide Channel and TV Guide Online vie for marketers’ advertising spend with other media outlets. TVG Network competes for viewers with other television networks, one of which is under common ownership with several racetracks and accepts wagers from residents of more states than TVG Network accepts. In addition, TVG Network and its licensees compete for wagering revenue with other account wagering operations and industry participants.
New products and services, rapid technological change and changes in consumer demand may adversely affect our operations.
The emergence of new consumer entertainment products, services and technologies, changes in consumer preferences and other factors may limit the life cycle of our products, services and technologies and any future products, services or technologies we might develop. Although we believe that we will continue to develop attractive new products and services, the industries in which we operate are characterized by rapid changes, including technological changes and changes in consumer demand. Our future operations could be adversely impacted by our ability to identify emerging trends in our markets and to develop and market new products and services that respond to competitive offerings, technological changes and changing consumer preferences in a timely manner and at competitive costs.
Our investments in developing new products and services, improving existing products and services, and enhancing infrastructure may not be effective.
We have recently established a new product group to enhance the Company’s product development efforts. The process of developing and marketing new products and services is inherently complex and uncertain, and there are a number of risks, including the following:
| • | | we cannot assure you that the level of funding and significant resources we are committing for investments in new products, services, technologies and initiatives will be sufficient or result in successful new products, services or technologies; |
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| • | | we cannot assure you that we can anticipate successfully the new products, services and technologies which will gain the market acceptance necessary to generate significant revenues; |
| • | | we cannot assure you that our newly developed products, services or technologies can be successfully protected as proprietary intellectual property rights or will not infringe the intellectual property rights of others; and |
| • | | our products, services and technologies may become obsolete due to rapid advancements in technology and changes in consumer preferences. |
Furthermore, we have made significant investments in the development of new products, services and technologies, such as our initiatives to transformTV Guide magazine, enhance TV Guide Channel’s programming, launch TV Guide Spot, create TV Guide Mobile and other digital media initiatives, and increase and enhance the functionality of our interactive products, but the success of such products, services and technologies is largely dependent on factors such as market acceptance. Furthermore, the success of TV Guide Channel, TV Guide Spot and TV Guide Mobile will depend, in part, upon our ability to enter into and maintain agreements with third parties to distribute these services to consumers. Our failure to anticipate adequately changes in the industries in which we operate and the markets we serve, and to develop attractive new products and services, including any of the risks described above, may reduce our future growth and profitability and may adversely affect our business results and financial condition.
Additionally, we have made and expect to make significant investments in infrastructure, tools, systems, technologies and content, including initiatives relating to digital asset and rights management and data warehouses, aimed to create, assist in the development or operation of, or enhance our ability to deliver, innovative guidance products and services across multiple media, digital and emerging platforms. These investments may ultimately cost more than is anticipated, their implementation may take longer than expected and they may not meaningfully contribute to or result in successful new or enhanced products, services or technologies.
We are also investing in integrated financial, contract management and reporting systems, aimed to support our current and future businesses, as well as to enhance our operational and corporate infrastructure. These additional infrastructure investments may ultimately cost more than is anticipated, their implementation may take longer than we expect or they may otherwise fail to meet our needs and expectations.
Any infringement by us or some of our licensees on patent rights of others could affect the development of our products and services or result in litigation.
Patents of third parties may have an important bearing on our ability to offer some of our products and services. Many of our competitors as well as other companies and individuals have obtained, and may be expected to obtain in the future, patents that concern products or services related to the types of products and services we plan to offer. We may not be aware of all patents containing claims that may pose a risk of infringement by our products and services. In addition, in the United States, patent applications are generally confidential for a period of 18 months from the filing date, or until a patent is issued in some cases, so we cannot evaluate the extent to which our products and services may be covered or asserted to be covered by claims contained in pending patent applications prior to their publication. If one or more of our products or services is found to infringe patents held by others, we may be required to stop developing or marketing the products or services, to obtain licenses to develop and market the products or services from the holders of the patents or to redesign the products or services in such a way as to avoid infringing the patent claims. We cannot assess the extent to which we may be required in the future to obtain licenses with respect to patents held by others and whether the licenses would be available or, if available, whether we would be able to obtain the licenses on commercially reasonable terms. If we were unable to obtain the licenses, we might not be able to redesign our products or services to avoid infringement. Furthermore, we provide indemnification protection to some of our CE IPG licensees and to some of our MSO and DBS provider licensees under which we may be obligated to indemnify those licensees and hold them harmless from some claims, including claims that our or their products or services infringe other parties’ patents. During the second quarter of 2005, the Company received notice of such indemnification claims from one of its licensees. The costs of investigating, defending or remedying alleged infringement could be substantial and could have a material adverse effect on our financial condition or results of operations.
Some terms of our agreements with licensees could be interpreted in a manner that could adversely affect licensing revenue payable to us under those agreements.
Some of our agreements with CE manufacturers, cable and satellite service providers and other licensees contain “most favored nation” clauses. These clauses typically provide that if we enter into an agreement with another licensee on more favorable terms, we must offer some of those terms to our existing licensee. We have entered into a number of license agreements with terms that differ in some respects from those contained in other agreements. These agreements may obligate us to provide different terms to licensees, which could, if applied, result in lower revenues or otherwise adversely affect our business, financial condition, results of operations or prospects. While we believe that we have appropriately accounted for the most favored nation terms included in our license agreements, these contracts are complex and other parties could reach a different conclusion that, if correct, could have an adverse effect on our financial condition or results of operations.
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Dependence on the cooperation of MSOs and DBS providers, television broadcasters, hardware manufacturers, publications, data providers and delivery mechanisms could adversely affect our revenues.
We rely on third party providers to deliver our CE IPG data to CE devices that include our CE IPG. Further, our national data network provides customized and localized listings to our IPG service for MSOs and DBS providers and licensees of our data used in third party IPGs for MSOs and DBS providers. There can be no assurance that these delivery mechanisms will distribute the data without error or that the agreements that govern some of these relationships can be maintained on favorable economic terms.
To deliver our CE IPG data to CE devices, we have arrangements to carry our data in a part of the television signal called the vertical blanking interval (“VBI”) or its digital signal equivalent, of television stations included in the public broadcasting network, independently owned stations, and stations owned and operated by various station group owners. Our contract related to the public broadcasting network stations covers substantially all of the territory required to be covered to effectively transmit our data for delivery to CE devices incorporating our CE IPGs in the United States. We nevertheless continue to rely on arrangements, which are not long-term, with station group owners and operators and independently owned stations for VBI carriage of our IPG data. We cannot assure you that our carriage arrangements with station group owners and operators and independently owned stations will continue. Our data broadcast through the VBI can be, and has been in the past in some markets, deleted or modified by some of the local service providers. Widespread deletion or modification of this data by service providers could have a material adverse impact on our CE IPG business. To mitigate this risk, we have entered into agreements with many service providers to ensure that our CE IPG data will not be deleted or modified by such systems.
Generally, we deliver our data to our IPG service for MSOs and DBS providers and to licensees of our data used in third party IPGs for MSOs and DBS providers via satellite transmission. Currently, we rely on a single third party who provides us with satellite capacity to transmit our data to our IPG service for MSOs and DBS providers and to licensees of our data used in third party IPGs for MSOs and DBS providers. Our arrangement with the third party provider may be terminated on little or no notice. In the event that such provider elects not to transmit our data, our business, operating results and financial condition could be significantly affected. To mitigate this risk, we have built in certain redundancies in our data delivery operation to allow for transmission of our data via an alternative satellite and via the Internet. However, in the event that this provider of satellite capacity elects not to provide this capacity to transmit our data, there can be no assurance that all of our customers who currently receive our data via this provider will be able to receive our data via alternative means without significant delay or additional cost to us.
Furthermore, in order for consumer electronics devices that incorporate our CE IPGs to receive our data, such data must also be able to pass through any receivers through which such devices are receiving television programming signals. We do not currently deliver our CE IPG data over satellite networks. Even if our CE IPG data is passed to cable subscribers through cable networks by the service providers, there is a risk that the cable set-top boxes deployed by such subscribers can impede the passage of our CE IPG data. Additionally, cable companies are progressively moving their systems from an analog format to a digital format, which poses certain problems to our data carriage. Solving such problems will require the cooperation of third parties such as the MSOs and DBS providers, television broadcasters and hardware manufacturers, and may also require additional investment by the Company. Widespread impedance of our CE IPG data could have a material adverse impact on our CE IPG business.
In addition, we purchase some of our program guide information from commercial vendors. The quality, accuracy and timeliness of that data may not continue to meet our standards or be acceptable to consumers. Our VCR Plus+ system relies on consumer access to PlusCode numbers through licensed publications. We depend on the maintenance and renewal of agreements governing the PlusCode publications to ensure the distribution of the PlusCodes.
Interruption or failure of communications and transmission systems and mechanisms could impair our abilities to effectively provide our products and services, which could affect our revenues.
The provision of certain of our products and services depends on the continuing operation of communications and transmission systems and mechanisms, including satellite, cable, wire, over the air broadcast communications and transmission systems and mechanisms. These communication and transmission systems and mechanisms are subject to significant risks and any damage to or failure of these systems and mechanisms could result in an interruption of the provision of our products and services. Interruptions in the provision of our products and services could adversely affect our revenues, and our brand could be damaged if people believe our products and services are unreliable. The communications and transmission systems and mechanisms that we depend on are vulnerable to damage or interruption from telecommunications and satellite failures, natural disasters, terrorists attacks, power loss, computer viruses and similar events. The communications and transmission systems and mechanisms that we depend on are not fully redundant, and our disaster recovery planning cannot account for all eventualities.
Limitations on Control of Joint Ventures.
The Company holds its interests in certain businesses, including Guideworks and Interactive Program Guide, Inc., as a joint venture or in partnership with nonaffiliated third parties. As a result of such arrangements, the Company may be unable to control the operations, strategies and financial decisions of such joint venture or partnership entities which could in turn result in limitations on the Company’s ability to implement strategies that the Company may favor, or to cause dividends or distributions to be paid. In addition, the Company’s ability to transfer its interests in businesses owned with third parties is limited under certain joint venture, partnership or similar agreements.
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Seasonality and variability of consumer electronics product shipments and advertising sales may affect our revenues and results of operations on a quarterly or annual basis.
Shipments of CE products tend to be higher in the second and fourth calendar quarters. We recognize revenues associated with our technology incorporated in these CE products when the shipments are reported to us, which is normally the quarter immediately following that of actual shipment by the licensee. In addition, manufacturer shipments vary from quarter to quarter depending on a number of factors, including retail inventory levels and retail promotional activities. General advertising also tends to be higher in the fourth quarter. As a result, we may experience variability in our licensing and advertising revenues.
Paper and postal price increases can materially raise our costs associated with the production and delivery of TV Guide magazine.
The price of paper can be a significant factor affecting TV Guide magazine’s operating performance. We do not hedge against increases in paper costs. Paper prices may increase and if we cannot pass these costs on to our customers, the increases may have a material adverse effect on us. Postage for product distribution, billings, renewals, and direct mail solicitations is also a significant, uncontrollable expense to us.
Digital recapture could adversely affect carriage of our analog products and services.
Cable television is transmitted on a limited frequency spectrum that must be allocated between multiple analog and digital channels. As digital penetration increases, MSOs are reclaiming analog bandwidth to launch more digital networks and interactive television services, and are likely to continue this recapture until they rebuild their plants to increase bandwidth or there is stability in the mix of analog and digital carriage. If this trend continues, digital recapture may result in a significant decline in the distribution of our analog TV Guide Channel, which could negatively impact our operating results.
The gaming activities of TVG Network are extensively regulated.
TVG Network derives a substantial portion of its revenue from pari-mutuel wagering, which is subject to extensive statutory and regulatory oversight. Additionally, TVG Network’s Internet-based horse race wagering operations are heavily regulated. Adverse changes in the political climate, new legislation or regulatory activity could harm our business. From time to time, the California Horse Racing Board has considered various proposals that, if enacted, would detrimentally impact the revenue that TVG derives from the California market or otherwise adversely impact TVG’s business model. From time to time, members of Congress and state legislatures have introduced bills that would prohibit or severely restrict off-track interstate pari-mutuel or Internet-based wagering. At this time, there is a risk that new legislation or regulatory activity that would prohibit Internet-based wagering will be pursued in order to rectify possible nonconformity by the United States with the General Agreement on Trade in Services treaty as recently determined by an appellate body of the World Trade Organization. In addition, from time to time, payment systems have, on behalf of their member financial institutions, taken actions to limit the use of credit cards and debit cards for non face-to-face gaming transactions as a means of combating illegal Internet-based gambling operations. Although such efforts to restrict payment mechanisms may not be targeted at the lawful activity of licensed operations such as TVG Network, the resulting inconvenience to our customers caused by such measures could harm our business or growth prospects.
Continued consolidation of the cable and satellite broadcasting industry could adversely affect existing agreements; the impact of these changes is not clear.
We have entered into agreements with a large number of cable MSOs and DBS providers for the licensing or distribution of our technology, products and services. If, as expected, consolidation of the cable and satellite broadcasting industry continues, some of these agreements may be affected by mergers, acquisitions or system swaps. We cannot assure you that any measures that we have taken to protect us against any negative consequences resulting from those transactions will be effective. Also, a service provider that files a bankruptcy petition or otherwise restructures or liquidates could avoid its future obligations and discharge its past payment obligations under the agreement in some circumstances. Any such events could have a material adverse effect on the amount of revenue we receive under these agreements.
We face risks related to the ongoing SEC enforcement action, securities litigation and DOJ investigation involving certain of our former executives.
Although we have settled with the Securities and Exchange Commission (“SEC”) regarding its investigation of the Company and we have settled all of the related shareholder and securities litigation filed against the Company, some of our former officers and directors have been named as defendants in certain of these matters. The plaintiff class in the purported class action captionedIn reGemstar-TV Guide International Securities Litigation, Case No. CV 02-2775 MRP (PLAx) has retained all of its securities fraud claims against our former chief executive officer and former chief financial officer. In addition, although four of the former officers and directors of the Company who were named defendants in the pending SEC civil action completed settlements with the SEC, the Company’s former chief executive officer sought to defend his conduct in a trial against the SEC and was recently found to have committed violations of the securities laws by a Federal court. Further, a proposed plea bargain agreement with our former chief executive officer and the Department of Justice (“DOJ”),
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which had also been conducting an investigation into allegations raised against some of the Company’s former officers and directors in the SEC investigation and the related shareholder lawsuits, was recently rejected by a U.S. District Court judge. The Company may be obligated to advance additional defense costs and expenses and/or indemnify our former directors and officers who are named defendants in some of these lawsuits and investigations. The amount of such legal defense costs and expenses may be significant. Furthermore, the timing of the final resolution of these proceedings is uncertain. The possible resolutions of these proceedings could include judgments or settlements against our former directors and officers for which we may be required to provide indemnification in substantial amounts, which could have a material adverse effect on our financial position and results of operations.
Unfavorable outcomes in legal proceedings may adversely affect our business and operating results.
Our results may be affected by the outcome of pending and future litigation and the protection and validity of our patents and other intellectual property rights. Our patents and other intellectual property rights are important competitive tools and many generate income under license agreements. We cannot assure you that our intellectual property rights will not be challenged, invalidated or circumvented in the United States or abroad. Unfavorable rulings in our legal proceedings, including those described in footnote 3, “Litigation and Other Contingencies,” to the Condensed Consolidated Financial Statements, may have a negative impact on us that may be greater or smaller depending on the nature of the rulings. In addition, we are currently, and from time to time in the future may be, subject to various other claims, investigations, legal and administrative cases and proceedings (whether civil or criminal) or lawsuits by governmental agencies or private parties. If the results of these investigations, proceedings or suits are unfavorable to us or if we are unable to successfully defend against third party lawsuits, we may be required to pay monetary damages or may be subject to fines, penalties, injunctions or other censure that could have a material adverse effect on our business, financial condition and operating results. Even if we adequately address the issues raised by an investigation or proceeding or successfully defend a third-party lawsuit or counterclaim, we may have to devote significant financial and management resources to address these issues, which could harm our business, financial condition and operating results.
Government regulations may adversely affect our business.
The satellite transmission, cable and telecommunications industries are subject to pervasive federal regulation, including FCC licensing and other requirements. These industries are also often subject to extensive regulation by local and state authorities. While these regulations do not apply directly to us, they affect cable television providers and other multichannel video programming distributors (“MVPDs”), which are the primary customers for certain of our products and services. In March 2005, the FCC extended to July 1, 2007 a deadline under which MVPDs (except DBS providers) must phase-out consumer electronic navigation devices (e.g., set-top boxes) with combined security and non-security functions. The FCC has indicated that it may eliminate this separation requirement altogether if the cable and consumer electronics industries successfully negotiate a bi-directional “plug-and-play” agreement, which would allow interactive services to be provided on digital televisions without the need for a set-top box. A plug and play agreement could affect demand for IPGs incorporated into set-top boxes or consumer electronics devices, such as TV Guide Interactive and our CE IPGs. Future developments relating to any of these or other regulatory matters may adversely affect our business.
Our stock price has been volatile.
The market price of our common stock has historically been volatile. It is likely that the market price of our common stock will continue to be subject to significant fluctuations. We believe that future announcements concerning us, our competitors or our principal customers, including technological innovations, new product and service introductions, governmental regulations, litigation or changes in earnings estimated by us or analysts may cause the market price of our common stock to fluctuate substantially in the future. Sales of substantial amounts of outstanding common stock in the public market could materially and adversely affect the market price of our common stock. Further, in recent years the stock market has experienced extreme price fluctuations in equity securities of technology and media companies. These price and volume fluctuations often have been unrelated to the operating performance of those companies. These fluctuations, as well as general economic, political and market conditions, such as armed hostilities, acts of terrorism, civil disturbances, recessions, international currency fluctuations, or tariffs and other trade barriers, may materially and adversely affect the market price of our common stock.
Although we recently implemented a disaster recovery program, a disaster could nevertheless damage our operations.
We recently implemented a disaster recovery or business continuity program as part of a phased implementation of a more comprehensive and responsive recovery capability. While the new plan provides recoverability for our critical operations, the system is not yet comprehensive as it relates to all of our production, publishing and transmission operations. In the event of a catastrophic disruption, there remain some single points of failure or delays in timely recovery of or within our processes and technology that would cause us to lose, or cause an undue delay in, our ability to provide transmission or publishing capabilities. In that event, we would have to operate at reduced service levels that could have a material adverse affect on our relationships with our customers, our revenue generation and our brand.
News Corporation’s interests may diverge from those of other stockholders and the Company.
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News Corporation has significant influence over our business because of its beneficial ownership of our common stock and the number of its executives who serve on our Board of Directors. There can be no assurance that its interests are aligned with that of our other stockholders. Investor interests can differ from each other and from other corporate interests and it is possible that this significant stockholder with a stake in corporate management may have interests that differ from those of other stockholders and of the Company itself. If News Corporation were to sell, or otherwise transfer, all or a large percentage of its holdings, our stock price could decline and we could find it difficult to raise capital, if needed, through the sale of additional equity securities. In addition, this concentration of ownership could delay or prevent a third party from acquiring control over us at a premium over the then-current market price of our common stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to the impact of interest rate changes and changes in the market values of our investments. Our exposure to market rate risk for changes in interest rates relates primarily to our investment account. We have not used derivative financial instruments in our investment portfolio. We invest a majority of our excess cash in funds maintained with several high-credit quality financial institutions. We also invest in debt instruments of the U.S. government and its agencies and high-quality corporate issuers and, by policy, limit the amount of credit exposure to any one issuer. We protect and preserve our invested funds by limiting default, market and reinvestment risk. Investments in fixed rate interest-earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities that have declined in fair value due to changes in interest rates.
ITEM 4. CONTROLS AND PROCEDURES
Our management, including our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of disclosure controls and procedures as of March 31, 2006 pursuant to Exchange Act Rule 13a-15. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of March 31, 2006 in ensuring that material information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act has been made known to them in a timely fashion. There has been no change in the Company’s internal control over financial reporting during the quarter ended March 31, 2006 that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.
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PART II—OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Footnote 3 to the Condensed Consolidated Financial Statements—Unaudited is incorporated herein by reference.
ITEM 1A. RISK FACTORS
See "Certain Risks Affecting Business, Operating Results and Financial Conditions" beginning on page 21, which is incorporated by reference.
ITEM 6. EXHIBITS
Exhibits
| 10.55 | Employment agreement between Gemstar-TV Guide International, Inc. and Bedi Ajay Singh dated April 17, 2006 (incorporated by reference to Gemstar’s Form 8-K filed on April 18, 2006) |
| 10.56 | Form of Nonqualified Stock Option Agreement for employees under the Gemstar-TV Guide International, Inc. 1994 Stock Incentive Plan, as amended and restated |
| 31.1 | CEO Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002 |
| 31.2 | CFO Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002 |
| 32.1 | CEO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2 | CFO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: May 4, 2006 | | GEMSTAR-TV GUIDE INTERNATIONAL, INC.
(Registrant)
By: /s/ Bedi Ajay Singh
——————————————
Bedi Ajay Singh
Executive Vice President and Chief Financial Officer
(Principal Financial Officer) |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934