Gemstar Q3 Numbers Interpeted
tekboy,
Having alluded to the idea that you expect a response from me regarding Gemstar's numbers, I wouldn't want to make a liar out of you. :)
I'd like to make it clear from the get-go that it probably makes little sense to evalue Gemstar's report without at the same time examining TV Guide's report. A consolidation of the two giving an idea of what the pro forma numbers would lool like would be ideal. But I don't have the time and I seriously doubt that I've got the requisite accounting skills. Understanding that, I'll focus on Gemstar's core business as it currently stands apart from TV Guide's business.
Gemtsar's margins continue to expand as Stew and I have long been saying would be the case. To fully grasp that, we need to appreciate:
1) why they are currently expanding and
2) why they might continue to expand
As for current margin expansion, using Q3 as the benchmark, the profits are growing faster than the revenues because:
--$18 million of fees from GIC were recognized this quarter (leaving about $23 million more to be recognized depending on the final determination by the arbiter, including punitive damages which I don't know whether or not they are subject to income tax)
--selling and marketing expenses are growing slower than revenue;
--general and administrative expenses are growing slower than revenue;
--R&D costs are practically the same as a year ago despite that revenue increased nearly 50%; and
--the income tax rate is slightly lower than a year ago. Don't ask me why.
As for future margin expansion, I expect that selling, marketing, general and administrative expenses to continue growing at a slower pace than revenue increases. To the extent that advertising revenue increases, the difference between growth of revenue and growth of costs will widen. As the company continues to receive fees from the first ruling against GIC and what I think will be future rulings by others, those fees will also dramatically affect margins. But as you'll see below, I've got significant concerns about the core growth not including the past due fees.
Because the company will soon become incorporated in Delaware (a requirement of the proposed merger with TV Guide), I expect the income tax rate to increase to about 35% from about 27%. Despite that increase, I expect the net result to be ever widening margins over the long term if not the short term.
Now the bummer information.
I'm not sure how investors should take into account the $18 million in past fees from GIC accounted for in this one quarter. To take the most conservative slant, after applying a 27% income tax rate to that revenue, we would back out net income in the amount of $13,140,000 as a one-time gain. That would reduce net income to $18,838,000 for Q3, or $.08 diluted EPS.
The bad news about that view is that it means virtually no change in net income and less than a 6% increase in revenue from the year-earlier quarter. All categories of expenses would then be viewed as growing faster than revenues, resulting in a net profit margin decreasing from 45% to 43% for the comparable quarter.
This is NOT good! Frankly, I don't understand why the stock was trading higher in after-hour orders seeing those numbers. I expect the stock to go down significantly once the impact of netting out the GIC fees becomes evident.
To be more optimistic and I think more accurate, we would need to know the dollar amount of the fees Gemstar would have received this quarter had the arbitration not been necessary to collect those fees. Similarly, we would need to know the amount that would have been collected a year ago to ascertain the implied growth. Not having any of that information, I suspect that the company's growth that is important for us to recognize is somewhere in between the worst-case picture I painted above and the numbers shown in the financial statements.
Despite the obvious reasons the Q3 earnings report gives us reason to be optimistic about the future if you believe as I do that the past due fees and punitive damage awards will continue to roll is, I still feel as if I won't have a firm grasp of the company's prospects until the merger is done and we see post-merger activities. Apparently the conference call (not available on replay) revealed that Henry does not plan to spin off the TV Guide publication. The call also informed us that the reasons to own both e-book companies is because one is best for full-length books while the other is best for periodicals and articles; owning both allows the company to take advantage of the best features of both. For more details about one person's notes from the conference call: boards.fool.com
In a nutshell, the long-term prospects for the company remain on target. We don't have any reason to think the product adoption at a different place in the adoption life cylce than where it was three months ago. There are probably a lot more questions about the immediate future than anything else, none of which affects Gorilla Gamers keeping an eye on bowling alleys and tornados.
Comments anyone?
--Mike Buckley
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