ITEM 1. BUSINESS
Overview
We were incorporated in Delaware on October 12, 1993 and are a leading provider of automated retail solutions that offer convenient products and services that benefit consumers and drive incremental retail traffic and revenue for retailers. In 2013, we changed our name from Coinstar, Inc. to Outerwall Inc. Our core offerings in automated retail include our Redbox business, where consumers can rent or purchase movies and video games from self-service kiosks (“Redbox” segment), and our Coinstar business, where consumers can convert their coin to cash or stored value products at self-service coin counting kiosks (“Coinstar” segment). Our New Ventures business (“New Ventures” segment) is focused on identifying, evaluating, building or acquiring, and developing innovative self-service concepts in the marketplace.
Summary of Recent Divestitures and Acquisitions
The following is a summary of the acquisitions and divestitures that we made during the last five years:
Year
Transaction
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We sold our subsidiaries comprising our electronic payment business in the second quarter.
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We sold our subsidiaries comprising our money transfer business in the second quarter.
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We entered into a joint venture, Redbox InstantTM by Verizon (the "Joint Venture"), with Verizon Ventures IV LLC (“Verizon”) in the first quarter. (1)
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We acquired NCR Corporation’s self-service entertainment DVD kiosk business in the second quarter.
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We sold certain kiosks previously acquired from NCR through the sale of a previously consolidated entity in the second quarter.(2)
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We acquired ecoATM, Inc. ("ecoATM") in the third quarter.(1)(3)
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We reclassified four concepts previously included in our New Ventures operating segment as discontinued operations, Orango™, Rubi™, Crisp Market™, and Star Studio™, in the fourth quarter.(4)
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We withdrew Redbox as a member of the Joint Venture in the fourth quarter.(1)
Additional information can be found in our Notes to Consolidated Financial Statements as follows:
(1) Note 5: Equity Method Investments and Related Party Transactions
(2) Note 17: Commitments and Contingencies
(3) Note 14: Business Segments and Enterprise-Wide Information
(4) Note 12: Discontinued Operations
Business Segments
Redbox
Within our Redbox segment, we operate 43,680 Redbox kiosks, in 36,140 locations, where consumers can rent or purchase movies and video games. Our Redbox kiosks are available in every U.S. state, Puerto Rico, and Canada, and are installed primarily at leading grocery stores, mass retailers, drug stores, restaurants and convenience stores including Walgreens, Walmart, Kroger and 7-Eleven. Our Redbox kiosks supply the functionality of a traditional video rental store, yet typically occupy an area of less than ten square feet. Consumers use a touch screen to select their titles, swipe a valid credit or debit card, and receive their movie(s) or video game(s). The process is designed to be fast, efficient and fully automated. We generate revenue primarily through fees charged to rent or purchase a movie or video game, and we pay retailers a percentage of our revenue. Typically, the daily rental fee at a Redbox kiosk is a flat fee plus tax for each disc and, if the consumer chooses to keep the movie or video game for additional days, the consumer is charged for each additional day at the same daily rental fee. Our consumers can rent a movie or video game from one location and return their rental to any of our Redbox locations. Additionally, our consumers may reserve a movie or video game online or via a smart phone application and pick it up at the selected Redbox location.
On October 20, 2014, we withdrew from the Joint Venture due primarily to a lower than anticipated subscriber base. We entered the Joint Venture to provide consumers a nationwide “over-the-top” video distribution service that offered rental of physical DVDs and Blu-ray Discs™ from our kiosks. While a member of the Joint Venture, we recognized revenue attributable to the rental of DVDs and Blu-ray Discs within our Redbox segment and accounted for our interest in the Joint Venture using the equity method of accounting. See Note 5: Equity Method Investments and Related Party Transactions in our Notes to Consolidated Financial Statements for additional details.
Our content library consists of movies and video games available for rent or purchase. We obtain our movie and video game content through revenue sharing agreements and license agreements with studios and game publishers, as well as through distributors and other suppliers. Our goal is to achieve satisfactory availability rates to meet consumer demand while also maximizing our margins. For additional information related to our content license agreements with studios see Note 17: Commitments and Contingencies in our Notes to Consolidated Financial Statements.
Coinstar
Within our Coinstar segment, we own and operate 21,340 kiosks in 20,250 locations. Consumers feed loose change into coin-counting kiosks, which count the change and then dispense vouchers redeemable for cash or, in some cases, issue stored value products at the consumer’s election. Included in our kiosk total is a limited number of kiosks that exchange gift cards for a voucher redeemable for cash. Our Coinstar kiosks are available across the U.S., where they provide a convenient and trouble-free service to retailers such as Kroger and Walmart, and in Canada, Puerto Rico, Ireland and the United Kingdom. We are the only multi-national, fully automated network of self-service coin-counting kiosks and are the leader in the U.S. market.
We generate revenue through transaction fees from our consumers and product partners. Each voucher lists the dollar value of coins counted, less our transaction fee. When consumers elect to have a stored value product issued, the transaction fee normally charged to the consumer for the coin-counting services is charged instead to the stored value product issuer.
New Ventures
We identify, evaluate, build or acquire and develop innovative new self-service concepts in the automated retail space in our New Ventures business segment. The self-service kiosk concept we are currently exploring in the marketplace is our consumer product sampling concept SAMPLEit, in the Beauty and Consumer Packaged Goods sector.
In the Electronics sector we acquired and continue to build the ecoATM business which provides an automated self-service kiosk where consumers can recycle mobile devices for cash and generates revenue through the sale of devices collected at our kiosks to third parties. We began reporting the results of this business in our New Ventures segment subsequent to its acquisition in the third quarter of 2013 and ended 2014 with approximately 1,890 kiosks in service.
New Ventures concepts and ecoATM are regularly assessed to determine whether continued funding or other alternatives are appropriate.
Strategic Investments
On occasion, we make strategic investments in external companies that provide automated self-service kiosk solutions. For example, in the Health sector we have invested in SoloHealth, Inc. See Note 5: Equity Method Investments and Related Party Transactions in our Notes to Consolidated Financial Statements for more information and information regarding our acquisition of ecoATM, one of our prior strategic investments.
Seasonality
We have historically experienced seasonality in our revenue from our Redbox segment. December and the summer months have historically been high rental months. April has been a low rental month due, in part, to retail release timing in connection with the Academy award ceremonies and the Easter holiday that historically has provided stronger content and resulted in higher rentals in March. September and October have been low rental months, due, in part, to the beginning of the school year and the introduction of the new fall television season. However, we have entered into licensing agreements with certain studios that contain delayed rental windows. This has shifted the availability of titles affected by the delayed rental windows relative to historic patterns. Seasonal effects, however, may be minimized or increased by the actual release slate and the relative attractiveness of movie titles in a particular quarter or year which may have lingering effects in subsequent periods. Our Coinstar segment generally experiences its highest revenue in the second half of the year due to increased retailer foot traffic and holiday shopping in the fourth quarter and an increase in consumers’ desire for disposable income in the summer months. In our New Ventures segment, seasonality generally peaks during the summer months, declines in the fourth quarter and remains flat into the following quarter before increasing in late February but can be significantly impacted by the timing of new phone releases.
Employees
As of December 31, 2014, we had approximately 2,760 employees. Included in this total were approximately 1,900 field service employees throughout the U.S. and internationally who have broadened our geographic reach to develop and maintain strong relationships with retailers and service our kiosks.
Additional Business Information
See Note 14: Business Segments and Enterprise-Wide Information in our Notes to Consolidated Financial Statements as well as Item 1A.
ITEM 1A. RISK FACTORS
You should carefully consider the following risk factors that may affect our business, including our financial condition and results of operations. The risks and uncertainties described below are not the only risks we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business. If any of the following risks or uncertainties actually occurs, our business could be harmed, the trading price of our common stock could decline and you could lose all or part of your investment in us.
Competitive pressures could seriously harm our business, financial condition and results of operations.
Our Redbox business faces competition from many other providers, including those using other distribution channels, having more experience, greater or more appealing inventory, better financing, and better relationships with those in the movie and video game industries, than we have, including:
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mail-delivery and online content providers, like Netflix, iTunes or Amazon;
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cable, satellite, and telecommunications providers, like Comcast or DISH Network;
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traditional movie programmers, like HBO or Showtime;
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traditional brick and mortar video retailers, and other DVD kiosk businesses;
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other retailers like Walmart and other chain stores selling DVDs and video games;
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video game rental providers, like GameFly;
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noncommercial sources like libraries; and;
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general competition from other forms of entertainment, such as movie theaters, television and sporting events.
Our Coinstar business faces competition from supermarkets, banks and other companies that obtain coin-counting equipment from companies such as ScanCoin, Cummins-Allison Corporation and others. Our retailers may choose to replace our coin-counting kiosks with competitor machines and operate such kiosks themselves or through a third party, or not carry coin-counting kiosks at all deciding that floor space could be used for other purposes. In addition, retailers, some of which have significantly more resources than we do, may decide to enter the coin-counting market. Some banks and other competitors already provide coin-counting free of charge or for an amount that yields very low margins or that may not generate a profit at all. An expansion of the coin-counting services provided or a reduction in related fees charged by any of these competitors or retailer decisions to use floor space for other than coin-counting, could materially and adversely affect our business and results of operations.
Our ecoATM business faces competition from companies whose primary business consists of the purchase of used electronics, including online retailers and web sites such as Gazelle, as well as brick and mortar stores which buy back used electronics. The business also faces competition from companies in other businesses who also have buyback programs, such as GameStop, Best Buy, Target, Apple, AT&T, Verizon, T-Mobile and Sprint. These competitors may have significantly more resources than we do or offer their customers a higher price or more convenient offering than we do for the same item. Both the proliferation of such programs and the perceived value to consumers provided by such programs could materially and adversely affect our business and results of operations.
There are many risks related to our Redbox business that may negatively impact our business.
The home video industry is highly competitive with many factors affecting our ability to profitably manage our Redbox business. We have invested, and plan to continue to invest, substantially to establish and maintain our infrastructure of Redbox kiosks in the U.S. Because we have now substantially completed our U.S. build-out of Redbox kiosks, future growth of our Redbox business in the U.S. will depend substantially upon growth in same store sales. As a result, we expect our Redbox business to grow more slowly in the future, compared with our historical experience. In addition, the home video distribution market is rapidly evolving as newer technologies and distribution channels compete for market share, and we face an expected secular decline in the physical rental market. If it does, our business, operating results and financial condition could be materially and adversely affected. Some of the risks that could negatively impact our participation in this industry include:
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Increased availability of digital movie content and changes in consumer content delivery and viewing options and preferences, including increased use of online streaming, video-on-demand, subscription video-on-demand and time- and place-shifting technologies
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Decreased quantity and quality of movie content availability for DVD distribution due to changes in quantity of new releases by studios, movie content failing to appeal to consumers’ tastes, increased focus on digital sales and rentals, and other general industry-related factors, including financial disruptions, and labor conflicts;
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Due to arrangements with certain studios that provide content on a delayed basis, the availability of some new releases in our kiosks may shift to times when consumers are relatively less likely to rent movies, or may be in genres that are off seasonally, such as a holiday movie unavailable until January; and
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Decreased costs for consumers to purchase or receive movie content, including less expensive DVDs, more aggressive competitor pricing strategies and piracy.
Adverse developments relating to any of these risks, as well as others relating to our participation in the home video industry, could significantly affect our business, financial condition and operating results.
The termination, non-renewal or renegotiation on materially adverse terms of our contracts or relationships with one or more of our significant retailers, studios or game publishers could seriously harm our business, financial condition and results of operations.
The success of our business depends in large part on our ability to maintain contractual relationships with our partners in profitable locations. Certain contract provisions with our partners vary, including product and service offerings, the service fees we are committed to pay, and the ability to cancel the contract upon notice after a certain period of time. For Redbox and Coinstar, we typically enter multi-year kiosk installation agreements that automatically renew until we or the retailer gives notice of termination. Our typical ecoATM agreements with mall operators allow the operators to terminate for convenience with minimal notice. We strive to provide direct and indirect benefits to our partners that are superior to, or competitive with, other providers or systems or alternative uses of the floor space that our kiosks occupy. If we are unable to provide them with adequate benefits, we may be unable to maintain or renew our contractual relationships on acceptable terms, causing our business, financial condition and results of operations to suffer.
We do a substantial amount of our business with certain retailers. For example, we have significant relationships with Wal-Mart Stores, Inc., Walgreen Co., and The Kroger Company, which accounted for approximately 15.5%, 13.7%, and 9.7% of our consolidated revenue from continuing operations, respectively, during 2014. In addition, our ecoATM business is largely concentrated within the largest mall operators in the United States. Although we have had, and expect to continue to have, a successful relationship with these partners, changes to these relationships will continue to occur both in the long- and short-term, some of which could adversely affect our business and reputation. For example, our Redbox, Coinstar and ecoATM relationship with Walmart is governed by contracts that provide either party the right to terminate the contracts in their entirety, or as to any store serviced by the contracts, with or without cause, on as little as 90 days’ notice. Cancellation, adverse renegotiation of or other changes to these relationships could seriously harm our business and reputation.
Our business also depends on our ability to obtain adequate content from movie studios and video game publishers. We have entered into licensing agreements with certain studios to provide delivery of their DVDs by the “street date,” the first date on which DVD releases are available to the general public for home entertainment purposes on either a rental or sell-through basis. In addition, we have licensing arrangements with other studios that make DVDs available for rent 28 days after the street date. If we are unable to maintain or renew our current relationships to obtain movie or video game content on acceptable terms, our business, financial condition and results of operations may suffer.
Our inability to receive delivery of DVDs on the date of their initial release to the general public, or shortly thereafter, for home entertainment viewing could adversely affect our Redbox business.
Traditionally, businesses that rented movies in physical formats, such as DVDs, had enjoyed a competitive advantage over other movie distribution rental channels. After the initial theatrical release of a movie, the major studios generally had made their movies available on physical formats for a 30- to 45-day release window before release to other movie distribution rental channels, such as pay-per view, video-on-demand, premium television, basic cable, and network and syndicated television.
However, movie studios are experimenting with this model, including shortening or discontinuing altogether, or otherwise restricting, movie distribution windows, including making video-on-demand or other digital delivery methods available prior to or simultaneous with the physical DVD release. For example, certain movie studios have made new release titles available on video-on-demand or for online purchase on the same date as the DVD release, and certain movies have been made available via premium video-on-demand while they are still in theaters. Further, some studios have implemented restrictions on renting DVDs for weeks following the initial release of the same title for purchase. For example, Redbox has entered into arrangements with certain studios that include delayed rental windows. Entering into these studio licensing arrangements that contain a delayed rental window may decrease consumer satisfaction and consumer demand, and we may lose consumers to our competitors that offer DVD titles without a delayed rental window. In addition, studios may seek to impose longer delays, or studios that currently provide content on street date may seek similar delays. Any of these developments could have a material adverse effect on our business, financial condition and results of operations.
If we do not manage our content library effectively, our business, financial condition and results of operations could be materially and adversely affected.
A critical element of our Redbox business model is to optimize our library of DVD titles, formats, and copy depth to achieve satisfactory availability rates to meet consumer demand while also maximizing margins. If we do not timely acquire sufficient DVD titles, due to, for example, not correctly anticipating demand, intentionally acquiring fewer copies than needed to fully satisfy demand or the lack of available titles, we may not appropriately satisfy consumer demand, which could decrease consumer satisfaction and we could lose consumers to competitors. Conversely, if we attempt to mitigate this risk and acquire a larger number of copies to achieve higher availability rates for select titles or a wider range of titles, our library utilization would become less efficient and our margins for the Redbox business would be adversely affected. Our ability to accurately predict consumer demand as well as market factors, such as our ability to obtain satisfactory distribution arrangements, may impact our ability to timely acquire appropriate quantities of certain DVD titles. In addition, if we are unable to obtain or maintain favorable terms from our suppliers with respect to such matters as timely movie access, copy depth, formats and product destruction, among others, or if the price of DVDs increases or decreases generally or for certain titles, our library may become unbalanced and our margins may be adversely affected.
Further, the delay in our ability to rent certain studios’ DVD titles pursuant to a delayed rental window may negatively affect consumer satisfaction and demand, and we could lose consumers to our competitors because of the timing of our library.
We have entered into licensing agreements with certain studios to allow rental of their titles on the “street date,” and with other studios to make DVDs available for rent 28 days or more after the street date. Our business, financial condition and results of operations could be materially and adversely affected if these agreements do not provide the expected benefits to us. For example, agreements may require us to license minimum quantities of theatrical and direct-to-video DVDs for rental at our kiosks. If the titles or format provided are not attractive to our consumers, we could be required to purchase too many copies of undesirable titles or an undesirable format, possibly in substantial amounts, which could adversely affect our Redbox business by decreasing consumer demand for offered DVD titles and consumer satisfaction with our services or negatively impacting margins. If studios that do not have a delayed rental window elect to delay the general release of DVDs to the rental market for significant periods after they are released for retail sales, demand for rental of these titles may be adversely affected. In addition, we have incurred, and may continue to incur, additional non-cash increases to operating expenses, which are amortized over the terms of any such arrangements, that also could have a dilutive impact on our stockholders, such as the issuance of equity under certain of our existing studio contracts or to the extent we enter into similar arrangements with other movie studios in the future. Further, if some or all of these agreements prove beneficial but are early terminated, we could be negatively impacted. Moreover, if we cannot maintain similar arrangements in the future with these or other studios or distributors, or these arrangements do not provide the expected benefits to us, our business could suffer.
In addition, if we are unable to comply with, or lack the necessary internal controls to ensure appropriate documentation and tracking of our content library, we may, among other things, violate certain of our studio licensing arrangements, be forced to pay a fee for unaccounted for DVDs and be susceptible to risks of theft and misuse of property, any of which may negatively affect our margins in the Redbox business. Any of these developments could have a material adverse effect on our business, financial condition and results of operations.
Defects, failures or security breaches in and inadequate upgrades of, or changes to, our operating systems could harm our business.
The operation of our business depends on sophisticated software, hardware, and computer networking and communication services that may contain undetected errors or may be subject to failures or complications. These errors, failures or complications may arise particularly when new, changed or enhanced products or services are added. In the past, there have been limited delays and disruptions resulting from upgrading or improving these operating systems. Future upgrades, improvements or changes that may be necessary to expand and maintain our business could result in delays or disruptions or may not be timely or appropriately made, any of which could seriously harm our operations.
Further, certain aspects of the operating systems relating to our business are provided by third parties, including telecommunications. Accordingly, the effectiveness of these operating systems is, to a certain degree, dependent on the actions and decisions of third parties over whom we may have limited control.
Failure to adequately comply with privacy notices, information security policies, standards or legal requirements or to adequately safeguard against breaches of such policies could adversely affect our operations and could damage our business, reputation, financial position and results of operations.
As our business expands to provide new products and services, such as ecoATM and Coinstar Exchange, we are increasing the amount of consumer data that we collect, transfer and retain as part of our business. These activities are subject to laws and regulations, as well as industry standards, in the United States and other jurisdictions in which our products and services are available. These requirements, which often differ materially and sometimes conflict among the many jurisdictions in which we operate, are designed to protect the privacy of consumers’ personal information and to prevent that information from being inappropriately collected, used or disclosed. We maintain and review technical and operational safeguards designed to protect this information and generally require third party vendors and others with whom we work to do so as well. However, despite those safeguards, it is possible that hackers, employees acting contrary to our policies, third-party agents or others could improperly access relevant systems or improperly obtain or disclose data about our consumers, or that we may be determined not to be in compliance with applicable legal requirements and industry standards for data security, such as the Payment Card Industry guidelines. A breach or purported breach of relevant security policies or controls that compromises consumer data or determination of non-compliance with applicable legal requirements, privacy notices or industry standards for data security could expose us to regulatory enforcement actions, civil litigation, card association or other monetary fines or sanctions, or contractual liabilities, limit our ability to provide our products and services, subject us to legal action and related costs and damage our business reputation, financial position, and results of operations.
Our failure to meet consumer expectations with respect to pricing our products and services may adversely affect our business and results of operations.
Demand for our products and services may be sensitive to pricing changes. We evaluate and update our pricing strategies from time to time, and changes we institute may have a significant impact on, among other things, our revenue and net income. For example, in December 2014 the rental price for DVDs increased by 30 cents to $1.50 a day, the price for Blu-ray Discs increased by 50 cents to $2.00 a day, and in January 2015, the rental price for video games increased by $1.00 to $3.00 a day. In the future, other fee increases or pricing changes may deter consumers from using our kiosks or reduce the frequency of their usage.
Payment of increased fees to retailers or other third party service providers could negatively affect our business results.
We face ongoing pricing pressure from our retailers to increase the service fees we pay to them on our products and services or to make other financial concessions to win or retain their business. If we are unable to respond effectively to ongoing pricing-related pressures, we may fail to win or retain certain accounts. Our fee arrangements are based on our evaluation of unique factors with each retailer, such as total revenue, long-term, non-cancelable contracts, installation of our kiosks in high-traffic, geographic locations and new product and service commitments. Together with other factors, an increase in service fees paid, or other financial concessions made, to our retailers could significantly increase our direct operating expenses in future periods and harm our business. In addition, we accept payment for movie and game rentals through debit and credit card transactions. For these payments, we pay interchange and other fees, which have increased and may increase further over time. Further, because Redbox processes millions of small dollar amount transactions, and interchange fees represent a larger percentage of card processing costs compared to a typical retailer, we are relatively more susceptible to any fee increase. When interchange or other fees increase, it generally raises our operating costs and lowers our profit margins or requires that we charge our customers more for our products and services.
We may be unable to attract new partners, broaden current partner relationships, and penetrate new markets and distribution channels.
To increase our kiosk installations, we need to attract new partners, broaden relationships with current partners, and develop operational efficiencies that make it feasible for us to penetrate lower density markets or new distribution channels, such as Coinstar kiosks in banks and credit unions and ecoATM kiosks in grocery locations. We may be unable to attract new retailers or drive down costs relating to the manufacture, installation or servicing of our kiosks to levels that would enable us to operate profitably in lower density markets or penetrate new distribution channels. If we are unable to do so, our future financial performance could be adversely affected.
Our future operating results may fluctuate.
Our future operating results will depend significantly on our ability to continue to drive new and repeat use of our Redbox and Coinstar kiosks, our ability to develop and commercialize new products and services, such as ecoATM, and the costs incurred to do so, and our ability to successfully integrate acquisitions and other third-party relationships into our operations. Our operating results have a history of fluctuating and may continue to fluctuate based upon many factors, including fluctuations in revenue generated by and operating expenses incurred by our different lines of business, seasonality, the timing of the release slate and the relative attractiveness of the titles available for rent in a particular quarter or year which may have lingering effects in subsequent periods, fluctuations in consumer rental patterns, including the number of movies rented per visit, the type of DVDs they want to rent and for how long, and the level of DVD migration between kiosks.
We have historically experienced seasonality in our revenue from our Redbox segment. December and the summer months have historically been high rental months. April has been a low rental month due, in part, to retail release timing in connection with the Academy award ceremonies and the Easter holiday that historically has provided stronger content and resulted in higher rentals in March. September and October have been low rental months, due, in part, to the beginning of the school year and the introduction of the new fall television season. However, we have entered into licensing agreements with certain studios that contain delayed rental windows. This has shifted the availability of titles affected by the delayed rental windows relative to historic patterns. Seasonal effects, however, may be minimized or increased by the actual release slate and the relative attractiveness of movie titles in a particular quarter or year which may have lingering effects in subsequent periods. Our Coinstar segment generally experiences its highest revenue in the second half of the year due to increased retailer foot traffic and holiday shopping in the fourth quarter and an increase in consumers’ desire for disposable income in the summer months. In our New Ventures segment, seasonality generally peaks during the summer months, declines in the fourth quarter and remains flat into the following quarter before increasing in late February but can be significantly impacted by the timing of new phone releases.
If we cannot manage our growth effectively, we could experience a material adverse effect on our business, financial condition and results of operations.
We have experienced periods of substantial growth in our business, particularly due to Redbox, and more recently, the acquisition of ecoATM. This growth has placed, and may continue to place, significant demands on our operational, financial and administrative infrastructure and our management. As our operations have grown in size, scope and complexity, we have focused on integrating, as appropriate, and improving and upgrading our systems and infrastructure, both those relating to providing attractive and efficient consumer products and services and those relating to our administration and internal systems, processes and controls. For example, management has had to adapt to and provide for oversight of a more decentralized organization as Redbox and ecoATM operations have remained primarily in Oakbrook Terrace, Illinois, and San Diego, California, respectively, while Outerwall’s corporate headquarters and Coinstar operations have remained in Bellevue, Washington. This integration and expansion of our administration, processes, systems and infrastructure have required us to commit and will continue to cause us to commit, substantial financial, operational and technical resources to managing our business.
Although we believe that the total addressable market for automated kiosks is large, we cannot be certain about its size, the most effective plan for locating kiosks, or the optimum market density. Because the kiosk market and our business model are continually evolving, we have incomplete data and track records for predicting kiosk and market performance in future periods. As a result, we may make errors in predicting and reacting to relevant business trends, which could have a material adverse effect on our business, financial condition and results of operations. For example, we may, among other things, over-install kiosks in certain geographic areas leading to non-accretive installations, and we cannot be certain that historical revenue ramps for new kiosks will be sustainable in the future.
Managing our growth will require significant expenditures and allocation of valuable management and operational resources. If we fail to achieve the necessary level of efficiency in our organization, including otherwise effectively growing our business lines, our business, operating results and financial condition could be harmed.
If we cannot execute on our strategy and offer new automated retail products and services, our business could suffer.
Our strategy is based upon leveraging our core competencies in the automated retail space to provide the consumer with convenience and value and to help retailers drive incremental traffic and revenue. To be competitive, we need to offer new product and service offerings that are accepted by the market and establish third-party relationships necessary to develop and commercialize such product and service offerings. We are exploring new businesses to enter, and new products and services to offer, including through our New Ventures segment; however, the complexities and structures of these new businesses and products could create conflicting priorities, constrain limited resources, and negatively impact our core businesses. We may use our financial resources and management’s time and focus to invest in other companies offering automated retail services, such as our acquisition of ecoATM, we may seek to grow businesses organically, such as our SAMPLEitTM product sampling kiosk venture, or we may seek to offer new products or services on our current kiosks. We may enter into joint ventures through which we may expand our product offerings. Any new business opportunity also may have its own unique risks related to operations, finances, intellectual property, technology, legal and regulatory issues, corporate governance or other challenges, for which we may have limited or no prior experience. In addition, if we fail to timely establish or maintain relationships with significant retailers and suppliers, we may not be able to provide our consumers with desirable new products and services. Further, to develop and commercialize certain new products and services, we will need to create new kiosks or enhance the capabilities of our current kiosks, as well as adapt our related networks and systems through appropriate technological solutions for an automated retail environment, and establish market acceptance of such products or services. We cannot assure you that new products or services that we provide will be successful or profitable.
Acquisitions and investments involve risks that could harm our business and impair our ability to realize potential benefits from such acquisitions and investments.
As part of our business strategy, we have in the past sought, and may in the future seek, to acquire or invest in businesses, products or technologies that we feel could complement or expand our business. For example, in July 2013, we acquired ecoATM. However, we may be unable to adequately address the financial, legal and operational risks raised by such acquisitions or investments and may not successfully integrate these acquisitions or investments, which could harm our business and prevent us from realizing the projected benefits of the acquisitions and investments. In addition, we may not have the right or power to direct the management or policies of companies we have invested in. Further, the evaluation and negotiation of potential acquisitions and investments, as well as the integration of acquired businesses, divert management time and other resources. Accordingly, we cannot assure you that any particular transaction, even if successfully completed, will ultimately benefit our business. Certain financial and operational risks related to acquisitions and investments that may have a material impact on our business are:
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the assumption of known and unknown liabilities of an acquired company, including employee and intellectual property claims and other violations of applicable law;
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losses related to acquisitions and investments;
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managing relationships with other investors and the companies in which we have made investments, including, in some cases, as minority partner;
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reduced liquidity, including through the use of cash resources and incurrence of debt and contingent liabilities in funding acquisitions and investments;
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entrance into markets in which we have no direct prior experience, , and where we face competition from many other companies, including those having more experience, better financing, or better relationships with others in the industry than we have;
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impairment of goodwill and acquired intangible assets arising from our arrangements and investments;
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difficulties and expenses in assimilating the operations, products, technology, information systems or personnel of an acquired company, acquired assets or joint ventures;
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inability to efficiently divest unsuccessful acquisitions and investments;
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stockholder dilution if an acquisition is consummated through an issuance of our securities;
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imposition of restrictive covenants and increased debt service obligations that provide us less flexibility in how we operate our business to the extent we borrow to finance an acquisition or investment;
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amortization expenses related to acquired intangible assets and other adverse accounting consequences;
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costs incurred in identifying and performing due diligence on potential targets and negotiating agreements that may or may not be successful, including payment of break-up fees if transactions are not closed; and
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impairment of relationships with employees, retailers and affiliates of our business and the acquired business.
We depend upon third-party manufacturers, suppliers and service providers for key components and substantial support for our kiosks.
We conduct limited manufacturing operations and depend on outside parties to manufacture key components of our kiosks. We intend to continue to expand our installed base of kiosks. Such expansion may be limited by the manufacturing capacity of our third-party manufacturers and suppliers. Third-party manufacturers may not be able to meet our manufacturing needs in a satisfactory and timely manner. If there is an unanticipated increase in demand for our kiosks or our manufacturing needs are not met in a timely and satisfactory manner, we may be unable to meet demand due to manufacturing limitations.
Some key hardware components used in our kiosks are obtained from a limited number of suppliers. We may be unable to continue to obtain an adequate supply of these components from our suppliers in a timely manner or, if necessary, from alternative sources. If we are unable to obtain sufficient quantities of components from our current suppliers or locate alternative sources of supply on a timely basis, we may experience delays in installing or maintaining our kiosks, either of which could seriously harm our business, financial condition and results of operations.
In addition, we rely on third-party service providers for substantial support and service efforts that we currently do not provide directly. In particular, we contract with third-party providers to arrange for pick-up, processing and depositing of coins, as well as to provide limited servicing of our kiosks. We generally contract with a single transportation provider and coin processor to service a particular region. We do not currently have, nor do we expect to have in the foreseeable future, the internal capability to provide back-up coin processing service in the event of a sudden disruption in service from a commercial coin processor. Any failure by us to maintain our existing coin processing relationships or to establish new relationships on a timely basis or on acceptable terms could harm our business, financial condition and results of operations.
There are risks associated with conducting our business and sourcing goods internationally.
We currently have Coinstar operations in Canada, the United Kingdom and Ireland. We expect to continue our deployment of kiosks internationally. Accordingly, political uncertainties, economic changes, exchange rate fluctuations, restrictions on the repatriation of funds, adverse changes in legal requirements, including tax, tariff and trade regulations, difficulties with foreign distributors, operating challenges and other difficulties in managing an organization outside the United States, could seriously harm the development of our business and ability to operate profitably. For example, in January 2015, we made the decision to shut down our Redbox operations in Canada as the business was not meeting the company's performance expectations. Further, as we do more business in an increasing number of countries, our business becomes more exposed to the impact of the political and economic uncertainties, including government oversight, of foreign jurisdictions.
We purchase products from vendors that obtain a significant percentage of such products from foreign manufacturers. As a result, we are subject to changes in governmental policies, exchange rate fluctuations, various product quality standards, the imposition of tariffs, import and export controls, transportation delays and interruptions and political and economic disruptions which could disrupt the supply and timely delivery of products manufactured abroad. In addition, we could be affected by labor strikes in the sea shipping, trucking and railroad industries. A reduction or interruption in supplies, or a significant increase in the price of one or more supplies could have a material adverse effect on our business.
We are subject to substantial federal, state, local and foreign laws and government regulation specific to our business.
Our business is subject to federal, state, local and foreign laws and government regulation, including those relating to copyright law, access to kiosks in public places, consumer privacy and protection, data protection and information security, taxes, secondhand dealers, vehicle safety, charitable fundraising, the transfer of money or things of value, coins, currency controls, weights and measures, payment cards and other payment instruments, sweepstakes, and contests. The application of existing laws and regulations, changes in laws or enactment of new laws and regulations, that apply, or may in the future apply, to our current or future products or services, changes in governmental authorities’ interpretation of the application of various government regulations to our business, or the failure or inability to gain and retain required permits and approvals could materially and adversely affect our business.
In addition, many jurisdictions require us to obtain certain licenses in connection with the operations of our businesses. There can be no assurance that we will be granted all necessary licenses or permits in the future, that current licenses or permits will be renewed or that regulators will not revoke current licenses or permits. Given the unique nature of our business and new products and services we may develop or acquire in the future, the application of various laws and regulations to our business is uncertain. Further, as governmental and regulatory scrutiny and action with regard to many aspects of our business increase, we expect that our costs of complying with the applicable legal requirements may increase, perhaps substantially.
ecoATM is subject to secondhand dealer laws that regulate the purchase of used goods, such as the phones it purchases from consumers. Such laws contain requirements, or laws may be amended or enacted to create requirements, with which we cannot comply, thus requiring us to cease operations in certain jurisdictions. Moreover, a few legislatures have in the past enacted secondhand dealer laws which directly target our ecoATM business, or potentially Coinstar Exchange, and restrict or prohibit us from operating. If additional similar laws are enacted at either the state or local level, our ability to operate may be adversely impacted, thereby damaging our business and results of operations.
Also, if U.S. copyright law were altered to amend or eliminate the First Sale Doctrine, our business could be adversely affected. Under U.S. copyright law, the First Sale Doctrine provides that once a copyright owner sells a copy of his work, the copyright owner relinquishes all further rights to sell or otherwise dispose of that copy. While the copyright owner retains the underlying copyright to the expression fixed in the work, the copyright owner gives up his ability to control the fate of the work once sold. As such, once we purchase a DVD in the market, we are permitted to re-sell it, rent it or otherwise dispose of it. Although the majority of our content library is licensed directly from studios, and not purchased, if Congress or the courts were to change, or substantially limit, this First Sale Doctrine, our ability to obtain certain purchased content and then rent it could be adversely affected.
Failure to comply with these laws and regulations could result in, among other things, revocation of required licenses or permits, loss of approved status, termination of contracts, administrative enforcement actions and fines, class action lawsuits, cease and desist orders and civil and criminal liability. The occurrence of one or more of these events, as well as the increased cost of compliance, could materially adversely affect our business, financial condition and results of operations.
Events outside of our control, including the current economic environment, have negatively affected, and could continue to negatively affect, consumers’ use of our products and services.
Our consumers’ use of many of our products and services is dependent on discretionary spending, which is affected by, among other things, economic and political conditions, consumer confidence, interest and tax rates, and financial and housing markets. With economic uncertainty still affecting potential consumers, we may be impacted by more conservative purchasing tendencies with fewer non-essential products and services purchases during the coming periods if the current economic environment continues. In addition, because our business relies in part on consumers initially visiting retailers to purchase products and services that are not necessarily our products and services, if consumers are visiting retailers less frequently and being more careful with their money when they do, these tendencies may also negatively impact our business.
Further, our ability to obtain additional funding in the future, if and as needed, through equity issuances or loans, or otherwise meet our current obligations to third parties, could be adversely affected if the economic environment continues to be difficult. In addition, the ability of third parties to honor their obligations to us could be negatively impacted, as retailers, suppliers and other parties deal with the difficult economic environment. Finally, there may be consequences that will ultimately result from the current economic conditions that are not yet known, and any one or more of these unknown consequences (as well as those currently being experienced) could potentially have a material adverse effect on our financial condition, operating results and liquidity, as well as our business generally.
Our business can be adversely affected by severe weather, natural disasters and other events beyond our control, such as earthquakes, fires, power failures, telecommunication loss and terrorist attacks.
A catastrophic event that results in the destruction or disruption of any of our critical business or information technology systems could harm our ability to conduct normal business operations and our operating results. For example, our corporate headquarters and certain critical business operations are located in the Bellevue, Washington area, which is near major earthquake faults. While we have taken steps to protect the security of critical business processes and systems and have established certain back-up systems and disaster recovery procedures, any disruptions, whether due to inadequate back-up or disaster recovery planning, failures of information technology systems, interruptions in the communications network, or other factors, could seriously harm our business, financial condition and results of operations.
In addition, our operational and financial performance is a direct reflection of consumer use of and the ability to operate and service our kiosks used in our business. Severe weather, natural disasters and other events beyond our control can, for extended periods of time, significantly reduce consumer use of our products and services as well as interrupt the ability of our employees and third-party providers to operate and service our kiosks. For example, in October 2012, Hurricane Sandy caused disruptions to our normal operations in the impacted region for an extended period of time. In some cases, severe weather, natural disasters and other events beyond our control may result in extensive damage to, or destruction of, our infrastructure and equipment, including loss of kiosks used to provide our products and services, which losses may not be fully covered by insurance.
Our business involves the movement of large sums of money, and, as a result, our business is particularly dependent on our ability to process and settle transactions accurately and efficiently.
Our business involves the movement of large sums of money. Our Coinstar business requires the effective transfer of large sums of money between many different locations. Because we are responsible for large sums of money that often are substantially greater than the revenues generated, the success of our business particularly depends upon the efficient, secure, and error-free handling of the money. We rely on the ability of our employees and our operating systems and network to process these transactions in an efficient, uninterrupted and error-free manner. In the event of a breakdown, catastrophic event, security breach, improper operation or any other event impacting our systems or network or our vendors’ systems or processes, or improper or other actions taken by employees, or third party vendors, we could suffer financial loss, loss of consumers, regulatory sanctions and damage to our reputation.
We may be unable to adequately protect our intellectual property or enforce our patents and other proprietary rights.
Our success depends, in part, on our ability to protect our intellectual property and maintain the proprietary nature of our technology through a combination of patents, trademarks, copyrights, trade secrets, licenses and other intellectual property arrangements. We have over 100 U.S. and international patents. For example, we have patents regarding kiosk systems for DVD rentals, managing credits and security and inventory management related to our Redbox business, and patents regarding coin counting, kiosk networking, fraud avoidance and voucher authentication related to our Coinstar business. We also have patents and other rights in the U.S., Canada and Europe related to our New Venture kiosk technologies, including U.S. patents on kiosk systems for identifying and analyzing electronic devices relating to our ecoATM business. In addition, we may apply for or obtain (through development, acquisition or otherwise) additional patents regarding technologies used in our businesses.
Our patents may not be held valid if challenged, our patent applications may not be issued, and other parties may claim rights in or ownership of our patents and other proprietary rights. Patents issued to us may be circumvented or fail to provide adequate protection of our technologies. Our competitors might independently develop or patent technologies that are substantially equivalent or superior to our technologies. Further, since patent terms are limited, other parties may begin practicing our patented technologies when our related patents expire.
In addition, certain parties may assert claims of patent infringement or misappropriation against us based on current or pending U.S. or foreign patents, copyrights or trade secrets, or contracts. If such claims were successful, our business could be harmed. Defending ourselves, our retailers or other third parties against these types of claims, regardless of their merits, or initiating litigation to enforce our rights, could require us to incur substantial costs, divert the attention of key personnel and result in an award of substantial damages. Parties making these types of claims may be able to obtain injunctive or other equitable relief, which could effectively block or impair our ability to provide our DVD, coin-counting or New Venture products and services in the U.S. or abroad. If third parties have, or obtain, proprietary rights that our products or services infringe, we may be unable to obtain necessary licenses from others at a reasonable cost or at all. The failure to protect our intellectual property rights effectively or to avoid infringing the intellectual property rights of others, as well as unfavorable rulings or settlements, could seriously harm our business, financial condition and results of operations.
Litigation, arbitration, mediation, regulatory actions, investigations or other legal proceedings could result in material rulings, decisions, settlements, fines, penalties or publicity that could adversely affect our business, financial condition and results of operations.
Our business has in the past been, is currently and may in the future continue to be, party to class actions, regulatory actions, investigations, arbitration, mediation and other legal proceedings. The outcome of such proceedings is often difficult to assess or quantify. Plaintiffs, regulatory bodies or other parties may seek very large or indeterminate amounts of money from us or substantial restrictions on our business activities, and the results, including the magnitude, of lawsuits, actions, settlements, decisions and investigations may remain unknown for substantial periods of time. The cost to defend, settle or otherwise finalize lawsuits, regulatory actions, investigations, arbitrations, mediations or other legal proceedings may be significant and such proceedings may divert management’s time. For example, in recent years we have been involved in consumer class action lawsuits, a securities class action and derivative lawsuit, and studio litigation, as well as other litigation in the ordinary course of business. In addition, there may be adverse publicity associated with any such developments that could decrease consumer acceptance of our products and services. As a result, litigation, arbitration, mediation, regulatory actions or investigations involving us or our affiliates may adversely affect our business, financial condition and results of operations.
The loss of key personnel or the inability of replacements to quickly and successfully perform in their new roles could adversely affect our business.
In recent years, we have experienced significant changes in our senior management team, including changes in the presidents of our business lines in 2013 and 2014 and the departure of our CEO in 2015. Further changes in senior management could result in disruptions to our operations. If we lose or terminate the services of one or more of our current executives or key employees or if one or more of our current or former executives or key employees joins a competitor or otherwise leaves or competes with us, it could harm our business and our ability to successfully implement our business plan. Additionally, if we are unable to timely hire qualified replacements for our executive and other key positions, our ability to execute our business plan could be harmed. Even if we can timely hire qualified replacements, we would expect to experience operational disruptions and inefficiencies during any transition.
Our stock price has been, and may continue to be, volatile.
Our stock price has fluctuated substantially since our initial public offering in July 1997. For example, during the year ended December 31, 2014, the closing price of our common stock ranged from $75.22 to $51.37 per share. Our stock price may fluctuate significantly in response to a number of factors, including:
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the termination, non-renewal or re-negotiation of one or more retailer, supplier, distributor, or other third-party relationships;
•
trends and fluctuations in the use of our different lines of business;
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operating results below market expectations and changes in, or our failure to meet, financial estimates of securities analysts or our own guidance;
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acquisition, merger, investment and disposition activities;
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period-to-period fluctuations in our financial results;
•
changes in management;
•
share repurchases and dividends;
•
announcements of technological innovations or new products or services by us or our competitors;
•
announcements regarding the establishment, modification or termination of relationships regarding the development of new or enhanced products and services;
•
release of analyst reports;
•
the level of demand for our stock, including the amount of short interest in our stock;
•
economic or other external factors, for example, those relating to the current economic environment and fluctuations in the trading price of stocks generally;
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ineffective internal controls; and
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industry developments.
In addition, the securities markets have experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These market fluctuations may also seriously harm the market price of our common stock.
Our anti-takeover mechanisms may affect the price of our common stock and make it harder for a third party to acquire us without the consent of our board of directors.
We have implemented anti-takeover provisions that may discourage takeover attempts and depress the market price of our stock. Provisions in our certificate of incorporation and bylaws could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. Delaware law also imposes some restrictions on mergers and other business combinations between us and any acquirer of 15% or more of our outstanding common stock. Furthermore, Washington law may impose additional restrictions on mergers and other business combinations between us and any acquirer of 10% or more of our outstanding common stock. These provisions may make it harder for a third party to acquire us without the consent of our board of directors, even if the offer from a third party may be considered beneficial by some stockholders.
Our obligations under our substantial debt could adversely affect our cash flow and business.
As of December 31, 2014, the total principal value of our outstanding debt, including capital leases, was $971.6 million. Our level of indebtedness could have important consequences for you, including:
•
increasing our vulnerability to general adverse economic and industry conditions;
•
requiring a substantial portion of our cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, thereby reducing our ability to use our cash flow to fund our operations, capital expenditures, share repurchases, dividends and future business opportunities;
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restricting us from making strategic acquisitions or investments or causing us to make non-strategic divestitures;
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limiting our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions and general corporate or other purposes;
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limiting our flexibility in planning for, or reacting to, changes in our business or the industry in which we operate, placing us at a competitive disadvantage compared to our competitors who are less highly leveraged and who, therefore, may be able to take advantage of opportunities that our leverage prevents us from exploiting; and
•
exposing us to variability in interest rates, as our borrowings under our credit facility bear interest at variable rates determined by prevailing interest rates and our leverage ratio.
If we are unable to meet our debt obligations, we could be forced to restructure or refinance such obligations, seek additional equity financing or sell assets, which we may not be able to do on satisfactory terms or at all. As a result, we could default on those obligations, which could prevent or impede us from fulfilling our obligations and adversely affect our business.
To service or repay our indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control.
Our ability to make payments on our indebtedness, including without limitation any payments required to be made to holders of the Senior Notes due 2021, the Senior Notes due 2019, or under our Credit Facility, and to fund our operations, will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.
We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to pay our indebtedness when due or to fund our other liquidity needs. We may need to refinance all or a portion of our indebtedness on or before maturity, sell assets, reduce or delay capital expenditures, seek additional equity financing or seek other third-party financing to satisfy such obligations. We cannot assure you that we will be able to refinance any of our indebtedness on commercially reasonable terms or at all. Our failure to fund indebtedness obligations at any time could constitute an event of default under the instruments governing such indebtedness, and could trigger a cross default under our other outstanding debt, which could result in an acceleration of such indebtedness.
If we do not comply with the covenants in the Amended and Restated Credit Agreement that governs our Credit Facility, the indentures that govern our Senior Notes due 2019, or our Senior Notes due 2021, respectively, we may not have the funds necessary to pay all of our indebtedness that could become due.
The Amended and Restated Credit Agreement governing our Credit Facility and the indentures that govern our Senior Notes due 2019 and our Senior Notes due 2021 require us to comply with certain covenants that may limit our ability to engage in activities that may be in our long-term best interests. For example, our Amended and Restated Credit Agreement prohibits us from incurring any additional indebtedness, except in specified circumstances, without lender approval. Further, our Amended and Restated Credit Agreement restricts our ability to acquire and dispose of assets, engage in mergers or reorganizations, pay dividends or make investments or capital expenditures. Other restrictive covenants require that we meet a maximum consolidated net leverage ratio and a minimum consolidated interest coverage ratio, each as defined in our Amended and Restated Credit Agreement. A violation of any of these covenants could cause an event of default under our Amended and Restated Credit Agreement, which could result in the acceleration of our outstanding indebtedness.
Our failure to comply with these covenants or others under our indentures could result in an event of default which, if not cured or waived, could result in the acceleration of all of our indebtedness, which would adversely affect our financial health. We cannot assure you that we would have sufficient funds to repay all the outstanding amounts, and any acceleration of amounts due under our Amended and Restated Credit Agreement or the indentures governing our outstanding indebtedness likely would have a material adverse effect on us.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
We are headquartered in Bellevue, Washington. Our corporate administrative, marketing and product development facility in Bellevue, Washington is located in three office buildings, totaling 156,644 square feet under three leases, two of which expire December 31, 2019, and the third will expire December 9, 2017. Our Coinstar and New Ventures segments each use part of this space.
Our Redbox subsidiary has offices in Oakbrook Terrace, Illinois. The Redbox offices currently occupy 211,742 square feet, and these premises are under a lease that expires on July 31, 2021. Our Redbox and New Ventures segments each use part of this space.
Our ecoATM business has facilities in San Diego, California that occupy 53,512 square feet and consist of facilities supporting administration, marketing, engineering, customer service and inventory processing. The lease for this space will expire on October 31, 2024.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In October 2009, an Illinois resident, Laurie Piechur, individually and on behalf of all others similarly situated, filed a putative class action complaint against our Redbox subsidiary in the Circuit Court for the Twentieth Judicial Circuit, St. Clair County, Illinois. The plaintiff alleged that, among other things, Redbox charges consumers illegal and excessive late fees in violation of the Illinois Consumer Fraud and Deceptive Business Practices Act, and that Redbox's rental terms violate the Illinois Rental Purchase Agreement Act or the Illinois Automatic Contract Renewal Act and the plaintiff is seeking monetary damages and other relief. In November 2009, Redbox removed the case to the U.S. District Court for the Southern District of Illinois. In February 2010, the District Court remanded the case to the Circuit Court for the Twentieth Judicial Circuit, St. Clair County, Illinois. In May 2010, the court denied Redbox's motion to dismiss the plaintiff's complaint. In November 2011, the plaintiff moved for class certification, and Redbox moved for summary judgment. The court denied Redbox's motion for summary judgment in February 2012. The plaintiff filed an amended complaint on April 19, 2012, and an amended motion for class certification on June 5, 2012. The court denied Redbox's motion to dismiss the amended complaint. The amended class certification motion was briefed and argued. At the hearing on plaintiff's amended motion for class certification, the plaintiff dismissed all claims but two and is pursuing only her claims under the Illinois Rental Purchase Agreement Act and the Illinois Automatic Contract Renewal Act. On May 21, 2013, the court denied plaintiff's amended class action motion. On January 29, 2014, the Illinois Supreme Court denied plaintiff’s petition for leave to appeal the trial court’s denial of class certification. Redbox has moved to dismiss all remaining claims on mootness grounds, and the Court granted Redbox’s motion on December 11, 2014. The plaintiffs appealed on January 7, 2015. We believe that the claims against us are without merit and intend to defend ourselves vigorously in this matter. Currently, no accrual has been established as it was not possible to estimate the possible loss or range of loss because this matter had not advanced to a stage where we could make any such estimate.
In March 2011, a California resident, Blake Boesky, individually and on behalf of all others similarly situated, filed a putative class action complaint against our Redbox subsidiary in the U.S. District Court for the Northern District of Illinois. The plaintiff alleges that Redbox retains personally identifiable information of consumers for a time period in excess of that allowed under the Video Privacy Protection Act, 18 U.S.C. §§ 2710, et seq. A substantially similar complaint was filed in the same court in March 2011 by an Illinois resident, Kevin Sterk. Since the filing of the complaint, Blake Boesky has been replaced by a different named plaintiff, Jiah Chung, and an amended complaint has been filed alleging disclosures of personally identifiable information, in addition to plaintiffs' claims of retention of such information. Plaintiffs are seeking statutory damages, injunctive relief, attorneys' fees, costs of suit, and interest. The court has consolidated the cases. The court denied Redbox's motion to dismiss the plaintiffs' claims upon interlocutory appeal. The U.S. Court of Appeals for the Seventh Circuit reversed the district court's denial of Redbox's motion to dismiss plaintiff's claims involving retention of information, holding that the plaintiffs could not maintain a suit for damages under this theory. On April 25, 2012, the plaintiffs amended their complaint to add claims under the Stored Communications Act, 18 U.S.C. § 2707, and for breach of contract. On May 9, 2012, Redbox moved to dismiss the amended complaint. On July 23, 2012, the court dismissed the added retention claims, except to the extent that plaintiffs seek injunctive, non-monetary relief. On August 16, 2013, the court granted summary judgment in Redbox's favor on all remaining claims, and entered a final judgment for Redbox. On September 16, 2013, plaintiff filed a notice of appeal. On October 23, 2014, the U.S. Court of Appeals for the Seventh Circuit affirmed the district court’s judgment in Redbox’s favor.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information and Stock Prices
Our common stock is traded on the NASDAQ Global Select Market under the symbol “OUTR.” The following table sets forth the high and low sale prices per share as reported by the NASDAQ Global Select Market for our common stock for each quarter during the last two fiscal years. The quotations represent inter-dealer prices without retail markup, markdown or commission and may not necessarily represent actual transactions.
The approximate number of holders of record of our common stock at February 3, 2015 was 79.
Dividends
Although we have never declared or paid any cash dividends on our common stock, on February 5, 2015, we announced that the Board of Directors has decided to initiate a quarterly cash dividend. The first cash dividend of $0.30 per outstanding share of our common stock is expected to be paid on March 18, 2015 to all stockholders of record on March 3, 2015. While it is our intention to pay quarterly cash dividends for the foreseeable future, the decision to pay future cash dividends will be made by our Board of Directors each quarter and will depend upon, among other things, existing conditions, including earnings, financial condition and capital requirements, restrictions in financing agreements, business opportunities and other conditions and factors, including prospects. We are required to meet certain financial covenants under our Credit Facility and the indentures related to the Senior Notes due 2019 and the Senior Notes due 2021 in order to pay dividends. We were in compliance with these financial covenants at December 31, 2014.
Repurchases of Common Stock
On January 30, 2014, our Board of Directors approved an additional stock repurchase program of up to $500.0 million of our common stock plus the cash proceeds received from the exercise of stock options by our officers, directors, and employees. The Board also authorized a tender offer for up to $350.0 million with the option to increase the tender by up to 2% of outstanding shares.
As of December 31, 2014, we were authorized to repurchase up to $163.7 million of our common stock under our share repurchase programs. Repurchased shares become a part of treasury stock.
The following table summarizes information regarding shares repurchased during the quarter ended December 31, 2014:
(1)
The only shares repurchased in the quarter ended December 31, 2014 represented shares tendered for tax withholding on vesting of restricted stock awards, none of which are included against the dollar value of shares that may be purchased under programs approved by our Board of Directors.
(2)
Dollars in thousands
Unregistered Sales of Equity Securities
On October 1, 2014, we issued 25,000 shares of unregistered restricted common stock to Sony as partial consideration for the extension of our existing content license agreement with Sony discussed in Note 9: Share-Based Payments and Note 17: Commitments and Contingencies in our Notes to Consolidated Financial Statements. The issuance of the common stock was exempt from registration pursuant to the Securities Act of 1933, as amended (the “Securities Act”) by virtue of Section 4(a)(2) and/or Regulation D promulgated thereunder as a transaction not involving a public offering. We believe that the issuance is exempt from the registration requirements of the Securities Act on the basis that: (1) Sony represented it was an accredited investor as defined under the Securities Act; (2) there was no general solicitation; and (3) Sony represented that it was purchasing such shares for its own account and not with a view towards distribution. The shares of common stock carry a legend stating that the shares are not registered under the Securities Act and therefore cannot be resold unless they are registered under the Securities Act or unless an exemption to registration is available.
On November 20, 2014 Redbox announced a contract extension with Paramount Home Entertainment under the existing terms of the revenue sharing license agreement discussed in Note 9: Share-Based Payments and Note 17: Commitments and Contingencies in our Notes to Consolidated Financial Statements. The one-year extension requires us to issue 50,000 shares of unregistered restricted common stock to Paramount during the first quarter of 2015.
Securities Authorized for Issuance Under Equity Compensation Plans
For information regarding securities authorized for issuance under equity compensation plans, see Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, which incorporates by reference to the Proxy Statement relating to our 2015 Annual Meeting of Stockholders.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data below should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and notes thereto included elsewhere in this Form 10-K.
(1)
Discontinued operations for all periods presented includes the results of operations from:
◦
our Money Transfer Business, which we met the criteria to classify as a discontinued operation in the second quarter of 2010 and sold in June 2011;
◦
our E-Payment Business, which was sold in the second quarter of 2010; and
◦
our Entertainment Business, which was sold in the third quarter of 2009.
◦
four ventures previously included in our New Ventures operating segment, Orango, Rubi, Crisp Market, and Star Studio which were discontinued during 2013.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this Annual Report. Except for the consolidated historical information, the following discussion contains forward-looking statements. Actual results could differ from those projected in the forward-looking statements. Please refer to “Special Note Regarding Forward-Looking Statements” and “Risk Factors” elsewhere in this Annual Report.
Overview
We are a leading provider of automated retail solutions offering convenient products and services that benefit consumers and drive incremental retail traffic and revenue for retailers. Our automated retail business model leverages technology advancements that allow delivery of new and innovative consumer products in a compact, automated format. We believe this model positions us to address retailers’ increasing need to provide more in less space driven by increased urbanization and consumers’ increasing expectation of instant gratification. Our products and services can be found at approximately 67,000 kiosks in leading supermarkets, drug stores, mass merchants, financial institutions, convenience stores, malls and restaurants. While we are focused on four consumer sectors, collectively our business segments and strategic investments currently operate within five consumer sectors: Entertainment, Money, Electronics, Beauty & Consumer Packaged Goods, and Health.
Core Offerings
We have two core businesses:
•
Our Redbox business segment (“Redbox”), where consumers can rent or purchase movies and video games from self-service kiosks is focused on the entertainment consumer sector.
•
Our Coinstar business segment (“Coinstar”) is focused on the money consumer sector and provides self-service kiosks where consumers can convert their coins to cash and convert coins and paper bills to stored value products. We also offer self-service kiosks that exchange gift cards for cash under our Coinstar Exchange brand.
New Ventures
We identify, evaluate, build or acquire and develop innovative new self-service concepts in the automated retail space in our New Ventures business segment (“New Ventures”).
In the Electronics sector we acquired and continue to build the ecoATM business which provides an automated self-service kiosk where consumers can recycle mobile devices for cash and generates revenue through the sale of devices collected at our kiosks to third parties. We began reporting the results of this business in our New Ventures segment subsequent to its acquisition in the third quarter of 2013 and ended 2014 with approximately 1,890 kiosks in service. A self-service kiosk concept we are currently exploring in the marketplace is our consumer product sampling concept SAMPLEit, which is in the Beauty and Consumer Packaged Goods sector. Beginning in the first quarter of 2015, we anticipate reporting ecoATM results as a separate segment.
New Ventures concepts and ecoATM are regularly assessed to determine whether continued funding or other alternatives are appropriate.
Strategic Investments and Joint Venture
On occasion, we make strategic investments in external companies that provide automated self-service kiosk solutions. For example, in the Health sector we have invested in SoloHealth, Inc. Additionally, we held an equity interest in ecoATM prior to acquisition in the third quarter of 2013. On October 20, 2014, Redbox withdrew as a member of Redbox Instant by Verizon, (the "Joint Venture") a joint venture between Redbox and Verizon Ventures IV LLC ("Verizon").
See Note 5: Equity Method Investments and Related Party Transactions in our Notes to Consolidated Financial Statements for more information about our strategic investments.
Strategy
Our strategy is based upon leveraging our core competencies in the automated retail space to provide the consumer with convenience and value and to help retailers drive incremental traffic and revenue. Our competencies include success in building strong consumer and retailer relationships, and in deploying, scaling and managing kiosk businesses. We build strong retailer relationships by providing retailers with turnkey solutions that complement their businesses without significant outlays of time and financial resources. We believe we have significant opportunities to continue to grow our revenues, profitability and cash flow by capitalizing on our strengths and favorable industry trends through the execution of the following strategies:
•
Continue growing our Redbox business profitably. We are focused on profitably growing Redbox through increased revenue generation and improved kiosk-operations efficiency.
We expect to grow revenue through attracting new customers, testing pricing strategies, improving the Blu-ray rental mix, and utilizing our customer management tools. Blu-ray drives revenue growth by shifting rentals to its higher revenue price point, $2.00 per night, and higher margin dollars per rental. Not only does Blu-ray provide a strong financial benefit to our business, but it also offers consumers a better viewing experience due to superior picture and sound quality compared to other home video rental formats (including digital streaming). Further, our customer management tools allow us to provide personalized recommendations and promotions to our customers, which helps us generate incremental revenue. We continually test pricing strategies and make decisions based on results, for example, following price testing in 2014, effective December 2, 2014, the rental price for DVDs increased by 30 cents to $1.50 a day, and the price for Blu-ray Discs increased by 50 cents to $2.00 a day; and, effective January 6, 2015, the rental price for video games increased by $1.00 to $3.00 a day.
While we have substantially completed the build out of our Redbox network in the U.S., we believe we can improve financial performance by redeploying underperforming kiosks to lower kiosk density or higher-consumer-traffic areas. We also have retrofitted a significant percentage of our existing kiosks to provide increased capacity, which enables Redbox to retain discs in the kiosks longer without a material increase in product cost thereby allowing us to provide greater title selection and copy depth to generate incremental rentals. We also continuously improve our proprietary algorithms allowing Redbox to more accurately predict daily title availability and demand at individual kiosk locations. From a financial perspective, we expect these strategies to help offset the expected secular decline in the physical rental market.
•
Optimize and grow revenues from our Coinstar business. As with Redbox, we believe we can improve financial performance in our Coinstar business through kiosk optimization. We continue to focus on finding attractive locations for our kiosks, including through redeployment of underperforming kiosks to lower-kiosk-density or higher-consumer-traffic areas. Further, the Coinstar business continues to develop consumer-oriented products and services, such as Coinstar Exchange, and to expand into other channels, such as financial institutions, where we can leverage our Coinstar platform.
•
Use our expertise to continue to develop our existing businesses and new innovative automated retail solutions. Through Redbox and Coinstar, we have demonstrated our ability to profitably scale automated retail solutions. We also leverage those core competencies to identify, evaluate, build or acquire, and develop new automated retail concepts through both organic and inorganic opportunities. For example, in the third quarter of 2013, we acquired ecoATM, one of our previous strategic investments. Further, we continue to make modest investments to test our product sampling kiosk concept, SAMPLEit. We are committed to addressing the changing needs and preferences of our consumers, including through strategic investments.
Recent Events
Subsequent Events
•
On January 20, 2015, the Board of Directors of Outerwall Inc. announced that Nora M. Denzel, a director of the Company, was appointed by the Board to serve as Interim Chief Executive Officer of the Company, effective January 18, 2015, and that J. Scott Di Valerio stepped down as the Company’s Chief Executive Officer, effective January 18, 2015, and resigned from the Board, effective January 19, 2015.
•
On January 23, 2015, we made the decision to shut down our Redbox operations in Canada as the business was not meeting the company's performance expectations. As a result, we updated certain estimates used in the preparation of the financial statements and recognized an additional after-tax expense of $1.5 million in the fourth quarter of 2014 related to accelerated recognition of content library and capitalized installation costs on property and equipment. The remaining value of the content library and capitalized installation costs will be amortized over an expected three-month wind-down period ending March 31, 2015. Following the final shutdown of the operations in Canada, we expect Redbox Canada results will be reported as a discontinued operation.
•
On February 3, 2015, the Board approved an additional stock repurchase authorization of up to $250.0 million of its common stock plus the cash proceeds received from the exercise of stock options by the Company's directors and employees, bringing the total available for repurchases to approximately $413.7 million.
•
On February 3, 2015, our board of directors approved a dividend policy and declared a quarterly cash dividend of $0.30 per share to be paid on March 18, 2015, to all stockholders of record as of the close of business on March 3, 2015. Future quarterly dividend payments will be subject to approval by our board of directors.
Q4 2014 Events
•
On November 24, 2014, Redbox announced that, effective December 2, 2014, the rental price for DVDs would increase by 30 cents to $1.50 a day, and the price for Blu-ray Discs would increase by 50 cents to $2.00 a day; and that, effective January 6, 2015, the rental price for video games would increase by $1.00 to $3.00 a day.
•
On November 20, 2014 Redbox announced a contract extension with Paramount Home Entertainment under the existing terms. The one-year extension maintains day-and-date access for our customers to Paramount titles through the end of 2015.
•
On October 27, 2014, Redbox entered into an amended and restated content license agreement with Lions Gate Films, Inc. which extends the term of the existing agreement through September 30, 2016 and can be extended for an additional year under certain circumstances.
•
On October 19, 2014, Redbox, Verizon, the Joint Venture and Verizon Corporate Services Group, Inc. entered into a Withdrawal and Extinguishment of Rights Agreement pursuant to which Redbox withdrew as a member of the Joint Venture effective on October 20, 2014. The Joint Venture ceased operation of its consumer service effective October 7, 2014.
Q3 2014 Events
•
On September 26, 2014, Universal Studios Home Entertainment LLC exercised its option to extend the term of the revenue sharing license agreement between Redbox and Universal through December 31, 2015.
•
On September 2, 2014, our remaining outstanding 4.0% Convertible Senior Notes ("Convertible Notes") matured. In the three months ended September 30, 2014, we retired or settled upon maturity $33.4 million in face value of Convertible Notes for $33.4 million in cash and the issuance of 248,944 shares of our common stock. See Note 7: Debt and Other Long-Term Liabilities in our Notes to Consolidated Financial Statements for more information.
•
During the three months ended September 30, 2014, we repurchased 1,185,970 shares of our common stock at an average price of $59.52 per share for $70.6 million.(1)
Q2 2014 Events
•
On June 27, 2014, Sony notified us of their intent to extend our existing content license agreement with them. This extension will extend the license period through September 30, 2015.
•
On June 24, 2014, we entered into a new credit facility arrangement consisting of a senior secured $600.0 million revolving line of credit that, under certain conditions, may be increased up to an additional $200.0 million in aggregate, and a senior secured $150.0 million amortizing term loan. The maturity of the credit facility is extended until June 24, 2019.
•
On June 9, 2014, we consummated a private offering to sell $300.0 million in aggregate principal amount of senior unsecured notes due 2021. We used the proceeds to repay indebtedness under our prior credit facility and for general corporate purposes.
•
During the three months ended June, 30, 2014, we repurchased 711,556 shares of our common stock at an average price of $70.27 per share for $50.0 million.(1)
Q1 2014 Events
•
During January 2014, we repurchased 736,000 shares of our common stock at an average price of $67.93 per share for $50.0 million.(1)
•
During the three months ended March 31, 2014, we executed a tender offer in which we accepted for payment an aggregate of 5,291,701 shares of our common stock at a final purchase price of $70.07 per share, for an aggregate cost of $370.8 million, excluding fees and expenses.(1)
(1)
Shares purchased as part of publicly announced repurchase plans or programs as approved by Board of Directors. See Note 8: Repurchases of Common Stock in our Notes to Consolidated Financial Statements for more information.
Results of Operations
Consolidated Results
The discussion and analysis that follows covers our results from continuing operations:
Comparing 2014 to 2013
Revenue decreased $3.6 million, or 0.2%, primarily due to:
•
$81.4 million decrease from our Redbox segment primarily due to
◦
4.9% decrease in same store sales primarily due to the relative attractiveness and timing of title releases - while total box office for content released during 2014 increased 8.1%, significantly lower box office during certain periods of 2014, in particular content released in the second and third quarters, led to a lack of strong content throughout the year and contributed to a 6.8% decrease in rentals in 2014; and
◦
$17.3 million decrease in video game rentals primarily due to a lighter release slate during the first and second quarters because of the game industry’s shift to next generation platforms; partially offset by
•
$62.4 million increase from our New Ventures segment primarily due to the inclusion of a full year of ecoATM results subsequent to our acquisition of ecoATM on July 23, 2013 and an increase of 1,080 New Ventures kiosks during the year; and
•
$15.4 million increase from our Coinstar segment, primarily due to growth in U.S. same store sales driven by a price increase effective October 1, 2013, higher volume in the U.K. due to an increased kiosk base, growth in U.K. same store sales driven by a price increase effective August 1, 2014 and growth in the number of Coinstar Exchange kiosks.
Operating income decreased $12.6 million, or 4.8%, primarily due to:
•
$22.2 million increase in operating loss within our New Ventures segment, primarily from costs associated with scaling the ecoATM business;
•
$4.6 million increase in share based expense, which is not allocated to our segments, primarily as a result of rights to receive cash we issued as replacement awards for unvested restricted stock as part of our acquisition of ecoATM in the third quarter of 2013; and
•
$2.3 million decrease in operating income within our Redbox segment primarily where the following items partially offset the decrease in revenue discussed above:
◦
$44.7 million decrease in direct operating expenses which stayed in line with revenue at 70.7% of revenue in 2014 as compared to 70.1% in 2013;
◦
$29.4 million decrease in general and administrative expenses primarily as a result of ongoing cost reduction initiatives;
◦
$6.0 million decrease in depreciation and amortization expenses primarily due to certain of our kiosk assets becoming fully depreciated; partially offset by
•
$16.5 million increase in operating income within our Coinstar segment primarily due to revenue growth.
Comparing 2014 to 2013 Continued
Income from continuing operations decreased $100.7 million, or 48.4%, primarily due to:
•
$48.7 million increase in loss from equity method investments primarily due to a $68.4 million gain recorded in the third quarter of 2013 on the re-measurement of our previously held equity interest in ecoATM to its acquisition date fair value;
•
$25.3 million increase in income tax expense due primarily to discrete tax benefits in 2013;
•
$14.8 million increase in interest expense due to increased average borrowings which includes the impact of the $300.0 million principal amount of Senior Notes due 2021 we issued on June 9, 2014 (see Note 7: Debt and Other Long-Term Liabilities in our Notes to Consolidated Financial Statements for more information); and
•
$12.6 million decrease in operating income discussed above.
Comparing 2013 to 2012
Revenue increased $106.7 million, or 4.9%, primarily due to:
•
$65.8 million increase from our Redbox segment, $141.7 million from new kiosk installations including the acquisition and replacement of NCR kiosks, offset by a $75.9 million decrease from a decline in same store sales due primarily to a lower box office;
•
$31.5 million increase from our New Ventures segment primarily due to the inclusion of ecoATM results;
•
$9.5 million increase from our Coinstar segment, primarily due to growth of U.S. same store sales as a result of the price increase in the fourth quarter of 2013 and revenue from kiosks installed at TD Canada Trust ("TDCT") locations.
Operating income decreased $18.4 million, or 6.6%, primarily due to:
•
Increased operating loss within our New Ventures segment for 2013, which includes only continuing operations related to our ecoATM and SAMPLEit concepts, primarily due to the inclusion of ecoATM results subsequent to our acquisition of ecoATM on July 23, 2013;
•
Increased share based expense, which is not allocated to our segments, primarily as a result of $8.7 million in expense associated with rights to receive cash issued as a part of the acquisition of ecoATM; offset partially by
•
Stable operating income in our Redbox segment where revenue growth was offset by:
◦
Increased product costs included in direct operating expenses due to higher content purchases attributable to:
▪
A 19.0% increase in theatrical titles in 2013 driven largely by a weaker release schedule in the third quarter of 2012 due to the Summer Olympics;
▪
Content purchases in anticipation of higher rental demand, growth in our installed kiosk base, increased content purchases under our Warner agreement which was signed in the fourth quarter of 2012 relative to the January through October 2012 period when we were procuring Warner content through alternative sources;
▪
Increased Blu-ray content purchases as we continue to grow this format; partially offset by
▪
A $31.8 million reduction in product costs due to the content library amortization change as explained in Note 2: Summary of Significant Accounting Policies in our Notes to Consolidated Financial Statements, as well as a weaker release schedule in the fourth quarter of 2013, down 21.0% from a year ago;
Comparing 2013 to 2012 Continued
◦
Increases in other direct operating expenses including revenue share, payment card processing fees, customer service and support function costs directly attributable to our revenue and kiosk growth and certain costs incurred to service the kiosks that were under the transition services agreement with NCR, offsetting this was a benefit from an $11.4 million reduction in a loss contingency accrual recorded during first quarter of 2013, of which $11.4 million had been previously expensed in 2012;
◦
Higher depreciation and amortization expenses primarily due to higher depreciation from the continued investment in our technology infrastructure, incremental depreciation associated with our 2012 installed kiosks, including the NCR kiosks, as well as the launch of Redbox Instant by Verizon; and
◦
Increased general and administrative expenses primarily due to higher expenses related to corporate information technology initiatives including the continued implementation and maintenance of our enterprise resource planning system and professional fees related to the sale of kiosks acquired in our NCR Asset Acquisition.
•
Increased operating income in our Coinstar segment primarily attributable to revenue growth.
Income from continuing operations increased $47.6 million, or 29.7%, primarily due to:
•
A gain of $68.4 million on the re-measurement of our previously held equity interest in ecoATM during 2013;
•
Lower income tax expenses due to lower pretax income and a lower effective tax rate driven primarily by a tax benefit of $24.3 million related to the non-taxable gain upon the acquisition of ecoATM noted above, a discrete one-time tax benefit of $17.8 million, net of a valuation allowance, related to outside tax basis from a restructuring and sale of a subsidiary and a $16.7 million discrete one-time tax benefit related to the recognition of an outside basis difference in a subsidiary; partially offset by
•
Lower operating income as described above;
•
A $19.5 million gain on a license grant to the Joint Venture during 2012 which did not recur in 2013;
•
Increased interest expense primarily due to the $350.0 million in Senior Notes we issued on March 12, 2013 and loss from early extinguishment or conversion of debt.
Share-Based Payments and Rights to Receive Cash
Our share-based payments consist of share-based compensation granted to executives, non-employee directors and employees and share-based payments granted to movie studios as part of content agreements. We grant stock options, restricted stock and performance-based restricted stock to executives and non-employee directors and restricted stock to our employees. In connection with our acquisition of ecoATM, we also granted certain rights to receive cash (the "rights to receive cash"). We also granted restricted stock to certain movie studios as part of content agreements with our Redbox segment. The expense associated with the grants to movie studios is allocated to our Redbox segment and included within direct operating expenses. The expenses associated with share-based compensation to our executives, non-employee directors, employees and related to the rights to receive cash are part of our corporate function and are not allocated to our segments. The components of our unallocated share-based compensation expense are presented in the following table:
* Not meaningful
Unallocated share-based compensation expense increased $4.6 million, or 22.0% and $7.5 million, or 56.5% during the years ended December 31, 2014 and 2013, respectively, due to the rights to receive cash and changes in the fair value of restricted stock awards granted. See Note 9: Share-Based Payments in our Notes to Consolidated Financial Statements for more information.
Segment Results
Our discussion and analysis that follows covers results of operations for our Redbox, Coinstar and New Ventures segments.
We manage our business by evaluating the financial results of our segments, focusing primarily on segment revenue and segment operating income before depreciation, amortization and other; share-based compensation granted to executives, non-employee directors and employees and the rights to receive cash (“segment operating income”). Segment operating income contains internally allocated costs of our shared services support functions, including but not limited to, corporate executive management, business development, sales, customer service, finance, legal, human resources, information technology, and risk management. We also review depreciation and amortization allocated to each segment.
Management utilizes segment revenue and segment operating income to evaluate the health of our business segments and in consideration of allocating resources among our business segments. Specifically, our CEO evaluates segment revenue and segment operating income, and assesses the performance of each business segment based on these measures, as well as, among other things, the prospects of each of the segments and how they fit into our overall strategy. Our CEO then decides how resources should be allocated among our business segments. For example, if a segment’s revenue increases more than expected, our CEO may consider allocating more financial or other resources to that segment in the future. We periodically evaluate our shared services support function’s allocation methods used for segment reporting purposes, which may result in changes to segment allocations in future periods.
We also review same store sales, which we calculate for our segments on a location basis. Most of our locations have a single kiosk, but in locations with a high-performing kiosk, we may add additional kiosks to drive incremental revenue and provide a broader product offering. Same store sales reflects the change in revenue from locations that have been operating for more than 13 months by the end of the reporting period compared with the same locations in the same period of the prior year. The same store sales metric is not applicable to our ecoATM business because transactions at the kiosk are for product acquisition, not sales.
Detailed financial information about our business segments, including significant customer relationships is provided in Note 14: Business Segments and Enterprise-Wide Information in our Notes to Consolidated Financial Statements.
Revenue
Our Redbox segment generates revenue primarily through fees charged to rent or purchase a movie or video game, and we pay retailers a percentage of our revenue. Our Coinstar segment generates revenue primarily through transaction fees from our consumers and product partners and we pay retailers a percentage of our revenue. Our New Ventures segment generates revenue primarily through sales of devices collected at our ecoATM kiosks to third parties.
Our segment operating expenses include the following categories:
Direct Operating
Direct operating expenses consist primarily of (1) amortization of our content library, (2) transaction fees and commissions we pay to our retailers, (3) credit card fees and coin processing expenses, (4) field operations support, (5) cost to acquire devices that are resold to third parties through our ecoATM business, and (6) revenue share we pay to studios. Variations in the percentage of transaction fees and commissions we pay to our retailers may result in increased expenses. Such variations are based on certain factors, such as total revenue, long-term non-cancelable contracts, installation of our kiosks in high traffic and/or urban or rural locations, new product commitments, or other criteria.
Marketing
Our marketing expenses represent our cost of advertising, traditional marketing, on-line marketing, and public relations efforts in national and regional advertising and major international markets.
Research and Development
Our research and development expenses consist primarily of the development costs of our kiosk software, network applications, machine improvements, and new product development. Research and development expenses represent expenditures to support development and design of our complementary new product ideas and to continue our ongoing efforts to enhance our existing products and services.
General and Administrative
Our general and administrative expenses consist primarily of executive management, business development, supply chain management, finance, management information system, human resources, legal, facilities, risk management, and administrative support for field operations.
Depreciation and Amortization
Our depreciation and other expenses consist primarily of depreciation charges on our installed kiosks as well as on computer equipment and leased automobiles.
Detailed financial information about our business segments, including geographic financial information and significant customer relationships is provided in Note 14: Business Segments and Enterprise-Wide Information in our Notes to Consolidated Financial Statements.
Redbox
*
Excludes kiosks and the impact of kiosks acquired as part of the 2012 NCR Asset Acquisition which occurred on June 22, 2012. We acquired approximately 6,200 active kiosks. Approximately 1,900 of these kiosks remained in service at December 31, 2012. During the first quarter of 2013, we replaced 100 of these kiosks with Redbox kiosks and during the first and second quarters of 2013, we removed but did not replace all remaining kiosks acquired. During the years ended December 31, 2013 and 2012, kiosks acquired as part of the NCR acquisition generated revenue of approximately $2.7 million from 0.8 million rentals and $22.0 million from 7.4 million rentals, respectively.
The comparable performance of our content library is continually affected by seasonality, strength of box office and timing of the release slate and the relative attractiveness of titles available for rent in a particular quarter or year which may have lingering effects in subsequent periods. Compared with prior periods when kiosk installations were increasing and helping drive growth, Redbox revenue and other operating results may be more affected by these factors. We also anticipate negative impacts in future periods arising from the expected secular decline in the physical rental market.
2014 Events
•
On November 24, 2014, Redbox announced that, effective December 2, 2014, the rental price for DVDs would increase by 30 cents to $1.50 a day, and the price for Blu-ray Discs would increase by 50 cents to $2.00 a day; and that, effective January 6, 2015, the rental price for video games would increase by $1.00 to $3.00 a day.
•
During the fourth quarter of 2014, Redbox launched Redbox Play Pass, a new loyalty program, which we expect to drive continued improvement in customer engagement and rental frequency.
•
On November 20, 2014 Redbox announced a contract extension with Paramount Home Entertainment under the existing terms. The one-year extension maintains day-and-date access for our customers to Paramount titles through the end of 2015.
•
On October 27, 2014, Redbox entered into a new content license agreement with Lions Gate Films, Inc. which extends the term of the existing agreement through September 30, 2016 and can be extended for an additional year under certain circumstances.
•
On October 19, 2014, Redbox entered into an agreement with Verizon to withdraw from the Joint Venture
•
On September 26, 2014, Universal Studios Home Entertainment LLC exercised its option to extend the term of the revenue sharing license agreement between Redbox and Universal through December 31, 2015.
•
On June 27, 2014, Sony notified us of their intent to extend our existing content license agreement with them. The extension became effective October 1, 2014 and extended the license period through September 30, 2015.
Comparing 2014 to 2013
Revenue decreased $81.4 million, or 4.1%, primarily due to the following:
•
$95.8 million decrease from a 4.9% decrease in same store sales primarily due to:
◦
Relative attractiveness and timing of title releases - while total box office (representing titles with total North American box office receipts of at least $5.0 million) for content released during 2014 increased 8.1%, significantly lower box office during certain periods of 2014 (particularly in the second and third quarters) led to a lack of strong content throughout the year which, combined with the impact from the expected secular decline in the market, contributed to a 6.8% decrease in rentals in 2014;
◦
Revenue from video game rentals decreased $17.3 million primarily due to a lighter release slate during the first and second quarters because of the game industry’s shift to next generation platforms and under performance of certain games titles; partially offset by
◦
More effective promotional activity that leverages customer-specific offerings and an increase in the daily rental fees for movie content implemented in December 2014.
•
$2.7 million decrease to zero from revenue earned by kiosks acquired from NCR as noted above; partially offset by
•
$17.1 million in revenue from newly installed or relocated kiosks including those that replaced the remaining NCR kiosks.
Net revenue per rental increased $0.08 to $2.62 primarily due to:
•
A continued increase in Blu-ray rentals which we consider a key focus for future revenue growth as it has a higher revenue and margin dollar per rental and offers consumers a better viewing experience due to superior picture and sound quality compared to other options such as digital streaming and video on demand. Blu-ray rentals represented 15.0% of total disc rentals and 17.6% of revenue during 2014 as compared to 13.1% of total disc rentals and 15.4% of revenue during 2013; partially offset by
•
Lower video game rentals, which declined 16.8% during 2014 as compared to 2013 primarily due to the factors discussed above.
Operating income decreased $2.3 million, primarily due to the following:
•
$81.4 million decrease in revenue as described above; partially offset by
•
$44.7 million decrease in direct operating expenses, which were 70.7% of revenue in 2014 as compared to 70.1% in 2013, primarily as a result of:
◦
Product costs decreased $9.8 million to $820.8 million primarily due to lower spending on content in 2014 partially offset by a change in how we amortize our product costs in our content library that was prospectively applied as explained in Note 2: Summary of Significant Accounting Policies in our Notes to Consolidated Financial Statements resulting in a $21.7 million benefit which was recorded in the second quarter of 2013 to reflect an increase in the ending value of the Redbox content library as of June 30, 2013. For comparability purposes, product cost in 2013 would have been $23.8 million higher had the new methodology been applied retrospectively as costs would have shifted from prior periods into 2013;
◦
Gross margin decreased by 130 basis points to 56.6% in 2014 primarily due to the performance of the content library as a result of the relative attractiveness of titles available for rent and the timing of the release schedule in 2014 partially offset by a $3.4 million decrease in studio-related share-based expenses and closing underperforming NCR kiosks. The 2013 period also benefited from an $11.4 million reduction in a loss contingency that had been previously expensed in 2012;
◦
Direct operating expenses were also impacted by lower retailer revenue sharing expenses primarily due to lower revenue, lower payment card processing fees due to fewer rentals and general cost containment initiatives. The 2014 period also included a one-time benefit from a $5.6 million adjustment to expenses related to personal property taxes due to a reduction of the estimated liability; and
•
$29.4 million decrease in general and administrative expenses primarily as a result of ongoing cost reduction initiatives, including payroll related savings arising from our December 2013 workforce reduction and lower variable expenses associated with IT infrastructure costs, temporary staffing, legal and professional fees; and
•
$6.0 million decrease in depreciation and amortization expenses primarily due to certain of our kiosk assets that are depreciated over three to five years becoming fully depreciated partially offset by higher depreciation expense as a result of continued investment in our corporate technology infrastructure and additional depreciation for newly installed or replaced kiosks.
Comparing 2013 to 2012
Revenue increased $65.8 million, or 3.4%, primarily due to the following:
•
$139.0 million from new kiosk installations that were primarily installed in the second half of 2012 and were not included in our same store sales until the second half of 2013, as well as the replacement of NCR kiosks; and
•
$2.7 million from kiosks acquired from NCR; partially offset by a
•
$75.9 million decrease from a 4.1% decline in same store sales due primarily to a considerably weaker start to first quarter’s release schedule, which has a significant influence on first quarter rentals, with only 36.0% of the total first quarter box office available to rent in January versus 50.0% last year, an overall weaker box office during the second and fourth quarters, an increase in single night and discounted rentals for most of the year, as well as cannibalization of rentals as we installed over 5,200 new kiosks during the second half of 2012. Partially offsetting this was growth in third and fourth quarter same stores sales from over 4,200 of our 2012 kiosk installations that are now included in same store sales, a significantly stronger box office during the third quarter; up 46.0% from prior year as a result of the Summer Olympics in 2012, as well as substantial growth in Blu-ray and video game disc rentals, which were up 59.3% and 16.3%, respectively. While our same store sales declined from the prior period as noted above, we saw improvement in 2013 as some of the converted kiosk installs begin contributing to same store sales and product strength compares more favorably year over year. Additionally, we saw improvement in our single versus multiple night rental mix in December as they moved closer to historical averages due to less reliance on discounted rentals both of which drive higher net revenue per rental.
Net revenue per rental decreased $0.01 to $2.54 primarily due to higher than expected customer response to promotions during the third quarter which drove discounted rentals and an increase in single night rentals for most of the year. This decrease was partially offset by increases in Blu-ray and video game rentals as a percentage of our total rentals, both of which have a higher daily rental fee.
Blu-ray rentals continued prior trends and increased to 13.1% of total rentals for the year, with fourth quarter Blu-ray rentals hitting an all-time high of 14.2% of total disc rentals. Video game rentals increased from 2.0% to 2.2% of total rentals despite several popular releases being available only on multi-disc sets, which presented a challenge for our customers in renting these releases.
Operating income increased $0.4 million, or 0.1%, primarily due to the following:
•
$65.8 million increase in revenue as described above; offset by
•
$42.7 million increase in direct operating expenses composed of the following;
◦
Product costs increased $33.7 million to $830.6 million due to the following main factors:
▪
Increased content purchases in the third quarter as a result of a 19.0% increase in theatrical titles driven largely by a weaker release schedule in the third quarter of 2012 due to the Summer Olympics;
▪
Greater content purchases in anticipation of higher rental demand, growth in our installed kiosk base, increased content purchases under our Warner agreement which was signed in the fourth quarter of 2012 relative to the January through October 2012 period when we were procuring Warner content through alternative sources;
▪
Increased Blu-ray content purchases as we continued to grow this format; partially offset by
▪
A $31.8 million reduction in product costs due to the content library amortization change as explained in Note 2: Summary of Significant Accounting Policies in our Notes to Consolidated Financial Statements, as well as a weaker release schedule in the fourth quarter of 2013, down 21.0% from a year ago;
▪
Product is typically purchased 6-8 weeks in advance based on forecasted demand and revenue and future content purchases are adjusted if results in the current period do not meet expectations but it impacts operating income in the short-term.
◦
Increases in revenue share, payment card processing fees, customer service and support function costs directly attributable to our revenue and kiosk growth and certain costs incurred to service the kiosks under the transition services agreement with NCR;
◦
Benefiting the period was an $11.4 million reduction in a loss contingency accrual recorded during in the first quarter of 2013, of which $11.4 million had been previously expensed in 2012 as well as a $1.4 million reduction in studio related share based expenses primarily due to a larger change in our share price during the period, partially offset by a lower number of unvested shares on the last day of the calculation period;
◦
Direct operating expenses as a percent of revenue for 2013 were 70.1% as compared to 70.2% in the prior period.
•
$14.6 million increase in depreciation and amortization expenses primarily due to higher depreciation from continued investment in our technology infrastructure, incremental depreciation associated with our 2012 installed kiosks, including the NCR kiosks, as well as the launch of Redbox Instant by Verizon;
•
$6.2 million increase in general and administrative expenses primarily due to higher expenses related to corporate information technology initiatives including the continued implementation and maintenance of our enterprise resource planning system and professional fees related to the sale of kiosks acquired in our NCR Asset Acquisition; and
•
$2.5 million increase in marketing costs due to initiatives to increase our revenue by improving consumer insight and data capabilities to offer a better consumer experience through personalized recommendations for the latest new releases, search engine marketing, growth in our SMS and text club messages due to an increase in our subscriber list, promotional email campaigns and social media, as well as our expansion into Canada.
Coinstar
* Not Meaningful
2014 Events
•
Effective August 1, 2014, we increased the coin voucher product transaction fee from 8.9% to 9.9% at all U.K. grocery retail locations.
Comparing 2014 to 2013
Revenue increased $15.4 million, or 5.1%, primarily due to:
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Same store sales growth in the U.S. driven by a price increase implemented across all grocery locations effective October 1, 2013;
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Higher volume in the U.K. due to an increased U.K. kiosk base;
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Same store sales growth in the U.K driven by a price increase on August 1, 2014; and
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Growth in the number of Coinstar Exchange kiosks.
The average transaction size continued to increase during 2014 while the number of transactions has declined. The decline in transactions is the result of larger pours and less frequent visits, a slight decrease in the U.S. kiosk base year over year as a result of optimization efforts, the expected volume decline as a result of the U.S. price increase, and the impact of the Royal Canadian Mint’s penny reclamation efforts in Canada.
Operating income increased $16.5 million, or 24.0%, primarily due to the following:
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$15.4 million increase in revenue as described above; and
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$6.4 million decrease in research and development expenses primarily due to a reduction in kiosk hardware and software engineering efforts for Coinstar and Coinstar Exchange; partially offset by
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$1.1 million increase in general and administrative expenses primarily due to increased expenses associated with the growth of our Coinstar Exchange business;
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$2.7 million increase in direct operating expenses due to increased revenue sharing, selling and customer service costs to support higher revenues; and
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$1.6 million increase in depreciation and amortization expense due to higher depreciation expense as a result of continued investment in our corporate technology infrastructure and the write-off of technology assets.
Comparing 2013 to 2012
Revenue increased $9.5 million, or 3.3%, primarily due to growth of U.S. same store sales and revenue from TDCT locations. The increase in same store sales in the U.S. was driven by the price increase implemented across all grocery locations in the U.S. The average coin-to-voucher transaction size continued to increase and the volume of non-cash voucher products increased by 0.3%. Revenue increased at a rate lower than the increase in transaction size due to variations in country and product mix, including growth in Canada driven by TDCT, which has a different revenue model than regular coin-to-voucher transactions. Same store sales grew in the U.S. driven by growth from the fee increase in fourth quarter of 2013, and the fact that revenue from kiosks installed in 2011 was fully included in the 2012 same store sales measurement. This was slightly offset by reduced same store sales in the UK and Canada.
The average coin-to-voucher transaction size continued to increase and the volume of non-cash voucher products increased by 0.3%. Revenue increased at a rate lower than the increase in transaction size due to variations in country and product mix, including growth in Canada driven by TDCT, which has a different revenue model than regular coin-to-voucher transactions.
Operating income increased $5.4 million, or 8.6%, primarily due to the following:
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$9.5 million increase in revenue as described above; and
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$2.2 million decrease in depreciation and amortization expense due to incremental expense associated with one-time expense for internal use software in the nine months ended September 30, 2012 for $2.5 million which did not recur in 2013, offset by lower machine disposal losses; partially offset by
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$1.3 million increase in marketing expenses primarily due to timing of advertising and spending to support our programs in 2013;
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$2.8 million increase in direct operating expenses primarily due to higher revenue share expense attributable to both revenue growth and increased revenue share rates with certain retail partners as a result of long-term contract renewals; higher coin processing and transportation related expenses arising from higher revenue and incremental costs to outsource the transportation function in Canada in 2013; and
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$2.5 million increase in research and development expenses primarily due to an increase in kiosk software and hardware engineering efforts for our Coinstar and gift card exchange business kiosks.
New Ventures
On July 23, 2013 we completed the acquisition of ecoATM. The primary reason for the business combination was to expand Outerwall’s presence in automated retail and gain exposure to the growing demand for refurbished electronic products and mobile devices. Also during 2013, except for ecoATM and our product sampling kiosk venture, SAMPLEit, we discontinued all other concepts and reclassified their results of operations to discontinued operations for all periods presented. See Note 12: Discontinued Operations for more information. The New Ventures results of operations presented here represent the results of ecoATM from the July 23, 2013 acquisition date and the results of SAMPLEit.
Comparing 2014 to 2013
Revenue increased $62.4 million primarily due to the inclusion of a full year of ecoATM results in 2014 and from kiosks installed in 2014. We installed approximately 910 net new ecoATM kiosks, primarily in the grocery channel, during the second half of 2014. Relative to our mall and mass merchant channels, sites in the grocery channel typically are smaller in overall square footage and have less foot traffic. As a result, we expect ecoATM kiosks in the grocery channel to ramp slower than our mall and mass merchant kiosks. While there are several drivers that impact ecoATM revenue, the key revenue drivers are the number of devices collected, the percentage of those devices that are non-scrap devices and the average selling price that ecoATM receives when reselling the devices. New Ventures segment revenue decreased sequentially from the quarter ended September 30, 2014 primarily due to seasonal trends, a lower mix of high value devices, and a lower average selling price in the secondary market resulting from an increased supply of devices following the iPhone 6 release in September 2014.
Operating loss increased $22.2 million, or 85.8%, primarily due to the following;
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$65.6 million increase in direct operating expenses mainly due to costs associated with the acquisition, transportation and processing of mobile devices in our ecoATM business, as well as costs for servicing of our kiosks and payments to our retailers. Additionally, in 2014 the highly successful launch of the iPhone 6/6+ caused a significant increase in device trade-ins that lowered resale values in the secondary market to below historical levels during the fourth quarter. Additionally, the 2014 operating expenses include a full year of ecoATM whereas 2013 includes costs only after the acquisition date and reflects the increased New Ventures kiosk base. As we install additional kiosks we expect our variable operating costs to increase proportionately, however, as our existing kiosks continue to ramp, we expect to leverage the fixed cost portions of our direct operating expenses;
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$11.2 million increase in depreciation and amortization expense from depreciation on our increased installed kiosk base, amortization expense related to certain ecoATM intangible assets acquired as part of the business combination and higher depreciation expense as a result of continued investment in our corporate technology infrastructure;
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$3.9 million increase in research and development expense at ecoATM due to continued development of our kiosk hardware and software platforms, as well as an increase to support our SAMPLEit kiosks;
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$3.2 million increase in marketing costs primarily due to costs to promote the ecoATM and SAMPLEit kiosks, as well as additional headcount to support our installed kiosk base; and
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$0.7 million increase in general and administrative expense primarily due to higher costs to support the continued growth in our installed kiosk base, as well as expenses related to facilities expansion and human resource programs, partially offset by $5.7 million in transaction expenses related to the acquisition of ecoATM in 2013; partially offset by
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$62.4 million increase in revenue described above.
Comparing 2013 to 2012
Revenue increased $31.5 million primarily due to the acquisition of ecoATM.
Operating loss increased $16.7 million, or 182.2%, primarily due to the following:
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$28.1 million increase in direct operating expenses primarily due to results in 2013 including ecoATM since its acquisition and shared services costs associated with adding kiosks to the marketplace;
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$9.3 million increase in general and administrative expenses primarily due to $5.7 million in transaction expenses related to the acquisition of ecoATM, general and administrative expenses for ecoATM in 2013 since its acquisition, and shared services costs to support concept growth;
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$6.3 million increase in depreciation and amortization primarily due to results in 2013 including ecoATM since its acquisition and additional depreciation on equipment to support growth;
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$3.4 million increase in research and development due to results in 2013 including ecoATM since its acquisition and spending to support existing concepts; and
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$1.1 million increase in marketing expense primarily due to results in 2013 including ecoATM since its acquisition and spending initiatives to support growth of existing concepts; partially offset by
•
$31.5 million increase in revenue as described above.
Income (loss) from equity method investments
Comparing 2014 to 2013
Loss and income from equity method investments was $28.7 million of loss compared to income of $19.9 million primarily due to:
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$68.4 million gain in 2013 resulting from the re-measurement of our previously held equity interest in ecoATM during 2013; partially offset by
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$19.7 million in lower losses from our investment in the Joint Venture and other equity method investments.
In 2015 we expect reduced impact from equity method investments as a result of our withdrawal from the Joint Venture in 2014. See Note 5: Equity Method Investments and Related Party Transactions in our Notes to Consolidated Financial Statements for more information.
Comparing 2013 to 2012
Income from equity method investments increased to $19.9 million from a $5.2 million loss, primarily due to:
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$68.4 million gain in 2013 on the re-measurement of our previously held equity interest in ecoATM; and
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$19.5 million gain on a license grant to the Joint Venture during 2012 which did not recur in 2013.
Interest Expense, Net
Comparing 2014 to 2013
Interest expense, net increased $14.8 million, or 45.2%, primarily due to:
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$14.5 million higher interest expense from increased average borrowings which includes the impact of the $300.0 million principal amount of Senior Notes due 2021 we issued on June 9, 2014 (see Note 7: Debt and Other Long-Term Liabilities in our Notes to Consolidated Financial Statements for more information); and
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$4.3 million decrease in interest income primarily due to income from the settlement of a note receivable in 2013; partially offset by
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$4.0 million decrease in losses from the early extinguishment or conversion of debt. See Note 7: Debt and Other Long-Term Liabilities in our Notes to Consolidated Financial Statements for more information.
Comparing 2013 to 2012
Interest expense, net increased $17.2 million, or 109.6%, during the year primarily due to:
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$11.8 million higher interest expense associated with the $350.0 million in Senior Notes we issued on March 12, 2013 and
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$5.1 million higher losses from the early extinguishment or conversion of debt. See Note 7: Debt and Other Long-Term Liabilities in our Notes to Consolidated Financial Statements for more information.
Other Expense, Net
* Not Meaningful
Comparing 2014 to 2013
Other expense, net decreased by $0.7 million or 11.8% to $4.9 million primarily due to:
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$3.0 million higher foreign currency related losses to $6.2 million primarily due to the impact of the Canadian dollar exchange rates on our Redbox Canada and Coinstar Canada operations; offset by
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$2.8 million in expense incurred to write-down the carrying value of a note receivable from Sigue incurred during 2013 which did not recur in 2014.
Comparing 2013 to 2012
Other expense, increased by $5.3 million to $5.5 million primarily due to:
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$3.1 million higher foreign currency related losses to $3.3 million primarily due to the impact of the Canadian dollar exchange rates on our Redbox Canada and Coinstar Canada operations; and
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$2.8 million in expense incurred to write-down the carrying value of a note receivable from Sigue. See Note 16: Fair Value
Income Tax Expense
Income tax expense and effective tax rates are driven by recurring items, such as tax rates in foreign jurisdictions and the relative amount of income we earn in each. It is also affected by permanent differences in the recognition of income and expenses for income tax purposes vs. financial reporting purposes and various discrete items that may occur in any given year, but are not consistent from year to year. The most significant, recurring permanent difference impacting our income tax expense is the Domestic Production Activities Deduction ("DPAD") which we are entitled to based on Redbox's domestic production activities.
Comparing 2014 to 2013
Income tax expense increased by $25.3 million resulting from higher taxable income primarily driven by:
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$34.5 million in tax benefits related to discrete items occurring in 2013 composed of:
◦
$16.7 million related to the recognition of a worthless stock deduction from an outside basis difference in a corporate subsidiary in 2013; and
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$17.8 million, net of a valuation allowance, through the realization of capital and ordinary gains and losses associated with the series of transactions to reorganize Redbox related subsidiary structures through the sale of a wholly owned subsidiary; partially offset by
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$5.3 million increase in the DPAD from $1.5 million in 2013 to $6.8 million in 2014; and
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$3.9 million in additional impact primarily driven by the $7.1 million decrease in Income from continuing operations before income taxes excluding the $68.4 million non-taxable gain on previously held equity interest in ecoATM.
Comparing 2013 to 2012
Income tax expense decreased by $63.5 million primarily driven by:
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$34.5 million in tax benefits related to discrete items occurring in 2013 composed of:
◦
$16.7 million related to the recognition of a worthless stock deduction from an outside basis difference in a corporate subsidiary in 2013; and
◦
$17.8 million, net of a valuation allowance, through the realization of capital and ordinary gains and losses associated with the series of transactions to reorganize Redbox related subsidiary structures through the sale of a wholly owned subsidiary; and
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$30.5 million decrease driven by the $84.2 million decrease in income from continuing operations before income taxes excluding the $68.4 million non-taxable gain on previously held equity interest in ecoATM; partially offset by
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$1.5 million in additional impact primarily driven by other permanent differences, including the DPAD, in the recognition of income and expenses for income tax purposes vs. financial reporting purposes and various discrete items.
Non-GAAP Financial Measures
Non-GAAP measures may be provided as a complement to results provided in accordance with United States generally accepted accounting principles (“GAAP”).
We use the following non-GAAP financial measures to evaluate our financial results:
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Core adjusted EBITDA from continuing operations;
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Core diluted earnings per share (“EPS”) from continuing operations;
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Free cash flow; and
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Net debt and net leverage ratio.
These measures, the definitions of which are presented below, are non-GAAP because they exclude certain amounts which are included in the most directly comparable measure calculated and presented in accordance with GAAP. Our non-GAAP financial measures are not meant to be considered in isolation or as a substitute for our GAAP financial measures and may not be comparable with similarly titled measures of other companies.
Core and Non-Core Results
We distinguish our core activities, those associated with our primary operations which we directly control, from non-core activities. Non-core activities are primarily nonrecurring events or events we do not directly control. Our non-core adjustments for the periods presented include, but not limited to, i) restructuring costs associated with actions to reduce costs in our continuing operations primarily through workforce reductions across the Company, ii) acquisition costs primarily related to the acquisition of ecoATM, iii) compensation expense for rights to receive cash issued in conjunction with our acquisition of ecoATM and attributable to post-combination services as they are fixed amount acquisition related awards and not indicative of the directly controllable future business results, iv) income or loss from equity method investments, which represents our share of income or loss from entities we do not consolidate or control and includes the impacts of the gain on re-measurement of our previously held equity interest in ecoATM upon acquisition, v) benefits from release of indemnification reserves upon settlement of the Sigue Note and vi) tax benefits related to a net operating loss adjustment and the recognition of a worthless stock deduction in a corporate subsidiary ("Non-Core Adjustments").
We believe investors should consider our core results because they are more indicative of our ongoing performance and trends, are more consistent with how management evaluates our operational results and trends, provide meaningful supplemental information to investors through the exclusion of certain expenses which are either nonrecurring or may not be indicative of our directly controllable business operating results, allow for greater transparency in assessing our performance, help investors better analyze the results of our business and assist in forecasting future periods.
Core Adjusted EBITDA from continuing operations
Our non-GAAP financial measure core adjusted EBITDA from continuing operations is defined as earnings from continuing operations before depreciation, amortization and other; interest expense, net; income taxes; share-based payments expense; and Non-Core Adjustments.
A reconciliation of core adjusted EBITDA from continuing operations to net income from continuing operations, the most comparable GAAP financial measure, is presented in the following table:
* Not Meaningful
(1)	Includes both non-cash share-based compensation for executives, non-employee directors and employees as well as share-based payments for content arrangements.
Comparing 2014 to 2013
The decrease in our core adjusted EBITDA from continuing operations was primarily due to:
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Lower segment operating income in our Redbox segment, and
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Higher segment operating loss in our New Ventures segment, partially offset by
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Higher segment operating income in our Coinstar segment.
The other significant components of core adjusted EBITDA from continuing operations have been discussed previously in the Results of Operations section above.
Comparing 2013 to 2012
The increase in our core adjusted EBITDA from continuing operations was primarily due to:
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Higher operating income in our Redbox and Coinstar segments, partially offset by
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Higher operating loss in our New Ventures segment.
The other components of core adjusted EBITDA from continuing operations have been discussed previously in the Results of Operations section above.
Core Diluted EPS from continuing operations
Our non-GAAP financial measure core diluted EPS from continuing operations is defined as diluted earnings per share from continuing operations excluding Non-Core Adjustments, net of applicable taxes.
A reconciliation of core diluted EPS from continuing operations to diluted EPS from continuing operations, the most comparable GAAP financial measure, is presented in the following table:
* Not Meaningful
(1)	Non-Core Adjustments are presented after-tax using the applicable effective tax rate for the respective periods.
Free Cash Flow
Our non-GAAP financial measure free cash flow is defined as net cash provided by operating activities after capital expenditures. We believe free cash flow is an important non-GAAP measure as it provides additional information to users of the financial statements regarding our ability to service, incur or pay down indebtedness and repurchase our securities. A reconciliation of free cash flow to net cash provided by operating activities, the most comparable GAAP financial measure, is presented in the following table:
An analysis of our net cash from operating activities and used in investing and financing activities is provided below in the Liquidity and Capital Resources section.
Net Debt and Net Leverage Ratio
Our non-GAAP financial measure net debt is defined as the total face value of outstanding debt, including capital leases, less cash and cash equivalents held in financial institutions domestically. Our non-GAAP financial measure net leverage ratio is defined as net debt divided by core adjusted EBITDA from continuing operations for the last twelve months ("LTM"). We believe net debt and net leverage ratio are important non-GAAP measures because they:
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are used to assess the degree of leverage by management;
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provide additional information to users of the financial statements regarding our ability to service, incur or pay down indebtedness and repurchase our securities as well as additional information about our capital structure; and
•
are reported quarterly to support covenant compliance under our credit agreement.
A reconciliation of net debt to total outstanding debt including capital leases, the most comparable GAAP financial measure, is presented in the following table:
* Not Meaningful
(1) See debt section of Liquidity and Capital Resources below and Note 7: Debt and Other Long-Term Liabilities in our Notes to Consolidated Financial Statements for detail of associated debt discount.
Liquidity and Capital Resources
We believe our existing cash, cash equivalents and amounts available to us under our Credit Facility will be sufficient to fund our cash requirements and capital expenditure needs for at least the next 12 months. After that time, the extent of additional financing needed, if any, will depend on the success of our business. If we significantly increase kiosk installations beyond planned levels or if our Redbox, Coinstar or New Venture kiosks generate lower than anticipated revenue or operating results, then our cash needs may increase. Furthermore, our future capital requirements will depend on a number of factors, including consumer use of our services, the timing and number of machine installations, the number of available installable kiosks, the type and scope of service enhancements, the cost of developing potential new product service offerings, and enhancements, and cash required to fund potential future acquisitions, investment or capital returns to shareholders such as through share repurchases.
The following is an analysis of our year-to-date cash flows:
Net Cash from Operating Activities
Our net cash from operating activities increased by $10.5 million primarily due to:
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$76.9 million increase in net cash inflows from changes in working capital primarily due to changes in prepaid expenses and other current assets, accounts payable, content library, and other accrued liabilities; partially offset by
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$68.2 million decrease in net income to $106.6 million as discussed in the Consolidated Results section above; and
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$1.8 million change in net non-cash income and expense included in net income.
Net Cash used in Investing Activities
We used $115.4 million of net cash in our investing activities primarily due to:
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$97.9 million used for purchases of property and equipment for kiosks and corporate infrastructure, including information technology primarily related to our Enterprise Resource Planning implementation; and
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$24.5 million used for capital contributions to the Joint Venture; partially offset by
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$5.0 million extinguishment payment from the Joint Venture upon finalization of our withdrawal from it.
Net Cash used in Financing Activities
We used $354.3 million of net cash from financing activities as follows:
•
$545.1 million for repurchases of our common stock;
•
$51.1 million to repurchase and settle convertible debt;
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$38.1 million in net re-payments on our Credit Facility. The revolving line of credit had an average daily balance of $163.2 million in 2014 and was used to support the activities discussed above relative to the timing of cash flows from operations throughout the same period;
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$14.0 million to pay capital lease obligations and other debt; and
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$1.5 million for other financing activities; partially offset by
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$295.5 million from issuance of our senior unsecured notes due 2021.
Cash and Cash Equivalents
A portion of our business involves collecting and processing large volumes of cash, most of it in the form of coins. As of December 31, 2014, our cash and cash equivalent balance was $242.7 million, of which $81.7 million was identified for settling our payable to the retailer partners in relation to our Coinstar kiosks. The remaining balance of our cash and cash equivalents was available for use to support our liquidity needs.
Debt
Debt comprises the following:
Senior Unsecured Notes Due 2019
On March 12, 2013, we entered into an indenture pursuant to which we issued $350.0 million principal amount of 6.000% Senior Notes due 2019 (the “Senior Notes due 2019”) at par for proceeds, net of expenses, of $343.8 million. The expenses were allocated between debt discount and deferred financing fees based on their nature. Each of our direct and indirect U.S. subsidiaries guarantees the Senior Notes due 2019. As of December 31, 2014, we were in compliance with the covenants of the related indenture.
Senior Unsecured Notes Due 2021
On June 9, 2014, we entered into an indenture pursuant to which we issued $300.0 million principal amount of 5.875% Senior Notes due 2021 (the "Senior Notes due 2021") at par for proceeds, net of expenses, of $294.0 million. The expenses were allocated between debt discount and deferred financing fees based on their nature. Each of our direct and indirect U.S. subsidiaries guarantees the Senior Notes due 2021.
The Senior Notes due 2021 and related guarantees:
•
are general unsecured obligations and are effectively subordinated to all of our and our subsidiary guarantors’ existing and future secured debt to the extent of the collateral securing that secured debt, and
•
will rank equally to all of our and our subsidiary guarantors’ other unsecured and unsubordinated indebtedness.
In addition, the Senior Notes due 2021:
•
will be effectively subordinated to all of the liabilities of our existing and future subsidiaries that are not guaranteeing the Senior Notes due 2021,
•
require interest payable on June 15 and December 15 of each year, beginning on December 15, 2014, and
•
mature on June 15, 2021.
We may redeem any of the Senior Notes due 2021:
•
beginning on June 15, 2017 at a redemption price of 104.406% of their principal amount plus accrued and unpaid interest and additional interest, if any; then
•
the redemption price will be 102.938% of their principal amount plus accrued and unpaid interest and additional interest, if any, for the twelve-month period beginning June 15, 2018; then
•
the redemption price will be 101.469% of their principal amount plus accrued and unpaid interest and additional interest, if any, for the twelve-month period beginning June 15, 2019; and then
•
the redemption price will be 100.000% of their principal amount plus accrued interest and unpaid interest and additional interest, if any, beginning on June 15, 2020.
•
We may also redeem some or all of the Senior Notes due 2021 before June 15, 2017 at a redemption price of 100.000% of the principal amount, plus accrued and unpaid interest and additional interest, if any, to the redemption date, plus an applicable “make-whole” premium.
•
In addition, before June 15, 2017, we may redeem up to 35% of the aggregate principal amount with the proceeds of certain equity offerings at 105.875% of their principal amount plus accrued and unpaid interest and additional interest, if any; we may make such redemption only if, after any such redemption, at least 65% of the aggregate principal amount originally issued remains outstanding.
Upon a change of control as defined in the indenture related to the Senior Notes due 2021, we will be required to make an offer to purchase the Senior Notes due 2021 or any portion thereof. That purchase price will equal 101% of the principal amount of the Senior Notes due 2021 on the date of purchase plus accrued and unpaid interest and additional interest, if any. If we make
certain asset sales and do not reinvest the proceeds or use such proceeds to repay certain debt, we will be required to use the proceeds of such asset sales to make an offer to purchase the Senior Notes due 2021 at 100% of their principal amount, together with accrued and unpaid interest and additional interest, if any, to the date of purchase.
The terms of the Senior Notes due 2021 restrict our ability and the ability of certain of our subsidiaries to, among other things: incur additional indebtedness; create liens; pay dividends or make distributions in respect of capital stock; purchase or redeem capital stock; make investments or certain other restricted payments; sell assets; enter into transactions with stockholders or affiliates; or effect a consolidation or merger. However, these and other limitations set forth in the related indenture will be subject to a number of important qualifications and exceptions.
The indenture related to the Senior Notes due 2021 provides for customary events of default which include (subject in certain cases to grace and cure periods), among others: nonpayment of principal or interest or premium; breach of covenants or other agreements in the indenture; defaults in failure to pay certain other indebtedness; the failure to pay certain final judgments; the invalidity of certain of the Subsidiary Guarantors’ guarantees; and certain events of bankruptcy, insolvency or reorganization. Generally, if an event of default occurs and is continuing under the indenture, either the trustee or the holders of at least 25% in aggregate principal amount then outstanding may declare the principal amount plus accrued and unpaid interest to be immediately due and payable. As of December 31, 2014, we were in compliance with the covenants of the related indenture.
In connection with the issuance of the Senior Notes due 2021 and related guarantees, we agreed to register the Senior Notes due 2021 and related guarantees under the Securities Act of 1933, as amended (the “Securities Act”) so as to allow holders of the Senior Notes due 2021 and related guarantees to exchange the Senior Notes due 2021 and the related guarantees for the same principal amount of a new issue of Senior Notes due 2021 and related guarantees (collectively, the “Exchange Notes”) with substantially identical terms, except that the Exchange Notes will generally be freely transferable under the Securities Act. If we fail to comply with these obligations on time (a “registration default”), we generally will be required to pay additional interest at a rate of 0.25% per annum for the first 90-day period following a registration default and an additional 0.25% per annum for each subsequent 90-day period that such additional interest continues to accrue (provided that such rate may not exceed 1.00% per annum).
Revolving Line of Credit and Term Loan
On June 24, 2014, we entered into the Third Amended and Restated Credit Agreement (the “Amended and Restated Credit Agreement”) providing for a senior secured credit facility (the "Credit Facility"). The Amended and Restated Credit Agreement amended and restated in its entirety the Second Amended and Restated Credit Agreement dated as of November 20, 2007 and amended and restated as of April 29, 2009 and as of July 15, 2011 and all amendments and restatements thereto. The credit facility provided under the previous credit agreement was replaced by the Credit Facility. As a result of this refinancing activity, in the six months ended June 30, 2014, we recorded a loss on the extinguishment of the previous credit agreement of $1.7 million for certain previously capitalized and unamortized debt issuance costs. The loss on extinguishment is recorded within Interest expense, net in our Consolidated Statements of Comprehensive Income.
The Credit Facility consists of (a) a $150.0 million amortizing term loan (the “Term Loan”) and (b) a $600.0 million revolving line of credit (the “Revolving Line”), which includes (i) a $75.0 million sublimit for the issuance of letters of credit, (ii) a $50.0 million sublimit for swingline loans and (iii) a $75.0 million sublimit for loans in certain foreign currencies available to us and certain wholly owned Company foreign subsidiaries (the “Foreign Borrowers”). We may, subject to applicable conditions and subject to obtaining commitments from lenders, request an increase in the Revolving Line of up to $200.0 million in aggregate (the “Accordion”).
We (or the Foreign Borrowers, if applicable), subject to applicable conditions, may generally elect interest rates on the Term Loan and Revolving Line calculated by reference to (a) LIBOR (“London Interbank Offered Rate”) (or the Canadian Dealer Offered Rate, in the case of loans denominated in Canadian Dollars or, if LIBOR is not available for a foreign currency, such other interest rate customarily used by Bank of America for such foreign currency) for given interest periods (the “LIBOR/Eurocurrency Rate”) or (b) on loans in U.S. Dollars made to us, Bank of America’s prime rate (or, if greater, (i) the average rate on overnight federal funds plus 0.50% or (ii) the daily floating one month LIBOR plus 1%) (the “Base Rate”), plus a margin determined by our consolidated net leverage ratio. For swingline borrowings, we will pay interest at the Base Rate, plus a margin determined by our consolidated net leverage ratio. For borrowings made with the LIBOR/Eurocurrency Rate, the margin ranges from 125 to 200 basis points, while for borrowings made with the Base Rate, the margin ranges from 25 to 100 basis points.
The Amended and Restated Credit Agreement requires principal amortization payments under the Term Loan as follows:
The Revolving Line matures on June 24, 2019, at which time all outstanding borrowings must be repaid and all outstanding letters of credit must have been terminated or cash collateralized. The maturity date of the borrowings under the Credit Facility may be accelerated to December 18, 2018 if our senior unsecured notes due 2019 remain outstanding on or after such date. We may prepay amounts borrowed under the Term Loan without premium or penalty (other than breakage costs in the case of borrowings made with the LIBOR/Eurocurrency Rate), but amounts prepaid may not be re-borrowed.
The Amended and Restated Credit Agreement contains events of default that include, among others, non-payment of principal, interest or fees, violation of covenants, inaccuracy of representations and warranties, bankruptcy and insolvency events, material judgments, cross defaults to certain other indebtedness, and events constituting a change of control. The occurrence of an event of default will increase the applicable rate of interest and could result in the acceleration of our obligations under the Credit Facilities and the obligations of any or all of the Guarantors to pay the full amount of our (or any Foreign Borrower’s) obligations under the Credit Facility.
The Amended and Restated Credit Agreement contains certain loan covenants, including, among others, financial covenants providing for a maximum consolidated net leverage ratio (i.e., consolidated total debt (net of certain cash and cash equivalents held by us and our domestic subsidiaries) to consolidated EBITDA) and a minimum consolidated interest coverage ratio, and limitations on our ability with regard to the incurrence of debt, the existence of liens, capital expenditures, stock repurchases and dividends, investments, and mergers, dispositions and acquisitions. Our obligations under the Credit Facility are guaranteed by each of our direct and indirect U.S. subsidiaries (collectively, the “Guarantors”), and if any Foreign Borrower is added to the Credit Facility, the Foreign Borrower’s obligations will be guaranteed by us and each of the Guarantors. As of December 31, 2014, the interest rate on amounts outstanding under the Credit Facility was 1.92% and we were in compliance with the covenants of the Credit Facility.
Convertible Debt
On September 2, 2014, our 4.0% Convertible Senior Notes (the “Convertible Notes”) matured. The aggregate outstanding principal was $51.1 million at December 31, 2013.
The Convertible Notes were convertible as of December 31, 2013 and the debt conversion feature was classified as temporary equity on our Consolidated Balance Sheets. In 2014, we retired or settled upon maturity, a combined 51,148 Convertible Notes for total consideration of $51.1 million in cash and the issuance of 431,760 shares of common stock. The amount by which total consideration exceeded the fair value of the Convertible Notes has been recorded as a reduction of stockholders’ equity. The loss from early extinguishment of the Convertible Notes was approximately $0.3 million and is recorded in Interest expense, net in our Consolidated Statements of Comprehensive Income.
Letters of Credit
As of December 31, 2014, we had six irrevocable standby letters of credit that totaled $6.4 million. These standby letters of credit, which expire at various times through September 2015, are used to collateralize certain obligations to third parties. As of December 31, 2014, no amounts were outstanding under these standby letter of credit agreements.
Other Contingencies
During the year ended December 31, 2013, we resolved a previously disclosed loss contingency related to a supply agreement and recorded a benefit of $11.4 million in the direct operating line item in our Consolidated Statements of Comprehensive Income.
Contractual Payment Obligations
(1)
See Note 17: Commitments and Contingencies in our Notes to Consolidated Financial Statements.
(2)
Excludes any amounts associated with the manufacturing and services agreement entered into as part of the NCR Asset Acquisition, pursuant to which Outerwall, Redbox or an affiliate will purchase goods and services from NCR for a period of five years from June 22, 2012. At the end of the five-year period, if the aggregate amount paid in margin to NCR for goods and services delivered equals less than $25.0 million, Outerwall will pay NCR the difference between such aggregate amount and $25.0 million. As of December 31, 2014, the remaining commitment is $15.8 million under this agreement.
(3)
Income tax liabilities for uncertain tax positions were excluded as we are not able to make a reasonably reliable estimate of the amount and period of related future payments. As of December 31, 2014, we had $4.6 million of gross unrecognized tax benefits for uncertain tax positions.
Off-Balance Sheet Arrangements
Other than certain contractual arrangements listed above, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. For additional information see Note 17: Commitments and Contingencies in our Notes to Consolidated Financial Statements.
Inflation
We believe that the impact of inflation was minimal on our business in 2014, 2013 and 2012.
Critical Accounting Policies
Our consolidated financial statements have been prepared in accordance with U.S. GAAP. Preparation of these statements requires management to make judgments and estimates. We base our estimates on historical experience and on other assumptions that we believe to be reasonable under the present circumstances.
Significant estimates underlying our consolidated financial statements include the:
•
useful lives and salvage values of our content library;
•
determination of goodwill impairment;
•
lives of equipment and other long-lived assets;
•
recognition and measurement of current and long-term deferred income taxes (including the measurement of uncertain tax positions);
•
recognition and measurement of purchase price allocation for business combinations; and
•
loss contingencies.
It is reasonably possible that the estimates we make may change in the future and could have a material effect on our financial statements.
Content Library
Content library consists of movies and video games available for rent or purchase. We obtain our movie and video game content primarily through revenue sharing agreements and license agreements with studios and game publishers, as well as through distributors and other suppliers. The cost of content mainly includes the cost of the movies and video games, labor, overhead, freight, and studio revenue sharing expenses. The content purchases are capitalized and amortized to their estimated salvage value as a component of direct operating expenses over the usage period. For purchased content that we expect to sell at the end of its useful life, we determine an estimated salvage value. Content salvage values are estimated based on the amounts that we have historically recovered on disposal. For licensed content that we do not expect to sell, no salvage value is provided. The useful lives and salvage value of our content library are periodically reviewed and evaluated. Amortization charges are derived utilizing rental curves based on historical performance of movies and games over their useful lives and recorded on an accelerated basis, reflecting higher rentals of movies and video games in the first few weeks after release, and substantially all of the amortization expense is recognized within one year of purchase.
Goodwill
Goodwill represents the excess purchase price of an acquired enterprise or assets over the estimated fair value of identifiable net assets acquired. We assess goodwill for potential impairment at the reporting unit level on an annual basis as of November 30, or whenever an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. We may assess qualitative factors to make this determination, or bypass such a qualitative assessment and proceed directly to testing goodwill for impairment using a two-step process. Qualitative factors we may consider include, but are not limited to, macroeconomic conditions, industry conditions, the competitive environment, changes in the market for our products and services, regulatory and political developments and entity specific factors such as strategies and financial performance. If, after completing such assessment, it is determined more likely than not that the fair value of a reporting unit is less than its carrying value, we proceed to a two-step impairment test, whereby the first step is comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired and the second step of the test is not performed. The second step of the impairment test is performed when the carrying amount of the reporting unit exceeds the fair value, then the implied fair value of the reporting unit goodwill is compared with the carrying amount of that goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to the excess. For additional information see Note 4: Goodwill and Other Intangible Assets in our Notes to Consolidated Financial Statements.
Lives and Recoverability of Equipment and Other Long-Lived Assets
We evaluate the estimated remaining life and recoverability of equipment and other assets, including intangible assets subject to amortization, whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Factors that would indicate potential impairment include, but are not limited to, significant decreases in the market value of the long-lived asset(s), a significant change in the long-lived asset’s use or physical condition, and operating or cash flow losses associated with the use of the long-lived asset. When there is an indication of impairment, we prepare an estimate of future undiscounted cash flows expected to result from the use of the asset and its eventual disposition to test recoverability. If the sum of the future undiscounted cash flow is less than the carrying value of the asset, it indicates that the long-lived asset is not recoverable, in which case we will then compare the estimated fair value to its carrying value. If the estimated fair value is less than the carrying value of the asset, we recognize the impairment loss and adjust the carrying amount of the asset to its estimated fair value.
During the fourth quarter of 2013, we discontinued three new venture concepts, Rubi, Crisp Market and Star Studio. During the second quarter of 2013 we discontinued our Orango concept. As a result of the decision to discontinue the four concepts, for each concept we estimated the fair value of assets held utilizing a cash flow approach. For each of the concepts and for certain shared service assets used for the new ventures, as of December 31, 2013, we estimated the fair value of the assets was zero and recorded impairment charges for each concept. See Note 12: Discontinued Operations in our Notes to Consolidated Financial Statements.
Income Taxes
Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of our assets and liabilities and operating loss and tax credit carryforwards. We record a valuation allowance to reduce deferred tax assets to the amount expected to more likely than not be realized in our future tax returns. Deferred tax assets and liabilities and operating loss and tax credit carryforwards are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and operating loss and tax credit carryforwards are expected to be recovered or settled.
We assess our income tax positions and record tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where it is more likely than not that a tax benefit will be sustained, we have recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate or effective settlement with a taxing authority that has full knowledge of all relevant information. In the event of a tax position where it would not be more likely than not that a tax benefit would be sustained, no tax benefit would be recognized in the financial statements. When applicable, associated interest and penalties have been recognized as a component of income tax expense. See Note 11: Income Taxes From Continuing Operations in our Notes to Consolidated Financial Statements.
Loss Contingencies
We accrue estimated liabilities for loss contingencies arising from claims, assessments, litigation and other sources when it is probable that a liability has been incurred and the amount of the claim assessment or damages can be reasonably estimated. We believe that we have sufficient accruals to cover any obligations resulting from claims, assessments or litigation that have met these criteria.
Accounting Pronouncements Not Yet Effective
In April 2014, the FASB issued ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360) Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU 2014-08 changes the requirements for reporting discontinued operations. Under the ASU discontinued operations is defined as either a:
•
Component of an entity, or group of components, that
◦
has been disposed of, meets the criteria to be classified as held-for-sale, or has been abandoned/spun-off; and
◦
represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results, or a
•
Business or nonprofit activity that, on acquisition, meets the criteria to be classified as held-for-sale.
We are currently evaluating the impact of ASU 2014-08, which is effective for us in our fiscal year beginning on January 1, 2015.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 requires revenue recognition to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 sets forth a new revenue recognition model that requires identifying the contract, identifying the performance obligations, determining the transaction price, allocating the transaction price to performance obligations and recognizing the revenue upon satisfaction of performance obligations. The amendments in the ASU can be applied either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the update recognized at the date of the initial application along with additional disclosures. We are currently evaluating the impact of ASU 2014-09, which is effective for us in our fiscal year beginning January 1, 2017.
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This ASU describes how an entity’s management should assess whether there are conditions and events that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Management should consider both quantitative and qualitative factors in making its assessment.
If after considering management’s plans, substantial doubt about an entity’s going concern is alleviated, an entity shall disclose information in the footnotes that enables the users of the financial statements to understand the events that raised the going concern and how management’s plan alleviated this concern.
If after considering management’s plans, substantial doubt about an entity’s going concern is not alleviated, the entity shall disclose in the footnotes indicating that a substantial doubt about the entity’s going concern exists within one year of the date of the issued financial statements. Additionally, the entity shall disclose the events that led to this going concern and management’s plans to mitigate them.
We are currently evaluating the impact of ASU 2014-15, which is effective for us in our fiscal year beginning January 1, 2016.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Variable Rates of Interest
We are subject to the risk of fluctuating interest rates in the normal course of business, primarily as a result of our Credit Facility and investment activities that generally bear interest at variable rates. Because our investments have maturities of three months or less and our Credit Facility interest rates are based upon either the LIBOR, prime rate or base rate plus an applicable margin, we believe that the risk of material loss is low and that the carrying amount of these balances approximates fair value.
Based on the principal balance of our outstanding term loans of $146.3 million as of December 31, 2014, an increase or decrease of one percentage point in the interest rate over the next year would increase or decrease our annual interest expense by approximately $1.5 million, before tax benefits.
Foreign Exchange Rate Fluctuation
We are subject to the risk of foreign exchange rate fluctuation in the normal course of business as a result of our operations in the United Kingdom, Ireland, and Canada.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Unaudited quarterly financial data for each of the eight quarters in the two-year period ended December 31, 2014 is as follows:
(1)
Net income in the third quarter of 2013 includes a $68.4 million gain on the re-measurement of our previously held equity interest in ecoATM to its acquisition date fair value.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Outerwall Inc.:
We have audited the accompanying consolidated balance sheets of Outerwall Inc. and subsidiaries (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Outerwall Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 2 to the financial statements, the Company elected to change its method of accounting for content library amortization in 2013.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Outerwall Inc.’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 5, 2015 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
(signed) KPMG LLP
Seattle, Washington
February 5, 2015
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Outerwall Inc.:
We have audited Outerwall Inc.’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Outerwall Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Outerwall Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Outerwall Inc. and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014, and our report dated February 5, 2015 expressed an unqualified opinion on those consolidated financial statements.
(signed) KPMG LLP
Seattle, Washington
February 5, 2015
OUTERWALL INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
See accompanying Notes to Consolidated Financial Statements
OUTERWALL INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands, except per share data)
(1)
“Direct operating” excludes depreciation and other of $128.8 million, $130.3 million and $127.2 million for 2014, 2013 and 2012, respectively.
(2)
Foreign currency translation adjustment had no tax effect in 2014, 2013 and 2012.
See accompanying Notes to Consolidated Financial Statements
OUTERWALL INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except share data)
(1)
Foreign currency translation adjustment has no tax effect for the years ended December 31, 2014, 2013, and 2012.
See accompanying Notes to Consolidated Financial Statements
OUTERWALL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(1)
During 2013, we discontinued four ventures previously included in our New Ventures operating segment, Orango, Rubi, Crisp Market, and Star Studio. Cash flows from these discontinued operations are not segregated from cash flows from continuing operations in all periods presented because they were not material.
(2)
Total financing costs associated with the Credit Facility and senior unsecured notes issued in the second quarter of 2014 were $8.2 million composed of non-cash debt issue costs of $4.5 million recorded as debt discount associated with our issuance of $300.0 million senior unsecured notes due 2021, $1.5 million in deferred financing fees associated with the senior unsecured notes, and $2.2 million in deferred financing fees associated with the refinancing of our credit facility. The cash payments for financing costs associated with the Credit Facility and senior unsecured notes in 2014 were $2.9 million. The remaining accrued balance of the total financing cost as of December 31, 2014 was $0.8 million.
(3)
The total cost of repurchases of common stock in 2014 was $545.1 million, which includes $3.7 million in fees and expenses relating to the tender offer recorded as part of the cost of treasury stock in our Consolidated Balance Sheets. The cash payments for the tender offer fees in 2014 were $3.7 million.
See accompanying Notes to Consolidated Financial Statements
INDEX FOR NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OUTERWALL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2014, 2013, 2012
Note 1: Organization and Business
Description of Business
We are a leading provider of automated retail solutions offering convenient products and services that benefit consumers and drive incremental retail traffic and revenue for retailers.
Our core offerings in automated retail include our Redbox and Coinstar segments. Our Redbox segment consists of self-service kiosks where consumers can rent or purchase movies and video games. Our Coinstar segment consists of self-service coin-counting kiosks where consumers can convert their coins to cash or stored value products. We also offer self-service kiosks that exchange gift cards for cash under our Coinstar™ Exchange brand. Our New Ventures segment is focused on identifying, evaluating, building, or acquiring and developing innovative self-service concepts in the marketplace. New Ventures concepts are regularly assessed to determine whether continued funding or other alternatives are appropriate.
On July 23, 2013 we acquired the remaining 77.0% equity interest in our ecoATM business which provides an automated self-service kiosk system to purchase used mobile phones, tablets and MP3 players for cash. We paid $262.9 million in cash and the primary assets received included property and equipment of $23.2 million, identified intangible assets of $41.4 million and goodwill of $264.2 million, which is not deductible for tax purposes. The primary reason for the business combination was to expand Outerwall’s presence in automated retail and gain exposure to the growing demand for refurbished products and mobile devices. Since the acquisition date, the results of ecoATM operations, with the exception of expense for rights to receive cash which are unallocated corporate expenses, are included in our New Ventures segment. See Note 14: Business Segments and Enterprise-Wide Information for more information. The majority of our New Ventures kiosks are those of our ecoATM business.
Our kiosks are located primarily in supermarkets, drug stores, mass merchants, financial institutions, convenience stores, malls and restaurants. Our kiosk and location counts as of December 31, 2014, are as follows:
Note 2: Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Outerwall Inc. and our wholly-owned subsidiaries. Investments in companies of which we may have significant influence, but not a controlling interest, are accounted for using the equity method of accounting. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates in Financial Reporting
We prepare our financial statements in conformity with accounting principles generally accepted in the U.S. which requires management to make estimates and assumptions that affect the reported amounts in our consolidated financial statements and our notes thereto. The most significant estimates and assumptions include the:
•
useful lives and salvage values of our content library;
•
determination of goodwill impairment;
•
lives and recoverability of equipment and other long-lived assets;
•
recognition and measurement of current and long-term deferred income taxes (including the measurement of uncertain tax positions); and
•
loss contingencies.
It is reasonably possible that the estimates we make may change in the future and could have a material effect on our financial statements.
Cash and Cash Equivalents
We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. Our cash and cash equivalents were $242.7 million and $371.4 million at December 31, 2014, and December 31, 2013, respectively. Of this total, cash equivalents were $0.9 million and $65.8 million, respectively, and consisted of money market demand accounts and investment grade fixed income securities such as money market funds, certificate of deposits, and commercial paper. Our cash balances with financial institutions may exceed the deposit insurance limits.
Included in our cash and cash equivalents at December 31, 2014, and December 31, 2013, were $81.7 million and $85.5 million, respectively that we identified for settling our accrued payable to our retailer partners in relation to our Coinstar kiosks.
Separately included in our cash and cash equivalents at December 31, 2014, and December 31, 2013, were $66.5 million and $199.0 million, respectively in cash and cash equivalents held in financial institutions domestically and $11.6 million and $15.2 million, respectively in cash and cash equivalents held in foreign financial institutions.
Accounts Receivable
Accounts receivable represents receivables, net of allowances for doubtful accounts. The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on historical experience and other currently available information. When a specific account is deemed uncollectible, the account is written off against the allowance. Amounts expensed for uncollectible accounts and amounts charged against the allowance were immaterial in all periods presented.
Content Library
Content library consists of movies and video games available for rent or purchase. We obtain our movie and video game content primarily through revenue sharing agreements and license agreements with studios and game publishers, as well as through distributors and other suppliers. The cost of content mainly includes the cost of the movies and video games, labor, overhead, freight, and studio revenue sharing expenses. The content purchases are capitalized and amortized to their estimated salvage value as a component of direct operating expenses over the usage period. For purchased content that we expect to sell at the end of its useful life, we determine an estimated salvage value. Content salvage values are estimated based on the amounts that we have historically recovered on disposal. For licensed content that we do not expect to sell, no salvage value is provided. The useful lives and salvage value of our content library are periodically reviewed and evaluated. Amortization charges are derived utilizing rental curves based on historical performance of movies and games over their useful lives and recorded on an accelerated basis, reflecting higher rentals of movies and video games in the first few weeks after release, and substantially all of the amortization expense is recognized within one year of purchase.
In the second quarter of 2013, we completed a review of its content library amortization methodology and updated the methodology in order to add greater precision to product cost amortization. The previous method recognized accelerated amortization of content library costs at a rate faster than the decline in the content library's value due to the recognition of charges in addition to the normal rental curve amortization whenever individual discs were removed from kiosks, a process we define as "thinning". The Company's most recent analysis has shown that its amortization curves can reasonably capture the effect of thinning and therefore eliminates the need for additional charges at the time of thinning and provides a better correlation of costs to revenue. The modified approach to amortizing the cost of the content library is based on updated rental curves, which incorporate thinning estimates, and provides a more systematic method for recognizing the costs of movie and game titles. The Company anticipates that this new method will better align the recognition of costs with the related revenue.
The Company believes that the change in its content library amortization methodology, made on a prospective basis, is a change in accounting estimate that is effected by a change in accounting principle. The Company believes that the modified content library amortization methodology is preferable because it better reflects the pattern of consumption of the expected benefits of the content library. A copy of our auditor's preferability letter is filed as an exhibit to our 10-Q for the period ended June 30, 2013.
The effect of this change resulted in a reduction of product costs, as reported in direct operating expenses, of approximately $21.7 million in the second quarter of 2013, with those costs shifted to primarily the third and fourth quarters and some into 2014. The change resulted in a corresponding increase to the balance of our content library. In addition, the change in amortization methodology shifted product costs on titles purchased during the second half of 2013 into 2014 as amortization is less accelerated than under the prior method. Under the modified amortization methodology we continue to recognize substantially all of the amortization expense within one year of purchase. For year ended December 31, 2013, the change resulted in a total pretax benefit of $31.8 million or $1.17 per basic share and $1.12 per diluted share.
Property and Equipment
Property and equipment are stated at cost, net of accumulated depreciation. Expenditures that extend the life, increase the capacity, or improve the efficiency of property and equipment are capitalized, while expenditures for repairs and maintenance are expensed as incurred. Depreciation is recognized using the straight-line method over the following approximate useful lives:
Internal-Use Software
We capitalize costs incurred to develop or obtain internal-use software during the application development stage. Capitalization of software development costs occurs after the preliminary project stage is complete, management authorizes the project, and it is probable that the project will be completed and the software will be used for the function intended. We expense costs incurred for training, data conversion, and maintenance, as well as spending in the post-implementation stage. A subsequent addition, modification or upgrade to internal-use software is capitalized only to the extent that it enables the software to perform a task it previously could not perform. The internal-use software is included in computers and software under property and equipment in our Consolidated Balance Sheets. We amortize the internal-use software based on the estimated useful life on a straight-line basis.
Intangible Assets Subject to Amortization
Our intangible assets subject to amortization are primarily composed of developed technology and retailer relationships acquired in connection with our acquisitions. We used expectations of future cash flows, with appropriate discount rates based on the stage of the enterprise acquired, to estimate the fair value of our intangible assets. We amortize our intangible assets on a straight-line basis over their expected useful lives.
Goodwill
Goodwill represents the excess purchase price of an acquired enterprise or assets over the estimated fair value of identifiable net assets acquired. We assess goodwill for potential impairment at the reporting unit level on an annual basis as of November 30, or whenever an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. We may assess qualitative factors to make this determination, or bypass such a qualitative assessment and proceed directly to testing goodwill for impairment using a two-step process. Qualitative factors we may consider include, but are not limited to, macroeconomic conditions, industry conditions, the competitive environment, changes in the market for our products and services, regulatory and political developments and entity specific factors such as strategies and financial performance. If, after completing such assessment, it is determined more likely than not that the fair value of a reporting unit is less than its carrying value, we proceed to a two-step impairment test, whereby the first step is comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired and the second step of the test is not performed. The second step of the impairment test is performed when the carrying amount of the reporting unit exceeds the fair value, then the implied fair value of the reporting unit goodwill is compared with the carrying amount of that goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to the excess. For additional information see Note 4: Goodwill and Other Intangible Assets.
Lives and Recoverability of Equipment and Other Long-Lived Assets
We evaluate the estimated remaining life and recoverability of equipment and other assets, including intangible assets subject to amortization, whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Factors that would indicate potential impairment include, but are not limited to, significant decreases in the market value of the long-lived asset(s), a significant change in the long-lived asset’s use or physical condition, and operating or cash flow losses associated with the use of the long-lived asset. When there is an indication of impairment, we prepare an estimate of future undiscounted cash flows expected to result from the use of the asset and its eventual disposition to test recoverability. If the sum of the future undiscounted cash flow is less than the carrying value of the asset, it indicates that the long-lived asset is not recoverable, in which case we will then compare the estimated fair value to its carrying value. If the estimated fair value is less than the carrying value of the asset, we recognize the impairment loss and adjust the carrying amount of the asset to its estimated fair value.
During the fourth quarter of 2013, we discontinued three new venture concepts, RubiTM, Crisp MarketTM and Star StudioTM. During the second quarter of 2013 we discontinued our OrangoTM concept. As a result of the decision to discontinue the four concepts, for each concept we estimated the fair value of assets held utilizing a cash flow approach. For each of the concepts and for certain shared service assets used for the new ventures, as of December 31, 2013, we estimated the fair value of the assets was zero and recorded impairment charges for each concept. See Note 12: Discontinued Operations for additional information.
Income Taxes
Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of our assets and liabilities and operating loss and tax credit carryforwards. We record a valuation allowance to reduce deferred tax assets to the amount expected to more likely than not be realized in our future tax returns. Deferred tax assets and liabilities and operating loss and tax credit carryforwards are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and operating loss and tax credit carryforwards are expected to be recovered or settled.
We assess our income tax positions and record tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where it is more likely than not that a tax benefit will be sustained, we have recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate or effective settlement with a taxing authority that has full knowledge of all relevant information. In the event of a tax position where it would not be more likely than not that a tax benefit would be sustained, no tax benefit would be recognized in the financial statements. When applicable, associated interest and penalties have been recognized as a component of income tax expense. See Note 11: Income Taxes From Continuing Operations for additional information.
Taxes Collected from Customers and Remitted to Governmental Authorities
We account for tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction (i.e., sales, value added) on a net (excluded from revenue) basis.
Convertible Debt
In September 2009, we issued $200.0 million aggregate principal amount of 4% Convertible Senior Notes (the “Convertible Notes”). The Convertible Notes were convertible as of December 31, 2013 and the debt conversion feature was classified as temporary equity on our Consolidated Balance Sheets. On September 2, 2014, the Convertible Notes matured. In 2014, we retired or settled upon maturity, a combined 51,148 Convertible Notes for total consideration of $51.1 million in cash and the issuance of 431,760 shares of common stock. The amount by which total consideration exceeded the fair value of the Convertible Notes has been recorded as a reduction of stockholders’ equity. The loss from early extinguishment of the Convertible Notes was approximately $0.3 million and is recorded in interest expense in our Consolidated Statements of Comprehensive Income.
Loss Contingencies
We accrue estimated liabilities for loss contingencies arising from claims, assessments, litigation and other sources when it is probable that a liability has been incurred and the amount of the claim assessment or damages can be reasonably estimated. We believe that we have sufficient accruals to cover any obligations resulting from claims, assessments or litigation that have met these criteria.
Revenue Recognition
We recognize revenue when persuasive evidence of a sales arrangement exists, delivery has occurred or services are rendered, the sales price or fee is fixed or determinable and collectibility is reasonably assured as follows:
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Redbox - Revenue from movie and video game rentals is recognized ratably over the term of a consumer’s rental transaction. Revenue from a direct sale out of the kiosk of previously rented movies or video games is recognized at the time of sale. On rental transactions for which the related movie or video game has not yet been returned to the kiosk at month-end, revenue is recognized with a corresponding receivable recorded in the balance sheet, net of a reserve for potentially uncollectible amounts. We record revenue net of refunds and applicable sales taxes collected from consumers. In the fourth quarter of 2014, Redbox launched Redbox Play Pass, a new loyalty program, where customers can earn points redeemable for movie rentals. As customers accumulate points, we defer the estimated fair value of the points earned as deferred revenue (included within other current accrued liabilities). We deferred $1.5 million as of December 31, 2014.
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Coinstar - Revenue from a coin-counting transaction, which is collected from either consumers or card issuers (in stored value product transactions), is recognized at the time the consumers’ coins are counted by our coin-counting kiosks. Our revenue represents the fee charged for coin-counting transactions.
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New Ventures - Revenue is recognized in our ecoATM business upon the sale and shipment of devices collected at our kiosks to third parties and when the service transaction is complete in our SAMPLEit concept.
Fees Paid to Retailers
Fees paid to retailers relate to the amount we pay our retailers for the benefit of placing our kiosks in their stores and their agreement to provide certain services on our behalf to our consumers. The fee is generally calculated as a percentage of each coin-counting transaction or as a percentage of our net movie or video game rental revenue or a fixed fee and is recorded in our Consolidated Statements of Comprehensive Income within Direct operating expenses. The fee arrangements are based on our negotiations and evaluation of certain factors with the retailers such as total revenue, long-term non-cancelable contracts, installation of our kiosks in high traffic and/or urban or rural locations, co-op marketing incentives, or other criteria.
Advertising
Advertising costs, which are included as a component of marketing expenses, are expensed as incurred and totaled $13.5 million, $13.7 million and $13.5 million in 2014, 2013 and 2012, respectively.
Research and Development
Costs incurred for research and development activities are expensed as incurred.
Foreign Currency Translation
The functional currencies of our international subsidiaries are the British pound Sterling for our subsidiary Coinstar Limited in the United Kingdom, Canadian dollar for Coinstar International and Redbox Canada GP, and the Euro for our Coinstar Ireland Limited subsidiary. We translate assets and liabilities related to these operations to U.S. dollars at the exchange rate in effect at the date of the Consolidated Balance Sheets; we convert revenues and expenses into U.S. dollars using average exchange rates. Transaction gains and losses including on foreign currency intercompany transactions not deemed to be of a long term investment nature are included in Other income (expense), net on our Consolidated Statements of Comprehensive Income. Translation gains and losses, including gains and losses on foreign currency intercompany transactions deemed to be of a long term investment nature, are reported as Accumulated other comprehensive loss in our Consolidated Balance Sheets.
Share-Based Payments
We measure and recognize expense for all share-based payment awards granted, including employee stock options and restricted stock awards, based on the estimated fair value of the award on the grant date. We utilize the Black-Scholes-Merton (“BSM”) valuation model for valuing our stock option awards and the determination of the expenses.
The use of the BSM valuation model to estimate the fair value of stock option awards requires us to make judgments on assumptions regarding the risk-free interest rate, expected dividend yield, expected term and expected volatility over the expected term of the award. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates at the time they are made, but these estimates involve inherent uncertainties and the determination of expense could be materially different in the future.
We amortize share-based payment expense on a straight-line basis over the vesting period of the individual award with estimated forfeitures considered. Vesting periods are generally four years. Expense for performance based shares is recognized over the vesting period if and when we conclude that it is probable that the performance condition will be achieved. We reassess the probability of vesting at each reporting period for awards with performance conditions and adjust compensation cost based on our probability assessment.
Shares to be issued upon the exercise of stock options will come from newly issued shares. The expense related to restricted stock granted to movie studios as part of license agreements is adjusted based on the number of unvested shares and market price of our common stock each reporting period.
Share-based payment expense is only recognized on awards that ultimately vest. Therefore, we have reduced the share-based payment expense to be recognized over the vesting period for anticipated future forfeitures. Forfeiture estimates are based on historical forfeiture patterns. We review and assess our forfeiture estimates quarterly and update them if necessary. Any changes to accumulated share-based payment expense are recognized in the period of change. If actual forfeitures differ significantly from our estimates, our results of operations could be materially impacted. For additional information see Note 9: Share-Based Payments.
Fair Value of Financial Instruments
The carrying amounts for cash equivalents approximate fair value, which is the amount for which the instrument could be exchanged in a current transaction between willing parties. Available-for-sale securities are marked to fair value on a quarterly basis. The fair value of our revolving line of credit approximates its carrying amount. For additional information see Note 16: Fair Value.
Reclassifications
During 2014, we reclassified certain deferred fees associated with the issuance of our Senior Notes due 2019 from other long-term assets to long-term debt and other long-term liabilities. We have reclassified these amounts for all periods presented in our Consolidated Balance Sheets.
During 2013, we discontinued four new venture concepts, Rubi, Crisp Market, Orango, and Star Studio. We have reclassified the results of operations of these four ventures to discontinued operations for all periods presented in our Consolidated Statements of Comprehensive Income. See Note 12: Discontinued Operations for more information.
The accompanying consolidated financial statements include the accounts of Outerwall Inc. and our wholly-owned subsidiaries. Investments in companies of which we may have significant influence, but not a controlling interest, are accounted for using the equity method of accounting. All significant intercompany balances and transactions have been eliminated in consolidation.
Revision of Previously Issued Financial Statements
During the second quarter of 2014, we identified adjustments to prior periods related to purchases of property and equipment included in ending accounts payable which impact the amounts presented as cash paid for purchases of property and equipment in the investing activities section of our consolidated statements of cash flows, the change in accounts payable within the operating activities section of the cash flow statement and the supplemental non-cash investing and financing activities disclosure of purchases of property and equipment included in ending accounts payable. We concluded that the error was not material to any of our prior period financial statements under the guidance of SEC Staff Accounting Bulletin (“SAB”) No. 99, Materiality. We applied the guidance of SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements, and revised the prior period financial statements presented.
The impact of the immaterial error on our prior period Consolidated Statements of Cash Flows is presented in the following table:
Accounting Pronouncements Adopted During the Current Year
In May 2013, the FASB issued ASU No. 2013-05, "Foreign Currency Matters (Topic 830): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity." This ASU addresses the accounting for the cumulative translation adjustment when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. For public entities, the ASU is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013. The amendments should be applied prospectively to derecognition events occurring after the effective date. Prior periods should not be adjusted. Our adoption of ASU No. 2013-05 in the first quarter of 2014 did not have a material impact on our financial position, results of operations or cash flows.
In November 2013, the FASB issued ASU 2013-11, "Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists." This ASU requires an entity to present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss (NOL) carryforward, or similar tax loss or tax credit carryforward, rather than as a liability when:
1.
the uncertain tax position would reduce the NOL or other carryforward under the tax law of the applicable jurisdiction, and
2.
the entity intends to use the deferred tax asset for that purpose.
The ASU changes existing presentation requirements but does not require new recurring disclosures. The ASU is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013 for public entities. Our adoption of ASU No. 2013-11 in the first quarter of 2014 did not have a material impact on our financial position, results of operations or cash flows.
Accounting Pronouncements Not Yet Adopted
In April 2014, the FASB issued ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360) Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU 2014-08 changes the requirements for reporting discontinued operations. Under the ASU discontinued operations is defined as either a:
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Component of an entity, or group of components, that
◦
has been disposed of, meets the criteria to be classified as held-for-sale, or has been abandoned/spun-off; and
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represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results, or a
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Business or nonprofit activity that, on acquisition, meets the criteria to be classified as held-for-sale.
We are currently evaluating the impact of ASU 2014-08, which is effective for us in our fiscal year beginning on January 1, 2015.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 requires revenue recognition to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 sets forth a new revenue recognition model that requires identifying the contract, identifying the performance obligations, determining the transaction price, allocating the transaction price to performance obligations and recognizing the revenue upon satisfaction of performance obligations. The amendments in the ASU can be applied either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the update recognized at the date of the initial application along with additional disclosures. We are currently evaluating the impact of ASU 2014-09, including the methods of implementation, which is effective for us in our fiscal year beginning on January 1, 2017.
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This ASU describes how an entity’s management should assess whether there are conditions and events that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Management should consider both quantitative and qualitative factors in making its assessment.
If after considering management’s plans, substantial doubt about an entity’s going concern is alleviated, an entity shall disclose information in the footnotes that enables the users of the financial statements to understand the events that raised the going concern and how management’s plan alleviated this concern.
If after considering management’s plans, substantial doubt about an entity’s going concern is not alleviated, the entity shall disclose in the footnotes indicating that a substantial doubt about the entity’s going concern exists within one year of the date of the issued financial statements. Additionally, the entity shall disclose the events that led to this going concern and management’s plans to mitigate them.
We are currently evaluating the impact of ASU 2014-15, which is effective for us in our fiscal year beginning January 1, 2016.
Note 3: Property and Equipment
Note 4: Goodwill and Other Intangible Assets
Goodwill
The carrying amount of goodwill was as follows:
Goodwill by Segment
The carrying amount of goodwill by segment was as follows:
We elected to by-pass the qualitative assessment and performed the annual goodwill impairment test based on a quantitative analysis as of November 30, 2014. We estimated the fair value of our goodwill bearing reporting units using both the income and market approaches. Our estimates of fair value can change significantly based on factors such as revenue growth rates, profit margins, discount rates, market conditions, market prices, and changes in business strategies. As the estimated fair value of each reporting unit exceeded its respective carrying value in the first step of the goodwill impairment test it was not necessary to proceed to the second step and there was no goodwill impairment in 2014.
Other Intangible Assets
The gross amount of our other intangible assets and the related accumulated amortization were as follows:
Amortization expense was as follows:
Assuming no future impairment, the expected future amortization as of December 31, 2014 is as follows:
Note 5: Equity Method Investments and Related Party Transactions
Redbox Instant™ by Verizon
In February 2012, Redbox and Verizon Ventures IV LLC (“Verizon”), a wholly owned subsidiary of Verizon Communications Inc., entered into a Limited Liability Company Agreement (the “LLC Agreement”) and related arrangements. The LLC Agreement governs the relationship of the parties with respect to a joint venture, Redbox Instant by Verizon (the “Joint Venture”). Redbox initially acquired a 35.0% ownership interest in the Joint Venture and made an initial capital contribution of $14.0 million in cash in February 2012 subsequent to the formation of the Joint Venture. The following table summarizes Redbox's initial cash capital contribution and subsequent cash capital contributions representing its pro-rata share of requests made by the Joint Venture board of managers:
On October 19, 2014, the Company and Verizon entered into an agreement whereby we would withdraw from the Joint Venture effective October 20, 2014. Pursuant to the Withdrawal Agreement, all of Redbox’s rights under the Joint Venture’s operating agreement were extinguished for a total payment of $16.8 million made to Redbox and no further capital contributions were required. The $16.8 million payment received was composed of an $11.8 million expense reimbursement payment to satisfy all outstanding amounts due and additional expenses incurred by Redbox inclusive of transition services performed for the Joint Venture to Redbox and a $5.0 million extinguishment payment which is included within Income (loss) from equity method investments within our Consolidated Statements of Comprehensive Income.
Other Equity Method Investments
We include our equity method investments within other long-term assets on our Consolidated Balance Sheets. As of December 31, 2014 our $1.5 million investment in SoloHealth, Inc., representing 10% ownership, was our only equity method investment.
Since we acquired ecoATM on July 23, 2013, the results of ecoATM operations, with the exception of expense for rights to receive cash which are unallocated corporate expenses, are included in our New Ventures segment. See Note 14: Business Segments and Enterprise-Wide Information for more information.
Income (Loss) from Equity Method Investments and Summarized Financial Information
Income (loss) from equity method investments within our Consolidated Statements of Comprehensive Income is composed of the following:
A summary of financial information for our equity method investees in the aggregate, as provided to us by the investees, is as follows and includes the balance sheet as of and statement of operations through October 20, 2014, the date of our withdrawal from the Joint Venture, and as of December 31, 2014 and the period ended December 31, 2014 for SoloHealth:
(1) Represents the Joint Venture only
(2) Represents SoloHealth only
Related Party Transactions
At December 31, 2013, included within accounts receivable, net of allowance, on our Consolidated Balance Sheets, was $5.9 million due from the Joint Venture related to costs incurred by Redbox on behalf of the Joint Venture during the normal course of business. There were no amounts due as of December 31, 2014.
Note 6: Prepaid Expenses and Other Current Assets and Other Accrued Liabilities
Prepaid expenses and other current assets
Other accrued liabilities
Note 7: Debt and Other Long-Term Liabilities
(1)Deferred financing fees are recorded in other long-term assets in our Consolidated Balance Sheets and are amortized on a straight line basis over the life of the related loan.
Interest Expense
Senior Unsecured Notes Due 2019
On March 12, 2013, we entered into an indenture pursuant to which we issued $350.0 million principal amount of 6.000% Senior Notes due 2019 (the “Senior Notes due 2019”) at par for proceeds, net of expenses, of $343.8 million. The expenses were allocated between debt discount and deferred financing fees based on their nature. Each of our direct and indirect U.S. subsidiaries guarantees the Senior Notes due 2019. As of December 31, 2014, we were in compliance with the covenants of the related indenture.
Senior Unsecured Notes Due 2021
On June 9, 2014, we entered into an indenture pursuant to which we issued $300.0 million principal amount of 5.875% Senior Notes due 2021 (the "Senior Notes due 2021") at par for proceeds, net of expenses, of $294.0 million. The expenses were allocated between debt discount and deferred financing fees based on their nature. Each of our direct and indirect U.S. subsidiaries guarantees the Senior Notes due 2021.
The Senior Notes due 2021 and related guarantees:
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are general unsecured obligations and are effectively subordinated to all of our and our subsidiary guarantors’ existing and future secured debt to the extent of the collateral securing that secured debt, and
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will rank equally to all of our and our subsidiary guarantors’ other unsecured and unsubordinated indebtedness.
In addition, the Senior Notes due 2021:
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will be effectively subordinated to all of the liabilities of our existing and future subsidiaries that are not guaranteeing the Senior Notes due 2021,
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require interest payable on June 15 and December 15 of each year, beginning on December 15, 2014, and
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mature on June 15, 2021.
We may redeem any of the Senior Notes due 2021:
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beginning on June 15, 2017 at a redemption price of 104.406% of their principal amount plus accrued and unpaid interest and additional interest, if any; then
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the redemption price will be 102.938% of their principal amount plus accrued and unpaid interest and additional interest, if any, for the twelve-month period beginning June 15, 2018; then
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the redemption price will be 101.469% of their principal amount plus accrued and unpaid interest and additional interest, if any, for the twelve-month period beginning June 15, 2019; and then
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the redemption price will be 100.000% of their principal amount plus accrued interest and unpaid interest and additional interest, if any, beginning on June 15, 2020.
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We may also redeem some or all of the Senior Notes due 2021 before June 15, 2017 at a redemption price of 100.000% of the principal amount, plus accrued and unpaid interest and additional interest, if any, to the redemption date, plus an applicable “make-whole” premium.
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In addition, before June 15, 2017, we may redeem up to 35% of the aggregate principal amount with the proceeds of certain equity offerings at 105.875% of their principal amount plus accrued and unpaid interest and additional interest, if any; we may make such redemption only if, after any such redemption, at least 65% of the aggregate principal amount originally issued remains outstanding.
Upon a change of control as defined in the indenture related to the Senior Notes due 2021, we will be required to make an offer to purchase the Senior Notes due 2021 or any portion thereof. That purchase price will equal 101% of the principal amount of the Senior Notes due 2021 on the date of purchase plus accrued and unpaid interest and additional interest, if any. If we make certain asset sales and do not reinvest the proceeds or use such proceeds to repay certain debt, we will be required to use the proceeds of such asset sales to make an offer to purchase the Senior Notes due 2021 at 100% of their principal amount, together with accrued and unpaid interest and additional interest, if any, to the date of purchase.
The terms of the Senior Notes due 2021 restrict our ability and the ability of certain of our subsidiaries to, among other things: incur additional indebtedness; create liens; pay dividends or make distributions in respect of capital stock; purchase or redeem capital stock; make investments or certain other restricted payments; sell assets; enter into transactions with stockholders or affiliates; or effect a consolidation or merger. However, these and other limitations set forth in the related indenture will be subject to a number of important qualifications and exceptions.
The indenture related to the Senior Notes due 2021 provides for customary events of default which include (subject in certain cases to grace and cure periods), among others: nonpayment of principal or interest or premium; breach of covenants or other agreements in the indenture; defaults in failure to pay certain other indebtedness; the failure to pay certain final judgments; the invalidity of certain of the Subsidiary Guarantors’ guarantees; and certain events of bankruptcy, insolvency or reorganization. Generally, if an event of default occurs and is continuing under the indenture, either the trustee or the holders of at least 25% in aggregate principal amount then outstanding may declare the principal amount plus accrued and unpaid interest to be immediately due and payable. As of December 31, 2014, we were in compliance with the covenants of the related indenture.
In connection with the issuance of the Senior Notes due 2021 and related guarantees, we agreed to register the Senior Notes due 2021 and related guarantees under the Securities Act of 1933, as amended (the “Securities Act”) so as to allow holders of the Senior Notes due 2021 and related guarantees to exchange the Senior Notes due 2021 and the related guarantees for the same principal amount of a new issue of Senior Notes due 2021 and related guarantees (collectively, the “Exchange Notes”) with substantially identical terms, except that the Exchange Notes will generally be freely transferable under the Securities Act. If we fail to comply with these obligations on time (a “registration default”), we generally will be required to pay additional interest at a rate of 0.25% per annum for the first 90-day period following a registration default and an additional 0.25% per annum for each subsequent 90-day period that such additional interest continues to accrue (provided that such rate may not exceed 1.00% per annum).
Revolving Line of Credit and Term Loan
On June 24, 2014, we entered into the Third Amended and Restated Credit Agreement (the “Amended and Restated Credit Agreement”) providing for a senior secured credit facility (the "Credit Facility"). The Amended and Restated Credit Agreement amended and restated in its entirety the Second Amended and Restated Credit Agreement dated as of November 20, 2007 and amended and restated as of April 29, 2009 and as of July 15, 2011 and all amendments and restatements thereto. The credit facility provided under the previous credit agreement was replaced by the Credit Facility. As a result of this refinancing activity, in the six months ended June 30, 2014, we recorded a loss on the extinguishment of the previous credit agreement of $1.7 million for certain previously capitalized and unamortized debt issuance costs. The loss on extinguishment is recorded within Interest expense, net in our Consolidated Statements of Comprehensive Income.
The Credit Facility consists of (a) a $150.0 million amortizing term loan (the “Term Loan”) and (b) a $600.0 million revolving line of credit (the “Revolving Line”), which includes (i) a $75.0 million sublimit for the issuance of letters of credit, (ii) a $50.0 million sublimit for swingline loans and (iii) a $75.0 million sublimit for loans in certain foreign currencies available to us and certain wholly owned Company foreign subsidiaries (the “Foreign Borrowers”). We may, subject to applicable conditions and subject to obtaining commitments from lenders, request an increase in the Revolving Line of up to $200.0 million in aggregate (the “Accordion”).
We (or the Foreign Borrowers, if applicable), subject to applicable conditions, may generally elect interest rates on the Term Loan and Revolving Line calculated by reference to (a) LIBOR (“London Interbank Offered Rate”) (or the Canadian Dealer Offered Rate, in the case of loans denominated in Canadian Dollars or, if LIBOR is not available for a foreign currency, such other interest rate customarily used by Bank of America for such foreign currency) for given interest periods (the “LIBOR/Eurocurrency Rate”) or (b) on loans in U.S. Dollars made to us, Bank of America’s prime rate (or, if greater, (i) the average rate on overnight federal funds plus 0.50% or (ii) the daily floating one month LIBOR plus 1%) (the “Base Rate”), plus a margin determined by our consolidated net leverage ratio. For swingline borrowings, we will pay interest at the Base Rate, plus a margin determined by our consolidated net leverage ratio. For borrowings made with the LIBOR/Eurocurrency Rate, the margin ranges from 125 to 200 basis points, while for borrowings made with the Base Rate, the margin ranges from 25 to 100 basis points.
The Amended and Restated Credit Agreement requires principal amortization payments under the Term Loan as follows:
The Revolving Line matures on June 24, 2019, at which time all outstanding borrowings must be repaid and all outstanding letters of credit must have been terminated or cash collateralized. The maturity date of the borrowings under the Credit Facility may be accelerated to December 18, 2018 if our senior unsecured notes due 2019 remain outstanding on or after such date. We may prepay amounts borrowed under the Term Loan without premium or penalty (other than breakage costs in the case of borrowings made with the LIBOR/Eurocurrency Rate), but amounts prepaid may not be re-borrowed.
The Amended and Restated Credit Agreement contains events of default that include, among others, non-payment of principal, interest or fees, violation of covenants, inaccuracy of representations and warranties, bankruptcy and insolvency events, material judgments, cross defaults to certain other indebtedness, and events constituting a change of control. The occurrence of an event of default will increase the applicable rate of interest and could result in the acceleration of our obligations under the Credit Facilities and the obligations of any or all of the Guarantors to pay the full amount of our (or any Foreign Borrower’s) obligations under the Credit Facility.
The Amended and Restated Credit Agreement contains certain loan covenants, including, among others, financial covenants providing for a maximum consolidated net leverage ratio (i.e., consolidated total debt (net of certain cash and cash equivalents held by us and our domestic subsidiaries) to consolidated EBITDA) and a minimum consolidated interest coverage ratio, and limitations on our ability with regard to the incurrence of debt, the existence of liens, capital expenditures, stock repurchases and dividends, investments, and mergers, dispositions and acquisitions. Our obligations under the Credit Facility are guaranteed by each of our direct and indirect U.S. subsidiaries (collectively, the “Guarantors”), and if any Foreign Borrower is added to the Credit Facility, the Foreign Borrower’s obligations will be guaranteed by us and each of the Guarantors. As of December 31, 2014, the interest rate on amounts outstanding under the Credit Facility was 1.92% and we were in compliance with the covenants of the Credit Facility.
Convertible Debt
On September 2, 2014, our 4.0% Convertible Senior Notes (the “Convertible Notes”) matured. The aggregate outstanding principal was $51.1 million at December 31, 2013.
The Convertible Notes were convertible as of December 31, 2013 and the debt conversion feature was classified as temporary equity on our Consolidated Balance Sheets. In 2014, we retired or settled upon maturity, a combined 51,148 Convertible Notes for total consideration of $51.1 million in cash and the issuance of 431,760 shares of common stock. The amount by which total consideration exceeded the fair value of the Convertible Notes has been recorded as a reduction of stockholders’ equity. The loss from early extinguishment of the Convertible Notes was approximately $0.3 million and is recorded in Interest expense, net in our Consolidated Statements of Comprehensive Income.
Asset Retirement Obligation
We have entered into agreements with our partners to place kiosks in their stores. Upon contract terminations, we are obligated to remove the kiosks from the store locations and, accordingly, we recognize the estimated fair value of the liability under the long-term section of our liabilities in our Consolidated Balance Sheets.
Other Long-Term Liabilities
Included in other long-term liabilities were primarily tenant improvements related to our office building renovation in Oakbrook Terrace, Illinois; Bellevue, Washington; and San Diego, California as well as the related unrecognized tax benefits as follows:
Note 8: Repurchases of Common Stock
Board Authorization
On January 30, 2014, our Board of Directors approved an additional stock repurchase program of up to $500.0 million of our common stock plus the cash proceeds received from the exercise of stock options by our officers, directors, and employees. The Board also authorized a tender offer for up to $350.0 million with the option to increase the tender by up to 2% of outstanding shares. The tender offer expired on March 7, 2014.
Repurchases
Repurchased shares become a part of treasury stock. The shares tendered for tax withholding on vesting of restricted stock awards do not impact the repurchase program approved by our Board. The following tables present a summary of our 2014 authorized stock repurchase balance and repurchases made during the past three years:
(1)
In addition to these amounts, the repurchase program approved by our Board of Directors allows for the use of cash proceeds received from the exercise of stock options by our officers, directors, and employees.
(2)
Fees and expenses totaling $3.7 million associated with the tender offer do not impact the repurchase program approved by our Board, are excluded from the total purchase price shown here and were recorded as part of the cost of treasury stock in our Consolidated Balance Sheets.
Credit Facility Requirements
Under our Credit Facility, we are permitted to repurchase shares of our common stock without limitation, provided that we are in compliance with certain covenants required under the terms of the Credit Facility. See Note 7: Debt and Other Long-Term Liabilities for additional information about the terms of the Credit Facility.
Note 9: Share-Based Payments
We currently grant share-based awards to our employees, non-employee directors and consultants under our 2011 Incentive Plan (the “Plan”). The Plan permits the granting of stock options, restricted stock, restricted stock units, and performance-based restricted stock.
The following is the summary of grant information:
Certain information regarding our share-based payments is as follows:
(1)
Related to 25,000 shares of restricted stock granted to Sony in connection with extending our existing content license agreement. The unrecognized expense associated with these vested shares is recognized over the agreement term.
Share-Based Compensation
Stock options
Shares of common stock are issued upon exercise of stock options. The following table presents a summary of stock option activity for 2014:
Certain information regarding stock options outstanding as of December 31, 2014, is as follows:
Restricted stock and performance based restricted stock awards
Restricted stock awards are granted to eligible employees, including executives, and non-employee directors. Awards granted to employees and executives vest annually in equal installments over four years. Non-employee director awards vest one year after the grant date. Performance-based restricted stock awards are granted to executives only, with established performance criteria approved by the Compensation Committee of the Board of Directors. The fair value of non-performance-based awards is based on the market price on the grant date and is recognized on a straight-line basis over the vesting period.
Awards of performance-based restricted stock made prior to 2013, once earned, vest in equal installments over three years from the date of grant. Awards of performance-based restricted stock made in and subsequent to 2013, once earned, vest in two installments over three years from the date of grant (65% of the award vests two years from the date of grant and the remaining 35% of the award vests three years from the date of grant). The restricted shares require no payment from the grantee. The fair value of performance-based awards is based on achieving specific performance conditions and is recognized over the vesting period if and when we conclude that it is probable that the performance condition will be achieved.
The following table presents a summary of restricted stock award activity for 2014:
Share-Based Payments for Content Arrangements
We have granted restricted stock as part of content license agreements with certain movie studios. The expense related to these agreements is included within direct operating expenses in our Consolidated Statements of Comprehensive Income and is adjusted based on the number of unvested shares and market price of our common stock each reporting period. See Note 17: Commitments and Contingencies for more information on changes in commitments to issue restricted stock for content license agreements.
Information related to the shares of restricted stock granted as part of these agreements as of December 31, 2014, is as follows:
(1)
Includes 25,000 shares granted and fully vested in 2014 due to one-year contract extension executed in 2014.
(2)
Vested on January 1, 2015.
Rights to Receive Cash
As a part of the acquisition of ecoATM, we issued replacement awards for unvested restricted stock and options in ecoATM with rights to receive cash equal to the per share merger consideration for restricted stock and net of the exercise price for options. The replacement awards vest in accordance with the terms of the original replaced award. The fair value of the original and replacement awards amounted to $32.1 million, of which $1.4 million was attributed to pre-combination services rendered and included in the calculation of total consideration transferred. The replacement awards are considered liability classified as they represent rights to receive cash. Expense associated with the post-combination awards will be recognized net of forfeitures, and cash payments will be made, in accordance with the awards' vesting schedule, generally on a monthly basis. We recognized $13.3 million and $8.7 million in expense associated with the issuance of rights to receive cash for the twelve months ended December 31, 2014 and 2013, respectively. The expected future recognition of expense associated with the rights to receive cash as of December 31, 2014 is as follows:
Note 10: Restructuring
During the fourth quarter of 2013, as a result of a comprehensive operational review, we committed to a restructuring plan intended to, among other things, better align our cost structure with revenue growth in our core businesses. As part of the plan, we discontinued the Rubi, Crisp Market, and Star Studio concepts in our New Ventures operating segment (see Note 12: Discontinued Operations for further information). Also as part of the restructuring plan, we implemented actions to reduce costs in our continuing operations primarily through workforce reductions across the Company. The closure of all discontinued ventures and the workforce reductions were completed in 2014 and we expect no further restructuring charges.
The detail of restructuring charges incurred by reportable segment (on an allocated basis) and expense type is as follows:
A reconciliation of the beginning and ending liability balance by expense type is as follows:
The line items in our Consolidated Statements of Comprehensive Income in which the expenses are recorded are as follows:
Note 11: Income Taxes From Continuing Operations
Components of Income Taxes
The components of income from continuing operations before income taxes were as follows:
Components of Income Tax Expense
The components of income tax expense from continuing operations were as follows:
Rate Reconciliation
The income tax expense differs from the amount that would result by applying the U.S. statutory rate to income before income taxes as follows:
Our effective tax rate for the year ended December 31, 2014 was higher than the U.S. Federal statutory rate of 35.0% due primarily to state income taxes, offset partially by the Domestic Production Activities Deduction, which we are entitled to based on our domestic production activities.
Our effective tax rate for the year ended December 31, 2013 was lower than the U.S. Federal statutory rate of 35.0% due primarily to the following items:
•
During the fourth quarter of 2013, we reported a $16.7 million tax benefit related to the recognition of a worthless stock deduction from an outside basis difference in a corporate subsidiary.
•
During the third quarter of 2013, we reported a $24.3 million tax benefit related to the non-taxable gain upon the re-measurement of our previously held equity interest in ecoATM.
•
During the second quarter of 2013, we entered into an arrangement to sell certain NCR kiosks and a series of transactions to reorganize Redbox related subsidiary structures through the sale of a wholly owned subsidiary. As a result of the series of transactions we recorded a discrete one-time tax benefit of $17.8 million, net of a valuation allowance, through the realization of capital and ordinary gains and losses.
The combined impact of these three items was a 24.3 percentage point reduction in the effective tax rate for the year ended December 31, 2013. In addition, our 2013 effective tax rate was increased by state income taxes, offset partially by the Domestic Production Activities Deduction.
Our effective tax rate for the year ended December 31, 2012 was higher than the U.S. Federal statutory rate of 35.0% due primarily to state income taxes.
We did not provide for U.S. income taxes on certain undistributed earnings of foreign operations that were considered permanently invested outside of the United States. Upon repatriation, some of these earnings would generate foreign tax credits, which may reduce the U.S. tax liability associated with any future foreign dividend. At December 31, 2014, the cumulative amount of earnings upon which U.S. income taxes have not been provided was approximately $18.8 million.
Unrecognized Tax Benefits
The aggregate changes in the balance of unrecognized tax benefits were as follows:
We recognize interest and penalties, if any, related to income tax matters in Income tax expense. As of December 31, 2014 we accrued interest of $0.1 million. It was not necessary to accrue interest in 2013 or 2012 or accrue for penalties in any period presented.
Tax Years Open for Examination
As of December 31, 2014 for our major tax jurisdictions, the years 2011 through 2013 were open for examination by U.S. Federal and most state tax authorities. Additionally, the years 1998 through 2010 are subject to examination, to the extent that net operating loss and income tax credit carryforwards from those years were utilized in 2010 and later years.
Deferred Income Taxes
Deferred income tax assets and liabilities reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the carrying amounts used for income tax purposes. Future tax benefits for net operating loss and tax credit carryforwards are also recognized to the extent that realization of such benefits is more likely than not.
In determining our tax provisions, management determined the deferred tax assets and liabilities for each separate tax jurisdiction and considered a number of factors including the positive and negative evidence regarding the realization of our deferred tax assets to determine whether a valuation allowance should be recognized with respect to our deferred tax assets.
Significant components of our deferred tax assets and liabilities and the net increase (decrease) in the valuation allowance were as follows:
Change in Valuation Allowance
Deferred Tax Assets Relating to Income Tax Loss Carryforwards
Our deferred tax assets relating to income tax loss carryforwards and expiration periods are summarized as follows:
Based upon our projections for future taxable income over the periods in which the deferred tax assets are deductible, we believe it is more likely than not that we will realize the benefits of these deductible differences.
U.S. State Tax Credits and Expiration Periods
The following table shows our U.S. state tax credits and related expiration periods. Based upon our projections for future taxable income, we believe it is more likely than not that we will realize the benefits of these credits prior to their expiration.
Note 12: Discontinued Operations
Discontinuation of Certain New Ventures
During 2013, we discontinued four new venture concepts; Rubi, Crisp Market, Orango, and Star Studio. As a result, for each concept we estimated the fair value of assets held utilizing a cash flow approach. For each of the concepts and for certain shared service assets used for the new ventures, we estimated the fair value of the assets was zero and recorded impairment charges for each concept. Total asset impairment charges related to the concepts and relevant shared service assets were recorded in 2013 as follows:
We completed the wind-down process of all discontinued ventures in 2014. The results of the discontinued ventures and associated impairment and restructuring charges, net of tax, are recorded within Loss from discontinued operations, net of tax in our Consolidated Statements of Comprehensive Income (see Note 10: Restructuring). The discontinued concepts did not meet the criteria to be classified as held for sale and accordingly the assets and liabilities are not separately presented in our Consolidated Balance Sheets.
Summary Financial Information
The disposition and operating results of the discontinued ventures are presented in discontinued operations in our Consolidated Statements of Comprehensive Income for all periods presented. The continuing cash flows from these operations after discontinuation are insignificant and are not segregated from cash flows from continuing operations in all periods presented in our Consolidated Statements of Cash Flows.
The following table sets forth the components of discontinued operations included in our Consolidated Statements of Comprehensive Income:
Note 13: Earnings Per Share
Basic earnings per share (“EPS”) is computed by dividing the net income for the period by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing the net income for the period by the weighted average number of common and dilutive potential common shares outstanding during the period. We consider restricted stock that provides the holder with a non-forfeitable right to receive dividends to be a participating security. Net income available to participating securities was not material for the periods presented.
Net income used for calculating basic and diluted EPS is the same for all periods presented. The following table sets forth the computation of shares used for the basic and diluted EPS calculations:
Note 14: Business Segments and Enterprise-Wide Information
Management, including our chief operating decision maker, who is our CEO, evaluates the performances of our business segments primarily on segment revenue and segment operating income before depreciation, amortization and other, and share-based compensation granted to executives, non-employee directors and employees (“segment operating income”). Segment operating income contains internally allocated costs of our shared service support functions, including but not limited to, corporate executive management, business development, sales, finance, legal, human resources, information technology and risk management. We also review depreciation and amortization allocated to each segment. Share-based payments expense related to share-based compensation granted to executives, non-employee directors and employees and expense related to the rights to receive cash issued in connection with our acquisition of ecoATM are not allocated to our segments and are included in the corporate unallocated column in the analysis and reconciliation below; however, share-based payments expense related to our content arrangements with certain movie studios has been allocated to our Redbox segment and is included within direct operating expenses. Our performance evaluation does not include segment assets.
On July 23, 2013, we completed the acquisition of ecoATM. Prior to July 23, 2013 we held a non-controlling equity interest in ecoATM and reported our share of ecoATM's operating results in loss from equity method investments in our Consolidated Statements of Comprehensive Income. Subsequent to our acquisition of ecoATM on July 23, 2013, the assets acquired and liabilities assumed, as well as the results of operations, with the exception of expense for rights to receive cash which are unallocated corporate expenses, are included in our New Ventures segment as our chief operating decision maker reviews the results in aggregate with other new ventures concepts.
During the year ended December 31, 2013, we discontinued the Rubi, Crisp Market, Orango and Star Studio concepts and accordingly their results of operations were reclassified from the New Ventures segment to Loss from discontinued operations, net of tax in our Consolidated Statements of Comprehensive Income for all periods presented. See Note 12: Discontinued Operations for further information.
Our analysis and reconciliation of our segment information to the consolidated financial statements that follows covers our results of operations, which consists of our Redbox, Coinstar and New Ventures segments. Unallocated general and administrative expenses relate to share-based compensation and expense related to the rights to receive cash issued in connection with our acquisition of ecoATM.
Significant Retailer Relationships
Our Redbox and Coinstar kiosks are primarily located within retailers. The following retailers accounted for 10% or more of our consolidated revenue:
Revenue and Long-lived Assets by Geographic Location
Revenue is allocated to geographic locations based on the location of the kiosk. Revenue by geographic location was as follows:
Long-lived assets by geographic location were as follows:
Note 15: Retirement Plans
We sponsor a defined contribution plan for our employees who satisfy certain age and service requirements. Our Redbox subsidiary also sponsors a defined contribution plan to which new contributions were frozen effective January 1, 2010. Our contributions to these plans were $4.3 million, $4.9 million and $4.0 million in 2014, 2013 and 2012, respectively.
Note 16: Fair Value
Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. To measure fair value, we use a three-tier valuation hierarchy based upon observable and non-observable inputs:
•
Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities;
•
Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly; these include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active; or
•
Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.
The factors or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities.
Assets and Liabilities Measured and Reported at Fair Value on a Recurring Basis
The following table presents our financial assets and (liabilities) that are measured and reported at fair value in our Consolidated Balance Sheets on a recurring basis, by level within the fair value hierarchy (in thousands):
Money Market Demand Accounts and Investment Grade Fixed Income Securities
We determine fair value for our money market demand accounts and investment grade fixed income securities based on quoted market prices. The fair value of these assets is included in cash and cash equivalents on our Consolidated Balance Sheets.
Assets and Liabilities Measured and Reported at Fair Value on a Nonrecurring Basis
We recognize or disclose the fair value of certain assets such as non-financial assets, primarily long-lived assets, goodwill, intangible assets and certain other assets in connection with impairment evaluations. All of our nonrecurring valuations use significant unobservable inputs and therefore fall under Level 3 of the fair value hierarchy.
Trademark License
During the first quarter of 2012, Redbox granted the Joint Venture a limited, non-exclusive, non-transferable, royalty-free right and license to use certain Redbox trademarks. We estimated the fair value of the trademarks to be approximately $30.0 million as of the date of grant based on the relief-from-royalty method. We estimated the preliminary fair value using the information available on the grant date, which consisted of the expected future discounted and tax-effected cash flows attributable to the projected gross revenue stream of the Joint Venture, estimated market royalty rates of approximately 1.5%, as well as a discount rate of approximately 45.0%, which reflected our view of the risks and uncertainties associated with an early development stage entity.
Notes Receivable
On June 9, 2011, we completed the sale transaction of the Money Transfer Business to Sigue Corporation (“Sigue”). We received $19.5 million in cash and a note receivable of $29.5 million (the “Sigue Note”). In December 2011, as part of the sale transaction, we were required to provide Sigue with an additional loan of $4.0 million under terms consistent with the Sigue Note. We estimated the fair value of the Sigue Note based on the future note payments discounted at a market rate for similar risk profile companies, approximately 18.0%, which reflected our best estimate of default risk, and was not an exit price based measure of fair value or the stated value on the face of the Sigue Note. We evaluated the Sigue Note for collectability on a quarterly basis. Our evaluation at September 30, 2013 included consideration of ongoing discussions surrounding early payment on the note and certain indemnification obligations we have previously undertaken, as a result of our evaluation we did not record interest income on the note and also recorded a charge of $2.8 million against the note balance to arrive at a carrying value which approximated its estimated fair value. During the fourth quarter of 2013, we received $24.8 million in cash from Sigue for full settlement of the Sigue Note, interest and a release of certain indemnification claims. We recorded a benefit of $2.5 million from the release of indemnification related reserves.
Fair Value of Other Financial Instruments
The carrying value of our term loans approximates their fair value and falls under Level 2 of the fair value hierarchy.
We estimated the fair value of our convertible debt outstanding using a market rate of approximately 6.0% for similar high-yield debt at December 31, 2013. The estimated fair value of our convertible debt was approximately $50.5 million at December 31, 2013, and was determined based on its stated terms, maturing on September 1, 2014, and an annual interest rate of 4.0%. The fair value estimate of our convertible debt falls under Level 3 of the fair value hierarchy. We have reported the carrying value of our convertible debt, face value less the unamortized debt discount, in our Consolidated Balance Sheets.
We estimated the fair value of our senior unsecured notes due 2019 and 2021 outstanding using market rates of approximately 6.0% and 5.875%, respectively, for similar high-yield debt at December 31, 2014. We estimated the fair value of our senior unsecured notes due 2019 outstanding using a market rate of approximately 6.0% for similar high-yield debt at December 31, 2013. The estimated fair value of our senior unsecured notes due 2019 and 2021 was approximately $350.0 million and $300.0 million, respectively, at December 31, 2014. The estimated fair value of our senior unsecured notes due 2019 was approximately $350.0 million at December 31, 2013. These estimated fair values for our senior unsecured notes due 2019 and 2021 were determined based on their stated terms, maturing on March 15, 2019, and June 15, 2021, respectively, and annual interest rates of 6.0% and 5.875%. The fair value estimate of our senior unsecured notes falls under Level 3 of the fair value hierarchy. We have reported the carrying value, face value less the unamortized debt discount, of our senior unsecured notes, issued at par, in our Consolidated Balance Sheets.
Note 17: Commitments and Contingencies
Lease Commitments
Operating Leases
We lease our corporate administrative, marketing, and product development facilities in Bellevue, Washington under operating leases that expire December 31, 2019 and December 31, 2017.
We lease our Redbox facility in Oakbrook Terrace, Illinois under an operating lease that expires on July 31, 2021. Under certain circumstances, we have the ability to extend the lease for a five-year period, rent additional office space under a right of first offer and refusal and have the option to terminate the lease in July 2016. Under the terms of the lease, we are responsible for certain tax, construction and operating costs associated with the rented space.
During 2014 we consolidated our ecoATM business offices and facilities into one new location in San Diego, California. The lease for the space we vacated during 2014 will expire in 2015. The new location occupies 53,512 square feet and consists of facilities supporting administration, marketing, engineering, customer service and inventory processing. The lease for this space will expire on October 31, 2024.
Rent expense under our operating lease agreements was $16.8 million, $12.3 million and $9.0 million during 2014, 2013 and 2012, respectively.
Capital Leases
We lease automobiles and computer equipment under capital leases expiring at various dates through 2019. In most circumstances, we expect that, in the normal course of business, these leases will be renewed or replaced by other leases.
Assets held under capital leases are included in property and equipment, net on the Consolidated Balance Sheets and include the following:
As of December 31, 2014, our future minimum lease payments are as follows:
(1)
Includes all operating leases having an initial or remaining non-cancelable lease term in excess of one year.
Purchase Commitments
We have entered into certain miscellaneous purchase agreements, primarily related to purchases of equipment, which resulted in total purchase commitments of $62.0 million as of December 31, 2014.
Pursuant to the manufacturing and services agreement entered into as part of the NCR Asset Acquisition, Outerwall, Redbox or an affiliate were committed to purchase goods and services from NCR for a period of five years from June 22, 2012. At the end of the five-year period, if the aggregate amount paid in margin to NCR for goods and services delivered were to equal less than $25.0 million, Outerwall was to pay NCR the difference between such aggregate amount and $25.0 million. We made purchases in 2014 and 2013 that reduced this commitment by $2.1 million and $7.1 million, respectively. As of December 31, 2014, our remaining commitment is $15.8 million under this arrangement.
Content License Agreements
On November 20, 2014 Redbox announced a contract extension with Paramount Home Entertainment under the existing terms. The one-year extension maintains day-and-date access for our customers to Paramount titles through the end of 2015 and requires us to issue 50,000 shares of additional restricted stock to Paramount during the first quarter of 2015 which will vest immediately. See Note 9: Share-Based Payments for more information about our share-based payments for content arrangements.
We have entered into certain license agreements to obtain content for movie and video game rentals. A summary of the estimated commitments in relation to these agreements as of December 31, 2014 is presented in the following table:
General terms of our content license agreements with studios are as follows as of December 31, 2014:
(1)
Agreement extends the term of the arrangement automatically for an additional year under certain conditions.
(2)
Content licensed under the agreement is available for rental on the same day and date as the retail release.
(3)
Agreement includes, at the studio’s sole discretion, the option of a one-year extension following the end date.
(4)
Content licensed under the agreement is available for rental after a certain number of days following the retail release.
Revenue Share Commitments
Certain of our Retailer agreements include minimum revenue share commitments through the term of the arrangement. Our minimum commitments under these agreements are presented in the following table:
Letters of Credit
As of December 31, 2014, we had six irrevocable standby letters of credit that totaled $6.4 million. These standby letters of credit, which expire at various times through September 2015, are used to collateralize certain obligations to third parties. As of December 31, 2014, no amounts were outstanding under these standby letter of credit agreements.
Legal Matters
In October 2009, an Illinois resident, Laurie Piechur, individually and on behalf of all others similarly situated, filed a putative class action complaint against our Redbox subsidiary in the Circuit Court for the Twentieth Judicial Circuit, St. Clair County, Illinois. The plaintiff alleged that, among other things, Redbox charges consumers illegal and excessive late fees in violation of the Illinois Consumer Fraud and Deceptive Business Practices Act, and that Redbox's rental terms violate the Illinois Rental Purchase Agreement Act or the Illinois Automatic Contract Renewal Act and the plaintiff is seeking monetary damages and other relief. In November 2009, Redbox removed the case to the U.S. District Court for the Southern District of Illinois. In February 2010, the District Court remanded the case to the Circuit Court for the Twentieth Judicial Circuit, St. Clair County, Illinois. In May 2010, the court denied Redbox's motion to dismiss the plaintiff's complaint. In November 2011, the plaintiff moved for class certification, and Redbox moved for summary judgment. The court denied Redbox's motion for summary judgment in February 2012. The plaintiff filed an amended complaint on April 19, 2012, and an amended motion for class certification on June 5, 2012. The court denied Redbox's motion to dismiss the amended complaint. The amended class certification motion was briefed and argued. At the hearing on plaintiff's amended motion for class certification, the plaintiff dismissed all claims but two and is pursuing only her claims under the Illinois Rental Purchase Agreement Act and the Illinois Automatic Contract Renewal Act. On May 21, 2013, the court denied plaintiff's amended class action motion. On January 29, 2014, the Illinois Supreme Court denied plaintiff’s petition for leave to appeal the trial court’s denial of class certification. Redbox has moved to dismiss all remaining claims on mootness grounds, and the Court granted Redbox’s motion on December 11, 2014. The plaintiffs appealed on January 7, 2015. We believe that the claims against us are without merit and intend to defend ourselves vigorously in this matter. Currently, no accrual has been established as it was not possible to estimate the possible loss or range of loss because this matter had not advanced to a stage where we could make any such estimate.
In March 2011, a California resident, Blake Boesky, individually and on behalf of all others similarly situated, filed a putative class action complaint against our Redbox subsidiary in the U.S. District Court for the Northern District of Illinois. The plaintiff alleges that Redbox retains personally identifiable information of consumers for a time period in excess of that allowed under the Video Privacy Protection Act, 18 U.S.C. §§ 2710, et seq. A substantially similar complaint was filed in the same court in March 2011 by an Illinois resident, Kevin Sterk. Since the filing of the complaint, Blake Boesky has been replaced by a different named plaintiff, Jiah Chung, and an amended complaint has been filed alleging disclosures of personally identifiable information, in addition to plaintiffs' claims of retention of such information. Plaintiffs are seeking statutory damages, injunctive relief, attorneys' fees, costs of suit, and interest. The court has consolidated the cases. The court denied Redbox's motion to dismiss the plaintiffs' claims upon interlocutory appeal. The U.S. Court of Appeals for the Seventh Circuit reversed the district court's denial of Redbox's motion to dismiss plaintiff's claims involving retention of information, holding that the plaintiffs could not maintain a suit for damages under this theory. On April 25, 2012, the plaintiffs amended their complaint to add claims under the Stored Communications Act, 18 U.S.C. § 2707, and for breach of contract. On May 9, 2012, Redbox moved to dismiss the amended complaint. On July 23, 2012, the court dismissed the added retention claims, except to the extent that plaintiffs seek injunctive, non-monetary relief. On August 16, 2013, the court granted summary judgment in Redbox's favor on all remaining claims, and entered a final judgment for Redbox. On September 16, 2013, plaintiff filed a notice of appeal. On October 23, 2014, the U.S. Court of Appeals for the Seventh Circuit affirmed the district court’s judgment in Redbox’s favor.
Other Contingencies
During the year ended December 31, 2013, we resolved a previously disclosed loss contingency related to a supply agreement and recorded a benefit of $11.4 million in the direct operating line item in our Consolidated Statements of Comprehensive Income.
Note 18: Guarantor Subsidiaries
Certain of our wholly-owned subsidiaries have, jointly and severally, fully and unconditionally guaranteed the Senior Notes due 2019 and 2021. Pursuant to SEC regulations, we have presented in columnar format the condensed consolidating financial information for Outerwall Inc., the guarantor subsidiaries on a combined basis, and all non-guarantor subsidiaries on a combined basis in the following tables:
(1)
Foreign currency translation adjustment had no tax effect in 2014.
(1)
Foreign currency translation adjustment had no tax effect in 2013.
(1)
Foreign currency translation adjustment had no tax effect in 2012.
(1)
During 2013, we discontinued four ventures previously included in our New Ventures operating segment, Orango, Rubi, Crisp Market, and Star Studio. Cash flows from these discontinued operations are not segregated from cash flows from continuing operations in all periods presented because they were not material.
(1)
During 2013, we discontinued four ventures previously included in our New Ventures operating segment, Orango, Rubi, Crisp Market, and Star Studio. Cash flows from these discontinued operations are not segregated from cash flows from continuing operations in all periods presented because they were not material.
(1)
During 2013, we discontinued four ventures previously included in our New Ventures operating segment, Orango, Rubi, Crisp Market, and Star Studio. Cash flows from these discontinued operations are not segregated from cash flows from continuing operations in all periods presented because they were not material.
Note 19: Subsequent Events
On January 20, 2015, the Board of Directors of Outerwall Inc. announced that Nora M. Denzel, a director of the Company, was appointed by the Board to serve as Interim Chief Executive Officer of the Company, effective January 18, 2015, and that J. Scott Di Valerio stepped down as the Company’s Chief Executive Officer, effective January 18, 2015, and resigned from the Board, effective January 19, 2015.
On January 23, 2015, we made the decision to shut down our Redbox operations in Canada as the business was not meeting the company's performance expectations. As a result, we updated certain estimates used in the preparation of the financial statements and recognized an additional after-tax expense of $1.5 million in the fourth quarter of 2014 related to accelerated recognition of content library and capitalized installation costs on property and equipment. The remaining value of the content library and capitalized installation costs will be amortized over an expected three-month wind-down period ending March 31, 2015. Following the final shutdown of the operations in Canada, we expect Redbox Canada results will be reported as a discontinued operation.
On February 3, 2015, the Board approved an additional stock repurchase authorization of up to $250.0 million of its common stock plus the cash proceeds received from the exercise of stock options by the Company's directors and employees, bringing the total available for repurchases to approximately $413.7 million.
On February 3, 2015, our board of directors approved a dividend policy and declared a quarterly cash dividend of $0.30 per share to be paid on March 18, 2015, to all stockholders of record as of the close of business on March 3, 2015. Future quarterly dividend payments will be subject to approval by our board of directors.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain a set of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report and has determined that such disclosure controls and procedures are effective.
Changes in Internal Control over Financial Reporting
We also maintain a system of internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act). No changes in our internal control over financial reporting occurred during the quarter ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2014 as required by the Exchange Act Rule 13a-15(c). In making this assessment, we used the criteria set forth in the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission issued in 1992 and amended in 1994.
Based on our evaluation under the framework in Internal Control-Integrated Framework (1992), our management concluded that our internal control over financial reporting was effective as of December 31, 2014.
Attestation Report of the Independent Registered Public Accounting Firm
The attestation report of KPMG LLP, our independent registered public accounting firm, on the effectiveness of our internal control over financial reporting is set forth on page 54.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Pursuant to the approval of the Company’s Board of Directors on February 3, 2015, the Company is entering into indemnification agreements with its directors and Section 16 officers (and expects to do so with future individuals taking such positions). The indemnification agreements generally require the Company to indemnify these individuals to the fullest extent permitted under Delaware law against liabilities that may arise by reason of their service to the Company, and to advance expenses incurred as a result of any proceeding against them as to which they could be indemnified under such agreement. The foregoing description of the indemnification agreements is not complete and is qualified in its entirety by reference to the full text of the form of indemnification agreement, which is included in this Form 10-K as Exhibit 10.51 and incorporated herein by reference.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item is incorporated herein by reference to the Proxy Statement relating to our 2015 Annual Meeting of Stockholders.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the Proxy Statement relating to our 2015 Annual Meeting of Stockholders.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated herein by reference to the Proxy Statement relating to our 2015 Annual Meeting of Stockholders.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item is incorporated herein by reference to the Proxy Statement relating to our 2015 Annual Meeting of Stockholders.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated herein by reference to the Proxy Statement relating to our 2015 Annual Meeting of Stockholders.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Financial Statements and Schedules
The consolidated financial statements, together with the report thereon of our independent registered public accounting firm, are included on the pages indicated below:
There are no schedules required to be filed herewith.
Exhibits
The following exhibits are filed herewith and this list is intended to constitute the exhibit index.
In reviewing the agreements included as exhibits to this Annual Report on Form 10-K, please remember that they are included to provide you with information regarding their terms and are not intended to provide any other factual or disclosure information about the Company or the other parties to the agreement. The agreements may contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other party or parties to the applicable agreement and (i) should not in all instances be treated as categorical statements of fact, but rather as a means of allocating the risk to one of the parties if those statements prove to be inaccurate; (ii) may have been qualified by disclosures that were made to the other party or parties in connection with the negotiation of the applicable agreement, which disclosures are not necessarily reflected in the agreement; (iii) may apply standards of materiality in a manner that is different from what may be viewed as material to you or other investors; and (iv) were made only as of the date of the applicable agreement or other date or dates that may be specified in the agreement and are subject to more recent developments. Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time. Additional information about the Company may be found elsewhere in this Annual Report on Form 10-K and the Company’s other public filings, which are available without charge through the SEC’s website at http://www.sec.gov.
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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on February 5, 2015:
Signature
Title
/S/ Nora M. Denzel
Interim Chief Executive Officer and Director
(Principal Executive Officer)
Nora M. Denzel
/S/ Galen C. Smith
Chief Financial Officer
(Principal Financial Officer)
Galen C. Smith
/S/ Peter Osvaldik
Chief Accounting Officer
(Principal Accounting Officer)
Peter Osvaldik
/S/ Nelson C. Chan
Chair of the Board
Nelson C. Chan
/S/ Seth Bernstein
Director
Seth Bernstein
/S/ David M. Eskenazy
Director
David M. Eskenazy
/S/ Ross G. Landsbaum
Director
Ross G. Landsbaum
/S/ Robert D. Sznewajs
Director
Robert D. Sznewajs
/S/ Ronald B. Woodard
Director
Ronald B. Woodard