Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2013
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Note 1 -
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Basis of Presentation and Description of Business
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Presentation
Starz, through its wholly-owned subsidiary Starz, LLC, provides premium subscription video programming to United States (“U.S.”) multichannel video programming distributors (“MVPDs”), including cable operators, satellite television providers and telecommunications companies. Starz also develops, produces and acquires entertainment content and distributes this content to consumers in the U.S. and throughout the world.
The accompanying condensed consolidated financial statements include the accounts of Starz and its majority-owned and controlled subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
The accompanying interim unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the results for such periods have been included. The results of operations for any interim period are not necessarily indicative of results for the full year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in Starz’s Annual Report on Form 10-K for the year ended December 31, 2012.
LMC Spin-Off
In January 2013, Starz (formerly known as Liberty Media Corporation (“Old LMC”)) completed the spin off (the “LMC Spin-Off”) of its wholly-owned subsidiary Liberty Media Corporation (formerly known as Liberty Spinco, Inc. (“Liberty Media”)) in a tax-free manner through the distribution, by means of a dividend, of shares of Liberty Media’s common stock to holders of Old LMC common stock. In this distribution, each holder of a share of Old LMC common stock received one share of the corresponding series of Liberty Media common stock. Following the LMC Spin-Off, Starz retained the businesses of its wholly-owned subsidiary, Starz, LLC, and all other businesses, assets and liabilities of Old LMC are included in Liberty Media. Unless the context otherwise requires, Old LMC is used when events or circumstances being described occurred prior to the LMC Spin-Off and Starz is used when events or circumstances being described occurred following the LMC Spin-Off.
In accordance with GAAP, Liberty Media was determined to be the accounting successor to Old LMC for financial reporting purposes following the LMC Spin-Off due to the relative significance of Liberty Media to Starz (which is the legal spinnor) and the continued involvement of Old LMC’s senior management with Liberty Media following the LMC Spin-Off. Accordingly, the historical financial statements of Old LMC prior to the LMC Spin-Off will continue to be the historical financial statements of Liberty Media and Starz’s historical financial information will be deemed to be the financial information of Starz, LLC. The financial statements of Starz reflect Starz, LLC on a historical cost basis. Starz, LLC is the only directly owned subsidiary of Starz which in turn owns either directly or indirectly various operating subsidiaries. Starz is a holding company with no assets or liabilities of its own, other than offsetting tax receivables and payables related to the Tax Sharing Agreement discussed below, or operations other than those of Starz, LLC. Accordingly, the financial position, results of operations, comprehensive income and cash flows of Starz and Starz, LLC are identical for periods prior to the LMC Spin-Off.
In connection with the LMC Spin-Off, Starz, LLC distributed
$1.8 billion
in cash to Old LMC which was funded by a combination of cash on hand and
$550.0 million
of borrowings under Starz, LLC’s senior secured revolving credit facility. The
$1.8 billion
was paid as follows:
$100.0 million
on July 9, 2012,
$250.0 million
on August 17, 2012,
$50.0 million
on September 4, 2012,
$200.0 million
on November 16, 2012 and
$1.2 billion
on January 10, 2013. Such distributed cash was contributed to Liberty Media prior to the LMC Spin-Off. Additionally, in connection with the LMC Spin-Off, Starz, LLC distributed its Englewood, Colorado corporate office building and related building improvements to Old LMC (and Old LMC transferred such building and related improvements to Liberty Property Holdings, Inc. (“LPH”), a subsidiary of Liberty
Starz and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2013
Media) and then leased back the use of such facilities from LPH. Following the LMC Spin-Off, Liberty Media and Starz operate independently, and neither have any stock ownership, beneficial or otherwise, in the other.
In connection with the LMC Spin-Off, Old LMC entered into several agreements with Liberty Media or Liberty Media’s subsidiaries:
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•
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Reorganization Agreement, dated as of January 10, 2013, by and between Starz and Liberty Media, which provides for, among other things, the principal corporate transactions required to effect the LMC Spin-Off, certain conditions to the LMC Spin-Off and provisions governing the relationship between Starz and Liberty Media with respect to and resulting from the LMC Spin-Off;
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•
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Tax Sharing Agreement, dated as of January 11, 2013, by and between Starz and Liberty Media, which governs the allocation of taxes, tax benefits, tax items and tax-related losses between Starz and Liberty Media. In connection with the LMC Spin-Off, deferred tax assets of
$154.2 million
related to capital loss and foreign tax credit carryforwards were allocated to Liberty Media along with their corresponding valuation allowances of
$154.2 million
. In addition, state net operating losses, foreign tax credit carryforwards and other attributes of
$11.6 million
were allocated to Starz;
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•
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Services Agreement, dated as of January 11, 2013, by and between Starz and Liberty Media, which governs the provision by Liberty Media to Starz and by Starz to Liberty Media of specified services and benefits following the LMC Spin-Off. During the three months ended March 31, 2013, Starz recognized
$0.1 million
of net expenses under the Services Agreement;
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•
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Facilities Sharing Agreement, dated as of January 11, 2013, by and between Starz and LPH, pursuant to which Starz shares office facilities with Liberty Media. During the three months ended March 31, 2013, Starz recognized
$0.1 million
of expense for shared office space;
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•
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Two Aircraft Time Sharing Agreements, each dated as of January 11, 2013, by and between Starz and Liberty Media, which govern the lease for each of two aircraft from Liberty Media to Starz and the provision of fully qualified flight crew for all operations on a periodic, non-exclusive time sharing basis. There were no charges under the Two Aircraft Time Sharing Agreements during the three months ended March 31, 2013; and
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Commercial Lease, dated as of January 11, 2013, by and between LPH, Starz, LLC, and, for the limited purposes described therein, Starz Entertainment, LLC (“Starz Entertainment”), pursuant to which Starz, LLC leases its headquarters building that was distributed to Liberty Media in connection with the LMC Spin-Off from LPH for a period of
ten
years, with successive
five
-year renewal periods at the option of Starz, LLC. Starz, LLC pays a monthly base rent of
$0.3 million
(subject to annual increases) under the lease agreement. Starz, LLC recorded a
$44.8 million
capital lease in connection with this lease agreement.
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Business
Starz’s business operations are conducted by its wholly-owned subsidiaries Starz, LLC, Starz Entertainment, Film Roman, LLC (“Film Roman”) and certain other immaterial subsidiaries, and its majority-owned (
75%
) subsidiary Starz Media Group, LLC (“Starz Media”). The Weinstein Company LLC (“TWC”) owns a
25%
interest in Starz Media.
Starz is managed by and organized around the following operating segments:
Starz Networks
Starz Networks’ flagship premium networks are
Starz
and
Encore
.
Starz
, a first-run movie service, exhibits contemporary hit movies, original series, and documentaries.
Encore
airs first-run movies and classic contemporary movies. Starz Network’s third network,
MoviePlex
, offers a variety of art house, independent films and classic movie library content.
Starz
and
Encore
, along with
MoviePlex
, air across
17
linear networks complemented by on-demand and Internet services. Starz Networks’ premium networks are offered by MVPDs to their subscribers either on a fixed monthly price as part of a programming tier or package or on an a-la-carte basis.
Starz and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2013
Starz Distribution
Starz Distribution includes Starz’s Home Video, Digital Media and Worldwide Distribution businesses:
Home Video
Starz, through its majority-owned subsidiary Anchor Bay Entertainment, LLC (“Anchor Bay Entertainment”), sells or rents DVDs (standard definition and Blu-ray™) under the Anchor Bay and Manga brands, in the U.S., Canada, the United Kingdom, Australia and other international territories to the extent it has rights to such content in international territories. Anchor Bay Entertainment develops and produces certain of its content and also acquires and licenses various titles from third parties. Certain of the titles produced or acquired by Anchor Bay Entertainment air on Starz Networks’
Starz
and
Encore
networks. Anchor Bay Entertainment also distributes Starz Networks’ original programming content and TWC’s titles. Each of these titles are sold to and distributed by regional and national retailers and other distributors, including Wal-Mart, Target, Best Buy, Ingram Entertainment, Amazon and Netflix.
Digital Media
Digital Media distributes digital and on-demand content for Starz’s owned content and content for which it has licensed digital ancillary rights in the U.S. and throughout the world to the extent it has rights to such content in international territories. Digital Media receives fees for such services from a wide array of partners and distributors. These range from traditional MVPDs, Internet/mobile distributors, game developers/publishers and consumer electronics companies. Digital Media also distributes Starz Networks’ original programming content and TWC’s titles.
Worldwide Distribution
Worldwide Distribution distributes movies, television series, documentaries, children’s programming and other video content. Worldwide Distribution exploits Starz’s owned content and content for which it has licensed ancillary rights on free or pay television in the U.S. and throughout the world on free or pay television and other media to the extent it has rights to such content in international territories. It also distributes Starz Networks’ original programming content.
Starz Animation
Starz, through its wholly-owned subsidiary Film Roman, develops and produces two-dimensional animated content on a for-hire basis for distribution theatrically and on television for various third party entertainment companies.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Starz considers amortization of program rights, the fair value of goodwill and any related impairment, the development of ultimate revenue estimates associated with released films and television programs, the assessment of investment in films and television programs for impairment, valuation allowances associated with deferred income taxes and allowances for sales returns to be its most significant estimates. Actual results may differ from those estimates.
Prior Period Reclassifications
Certain prior period amounts have been reclassified for comparability with the 2013 presentation.
Starz and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2013
Note 2 - Debt
Debt consists of the following
(in thousands)
:
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March 31,
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December 31,
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2013
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2012
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Senior Secured Credit Facilities (a)
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$
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235,000
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$
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5,000
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Senior Notes and New Notes, including premium of $3,411 and none (b)
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678,411
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500,000
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Capital leases (c)
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78,484
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34,805
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Total debt
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991,895
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539,805
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Less current portion of debt
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(4,718
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)
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(4,134
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)
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Debt
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$
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987,177
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$
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535,671
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(a)
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On November 16, 2011, Starz, LLC entered into a credit agreement that provides a
$1,000.0 million
revolving credit facility, with a
$50.0 million
sub-limit for standby letters of credit, and a
$500.0 million
term loan facility (the “Senior Secured Credit Facilities”). At closing, Starz, LLC borrowed
$500.0 million
under the term loan facility and
$5.0 million
under the revolving credit facility. Net proceeds from the Senior Notes, as defined below, and cash on hand were used to repay and terminate the term loan facility in September 2012. Borrowings under the revolving credit facility may be prepaid at any time and from time to time without penalty other than customary breakage costs. Any amounts prepaid on the revolving credit facility may be reborrowed. The revolving credit facility is scheduled to mature on November 16, 2016. As of
March 31, 2013
,
$765.0 million
of borrowing capacity was available under the revolving credit facility.
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Interest on each loan under the Senior Secured Credit Facilities is payable at either an alternate base rate or LIBOR at Starz, LLC’s election. Borrowings that are alternate base rate loans bear interest at a per annum rate equal to the alternate base rate plus a margin that varies between
0.5%
and
1.5%
depending on the consolidated leverage ratio, as defined in the Senior Secured Credit Facilities. The alternate base rate is the highest of (a) the Prime Rate, (b) the Federal Funds Effective Rate plus ½ of
1.0%
or (c) LIBOR for a
one
-month interest period plus
1.0%
. Borrowings that are LIBOR loans bear interest at a per annum rate equal to the applicable LIBOR plus a margin that varies between
1.5%
and
2.5%
depending on the consolidated leverage ratio. The Senior Secured Credit Facilities require Starz, LLC to pay a commitment fee on any unused portion under the revolving credit facility. The commitment fee varies between
0.25%
and
0.50%
, depending on the consolidated leverage ratio.
As of
March 31, 2013
, the following borrowings and related LIBOR interest rates plus the applicable margin were outstanding under the Senior Secured Credit Facilities
(dollars in thousands)
:
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LIBOR period:
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Interest Rate
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Loan Amount
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March 2013 - April 2013
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1.7022%
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$
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185,000
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March 2013 - April 2013
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1.7042%
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35,000
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March 2013 - April 2013
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1.7037%
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15,000
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$
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235,000
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The Senior Secured Credit Facilities contain certain covenants that include restrictions on, among others, incurring additional debt, paying dividends, entering into liens or guarantees, or making certain distributions, investments and other restricted payments. In addition, Starz, LLC must comply with certain financial covenants including a consolidated leverage ratio, as defined in the agreement. As of
March 31, 2013
, Starz, LLC is in compliance with all covenants under the Senior Secured Credit Facilities.
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(b)
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On September 13, 2012, Starz, LLC and Starz Finance Corp. co-issued
$500.0 million
aggregate principal amount of
5.0%
senior notes due September 15, 2019 (the “Senior Notes”). The Senior Notes bear interest at a rate of
5.0%
payable semi-annually on September 15 and March 15 of each year. Starz Finance Corp. is a wholly-owned subsidiary of Starz, LLC and was formed for the sole purpose of co-issuing the Senior Notes. Starz Finance Corp. does not have and will not have any operations, assets or subsidiaries of its own. The Senior Notes are guaranteed
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Starz and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2013
by Starz Entertainment. The net proceeds from the issuance of the Senior Notes and cash on hand were used to repay and terminate the
$500.0 million
term loan facility under the Senior Secured Credit Facilities. On February 14, 2013, Starz, LLC completed an exchange offer, exchanging the majority of the Senior Notes for new registered Senior Notes. The new registered Senior Notes are substantially identical to the original Senior Notes, except the new registered Senior Notes are registered under the Securities Act of 1933, as amended, and the transfer restrictions and registration rights, and related special interest provisions applicable to the original Senior Notes will not apply to the new registered Senior Notes.
On February 8, 2013, Starz, LLC and Starz Finance Corp. completed the issuance of an additional
$175.0 million
5.0%
senior notes (the “New Notes”), which were issued as additional notes under the indenture governing the Senior Notes. The net proceeds from the issuance of the New Notes were used to repay indebtedness under the revolving portion of the Senior Secured Credit Facilities. Starz, LLC and Starz Finance Corp. have filed a registration statement with the Securities and Exchange Commission related to a registered offering to exchange the New Notes for new registered notes having substantially identical terms as the New Notes. The New Notes were issued at a price of
102.0%
plus accrued interest from September 13, 2012.
The Senior Notes and New Notes rank equally in right of payment to all existing and future senior obligations and existing and future subordinated obligations. The Senior Notes and New Notes are effectively subordinated to any existing and future secured obligations and to all the liabilities of the subsidiaries that do not guarantee the Senior Notes or New Notes.
The Senior Notes and New Notes contain certain covenants that include restrictions on, among others, incurring additional debt, paying dividends, entering into liens and guarantees, or making certain distributions, investments and other restricted payments. As of
March 31, 2013
, Starz, LLC is in compliance with all covenants under the Senior Notes and New Notes.
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(c)
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On January 11, 2013, Starz, LLC entered into the Commercial Lease with LPH for its headquarters building. The term of the lease is
ten
years, with successive
five
-year renewal periods at the option of Starz, LLC. Starz, LLC has recorded a
$44.8 million
capital lease in connection with this lease agreement with an imputed annual interest rate of
6.4%
.
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Starz Entertainment has entered into capital lease agreements for its transponder capacity. The agreements expire during
2018
to
2021
and have imputed annual interest rates ranging from
5.5%
to
7.0%
.
At
March 31, 2013
, the fair value of the Senior Notes and New Notes was
$696.9 million
and was based upon quoted prices in active markets. Starz believes the fair value of the revolving portion of the Senior Secured Credit Facilities approximates its carrying value as of
March 31, 2013
due to its variable rate nature and Starz’s stable credit spread.
Amounts totaling
$1.3 million
and
$0.3 million
of interest expense have been capitalized as investment in films and television programs during the three months ended
March 31, 2013
and
2012
, respectively.
Note 3 - Stockholders’ Equity
Preferred Stock
Preferred stock is issuable, from time to time, with such designations, preferences and relative participating, optional or other rights, qualifications, limitations or restrictions thereof, as shall be stated and expressed in a resolution or resolutions providing for the issue of such preferred stock adopted by Starz’s board of directors. As of March 31, 2013, no shares of preferred stock were issued.
Common Stock
Series A Liberty Capital (“Series A”) common stock has one vote per share and Series B Liberty Capital (“Series B”) common stock has ten votes per share. Each share of the Series B common stock is exchangeable at the option of the holder for one share of Series A common stock. The Series A and Series B common stock participate on an equal basis with respect to dividends and distributions.
Starz and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2013
As of March 31, 2013, there were
40.9 million
shares of Series A common stock reserved for issuance under the exercise privileges of outstanding stock options. In addition to the Series A and Series B common stock, there are
2.0 billion
shares of Series C Liberty Capital common stock authorized for issuance.
Purchases of Common Stock
Shares of Series A common stock are subject to repurchase pursuant to a share repurchase program. Repurchased shares are retired and returned to the status of authorized and available for issuance.
Note 4 – Stock Options and Long Term Incentive Plan
Stock Options and Restricted Stock
Prior to the LMC Spin-Off, Old LMC granted, and Starz has since granted to certain of its directors and employees, stock options to purchase Series A common stock and restricted shares of Series A common stock pursuant to Old LMC incentive plans, which are now the Starz incentive plans. As of
March 31, 2013
, the total unrecognized compensation cost related to the unvested stock options and restricted stock was approximately
$89.7 million
. Such amount will be recognized in Starz’s condensed consolidated statements of operations over a weighted average period of approximately
3.1
years.
In connection with the LMC Spin-Off, all outstanding stock options and stock appreciation rights with respect to Old LMC’s Series A common stock (the “Liberty Capital Awards”) were adjusted pursuant to the anti-dilution provisions of the incentive plans under which the equity awards were granted, such that a holder of a Liberty Capital Award received i) an adjustment to the exercise price or base price and the number of shares for each Liberty Capital Award (as so adjusted, a “Liberty Media Award”) and ii) an equity award of shares of Series A common stock (a “Starz Award”).
The exercise prices and number of shares subject to the Liberty Media Award and the Starz Award were determined based on 1) the exercise prices and number of shares subject to a Liberty Capital Award, 2) the pre-distribution trading price of Series A common stock and 3) the post-distribution trading prices of Liberty Media common stock and Series A common stock. For employees of Starz, the pre-distribution intrinsic value of the vested Liberty Capital Award was allocated between a vested Liberty Media Award and a vested Starz Award, while the pre-distribution intrinsic value of the unvested Liberty Capital Award was maintained solely within an unvested Starz Award. For Liberty Media’s employees and directors, the pre-distribution intrinsic value of the Liberty Capital Award was allocated between a Liberty Media Award and a Starz Award.
Following the LMC Spin-Off, employees of Starz and Liberty Media hold awards in both Series A common stock and Liberty Media common stock. The accompanying condensed consolidated statements of operations include compensation expense related solely to employees of Starz.
Awards granted during the three months ended
March 31, 2013
are summarized as follows:
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Options
Granted
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Weighted
Average Grant-Date Fair Value
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2013 Awards:
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Stock options
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6,030,106
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$7.61
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Restricted stock
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308,409
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$18.93
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Of the total
2013
stock option awards,
2,666,983
vest quarterly over a
4
year period and have a term of
7
years and
3,363,123
vest
50%
on each of
December 31, 2015
and
2016
and have a term of
10 years
. Starz calculates the grant-date fair value for the stock options using the Black-Scholes Model. The expected term used in the Black-Scholes calculation was a range of
4.70
to
6.92
years. The expected volatility was
41.35%
. The expected volatility used in the calculation for the awards is based on the historical volatility of Series A common stock and the implied volatility of Old LMC’s publicly traded options. Starz used a
zero
dividend rate as Old LMC/Starz has not historically declared dividends and a range of risk-free rates of
0.7%
to
1.2%
, which was derived from U.S. Treasury Bonds with a term similar to that of the subject options. The grant-date fair value of the
308,409
restricted shares granted in
2013
was based on the market value of Series A common
Starz and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2013
stock at the grant date of
$18.93
per share. Of the
308,409
restricted shares granted,
51,840
will vest on
March 4, 2014
and
256,569
will vest annually over
four
years beginning
March 4, 2014
.
The following table presents the number of options and weighted average exercise price (“WAEP”) for the activity during the three months ended March 31, 2013:
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Options
|
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WAEP
|
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Outstanding at December 31, 2012
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1,615,711
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$
|
93.14
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|
|
LMC Spin-Off adjustment to existing stock options
|
7,589,815
|
|
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*
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LMC Spin-Off adjustment for Liberty Media employees
|
3,527,791
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|
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$
|
12.78
|
|
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Granted
|
6,030,106
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|
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$
|
18.93
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Exercised
|
(139,599
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)
|
|
$
|
10.21
|
|
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Forfeited
|
(175,548
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)
|
|
$
|
11.00
|
|
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Expired/cancelled
|
—
|
|
|
$
|
—
|
|
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Outstanding at March 31, 2013
|
18,448,276
|
|
|
$
|
14.25
|
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|
|
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Exercisable at March 31, 2013
|
2,070,012
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|
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$
|
11.64
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* The adjustment to the existing stock options from the LMC Spin-Off increased the number of existing stock options and reduced the WAEP. After giving effect to the LMC Spin-Off, the WAEP for the existing stock options was $11.62.
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At
March 31, 2013
, the weighted-average remaining contractual terms of the outstanding options is
6.1
years and the exercisable options is
4.0
years.
At
March 31, 2013
,
3.5 million
of the outstanding stock options were held by Liberty Media employees.
Long Term Incentive Plan
Starz granted incentive units to certain officers and key employees (“Plan Participants”) under the 2006 long term incentive plan (“2006 LTIP”). Such grants vested over a period of
four
years and were fully vested as of June 30, 2011. All amounts accrued under the 2006 LTIP are payable in cash, Series A common stock or a combination thereof at specified dates through 2013. During the three months ended
March 31, 2013
and
2012
, Starz made payments of
$2.4 million
and
$27.5 million
, respectively, to certain Plan Participants under the 2006 LTIP. Starz has accrued
$0.8 million
as of
March 31, 2013
related to the 2006 LTIP, which is included in accrued liabilities in the accompanying condensed consolidated balance sheet.
Note 5 – Related Party Transactions
Due to Affiliate
Prior to the LMC Spin-Off, Starz, LLC participated in Old LMC’s employee benefit plans (medical, dental, life insurance, etc.) and now participates in Starz’s plans following the LMC Spin-Off. Charges from Old LMC related to these benefits and other miscellaneous charges are included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations and aggregated
none
and
$3.0 million
for the three months ended
March 31, 2013
and
2012
, respectively. Such amounts were invoiced by Old LMC on a monthly basis and were due upon receipt of the invoice by Starz, LLC. Amounts due to affiliate for such charges totaled
none
and
$1.0 million
as of
March 31, 2013
and
December 31, 2012
, respectively.
Due to affiliate at
December 31, 2012
also includes
$38.5 million
for amounts owed to Old LMC for income tax obligations.
Related Party
On January 28, 2011, Starz, LLC sold a
25%
interest in Starz Media to TWC. In December 2010, Anchor Bay Entertainment entered into a
five
-year license agreement with TWC for the distribution, by the Home Video and Digital
Starz and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2013
Media businesses, of certain of TWC’s theatrical releases. Starz recognized expense of
$17.0 million
and
$16.3 million
, which is included in production and acquisition costs in the accompanying condensed consolidated statements of operations, for TWC’s share of the net proceeds under the license agreement, for the three months ended
March 31, 2013
and
2012
, respectively. Amounts due to TWC totaled
$26.3 million
and
$23.9 million
, which is included in accrued liabilities in the accompanying condensed consolidated balance sheets, at
March 31, 2013
and
December 31, 2012
, respectively. Starz Entertainment guarantees Anchor Bay Entertainment’s advance payments to TWC under this agreement up to
$50.0 million
.
Note 6 - Income Taxes
Prior to the LMC Spin-Off, Starz, LLC was included in the consolidated federal and state income tax returns of Old LMC. The income tax accounts and provisions included in these condensed consolidated financial statements prior to the LMC Spin-Off have been prepared as if Starz, LLC was a stand-alone federal and state taxpayer. Subsequent to the LMC Spin-Off, Starz will file its own consolidated tax return.
Income tax expense consists of the following
(in thousands)
:
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|
|
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|
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Three Months Ended March 31,
|
|
|
2013
|
|
2012
|
|
Current:
|
|
|
|
|
Federal
|
$
|
17,435
|
|
|
$
|
27,583
|
|
|
State and local
|
(650
|
)
|
|
2,378
|
|
|
Foreign
|
291
|
|
|
670
|
|
|
|
17,076
|
|
|
30,631
|
|
|
Deferred:
|
|
|
|
|
Federal
|
14,311
|
|
|
12,356
|
|
|
State and local
|
3,557
|
|
|
(2,795
|
)
|
|
|
17,868
|
|
|
9,561
|
|
|
Income tax expense
|
$
|
34,944
|
|
|
$
|
40,192
|
|
Income tax expense differs from the amounts computed by applying the U.S. federal income tax rate of
35%
as a result of the following
(in thousands)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
2013
|
|
2012
|
|
Computed expected tax expense
|
$
|
32,601
|
|
|
$
|
41,785
|
|
|
State and local income taxes, net of federal income taxes
|
1,813
|
|
|
2,439
|
|
|
Foreign taxes, net of foreign tax credit
|
503
|
|
|
141
|
|
|
Change in valuation allowance affecting tax expense
|
(693
|
)
|
|
(4,212
|
)
|
|
Change in subsidiary tax status
|
791
|
|
|
—
|
|
|
Other, net
|
(71
|
)
|
|
39
|
|
|
Income tax expense
|
$
|
34,944
|
|
|
$
|
40,192
|
|
Starz and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2013
The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities at
March 31, 2013
and
December 31, 2012
are presented below
(in thousands)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2013
|
|
December 31,
2012
|
|
Deferred tax assets:
|
|
|
|
|
Tax loss and credit carryforwards
|
$
|
10,777
|
|
|
$
|
155,861
|
|
|
Accrued stock compensation
|
6,376
|
|
|
5,575
|
|
|
Investments
|
26,439
|
|
|
25,516
|
|
|
Investment in films and television programs
|
—
|
|
|
1,163
|
|
|
Other future deductible amounts
|
3,613
|
|
|
219
|
|
|
Deferred tax assets
|
47,205
|
|
|
188,334
|
|
|
Valuation allowance
|
(935
|
)
|
|
(155,861
|
)
|
|
Deferred tax assets, net
|
46,270
|
|
|
32,473
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
Property and equipment
|
(18,200
|
)
|
|
(18,807
|
)
|
|
Investment in films and television programs
|
(20,095
|
)
|
|
—
|
|
|
Other future taxable amounts
|
—
|
|
|
(454
|
)
|
|
Deferred tax liabilities
|
(38,295
|
)
|
|
(19,261
|
)
|
|
|
|
|
|
|
Net deferred tax assets
|
$
|
7,975
|
|
|
$
|
13,212
|
|
In connection with the LMC Spin-Off, deferred tax assets of
$154.2 million
related to capital loss and foreign tax credit carryforwards were allocated to Liberty Media along with their corresponding valuation allowances of
$154.2 million
. In addition, state net operating losses, foreign tax credit carryforwards and other attributes of
$11.6 million
were allocated to Starz.
In April 2013, the Internal Revenue Service completed its review of the LMC Spin-Off and notified Starz that it agreed with the nontaxable characterization of the transaction.
Note 7 - Commitments and Contingencies
Programming Rights
On February 11, 2013, Starz announced a new, multi-year output licensing agreement for qualifying films that are released theatrically in the U.S. by Sony Pictures Entertainment Inc.’s (“Sony”) Columbia Pictures, Screen Gems, Sony Pictures Classics and TriStar labels that extends its relationship with Sony through 2021, subject to certain limitations. The previous agreement had covered motion pictures released theatrically through 2016. In addition, Starz has entered into an exclusive long-term licensing agreement for theatrically released films from the Walt Disney Company (“Disney”) through 2015. The agreement provides Starz with exclusive pay TV rights to exhibit qualifying theatrically released live-action and animated feature films under the Disney, Touchstone, Pixar and Marvel labels. Theatrically released films produced by DreamWorks are not licensed to Starz under the agreement. The programming fees to be paid to Sony and Disney are based on the quantity and domestic theatrical exhibition receipts of qualifying films. Starz has also entered into agreements with a number of other motion picture producers and is obligated to pay fees for the rights to exhibit certain films that are released by these producers.
The unpaid balance for film rights related to films that were available at
March 31, 2013
is reflected in accrued liabilities and in other liabilities in the accompanying condensed consolidated balance sheets. As of
March 31, 2013
, such liabilities aggregated approximately
$102.5 million
and are payable as follows:
$99.4 million
in 2013 and
$3.1 million
in 2014.
Starz and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2013
Under the agreements with Sony and Disney, Starz is obligated to pay fees for the rights to exhibit films that have been released theatrically, but are not available for exhibition by Starz until some future date. The estimated amounts payable under Starz’s programming license agreements, including the Sony and Disney agreements, which have not been accrued as of
March 31, 2013
, are as follows:
$172.1 million
in 2013;
$222.6 million
in 2014;
$73.7 million
in 2015;
$63.9 million
in 2016,
$64.0 million
in 2017 and
$266.4 million
thereafter.
Starz is also obligated to pay fees for films that have not yet been released in theaters. Starz is unable to estimate the amounts to be paid under these agreements for films that have not yet been released; however, such amounts are expected to be significant.
Total amortization of program rights was
$135.5 million
and
$150.3 million
for the three months ended
March 31, 2013
and
2012
, respectively. These amounts are included in programming costs in the accompanying condensed consolidated statements of operations.
Guarantee
Starz Media Canada Co. (“Canada Co.”) entered into an agreement with the Ontario government whereby Canada Co. is eligible to receive funds under the Canadian Next Generation of Jobs Fund Grant (“NGOJF”) through the termination date of March 31, 2014. The maximum amount of the grant available and the guarantee in U.S. dollars is
$22.6 million
. Starz Entertainment entered into a guarantee for any amounts owed to the Ontario government under the grant if Canada Co. does not meet its obligations. The Ontario government can demand payment from Starz Entertainment if Canada Co. does not perform any of its obligations. The maximum potential amount payable under the guarantee is
$12.5 million
at
March 31, 2013
and Starz has accrued
$10.0 million
related to this guarantee in accrued liabilities in the accompanying condensed consolidated balance sheet as of
March 31, 2013
. Starz sold its controlling interest in Canada Co. on March 3, 2011. The terms of the guarantee have not changed.
Legal Proceedings
On March 9, 2011, Starz Entertainment notified DISH Network L.L.C. (“DISH”) that DISH breached its affiliation agreement with Starz Entertainment by providing a free preview for
one
year of
eight
of the Starz and Encore channels to a substantial number of DISH customers without Starz Entertainment’s written approval. On May 3, 2011, Starz Entertainment filed a lawsuit against DISH in Douglas County, Colorado District Court, 18th Judicial District, alleging that DISH breached its affiliation agreement with Starz Entertainment in connection with such free preview and seeking damages for breach of contract. On May 2, 2011, Disney Enterprises, Inc. filed a lawsuit against DISH in connection with the same free preview in U.S. District Court for the Southern District of New York, seeking damages for copyright infringement. In addition, on July 19, 2011, FX Networks filed a separate lawsuit against DISH and Starz Entertainment in connection with the same free preview in Los Angeles County, California Superior Court, seeking damages for tortious interference with its contracts for studio movie content. DISH filed a counterclaim against Starz Entertainment in the first lawsuit, seeking indemnification from Starz Entertainment against Disney Enterprises, Inc. in the second lawsuit and against FX Networks in the third lawsuit. On April 29, 2013, Starz Entertainment and DISH entered into a confidential settlement agreement with respect to the first lawsuit. The second and third lawsuits have not yet gone to trial. Any potential indemnification obligations of Starz relating to these remaining matters is uncertain at this time.
In the normal course of business, Starz is subject to lawsuits and other claims. While it is not possible to predict the outcome of these matters, it is the opinion of management, based upon consultation with legal counsel, that the ultimate disposition of known proceedings, other than as discussed above, will not have a material adverse impact on its consolidated financial position, results of operations or liquidity.
Starz and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2013
Note 8 – Other Information
Supplemental Disclosure of Cash Flow Information
The following table presents the supplemental disclosure of cash flow information
(in thousands)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
2013
|
|
2012
|
|
|
|
|
|
|
Cash paid for interest, net of amounts capitalized
|
$
|
19,143
|
|
|
$
|
4,016
|
|
|
Cash paid for income taxes
|
$
|
16,528
|
|
|
$
|
57,825
|
|
|
Distribution of corporate office building to Old LMC
|
$
|
45,668
|
|
|
$
|
—
|
|
|
Capital lease related to Commercial Lease with LPH
|
$
|
44,800
|
|
|
$
|
—
|
|
|
Tax attributes related to LMC Spin-Off
|
$
|
11,565
|
|
|
$
|
—
|
|
Net Income Attributable to Common Stockholders
Basic net income per common share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS presents the dilutive effect on a per share basis of potential common shares as if they had been converted at the beginning of the periods presented. For presentation purposes, the basic weighted average number of common shares reflected as outstanding for all periods prior to the LMC Spin-Off (including as of March 31, 2012) represents the shares outstanding as of January 14, 2013, excluding unvested outstanding restricted shares as of any applicable date. The diluted weighted average number of common shares reflected as outstanding for the three months ended
March 31, 2012
includes the unvested outstanding restricted shares actually held by Starz employees as of
March 31, 2012
, and excludes restricted shares and stock options issued to others in the LMC Spin-Off (which are included, if dilutive, in periods subsequent to the LMC Spin-Off). The following is a reconciliation between basic and diluted weighted average shares outstanding as of March 31, 2013 and reflected as outstanding as of March 31, 2012
(in thousands)
:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
2013
|
|
2012
|
|
|
|
|
|
|
Basic weighted average shares outstanding
|
119,924
|
|
|
119,996
|
|
|
Effect of dilution:
|
|
|
|
|
Stock options
|
2,479
|
|
|
—
|
|
|
Restricted shares
|
1,903
|
|
|
95
|
|
|
Diluted weighted average shares outstanding
|
124,306
|
|
|
120,091
|
|
For the three months ended
March 31, 2013
and
2012
, approximately
6.0 million
shares and
10.2 million
shares (as adjusted for the LMC Spin-Off), respectively, have been excluded from the diluted weighted average shares outstanding since the shares would have been anti-dilutive.
Note 9 – Information about Operating Segments
Starz is primarily engaged in video programming and development, production, acquisition and distribution of entertainment content. Starz evaluates performance and makes decisions about allocating resources to its operating segments based on financial measures such as Adjusted OIBDA. Adjusted OIBDA is defined as: revenue less programming costs, production and acquisition costs, home video cost of sales, operating expenses and selling, general and administrative expenses. Starz’s chief operating decision maker uses this measure of performance in conjunction with other measures to evaluate the operating segment’s performance and make decisions about allocating resources among the operating segments. Starz believes Adjusted OIBDA is an important indicator of the operational strength and performance of its operating segments, including each operating segment’s ability to assist Starz in servicing its debt and to fund investments in films and television programs. In addition, this measure allows management to view operating results and perform analytical comparisons and benchmarking between operating segments and identify strategies to improve performance. This measure of performance excludes stock compensation and depreciation and amortization that are included in the measurement of operating income pursuant to GAAP. Accordingly, Adjusted OIBDA should be considered in addition to, but not as a substitute for, operating income, income before income taxes, net income, net cash provided by operating activities and other
Starz and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2013
measures of financial performance prepared in accordance with GAAP. Starz generally accounts for intersegment sales and transfers as if the sales or transfers were to third parties, that is, at current prices.
Starz’s reportable segments are strategic business units that offer different services. They are managed separately because each segment requires different technologies, content delivery methods and marketing strategies. Starz identifies its reportable segments as those operating segments that represent
10%
or more of its consolidated annual revenue, annual Adjusted OIBDA or total assets. Starz Networks and Starz Distribution have been identified as reportable segments; however, as Starz has only three operating segments, Starz Animation is also reported.
Performance Measures
(in thousands)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
2013
|
|
2012
|
|
Revenue:
|
|
|
|
|
Starz Networks
|
$
|
315,836
|
|
|
$
|
324,200
|
|
|
Starz Distribution
|
76,242
|
|
|
72,384
|
|
|
Starz Animation
|
7,469
|
|
|
11,336
|
|
|
Inter-segment eliminations
|
(230
|
)
|
|
(2,956
|
)
|
|
Total Revenue
|
$
|
399,317
|
|
|
$
|
404,964
|
|
|
|
|
|
|
|
Adjusted OIBDA:
|
|
|
|
|
Starz Networks
|
$
|
114,382
|
|
|
$
|
115,876
|
|
|
Starz Distribution
|
2,589
|
|
|
9,137
|
|
|
Starz Animation
|
(561)
|
|
|
37
|
|
|
Inter-segment eliminations
|
120
|
|
|
1,790
|
|
|
Total Adjusted OIBDA
|
$
|
116,530
|
|
|
$
|
126,840
|
|
Starz and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2013
Other Information
(in thousands)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
2013
|
|
2012
|
|
Cash paid for investment in films and television programs:
|
|
|
|
|
Starz Networks
|
$
|
33,610
|
|
|
$
|
27,695
|
|
|
Starz Distribution
|
24,400
|
|
|
34,943
|
|
|
Starz Animation
|
—
|
|
|
—
|
|
|
Inter-segment eliminations
|
—
|
|
|
—
|
|
|
Total cash paid for investment in films and television programs
|
$
|
58,010
|
|
|
$
|
62,638
|
|
|
|
|
|
|
|
|
March 31,
|
|
December 31,
|
|
|
2013
|
|
2012
|
|
Total assets:
|
|
|
|
|
Starz Networks
|
$
|
1,345,994
|
|
|
$
|
2,066,961
|
|
|
Starz Distribution
|
129,804
|
|
|
118,134
|
|
|
Starz Animation
|
2,529
|
|
|
3,225
|
|
|
Other unallocated assets (primarily cash, deferred taxes and other assets, including the Commercial Lease with LPH)
|
83,044
|
|
|
33,850
|
|
|
Inter-segment eliminations
|
(49,070
|
)
|
|
(46,120
|
)
|
|
Total assets
|
$
|
1,512,301
|
|
|
$
|
2,176,050
|
|
The following table provides a reconciliation of Adjusted OIBDA to income before income taxes
(in thousands)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
2013
|
|
2012
|
|
Consolidated Adjusted OIBDA
|
$
|
116,530
|
|
|
$
|
126,840
|
|
|
Stock compensation
|
(7,254
|
)
|
|
(2,582
|
)
|
|
Depreciation and amortization
|
(4,416
|
)
|
|
(4,255
|
)
|
|
Interest expense, net of amounts capitalized
|
(10,228
|
)
|
|
(4,881
|
)
|
|
Other income (expense), net
|
(1,485
|
)
|
|
4,265
|
|
|
Income before income taxes
|
$
|
93,147
|
|
|
$
|
119,387
|
|
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q includes statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements included in this Quarterly Report on Form 10-Q other than statements of historical fact or current fact are forward-looking statements that address activities, events or developments that we or our management expect, believe or anticipate will or may occur in the future. These statements represent our reasonable judgment on the future based on various factors and using numerous assumptions and are subject to known and unknown risks, uncertainties and other factors, many of which are beyond our control and could cause our actual results and financial position to differ materially from those contemplated by the statements. You can identify these statements by the fact that they do not relate strictly to historical or current facts. They use words such as “anticipate,” “estimate,” “project,” “forecast,” “plan,” “may,” “will,” “should,” “could,” “expect,” or the negative thereof, or other words of similar meaning. In particular, these include, but are not limited to, statements of our current views and estimates of future economic circumstances, industry conditions in domestic and international markets, and our future performance and financial results. These forward-looking statements are subject to a number of factors and uncertainties that could cause our actual results to differ materially from the anticipated results and expectations expressed in such forward-looking statements.
Among the factors that may cause actual results and experiences to differ from the anticipated results and expectations expressed in such forward-looking statements are the following:
|
|
|
|
•
|
changes in the nature of key strategic relationships with multichannel video programming distributors (“MVPDs”) and content providers and our ability to maintain and renew affiliation agreements with MVPDs and programming output agreements with content providers on terms acceptable to us;
|
|
|
|
|
•
|
distributor demand for our products and services, including the impact of higher rates paid by our distributors to other programmers, and our ability to adapt to changes in demand;
|
|
|
|
|
•
|
consumer demand for our products and services, including changes resulting from the unwillingness of certain distributors to allow us to participate in cooperative marketing campaigns, and our ability to adapt to changes in demand;
|
|
|
|
|
•
|
competitor responses to our products and services;
|
|
|
|
|
•
|
the cost of and our ability to acquire or produce desirable original programming;
|
|
|
|
|
•
|
the cost of and our ability to acquire desirable theatrical movie content;
|
|
|
|
|
•
|
disruption in the production of theatrical films or television programs due to strikes by unions representing writers, directors or actors;
|
|
|
|
|
•
|
changes in distribution and viewing of television programming, including the expanded deployment of personal video recorders, video on-demand, and IP television and their impact on media content consumption;
|
|
|
|
|
•
|
continued consolidation of the broadband distribution and movie studio industries;
|
|
|
|
|
•
|
uncertainties inherent in the development and deployment of new business lines and business strategies;
|
|
|
|
|
•
|
uncertainties associated with product and service development and market acceptance, including the development and provision of programming for new television and telecommunications technologies;
|
|
|
|
|
•
|
our future financial performance, including availability, terms and deployment of capital;
|
|
|
|
|
•
|
the ability of our suppliers and vendors to deliver products, equipment, software and services;
|
|
|
|
|
•
|
the outcome of any pending or threatened litigation, including matters described in the notes to our condensed consolidated financial statements;
|
|
|
|
|
•
|
availability of qualified personnel;
|
|
|
|
|
•
|
the regulatory and competitive environment of the industry in which we operate;
|
|
|
|
|
•
|
changes in, or failure or inability to comply with, government regulations, including, without limitation, regulations of the Federal Communications Commission, and/or adverse outcomes from regulatory proceedings;
|
|
|
|
|
•
|
changes in tax requirements, including tax rate changes, new tax laws and revised tax law interpretations;
|
|
|
|
|
•
|
general economic and business conditions and industry trends, including the current economic downturn;
|
|
|
|
|
•
|
consumer spending levels, including the availability and amount of individual consumer debt;
|
|
|
|
|
•
|
rapid technological changes;
|
|
|
|
|
•
|
fluctuation in foreign currency exchange rates; and
|
|
|
|
|
•
|
threatened terrorist attacks or political unrest in international markets.
|
For a description of our risk factors, please see Part I, Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2012.
All forward-looking statements contained in this Quarterly Report on Form 10-Q are qualified in their entirety by this cautionary statement. We caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made. We undertake no obligation to publicly update any forward-looking statements whether as a result of new information, future events or otherwise.
The following discussion and analysis provides information concerning our results of operations and financial condition. This discussion should be read in conjunction with our accompanying condensed consolidated financial statements and the notes thereto and our Annual Report on Form 10-K for the year ended December 31, 2012.
EXPLANATORY NOTE
In January 2013, Starz (formerly known as Liberty Media Corporation (“Old LMC”)) completed the spin off (the “LMC Spin-Off”) of its wholly-owned subsidiary Liberty Media Corporation (formerly known as Liberty Spinco, Inc. (“Liberty Media”)) in a tax-free manner through the distribution, by means of a dividend, of shares of Liberty Media’s common stock to holders of Old LMC common stock. In this distribution, each holder of a share of Old LMC common stock received one share of the corresponding series of Liberty Media common stock. Following the LMC Spin-Off, Starz retained the businesses of its wholly-owned subsidiary, Starz, LLC, and all other businesses, assets and liabilities of Old LMC are included in Liberty Media. Unless the context otherwise requires, Old LMC is used when events or circumstances being described occurred prior to the LMC Spin-Off and Starz is used when events or circumstances being described occurred following the LMC Spin-Off.
In accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”), Liberty Media was determined to be the accounting successor to Old LMC for financial reporting purposes following the LMC Spin-Off due to the relative significance of Liberty Media to Starz (which is the legal spinnor) and the continued involvement of Old LMC’s senior management with Liberty Media following the LMC Spin-Off. Accordingly, the historical financial statements of Old LMC prior to the LMC Spin-Off will continue to be the historical financial statements of Liberty Media and Starz’s historical financial information will be deemed to be the financial information of Starz, LLC. The financial statements of Starz reflect Starz, LLC on a historical cost basis. Starz, LLC is the only directly owned subsidiary of Starz which in turn owns either directly or indirectly various operating subsidiaries. Starz is a holding company with no assets or liabilities of its own, other than offsetting tax receivables and payables related to the Tax Sharing Agreement, or operations other than those of Starz, LLC. Accordingly, the financial position, results of operations, comprehensive income and cash flows of Starz and Starz, LLC are identical for the periods prior to the LMC Spin-Off.
OVERVIEW
Our business operations are conducted by our wholly-owned subsidiaries Starz, LLC, Starz Entertainment, LLC, Film Roman, LLC and certain other immaterial subsidiaries, and our majority-owned subsidiary Starz Media Group, LLC (75%), which is owned 25% by The Weinstein Company LLC (“TWC”).
We provide premium subscription video programming to U.S. MVPDs, including cable operators, satellite television providers and telecommunications companies. We also develop, produce and acquire entertainment content and distribute this content to consumers in the U.S. and throughout the world. Our operations are managed by and organized around our Starz Networks, Starz Distribution and Starz Animation operating segments. Our integrated operating segments enable us to maintain control, and maximize the profitability of our original programming content and its marketing and distribution in the home video, digital (Internet) and television ancillary markets both domestically and internationally, and we are not reliant on other parties to distribute content on our behalf. Our expanding original programming line-up also provides downstream revenue opportunities for our Starz Distribution operating segment to the extent we retain rights to exploit such programming in these ancillary markets both in the U.S. and around the world.
Our reportable segments are strategic business units that offer different services. They are managed separately because each segment requires different technologies, content delivery methods and marketing strategies. We identify our reportable segments as those operating segments that represent 10% or more of our consolidated annual revenue, annual Adjusted OIBDA or total assets. Starz Networks and Starz Distribution have been identified as reportable segments; however, as we have only three operating segments, Starz Animation is also reported separately.
ADJUSTED OPERATING INCOME BEFORE DEPRECIATION AND AMORTIZATION (ADJUSTED OIBDA)
We evaluate performance and make decisions about allocating resources to our operating segments based on financial measures such as Adjusted OIBDA. We define Adjusted OIBDA as: revenue less programming costs, production and acquisition costs, home video cost of sales, operating expenses and selling, general and administrative expenses. Our chief operating decision maker uses this measure of performance in conjunction with other measures to evaluate our operating segment’s performance and make decisions about allocating resources among our operating segments. We believe that Adjusted OIBDA is an important indicator of the operational strength and performance of our operating segments, including each operating segment’s ability to assist in servicing our debt and to fund investments in films and television programs. In addition, this measure allows management to view operating results and perform analytical comparisons and benchmarking between operating segments and identify strategies to improve performance. This measure of performance excludes stock compensation and depreciation and amortization that are included in the measurement of operating income pursuant to GAAP. Accordingly, Adjusted OIBDA should be considered in addition to, but not as a substitute for, operating income, income before income taxes, net income, net cash provided by operating activities and other measures of financial performance prepared in accordance with GAAP.
The tables below set forth, for the periods presented, certain historical financial information for our reportable segments
(in thousands)
. We generally account for intersegment sales and transfers as if the sales or transfers were to third parties, that is, at current market prices.
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Three Months Ended March 31,
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$ Change
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% Change
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|
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2013
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2012
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‘13 vs ‘12
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‘13 vs ‘12
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Revenue
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|
|
Starz Networks
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$
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315,836
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$
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324,200
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$
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(8,364
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)
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(2.6
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)%
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|
Starz Distribution
|
76,242
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72,384
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3,858
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5.3
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%
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|
Starz Animation
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7,469
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11,336
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(3,867
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)
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(34.1
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)%
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Inter-segment eliminations
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(230
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)
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(2,956
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)
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2,726
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92.2
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%
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Total Revenue
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$
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399,317
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$
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404,964
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$
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(5,647
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)
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(1.4
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)%
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Adjusted OIBDA
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Starz Networks
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$
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114,382
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$
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115,876
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$
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(1,494
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)
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(1.3
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)%
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Starz Distribution
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2,589
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9,137
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(6,548
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)
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(71.7
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)%
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Starz Animation
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(561
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)
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37
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(598
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)
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(1,616.2
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)%
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Inter-segment eliminations
|
120
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|
1,790
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(1,670
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)
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(93.3
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)%
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Total Adjusted OIBDA
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$
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116,530
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$
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126,840
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$
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(10,310
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)
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(8.1
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)%
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The following table provides a reconciliation of Adjusted OIBDA to income before income taxes
(in thousands)
:
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Three Months Ended March 31,
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2013
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2012
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Adjusted OIBDA
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$
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116,530
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$
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126,840
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Stock compensation
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(7,254
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)
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(2,582
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)
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Depreciation and amortization
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(4,416
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)
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(4,255
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)
|
|
Interest expense, net of amounts capitalized
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(10,228
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)
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(4,881
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)
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Other income (expense), net
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(1,485
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)
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4,265
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Income before income taxes
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$
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93,147
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$
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119,387
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RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2013 AND 2012
Operating results are as follows
(in thousands, except as otherwise indicated)
:
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Three Months Ended March 31,
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$ Change
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% Change
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2013
|
2012
|
‘13 vs ‘12
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‘13 vs ‘12
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Revenue:
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Programming networks and other services
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$
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349,488
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$
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367,251
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$
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(17,763
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)
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(4.8
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)%
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Home video net sales
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49,829
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37,713
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|
12,116
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32.1
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%
|
|
Total revenue
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399,317
|
|
404,964
|
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(5,647
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)
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(1.4
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)%
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|
Costs and expenses:
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Programming costs (including amortization)
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145,971
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160,949
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(14,978
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)
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(9.3
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)%
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Production and acquisition costs (including amortization)
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39,790
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36,076
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3,714
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10.3
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%
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Home video cost of sales
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15,121
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10,560
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4,561
|
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43.2
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%
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Operating expenses
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12,685
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13,422
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(737
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)
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(5.5
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)%
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Selling, general and administrative
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69,220
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57,117
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12,103
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21.2
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%
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Stock compensation
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7,254
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2,582
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4,672
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180.9
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%
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Depreciation and amortization
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4,416
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4,255
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|
161
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3.8
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%
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Total costs and expenses
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294,457
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284,961
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9,496
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3.3
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%
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Operating income
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104,860
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120,003
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(15,143
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)
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(12.6
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)%
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Other income (expense):
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Interest expense, net of amounts capitalized
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(10,228
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)
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(4,881
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)
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(5,347
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)
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109.5
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%
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Other income (expense), net
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(1,485
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)
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4,265
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(5,750
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)
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(134.8
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)%
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Income before income taxes
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93,147
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119,387
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(26,240
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)
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(22.0
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)%
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Income tax expense
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(34,944
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)
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(40,192
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)
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5,248
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(13.1
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)%
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Net income
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$
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58,203
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$
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79,195
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$
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(20,992
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)
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(26.5
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)%
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As of March 31,
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Operating Data
(in millions)
:
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2013
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2012
|
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Starz
subscriptions:
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Fixed-rate subscriptions
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12.0
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11.8
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Consignment subscriptions
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9.6
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8.3
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Total
Starz
subscriptions
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21.6
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20.1
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Encore
subscriptions:
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Fixed-rate subscriptions
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21.7
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21.9
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Consignment subscriptions
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13.4
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11.7
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Total
Encore
subscriptions
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35.1
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33.6
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Total subscriptions:
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Fixed-rate subscriptions
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33.7
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33.7
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Consignment subscriptions
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23.0
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20.0
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Total subscriptions
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56.7
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53.7
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COMPARISON OF THREE MONTHS ENDED MARCH 31, 2013 TO THREE MONTHS ENDED MARCH 31, 2012
Revenue
Our revenue decreased $5.6 million or 1.4% for the three months ended March 31, 2013 as compared to the corresponding prior year period. Revenue decreased primarily as a result of decreases in revenue for Starz Networks and Starz Animation which were partially offset by an increase in revenue for Starz Distribution and a decrease in our inter-segment eliminations. Starz Networks’ revenue represented 79.1% and 80.1% of our total revenue for the three months ended March 31, 2013 and 2012, respectively.
Revenue from Starz Networks decreased $8.4 million or 2.6% for the three months ended March 31, 2013 as compared to the corresponding prior year period. The decrease resulted from a $4.7 million decrease in volume and a $3.7 million decrease due to lower effective rates. These decreases were primarily attributable to the non-renewal of the Netflix agreement and the renewal of affiliation agreements with two distributors in the fourth quarter of 2012 on less favorable financial terms than the prior affiliation agreements (such agreements provide for annual contractual increases).
The
Starz
and
Encore
networks are the primary drivers of Starz Networks’ revenue.
Starz
and
Encore
average subscriptions increased 7.7% and 4.6% since March 31, 2012, respectively. The impact on revenue due to subscription increases is affected by the relative percentage change under consignment agreements and fixed-rate agreements. In this regard, as of March 31, 2013, subscriptions under fixed-rate agreements were 33.7 million while subscriptions under consignment agreements were 23.0 million. As of March 31, 2012, subscriptions under fixed-rate agreements were 33.7 million while subscriptions under consignment agreements were 20.0 million. The increase in consignment subscriptions is primarily due to subscriptions that moved from fixed to consignment on January 1, 2013.
Revenue from Starz Distribution increased $3.9 million or 5.3% for the three months ended March 31, 2013 as compared to the corresponding prior year period. Such increase is primarily due to an increase in revenue from our Home Video business which was partially offset by a decrease in revenue from our Worldwide Distribution business. The Home Video business experienced an increase in revenue from the distribution of our original series
Spartacus
and various films distributed for TWC. The decrease in revenue from our Worldwide Distribution business resulted from a decline in television revenue from our Overture Films’ titles.
Revenue from Starz Animation decreased $3.9 million or 34.1% for the three months ended March 31, 2013 as compared to the corresponding prior year period primarily due to fewer projects in production.
Programming
Programming costs are our largest expense. Programming costs decreased $15.0 million or 9.3% for the three months ended March 31, 2013 as compared to the corresponding prior year period. Programming costs vary due to costs associated with original productions, the number of films licensed and the cost per film paid under our output and library programming agreements. The decrease in programming costs is due to fewer first-run films and higher utilization of lower cost second window films licensed under our output agreements which was partially offset by increased exhibitions of our original programming. We expect programming costs related to original programming will continue to increase in the future as we continue to invest in original content.
Production and Acquisition
Production and acquisition costs primarily include the amortization of our investments in films and television programs and participation costs. The license fee associated with original productions is included in programming costs. All remaining production and acquisition costs for original productions as well as our other films and television programs are amortized to production and acquisition costs based on the proportion that current revenue bears to an estimate of ultimate revenue for each film or television program. The amount of production and acquisition costs that we will incur for original productions is impacted by both the number of original productions and the various distribution rights that we acquire or retain for these productions. Participation costs represent amounts paid or due to participants under agreements we have whereby Starz Distribution distributes content in which a participant has an ownership interest (e.g., TWC, producers or writers of our original programming, etc.).
Production and acquisition costs increased $3.7 million or 10.3% for the three months ended March 31, 2013 as compared to the corresponding prior year period. The increase is primarily due to higher Starz Distribution revenue associated with our original series
Spartacus
and lower margin films distributed for TWC (which resulted in higher production cost amortization and participation costs).
Home Video Cost of Sales
Home video cost of sales increased $4.6 million or 43.2% for the three months ended March 31, 2013 as compared to the corresponding prior year period. The increase is primarily due to the increase in revenue from our Home Video business described above.
Selling, General and Administrative
Selling, general and administrative expenses increased $12.1 million or 21.2% for the three months ended March 31, 2013 as compared to the corresponding prior year period. The increase was due to increased advertising and marketing for both Starz Networks and Starz Distribution along with increased litigation related legal costs and costs associated with becoming a separate public company. The increase in advertising and marketing costs for Starz Networks was due to increased cooperative marketing efforts with our distributors and increased spend related to our original programming line-up. The increase in advertising and marketing costs for Starz Distribution was related to increased spend for our original series
Spartacus
. We expect that advertising and marketing costs related to original programming will increase in future periods as we continue to increase our investment in original content.
Adjusted OIBDA
Adjusted OIBDA decreased $10.3 million or 8.1% for the three months ended March 31, 2013 as compared to the corresponding prior year period. In addition to the decrease in revenue mentioned above, Adjusted OIBDA was impacted by higher sales of lower margin titles by Starz Distribution and a decrease in inter-segment eliminations as a result of fewer exhibitions of Overture Films' titles on Starz Networks.
Stock Compensation
Stock compensation increased $4.7 million or 180.9% for the three months ended March 31, 2013 as compared to the corresponding prior year period as a result of an increase in the number of options granted, and at a higher grant-date fair value than options previously granted, and an increase in the number of restricted shares granted.
Interest Expense
Interest expense increased $5.3 million for the three months ended March 31, 2013 as compared to the corresponding prior year period due to $452.2 million of additional net borrowings in 2013 (including the capital lease with Liberty Property Holdings, Inc. for our corporate headquarters) and a higher average interest rate. The increase in the average interest rate resulted from the repayment of our term loan in 2012 with proceeds from the issuance of our $500.0 million 5.0% senior notes due September 15, 2019 (the “Senior Notes”). The Senior Notes bear interest at a fixed rate of 5.0% which is higher than the variable rate under the term loan.
Other Income (Expense)
We had other expense of $1.5 million for the three months ended March 31, 2013 as compared to other income of $4.3 million for the three months ended March 31, 2012. The expense for the three months ended March 31, 2013 is primarily comprised of additional expense that we recorded in connection with our guarantee of the Canadian Next Generation of Jobs Fund Grant as further described in Note 7 to the accompanying condensed consolidated financial statements. The income for the three months ended March 31, 2012 is primarily comprised of gains on foreign currency hedging transactions and foreign currency exchange gains.
Income Taxes
We had income before income taxes of $93.1 million and $119.4 million and income tax expense of $34.9 million and $40.2 million for the three months ended March 31, 2013 and 2012, respectively. Our effective tax rate was 37.5% and 33.7% for the three months ended March 31, 2013 and 2012, respectively.
Our effective tax rate differs from the U.S. federal income tax rate of 35% as a result of state and local taxes and changes in our valuation allowance for deferred taxes.
MATERIAL CHANGES IN FINANCIAL CONDITION
As of March 31, 2013, our cash and cash equivalents totaled $17.9 million. Our cash and cash equivalents are, from time to time, invested in U.S. Treasury securities, other government securities or government guaranteed funds, AAA rated money market funds and other highly rated commercial paper.
We generated cash from operating activities of $66.8 million for the three months ended March 31, 2013 and used cash of $23.7 million for the three months ended March 31, 2012. Our primary uses of cash are payments under our programming output and library agreements and production costs for our original programming, home video and other content (i.e., investment in films and television programs), which are included as a reduction of net cash provided by operating activities. Cash paid under our programming output and library agreements totaled $109.2 million and $153.1 million for the three months ended March 31, 2013 and 2012, respectively. Cash paid for original programming, home video and other content totaled $58.0 million and $62.6 million for the three months ended March 31, 2013 and 2012, respectively. We plan to make additional investments in original programming in the future.
Payments made under our long-term incentive plan and the timing of tax payments made to Old LMC negatively impacted net cash used in operating activities in 2012. For the three months ended March 31, 2012, we made cash payments of $57.8 million for income taxes and $27.5 million under our long-term incentive plan as compared to cash payments of $16.5 million for income taxes and $2.4 million under our long-term incentive plan for the three months ended March 31, 2013.
In connection with the LMC Spin-Off, Starz, LLC distributed $1.8 billion in cash to Old LMC which was funded by a combination of cash on hand and $550.0 million of borrowings under our senior secured revolving credit facility. The $1.8 billion was paid as follows: $100.0 million on July 9, 2012, $250.0 million on August 17, 2012, $50.0 million on September 4, 2012, $200.0 million on November 16, 2012 and $1.2 billion on January 10, 2013.
On February 8, 2013, Starz, LLC and Starz Finance Corp. completed the issuance of $175.0 million 5.0% senior notes, which were issued as additional notes under the indenture governing the Senior Notes. The net proceeds from such issuance were used to repay indebtedness under Starz, LLC’s senior secured revolving credit facility. The senior secured revolving credit facility contains certain covenants, including a covenant that limits our maximum leverage ratio, as defined in the credit agreement, to not more than 4.75 to 1.00 through December 31, 2013 and 4.25 to 1.00 thereafter. In addition, investments in unrestricted subsidiaries, as defined in the credit agreement, shall not exceed $150.0 million during the term of the credit agreement (starting on the closing date of November 16, 2011). Starz Entertainment and Starz Finance Corp. are the only guarantors and restricted subsidiaries under the senior secured revolving credit facility.
Additionally, we used $2.9 million of cash to buy back common stock under our share repurchase program for the three months ended March 31, 2013. We have $397.1 million available under our share repurchase program as of March 31, 2013.
We are continually projecting our anticipated cash requirements for our operating, investing and financing needs as well as net cash provided by operating activities available to meet these needs. Our potential sources of liquidity are net cash provided by operating activities and borrowings under our senior secured revolving credit facility and we expect that we will be able to utilize these sources to fund our cash commitments for investing and financing activities, which include debt repayments, buybacks of common stock and capital expenditures during 2013. Based upon our current operating plans, we believe that our net cash provided by operating activities will be sufficient to fund our cash commitments for investing and financing activities, such as our long term debt obligations and capital expenditures from 2014 through 2017. As of March 31, 2013, we had $765.0 million of borrowing capacity available under our revolving credit facility.