10-Q 1 a2013q3_10q.htm 10-Q 2013.Q3_10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 FORM 10-Q
 
 (Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2013
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-22555
 OUTERWALL INC.
(Exact name of registrant as specified in its charter)
Delaware
 
94-3156448
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
 
 
 
1800 114th Avenue SE, Bellevue, Washington
 
98004
(Address of principal executive offices)
 
(Zip Code)
(425) 943-8000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
ý
 
Accelerated filer
¨
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
 
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):    Yes  ¨    No  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
Outstanding at October 18, 2013
Common Stock, $0.001 par value
 
27,712,014





OUTERWALL INC.
FORM 10-Q
INDEX
 
  
Page
PART I - FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
 
PART II - OTHER INFORMATION
 
 
 
 
 
 
 






PART I - FINANCIAL INFORMATION

Item 1. Financial Statements


1


OUTERWALL INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
 
 
September 30,
 
December 31,
 
2013
 
2012
Assets
 
 
(As adjusted)
Current Assets:
 
 
 
Cash and cash equivalents
$
215,230

 
$
282,894

Accounts receivable, net of allowances of $1,525 and $2,003
58,624

 
58,331

Content library
167,963

 
177,409

Deferred income taxes

 
7,187

Prepaid expenses and other current assets
65,600

 
29,686

Total current assets
507,417

 
555,507

Property and equipment, net
560,075

 
586,124

Notes receivable
23,877

 
26,731

Deferred income taxes
5,466

 
1,373

Goodwill and other intangible assets
642,614

 
344,063

Other long-term assets
44,918

 
47,927

Total assets
$
1,784,367

 
$
1,561,725

Liabilities and Stockholders’ Equity

 

Current Liabilities:

 

Accounts payable
$
165,110

 
$
250,588

Accrued payable to retailers
128,535

 
138,413

Other accrued liabilities
122,858

 
146,125

Current callable convertible debt
51,625

 

Current portion of long-term debt and other
18,599

 
15,529

Current portion of capital lease obligations
13,386

 
13,350

Deferred income taxes
12,712

 

Total current liabilities
512,825

 
564,005

Long-term debt and other long-term liabilities
605,693

 
341,179

Capital lease obligations
11,345

 
15,702

Deferred income taxes
65,361

 
91,751

Total liabilities
1,195,224

 
1,012,637

Commitments and contingencies (Note 15)

 

Debt conversion feature
2,080

 

Stockholders’ Equity:

 

Preferred stock, $0.001 par value - 5,000,000 shares authorized; no shares issued or outstanding

 

Common stock, $0.001 par value - 60,000,000 authorized;

 

36,401,195 and 35,797,592 shares issued;

 

27,692,838 and 28,626,323 shares outstanding
475,404

 
504,881

Treasury stock
(377,510
)
 
(293,149
)
Retained earnings
491,096

 
338,979

Accumulated other comprehensive loss
(1,927
)
 
(1,623
)
Total stockholders’ equity
587,063

 
549,088

Total liabilities and stockholders’ equity
$
1,784,367

 
$
1,561,725

See accompanying Notes to Consolidated Financial Statements

2


OUTERWALL INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands, except per share data)
(unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Revenue
$
587,353

 
$
537,562

 
$
1,716,269

 
$
1,637,961

Expenses:

 

 

 

Direct operating(1)
408,713

 
351,541

 
1,183,613

 
1,098,750

Marketing
9,123

 
7,513

 
24,619

 
20,080

Research and development
3,819

 
3,140

 
12,105

 
10,684

General and administrative
61,838

 
56,010

 
172,800

 
156,609

Depreciation and other
52,250

 
50,470

 
149,435

 
133,579

Amortization of intangible assets
3,191

 
2,019

 
7,085

 
3,330

Total expenses
538,934

 
470,693

 
1,549,657

 
1,423,032

Operating income
48,419

 
66,869

 
166,612

 
214,929

Other income (expense), net:
 
 
 
 
 
 

Income (loss) from equity method investments, net (Note 4 and Note 8)
57,934

 
(6,021
)
 
41,280

 
4,094

Interest expense, net
(8,402
)
 
(3,892
)
 
(25,953
)
 
(11,033
)
Other, net
(2,402
)
 
(21
)
 
(3,323
)
 
(37
)
Total other income (expense), net
47,130

 
(9,934
)
 
12,004

 
(6,976
)
Income before income taxes
95,549

 
56,935

 
178,616

 
207,953

Income tax expense
(12,893
)
 
(20,161
)
 
(26,499
)
 
(80,608
)
Net income
82,656

 
36,774

 
152,117

 
127,345

Foreign currency translation adjustment(2)
1,852

 
1,477

 
(304
)
 
1,342

Comprehensive income
$
84,508

 
$
38,251

 
$
151,813

 
$
128,687

Basic earnings per share
$
3.03

 
$
1.21

 
$
5.55

 
$
4.16

Diluted earnings per share
$
2.95

 
$
1.14

 
$
5.32

 
$
3.90

Weighted average shares used in basic per share calculations
27,244

 
30,454

 
27,391

 
30,605

Weighted average shares used in diluted per share calculations
28,016

 
32,238

 
28,582

 
32,684

 
(1)
“Direct operating” excludes depreciation and other of $33.4 million and $98.3 million for the three and nine months ended September 30, 2013, respectively, and $34.2 million and $94.4 million for the three and nine months ended September 30, 2012, respectively.
(2)
Foreign currency translation adjustment has no tax effect for the three and nine months ended September 30, 2013 and 2012, respectively.
See accompanying Notes to Consolidated Financial Statements


3


OUTERWALL INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except share data)
(unaudited)
 
 
 
 
 
 
 
 
 
 
Accumulated
Other
 
 
 
Common Stock
 
Treasury
 
Retained
 
Comprehensive
 
 
 
Shares
 
Amount
 
Stock
 
Earnings
 
Loss
 
Total
BALANCE, June 30, 2013
28,060,007

 
$
470,777

 
$
(353,875
)
 
$
408,440

 
$
(3,779
)
 
$
521,563

Proceeds from exercise of stock options, net
37,767

 
1,256

 

 

 

 
1,256

Adjustments related to tax withholding for share-based compensation
(4,850
)
 
330

 

 

 

 
330

Share-based payments expense
7,464

 
2,774

 

 

 

 
2,774

Tax benefit on share-based compensation expense

 
293

 

 

 

 
293

Repurchases of common stock
(407,796
)
 

 
(23,616
)
 

 

 
(23,616
)
Repurchase and conversion of callable convertible debt, net of tax
246

 
(26
)
 
(19
)
 

 

 
(45
)
Net income

 

 

 
82,656

 

 
82,656

Foreign currency translation adjustment(1)

 

 

 

 
1,852

 
1,852

BALANCE, September 30, 2013
27,692,838

 
$
475,404

 
$
(377,510
)
 
$
491,096

 
$
(1,927
)
 
$
587,063


(1) Foreign currency translation adjustment has no tax effect for the three months ended September 30, 2013.


4


 
 
 
 
 
 
 
 
 
Accumulated
Other
 
 
 
Common Stock
 
Treasury
 
Retained
 
Comprehensive
 
 
 
Shares
 
Amount
 
Stock
 
Earnings
 
Loss
 
Total
BALANCE, December 31, 2012
28,626,323

 
$
504,881

 
$
(293,149
)
 
$
338,979

 
$
(1,623
)
 
$
549,088

Proceeds from exercise of stock options, net
381,773

 
11,775

 

 

 

 
11,775

Adjustments related to tax withholding for share-based compensation
(73,591
)
 
(4,012
)
 

 

 

 
(4,012
)
Share-based payments expense
295,330

 
11,454

 

 

 

 
11,454

Tax benefit on share-based compensation expense

 
2,925

 

 

 

 
2,925

Repurchases of common stock
(1,792,742
)
 

 
(95,004
)
 

 

 
(95,004
)
Repurchase and conversion of callable convertible debt, net of tax
255,745

 
(49,539
)
 
10,643

 

 

 
(38,896
)
Reclassification of debt conversion feature to temporary equity

 
(2,080
)
 

 

 

 
(2,080
)
Net income

 

 

 
152,117

 

 
152,117

Foreign currency translation adjustment(1)

 

 

 

 
(304
)
 
(304
)
BALANCE, September 30, 2013
27,692,838

 
$
475,404

 
$
(377,510
)
 
$
491,096

 
$
(1,927
)
 
$
587,063


(1) Foreign currency translation adjustment has no tax effect for the nine months ended September 30, 2013.


See accompanying Notes to Consolidated Financial Statements


5


OUTERWALL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Operating Activities:







Net income
$
82,656


$
36,774


$
152,117


$
127,345

Adjustments to reconcile net income to net cash flows from operating activities:







Depreciation and other
52,250


50,470


149,435


133,579

Amortization of intangible assets and deferred financing fees
3,800


2,551


8,967


4,925

Share-based payments expense
2,774


(1,586
)

11,454


13,144

Excess tax benefits on share-based payments
(318
)

(1,936
)

(3,347
)

(5,673
)
Deferred income taxes
24,813


16,566


(12,098
)

73,190

(Income) loss from equity method investments, net
(57,934
)

6,021


(41,280
)

(4,094
)
Non-cash interest on convertible debt
549


1,789


3,323


5,270

Loss from extinguishments of callable convertible debt
1

 

 
5,950

 

Other
2,831


(794
)

1,020


(4,107
)
Cash flows from changes in operating assets and liabilities:
 
 
 
 
 
 
 
Accounts receivable, net
2,344

 
3,623

 
(306
)
 
(2,992
)
Content library
4,534

 
10,441

 
9,446

 
6,401

Prepaid expenses and other current assets
(20,845
)
 
(3,134
)
 
(31,456
)
 
(10,008
)
Other assets
(633
)
 
(574
)
 
269

 
421

Accounts payable
(13,938
)
 
(14,175
)
 
(84,910
)
 
(40,202
)
Accrued payable to retailers
(9,368
)
 
7,295

 
(9,641
)
 
5,172

Other accrued liabilities
(11,789
)
 
4,142

 
(26,552
)
 
9,323

Net cash flows from operating activities
61,727


117,473


132,391


311,694

Investing Activities:
 
 
 
 
 
 
 
Acquisition of ecoATM, net of cash acquired
(244,036
)
 

 
(244,036
)
 

Purchases of property and equipment
(39,886
)

(56,480
)

(108,616
)

(133,181
)
Proceeds from sale of property and equipment
56


150


12,888


819

Net sales (purchases) of short term investments
10,000







Receipt of note receivable principal




95



Acquisition of NCR DVD kiosk business






(100,000
)
Cash paid for equity investments
(14,000
)

(11,377
)

(28,000
)

(39,727
)
Net cash flows from investing activities
(287,866
)

(67,707
)

(367,669
)

(272,089
)
Financing Activities:







Proceeds from issuance of senior unsecured notes




343,769



Proceeds from new borrowing of credit facility
150,000

 

 
150,000

 

Principal payments on credit facility
(54,376
)
 
(3,293
)
 
(60,938
)
 
(7,668
)
Financing costs associated with senior unsecured notes




(444
)


Repurchase of convertible debt
(30
)



(169,664
)


Repurchases of common stock
(23,616
)

(59,012
)

(95,004
)

(63,070
)
Principal payments on capital lease obligations and other debt
(3,373
)

(4,008
)

(10,824
)

(13,202
)
Excess tax benefits related to share-based payments
318


1,936


3,347


5,673

Proceeds from exercise of stock options, net
1,018


53


7,763


4,034

Net cash flows from financing activities
69,941


(64,324
)

168,005


(74,233
)
Effect of exchange rate changes on cash
1,183


1,381


(391
)

1,231

Increase (decrease) in cash and cash equivalents
(155,015
)

(13,177
)

(67,664
)

(33,397
)
Cash and cash equivalents:







Beginning of period
370,245


321,635


282,894


341,855

End of period
$
215,230


$
308,458


$
215,230


$
308,458


6


 
 
 
 
 
 
 
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Supplemental disclosure of cash flow information:
 
 
 
 
 
 
 
Cash paid during the period for interest
$
13,284

 
$
5,334

 
$
19,194

 
$
12,115

Cash paid during the period for income taxes
$
9,999

 
$
2,358

 
$
54,997

 
$
7,827

Supplemental disclosure of non-cash investing and financing activities:
 
 
 
 

 

Purchases of property and equipment financed by capital lease obligations
$
1,128

 
$
4,222

 
$
6,743

 
$
10,517

Purchases of property and equipment included in ending accounts payable
$
24,773

 
$
21,141

 
$
24,773

 
$
21,141

Non-cash gain included in equity investments
$
68,376

 
$

 
$
68,376

 
$
19,500

Common stock issued on conversion of callable convertible debt
$
14

 
$

 
$
14,292

 
$

Non-cash debt issue costs
$

 
$

 
$
6,231

 
$

See accompanying Notes to Consolidated Financial Statements




7


INDEX FOR NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 



8


OUTERWALL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1: BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The unaudited consolidated financial information included herein has been prepared by Outerwall Inc., pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). On June 27, 2013, we changed our name to Outerwall Inc. The name change reflects the evolution of our company from a single coin-counting kiosk business into multiple automated retail businesses. The unaudited consolidated financial statements of Outerwall Inc. included herein reflect all adjustments, consisting only of normal recurring adjustments that, in the opinion of management, are necessary to present fairly our consolidated financial position, results of operations, and cash flows for the periods presented. The financial information as of December 31, 2012, is derived from our 2012 Annual Report on Form 10-K. The consolidated financial statements included within this Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements and the notes thereto included in our 2012 Annual Report on Form 10-K. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.
The accompanying consolidated financial statements include the accounts of Outerwall Inc. and our wholly-owned subsidiaries. Investments in companies of which we may have significant influence, but not a controlling interest, are accounted for using the equity method of accounting. All significant intercompany balances and transactions have been eliminated in consolidation.
Accounting Pronouncements Adopted During the Current Year
In July 2012, the FASB issued ASU No. 2012-2, “Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment” ("ASU 2012-2"). ASU 2012-2 allows an entity to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test for indefinite-lived intangible assets. An organization that elects to perform a qualitative assessment no longer is required to perform the quantitative impairment test for an indefinite-lived intangible asset if it is not more likely than not that the asset is impaired. ASU 2012-2, which applies to all public, private, and not-for-profit organizations, is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Our adoption of ASU 2012-2 in the first quarter of 2013 did not have a material impact on our financial position, results of operations or cash flows.
On February 5, 2013, the FASB issued ASU No. 2013-2, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” ("ASU 2013-2"). ASU 2013-2 was issued to address concerns raised in the initial issuance of ASU No. 2011-5, “Presentation of Comprehensive Income”, for which the Board deferred the effective date of certain provisions relating to the presentation of reclassification adjustments in the income statement. With the issuance of ASU 2013-2 entities are now required to disclose:
For items reclassified out of accumulated other comprehensive income and into net income in their entirety, the effect of the reclassification on each affected net income line item; and
For AOCI reclassification items that are not reclassified in their entirety into net income, a cross reference to other required disclosures under generally accepted accounting standards in the United States ("US GAAP").
This information may be provided either in the notes or parenthetically on the face of the statement that reports net income as long as all the information is disclosed in a single location. However, an entity is prohibited from providing this information parenthetically on the face of the statement that reports net income if it has items that are not reclassified in their entirety into net income. For public entities, ASU 2013-2 is effective for annual reporting periods beginning after December 15, 2012 and interim periods within those years. Our adoption of ASU 2013-2 in the first quarter of 2013 did not have a material impact on our financial position, results of operations or cash flows.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Content Library
Content library consists of movies and video games available for rent or purchase. We obtain our movie and video game content through revenue sharing agreements and license agreements with studios and game publishers, as well as through distributors and other suppliers. The cost of content mainly includes the cost of the movies and video games, labor, overhead, freight, and studio revenue sharing expenses. The content purchases are capitalized and amortized to their estimated salvage value as a component of direct operating expenses over the usage period. Content salvage values are estimated based on the amounts that we have historically recovered on disposal. For purchased content that we expect to sell at the end of its useful life, we determine an estimated salvage value. For licensed content that we do not expect to sell, no salvage value is provided.

9


The useful lives and salvage value of our content library are periodically reviewed and evaluated. The amortization charges were derived utilizing rental curves based on historical performance of movies and games over their useful lives and recorded on an accelerated basis, reflecting higher rentals of movies and video games in the first few weeks after release, and substantially all of the amortization expense is recognized within one year of purchase.
In the second quarter of 2013, the Company completed a review of its content library amortization methodology and updated the methodology in order to add greater precision to product cost amortization. The previous method recognized accelerated amortization of content library costs at a rate faster than the decline in the content library's value due to the recognition of charges in addition to the normal rental curve amortization whenever individual discs were removed from kiosks, a process we define as "thinning". The Company's most recent analysis has shown that its amortization curves can reasonably capture the effect of thinning and therefore eliminates the need for additional charges at the time of thinning and provides a better correlation of costs to revenue. The modified approach to amortizing the cost of the content library is based on updated rental curves, which incorporate thinning estimates, and provides a more systematic method for recognizing the costs of movie and game titles. The Company anticipates that this new method will better align the recognition of costs with the related revenue.
The Company believes that the change in its content library amortization methodology, to be made on a prospective basis, is a change in accounting estimate that is effected by a change in accounting principle. The Company believes that the modified content library amortization methodology is preferable because it better reflects the pattern of consumption of the expected benefits of the content library. A copy of our auditor's preferability letter is filed as an exhibit to our 10-Q for the period ended June 30, 2013.
The effect of this change resulted in a reduction of product costs, as reported in direct operating expenses, of approximately $21.7 million in the second quarter of 2013, with those costs shifted to primarily the third and fourth quarters and some into 2014. The change resulted in a corresponding increase to the balance of our content library. In addition, the change in amortization methodology is expected to shift product costs on titles purchased during the second half of 2013 into 2014 as amortization is less accelerated than under the prior method. Under the modified amortization methodology, substantially all of the amortization expense will continue to be recognized within one year of purchase. For the three months ended September 30, 2013, the change resulted in a pretax benefit of $2.1 million or $0.08 per basic share and $0.07 per diluted share. For the nine months ended September 30, 2013, the change resulted in a pretax benefit of $23.8 million or $0.87 per basic share and $0.83 per diluted share.
NOTE 3: ORGANIZATION AND BUSINESS
Description of Business
We are a leading provider of automated retail solutions offering convenient products and services that benefit consumers and drive incremental retail traffic and revenue for retailers.
On June 27, 2013, our name change from Coinstar, Inc. to Outerwall Inc. was approved by stockholders. The name change reflects the evolution of our company from a single coin-counting kiosk business into multiple automated retail businesses. The name Outerwall was selected as an umbrella corporate brand that encompasses our current operations and provides a platform for future automated retail opportunities. As part of our name change, we changed the name of our Coin business segment to the Coinstar business segment.
Our core offerings in automated retail include our Redbox and Coinstar segments. Our Redbox segment consists of self-service kiosks where consumers can rent or purchase movies and video games. Our Coinstar segment consists of self-service coin-counting kiosks where consumers can convert their coins to cash or stored value products. Our New Ventures segment is focused on identifying, evaluating, building, or acquiring and developing innovative self-service concepts in the marketplace. New Ventures concepts are regularly assessed to determine whether continued funding or other alternatives are appropriate. Our kiosks are located primarily in supermarkets, drug stores, mass merchants, financial institutions, convenience stores, malls and restaurants. Our kiosk and location counts as of September 30, 2013, are as follows:

10


 
Kiosks
 
Locations
Redbox(1)
43,600

 
36,000

Coinstar
20,800

 
20,500

New Ventures(2)
1,220

 
1,030

Total(1) (2) 
65,620

 
57,530

(1) As of September 30, 2013, no kiosks acquired from NCR remained in service. See Note 4: Business Combinations for more information on the NCR Asset Acquisition.
(2) Includes approximately 700 kiosks acquired through the purchase of ecoATM, Inc. See Note 4: Business Combinations for more information. As of September 30, 2013, there were over 800 ecoATM kiosks in service.
NOTE 4: BUSINESS COMBINATIONS
Acquisition of ecoATM, Inc.,
On July 1, 2013, Outerwall Inc., entered into an agreement and plan of merger with ecoATM, Inc., a Delaware corporation (“ecoATM”) that provides an automated self-service kiosk system to purchase used mobile phones, tablets and MP3 players for cash. On July 23, 2013 all necessary approvals were obtained and we completed the acquisition of the remaining 77% equity interest which we did not already own. The primary reason for the business combination was to expand Outerwall’s presence in automated retail and gain exposure to the growing demand for refurbished products and mobile devices. We believe that we are uniquely well positioned to help scale the ecoATM footprint.
We accounted for the purchase of ecoATM as a business combination. Costs related to this acquisition of approximately $5.7 million were expensed during the second and third quarters 2013 and are included within general and administrative expenses in our Consolidated Statements of Comprehensive Income.
The following table highlights the consideration transferred, the fair value of our previously held equity interest and the fair value of replacement awards issued attributable to post-combination services.
 
 
Dollars in thousands
July 23, 2013
Consideration Transferred:
 
Cash paid
$
262,882

Replacement awards attributable to pre-combination services
1,398

Total consideration transferred
264,280

Previously held equity interest:
 
Acquisition date fair value of previously held equity interest
76,359

Total consideration transferred and fair value of previously held equity interest
$
340,639

 
 
Fair value of replacement awards attributable to post-combination services
$
30,671

As a part of the merger, we issued replacement awards for unvested restricted stock and options in ecoATM with rights to receive cash equal to the per share merger consideration for restricted stock and net of the exercise price for options. The replacement awards vest in accordance with the terms of the original replaced award. The fair value of the original and replacement awards amounted to $32.1 million, $1.4 million of which was attributed to pre-combination services rendered and included in the calculation of total consideration transferred. The replacement awards are considered liability classified as they require settlement in cash. Expense associated with the post-combination awards will be recognized net of forfeitures, and cash payments will be made, in accordance with the awards' vesting schedule, generally on a monthly basis.
Prior to the merger, we had a 23% equity interest in ecoATM. The guidance on accounting for business combinations requires that an acquirer remeasure its previously held equity interest in the acquiree at its acquisition date fair value and recognize the resulting gain or loss in earnings. We valued our previously held equity interest in ecoATM at $76.4 million, which was based on the per share merger consideration, resulting in a gain of $68.4 million included within income (loss) from equity method investments in our Consolidated Statements of Comprehensive Income and within (Income) loss from equity method investments, net in our Consolidated Statements of Cash Flows.

11


The following table shows the amounts recognized as of the acquisition date for each major class of assets acquired and liabilities assumed and the resultant purchase price allocation.
 
 
Dollars in thousands
July 23, 2013
Assets acquired:
 
Cash and cash equivalents
$
18,846

Accounts receivable
18

Prepaid expenses and other current assets
4,450

Current deferred income taxes
6,476

Property and equipment
23,207

Intangible assets
41,400

Goodwill
264,213

Other long-term assets
131

Total assets acquired
358,741

Liabilities assumed:
 
Accounts payable
(3,755
)
Other accrued liabilities
(1,605
)
Long term deferred tax liabilities
(12,742
)
Total consideration transferred and fair value of previously held equity interest
$
340,639

The assets acquired and liabilities assumed, as well as the results of operations from the date of the acquisition, are included within our New Ventures segment with the exception of expense for rights to receive cash which are unallocated corporate expenses. Goodwill of $264.2 million is calculated as the excess of the purchase price paid over the net assets acquired. The goodwill recorded as part of the ecoATM acquisition primarily reflects the expected market opportunity from the expansion of the ecoATM footprint in the growing U.S. mobile device market providing consumers with a convenient trade-in solution, as well as any intangible assets that do not qualify for separate recognition. All of the goodwill has been assigned to our New Ventures segment. None of the goodwill is deductible for tax purposes.
Acquired identifiable intangible assets and their estimated useful life in years are as follows:
Dollars in thousands
Purchase
Price
 
Estimated
Useful Life
in Years
Intangible assets:
 
 
 
Developed technology
$
34,000

 
5
Trade name
6,000

 
5
Covenants not to compete
1,400

 
5
Total
$
41,400

 
 
The following table shows the revenue and operating loss included in our Consolidated Statements of Comprehensive Income resulting from the acquisition of ecoATM since the closing date, including the amortization for acquired intangibles which are allocated to our New Ventures segment and expense for rights to receive cash which are unallocated corporate expenses:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
Dollars in thousands
2013
 
2013
Revenue
$
15,226

 
$
15,226

Operating loss
$
3,236

 
$
3,236


12


Pro forma information
The following unaudited pro forma information represents the results of operations for Outerwall Inc. and includes the ecoATM business acquired as if the acquisition was consummated as of January 1, 2012.
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
Dollars in thousands
2013
 
2012
 
2013
 
2012
Revenue
$
590,819

 
$
540,341

 
$
1,739,863

 
$
1,643,807

Net income (1)
$
17,041

 
$
29,632

 
$
73,432

 
$
176,843

(1) Net income includes the acquisition costs of $1.7 million and $4.0 million recorded in the first and second quarters of 2013, respectively.
The unaudited pro forma results have been adjusted with respect to certain aspects of our acquisition of ecoATM to reflect:
changes in assets and liabilities to record their acquisition date fair values and the resulting changes in certain expenses such as amortization;
recognition of the gain on our previously held equity interest as if the acquisition occurred on January 1, 2012;
recognition of expense associated with the post-combination rights to receive cash as if they were granted on January 1, 2012;
reversals of losses from our equity investment; and
the inclusion of the results of operations and the impact on taxes as if ecoATM had been a wholly owned subsidiary since January 1, 2012.
The unaudited pro forma results do not reflect future events that may occur after the acquisition, including, but not limited to, the anticipated realization of ongoing savings from operating synergies in subsequent periods.
Acquisition of NCR Corporation
On June 22, 2012, Redbox acquired certain assets of NCR Corporation (“NCR”) related to NCR’s self-service entertainment DVD kiosk business (the “NCR Asset Acquisition”). The purchased assets include, among others, self-service DVD kiosks, content library, intellectual property, and certain related contracts, including with certain retailers. In consideration, Redbox paid NCR $100.0 million in cash and assumed certain liabilities of NCR related to the purchased assets. The operating results of NCR’s self-service entertainment DVD kiosk business are included in our Redbox segment results.
We accounted for the NCR Asset Acquisition as a business combination. In accordance with US GAAP, the measurement period for our purchase price allocation ends as soon as information regarding our assessment of the quality and quantity of the kiosks acquired as well as certain facts and circumstances becomes available; such measurement period will not exceed twelve months from the acquisition date. During the second quarter of 2013, we obtained sufficient evidence regarding the quality and market value of the kiosks acquired (See Note 6: Property and Equipment for more information on the sale of certain NCR kiosks during the second quarter of 2013) to finalize our purchase price allocation. As a result, we retroactively adjusted our purchase price allocation to increase the value assigned to the kiosks acquired by $14.8 million with a corresponding decrease to goodwill to the period in which the NCR Asset Acquisition occurred. This adjustment to our purchase price allocation resulted in an immaterial difference in depreciation which we recorded as a cumulative adjustment in the second quarter of 2013.

13


The following table shows our preliminary purchase price allocation, adjustments we made during the six months ended June 30, 2013 and our final purchase price allocation based on the fair value of the assets acquired and liabilities assumed at the NCR Asset Acquisition date as follows: 
 
June 22, 2012
Dollars in thousands
Preliminary
 
Adjustments
 
Final
Assets acquired:
 
 
 
 
 
Content library
$
4,330

 
$

 
$
4,330

Prepaid expenses
240

 

 
240

Deferred income taxes
1,500

 

 
1,500

Property and equipment
9,130

 
14,766

 
23,896

Intangible assets
46,960

 

 
46,960

Goodwill
42,110

 
(14,766
)
 
27,344

Total assets acquired
104,270

 

 
104,270

Liabilities assumed:
 
 
 
 
 
Accrued liabilities
(4,270
)
 

 
(4,270
)
Total consideration paid in cash
$
100,000

 
$

 
$
100,000

Goodwill of $27.3 million, attributable primarily to the future expected synergies and operational efficiencies, as well as market expansion, has been assigned to our Redbox segment. The majority of the goodwill is deductible for tax purposes.
We estimated the fair value of the acquired identifiable intangible assets based on the forecasted future cash flows discounted at a rate of approximately 11%. A portion of the purchase price is allocated to the following identifiable intangible assets:
Dollars in thousands
Purchase
Price
 
Estimated
Useful Life
in Years
Intangible assets:
 
 
 
Retailer relationships
$
40,000

 
10
Patents
6,300

 
8
Trademark and trade name
500

 
1
Internal use software
160

 
1
Total
$
46,960

 
 
As of the date of acquisition, we estimated the weighted-average useful life of the acquired identifiable intangible assets to be 9.6 years.
NOTE 5: CASH AND CASH EQUIVALENTS
Cash and Cash Equivalents
We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. Our cash equivalents were $9.5 million and $60.4 million at September 30, 2013, and December 31, 2012, respectively, consisting of money market demand accounts and investment grade fixed income securities such as money market funds, certificate of deposits, and commercial paper. Our cash balances with financial institutions may exceed the deposit insurance limits.
Included in our cash and cash equivalents at September 30, 2013, and December 31, 2012, were $85.1 million and $91.8 million, respectively that we identified for settling our accrued payable to our retailer partners in relation to our Coinstar kiosks.

14


NOTE 6: PROPERTY AND EQUIPMENT
 
September 30,
 
December 31,
Dollars in thousands
2013
 
2012
Kiosks and components
$
1,107,205

 
$
1,041,755

Computers, servers, and software
226,166

 
195,756

Office furniture and equipment
7,270

 
6,538

Vehicles
6,782

 
7,278

Leasehold improvements
22,636

 
19,743

Property and equipment, at cost
1,370,059

 
1,271,070

Accumulated depreciation and amortization
(809,984
)
 
(684,946
)
Property and equipment, net
$
560,075

 
$
586,124

During the first quarter of 2013, we began exploring strategic alternatives for our New Ventures self-service concept for refurbished electronics called Orango™. We determined that certain assets related to this concept would be sold or otherwise disposed of before the end of their previously established useful lives and estimated that their fair value less costs to sell utilizing a cash flow approach exceeded their carrying value. As a result, during the first quarter of 2013, we recognized charges of $2.7 million in depreciation and other expense and $0.5 million in direct operating expense in our Consolidated Statements of Comprehensive Income. We ceased Orango™ operations during the second quarter of 2013 and during the third quarter of 2013 based on current information, we estimated the fair value less costs to sell utilizing a cash flow approach was zero and accelerated depreciation on the remaining carrying value of the assets of $2.6 million in order to fully depreciate the assets during the third quarter of 2013. Consequently, we recorded total charges of $2.6 million and $5.3 million for the three and nine months ended September 30, 2013, respectively to depreciation and other expense and $0.5 million to direct operating expense for the nine months ended September 30, 2013 in our Consolidated Statements of Comprehensive Income.
During the second quarter of 2013, we entered into an arrangement to sell certain kiosks previously acquired from NCR (the “NCR Kiosks”) through the sale of a previously consolidated entity which held certain of the NCR kiosks with a net book value of $12.4 million. Total proceeds from the sale of the entity were $11.8 million and are recorded within proceeds from sale of property and equipment within our Consolidated Statements of Cash Flows. As a result of this sale and certain reorganizations we recorded a one-time tax benefit as described in Note 16: Income Taxes.
During the third quarter of 2013, we acquired ecoATM, which included $23.2 million in property and equipment measured at fair value as of the acquisition date and is included in the table above. See Note 4: Business Combinations for more information.
NOTE 7: GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
The carrying amount of goodwill was as follows:
Dollars in thousands
 
Goodwill balance at December 31, 2012
$
309,860

Purchase price allocation adjustment
(14,766
)
Adjusted balance at December 31, 2012
295,094

Goodwill from acquisition of ecoATM
$
264,213

Goodwill balance at September 30, 2013
$
559,307

During the second quarter of 2013, we finalized the purchase price allocation associated with the NCR Asset Acquisition resulting in a $14.8 million decrease in Goodwill. During the third quarter of 2013 we acquired ecoATM resulting in a $264.2 million increase in Goodwill. See Note 4: Business Combinations for more information.

15


Other Intangible Assets
The gross amount of our other intangible assets and the related accumulated amortization were as follows:
 
Amortization
Period
 
September 30,
 
December 31,
Dollars in thousands
 
2013
 
2012
Retailer relationships
5 - 10 years
 
$
53,344

 
$
53,344

Accumulated amortization
 
 
(16,231
)
 
(11,518
)
 
 
 
37,113

 
41,826

Developed technology
5 years
 
34,000

 

Accumulated amortization
 
 
(1,133
)
 

 
 
 
32,867

 

Other
1 - 40 years
 
16,827

 
9,404

Accumulated amortization
 
 
(3,500
)
 
(2,261
)
 
 
 
13,327

 
7,143

Intangible assets, net
 
 
$
83,307

 
$
48,969

Amortization expense was as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
Dollars in thousands
2013
 
2012
 
2013
 
2012
Retailer relationships
$
1,568

 
$
1,614

 
$
4,713

 
$
2,843

Developed technology
1,133

 

 
1,133

 

Other
490

 
405

 
1,239

 
487

Total amortization of intangible assets
$
3,191

 
$
2,019

 
$
7,085

 
$
3,330

During the third quarter of 2013 we acquired ecoATM resulting in a $41.4 million increase in Other Intangible Assets. See Note 4: Business Combinations for more information.
Assuming no future impairment, the expected future amortization as of September 30, 2013 is as follows:
Dollars in thousands
Retailer
Relationships
 
Developed Technology
 
Other
Remainder of 2013
$
1,537

 
$
1,700

 
$
615

2014
5,432

 
6,800

 
2,454

2015
4,012

 
6,800

 
2,419

2016
4,012

 
6,800

 
2,307

2017
4,012

 
6,800

 
2,285

2018
4,012

 
3,967

 
1,664

Thereafter
14,096

 

 
1,583

Total expected amortization
$
37,113

 
$
32,867

 
$
13,327


NOTE 8: EQUITY METHOD INVESTMENTS AND RELATED PARTY TRANSACTIONS
Redbox Instant by Verizon
In February 2012, Redbox and Verizon Ventures IV LLC (“Verizon”), a wholly owned subsidiary of Verizon Communications Inc., entered into a Limited Liability Company Agreement (the “LLC Agreement”) and related arrangements. The LLC Agreement governs the relationship of the parties with respect to a joint venture, Redbox Instant by Verizon (the “Joint Venture”) formed for the primary purpose of developing, launching, marketing and operating a nationwide “over-the-top” video distribution service to provide consumers with access to video programming content, including linear content, delivered via broadband networks to video enabled viewing devices and offering rental of physical DVDs and Blu-ray discs from Redbox

16


kiosks. Redbox initially acquired a 35.0% ownership interest in the Joint Venture and made an initial capital contribution of $14.0 million in cash in February 2012 subsequent to the formation of the Joint Venture. The Joint Venture board of managers may request each member to make additional capital contributions, on a pro rata basis relative to its respective ownership interest. If a member does not make any or all of its requested capital contributions, as the case may be, the other contributing member generally may make such capital contributions. So long as Redbox contributes its pro rata share of the first $450.0 million of capital contributions to the Joint Venture, Redbox’s interest cannot be diluted below 10.0%. At the request of the Joint Venture board of managers, Redbox made a cash payment of $14.0 million during the first and third quarters of 2013 representing its pro-rata share of the requested capital contribution.
In addition to the initial cash capital contribution, Redbox granted the Joint Venture a limited, non-exclusive, non-transferable, royalty-free right and license to use certain Redbox trademarks, of which the estimated fair value was approximately $30.0 million based on an evaluation of information available as of the date of the grant. As a result, during the first quarter of 2012, we recognized a gain of $19.5 million related to the pro-rata amount of fair value given up in exchange for our 35.0% interest in the Joint Venture. See Note 14: Fair Value for additional information about how we estimated the fair value of the Redbox trademarks. The initial excess of our cost of the investment in the Joint Venture over our share of the Joint Venture’s equity will be used to adjust future amortization expense.
We account for Redbox’s ownership interest in the Joint Venture using the equity method of accounting. During the first quarter of 2012, the transaction related costs of $4.4 million were recorded as a part of the equity investment in the Joint Venture. We recognized a loss of approximately $23.8 and $13.8 million from our equity method investment, representing our share of the Joint Venture’s operating results as well as the amortization of differences in carrying amount and underlying equity for the nine months ended September 30, 2013, and 2012, respectively. Separate from equity method accounting for our ownership interest in the Joint Venture, we record revenue attributable with the rental of DVDs and Blu-ray discs from our Redbox kiosks arising from Joint Venture subscribers within our Redbox segment.
Redbox has certain rights to cause Verizon to acquire Redbox’s interest in the Joint Venture at fair value (generally following the fifth anniversary of the LLC Agreement or in limited circumstances, at an earlier period of time) and Verizon has certain rights to acquire Redbox’s interest in the Joint Venture at fair value (generally following the seventh anniversary of the LLC Agreement, or, in limited circumstances, the fifth anniversary of the LLC Agreement).
Other Equity Method Investments
We make strategic equity investments in external companies that provide automated self-service kiosk solutions. Our equity method investments and ownership percentages as of September 30, 2013, were as follows:
Dollars in thousands
Equity
Investment
 
Ownership
Percentage
Redbox Instant by Verizon
$
30,090

 
35%
SoloHealth, Inc.
1,984

 
10%
Equity method investments
$
32,074

 
 
Our equity method investments are included within other long-term assets on our Consolidated Balance Sheets.
During the third quarter of 2013, we acquired ecoATM, previously one of our equity method investments. See Note 4: Business Combinations for more information.

17


Income (loss) from Equity Method Investments
Income from equity method investments within our Consolidated Statements of Comprehensive Income is composed of the following:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
Dollars in thousands
2013
 
2012
 
2013
 
2012
Trademark gain
$

 
$

 
$

 
$
19,500

Gain on previously held equity interest on ecoATM
68,376

 

 
68,376

 

Proportionate share of net loss of equity method investees:
 
 
 
 

 

Redbox Instant by Verizon
(8,516
)
 
(4,918
)
 
(21,913
)
 
(12,176
)
Other
(1,307
)
 
(484
)
 
(3,326
)
 
(1,580
)
Total proportionate share of net loss of equity method investees
(9,823
)
 
(5,402
)
 
(25,239
)
 
(13,756
)
Amortization of difference in carrying amount and underlying equity in Redbox Instant by Verizon
(619
)
 
(619
)
 
(1,857
)
 
(1,650
)
Total income (loss) from equity method investments
$
57,934

 
$
(6,021
)
 
$
41,280

 
$
4,094

Related Party Transactions
At September 30, 2013 and December 31, 2012, included within accounts receivable, net of allowance, on our Consolidated Balance Sheets, was $10.8 million and $0.9 million, respectively, due from the Joint Venture related to costs incurred by Redbox on behalf of the Joint Venture during the normal course of business.
NOTE 9: DEBT AND OTHER LONG-TERM LIABILITIES
As of September 30, 2013
Debt and Other Liabilities
Dollars in thousands
Current
 
Long-term
 
Total
Senior unsecured notes
$

 
$
350,000

 
$
350,000

Callable convertible debt
51,625

 

 
51,625

Revolving line of credit under credit facility

 
100,000

 
100,000

Term loan under credit facility
18,594

 
130,156

 
148,750

Asset retirement obligation

 
12,689

 
12,689

Other liabilities
5

 
12,848

 
12,853

Total
$
70,224

 
$
605,693

 
$
675,917

As of December 31, 2012
Debt and Other Liabilities
Dollars in thousands
Current
 
Long-term
 
Total
Convertible debt
$

 
$
172,810

 
$
172,810

Term loan under credit facility
15,312

 
144,375

 
159,687

Asset retirement obligation

 
14,020

 
14,020

Other liabilities
217

 
9,974

 
10,191

Total
$
15,529

 
$
341,179

 
$
356,708

Senior Unsecured Notes
On March 12, 2013, we and certain subsidiaries of ours, as subsidiary guarantors (the “Subsidiary Guarantors”), entered into an indenture (the “Indenture”) with Wells Fargo Bank, National Association, as trustee, pursuant to which we issued $350.0 million principal amount of 6.000% Senior Notes due 2019 (the “Notes”) at par for proceeds, net of expenses, of $343.8 million and the Subsidiary Guarantors would guarantee the Notes (the “Guarantees”). We will use the proceeds of this offering primarily toward Convertible Note repayment and other corporate purposes. The Notes and the Guarantees are general unsecured obligations and are effectively subordinated to all of our and Subsidiary Guarantors’ existing and future secured debt to the extent of the collateral securing that secured debt. In addition, the Notes will be effectively subordinated to all of the liabilities of our existing and future subsidiaries that are not guaranteeing the Notes. Interest on the Notes will be payable on March 15 and September 15 of each year, beginning on September 15, 2013, with the Notes maturing on March 15, 2019.

18


We may redeem any of the Notes beginning on March 15, 2016, at a redemption price of 103% of their principal amount plus accrued and unpaid interest (and additional interest, if any); then the redemption price for the Notes will be 101.5% of their principal amount plus accrued and unpaid interest (and additional interest, if any) for the twelve-month period beginning March 15, 2017; and then the redemption price for the Notes will be 100% of their principal amount plus accrued interest and unpaid interest (and additional interest, if any) beginning on March 15, 2018. We may also redeem some or all of the Notes before March 15, 2016, at a redemption price of 100% of the principal amount, plus accrued and unpaid interest (and additional interest, if any), to the redemption date, plus an applicable “make-whole” premium. In addition, before March 15, 2016, we may redeem up to 35% of the aggregate principal amount of the Notes with the proceeds of certain equity offerings at 106% of their principal amount plus accrued and unpaid interest (and additional interest, if any); the Company may make such redemption only if, after any such redemption, at least 65% of the aggregate principal amount of Notes originally issued remains outstanding.
Upon a change of control (as defined in the Indenture), we will be required to make an offer to purchase the Notes or any portion thereof. That purchase price will equal 101% of the principal amount of the Notes on the date of purchase plus accrued and unpaid interest (and additional interest, if any). If we make certain asset sales and do not reinvest the proceeds or use such proceeds to repay certain debt, we will be required to use the proceeds of such asset sales to make an offer to purchase the Notes at 100% of their principal amount, together with accrued and unpaid interest and additional interest, if any, to the date of purchase.
The terms of the Notes restrict our ability and the ability of certain of its subsidiaries to, among other things: incur additional indebtedness; create liens; pay dividends or make distributions in respect of capital stock; purchase or redeem capital stock; make investments or certain other restricted payments; sell assets; enter into transactions with stockholders or affiliates; or effect a consolidation or merger. However, these and other limitations set forth in the Indenture will be subject to a number of important qualifications and exceptions.
The Indenture provides for customary events of default which include (subject in certain cases to grace and cure periods), among others: nonpayment of principal or interest or premium; breach of covenants or other agreements in the Indenture; defaults in failure to pay certain other indebtedness; the failure to pay certain final judgments; the invalidity of certain of the Subsidiary Guarantors’ Guarantees; and certain events of bankruptcy, insolvency or reorganization. Generally, if an event of default occurs and is continuing under the Indenture, either the trustee or the holders of at least 25% in aggregate principal amount of the Notes then outstanding may declare the principal amount plus accrued and unpaid interest on the Notes to be immediately due and payable.
During the third quarter of 2013 we filed a registration statement in order to offer to exchange, up to $350.0 million in aggregate principal amount of registered 6.000% senior notes due 2019 ("Exchange notes"), for the same principal amount of our currently outstanding 6.000% senior notes ("Original notes"). The terms of the Exchange notes are substantially identical to the terms of the Original notes, except that the Exchange notes will generally be freely transferable and do not contain certain terms with respect to registration rights and liquidated damages. We will issue the Exchange notes under the indenture governing the Original notes. The registration statement was declared effective on October 7, 2013.
Revolving Line of Credit and Term Loan
Our current credit facility, entered into on July 15, 2011, provides for a five-year, $175.0 million term loan and a $450.0 million revolving line of credit. Subject to additional commitments from lenders, we have the option to increase the aggregate facility size by $250.0 million, which can comprise additional term loans and a revolving line of credit.
The credit facility is secured by a first priority security interest in substantially all of our assets and the assets of our domestic subsidiaries, as well as a pledge of a substantial portion of certain equity interests in our subsidiaries. As of September 30, 2013, we were in compliance with the covenants of the credit facility.
On July 15, 2011, we borrowed $175.0 million under the term loan facility. On July 22, 2013, we drew on the revolving line of credit to fund the acquisition of ecoATM. As of September 30, 2013, there was $100.0 million outstanding on the revolving line of credit. The credit facility matures on July 15, 2016, at which time all outstanding borrowings must be repaid. The annual interest rate on the credit facility is variable, based on an index plus a margin determined by our consolidated net leverage ratio. In 2013, the applicable LIBOR Rate margin was fixed at 125 basis points and the applicable Base Rate margin was fixed at 25 basis points. The interest rate on amounts outstanding under the term loan and revolving line of credit at September 30, 2013, was 1.43%.

19


The term loan is subject to mandatory debt repayments of the outstanding borrowings. The schedule of future principal repayments is as follows:
Dollars in thousands
Repayment Amount
Remaining due in 2013
$
4,376

2014
19,687

2015
21,875

2016
102,812

Total
$
148,750

Convertible Debt
The aggregate outstanding principal of our 4.0% Convertible Senior Notes (the “Convertible Notes”) is $53.7 million. The Convertible Notes bear interest at a fixed rate of 4.0% per annum, payable semi-annually in arrears on each March 1 and September 1, and mature on September 1, 2014. The effective interest rate at issuance was 8.5%. As of September 30, 2013, we were in compliance with all covenants.
The Convertible Notes become convertible (the “Conversion Event”) when the closing price of our common stock exceeds $52.38, 130% of the Convertible Notes’ conversion price, for at least 20 trading days during the 30 consecutive trading days prior to each quarter-end date. If the Convertible Notes become convertible and should the holders elect to convert, we will be required to pay them up to the full face value of the Convertible Notes in cash as well as deliver shares of our common stock for any excess conversion value. The number of potentially issued shares increases as the market price of our common stock increases. As of September 30, 2013, such early conversion event was met. As a result, the Convertible Notes were classified as a current liability and the debt conversion feature was classified as temporary equity on our Consolidated Balance Sheets. In the nine months ended September 30, 2013, we retired a combined 131,278 Convertible Notes or $131.3 million in face value of Convertible Notes, through open market purchases and the note holders electing to convert, for $169.7 million in cash and the issuance of 255,745 shares of common stock. The amount by which the total consideration including cash paid and value of the shares issued exceeds the fair value of the Notes is recorded as a reduction of stockholders’ equity. The loss from early extinguishment of these Convertible Notes was approximately $6.0 million and is recorded in interest expense in our Consolidated Statements of Comprehensive Income. Additional details of our Convertible Notes are as follows:
Dollars in thousands
Principal
 
Discount
 
Net
Outstanding December 31, 2012
$
184,983

 
$
(12,173
)
 
$
172,810

Early extinguishments and debt conversion
(131,278
)
 
6,770

 
(124,508
)
Amortization of discount

 
3,323

 
3,323

Outstanding September 30, 2013
$
53,705

 
$
(2,080
)
 
$
51,625

The following interest expense was related to our Convertible Notes:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
Dollars in thousands
2013
 
2012
 
2013
 
2012
Contractual interest expense
$
537

 
$
2,000

 
$
3,353

 
$
6,000

Amortization of debt discount
549

 
1,789

 
3,323

 
5,270

Total interest expense related to the Convertible Notes
$
1,086

 
$
3,789

 
$
6,676

 
$
11,270

The remaining unamortized debt discount is expected to be recognized as non-cash interest expense as follows (in thousands):
 
Non-cash
Year
Interest Expense
Remainder of 2013
$
556

2014
1,524

Total unamortized discount
$
2,080


20


Total interest expense including the loss on early retirement of debt for the three months ended September 30, 2013 and 2012 was $8.4 million and $5.0 million, respectively, and was $28.3 and $14.4 million for the nine months ended September 30, 2013 and 2012 respectively. As of September 30, 2013, we were in compliance with all debt covenants.
NOTE 10: REPURCHASES OF COMMON STOCK
Board Authorization
On January 31, 2013, our Board of Directors approved an additional repurchase program of up to $250.0 million of our common stock plus the cash proceeds received from the exercise of stock options by our officers, directors, and employees.
The following table presents a summary of our authorized stock repurchase balance:
 
Board
Dollars in thousands
Authorization
Authorized repurchase - as of January 1, 2013
$
133,640

Additional board authorization
250,000

Proceeds from the exercise of stock options
11,775

Repurchase of common stock from open market
(95,004
)
Authorized repurchase - as of September 30, 2013
$
300,411

NOTE 11: SHARE-BASED PAYMENTS
We currently grant share-based awards to our employees, non-employee directors and consultants under our 2011 Incentive Plan (the “Plan”). The Plan permits the granting of stock options, restricted stock, restricted stock units, and performance-based restricted stock.
Certain information regarding our share-based payments is as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
Dollars in thousands
2013
 
2012
 
2013
 
2012
Share-based payments expense:
 
 
 
 
 
 
 
Share-based compensation - stock options
$
348

 
$
630

 
$
1,246

 
$
2,029

Share-based compensation - restricted stock
2,986

 
2,584

 
8,292

 
7,520

Share-based payments for content arrangements
(560
)
 
(4,800
)
 
1,916

 
3,595

Total share-based payments expense
$
2,774

 
$
(1,586
)
 
$
11,454

 
$
13,144

Tax benefit on share-based payments expense
$
1,040

 
$
(688
)
 
$
4,329

 
$
4,880

 
September 30, 2013
 
Unrecognized Share-
Based
 
Weighted-Average
Dollars in thousands
Payments Expense
 
Remaining Life
Unrecognized share-based payments expense:
 
 
 
Share-based compensation - stock options
$
2,058

 
2.4 years
Share-based compensation - restricted stock
22,514

 
2.5 years
Share-based payments for content arrangements
1,255

 
1.2 years
Total unrecognized share-based payments expense
$
25,827

 
 

21


Share-Based Compensation
Stock options
Shares of common stock are issued upon exercise of stock options. Certain other information regarding our stock-based awards is as follows:
Stock options are granted only to our executives and non-employee directors.
Options granted during the current year vest annually in equal installments over 4 years, and expire after 10 years.
The following table summarizes the weighted average valuation assumptions we used in the Black-Scholes-Merton Valuation model for stock options granted during 2013:
 
Nine Months Ended
 
September 30,
Expected term
6.3 years
Expected stock price volatility
45.0%
Risk-free interest rate
1.9%
Expected dividend yield
0.0%
The following table presents a summary of stock option activity for 2013:
 
 
 
Weighted
Average
Exercise
Shares in thousands
Options
 
Price
OUTSTANDING, December 31, 2012
669

 
$
34.86

Granted
93

 
$

Exercised
(383
)
 
$
30.84

Cancelled, expired, or forfeited
(101
)
 
$
42.40

OUTSTANDING, September 30, 2013
278

 
$
44.02

Certain information regarding stock options outstanding as of September 30, 2013, is as follows:
 
Options
 
Options
Shares and intrinsic value in thousands
Outstanding
 
Exercisable
Number
278

 
126

Weighted average per share exercise price
$
44.02

 
$
37.15

Aggregate intrinsic value
$
2,404

 
$
1,821

Weighted average remaining contractual term (in years)
5.72

 
3.16

Restricted stock awards
Restricted stock awards are granted to eligible employees, including executives, and non-employee directors. Awards granted to employees and executives vest annually in equal installments over four years. Non-employee director awards vest one year after the grant date. Performance-based restricted stock awards are granted to executives only, with established performance criteria approved by the Compensation Committee of the Board of Directors. Awards of performance-based restricted stock made prior to 2013, once earned, vest in equal installments over three years from the date of grant. Awards of performance-based restricted stock made in 2013, once earned, vest in two installments over three years from the date of grant (65% of the award vests two years from the date of grant and the remaining 35% of the award vests three years from the date of grant). The restricted shares require no payment from the grantee. The fair value of performance-based awards is based on achieving specific performance conditions and is recognized over the vesting period. The fair value of non-performance-based awards is based on the market price on the grant date and is recognized on a straight-line basis over the vesting period.

22


The following table presents a summary of restricted stock award activity for 2013:
 
Restricted
 
Weighted
Average
Grant Date
Shares in thousands
Stock Awards
 
Fair Value
NON-VESTED, December 31, 2012
604

 
$
48.95

Granted
415

 
$
53.90

Vested
(221
)
 
$
46.45

Forfeited
(119
)
 
$
50.43

NON-VESTED, September 30, 2013
679

 
$
52.53

Share-Based Payments for Content Arrangements
We granted restricted stock as part of content license agreements with certain movie studios. The expense related to these agreements is included within direct operating expenses in our Consolidated Statements of Comprehensive Income and is adjusted based on the number of unvested shares and market price of our common stock each reporting period.
Information related to the shares of restricted stock granted as part of these agreements as of September 30, 2013, is as follows:
 
Granted
 
Vested
 
Unvested
 
Remaining
Vesting Period
Sony
193,348

 
164,346

 
29,002

 
0.8 years
Paramount
300,000

 
180,000

 
120,000

 
1.3 years
Total
493,348

 
344,346

 
149,002

 
 
Rights to Receive Cash
As a part of the acquisition of ecoATM, we issued replacement awards for unvested restricted stock and options in ecoATM with rights to receive cash equal to the per share merger consideration for restricted stock and net of the exercise price for options. The replacement awards vest in accordance with the terms of the original replaced award. The fair value of the original and replacement awards amounted to $32.1 million, $1.4 million of which was attributed to pre-combination services rendered and included in the calculation of total consideration transferred. The replacement awards are considered liability classified as they represent rights to receive cash. Expense associated with the post-combination awards will be recognized net of forfeitures, and cash payments will be made, in accordance with the awards' vesting schedule, generally on a monthly basis. See Note 4: Business Combinations for more information. We recognized $2.3 million in expense associated with the issuance of rights to receive cash for the three and nine months ended September 30, 2013. The expected future recognition of expense associated with the rights to receive cash as of September 30, 2013 is as follows:
Dollars in thousands
 
Expense
Remainder of 2013
 
$
3,856

2014
 
15,361

2015
 
5,287

2016
 
3,438

2017
 
624

Total expected expense
 
$
28,566

NOTE 12: EARNINGS PER SHARE
Basic earnings per share (“EPS”) is computed by dividing the net income for the period by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing the net income for the period by the weighted average number of common and dilutive potential common shares outstanding during the period. We consider restricted stock that provides the holder with a non-forfeitable right to receive dividends to be a participating security. Net income available to participating securities was not material for the periods presented.
Net income used for calculating basic and diluted EPS is the same for all periods presented. The following table sets forth the computation of shares used for the basic and diluted EPS calculations:

23


 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
In thousands
2013
 
2012
 
2013
 
2012
Weighted average shares used for basic EPS
27,244

 
30,454

 
27,391

 
30,605

Dilutive effect of stock options and other share-based awards
351

 
536

 
439

 
625

Dilutive effect of convertible debt
421

 
1,248

 
752

 
1,454

Weighted average shares used for diluted EPS
28,016

 
32,238

 
28,582

 
32,684

Stock options and share-based awards not included in diluted EPS calculation because their effect would be antidilutive
19

 
110

 
67

 
141

NOTE 13: BUSINESS SEGMENTS AND ENTERPRISE-WIDE INFORMATION
Management, including our chief operating decision maker, who is our CEO, evaluates the performances of our business segments primarily on segment revenue and segment operating income before depreciation, amortization and other, and share-based compensation granted to executives, non-employee directors and employees (“segment operating income”). Segment operating income contains internally allocated costs of our shared service support functions, including but not limited to, corporate executive management, business development, sales, finance, legal, human resources, information technology and risk management. We also review depreciation and amortization allocated to each segment. Shared-based payments expense related to share-based compensation granted to executives, non-employee directors and employees and expense related to the rights to receive cash issued in connection with our acquisition of ecoATM are not allocated to our segments and are included in the corporate unallocated column in the analysis and reconciliation below; however, share-based payments expense related to our content arrangements with certain movie studios has been allocated to our Redbox segment and is included within direct operating expenses. Our performance evaluation does not include segment assets.
On July 23, 2013, we completed the acquisition of ecoATM. Prior to July 23, 2013 we held a non-controlling equity interest in ecoATM and reported our share of ecoATM's operating results in income (loss) from equity method investments in our Consolidated Statements of Comprehensive Income. Subsequent to our acquisition of ecoATM on July 23, 2013, the assets acquired and liabilities assumed, as well as the results of operations, with the exception of expense for rights to receive cash which are unallocated corporate expenses, are included in our New Ventures segment as our chief operating decision maker reviews the results in aggregate with other new ventures concepts. During the second quarter of 2012, we completed the NCR Asset Acquisition. The assets acquired and liabilities assumed, as well as the results of operations, are included in our Redbox segment. See Note 4: Business Combinations for additional information about these acquisitions.
Our analysis and reconciliation of our segment information to the consolidated financial statements that follows covers our results of operations, which consists of our Redbox, Coinstar and New Ventures segments. Unallocated general and administrative expenses relate to share-based compensation and expense related to the rights to receive cash issued in connection with our acquisition of ecoATM.
Dollars in thousands
 
 
 
 
New
 
Corporate
 
 
Three Months Ended September 30, 2013
Redbox
 
Coinstar
 
Ventures
 
Unallocated
 
Total
Revenue
$
491,694

 
$
79,611

 
$
16,048

 
$

 
$
587,353

Expenses:
 
 
 
 
 
 
 
 
 
Direct operating
350,759

 
41,833

 
14,854

 
1,267

 
408,713

Marketing
5,883

 
1,352

 
1,149

 
739

 
9,123

Research and development
69

 
1,428

 
1,667

 
655

 
3,819

General and administrative
44,017

 
7,349

 
7,499

 
2,973

 
61,838

Segment operating income (loss)
90,966

 
27,649

 
(9,121
)
 
(5,634
)
 
103,860

Less: depreciation, amortization and other
(41,478
)
 
(8,539
)
 
(5,424
)
 

 
(55,441
)
Operating income (loss)
49,488

 
19,110

 
(14,545
)
 
(5,634
)
 
48,419

Income from equity method investments, net

 

 

 
57,934

 
57,934

Interest expense, net

 

 

 
(8,402
)
 
(8,402
)
Other, net

 

 

 
(2,402
)
 
(2,402
)
Income (loss) before income taxes
$
49,488

 
$
19,110

 
$
(14,545
)
 
$
41,496

 
$
95,549


24


Dollars in thousands
 
 
 
 
New
 
Corporate
 
 
Three Months Ended September 30, 2012
Redbox
 
Coinstar
 
Ventures
 
Unallocated
 
Total
Revenue
$
459,538

 
$
77,616

 
$
408

 
$

 
$
537,562

Expenses:
 
 
 
 
 
 
 
 
 
Direct operating
309,842

 
40,417

 
967

 
315

 
351,541

Marketing
5,698

 
1,072

 
731

 
12

 
7,513

Research and development
1

 
968

 
2,116

 
55

 
3,140

General and administrative
42,794

 
7,244

 
3,140

 
2,832

 
56,010

Segment operating income (loss)
101,203

 
27,915

 
(6,546
)
 
(3,214
)
 
119,358

Less: depreciation, amortization and other
(41,478
)
 
(10,968
)
 
(43
)
 

 
(52,489
)
Operating income (loss)
59,725

 
16,947

 
(6,589
)
 
(3,214
)
 
66,869

Loss from equity method investments, net

 

 

 
(6,021
)
 
(6,021
)
Interest expense, net

 

 

 
(3,892
)
 
(3,892
)
Other, net

 

 

 
(21
)
 
(21
)
Income (loss) before income taxes
$
59,725

 
$
16,947

 
$
(6,589
)
 
$
(13,148
)
 
$
56,935

Dollars in thousands
 
 
 
 
New
 
Corporate
 
 
Nine Months Ended S