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13: R3 Consolidated Balance Sheets HTML 116K
14: R4 Consolidated Balance Sheets (Parentheticals) HTML 25K
15: R5 Consolidated Statements of Operations HTML 85K
16: R6 Consolidated Statements of Comprehensive Income HTML 40K
Statement
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18: R8 Consolidated Statement of Equity HTML 70K
19: R9 Other Comprehensive Income (Component of Other HTML 29K
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21: R11 Television Distribution Rights, Net HTML 32K
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(Exact
name of Registrant as specified in its charter)
State of iDelawarei23-2414041
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation
or organization) Number)
i1200 Wilson Drive
iWest Chester, iPennsylvaniai19380
(Address
of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: i(484)i701-1000
Securities
registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name of each exchange on which registered
i6.375% Senior Secured Notes due 2067
iQVCD
iNew
York Stock Exchange
i6.250% Senior Secured Notes due 2068
iQVCC
iNew
York Stock Exchange
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. iYesx No o
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). iYesx No o
Indicate by check mark whether
the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer,""accelerated filer,""smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer o iNon-accelerated
filer☒ Smaller reporting company Emerging growth
i☐company i☐
If
an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐ No x
None
of the voting stock of the registrant is held by a non-affiliate of the registrant. There is no publicly traded market for any class of voting stock of the registrant. There is one holder of record of our equity, Qurate Retail Group, Inc., an indirect wholly-owned subsidiary of Qurate Retail, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(1) iBasis of Presentation
QVC, Inc. and its consolidated subsidiaries
(unless otherwise indicated or required by the context, the terms "we,""our,""us," the "Company" and "QVC" refer to QVC, Inc. and its consolidated subsidiaries) is a retailer of a wide range of consumer products, which are marketed and sold primarily by merchandise-focused televised shopping programs, the Internet and mobile applications.
In the United States ("U.S."), QVC's televised shopping programs, including live and recorded content, are distributed across multiple channels nationally on a full-time basis, including QVC, QVC2, QVC3, HSN and HSN2. During the first quarter of 2019, the Company transitioned its televised Beauty iQ channel to QVC3 and Beauty iQ content was moved to a digital only platform.
The Company's U.S. programming is also available on QVC.com and HSN.com, QVC's "U.S. websites"; applications via streaming video; Facebook Live, Roku, Apple TV, and Amazon Fire; mobile applications; social pages and over-the-air broadcasters.
QVC's digital platforms enable consumers to purchase goods offered on our televised programming, along with a wide assortment of products that are available only on our U.S. websites. QVC.com, HSN.com and our other digital platforms (including our mobile applications, social pages and others) are natural extensions of our business model, allowing customers to
engage in our shopping experience wherever they are, with live or on-demand content customized to the device they are using. In addition to offering video content, our U.S. websites allow shoppers to browse, research, compare and perform targeted searches for products, read customer reviews, control the order-entry process and conveniently access their QVC account.
Internationally, QVC's televised shopping programs, including live and recorded content, are distributed to households outside of the U.S., primarily in Germany, Austria, Japan, the United Kingdom ("U.K."), the Republic of Ireland and Italy. In some of the countries where QVC operates, QVC's televised shopping programs are distributed across multiple QVC channels: QVC Style and QVC2 in Germany and QVC Beauty, QVC Extra and QVC Style in the
U.K. Similar to the U.S., our international businesses also engage customers via websites, mobile applications, and social pages. QVC's international business employs product sourcing teams who select products tailored to the interests of each local market.
The Company's Japanese operations ("QVC-Japan") are conducted through a joint venture with Mitsui & Co., LTD ("Mitsui"). QVC-Japan is owned i60%
by the Company and i40% by Mitsui. The Company and Mitsui share in all profits and losses based on their respective ownership interests. During the six months ended June 30, 2020 and 2019, QVC-Japan paid dividends to Mitsui of $i30
million and $i28 million, respectively.
The Company also has a joint venture with CNR Media Group, formerly known as China Broadcasting Corporation, a limited liability company owned by China National Radio (''CNR''). The Company owns a i49%
interest in a CNR subsidiary, CNR Home Shopping Co., Ltd. (''CNRS''). CNRS operates a retail business in China through a shopping television channel with an associated website. This joint venture is accounted for as an equity method investment recorded as equity in income (losses) of investee in the condensed consolidated statements of operations.
The Company is an indirect wholly-owned subsidiary of Qurate Retail, Inc. ("Qurate Retail") (Nasdaq: QRTEA and QRTEB), which owns interests in a broad range of digital commerce businesses, including Qurate Retail's other wholly-owned subsidiaries Zulily, LLC ("Zulily") and Cornerstone
Brands, Inc. ("CBI"), as well as other minority investments. QVC is part of the Qurate Retail Group, formerly QVC Group, a portfolio of brands including QVC, HSN, Inc. ("HSN"), Zulily and CBI.
During each of the six months ended June 30, 2020 and 2019, QVC and Zulily engaged in multiple transactions relating to sales, sourcing of merchandise, marketing initiatives and business advisory services. QVC allocated expenses of $i4
million to Zulily for each of the six months ended June 30, 2020 and 2019. Zulily allocated expenses of $i5 million and $i4
million to QVC for the six months ended June 30, 2020 and 2019, respectively.
During each of the six months ended June 30, 2020 and 2019, QVC and CBI engaged in multiple transactions relating to personnel and business advisory services. QVC allocated expenses of $i11
million to CBI for each of the six months ended June 30, 2020 and 2019. CBI allocated expenses of $i1 million to QVC for each of the six months ended June 30, 2020 and 2019. CBI also repaid a $i29
million note receivable to QVC during the six months ended June 30, 2019.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
In December 2019, a new coronavirus disease ("COVID-19'") pandemic was reported to have surfaced in Wuhan, China and has subsequently spread across the globe, including all of the countries in which QVC operates. As a result of the spread of the virus, certain local governmental
agencies have imposed travel restrictions, local quarantines or stay at home restrictions to contain the spread, which has caused a significant disruption to most sectors of the economy.
As a result of COVID-19, management has increased the amounts of certain estimated reserves including, but not limited to, uncollectible receivables and inventory obsolescence for each of the three and six months ended June 30, 2020. Other than these changes, management is not presently aware of any events or circumstances arising from the COVID-19 pandemic that would require the Company to update our estimates, judgments or revise the carrying value of our assets or liabilities. Management's estimates may change, however, as new events occur and additional information is obtained, and any such changes will be recognized
in the consolidated financial statements. Actual results could differ from estimates, and any such differences may be material to our financial statements.
In July 2020, QVC implemented a planned workforce reduction. As part of the workforce reduction, QVC has decided to eliminate live hours on QVC2 in the U.S. and other secondary channels within the various markets. As a result, QVC recorded $i16 million of severance expense during the three months ended June 30, 2020, which
is recorded in selling, general and administrative expense.
The condensed consolidated financial statements include the accounts of QVC, Inc. and its majority-owned subsidiaries. All significant intercompany accounts and transactions were eliminated in consolidation.
The accompanying (a) condensed consolidated balance sheet as of December 31, 2019, which has been derived from audited financial statements, and (b) the interim unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("U.S. 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 U.S. 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 QVC's Annual Report on Form 10-K for the year ended December 31, 2019.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Estimates include, but are not limited to, sales returns, uncollectible receivables, inventory obsolescence, internally-developed software, valuation of acquired intangible assets and goodwill and income taxes.
i
Adoption of new accounting pronouncements
In August 2018, the Financial Accounting Standards Board issued ASU 2018-15, Intangibles-
Goodwill and Other- Internal-Use Software (Subtopic 350-40), which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The Company prospectively adopted this new standard as of January 1, 2020 and it did not have a material impact on its consolidated financial statements.
The
Company recorded amortization expense of $i35 million and $i32 million for the three months ended June 30, 2020
and 2019, respectively, related to television distribution rights. For the six months ended June 30, 2020 and 2019, amortization expense for television distribution rights was $i69 million and $i66
million, respectively.
i
As of iJune 30, 2020, related amortization expense for each of the next five years ended December 31 was as
follows (in millions):
Remainder of 2020
$
i56
2021
i22
2022
i4
2023
i—
2024
i—
/
(3)
iGoodwill and Other Intangible Assets, Net
i
The changes in the carrying amount of goodwill for the six months ended June 30, 2020 were as follows:
The
Company recorded amortization expense of $i38 million and $i38 million for the three months ended June
30, 2020 and 2019, respectively, related to other intangible assets. For the six months ended June 30, 2020 and 2019, amortization expense for other intangible assets was $i75 million and $i76
million, respectively.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
Senior Secured Notes
All of QVC's senior secured notes are secured by the capital stock of QVC and certain of its subsidiaries and have equal priority to the senior secured credit facility. The interest on QVC's senior secured notes is payable semi-annually with the exception of the i6.375%
Senior Secured Notes due 2067 (the "2067 Notes") and the i6.25% Senior Secured Notes due 2068 (the "2068 Notes"), which is payable quarterly.
4.75% Senior Secured Notes due 2027
On February 4, 2020, QVC completed a registered debt offering for $i575 million
of the i4.75% Senior Secured Notes due 2027 (the "2027 Notes") at par. Interest on the 2027 Notes will be paid semi-annually in February and August, with payments commencing on August 15, 2020.
Senior Secured Credit Facility
On December 31, 2018, QVC entered into the Fourth Amended and Restated Credit Agreement with Zulily as borrowers
(collectively, the “Borrowers”) which is a multi-currency facility that provides for a $i2.95 billion revolving credit facility with a $i450
million sub-limit for standby letters of credit and $i1.5 billion of uncommitted incremental revolving loan commitments or incremental term loans. The Fourth Amended and Restated Credit Agreement includes a $i400
million tranche that may be borrowed by the Company or Zulily with a $i50 million sub-limit for standby letters of credit. The remaining $i2.55
billion and any incremental loans may be borrowed only by the Company. Borrowings that are alternate base rate loans will bear interest at a per annum rate equal to the base rate plus a margin that varies between i0.25% and i0.75%
depending on the Borrowers’ combined ratio of Consolidated Total Debt to Consolidated EBITDA (the “Combined Consolidated Leverage Ratio”). Borrowings that are London Interbank Offered Rate ("LIBOR") loans will bear interest at a per annum rate equal to the applicable LIBOR rate plus a margin that varies between i1.25% and i1.75%
depending on the Borrowers’ Combined Consolidated Leverage Ratio. Each loan may be prepaid at any time and from time to time without penalty other than customary breakage costs. No mandatory prepayments will be required other than when borrowings and letter of credit usage exceed availability; provided that, if Zulily ceases to be controlled by Qurate Retail, all of its loans must be repaid and its letters of credit cash collateralized. The facility matures on December 31, 2023. Payment of loans may be accelerated following certain customary events of default.
QVC had $i2.93
billion available under the terms of the Fourth Amended and Restated Credit Agreement as of iJune 30, 2020, including the portion available under the $i400
million tranche that Zulily may also borrow on.
The payment and performance of the Borrowers’ obligations under the Fourth Amended and Restated Credit Agreement are guaranteed by each of QVC’s Material Domestic Subsidiaries (as defined in the Fourth Amended and Restated Credit Agreement). Further, the borrowings under the Fourth Amended and Restated Credit Agreement are secured, pari passu with QVC’s existing notes, by a pledge of all of QVC’s equity interests. The payment and performance of the Borrowers’ obligations with respect to the $i400
million tranche available to both QVC and Zulily are also guaranteed by each of Zulily’s Material Domestic Subsidiaries (as defined in the Fourth Amended and Restated Credit Agreement), if any, and are secured by a pledge of all of Zulily’s equity interests.
The Fourth Amended and Restated Credit Agreement contains certain affirmative and negative covenants, including certain restrictions on the Company and Zulily and each of their respective restricted subsidiaries (subject to certain exceptions) with respect to, among other things: incurring additional indebtedness; creating liens on property or assets; making certain loans or investments; selling or disposing
of assets; paying certain dividends and other restricted payments; dissolving, consolidating or merging; entering into certain transactions with affiliates; entering into sale or leaseback transactions; restricting subsidiary distributions; and limiting the Company’s consolidated leverage ratio and the Borrowers’ Combined Consolidated Leverage Ratio.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
Interest
Rate Swap Arrangements
During the year ended December 31, 2016, QVC entered into a three-year interest rate swap arrangement with a notional amount of $i125 million to mitigate the interest rate risk associated with interest payments related to its variable rate debt. The swap arrangement did not qualify as a cash flow hedge under U.S. GAAP. The swap arrangement expired in June 2019. In July 2019, the Company
entered into a three-year interest swap arrangement with a notional amount of $i125 million. The swap arrangement did not qualify as a cash flow hedge under U.S. GAAP and the fair value of the swap instrument was in a net liability position of $i4
million as of iJune 30, 2020, which was included in other long-term liabilities.
On December 31, 2018, QVC entered into a thirteen month interest rate swap arrangement that effectively converted $i250
million of its variable rate bank credit facility to a fixed rate of i1.05%, which expired in January of 2020.
Changes in the fair value of the swaps are reflected in losses on financial instruments in the condensed consolidated statements of operations.
Other Debt Related Information
QVC was in compliance with all of its debt covenants as of June 30, 2020.
The
weighted average interest rate applicable to all of the outstanding debt (excluding finance leases) prior to amortization of bond discounts and related debt issuance costs was i5.1% as of June 30, 2020.
(6) iLeases
The
Company has finance lease agreements with transponder and transmitter network suppliers for the right to transmit its signals in the U.S. and Germany. The Company is also party to a finance lease agreement for data processing hardware and a warehouse.
QVC also leases data processing equipment, facilities, office space and land. These leases are classified as operating leases. Operating lease right-of-use assets and operating lease liabilities are recognized based on the present value of the future lease payments using our incremental borrowing rate. Leases with an initial term of i12
months or less are not recorded on the balance sheet. Our leases have remaining lease terms of less than i1 year to i14 years, some of which may include the option to extend or terminate the leases.
i
The
components of lease cost for the three and six months ended June 30, 2020 and 2019, were as follows:
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
i
Future payments under noncancelable operating leases and finance leases with initial terms of one year or more as of iJune 30,
2020 consisted of the following:
(in millions)
Finance leases
Operating leases
Total leases
Remainder of 2020
$
i13
i16
i29
2021
i25
i32
i57
2022
i25
i28
i53
2023
i25
i24
i49
2024
i23
i23
i46
Thereafter
i108
i183
i291
Total
lease payments
i219
i306
i525
Less:
imputed interest
(i47)
(i91)
(i138)
Total
lease liabilities
$
i172
i215
i387
/
On
October 5, 2018, QVC entered into a lease (“ECDC Lease”) for an East Coast distribution center. The i1.7 million square foot rental building is located in Bethlehem, Pennsylvania and the ECDC Lease has an initial term of i15
years. QVC obtained initial access to a portion of the ECDC Lease during March 2019 and obtained access to the remaining portion during September 2019. In total, QVC recorded a right of use asset of $i141 million and an operating lease liability of $i131
million relating to the ECDC Lease, with the difference attributable to prepaid rent. QVC is required to pay an initial base rent of $i10 million per year, with payments that began in the third quarter of 2019 and increasing to $i14
million per year, as well as all real estate taxes and other building operating costs. QVC also has the option to extend the term of the ECDC Lease for up to itwo consecutive terms of i5
years each and ione final term of i4 years.
QVC's revenue includes sales of consumer products in the following categories; home, beauty, apparel, accessories, electronics and jewelry, which are primarily sold through live merchandise-focused televised shopping programs and via our websites and other interactive media.
Other revenue consists primarily of income generated from our U.S. Private Label Credit Card ("PLCC") in which a large consumer financial services company provides revolving credit directly to QVC's customers for the sole purpose of purchasing merchandise or services with a PLCC. In return, the Company receives a portion of the net
economics of the credit card program.
i
Revenue Recognition
For each of the three and six months ended June 30, 2020 and 2019, revenue is recognized when obligations with our customer are satisfied; generally this occurs at the time of shipment to our customers consistent with when control of the shipped product passes. The recognized revenue reflects the consideration
we expect to receive in exchange for transferring goods, net of allowances for returns.
The Company generally recognizes revenue related to the PLCC program over time as the PLCC is used by QVC's customers.
Sales, value add, use and other taxes the Company collects concurrent with revenue-producing activities are excluded from revenue.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
The Company elected to treat shipping and handling activities that occur after the customer obtains control of the goods as a fulfillment cost and not as a promised good or service. Accordingly, the Company accrues the related shipping costs and recognizes revenue upon delivery of the goods to the shipping carrier. In electing this accounting policy, all shipping and handling activities will be treated as fulfillment costs.
The Company generally extends payment terms with
its customers of one year or less and does not consider the time value of money when recognizing revenue.
Significant Judgments
Our products are generally sold with a right of return and we may provide other credits or incentives, which are accounted for as variable consideration when estimating the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period as additional information becomes available. The Company has determined that it is generally the principal in vendor arrangements as the Company can establish
control over the goods prior to shipment. Accordingly, the Company records revenue for these arrangements on a gross basis.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
(8) iIncome
Taxes
The Company calculates its interim income tax provision by applying its best estimate of the annual expected effective tax rate to its ordinary year-to-date income or loss. The tax or benefit related to significant, unusual or extraordinary items that will be separately reported or reported net of their related tax effect are individually computed and recognized in the interim period in which those items occur.
The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the expected operating income for the year, projections of the proportion of income earned and taxed in foreign jurisdictions, permanent and temporary differences as a result of differences between amounts measured
and recognized in accordance with tax laws and financial accounting standards, and the likelihood of recovering deferred tax assets. The accounting estimates used to compute the provision for income taxes may change as new events occur, additional information is obtained or as the tax environment changes. To the extent that the estimated annual effective tax rate changes during a quarter, the effect of the change on the prior quarters is included in the tax expense for the current quarter.
For the three months ended June 30, 2020 and 2019, the Company recorded a tax provision of $i92
million and $i85 million, respectively, which represented an effective tax rate of i29.0% and i28.1%,
respectively. For the six months ended June 30, 2020 and 2019, the Company recorded a tax provision of $i152 million and $i159
million, respectively, which represented an effective tax rate of i29.3% and i28.2%, respectively. The 2020 rate differs from the U.S. federal income tax
rate of i21% due primarily to state and foreign tax expenses and a valuation allowance established for excess U.S. foreign tax credits. The 2020 effective tax rate has increased from the prior year for the six months ended June 30, 2020 primarily due to increases in state and foreign tax expense and the valuation allowance on foreign tax credits in the current year. The 2020 effective tax rate has increased from the prior year for the three months ended
June 30, 2020 primarily due to increases in state tax expense.
The Company participates in a consolidated federal return filing with Qurate Retail. As of June 30, 2019, the Company's tax years through 2015 are closed for federal income tax purposes, and the Internal Revenue Service ("IRS") has completed its examination of the Company's 2016 and 2017 tax years. The Company's 2018, 2019, and 2020 tax years are being examined currently as part of the Qurate
Retail consolidated return under the IRS's Compliance Assurance Process program. The Company, or one of its subsidiaries, files income tax returns in various states and foreign jurisdictions. As of iJune 30, 2020, the Company was under examination in the states of Pennsylvania and California, and certain of the
Company's subsidiaries were under examination in Germany and the U.K.
The Company is a party to a Tax Liability Allocation and Indemnification Agreement (the “Tax Agreement”) with Qurate Retail. The Tax Agreement establishes the methodology for the calculation and payment of income taxes in connection with the consolidation of the Company with Qurate Retail for income tax purposes. Generally, the Tax Agreement provides that the Company will pay Qurate Retail an amount equal to the tax liability, if any, that it would have if it were to file as a consolidated group separate
and apart from Qurate Retail, with exceptions for the treatment and timing of certain items, including but not limited to deferred intercompany transactions, credits, and net operating and capital losses. To the extent that the separate company tax expense is different from the payment terms of the Tax Agreement, the difference is recorded as either a dividend or capital contribution.
The amounts of the tax-related balance payable (receivable) due to (from) Qurate Retail as of iJune 30, 2020 and December
31, 2019 were $i76 million and $(i7) million, respectively, and were included in accrued liabilities in the accompanying condensed consolidated balance sheets.
(9)
iCommitments and Contingencies
The Company has contingent liabilities related to legal and tax proceedings and other matters arising in the ordinary course of business. Although it is reasonably possible the Company may incur losses upon conclusion of such matters, an estimate of any loss or range of loss cannot be made. In the opinion
of management, it is expected that the amounts, if any, which may be required to satisfy such contingencies will not be material in relation to the accompanying condensed consolidated financial statements.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
Network and information systems, including the Internet and telecommunication systems, third party delivery services and other technologies are critical to QVC's business activities. Substantially all of QVC's customer orders, fulfillment
and delivery services are dependent upon the use of network and information systems, including the use of third party telecommunication and delivery service providers. If information systems including the Internet or telecommunication services are disrupted, or if the third party delivery services experience a disruption in their transportation delivery services, the Company could face a significant disruption in fulfilling QVC's customer orders and shipment of QVC's products. The Company has active disaster recovery programs in place to help mitigate risks associated with these critical business activities.
(10)
iFinancial Instruments and Fair Value Measurements
For assets and liabilities required to be reported or disclosed at fair value, U.S. GAAP provides a hierarchy that prioritizes inputs to valuation techniques used to measure fair value into three broad levels. Level 1 inputs are quoted market prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs, other than quoted market prices included within Level 1, are observable for the asset or liability,
either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability.
i
The Company's assets and liabilities measured or disclosed at fair value were as follows:
The
2067 Notes (ticker: QVCD) and the 2068 Notes (ticker: QVCC) are considered Level 1 fair value instruments as reported in the foregoing tables as they are traded on the New York Stock Exchange, which the Company considers to be an "active market," as defined by U.S. GAAP. The remainder of the Company's Level 2 financial liabilities are debt instruments with quoted market prices that are not considered to be traded on "active markets." Accordingly, these financial instruments are reported in the foregoing tables as Level 2 fair value instruments.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
(11) iInformation about QVC's Operating Segments
The Company evaluates performance and makes decisions about allocating resources to its operating segments
based on financial measures such as net revenue, Adjusted OIBDA, gross margin, average sales price per unit, number of units shipped and revenue. For segment reporting purposes, the Company defines Adjusted OIBDA, as net revenue less cost of goods sold, operating expenses, and selling, general and administrative expenses (excluding stock-based compensation and transaction related costs). The Company believes this measure is an important indicator of the operational strength and performance of its segments by identifying those items that are not directly a reflection of each segment's performance or indicative of ongoing business trends. In addition, this measure allows management to view operating results and perform analytical comparisons and benchmarking among the
Company's businesses and identify strategies to improve performance. This measure of performance excludes depreciation, amortization, stock-based compensation, transaction related costs and impairment loss (if any) that are included in the measurement of operating income pursuant to U.S. GAAP. Accordingly, Adjusted OIBDA should be considered in addition to, but not as a substitute for, operating income, net income, cash flow provided by operating activities and other measures of financial performance prepared in accordance with U.S. GAAP.
QVC's chief operating decision maker ("CODM") is QVC's Chief Executive Officer. QVC's CODM has ultimate responsibility for enterprise decisions. QVC's CODM determines, in particular, resource allocation for, and monitors performance of, the consolidated enterprise. The segment managers have responsibility for operating decisions, allocating resources and assessing performance within
their respective segments. QVC's CODM relies on internal management reporting that analyzes enterprise results and segment results to the Adjusted OIBDA level.
For the three and six months ended June 30, 2020 and 2019, QVC identified QxH and QVC-International as its two reportable segments. Both operating segments are retailers of a wide range of consumer products, which are marketed and sold primarily by merchandise-focused televised-shopping programs as well as via the Internet and mobile applications in certain markets.
The
component of other comprehensive income is reflected in QVC's condensed consolidated statements of comprehensive income, net of taxes. The following table summarizes the tax effects related to the component of other comprehensive loss:
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Certain statements in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our business, product and marketing strategies; COVID-19 (as defined below); capital expenditures; revenue growth; remediation of a material weakness; the recoverability of our goodwill and other long-lived assets; our projected sources and uses of cash; repayment of debt; and the anticipated impact of certain
contingent liabilities related to legal and tax proceedings and other matters arising in the ordinary course of business. Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. The following include some but not all of the factors that could cause actual results or events to differ materially from those anticipated:
•the impact of the novel coronavirus ("COVID-19") pandemic and local, state and federal governmental responses to the pandemic on the economy, our customers, our vendors and our businesses generally;
•customer demand for our products and services and our ability to
anticipate customer demand and to adapt to changes in demand;
•competitor responses to our products and services;
•increased digital TV penetration and the impact on channel positioning of our programs;
•the levels of online traffic on our websites and our ability to convert visitors into consumers or contributors;
•uncertainties inherent in the development and integration of new business lines and business strategies;
•our future financial performance, including availability, terms and deployment of capital;
•our
ability to successfully integrate and recognize anticipated efficiencies and benefits from the businesses we acquire;
•the cost and ability of shipping companies, suppliers and vendors to deliver products, equipment, software and services;
•the outcome of any pending or threatened litigation;
•availability of qualified personnel;
•changes in, or failure or inability to comply with, government regulations, including, without limitation, regulations of the Federal Communications Commission, and adverse outcomes from regulatory proceedings;
•changes in the nature of key strategic relationships with partners, distributors, suppliers and
vendors;
•domestic and international economic and business conditions and industry trends;
•changes in tariffs, trade policy and trade relations following the 2016 U.S. presidential election and the United Kingdom ("U.K.")'s exit from the European Union (“Brexit”);
•consumer spending levels, including the availability and amount of individual consumer debt and customer credit losses;
•advertising spending levels;
•changes in distribution and viewing of television programming, including the expanded deployment of video on demand technologies and Internet Protocol television and their impact on home shopping programming;
•rapid
technological changes;
•failure to protect the security of personal information, subjecting us to potentially costly government enforcement actions and/or private litigation and reputational damage;
•the regulatory and competitive environment of the industries in which we operate;
•threatened
terrorist attacks, political unrest in international markets and ongoing military action around the world;
•fluctuations in foreign currency exchange rates;
•natural disasters, public health crises (including COVID-19), political crises, and other catastrophic events or other events outside of our control; and
•Qurate Retail, Inc.'s ("Qurate Retail") dependence on our cash flow for servicing its debt and for other purposes.
For additional risk factors, please see Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2019 and Part II, Item 1A. Risk Factors in our Quarterly Report on Form 10-Q for the quarter ended March
31, 2020. These forward-looking statements and such risks, uncertainties and other factors speak only as of the date of this Quarterly Report on Form 10-Q, and we expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein, to reflect any change in our expectations with regard thereto, or any other change in events, conditions or circumstances on which any such statement is based.
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, 2019.
Overview
QVC,
Inc. and its consolidated subsidiaries (unless otherwise indicated or required by the context, the terms "we,""our,""QVC" or the "Company" refer to QVC, Inc. and its consolidated subsidiaries) is a retailer of a wide range of consumer products, which are marketed and sold primarily by merchandise-focused televised shopping programs, the Internet and mobile applications.
In the United States ("U.S."), our televised shopping programs, including live and recorded content, are distributed across multiple channels nationally on a full-time basis, including QVC, QVC2, QVC3, HSN and HSN2. During the first quarter of 2019, the Company
transitioned its televised Beauty iQ channel to QVC3 and Beauty iQ content was moved to a digital only platform. Our U.S. programming is also available on QVC.com and HSN.com, our "U.S. websites"; applications via streaming video; Facebook Live, Roku, Apple TV, and Amazon Fire; mobile applications; social pages and over-the-air broadcasters.
QVC's digital platforms enable consumers to purchase goods offered on our televised programming, along with a wide assortment of products that are available only on U.S. websites. QVC.com, HSN.com and our other digital platforms (including our mobile applications, social pages and others) are natural extensions of our business model, allowing customers
to engage in our shopping experience wherever they are, with live or on-demand content customized to the device they are using. In addition to offering video content, our U.S. websites allow shoppers to browse, research, compare and perform targeted searches for products, read customer reviews, control the order-entry process and conveniently access their account.
Internationally, QVC's televised shopping programs, including live and recorded content, are distributed to households outside of the U.S., primarily in Germany, Austria, Japan, the U.K., the Republic of Ireland and Italy. In some of the countries where QVC operates, QVC's televised shopping programs are distributed across multiple QVC channels: QVC Style and QVC2 in Germany and QVC Beauty, QVC Extra and QVC Style in the U.K. Similar to the U.S., our international
businesses also engage customers via websites, mobile applications, and social pages. Our international business employs product sourcing teams who select products tailored to the interests of each local market.
The Company's Japanese operations ("QVC-Japan") are conducted through a joint venture with Mitsui & Co., LTD ("Mitsui"). QVC-Japan is owned 60% by the Company and 40% by Mitsui. The Company and Mitsui share in all profits and losses based on their respective ownership interests. During the six months
ended June 30, 2020 and 2019, QVC-Japan paid dividends to Mitsui of $30 million and $28 million, respectively.
The Company also has a joint venture with CNR Media Group, formerly known as China Broadcasting
Corporation, a limited liability company owned by China National Radio (''CNR''). The Company owns a 49% interest in a CNR subsidiary, CNR Home Shopping Co., Ltd. (''CNRS''). CNRS operates a retail business in China through a shopping television channel with an associated website. This joint venture is accounted for as an equity method investment recorded as equity in losses of investee in the condensed consolidated statements of operations.
The Company is an indirect wholly-owned subsidiary of Qurate Retail (Nasdaq: QRTEA and QRTEB), which owns interests in a broad range of digital commerce businesses, including Qurate Retail's other wholly-owned
subsidiaries Zulily, LLC ("Zulily") and Cornerstone Brands, Inc. ("CBI"), as well as other minority investments. QVC is part of the Qurate Retail Group, formerly QVC Group, a portfolio of brands including QVC, HSN, Inc. ("HSN"), Zulily and CBI.
During each of the six months ended June 30, 2020 and 2019, QVC and Zulily engaged in multiple transactions relating to sales, sourcing of merchandise, marketing initiatives and business advisory services. QVC allocated expenses of $4 million to Zulily for each of the six months ended June 30, 2020 and 2019. Zulily allocated expenses of $5 million and $4 million to QVC for the
six months ended June 30, 2020 and 2019, respectively.
During each of the six months ended June 30, 2020 and 2019, QVC and CBI engaged in multiple transactions relating to personnel and business advisory services. QVC allocated expenses of $11 million to CBI for each of the six months ended June 30, 2020 and 2019. CBI allocated expenses of $1 million to QVC for each of the six months ended June 30, 2020 and 2019. CBI also repaid a $29 million note receivable to QVC during the six months ended June
30, 2020.
Strategies and challenges of business units
The goal of QVC is to extend its leadership in video commerce, e-commerce, mobile commerce and social commerce by continuing to create the world’s most engaging shopping experiences, combining the best of retail, media, and social, highly differentiated from traditional brick-and-mortar stores or transactional e-commerce. QVC provides customers with curated collections of unique products, made personal and relevant by the power of storytelling. We curate experiences, conversations and communities for millions of highly discerning shoppers, and we also curate large audiences, across our many platforms, for our thousands of brand partners.
QVC intends to employ several strategies to achieve these objectives. Among these strategies are to (i) Curate special products at compelling
values; (ii) Extend video reach and relevance; (iii) Reimagine daily digital discovery; (iv) Expand and engage our passionate community; and (v) Deliver joyful customer service. In addition, we are exploring opportunities to evolve the International operating model to pursue growth opportunities in a more leveraged way across markets.
QVC's future net revenue growth will primarily depend on sales growth from e-commerce, mobile platforms, and applications via streaming video, additions of new customers from households already receiving QVC's televised programming and increased spending from existing customers. QVC's future net revenue may also be affected by (i) the willingness of cable television and direct-to-home satellite system operators to continue carrying QVC's programming service; (ii) QVC's ability to maintain favorable channel positioning, which may become more difficult due to governmental action
or from distributors converting analog customers to digital; (iii) changes in television viewing habits because of video-on-demand technologies and Internet video services; (iv) QVC's ability to source new and compelling products and (v) general economic conditions.
The current economic uncertainty in various regions of the world in which our subsidiaries and affiliates operate could adversely affect demand for our products and services since a substantial portion of our revenue is derived from discretionary spending by individuals, which typically declines during times of economic instability. Global financial markets have recently experienced disruptions, including increased volatility and diminished liquidity and credit availability. If economic and financial market conditions in the U.S. or other key markets, including
Japan and Europe, continues to be uncertain, our customers may respond by suspending, delaying or reducing their discretionary spending. A suspension, delay or reduction in discretionary spending could adversely affect revenue. Accordingly, our ability to increase or maintain revenue and earnings could be adversely affected to the extent that relevant economic environments decline. Such weak economic conditions may also inhibit our expansion into new European and other markets. We currently are unable to predict the extent of any of these potential adverse effects.
The
Brexit process and negotiations have created political and economic uncertainty, particularly in the U.K. and the E.U., and this uncertainty may last for years. On June 23, 2016, the U.K. held a referendum in which voters approved, on an advisory basis, an exit from the E.U. The U.K. formally left the E.U. on January 31, 2020. This has resulted in a transition period during which the E.U.-U.K. trade relationship will not change, and the U.K. will remain part of the E.U. Customs Union and Single Market, subject to all E.U. trade law. During the transition period, the E.U. and the U.K. will negotiate their new economic and security relationship, including a new agreement on trade. The transition will last until December 31, 2020, which can be extended for up to two years if the E.U. and the U.K. agree to do so. However, at
present, the U.K. government’s stated intention is not to seek or agree to an extension. A “no deal” outcome on trade remains a possibility if the E.U. and the U.K. fail to conclude a new trade agreement before December 31, 2020 and the transition period is not extended. In that case, with effect from January 1, 2021, the basis for E.U.-U.K. trade would automatically default to World Trade Organization terms. The potential impacts, if any, of the considerable uncertainty relating to Brexit or the resulting terms of the new economic and security relationship between the U.K. and the E.U. on the free movement of goods, services, people and capital between the U.K. and the E.U., customer behavior, economic conditions, interest rates, currency exchange rates, availability of capital or other matters are unclear. Our business could be affected with respect to these matters
during this period of uncertainty, and perhaps longer, depending on the resulting terms. In particular, our business could be negatively affected by new trade agreements between the U.K. and other countries, including the U.S., and by the possible imposition of trade or other regulatory barriers in the U.K. which could result in shipping delays and the shortage of products sold by our business. Additionally, the U.K. economy and consumer demand in the U.K., including for our products, could be negatively impacted. Further, various geopolitical forces related to Brexit may impact the global economy, the European economy and our business, including, for example, due to other E.U. member states where we have operations proposing referendums to, or electing to, exit the E.U. These possible negative impacts, and others resulting from the U.K.’s withdrawal from the E.U., may adversely affect our operating results.
The
President of the United States has expressed apprehension towards trade agreements, such as the Trans-Pacific Partnership, and suggested that the U.S. would renegotiate or withdraw from certain trade agreements. He has advocated for and imposed tariffs on certain goods imported into the U.S., particularly from China. In response to these new U.S. tariffs, some foreign governments, including China, have instituted or are considering instituting tariffs on certain U.S. goods. New tariffs and other changes in U.S. trade policy could trigger retaliatory actions by affected countries. Like many other multinational corporations, we do a significant amount of business that could be impacted by changes to U.S. and international trade policies (including governmental action related to tariffs and trade agreements). Such changes have the potential to adversely impact the U.S. economy or certain sectors thereof, our industry and the global demand for our products and, as a result,
could have a material adverse effect on our business, financial condition and results of operations.
On January 23, 2017, the President of the United States signed a presidential memorandum to withdraw the U.S. from the Trans-Pacific Partnership. On October 1, 2018, the U.S., Mexico and Canada agreed to the terms of the United States-Mexico-Canada Agreement (the "USMCA"), a successor to the North American Free Trade Agreement, which will impact imports and exports among those countries. The countries agreed to a revised version of the USMCA on December 10, 2019, which has been ratified by all countries as of March 2020. These and other proposed actions, if implemented, could adversely affect our business because we sell imported products.
In
December 2019, the COVID-19 pandemic was reported to have surfaced in Wuhan, China and has subsequently spread across the globe, including all of the countries in which QVC operates. As a result of the spread of the virus, certain local governmental agencies have imposed travel restrictions and imposed local quarantines or stay at home restrictions to contain the spread, which has caused a significant disruption to most sectors of the economy. In response to these stay at home restrictions, QVC has mandated that non-essential employees work from home and has reduced the number of employees who are allowed on its production set and has implemented increased cleaning protocols, social distancing measures and temperature screenings for those employees who enter into certain facilities. In some cases, the move to a work from home arrangement for our non-essential employees will be permanent, which may result in the reduction of office space. We have also mandated that all
essential employees who do not feel comfortable coming to work will not be required to do so. As a result of these resource constraints, QVC included fewer hours of live programming on some of its secondary channels and has experienced some delays in shipping at certain fulfillment centers. In certain markets, QVC temporarily increased the wages and salaries for those employees deemed essential who do not have the ability to work from home, including production and fulfillment center employees. The total increase in wages and salaries of approximately $8 million is primarily recorded in cost of goods sold. QVC has also paid a one-time work from home allowance to its employees totaling $4 million, which is primarily recorded in selling, general and administrative expenses. While the temporary increase in wages and salaries has
been terminated as of June 30, 2020, the inability to control the spread of COVID-19, or the expansion or extension of these stay at home restrictions could negatively impact our results in the future.
The stay at home restrictions imposed in response to COVID-19 required many traditional brick and mortar retailers to temporarily close their stores, but allowed distance retailers, including QVC, to continue operating. As a result, beginning at the end of March 2020 and continuing through the second quarter of 2020, we observed an increase in new
customers and an increase in demand for certain lower margin categories, such as home and electronics, and a decrease in demand for higher margin categories, such as apparel. We have continued to offer our installment payment option.
As a result, for the three and six months ended June 30, 2020, management has increased the amounts of certain estimated reserves including, but not limited to, uncollectible receivables in anticipation of higher defaults by customers billed through our installment payment option and inventory obsolescence due to decreased demand for certain categories, such as apparel.
In addition, there are several potential adverse impacts of COVID-19 that could cause a material negative impact to the
Company’s financial results, including its capital and liquidity, for the remainder of 2020 and beyond. These include governmental restrictions on QVC’s ability to continue to operate under stay at home restrictions and produce content; reduced demand for products we sell; decreases in the disposable income of existing and potential new customers; the impacts of any recession and other uncertainties with respect to the continuity of government stimulus programs implemented in response to COVID-19; increased currency volatility resulting in adverse currency rate fluctuations; higher unemployment; labor shortages; and an adverse impact to our supply chain and shipping disruptions for both the products we import and purchase domestically and the products we sell, including essential products experiencing higher demand, due to factory closures, labor shortages and other resource constraints. While the impact is currently uncertain, the inability to control the spread
of COVID-19 could cause any one of these adverse impacts, or combination of adverse impacts, to have a material impact on our financial results.
In July 2020, QVC implemented a planned workforce reduction with the goal of making the organizational structure streamlined and more efficient. As part of the workforce reduction, QVC has decided to eliminate live hours on QVC2 in the U.S. and other secondary channels within the various markets. As a result, QVC recorded $16 million of severance expense during the three months ended June 30, 2020, which is recorded in selling, general and administrative expense.
Cost
of goods sold (exclusive of depreciation and amortization shown separately below)
1,735
1,578
3,319
3,188
Operating
187
179
364
356
Selling,
general and administrative, excluding transaction related costs and stock-based compensation
294
256
570
517
Adjusted OIBDA (defined below)
507
501
897
954
Transaction
related costs
—
1
—
1
Stock-based compensation
10
11
16
20
Depreciation
43
54
86
100
Amortization
73
70
144
142
Operating
income
381
365
651
691
Other expense:
Equity in losses of investee
(1)
(1)
(2)
(1)
Losses
on financial instruments
—
(1)
(4)
(3)
Interest expense, net
(64)
(60)
(129)
(121)
Foreign
currency gain (loss)
1
—
2
(3)
(64)
(62)
(133)
(128)
Income
before income taxes
317
303
518
563
Income tax expense
(92)
(85)
(152)
(159)
Net
income
225
218
366
404
Less net income attributable to the noncontrolling interest
(14)
(12)
(26)
(22)
Net
income attributable to QVC, Inc. stockholder
$
211
206
340
382
Net revenue
Net revenue by segment was as follows:
Three
months ended June 30,
Six months ended June 30,
(in millions)
2020
2019
2020
2019
QxH
$
2,010
1,874
3,802
3,731
QVC-International
713
640
1,348
1,284
Consolidated
QVC
$
2,723
2,514
5,150
5,015
QVC's consolidated net revenue increased 8.3% and 2.7% for the three and six months ended June 30, 2020, respectively, as compared to the corresponding periods in the prior year. The three month increase in net revenue is primarily due to a 6.4% increase in units shipped, a $25 million decrease in estimated product returns, primarily driven by QxH and a slight increase in average selling price per unit ("ASP"),
which was partially offset by $6 million in unfavorable foreign exchange rates across all markets. The six months increase in net revenue is primarily due to a 1.7% increase in units shipped, a $59 million decrease in estimated product returns, primarily driven by QxH, which was partially offset by a slight decrease in ASP and $13 million in unfavorable foreign exchange rates across all markets.
During
the three and six months ended June 30, 2020 and 2019, the changes in revenue and expenses were affected by changes in the exchange rates for the U.K. Pound Sterling, the Euro and the Japanese Yen. In the event the U.S. Dollar strengthens against these foreign currencies in the future, QVC's revenue and operating cash flow will be negatively affected.
In discussing our operating results, the term currency exchange rates refers to the currency exchange rates we use to convert the operating results for all countries where the functional currency is not the U.S. Dollar. We calculate the effect of changes in currency exchange rates as the difference between current period activity translated using the prior period's currency exchange rates. Throughout our discussion, we refer to the results of this calculation as the impact of currency
exchange rate fluctuations. When we refer to constant currency operating results, this means operating results without the impact of the currency exchange rate fluctuations. The disclosure of constant currency amounts or results permits investors to understand better QVC’s underlying performance without the effects of currency exchange rate fluctuations.
The percentage change in net revenue for each of QVC's segments in U.S. Dollars and in constant currency was as follows:
QxH
net revenue increase for the three months ended June 30, 2020 was primarily due to a 4.5% increase in units shipped, a slight increase in ASP and a $29 million decrease in estimated product returns. For the six months ended June 30, 2020, QxH net revenue increased due to a 0.9% increase in units shipped and a $59 million decrease in estimated product returns partially offset by a slight decline in ASP. The decrease in estimated product returns for both comparable periods was primarily driven by a shift in product mix to lower return rate categories, partially offset by an increase in sales volume. For both the three and six months ended June 30, 2020, QxH experienced shipped sales growth in home, electronics and beauty with declines in all other categories.
QVC-International net
revenue growth in constant currency for the three months ended June 30, 2020 was primarily due to an 11% increase in units shipped, driven by increases in units shipped across all markets, while ASP remained flat. QVC-International net revenue growth in constant currency for the six months ended June 30, 2020 was primarily due to a 3.7% increase in units shipped, driven by increases in units shipped across all markets, and a 1.5% increase in ASP, driven by increases in ASP in Germany and the U.K., partially offset by ASP declines in Japan and Italy. For both the three and six months ended June 30, 2020, QVC-International experienced shipped sales growth in constant currency in home, beauty and electronics with declines in all other categories.
Cost of goods sold (excluding depreciation
and amortization)
QVC's cost of goods sold as a percentage of net revenue was 63.7% and 64.4% for the three and six months ended June 30, 2020, respectively, compared to 62.8% and 63.6% for the three and six months ended June 30, 2019, respectively. The increase in cost of goods sold as a percentage of revenue for both comparable periods is primarily due to a shift in product mix to the lower margin categories of home and electronics across all markets, and to a lesser extent, higher freight costs at QxH.
Operating expenses
QVC's operating expenses are principally comprised of commissions, order processing and customer service expenses, credit card processing fees and telecommunications expenses. Operating expenses increased
$8 million for both the three and six months ended June 30, 2020 as compared to the three and six months ended June 30, 2019. The increase for both comparable periods was primarily due to an increase in credit card fees at QxH as a result of increased sales during the periods and lower sales penetration of our U.S. Private Label Credit Cards, which do not charge credit card fees.
Selling,
general and administrative expenses (excluding transaction related costs and stock-based compensation)
QVC's selling, general, and administrative expenses (excluding transaction related costs as defined below and stock-based compensation) include personnel, information technology, provision for doubtful accounts, production costs, and marketing and advertising expenses. Such expenses increased $38 million and $53 million for the three and six months ended June 30, 2020, respectively, as compared to the three and six months ended June 30, 2019. As a percentage of net revenue, such expenses were 10.8% and 11.1% for the three and six months ended June 30, 2020, respectively, and were 10.2% and 10.3% for the three and six months ended June
30, 2019, respectively.
For the three months ended June 30, 2020, the increase was primarily due to a $27 million increase in personnel costs across all markets except Italy, a $14 million increase in marketing primarily at QxH, and a $4 million increase in estimated credit losses across all markets except Japan. The increases were partially offset by a $3 million decrease due to less travel expenses as a result of COVID-19 and a $2 million decrease in outside services primarily at QxH. For the six months ended June 30, 2020, the increase was primarily due to a $29 million increase in personnel costs across all markets, an $18 million increase in marketing primarily at QxH and a $12 million increase in estimated credit losses across all markets except Japan. The increases were partially offset by a $5 million decrease due
to less travel expenses as a result of COVID-19 across all markets. The increase related to personnel costs for both comparable periods was primarily related to increased severance, an increase to our estimated incentive pay and a work from home allowance as a result of COVID-19, which was partially offset by the closure of our operations in France in 2019. The increases related to estimated credit losses for both comparable periods were primarily due to a higher number of new customers and a shift in product mix into home and electronics, which have greater historical loss rates. In addition, there was an increase to our historical loss percentage as a result of additional risk due to COVID-19.
Stock-based compensation
Stock-based compensation includes compensation related to options and restricted stock units granted to certain officers and employees. QVC recorded $10 million and
$16 million of stock-based compensation expense for the three and six months ended June 30, 2020, respectively, and recorded $11 million and $20 million of stock-based compensation expense for the three and six months ended June 30, 2019, respectively. The decrease in stock compensation expense for the six months ended June 30, 2020 is primarily related to certain officers not reaching performance targets for restricted stock units.
Depreciation and amortization
Depreciation and amortization consisted of the following:
Three
months ended June 30,
Six months ended June 30,
(in millions)
2020
2019
2020
2019
Affiliate agreements
$
—
1
1
2
Customer
relationships
13
12
25
24
Other technology
3
4
7
8
Acquisition related
amortization
16
17
33
34
Property and equipment
43
54
86
100
Software
amortization
22
22
43
44
Channel placement amortization and related expenses
35
31
68
64
Total
depreciation and amortization
$
116
124
230
242
For the three and six months ended June 30, 2020, property and equipment depreciation decreased due to the disposition of assets in France in the second quarter of 2019.
Equity in losses of investee
The loss that was associated with our joint venture in China is accounted for as an equity method investment.
For the three and six months ended June 30, 2020, consolidated interest expense, net increased $4 million and $8 million, respectively, as compared to the corresponding periods in the prior year. The increases for both the three and six months ended June 30, 2020 are primarily related to refinancing our borrowings on our senior secured credit facility with newly issued senior secured notes, which have higher interest rates.
Foreign currency
gain (loss)
Certain loans between QVC and its subsidiaries are deemed to be short-term in nature, and accordingly, the translation of these loans is recorded in the condensed consolidated statements of operations. For the three and six months ended June 30, 2020, the change in foreign currency loss was also due to variances in interest and operating payables balances between QVC and its international subsidiaries denominated in the currency of the subsidiary and the effects of currency exchange rate changes on those balances.
Income taxes
Our effective tax rate was 29.0% and 29.3% for the three and six months ended
June 30, 2020, respectively, compared to an effective tax rate of 28.1% and 28.2% for the three and six months ended June 30, 2019, respectively. The 2020 rate differs from the U.S. federal income tax rate of 21% due primarily to state and foreign tax expenses, and valuation allowances established for excess U.S. foreign tax credits. The 2020 effective tax rate has increased from the prior year for the six months ended June 30, 2020 primarily due to increases in state and foreign tax expense and the valuation allowance on foreign tax credits in the current year.The 2020 effective tax rate has increased from the prior year for the three months ended June 30, 2020 primarily due to increases in state tax expense.
Adjusted
Operating Income before Depreciation and Amortization (Adjusted OIBDA)
To provide investors with additional information regarding our financial statements, we disclose Adjusted OIBDA, which is a non-GAAP measure. QVC defines Adjusted OIBDA as operating income plus depreciation and amortization, stock-based compensation, transaction related costs (if any) and impairment loss (if any). QVC's chief operating decision maker and management team use this measure of performance in conjunction with other measures to evaluate the businesses and make decisions about allocating resources among the businesses. QVC believes that this is an important indicator of the operational strength and performance of the segments by identifying those items that are not directly a reflection of each segment's performance or indicative of ongoing business trends. In addition, this measure allows QVC to view operating results, perform analytical comparisons
and perform benchmarking among its businesses and identify strategies to improve performance. Accordingly, Adjusted OIBDA should be considered in addition to, but not as a substitute for, operating income, net income, cash flow provided by operating activities and other measures of financial performance prepared in accordance with U.S generally accepted accounting principles ("U.S. GAAP").
The primary material limitations associated with the use of Adjusted OIBDA as compared to U.S. GAAP results are (i) it may not be comparable to similarly titled measures used by other companies in the industry, and (ii) it excludes financial information that some may consider important in evaluating QVC's performance. QVC compensates for these limitations by providing disclosure of the difference between Adjusted OIBDA and U.S. GAAP results, including providing a reconciliation of Adjusted OIBDA to U.S. GAAP results, to enable investors to perform
their own analysis of QVC's operating results. The following table provides a reconciliation of operating income to Adjusted OIBDA.
QVC
Adjusted OIBDA increased by $6 million for the three months ended June 30, 2020 compared to the three months ended June 30, 2019. The increase is comprised of a $13 million increase in QVC-International partially offset by a $7 million decrease in QxH. QVC-International was partially impacted due to the closure of operations in France in 2019. There were no Adjusted OIBDA losses related to France for the three months ended June 30, 2020 and Adjusted OIBDA losses were $2 million for the three months ended June 30, 2019.
QVC Adjusted OIBDA decreased by $57 million for the six months ended June 30, 2020 compared to the six months ended June
30, 2019. The decrease is comprised of a $66 million decrease in QxH partially offset by a $9 million increase in QVC-International, which was partially impacted due to the closure of operations in France in 2019. There were no Adjusted OIBDA losses related to France for the six months ended June 30, 2020 and Adjusted OIBDA losses were $6 million for the six months ended June 30, 2019.
Seasonality
QVC's business is seasonal due to a higher volume of sales in the fourth calendar quarter related to year-end holiday shopping. In recent years, QVC has earned, on average, between 22% and 23% of its revenue in each of the first three quarters of the year and 32% of its revenue in the fourth quarter of the year.
Financial Position, Liquidity
and Capital Resources
General
Historically, QVC's primary sources of cash have been cash provided by operating activities and borrowings. In general, QVC uses this cash to fund its operations, make capital purchases, make payments to Qurate Retail, make interest payments and minimize QVC's outstanding senior secured credit facility balance.
As of June 30, 2020, substantially all of QVC's cash and cash equivalents were invested in AAA rated money market funds and time deposits with banks rated equal to or above A.
Senior Secured Notes
All of QVC's senior secured notes are secured by the capital stock of QVC and certain of its subsidiaries
and have equal priority to the senior secured credit facility. With the exception of the 6.375% Senior Secured Notes due 2067 and the 6.25% Senior Secured Notes due 2068, for which interest is payable quarterly, the interest on QVC's senior secured notes is payable semi-annually.
4.75% Senior Secured Notes due 2027
On February 4, 2020, QVC completed a registered debt offering for $575 million of the 4.75% Senior Secured Notes due 2027 ("2027 Notes") at par. The proceeds were used to partially prepay existing indebtedness under QVC's senior secured credit facility. Interest on the 2027 Notes will be paid semi-annually in February and August, with payments commencing on August 15, 2020.
On December 31, 2018, QVC entered into the Fourth Amended and Restated Credit Agreement with Zulily as borrowers (collectively, the “Borrowers”) which is a multi-currency facility that provides for a $2.95 billion revolving credit facility with a $450 million sub-limit for standby letters of credit and $1.5 billion of uncommitted incremental revolving loan commitments or incremental term loans. The Fourth Amended and Restated Credit Agreement includes a $400 million tranche that may be borrowed by the
Company or Zulily with a $50 million sub-limit for standby letters of credit. The remaining $2.55 billion and any incremental loans may be borrowed only by the Company. Borrowings that are alternate base rate loans will bear interest at a per annum rate equal to the base rate plus a margin that varies between 0.25% and 0.75% depending on the Borrowers’ combined ratio of Consolidated Total Debt to Consolidated EBITDA for the most recent four fiscal quarter period (the “Combined Consolidated Leverage Ratio”). Borrowings that are London Interbank Offered Rate ("LIBOR") loans will bear interest at a per annum rate equal to the applicable LIBOR rate plus a margin that varies between 1.25% and 1.75% depending on the Borrowers’ Combined Consolidated Leverage Ratio. Each loan may be prepaid at any time and from time to time without penalty other than customary breakage costs.
No mandatory prepayments will be required other than when borrowings and letter of credit usage exceed availability; provided that, if Zulily ceases to be controlled by Qurate Retail, all of its loans must be repaid and its letters of credit cash collateralized. The facility matures on December 31, 2023. Payment of loans may be accelerated following certain customary events of default.
QVC had $2.93 billion available under the terms of the Fourth Amended and Restated Credit Agreement as of June 30, 2020, including the portion available under the $400 million tranche that Zulily may also borrow on.
The payment and performance of the Borrowers’ obligations under the Fourth Amended and Restated Credit Agreement are guaranteed by each of QVC’s Material Domestic Subsidiaries
(as defined in the Fourth Amended and Restated Credit Agreement). Further, the borrowings under the Fourth Amended and Restated Credit Agreement are secured, pari passu with QVC’s existing notes, by a pledge of all of QVC’s equity interests. The payment and performance of the Borrowers’ obligations with respect to the $400 million tranche available to both QVC and Zulily are also guaranteed by each of Zulily’s Material Domestic Subsidiaries (as defined in the Fourth Amended and Restated Credit Agreement), if any, and are secured by a pledge of all of Zulily’s equity interests.
The Fourth Amended and Restated Credit Agreement contains certain affirmative and negative covenants, including certain restrictions on the
Company and Zulily and each of their respective restricted subsidiaries (subject to certain exceptions) with respect to, among other things: incurring additional indebtedness; creating liens on property or assets; making certain loans or investments; selling or disposing of assets; paying certain dividends and other restricted payments; dissolving, consolidating or merging; entering into certain transactions with affiliates; entering into sale or leaseback transactions; restricting subsidiary distributions; and limiting the Company’s consolidated leverage ratio and the Borrowers’ Combined Consolidated Leverage Ratio.
Parent Issuer and Subsidiary Guarantor Summarized Financial Information
The following information
contains the summarized financial information for the combined parent (QVC, Inc.) and subsidiary guarantors (Affiliate Relations Holdings, Inc.; Affiliate Investment, Inc.; AMI 2, Inc.; ER Marks, Inc.; QVC Rocky Mount, Inc.; QVC San Antonio, LLC; QVC Global Holdings I, Inc.; QVC Global Holdings II, Inc.; QVC Deutschland GP, Inc.; HSN, Inc; HSNi, LLC; HSN Holding LLC; AST Sub, Inc.; Home Shopping Network En Espanol, L.P.; Home Shopping Network En Espanol, L.L.C; H.O.T. Networks Holdings (Delaware) LLC; HSN of Nevada LLC; Ingenious Designs LLC; NLG Merger Corp.; Ventana Television, Inc.; and Ventana Television Holdings, Inc.) pursuant to Rules 3-10, 13-01 and 13-02 of Regulation S-X.
This consolidated summarized financial information has been prepared from the Company's financial information on the same basis of accounting
as the Company's consolidated financial statements. Transactions between the parent and subsidiary guarantors presented on a combined basis have been eliminated. The principal elimination entries relate to investments in subsidiaries and intercompany balances and transactions, such as management fees, royalty revenue and expense, interest income and expense and gains on intercompany asset transfers. Goodwill and other intangible assets have been allocated to the subsidiaries based on management’s estimates. Certain costs have been partially allocated to all of the subsidiaries of the
Company.
The subsidiary guarantors are 100% owned by the Company. All guarantees are full and unconditional and are joint and several. There are no significant restrictions on the ability of the Company
to obtain funds from its U.S. subsidiaries, including the guarantors, by dividend or loan.
Summarized financial information for the year-to-date interim period and the most recent annual period was as follows:
Combined Parent-QVC, Inc. and Subsidiary Guarantors
QVC was in compliance with all of its debt covenants as of June 30,
2020.
There are no restrictions under the debt agreements on QVC's ability to pay dividends or make other restricted payments if QVC is not in default on its senior secured notes or the Fourth Amended and Restated Credit Agreement, and QVC's consolidated leverage ratio, and a Combined Consolidated Leverage Ratio for both QVC and Zulily, would be no greater than 3.5 to 1.0. As a result, Qurate Retail will, in many instances, be permitted to rely on QVC's cash flow for servicing Qurate Retail's debt and for other purposes, including repurchases of Qurate Retail's common stock, or to fund acquisitions or other operational requirements of Qurate Retail and its subsidiaries. These events may increase accumulated deficit or require QVC to borrow under the Fourth Amended and Restated Credit Agreement, increasing QVC's leverage and decreasing
liquidity. QVC has made significant distributions to Qurate Retail in the past. During the second quarter of 2020, QVC sent an $80 million dividend to Qurate Retail, which in turn sent a capital contribution of $80 million to Zulily in order to pay down Zulily's borrowings under the senior secured credit facility.
Interest Rate Swap Arrangements
During the year ended December 31, 2016, QVC entered into a three-year interest rate swap arrangement with a notional amount of $125 million to mitigate the interest rate risk associated with interest payments related to its variable rate debt. The swap arrangement did not qualify as a cash flow hedge under U.S. GAAP. The swap arrangement expired in June 2019. In July 2019, the Company entered into a three-year
interest swap arrangement with a notional amount of $125 million. The swap arrangement did not qualify as a cash flow hedge under U.S. GAAP and the fair value of the swap instrument was in a net liability position of $4 million as of June 30, 2020, which was included in other long-term liabilities.
On December 31, 2018, QVC entered into a thirteen month interest rate swap arrangement that effectively converted $250 million of its variable rate bank credit facility to a fixed rate of 1.05%, which expired in January of 2020.
Additional Cash Flow Information
During the six months ended June 30, 2020, QVC's primary uses of cash were $1,226 million of principal payments of the
senior secured credit facility and finance lease obligations, $262 million of dividends to Qurate Retail, $102 million of capital and television distribution rights expenditures and $30 million in dividend payments from QVC-Japan to Mitsui. These uses of cash were funded primarily with $1,179 million of cash provided by operating activities, $575 million of proceeds from issuance of senior secured notes and $112 million of principal borrowings from the senior secured credit facility. As of June 30, 2020, QVC's cash, cash equivalents and restricted cash balance was $803 million.
During the six months ended June 30, 2019, QVC's primary uses of cash were $1,425 million of principal payments on debt and finance lease obligations, $469 million of dividends to Qurate Retail, $400 million of principal repayments of our senior secured
notes, $277 million of capital and television distribution rights expenditures and $28 million in dividend payments from QVC-Japan to Mitsui. These uses of cash were funded primarily with $1,795 million of principal borrowings from the senior secured credit facility and $699 million of cash provided by operating activities. As of June 30, 2019, QVC's cash, cash equivalents balance and restricted cash was $458 million.
The change in cash provided by operating activities for the six months ended June 30, 2020 compared to the previous year was primarily due to changes in working capital. Working capital at any specific point in time is subject to many variables, including seasonality, inventory management, the timing of cash receipts and payments, vendor payment terms, which have been extended in 2020, and fluctuations in foreign
exchange rates.
As of June 30, 2020, $299 million of the $803 million in cash, cash equivalents and restricted cash was held by foreign subsidiaries. Cash in foreign subsidiaries is available for domestic purposes with no significant tax consequences upon repatriation to the U.S. QVC accrues taxes on the unremitted earnings of its international subsidiaries. Approximately 62% of this foreign cash balance was that of QVC-Japan. QVC owns 60% of QVC-Japan and shares all profits and losses with the 40% minority interest holder, Mitsui. We believe that we currently have appropriate legal structures in place
to repatriate foreign cash as tax efficiently as possible and meet the business needs of QVC.
Capital expenditures in 2020 are expected to be between $230 and $260 million, including $92 million already expended for the six months ended June 30, 2020. This range of annual spend includes
a planned reduction of capital spending as a result of COVID-19.
Refer to the chart under the "Off-balance Sheet Arrangements and Aggregate Contractual Obligations" section below for additional information concerning the amount and timing of expected future payments under QVC's contractual obligations as of June 30, 2020.
QVC has contingent liabilities related to legal and tax proceedings and other matters arising in the ordinary course of business. Although it is reasonably possible QVC may incur losses upon the conclusion of such matters, an estimate of any loss or range of loss cannot be made. In the opinion of management, it is expected that amounts, if any, that may be required to satisfy such contingencies will not be material in relation to the accompanying condensed consolidated financial statements.
Off-balance
Sheet Arrangements and Aggregate Contractual Obligations
Information concerning the amount and timing of required payments, both accrued and off-balance sheet, under our contractual obligations as of June 30, 2020 is summarized below:
(1) Amounts exclude Finance lease obligations and the issue discounts on the 4.375%, 4.45%, 4.85%, 5.45% and 5.95% Senior Secured Notes.
(2)
Amounts (i) are based on the terms of QVC's senior secured credit facility and senior secured notes, (ii) assumes the interest rates on the floating rate debt remain constant at the rates in effect as of June 30, 2020, (iii) assumes that our existing debt is repaid at maturity and (iv) excludes finance lease obligations.
Adoption of new accounting pronouncements
In August 2018, the Financial Accounting Standards Board issued ASU 2018-15, Intangibles- Goodwill and Other- Internal-Use Software (Subtopic 350-40), which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The
Company prospectively adopted this new standard as of January 1, 2020 and it did not have a material impact on its consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
QVC
is exposed to market risk in the normal course of business due to ongoing investing and financial activities and the conduct of operations by subsidiaries in different foreign countries. Market risk refers to the risk of loss arising from adverse changes in stock prices, interest rates and foreign currency exchange rates. The risk of loss can be assessed from the perspective of adverse changes in fair values, cash flows and future earnings. QVC has established procedures and internal processes governing the management of market risks and the use of financial instruments to manage exposure to such risks.
Interest rate risk
QVC is exposed to changes in interest rates primarily as a result of borrowing activities. Over the long-term, QVC manages the exposure to interest rates by maintaining what
QVC believes is an appropriate mix of fixed and variable rate debt.
The table below summarizes the Company’s debt obligations, related interest rates and fair value of debt at June 30, 2020:
(in
millions, except percentages)
Remainder of 2020
2021
2022
2023
2024
Thereafter
Total
Fair Value
Fixed rate debt (1) (2)
$
—
—
500
750
600
2,600
4,450
4,250
Weighted
average interest rate on fixed rate debt
—
%
—
%
5.1
%
4.4
%
4.9
%
5.4
%
5.1
%
N/A
Variable rate debt
$
—
—
—
—
—
—
—
—
Average
interest rate on variable rate debt
—
%
—
%
—
%
—
%
—
%
—
%
—
%
N/A
(1) Amounts exclude finance lease obligations and the issue discounts on the 4.375%, 4.45%, 4.85%, 5.45% and 5.95% Senior
Secured Notes.
(2) Amounts exclude impact related to interest rate swaps, which we have discussed further below.
N/A - Not applicable.
During the year ended December 31, 2016, QVC entered into a three-year interest rate swap arrangement with a notional amount of $125 million to mitigate the interest rate risk associated with interest payments related to its variable rate debt. The swap arrangement did not qualify as a cash flow hedge under U.S. GAAP. The swap arrangement expired in June 2019. In July 2019, the Company entered into a three-year interest swap arrangement with a notional amount of $125 million. The new swap arrangement did not qualify as a cash flow hedge under U.S. GAAP and the fair value of the
swap instrument was in a net liability position of approximately $4 million as of June 30, 2020, which was included in other long-term liabilities.
Foreign currency exchange rate risk
QVC is exposed to foreign exchange rate fluctuations related to the monetary assets and liabilities and the financial results of its foreign subsidiaries. Assets and liabilities of foreign subsidiaries for which the functional currency is the local currency are translated into U.S. Dollars at period-end exchange rates, and the statements of operations are translated at the average exchange rate for the period. Exchange rate fluctuations on translating
foreign currency financial statements into U.S. Dollars that result in unrealized gains or losses are referred to as translation adjustments. Cumulative translation adjustments are recorded in other comprehensive income as a separate component of stockholder's equity. Transactions denominated in currencies other than the functional currency are recorded based on exchange rates at the time such transactions arise. Subsequent changes in exchange rates result in transaction gains and losses, which are reflected in income as unrealized (based on period-end transactions) or realized upon settlement of the transactions. Cash flows from operations in foreign countries are translated at the average rate for the period. Accordingly, QVC may experience economic loss and a negative impact on earnings and equity with respect to its holdings solely as a result of foreign currency exchange rate fluctuations. QVC's reported Adjusted OIBDA for the three and six months ended June
30, 2020 would have been impacted by approximately $1 million and $2 million, respectively, for every 1% change in foreign currency exchange rates relative to the U.S. Dollar.
The Fourth Amended and Restated Credit Agreement provides QVC with the ability to borrow in multiple currencies. This allows QVC to somewhat mitigate foreign currency exchange rate risks. As of June 30, 2020, no borrowings in foreign currencies were outstanding.
In accordance with Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended, the Company carried out an evaluation, under the supervision and with the participation of management, including its chief executive officer and its principal accounting and financial officer (the "Executives"), of the effectiveness of its disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Executives concluded that the Company's disclosure controls and procedures were not effective as of June 30, 2020 because of the material weakness
in our internal control over financial reporting as discussed in more detail in our Annual Report on Form 10-K for the year ended December 31, 2019. Management has continued to monitor the implementation of the remediation plan described in our Annual Report on Form 10-K for the year ended December 31, 2019, as described below.
Changes in Internal Control Over Financial Reporting
During the second quarter of 2020, we continued to assess Information Technology system related risks and implement control improvements to alleviate the noted control deficiencies. Other than these items, there has been no change in the Company's internal control over financial reporting
that occurred during the three months ended June 30, 2020 that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting. We have not experienced any material impact to our internal controls over financial reporting despite the fact that most of our employees are working remotely due to the COVID-19 pandemic.
Remediation Plan for Material Weakness in Internal Control Over Financial Reporting
In response to the material weakness identified in Management’s Report on Internal Control Over Financial Reporting as set forth in Part II, Item 9A in our Annual Report on Form 10-K for the year ended December 31, 2019, the
Company developed a plan with oversight from the Audit Committee of the Board of Directors of Qurate Retail to remediate the material weakness. The remediation efforts include the following:
•Ensure user access is appropriately restricted to the IT systems in Germany that contributed to the material weakness
•Continue to assess the risks in and around IT systems that could impact internal controls over financial reporting
•Enhance design and/or operating effectiveness of control activities to address identified risks
The
Company has appropriately restricted access to the affected IT systems in Germany and has implemented annual and ongoing processes to assess and address risk in the IT environment. However, because the reliability of the internal control process requires repeatable execution, the successful on-going remediation of the material weakness will require on-going risk assessments and control improvements to mitigate risks identified. We expect to conclude the effective remediation of the material weakness prior to the end of 2020.
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.