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Assets (Details)
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Debt (Details)
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Financing Transactions (Details)
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Senior Debt (Details)
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Registrant's telephone number, including area code: (441) 296-1431
Indicate by check mark whether 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 each shorter period that the
registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes T No £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes T No £
Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer”, “large accelerated filer” or “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer £
Accelerated filer T
Non-accelerated filer £
Smaller reporting
company £
Emerging growth company £
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. £
Indicate by check mark whether the registrant is a shell company
(as defined by Rule 12b-2 of the Exchange Act) Yes £ No T
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in US$ 000’s, except share and per share data)
(Unaudited)
1. ORGANIZATION AND
BUSINESS
Central European Media Enterprises Ltd., a Bermuda company limited by shares, is a media and entertainment company operating in Central and Eastern Europe. Our assets are held through a series of Dutch and Curaçao holding companies. We manage our business on a geographical basis, with four operating segments; Bulgaria, the Czech Republic, Romania and the Slovak Republic, which are also our reportable segments and our main operating countries. See Note 19, "Segment Data" for financial information by segment. On July 9, 2017, we entered into a framework agreement with Slovenia Broadband S.à r.l., a wholly owned subsidiary of United Group B.V., relating to the sale of our Croatia and Slovenia operations. See Note 3, "Discontinued Operations and
Assets Held for Sale" for further information.
We are the market-leading broadcasters in each of our operating countries with a combined portfolio of 27 television channels. Each of our broadcast operations develops and produces content for their television channels. We generate advertising revenues in our country operations primarily through entering into agreements with advertisers, advertising agencies and sponsors to place advertising on the television channels that we operate. We generate additional revenues by collecting fees from cable and direct-to-home (“DTH”) and internet protocol television ("IPTV") operators for carriage of our channels. With the exception of our Bulgarian operations, we own 100% of our broadcast operating and license companies in each country.
Bulgaria
We
operate one general entertainment channel, BTV, and five other channels, BTV CINEMA, BTV COMEDY, RING, BTV ACTION and BTV LADY. We own 94.0% of CME Bulgaria B.V. ("CME Bulgaria"), the subsidiary that owns our Bulgaria operations.
Czech Republic
We operate one general entertainment channel, TV NOVA (Czech Republic), and seven other channels, NOVA CINEMA, NOVA SPORT 1, NOVA SPORT 2, NOVA ACTION, NOVA 2, NOVA GOLD and NOVA INTERNATIONAL, a general entertainment channel broadcasting in the Slovak Republic.
Romania
We operate one
general entertainment channel, PRO TV, and eight other channels, PRO 2 (formerly ACASA), PRO GOLD (formerly ACASA GOLD), PRO CINEMA, PRO X (formerly SPORT.RO), MTV ROMANIA, PRO TV INTERNATIONAL, PRO TV CHISINAU, a general entertainment channel broadcasting in Moldova, and ACASA IN MOLDOVA.
Slovak Republic
We operate one general entertainment channel, TV MARKIZA, and three other channels, DOMA (Slovak Republic), DAJTO, and MARKIZA INTERNATIONAL, a general entertainment channel broadcasting in the Czech Republic.
2. BASIS OF PRESENTATION
The terms the “Company”, “we”,
“us”, and “our” are used in this Form 10-Q to refer collectively to the parent company, Central European Media Enterprises Ltd. (“CME Ltd.”), and the subsidiaries through which we operate. Unless otherwise noted, all statistical and financial information presented in this report has been converted into U.S. dollars using period-end exchange rates. All references to “US$”, “USD” or “dollars” are to U.S. dollars; all references to “BGN” are to Bulgarian leva; all references to “CZK” are to Czech koruna; all references to “RON” are to the New Romanian lei; and all references to “Euro” or “EUR” are to the European Union Euro.
Interim Financial Statements
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the instructions to Quarterly Report on Form 10-Q and do not include all of the information and note disclosures required by generally accepted accounting principles in the United States of America (“US GAAP”). Amounts as of December 31, 2016 included in the unaudited condensed consolidated financial statements have been derived from audited consolidated financial statements as of that date. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission on February 9, 2017. Our significant
accounting policies have not changed since December 31, 2016, except as noted below.
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring items, necessary for their fair presentation in conformity with US GAAP for complete financial statements. The results of operations for interim periods are not necessarily indicative of the results to be expected for a full year.
Use of Estimates
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates and assumptions.
Discontinued Operations and Assets Held for Sale
We present our results of operations, financial position and cash flows of operations that have either been sold or that meet the criteria for "held-for-sale accounting" as discontinued operations if the disposal represents a strategic shift that will have a major effect on our operations and financial results. At the time an operation qualifies for held-for-sale accounting, the operation is evaluated to determine whether or not the carrying amount exceeds its fair value less cost to sell. Any loss as a result of carrying amounts in excess of fair value less cost to sell is recorded in the period the operation qualifies for held-for-sale accounting. Management judgment is
required to (1) assess the criteria required to qualify for held-for-sale accounting, and (2) estimate fair value. Our Croatia and Slovenia operations are classified as discontinued operations and assets held for sale for all periods presented. See Note 3, "Discontinued Operations and Assets Held for Sale".
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in US$ 000’s, except share and per share data)
(Unaudited)
Basis
of Consolidation
The unaudited condensed consolidated financial statements include the accounts of CME Ltd. and our subsidiaries, after the elimination of intercompany accounts and transactions. Entities in which we hold less than a majority voting interest but over which we have the ability to exercise significant influence are accounted for using the equity method. Other investments are accounted for using the cost method.
Seasonality
We experience seasonality, with advertising sales tending to be lowest during the third quarter of each calendar year due to the summer holiday period (typically July and August), and highest during the fourth quarter of each calendar year due to the holiday season.
Recent
Accounting Pronouncements
Accounting Pronouncements Adopted
On January 1, 2017 we adopted guidance issued by the Financial Accounting Standards Board (the “FASB”) which is intended to improve the accounting for the income tax consequences of intercompany transfers of assets other than inventory. The guidance requires an entity to recognize the income tax consequences of such transfers in the period in which the transfer occurs, rather than defer recognition of current and deferred income taxes for the transfer until the asset is sold to a third party. The early adoption of this guidance did not have a material impact on our condensed consolidated financial statements.
Recent Accounting Pronouncements Issued
In May 2014, the FASB issued
guidance which is intended to improve the comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets. The guidance supersedes existing revenue recognition guidance and requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance is effective for our fiscal year beginning January 1, 2018. We have substantially completed our evaluation of the contractual terms of our significant revenue streams in each of our operating segments. While we are still in the process of evaluating the impact of the adoption of this guidance on our condensed consolidated financial statements, we currently do not expect the impact of this new guidance to be material. We expect to adopt the standard in 2018 using
the modified retrospective transition method.
In February 2016, the FASB issued guidance to increase transparency and comparability among organizations by recognizing leasing assets and liabilities on the balance sheet and requiring additional disclosures about an entity's leasing arrangements. The guidance requires that a lessee recognize a liability to make lease payments and a right-of-use asset, with an available exception for leases shorter than twelve months. The guidance is effective for our fiscal year beginning January 1, 2019. We are currently in the process of evaluating the impact of the adoption of this guidance on our condensed consolidated financial statements.
In August 2016, the FASB issued guidance which is intended to reduce the existing diversity in practice related to specific cash flow issues. As applicable to
us, the guidance requires that cash flows at the settlement of zero-coupon debt instruments or debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing be bifurcated between cash outflows for operating activities for the portion attributable to accrued interest, and cash outflows for financing activities for the portion attributable to the principal. The guidance requires a retrospective transition method and is effective for our fiscal year beginning January 1, 2018, with early adoption permitted. We expect to adopt this guidance as of January 1, 2018. Upon adoption, our net cash flows generated from / used in continuing operating activities for the year ended December 31, 2016 will decrease by US$ 110.7
million with a corresponding increase in net cash used in / provided by continuing financing activities.
In January 2017, the FASB issued guidance which is intended to simplify goodwill impairment testing by eliminating Step 2, and instead recognize an impairment charge for the amount by which the carrying amount of the reporting unit exceeds the fair value of the reporting unit. The guidance also eliminates the requirement to perform a qualitative analysis for reporting units with a negative carrying value. The guidance is effective for annual and interim impairment tests after January 1, 2020, with early adoption permitted for interim and annual impairment tests performed from January 1, 2017. We expect to early adopt the guidance in the fourth quarter of 2017.
In
August 2017, the FASB issued guidance which is intended to simplify the application of hedge accounting and increase transparency of information about an entity's risk management activities. The guidance changes both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results in the financial statements. The guidance is effective for our fiscal year beginning January 1, 2019, with early adoption during interim periods permitted. All requirements and elections should be applied to hedging relationships existing on the date of adoption and reflected as of the beginning of the fiscal year of adoption. We are currently in the process of evaluating the impact of the adoption of this guidance on our condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in US$ 000’s, except share and per share data)
(Unaudited)
3. DISCONTINUED OPERATIONS AND ASSETS HELD FOR SALE
On July 9, 2017, we entered into a framework agreement with Slovenia Broadband S.à r.l. (the "Purchaser"), a wholly owned subsidiary of United Group B.V., relating to the sale of our Croatia and Slovenia operations for cash consideration of EUR 230.0 million (approximately US$ 271.5 million) (the "Divestment Transaction"), subject to customary working capital adjustments.
We expect the transaction to close by the end of 2017 or early 2018, subject to obtaining regulatory approvals and other customary closing conditions being satisfied. If the transaction is terminated by either party because the transaction has not closed prior to December 31, 2017 (which date may be extended under certain circumstances by the Purchaser to March 31, 2018), we would receive a termination fee of EUR 7.0 million (approximately US$ 8.3 million), subject to certain exceptions, including if the requisite regulatory approvals have not been obtained as a result of the Purchaser being required to make specified material divestitures as a condition to any requisite regulatory approvals or if a notification has not been declared complete by a relevant regulatory authority.
The
carrying amounts of the major classes of assets and liabilities of our discontinued operations that are classified as held for sale in the condensed consolidated balance sheets at September 30, 2017 and December 31, 2016 were:
For
the nine months ended September 30, 2017 and 2016, we paid US$ 9.6 million and US$ 24.5 million, respectively, of interest and Guarantee Fees (as defined below) associated with the 2018 Euro Term Loan (as defined below). These payments were allocated to Net cash provided by / (used in) discontinued operations - operating activities in our Condensed Consolidated Statements of Cash Flows as we are required to apply the expected proceeds from the sale of our Croatia and Slovenia operations towards the repayment of the remaining principal amounts owing in respect of the 2018 Euro Term Loan. (see Note 5,
"Long-term Debt and Other Financing Arrangements").
Broadcast
licenses consist of our TV NOVA license in the Czech Republic, which is amortized on a straight-line basis through the expiration date of the license in 2025. Our customer relationships are deemed to have an economic useful life of, and are amortized on a straight-line basis over, five years to fifteen years.
Total
long-term debt and other financing arrangements
1,069,578
1,002,636
Less: current maturities
(2,425
)
(1,228
)
Total non-current long-term debt and
other financing arrangements
$
1,067,153
$
1,001,408
Financing Transactions
Pursuant to an amendment in March 2017 to the Reimbursement Agreement (as defined below) with Time Warner Inc. ("Time Warner"), as guarantor of our obligations under the Euro Term Loans (as defined below), the grid pricing structure on the all-in rate that applied only to the 2021 Euro Term Loan (as defined below) was extended
to the 2018 Euro Term Loan (as defined below) and the 2019 Euro Term Loan (as defined below), with a reduction in the pricing under the grid for each of the Euro Term Loans resulting in an all-in rate ranging from 8.5% (if our net leverage is greater than or equal to seven times) to 5.0% (if our net leverage is less than five times). As at September 30, 2017, we reduced our net leverage ratio to below six times and anticipate a reduction of our all-in rate to 6.0% from the end of October 2017. In addition, we can achieve a further 50 basis point reduction in
the all-in rate if we reduce our long-term debt to less than EUR 815.0 million, subject to certain adjustments in respect of specified debt repayments, on or prior to September 30, 2018. We are required to pay the first 5.0% of the all-in rate (including the base rate and the rate paid pursuant to customary hedging arrangements) on the Euro Term Loans in cash and the remainder may be paid in cash or in kind, at our option. For details, see the table below under the heading "Reimbursement Agreement and Guarantee Fees".
On August 1, 2017, we elected to repay EUR 50.0 million (approximately US$ 59.1 million at August
1, 2017 rates) of the outstanding principal balance of the 2018 Euro Term Loan on which we recognized a loss on extinguishment of US$ 0.1 million.
We are required to apply the proceeds from the sale of our Croatia and Slovenia operations to the repayment of the remaining principal amounts owing in respect of the 2018 Euro Term Loan. Any excess amounts will then be applied to pay fees related to the 2019 Euro Term Loan, including Guarantee Fees and the Commitment Fee which we have previously paid in kind pursuant to the Reimbursement Agreement (see Note 3, "Discontinued Operations and Assets Held for Sale").
Overview
Total long-term debt and credit facilities comprised the following at September 30, 2017:
Principal
Amount of Liability Component
Debt Issuance
Costs (1)
Net Carrying Amount
2018 Euro Term Loan
$
237,064
$
(351
)
$
236,713
2019
Euro Term Loan
277,837
(411
)
277,426
2021 Euro Term Loan
553,465
(5,804
)
547,661
2021
Revolving Credit Facility
—
—
—
Total long-term debt and credit facilities
$
1,068,366
$
(6,566
)
$
1,061,800
(1)
Debt
issuance costs related to the 2018 Euro Term Loan, 2019 Euro Term Loan and 2021 Euro Term Loan (each as defined below and collectively, the “Euro Term Loans”) are being amortized on a straight-line basis, which approximates the effective interest method, over the life of the respective instruments. Debt issuance costs related to the 2021 Revolving Credit Facility are classified as non-current assets in our condensed consolidated balance sheet and are being amortized on a straight-line basis over the life of the 2021 Revolving Credit Facility.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in US$ 000’s, except share and per share data)
(Unaudited)
2018 Euro Term Loan
As at September 30, 2017, the principal amount of our floating rate senior unsecured term credit facility (as amended, the "2018 Euro Term Loan") outstanding was EUR 200.8 million (approximately US$ 237.1 million). On August 1, 2017, we elected to repay EUR 50.0 million (approximately US$ 59.1
million at August 1, 2017 rates) of the outstanding principal balance of that loan on which we recognized a loss on extinguishment of US$ 0.1 million.
The 2018 Euro Term Loan bears interest at three-month EURIBOR (fixed pursuant to customary hedging arrangements (see Note 12, "Financial Instruments and Fair Value Measurements") plus a margin of between 1.1% and 1.9% depending on the credit rating of Time Warner. The all-in borrowing rate including the Guarantee Fee ranges from 8.5% to 5.0% per annum based on our net leverage (see the table below under the heading "Reimbursement
Agreement and Guarantee Fees"). As at September 30, 2017, the all-in borrowing rate on amounts outstanding under the 2018 Euro Term Loan was 7.25%, the components of which are shown in the table below under the heading "Interest Rate Summary".
Interest on the 2018 Euro Term Loan is payable quarterly in arrears on each March 12, June 12, September 12 and December 12. The 2018 Euro Term Loan matures on November 1, 2018 and may currently be prepaid at our option, in whole or in part, without premium or penalty at any time. The 2018 Euro Term Loan is a senior unsecured obligation of CME Ltd., and is unconditionally guaranteed by our 100% owned subsidiary CME Media Enterprises B.V. ("CME
BV") and by Time Warner and certain of its subsidiaries.
The fair values of the 2018 Euro Term Loan as at September 30, 2017 and December 31, 2016 were determined based on comparable instruments that trade in active markets, plus an applicable spread. This measurement of estimated fair value uses Level 2 inputs as described in Note 12, "Financial Instruments and Fair Value Measurements". Certain derivative instruments, including contingent event of default and change of control put options, have been identified as being embedded in the 2018 Euro Term Loan. The embedded derivatives are considered
clearly and closely related to the 2018 Euro Term Loan, and as such are not required to be accounted for separately.
2019 Euro Term Loan
As at September 30, 2017, the principal amount of our floating rate senior unsecured term credit facility (the "2019 Euro Term Loan") outstanding was EUR 235.3 million (approximately US$ 277.8 million). The 2019 Euro Term Loan bears interest at three-month EURIBOR (fixed pursuant to customary hedging arrangements (see Note 12, "Financial Instruments and Fair Value Measurements")) plus a margin of between 1.1% and 1.9%
depending on the credit rating of Time Warner. The all-in borrowing rate including the Guarantee Fee ranges from 8.5% to 5.0% per annum based on our net leverage (see the table below under the heading "Reimbursement Agreement and Guarantee Fees"). As at September 30, 2017, the all-in borrowing rate on amounts outstanding under the 2019 Euro Term Loan was 7.25%, the components of which are shown in the table below under the heading "Interest Rate Summary".
Interest on the 2019 Euro Term Loan is payable quarterly in arrears on each February 13, May 13, August 13 and November 13. The 2019 Euro Term Loan matures on November 1, 2019 and
may currently be prepaid at our option, in whole or in part, without premium or penalty. The 2019 Euro Term Loan is a senior unsecured obligation of CME Ltd., and is unconditionally guaranteed by CME BV and by Time Warner and certain of its subsidiaries.
The fair values of the 2019 Euro Term Loan as at September 30, 2017 and December 31, 2016 were determined based on comparable instruments that trade in active markets, plus an applicable spread. This measurement of estimated fair value uses Level 2 inputs as described in Note 12, "Financial Instruments and Fair Value Measurements". Certain derivative
instruments, including contingent event of default and change of control put options, have been identified as being embedded in the 2019 Euro Term Loan. The embedded derivatives are considered clearly and closely related to the 2019 Euro Term Loan, and as such are not required to be accounted for separately.
2021 Euro Term Loan
As at September 30, 2017, the principal amount of our floating rate senior unsecured term credit facility (the "2021 Euro Term Loan") outstanding was EUR 468.8 million (approximately US$ 553.5 million). The 2021 Euro Term Loan bears interest at three-month EURIBOR (fixed pursuant to customary hedging arrangements (see Note 12, "Financial Instruments
and Fair Value Measurements")) plus a margin of between 1.1% and 1.9% depending on the credit rating of Time Warner. The all-in borrowing rate including the Guarantee Fee ranges from 8.5% to 5.0% per annum based on our net leverage (see the table below under the heading "Reimbursement Agreement and Guarantee Fees"). As at September 30, 2017, the all-in borrowing rate on amounts outstanding under the 2021 Euro Term Loan was 7.25%, the components of which are shown in the table below under the heading "Interest Rate Summary".
Interest on the 2021 Euro Term Loan is payable
quarterly in arrears on each January 7, April 7, July 7, and October 7. The 2021 Euro Term Loan matures on February 19, 2021 and may be prepaid at our option, in whole or in part, without premium or penalty, upon the earlier of the occurrence of certain events, including if our net leverage (as defined in the Reimbursement Agreement) decreases to below five times for two consecutive quarters, or at any time from February 19, 2020. The 2021 Euro Term Loan is a senior unsecured obligation of CME BV, and is unconditionally guaranteed by CME Ltd. and by Time Warner and certain of its subsidiaries.
The fair values of the 2021 Euro Term Loan as at September 30, 2017
and December 31, 2016 were determined based on comparable instruments that trade in active markets, plus an applicable spread. This measurement of estimated fair value uses Level 2 inputs as described in Note 12, "Financial Instruments and Fair Value Measurements". Certain derivative instruments, including contingent event of default and change of control put options, have been identified as being embedded in the 2021 Euro Term Loan. The embedded derivatives are considered clearly and closely related to the 2021 Euro Term Loan, and as such are not required to be accounted for separately.
Reimbursement Agreement and Guarantee Fees
In connection with Time Warner’s guarantees of the Euro Term Loans, we entered into a reimbursement agreement
(as amended, the “Reimbursement Agreement") with Time Warner. The Reimbursement Agreement provides for the payment of guarantee fees (collectively, the "Guarantee Fees") to Time Warner as consideration for those guarantees, and the reimbursement to Time Warner of any amounts paid by them under any guarantee or through any loan purchase right exercised by it. The loan purchase right allows Time Warner to purchase any amount outstanding under the Euro Term Loans from the lenders following an event of default under the Euro Term Loans or the Reimbursement Agreement. The Reimbursement Agreement is jointly and severally guaranteed by both our 100% owned subsidiary Central European Media Enterprises N.V. ("CME NV") and CME BV and is secured by a pledge over 100% of the outstanding shares of each of CME NV and CME BV. The covenants and events of default under the
Reimbursement Agreement are substantially the same as under the 2021 Revolving Credit Facility (described below).
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in US$ 000’s, except share and per share data)
(Unaudited)
We pay Guarantee Fees to Time Warner based on the amounts outstanding on the Euro Term Loans calculated on a per annum basis and on our consolidated net leverage
(as defined in the Reimbursement Agreement) as shown in the table below:
Consolidated Net Leverage
Cash Rate (1)
PIK Fee Rate
Total
Rate (2)
≥
7.0x
5.00
%
3.50
%
8.50
%
<
7.0x
-
6.0x
5.00
%
2.25
%
7.25
%
<
6.0x
-
5.0x
5.00
%
1.00
%
6.00
%
<
5.0x
5.00
%
—
%
5.00
%
(1)
Includes
cash paid for interest for the Euro Term Loans and the related customary hedging arrangements.
(2)
Subject to certain adjustments in respect of specified debt repayments, if we reduce our long-term debt to less than EUR 815.0 million prior to September 30, 2018, a 50 basis point reduction in the all-in rate would be applied.
Our consolidated net leverage as at September 30, 2017 and December 31, 2016
was 5.8x and 6.9x, respectively. For the three and nine months ended September 30, 2017 and 2016, we recognized US$ 11.8 million and US$ 36.3 million and US$ 16.5 million and US$ 37.7 million, respectively, of Guarantee Fees as interest expense in our condensed consolidated statements of operations and comprehensive income / loss.
The Guarantee Fees relating to the 2018 Euro Term Loan and the 2019 Euro Term Loan are payable
semi-annually in arrears on each May 1 and November 1, in cash or in kind, by adding such semi-annual Guarantee Fees to any such amount then outstanding. The Guarantee Fees relating to the 2021 Euro Term Loan are payable semi-annually in arrears on each June 1 and December 1. The first 5.0% of the all-in rate for each facility (including the base rate and the rate paid pursuant to the hedging arrangements) must be paid in cash and the remainder is payable at our election in cash or in kind.
The Guarantee Fees paid in kind are presented as a component of other non-current liabilities (see Note 11, "Other Liabilities") and bear interest per annum at their respective Guarantee Fee rate (as set forth in the table below). Guarantee Fees paid in cash are included in cash flows from operating activities in our condensed consolidated
statements of cash flows.
Interest Rate Summary
Base Rate
Rate Fixed Pursuant to Interest Rate Hedges
Guarantee
Fee Rate
All-in Borrowing Rate
2018 Euro Term Loan
1.50
%
0.21
%
(1)
5.54
%
7.25
%
2019
Euro Term Loan
1.50
%
0.31
%
5.44
%
7.25
%
2021 Euro Term Loan
1.50
%
0.28
%
5.47
%
7.25
%
2021
Revolving Credit Facility (2)
9.33
%
(3)
—
%
—
%
9.33
%
(1)
Effective
until November 1, 2017. From November 1, 2017 through maturity on November 1, 2018, the rate fixed pursuant to interest rate hedges will decrease to 0.14%, with a corresponding increase in the Guarantee Fee rate, such that the all-in borrowing rate following an improvement of our net leverage ratio will be 6.00% unless our net leverage ratio changes.
(2)
As at September 30, 2017, the 2021
Revolving Credit Facility was undrawn.
As at September 30, 2017, we had no balance outstanding under the US$ 115.0 million revolving credit facility (the “2021 Revolving Credit Facility”),
all of which was available to be drawn. The aggregate principal amount available decreases to US$ 50.0 million with effect from January 1, 2018 or, if earlier, upon the repayment of amounts owing in respect of the 2018 Euro Term Loan with the expected proceeds from the sale of our Croatia and Slovenia operations (see Note 3, "Discontinued Operations and Assets Held for Sale").
The 2021 Revolving Credit Facility bears interest at a rate per annum based on, at our option, an alternative base rate plus 7.0% or an amount equal to the greater of (i) an adjusted LIBOR and (ii) 1.0%, plus, in each case, 8.0%, with the first 5.0%
payable in cash and the remainder payable at our election in cash or in kind by adding such accrued interest to the applicable principal amount outstanding under the 2021 Revolving Credit Facility. The interest rate on the 2021 Revolving Credit Facility is determined on the basis of our net leverage ratio (as defined in the Reimbursement Agreement) and ranges from LIBOR (subject to a floor of 1.0%) plus 9.0% (if our net leverage is greater than or equal to seven times) to 7.0% per annum (if our net leverage ratio is less than five times). The maturity date of the 2021 Revolving Credit Facility is February 19, 2021. When drawn, the 2021 Revolving Credit Facility permits prepayment at our option
in whole or in part without penalty.
The 2021 Revolving Credit Facility is jointly and severally guaranteed by CME NV and CME BV and is secured by a pledge over 100% of the outstanding shares of each of CME NV and CME BV. The 2021 Revolving Credit Facility agreement contains limitations on our ability to incur indebtedness, incur guarantees, grant liens, pay dividends or make other distributions, enter into certain affiliate transactions, consolidate, merge or effect a corporate reconstruction, make certain investments, acquisitions and loans, and conduct certain asset sales. The agreement also contains maintenance covenants in respect of interest cover, cash flow cover and total leverage ratios, and has covenants in respect of incurring indebtedness, the provision of guarantees, making investments and disposals, granting security and certain events of defaults.
Total non-current credit facilities and capital leases
$
5,353
$
2,199
(1)
We
have a cash pooling arrangement with Bank Mendes Gans (“BMG”), a subsidiary of ING Bank N.V. (“ING”), which enables us to receive credit across the group in respect of cash balances deposited with BMG. Cash deposited by our subsidiaries with BMG is pledged as security against the drawings of other subsidiaries up to the amount deposited.
As at September 30, 2017, we had deposits of US$ 26.2 million in and no drawings on the BMG cash pool. Interest is earned on deposits at the relevant money market rate. As at December 31, 2016,
we had deposits of US$ 16.4 million in and no drawings on the BMG cash pool.
(2)
As at September 30, 2017 and December 31, 2016, there were no drawings outstanding under a CZK 575.0 million (approximately US$ 26.1 million) factoring framework agreement with Factoring České spořitelny,
a.s. Under this facility, up to CZK 575.0 million (approximately US$ 26.1 million) of receivables from certain customers in the Czech Republic may be factored on a recourse or non-recourse basis. The facility has a factoring fee of 0.19% of any factored receivable and bears interest at one-month PRIBOR plus 0.95% per annum for the period that receivables are factored and outstanding.
(3)
As at September 30, 2017 and December 31, 2016,
there were RON 67.8 million (approximately US$ 17.4 million) and RON 105.7 million (approximately US$ 24.6 million), respectively, of receivables factored under a factoring framework agreement with Global Funds IFN S.A. Under this facility, receivables from certain customers in Romania may be factored on a non-recourse basis. The facility has a factoring fee of 4.0% of any factored receivable and bears interest at 6.0% per annum from the date the receivables are factored to the due date of the factored receivable.
Total Group
At September 30, 2017,
the maturity of our long-term debt and credit facilities, excluding any future elections to pay interest in kind, was as follows:
2017
$
—
2018
237,064
2019
277,837
2020
—
2021
553,465
2022
and thereafter
—
Total long-term debt and credit facilities
1,068,366
Debt issuance costs
(6,566
)
Carrying amount of long-term debt and credit facilities
$
1,061,800
Capital
Lease Commitments
We lease certain of our office and broadcast facilities as well as machinery and equipment under various leasing arrangements. The future minimum lease payments, by year and in the aggregate, under capital leases with initial or remaining non-cancellable lease terms in excess of one year, consisted of the following at September 30, 2017:
Represents
the commitment fee (the "Commitment Fee") payable to Time Warner, including accrued interest, in respect of its obligation under a commitment letter dated November 14, 2014 between Time Warner and us whereby Time Warner agreed to provide or assist with arranging a loan facility to repay our 5.0% senior convertible notes at maturity in November 2015. The Commitment Fee is payable by November 1, 2019, the maturity date of the 2019 Euro Term Loan, or earlier if the repayment of the 2019 Euro Term Loan is accelerated. The Commitment Fee bears interest at 8.5% per annum and such interest is payable in arrears on each May 1 and November 1, and may be paid in cash or in kind, at our election.
12. FINANCIAL
INSTRUMENTS AND FAIR VALUE MEASUREMENTS
ASC 820, “Fair Value Measurements and Disclosure”, establishes a hierarchy that prioritizes the inputs to those valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are:
Basis of Fair Value Measurement
Level 1
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted instruments.
Level
2
Quoted prices in markets that are not considered to be active or financial instruments for which all significant inputs are observable, either directly or indirectly.
Level 3
Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
We evaluate the position of each financial instrument measured at fair value in the hierarchy individually based on the valuation methodology
we apply. The carrying amount of financial instruments, including cash and cash equivalents, accounts receivable, and accounts payable and accrued liabilities, approximate their fair value due to the short-term nature of these items. The fair value of our long-term debt is included in Note 5, "Long-term Debt and Other Financing Arrangements".
Hedging Activities
Cash Flow Hedges of Interest Rate Risk
We are party to interest rate swap agreements to mitigate our exposure to interest rate fluctuations on the outstanding principal amount of the Euro Term Loans. These interest rate swaps, designated as cash flow hedges, provide us with variable-rate cash receipts in exchange for fixed-rate payments over the lives of the agreements, with no exchange of the underlying notional amount. These
instruments are carried at fair value on our condensed consolidated balance sheets as other current and other non-current liabilities based on their maturity, and the effective portion of the changes in the fair value is recorded in accumulated other comprehensive income / loss and subsequently reclassified to interest expense when the hedged item affects earnings. The ineffective portion of changes in the fair value is recognized immediately in other non-operating income, net in our condensed consolidated statements of operations and comprehensive income / loss. For the three and nine months ended September 30, 2017 and 2016, we did not recognize any charges related to hedge ineffectiveness.
Interest rate hedge underlying
2018 Euro Term Loan
$
(52
)
We value the interest rate swap agreements using a valuation model which calculates the fair value on the basis of the net present value of the estimated future cash flows. The most significant input used in the valuation model is the expected EURIBOR-based yield curve. These instruments were allocated to Level 2 of the fair value hierarchy because the critical inputs to this model, including current interest rates, relevant yield curves and the known contractual terms of the instruments, were readily observable.
In August we settled in part the interest rate swaps underlying
the 2018 Euro Term Loan to align with the EUR 50.0 million reduction of the principal balance of that loan following the repayment on August 1, 2017 (see Note 5, "Long-term Debt and Other Financing Arrangements"). Changes in fair value for the settled portion of these interest rate swaps is recognized within other non-operating income, net in our condensed consolidated statements of operations and comprehensive income / loss.
The expected proceeds from the sale of the Croatia and Slovenia segments will be used to satisfy amounts owing in respect of the 2018 Euro Term Loan (see Note 5, "Long-term Debt and Other Financing Arrangements"). It is probable the sale will complete prior to the initial interest payment on the interest
rate swap maturing November 1, 2018 which precludes recognition of the effective portion of the changes in fair value within accumulated other comprehensive income / loss. All related fair value adjustments and those previously recognized in accumulated other comprehensive income / loss are recognized in other non-operating income, net in our condensed consolidated statements of operations and comprehensive income / loss (see Note 14, "Equity").
Foreign Currency Risk
We have entered into the below forward foreign exchange contracts to reduce our exposure to movements in foreign exchange rates related to contractual payments under certain dollar-denominated agreements. Information relating
to financial instruments as at September 30, 2017 is as follows:
These
forward foreign exchange contracts are considered economic hedges but were not designated as hedging instruments, so changes in the fair value of the derivatives were recorded in other non-operating income, net in the condensed consolidated statements of operations and comprehensive income / loss and in the condensed consolidated balance sheet in other current liabilities. We valued these contracts using an industry-standard pricing model which calculated the fair value on the basis of the net present value of the estimated future cash flows receivable or payable. These instruments were allocated to Level 2 of the fair value hierarchy because the critical inputs to this model, including foreign exchange forward rates and the known contractual terms of the instruments, were readily observable.
Fair
Value of Derivatives
The change in fair value of derivatives not recognized within accumulated other comprehensive income / loss comprised the following for the three and nine months ended September 30, 2017 and 2016:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in US$ 000’s, except share and per share data)
(Unaudited)
13. CONVERTIBLE REDEEMABLE PREFERRED SHARES
200,000 shares of our Series B Convertible Redeemable Preferred Stock, par value US$ 0.08 per share (the “Series B Preferred Shares”), were issued and outstanding as at September 30, 2017 and December 31, 2016. As at September 30, 2017
and December 31, 2016, the carrying value of the Series B Preferred Shares was US$ 262.1 million and US$ 254.9 million, respectively. The Series B Preferred Shares are held by Time Warner Media Holdings B.V. ("TW Investor"). As of September 30, 2017, the 200,000 Series B Preferred Shares were convertible into approximately 108.1 million shares of Class A common stock.
The initial stated value of the Series B Preferred Shares of US$ 1,000 per share accretes at an annual rate of 3.75%,
compounded quarterly, from June 25, 2016 to June 24, 2018. We have the right to pay cash to the holder in lieu of any further accretion. Each Series B Preferred Share may, at the holder's option, be converted into the number of shares of our Class A common stock determined by dividing (i) the accreted stated value plus accrued but unpaid dividends, if any, in each case as of the conversion date, by (ii) the conversion price, which was approximately US$ 2.42 at September 30, 2017, but is subject to adjustment from time to time pursuant to customary weighted-average anti-dilution provisions with respect to our issuances of equity or equity-linked securities at a price below the then-applicable conversion price (excluding any securities
issued under our benefit plans at or above fair market value). We have the right to redeem the Series B Preferred Shares in whole or in part upon 30 days' written notice. The redemption price of each outstanding Series B Preferred Share is equal to its accreted stated value plus accrued but unpaid dividends, if any, in each case as of the redemption date specified in the redemption notice. After receipt of a redemption notice, each holder of Series B Preferred Shares will have the right to convert, prior to the date of redemption, all or part of such Series B Preferred Shares to be redeemed by us into shares of our Class A common stock in accordance with the terms of conversion described above.
Holders of the Series B Preferred Shares have no voting rights on any matter presented to holders of any class of our capital stock, with the exception that they may vote with holders of
shares of our Class A common stock (i) with respect to a change of control event or (ii) as provided by our Bye-laws or applicable Bermuda law. Holders of Series B Preferred Shares will participate in any dividends declared or paid on our Class A common stock on an as-converted basis. The Series B Preferred Shares rank pari passu with our Series A Convertible Preferred Stock and senior to all other equity securities of the Company in respect of payment of dividends and distribution of assets upon liquidation. The Series B Preferred Shares have such other rights, powers and preferences as are set forth in the Certificate of Designation for the Series B Preferred Shares.
We concluded that the Series B Preferred Shares were not considered a liability and that the embedded conversion feature in the Series B Preferred Shares was clearly and closely
related to the host contract and therefore did not need to be bifurcated. The Series B Preferred Shares are required to be classified outside of permanent equity because such shares can be redeemed for cash in certain circumstances. The Series B Preferred Shares are carried on the balance sheet at redemption value. As the Series B Preferred Shares are redeemable, we have accreted changes in the redemption value since issuance. For the three and nine months ended September 30, 2017 and 2016, we recognized accretion on the Series B Preferred Shares of US$ 2.5 million and US$ 7.2
million; and US$ 2.4 million and US$ 11.3 million, respectively, with corresponding decreases in additional paid-in capital.
One share of Series A Convertible Preferred Stock (the "Series A Preferred Share") was issued and outstanding
as at September 30, 2017 and December 31, 2016. The Series A Preferred Share is convertible into 11,211,449 shares of Class A common stock on the date that is 61 days after the date on which the ownership of our outstanding shares of Class A common stock by a group that includes TW Investor and its affiliates would not be greater than 49.9%. The Series A Preferred Share is entitled to one vote per each share of Class A common stock into which it is convertible and has such other rights, powers and preferences, including potential adjustments to the number of shares of Class A common stock to be
issued upon conversion, as are set forth in the Certificate of Designation for the Series A Preferred Share.
200,000 shares of Series B Preferred Shares were issued and outstanding as at September 30, 2017 and December 31, 2016 (see Note 13, "Convertible Redeemable Preferred Shares"). As of September 30, 2017, the 200,000 Series B Preferred Shares were convertible into approximately 108.1 million shares of Class A common stock.
Class
A and Class B Common Stock
440,000,000 shares of Class A common stock and 15,000,000 shares of Class B common stock were authorized as at September 30, 2017 and December 31, 2016. The rights of the holders of Class A common stock and Class B common stock are identical except for voting rights. The shares of Class A common stock are entitled to one vote per share and the shares of Class B common stock are entitled to ten votes per share. Shares of Class B common stock are convertible into shares of Class A common stock on a one-for-one
basis for no additional consideration. Holders of each class of shares are entitled to receive dividends and upon liquidation or dissolution are entitled to receive all assets available for distribution to holders of our common stock. Under our Bye-laws, the holders of each class have no preemptive or other subscription rights and there are no redemption or sinking fund provisions with respect to such shares.
As at September 30, 2017, TW Investor owns 42.4% of the outstanding shares of Class A common stock and has a 46.5% voting interest in the Company due to its ownership of the Series A Preferred Share.
Warrants
On May 2, 2014, we issued 114,000,000
warrants in connection with a rights offering. Each warrant may be exercised until May 2, 2018 and entitles the holder thereof to receive one share of our Class A common stock at an exercise price of US$ 1.00 per share in cash. During the nine months ended September 30, 2017, 563,325 warrants were exercised resulting in net proceeds to us of approximately US$ 0.6 million. As at September 30, 2017, 106,439,720 warrants remained outstanding. Time Warner and TW
Investor collectively hold 100,926,996 of these warrants. The warrants are classified in additional paid-in capital, a component of equity, and are not subject to subsequent revaluation.
Accumulated Other Comprehensive Loss
The movement in accumulated other comprehensive loss during the nine months ended September 30, 2017 comprised the following:
Currency
translation adjustment, net
(Loss) / Gain on derivative instruments designated as hedging instruments
Represents
foreign exchange gains on intercompany loans that are of a long-term investment nature which are reported in the same manner as translation adjustments.
(2)
We will repay the 2018 Euro Term Loan with the expected proceeds from the sale of the Croatia and Slovenia segments (see Note 5, "Long-term Debt and Other Financing Arrangements"). It is probable the sale will complete prior to the initial interest payment on the interest rate swap maturing on November 1, 2018 which precludes recognition of the effective portion of the changes in fair value within accumulated other comprehensive income / loss. All related changes in
fair value and those previously recognized in accumulated other comprehensive income / loss are recognized in other non-operating income, net in our condensed consolidated statements of operations and comprehensive income / loss. See Note 12, "Financial Instruments and Fair Value Measurements".
15. INTEREST EXPENSE
Interest expense comprised the following for the three and nine months ended September 30, 2017 and 2016:
Interest
on long-term debt and other financing arrangements
$
16,850
$
21,000
$
50,491
$
70,236
Amortization
of capitalized debt issuance costs
1,502
1,424
4,282
7,459
Amortization of debt issuance discount
—
—
—
12,945
Total
interest expense
$
18,352
$
22,424
$
54,773
$
90,640
We
paid cash interest (including mandatory cash-pay Guarantee Fees) of US$ 22.2 million and US$ 38.3 million during the nine months ended September 30, 2017 and 2016, respectively. In addition, we paid US$ 1.4 million and US$ 5.5 million of Guarantee Fees in cash during the nine months ended September 30, 2017 and 2016,
respectively, for which we had the option to pay in kind. Interest expense related to the 2018 Euro Term Loan has been allocated to results from discontinued operations (see Note 3, "Discontinued Operations and Assets Held for Sale").
16. OTHER NON-OPERATING INCOME / EXPENSE
Other non-operating income / expense comprised the following for the three and nine months ended September 30, 2017 and 2016:
Under our 2015 Stock Incentive Plan (the "2015 Plan"), 6,000,000 shares of Class A common stock are authorized for grants of stock options, restricted stock units ("RSU"), restricted stock and stock appreciation rights to employees and non-employee directors. In addition, any shares available under our Amended and Restated Stock Incentive Plan (which expired on June 1, 2015), including in respect of any awards that expire, terminate or are forfeited, will be available for awards under the 2015 Plan. Under the 2015 Plan, awards are made to employees and directors at the discretion of the Compensation Committee. Any awards previously issued under the Amended and Restated Stock Incentive Plan will continue to be governed by the terms of that plan.
For the three
and nine months ended September 30, 2017 and 2016, we recognized charges for stock-based compensation of US$ 0.5 million and US$ 2.1 million; and US$ 0.7 million and US$ 2.5 million, respectively, presented as a component of selling, general and administrative expenses in our condensed consolidated statements of operations and comprehensive income / loss.
The charge for stock-based compensation in our condensed consolidated statement of operations and comprehensive income / loss was as follows:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in US$ 000’s, except share and per share data)
(Unaudited)
The fair value of stock options is estimated on the grant date using the Black-Scholes option-pricing model and recognized ratably over the requisite service period. The aggregate intrinsic value (the difference between the stock price on the last day of trading of the third quarter of September 30, 2017 and the exercise prices multiplied by the number of in-the-money options) represents the value that would have been received by the option holders had they exercised all in-the-money
options as at September 30, 2017. This amount changes based on the fair value of our Class A common stock. As at September 30, 2017, there was US$ 1.4 million of unrecognized compensation expense related to stock options which is expected to be recognized over a weighted-average period of 1.9 years.
Restricted Stock Units
Each RSU represents a right to receive one share of Class A common stock according to its vesting conditions. The majority of RSU issued have time-based vesting conditions and vest ratably over one
to four years from the date of grant. Vesting of RSU with performance-based vesting conditions ("PRSU") is contingent on the achievement of cumulative OIBDA and unlevered free cash flow targets over a multi-year period. Upon vesting, shares of Class A common stock are issued from authorized but unissued shares. Holders of RSU and PRSU awards are not entitled to receive cash dividend equivalents and are not entitled to vote. The grant date fair values of RSU and PRSU are calculated as the closing price of our Class A common stock on the date of grant.
The following table summarizes information about unvested RSU and PRSU as at September 30, 2017:
As at September 30, 2017, the intrinsic value of unvested RSUs was US$ 11.0 million. Total unrecognized compensation cost related to unvested RSUs as at September 30, 2017 was US$ 5.1
million and is expected to be recognized over a weighted-average period of 2.1 years.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in US$ 000’s, except share and per share data)
(Unaudited)
18. EARNINGS PER SHARE
We
determined that the Series B Preferred Shares are a participating security, and accordingly, our basic and diluted net income / loss per share is calculated using the two-class method. Under the two-class method, basic net income / loss per common share is computed by dividing the net income available to common shareholders after deducting contractual amounts of accretion on our Series B Preferred Shares by the weighted-average number of common shares outstanding during the period. Diluted net income / loss per share is computed by dividing the adjusted net income by the weighted-average number of dilutive shares outstanding during the period.
The components of basic and diluted earnings per share are as follows:
Less: preferred share accretion paid in kind (Note 13)
(2,454
)
(2,364
)
(7,216
)
(11,314
)
Less:
income allocated to Series B Preferred Shares
—
—
(4,334
)
—
(Loss) / income from continuing operations available to common shareholders, net of noncontrolling
interest
(4,211
)
(13,937
)
6,322
(196,722
)
Loss from discontinued operations, net of tax (Note 3)
(5,988
)
(8,054
)
(8,747
)
(15,971
)
Net
loss attributable to CME Ltd. available to common shareholders — basic
(10,199
)
(21,991
)
(2,425
)
(212,693
)
Effect
of dilutive securities
Dilutive effect of Series B Preferred Shares
—
—
—
—
Net
loss attributable to CME Ltd. available to common shareholders — diluted
$
(10,199
)
$
(21,991
)
$
(2,425
)
$
(212,693
)
Weighted
average outstanding shares of common stock — basic (1)
156,189
153,494
155,579
149,898
Dilutive
effect of common stock warrants, employee stock options and RSUs
—
—
78,182
—
Weighted average outstanding shares of common stock — diluted
156,189
153,494
233,761
149,898
Net
(loss) / income per share:
Continuing operations — basic
$
(0.03
)
$
(0.09
)
$
0.04
$
(1.31
)
Continuing
operations — diluted
(0.03
)
(0.09
)
0.03
(1.31
)
Discontinued operations — basic
(0.04
)
(0.05
)
(0.06
)
(0.11
)
Discontinued
operations — diluted
(0.04
)
(0.05
)
(0.06
)
(0.11
)
Net loss attributable to CME Ltd. — basic
(0.07
)
(0.14
)
(0.02
)
(1.42
)
Net
loss attributable to CME Ltd. — diluted
(0.07
)
(0.14
)
(0.02
)
(1.42
)
(1)
For
the purpose of computing basic earnings per share, the 11,211,449 shares of Class A common stock underlying the Series A Preferred Share are included in the weighted average outstanding shares of common stock - basic, because the holder of the Series A Preferred Share is entitled to receive any dividends payable when dividends are declared by the Board of Directors with respect to any shares of common stock.
The following weighted-average, equity awards and convertible shares were excluded from the calculation of diluted earnings per share because their effect would have been anti-dilutive for the periods presented:
These
instruments may become dilutive in the future. As set forth in the Certificate of Designation for the Series B Preferred Shares, the holders of our Series B Preferred Shares are not contractually obligated to share in our losses.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in US$ 000’s, except share and per share data)
(Unaudited)
19. SEGMENT
DATA
We manage our business on a geographical basis, with four operating segments: Bulgaria, the Czech Republic, Romania and the Slovak Republic, which are also our reportable segments and our main operating countries. These segments reflect how CME Ltd.’s operating performance is evaluated by our chief operating decision makers, who we have identified as our co-Chief Executive Officers; how operations are managed by segment managers; and the structure of our internal financial reporting.
Our segments generate revenues primarily from the sale of advertising and sponsorship on our channels. This is supplemented by revenues from cable and satellite television service providers that carry our channels on their platforms and from revenues through the sale of distribution rights to third parties. Intersegment revenues and profits have been
eliminated in consolidation.
We evaluate our consolidated results and the performance of our segments based on net revenues and OIBDA (as defined below). We believe OIBDA is useful to investors because it provides a meaningful representation of our performance as it excludes certain items that either do not impact our cash flows or the operating results of our operations. OIBDA is also used as a component in determining management bonuses.
OIBDA includes amortization and impairment of program rights and is calculated as operating income / loss before depreciation, amortization of intangible assets, impairments of assets and certain unusual or infrequent items that are not considered by our chief operating decision makers when evaluating our performance. Stock-based compensation and certain other items are not allocated to our segments for purposes of evaluating their performance
and therefore are not included in their respective OIBDA.
Below are tables showing our net revenues, OIBDA, total assets, capital expenditures and long-lived assets for our continuing operations by segment for the three and nine months ended September 30, 2017 and 2016 for condensed consolidated statements of operations and comprehensive income / loss data and condensed consolidated statements of cash flow data; and as at September 30, 2017 and December 31, 2016 for condensed consolidated balance sheet
data.
At September 30, 2017, we had total commitments of US$ 138.9 million (December 31, 2016:
US$ 128.2 million) in respect of future programming, including contracts signed with license periods starting after the balance sheet date. In addition, we have digital transmission obligations, future minimum operating lease payments for non-cancellable operating leases with remaining terms in excess of one year and other commitments as follows:
Programming
purchase
obligations
Other
commitments
Operating
leases
Capital
expenditures
2017
$
20,465
$
6,802
$
1,029
$
2,055
2018
41,150
10,334
2,953
32
2019
32,450
11,733
1,436
13
2020
26,094
1,410
687
—
2021
12,115
429
514
—
2022
and thereafter
6,612
474
1,971
—
Total
$
138,886
$
31,182
$
8,590
$
2,100
Contingencies
Litigation
We
are from time to time party to legal proceedings, arbitrations and regulatory proceedings arising in the normal course of our business operations, including the proceeding described below. We evaluate, on a quarterly basis, developments in such matters and provide accruals for such matters, as appropriate. In making such decisions, we consider the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of a loss. An unfavorable outcome in any such proceedings, if material, could have an adverse effect on our business or consolidated financial statements.
In the fourth quarter of 2016, our Slovak subsidiary MARKIZA-SLOVAKIA, spol. s.r.o. (“Markiza”) was notified of claims that were filed in June 2016 in a court of first instance in Bratislava, the Slovak Republic to collect amounts allegedly owing under four promissory notes. These
four promissory notes were purportedly issued in June 2000 by Pavol Rusko in his personal capacity and were purportedly guaranteed by Markiza under the signature of Mr. Rusko, who was an executive director of Markiza at that time as well as one of its shareholders. The notes purport to be issued in favor of Marian Kocner, a controversial Slovak businessman, and to a former associate of Mr. Kocner, and were supposedly assigned several times, ultimately to Sprava a inkaso zmeniek, s.r.o., a company owned by Mr. Kocner that is the plaintiff in these proceedings. Two of the notes allegedly matured in 2015 and the other two in 2016. The four notes purport to be in the aggregate amount of approximately EUR 69.0 million.
Despite a random case assignment system in the Slovak Republic, claims in
respect of three of the notes were initially assigned to the same judge. The judge who was assigned the claim in respect of the fourth promissory note (in the amount of approximately EUR 26.0 million) terminated proceedings in January 2017 because the plaintiff failed to pay court fees. The plaintiff refiled this claim in June 2017; the judge who was assigned the refiled claim terminated proceedings in September after the plaintiff again failed to pay court fees. In responses to the claims in respect of the other three promissory notes that were filed in August 2017, Mr. Rusko asserted that he signed the three notes in June 2000. We do not believe that the notes were signed in June 2000 or that any of the notes are authentic. We are vigorously defending the claims.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in US$ 000’s, except share and per share data)
(Unaudited)
21. RELATED PARTY TRANSACTIONS
We consider our related parties to be our officers, directors and shareholders who have direct control and/or influence over the Company as well as other parties that can significantly influence management. We have identified transactions with individuals or entities associated with Time Warner, which is represented on our Board of Directors and holds a 46.5% voting interest in CME Ltd. as at September 30, 2017,
as material related party transactions.
Amount
represents accrued Guarantee Fees for which we have not yet paid in cash or made an election to pay in kind. See Note 5, "Long-term Debt and Other Financing Arrangements".
(2)
Amount represents Guarantee Fees for which we have made an election to pay in kind and the Commitment Fee. See Note 5, "Long-term Debt and Other Financing Arrangements".
Item
2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following defined terms are used in this Quarterly Report on Form 10-Q:
•
"2017 PIK Notes" refers to our 15.0% senior secured notes due 2017, redeemed in April 2016;
•
"2017 Term Loan" refers to our 15.0% term loan facility due 2017, dated as of February 28, 2014,
as amended and restated on November 14, 2014, repaid in April 2016;
"2019
Euro Term Loan" refers to CME Ltd.'s floating rate senior unsecured term credit facility due 2019, guaranteed by CME BV and Time Warner, dated as of September 30, 2015 and amended on February 19, 2016 and June 22, 2017;
•
"2021 Euro Term Loan" refers to CME BV's floating rate senior unsecured term credit facility due 2021, guaranteed by Time Warner and CME Ltd., dated as of February 19, 2016 and amended on June 22, 2017;
"CME BV" refers to CME Media Enterprises B.V., our 100% owned subsidiary;
•
"CME
NV" refers to Central European Media Enterprises N.V., our 100% owned subsidiary;
•
"Divestment Transaction" refers to the framework agreement dated July 9, 2017 with Slovenia Broadband S.à r.l. for the sale of our Croatia and Slovenia operations (see Note 3, "Discontinued Operations and Assets Held for Sale" for further information);
•
"Euro
Term Loans" refers collectively to the 2018 Euro Term Loan, 2019 Euro Term Loan and 2021 Euro Term Loan;
•
"Guarantee Fees" refers to amounts accrued and payable to Time Warner as consideration for Time Warner's guarantees of the Euro Term Loans;
•
"Reimbursement Agreement" refers to an agreement with Time Warner which provides that we will reimburse Time Warner for any amounts paid by them under any guarantee
or through any loan purchase right exercised by Time Warner, dated as of November 14, 2014, amended and restated on February 19, 2016 and amended on March 2, 2017 and June 22, 2017;
•
"Time Warner" refers to Time Warner Inc.; and
•
"TW Investor"
refers to Time Warner Media Holdings B.V.
The exchange rates used in this report are as at September 30, 2017, unless otherwise indicated.
Please note that we may announce information using SEC filings, press releases, public conference calls, webcasts and posts to the "Investors" section of our website, www.cme.net. We intend to continue to use these channels to communicate important information about
CME Ltd. and our operations. We encourage investors, the media, our customers and others interested in the Company to review the information we post at www.cme.net.
I. Forward-looking Statements
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 22E of the Securities Exchange Act of 1934 (the "Exchange Act"), including those relating to our capital needs, business strategy, expectations and intentions. Statements that use the terms “believe”, “anticipate”, “trend”,
“expect”, “plan”, “estimate”, “forecast”, “should”,“intend” and similar expressions of a future or forward-looking nature identify forward-looking statements for purposes of the U.S. federal securities laws or otherwise. In particular, information appearing under the sections entitled "Business,""Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" includes forward looking-statements. For these statements and all other forward-looking statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are inherently subject to risks and uncertainties, many of which cannot be predicted with accuracy or are otherwise beyond our control and some of which might not even be anticipated. Forward-looking
statements reflect our current views with respect to future events and because our business is subject to such risks and uncertainties, actual results, our strategic plan, our financial position, results of operations and cash flows could differ materially from those described in or contemplated by the forward-looking statements contained in this report.
Important factors that contribute to such risks include, but are not limited to, those factors set forth under "Risk Factors” as well as the following: the expected timing of the closing of the sale of our operations in Croatia and Slovenia and the application of proceeds from it; changes in global or regional economic conditions and Eurozone instability in our markets; levels of television advertising spending and the rate of development of the advertising markets in the countries in which we operate; the extent to which our liquidity constraints and debt service obligations
restrict our business; our exposure to additional tax liabilities as well as liabilities resulting from regulatory or legal proceedings initiated against us; our ability to refinance our existing indebtedness; our success in continuing our initiatives to diversify and enhance our revenue streams; our ability to make cost-effective investments in our television businesses, including investments in programming; our ability to develop and acquire necessary programming and attract audiences; and changes in the political and regulatory environments where we operate and in the application of relevant laws and regulations. The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included in this report. All forward-looking statements speak only as of the date of this report. We undertake no obligation to publicly update or review any forward-looking statements, whether as a result
of new information, future developments or otherwise, except as required by law.
Central European Media Enterprises Ltd. ("CME Ltd.") is a media and entertainment company operating mainly in four countries in Central and Eastern Europe. We manage our business on a geographical basis, with four operating segments: Bulgaria, the Czech Republic, Romania, and the Slovak Republic, which are also our reportable segments. These operating segments reflect how CME Ltd.’s operating performance
is evaluated by our chief operating decision makers, who we have identified as our co-Chief Executive Officers, how our operations are managed by segment managers, and the structure of our internal financial reporting.
On July 9, 2017, we entered into a framework agreement with Slovenia Broadband S.à r.l., a wholly owned subsidiary of United Group B.V., relating to the sale of our Croatia and Slovenia operations. Accordingly, these operations are classified as held for sale and they are presented as discontinued operations for all periods in this report; and the discussion below relates to our continuing operations in the four remaining operating segments.
Non-GAAP Financial Measures
In this report we refer to several non-GAAP financial measures, including OIBDA, OIBDA margin, free cash
flow and unlevered free cash flow. We believe that each of these metrics is useful to investors for the reasons outlined below. Non-GAAP financial measures may not be comparable to similar measures reported by other companies. Non-GAAP financial measures should be evaluated in conjunction with, and are not a substitute for, US GAAP financial measures.
We evaluate our consolidated results and the performance of our segments based on net revenues and OIBDA. We believe OIBDA is useful to investors because it provides a meaningful representation of our performance, as it excludes certain items that do not impact either our cash flows or the operating results of our operations. OIBDA and unlevered free cash flow are also used as components in determining management bonuses.
OIBDA includes amortization and impairment of program rights and is calculated as operating income / loss before
depreciation, amortization of intangible assets and impairments of assets and certain unusual or infrequent items that are not considered by our co-Chief Executive Officers when evaluating our performance. Stock-based compensation and certain other items are not allocated to our segments for purposes of evaluating their performance and therefore are not included in their respective OIBDA. Our key performance measure of the efficiency of our consolidated operations and our segments is OIBDA margin. We define OIBDA margin as the ratio of OIBDA to net revenues.
Following a repricing of our Guarantee Fees completed in March 2017, the proportion of interest and related Guarantee Fees on our outstanding indebtedness that must be paid in cash has increased. In addition to this obligation to pay more interest and related Guarantee Fees in cash, we expect to use cash generated by the business to pay certain Guarantee Fees that are
payable in kind. These cash payments are all reflected in free cash flow; accordingly, we believe unlevered free cash flow, defined as free cash flow before cash payments for interest and Guarantee Fees, best illustrates the cash generated by our operations when comparing periods. We define free cash flow as net cash generated from continuing operating activities less purchases of property, plant and equipment, net of disposals of property, plant and equipment and excluding the cash impact of certain unusual or infrequent items that are not included in costs charged in arriving at OIBDA because they are not considered by our co-Chief Executive Officers when evaluating performance.
For additional information regarding our business segments, including a reconciliation of OIBDA to US GAAP financial measures, see Item 1, Note 19, "Segment Data". For a reconciliation of free
cash flow and unlevered free cash flow to a US GAAP financial measure, see "Free Cash Flow and Unlevered Free Cash Flow" below.
While our reporting currency is the dollar, our consolidated revenues and costs are divided across a range of European currencies and CME Ltd.’s functional currency is the Euro. Given the significant movement of the currencies in the markets in which we operate against the dollar, we believe that it is useful to provide percentage movements based on actual percentage movements (“% Act”), which includes the effect of foreign exchange, as well as like-for-like percentage movements (“% Lfl”). The like-for-like percentage movement references reflect the impact of applying the current period average exchange rates to the prior period revenues and costs. Since the difference between like-for-like and actual percentage movements is solely the impact of movements in foreign exchange rates,
our discussion in the following analysis is focused on constant currency percentage movements in order to highlight those factors influencing operational performance. The incremental impact of foreign exchange rates is presented in the tables preceding such analysis. Unless otherwise stated, all percentage increases or decreases in the following analysis refer to year-on-year percentage changes between the three and nine months ended September 30, 2017 and 2016.
Executive Summary
The following table provides a summary of our consolidated results of our continuing operations for the three and nine months
ended September 30, 2017 and 2016:
For
the Three Months Ended September 30, (US$ 000's)
For the Nine Months Ended September 30, (US$ 000's)
Movement
Movement
2017
2016
%
Act
% Lfl
2017
2016
% Act
%
Lfl
Net revenues
$
119,431
$
107,527
11.1
%
4.8
%
$
378,058
$
356,147
6.2
%
6.0
%
Operating
income
16,022
11,450
39.9
%
34.8
%
72,199
60,071
20.2
%
21.4
%
Operating
margin
13.4
%
10.6
%
2.8 p.p.
3.0 p.p.
19.1
%
16.9
%
2.2
p.p.
2.4 p.p.
OIBDA
$
25,145
$
19,324
30.1
%
23.6
%
$
97,893
$
83,452
17.3
%
17.8
%
OIBDA
margin
21.1
%
18.0
%
3.1 p.p.
3.2 p.p.
25.9
%
23.4
%
2.5
p.p.
2.6 p.p.
Our consolidated net revenues increased in the three and nine months ended September 30, 2017 compared to the corresponding periods in 2016 due to growth in both television advertising revenues and carriage fees and subscription revenues. Television advertising spending in the markets of the countries in which we operate grew an estimated 6% overall at constant rates in the first nine months
of 2017 compared to 2016. Our television advertising revenues grew 5% at actual rates and 4% at constant rates during the same period due primarily to significant year-on-year growth in Romania, as well as higher levels of spending in Bulgaria and the Czech Republic. Carriage fees and subscription revenues increased 16% at actual and constant rates in the nine months ended September 30, 2017 compared to the corresponding period in 2016 primarily due to additional carriage fees from contracts with cable, satellite and internet protocol television ("IPTV") operators in the Slovak Republic since January
of this year.
Costs charged in arriving at OIBDA increased 7% and 3% at actual rates in the three and nine months ended September 30, 2017 compared to the corresponding periods in 2016. At constant rates, costs were broadly flat in the third quarter, and increased 2% in the first nine months of 2017 compared to 2016. Content costs increased 2%
and 5% at constant rates in the third quarter and first nine months of 2017, respectively, as we made targeted investments in our programming line-up to monetize additional ratings in Romania when available, to improve our competitive positioning in Bulgaria and the Czech Republic, and to support the change in the way our channels are distributed in the Slovak Republic. Other operating costs decreased in the third quarter and first nine months of 2017 due to savings from transmission costs, which offset higher bad debt charges.
Since the growth in revenue outpaced the increase in costs, our OIBDA margin increased in the three and nine months ended September 30, 2017. This dynamic also drove an increase in operating income, with a similar improvement
in operating margin. We expect revenues to grow at a faster pace than costs in 2017 and for the next few years, leading to continued OIBDA margin expansion year on year although trends may vary from quarter to quarter.
The improvement in our operations during the twelve month period ended September 30, 2017 reduced our net leverage ratio to 5.8x at the end of the quarter, which will result in our cost of borrowing decreasing by 125 basis points to 6.0% from the end of October 2017.
We rolled-out the fall season in the third quarter, and its results contributed to our prime time and all day audience shares increasing in three out of four countries during the first nine months of 2017 compared to the same period in 2016. We continue to leverage popular content we produce for our prime time
schedules, and supplement that with both foreign and locally acquired content to ensure we continue to attract the largest audience in each of our countries in the most profitable manner.
Divestment Transaction to Accelerate Deleveraging
On July 9, 2017, we agreed to sell our operations in Croatia and Slovenia to Slovenia Broadband S.à r.l., a subsidiary of United Group B.V. (“United Group”), subject to obtaining regulatory approvals and other customary closing conditions. The transaction is expected to close by the end of 2017 or early 2018.
Total cash consideration for the transaction is EUR 230.0 million (approximately US$ 271.5 million), subject to customary working capital adjustments. Upon closing, the proceeds will be used to repay
the remaining balance of the 2018 Euro Term Loan in full, with any excess proceeds applied to repay the Commitment Fee and a portion of the 2019 Euro Term Loan and related Guarantee Fees, which will result in a significant decrease in our indebtedness and in our net leverage ratio. Based on our results for the period ended September 30, 2017, this would reduce CME’s net leverage ratio from 5.8x to 4.8x.
Once debt is repaid following closing of the transaction, our current average borrowing cost is expected to decrease from 6.0% to 4.5%. We estimate the annual savings from interest and Guarantee Fees resulting from the transaction will exceed both income and cash generated by the combined operations of Croatia and Slovenia in 2016. The net assets of these businesses, which are presented as held for sale on the Condensed Consolidated
Balance Sheet, were approximately US$ 102.9 million as at September 30, 2017.
Free Cash Flow and Unlevered Free Cash Flow
For the Nine Months Ended September 30, (US$ 000's)
2017
2016
Movement
Net
cash generated from continuing operating activities
$
90,638
$
56,972
59.1
%
Capital expenditures, net
(16,250
)
(14,762
)
(10.1
)%
Free
cash flow
74,388
42,210
76.2
%
Cash paid for interest (including mandatory cash-pay Guarantee Fees)
22,206
38,317
(42.0
)%
Cash
paid for Guarantee Fees that may be paid in kind
Our
unlevered free cash flow increased during the first nine months of 2017 compared to the same period in 2016 reflecting higher cash collections from revenue growth, which was partially offset by higher cash spending on programming as well as higher cash paid for income taxes and capital expenditures. Free cash flow increased significantly more than unlevered free cash flow due to a significant decrease in cash paid for interest and Guarantee Fees because last year we paid accrued interest related to the 2017 PIK Notes and 2017 Term Loan when they were refinanced in April 2016, and we also repaid accrued Guarantee Fees previously paid in kind in the first nine months of 2016.
In August 2017 we repaid EUR 50.0 million (approximately US$ 59.1 million at August 1, 2017 rates) of the principal
outstanding on the 2018 Euro Term Loan.
Following the repricing of our Guarantee Fees completed in March 2017, we are now required to pay a portion of the Guarantee Fees related to all of the Euro Term Loans in cash. However, the total amount of cash paid for interest and Guarantee Fees is expected to decrease significantly in 2017 due to the lower all-in rate payable following that transaction, the lower principal balance following the August repayment of debt and additional non-repeating payments that were made in 2016 when we elected to repay in cash a portion of the accrued Guarantee Fees related to the 2018 Euro Term Loan that were previously paid in kind. As a result, we expect free cash flow to increase significantly in 2017 compared to 2016.
The following table sets out our estimates of the year-on-year changes in real GDP, real private consumption and the television advertising market, net of discounts, in our countries for the nine months ended September 30, 2017:
Sources: Real GDP Growth and Real Private Consumption Growth, CME Ltd. estimates based on market consensus; TV Ad Market Growth, CME Ltd. estimates at constant exchange rates.
After adjusting for inflation, we estimate that during the first nine months of 2017, GDP grew in each of the countries in which we operate at a rate that exceeded the average growth rate for Western Europe. Romania continued to be one of the fastest growing economies in the European Union, and is forecast to be the leader for the remainder of 2017. Similar to the last few years, it has been reported that GDP growth in our markets has been less reliant on growth in exports, and domestic demand has played a larger role in economic expansion. In Romania, increases to the minimum wage have provided support for higher disposable income. Consumer confidence remains strong in the Czech and
Slovak Republics, reflecting historically low rates of unemployment in those countries. We believe the growth in real private consumption forecast for 2017 will support overall growth in the television advertising markets across the four countries where we continue to operate.
On March 29, 2017, the United Kingdom formally initiated the process to leave the European Union, commonly referred to as “Brexit”, triggering a two-year period to finalize the terms of that separation. While the negotiations over the exact terms of Brexit may negatively impact economic growth in the UK and Europe, the contribution of domestic demand as a component of GDP growth has reduced the sensitivity of our markets to external shocks affecting exports. Additionally, we have not seen an appreciable impact on the behavior of advertisers in the countries in which we operate since the UK electorate
voted in favor of Brexit in June 2016.
On April 6, 2017, the Czech National Bank determined that the recent increase in inflation in the country was sustainable and its mandate for price stability had been met. As a result, it ended its commitment to intervene in currency markets and withdrew the floor related to the EUR/CZK exchange rate. Following the announcement, the Czech Koruna has since strengthened more than 10% against the dollar, also reflecting some appreciation of the Euro versus the dollar. If the currency continues to appreciate, this will improve the results of our largest operation in dollar terms.
We estimate that the TV advertising markets in the countries in which we operate increased by 6% on average at constant rates in
the nine months ended September 30, 2017 compared to the same period in 2016. In Bulgaria, we estimate that all broadcasters increased their average prices, which more than offset selling fewer gross ratings points ("GRPs"). In the Czech Republic, market growth was driven primarily by higher average prices. In Romania, the market grew because the increase in demand for advertising that started in 2016 also led to significant increases in average prices in the first nine months of 2017 compared to the same period in 2016. In the second and third quarters of 2016, our main channel aired the European football championship, which increased inventory available and sold last year. If the benefit of the tournament last year was excluded, we estimate the market grew 15% in the first
nine months of 2017. In the Slovak Republic, the market grew due to higher average prices while inventory sold in the year-to-date period was flat compared to last year following the end of spending on informational and political campaigns that took place during the first half of 2016. If this spending in the first half of 2016 is excluded, we estimate the market grew 11% in the year-to-date period, reflecting continued strong demand by the private sector.
The television advertising market in Bulgaria increased an estimated 5% at constant rates in the nine months ended September 30, 2017 compared to the same period in 2016.
Our television advertising revenues increased at constant rates in the third quarter and first nine months of 2017 compared to the same periods in 2016 due to higher prices
in our sales policy for the year, which were particularly strong year-on-year in the third quarter. Carriage fees and subscription revenues decreased slightly at constant rates during the third quarter, but increased year to-date due to continued efforts to secure new contracts with cable, satellite and IPTV operators with improved pricing.
On a constant currency basis, costs charged in arriving at OIBDA increased in the third quarter and first nine months of 2017 compared to the same periods of 2016 due primarily to increases in content costs, resulting primarily from higher quality productions in certain time slots compared to the schedule in the prior year, as well as higher bad debt charges.
Czech Republic
Three
Months Ended September 30, (US$ 000's)
Nine Months Ended September 30, (US$ 000's)
Movement
Movement
2017
2016
%
Act
% Lfl
2017
2016
% Act
%
Lfl
Television advertising
$
37,792
$
34,518
9.5
%
0.0
%
$
121,453
$
115,981
4.7
%
2.8
%
Carriage
fees and subscriptions
3,269
2,612
25.2
%
14.6
%
8,790
7,743
13.5
%
11.2
%
Other
1,620
1,901
(14.8
)%
(22.3
)%
5,283
4,834
9.3
%
6.1
%
Net
revenues
42,681
39,031
9.4
%
(0.1
)%
135,526
128,558
5.4
%
3.5
%
Costs
charged in arriving at OIBDA
30,063
25,851
16.3
%
6.4
%
86,396
82,205
5.1
%
3.4
%
OIBDA
$
12,618
$
13,180
(4.3
)%
(12.8
)%
$
49,130
$
46,353
6.0
%
3.7
%
OIBDA
margin
29.6
%
33.8
%
(4.2) p.p.
(4.3) p.p.
36.3
%
36.1
%
0.2
p.p.
0.1 p.p.
The television advertising market in the Czech Republic increased an estimated 4% at constant rates in the nine months ended September 30, 2017 compared to the same period in 2016.
Television advertising revenues increased at constant rates in the first nine months of 2017 compared to the same period in 2016 due to higher average prices. Third
quarter revenues were flat at constant rates, as higher average prices were offset by selling fewer GRPs during the period. Carriage fees and subscription revenues increased on a constant currency basis in the third quarter and first nine months of 2017 due primarily to contracts for Nova International that became effective late in 2016.
Costs charged in arriving at OIBDA increased on a constant currency basis in the third quarter and first nine months of 2017 compared to the same periods in 2016 due to an increase in content costs from higher quality productions this year compared to the schedule in 2016, an earlier start to certain key shows, and increased costs for sport rights and news, which was partially offset by lower transmission costs.
The television advertising market in Romania increased an estimated 12% at constant rates in the nine months ended September 30, 2017 compared to the same period in 2016.
Our television advertising revenues increased at constant rates in the third quarter of 2017 compared to the same period last year due to higher prices, and the year-to-date
period in 2017 also benefited from selling more GRPs. The market continues to be largely sold-out in 2017 and we have increased our all-day audience share compared to 2016, and consequently our inventory available to sell. In addition, in the second and third quarters of 2016 our main channel aired the European football championship, which significantly increased the volume of inventory available and sold last year. If the benefit of the tournament last year was excluded, we estimate our television advertising revenues increased approximately 16% in the year-to-date period. Carriage fees and subscription revenues grew on a constant currency basis during the third quarter and first nine months of 2017 due to an increase in the number of reported subscribers.
Costs charged in arriving at OIBDA increased at constant rates during the first nine months of 2017 primarily due to a increase in content costs, as we invested more in
local productions of entertainment formats and aired more popular foreign programming to increase ratings. In the third quarter of 2017, these costs were mostly offset by savings from the European football championship that was broadcast in 2016.
Slovak Republic
Three
Months Ended September 30, (US$ 000's)
Nine Months Ended September 30, (US$ 000's)
Movement
Movement
2017
2016
%
Act
% Lfl
2017
2016
% Act
%
Lfl
Television advertising
$
17,354
$
16,809
3.2
%
(2.0
)%
$
54,701
$
55,900
(2.1
)%
(2.0
)%
Carriage
fees and subscriptions
2,095
400
NM(1)
NM(1)
5,649
1,276
NM(1)
NM(1)
Other
935
655
42.7
%
30.6
%
2,998
2,290
30.9
%
27.0
%
Net
revenues
20,384
17,864
14.1
%
8.1
%
63,348
59,466
6.5
%
6.6
%
Costs
charged in arriving at OIBDA
17,440
18,247
(4.4
)%
(9.4
)%
52,009
54,298
(4.2
)%
(4.4
)%
OIBDA
$
2,944
$
(383
)
NM(1)
NM(1)
$
11,339
$
5,168
119.4
%
125.7
%
OIBDA
margin
14.4
%
(2.1
)%
16.5 p.p.
16.5 p.p.
17.9
%
8.7
%
9.2
p.p.
9.4 p.p.
(1) Number is not meaningful.
The television advertising market in the Slovak Republic increased an estimated 3% at constant rates in the nine months ended September 30, 2017 compared to the same period in 2016.
Our television advertising revenues decreased
on a constant currency basis during the third quarter of 2017 compared to the same period in 2016 from selling fewer GRPs due to lower coverage for our channels, which have been distributed exclusively on cable, satellite and IPTV platforms in the country since January of this year. Demand for GRPs was also lower in the first nine months of 2017 compared to 2016 due to informational and political campaigns that took place in the first half of 2016. If this spending is excluded, our television advertising revenues increased 3% at constant rates in the first nine months of 2017. The change in the way our channels are distributed resulted in a significant increase in carriage fees and subscriptions revenue, as well as a cost reduction from significantly lower transmission costs. During the remainder of 2017 we anticipate reduced pressure on our ratings as additional households transition to cable, satellite and IPTV platforms and the measurement panel is updated to better
reflect how viewers watch television.
On a constant currency basis, costs charged in arriving at OIBDA decreased during the third quarter primarily due to lower transmission costs, which were partially offset in the first nine months of 2017 by an increase in content costs as we made targeted adjustments in the programming line-up since we changed the way our channels are distributed.
III. Analysis of the Results of Operations and Financial Position
For
the Three Months Ended September 30, (US$ 000's)
Movement
2017
2016
%
Act
% Lfl
Revenue:
Television advertising
$
93,830
$
85,282
10.0
%
3.5
%
Carriage
fees and subscriptions
21,547
17,940
20.1
%
14.9
%
Other revenue
4,054
4,305
(5.8
)%
(12.1
)%
Net
Revenues
119,431
107,527
11.1
%
4.8
%
Operating expenses:
Content
costs
55,871
51,920
7.6
%
1.8
%
Other operating costs
12,612
13,482
(6.5
)%
(12.3
)%
Depreciation
of property, plant and equipment
6,936
5,801
19.6
%
11.8
%
Amortization of broadcast licenses and other intangibles
2,187
2,073
5.5
%
(3.1
)%
Cost
of revenues
77,606
73,276
5.9
%
(0.1
)%
Selling, general and administrative expenses
25,803
22,801
13.2
%
5.8
%
Operating
income
$
16,022
$
11,450
39.9
%
34.8
%
For
the Nine Months Ended September 30, (US$ 000's)
Movement
2017
2016
%
Act
% Lfl
Revenue:
Television advertising
$
303,486
$
289,975
4.7
%
4.4
%
Carriage
fees and subscriptions
61,597
53,323
15.5
%
15.9
%
Other revenue
12,975
12,849
1.0
%
(0.4
)%
Net
Revenues
378,058
356,147
6.2
%
6.0
%
Operating expenses:
Content
costs
174,214
166,938
4.4
%
4.5
%
Other operating costs
35,747
40,773
(12.3
)%
(13.0
)%
Depreciation
of property, plant and equipment
19,345
17,134
12.9
%
11.8
%
Amortization of broadcast licenses and other intangibles
6,349
6,247
1.6
%
(0.2
)%
Cost
of revenues
235,655
231,092
2.0
%
1.8
%
Selling, general and administrative expenses
70,204
64,984
8.0
%
6.7
%
Operating
income
$
72,199
$
60,071
20.2
%
21.4
%
Revenue:
Television
advertising revenues: We estimate television advertising spending in our markets grew on average by 6% at constant rates in the nine months ended September 30, 2017 as compared to the same period in 2016, positively impacting our television advertising revenues. See "Overview - Segment Performance" above for additional information on television advertising revenues for each of our operating countries.
Carriage fees and subscriptions: Carriage fees and subscriptions revenue increased during the three and nine months ended September 30, 2017
to 18% and 16% of total net revenues, respectively, as compared to 17% and 15% for the same periods in 2016. The increases arose primarily in the Slovak Republic where our channels are exclusively available on cable, satellite and IPTV platforms since January 2017 and in Romania due to higher subscriber counts. See "Overview - Segment Performance" above for additional information on carriage fees and subscription revenues for each of our operating countries.
Other revenues: Other revenues include primarily internet advertising revenues and revenues generated through the licensing of our own productions. Other revenues decreased during the three months ended September 30, 2017 as compared to the same period in 2016
primarily due to lower internet advertising in the Czech Republic and fewer special events in Romania, offset by increases in production services in the Slovak Republic. Other revenues for the nine months ended September 30, 2017 remained in line with those of the same period in 2016.
Operating Expenses:
Content costs: Content costs (including production costs and amortization and impairment of program rights) increased during the three and nine months ended September 30, 2017 compared to the same periods in 2016 primarily due to the inclusion of both higher quality acquired programming
and more hours of local productions in our broadcast schedules.
Other operating costs: Other operating costs (excluding content costs, depreciation of property, plant and equipment, amortization of broadcast licenses and other intangibles as well as selling, general and administrative expenses) decreased during the three and nine months ended September 30, 2017 compared to the same periods in 2016, primarily due to cost savings in the Slovak Republic following our decision not to renew our contract for the terrestrial distribution of our channels there.
Depreciation
of property, plant and equipment: Total depreciation of property, plant and equipment increased during the three and nine months ended September 30, 2017 compared to the same periods in 2016 primarily due to depreciation on production and technical equipment placed in service as we replaced fully depreciated assets.
Amortization of broadcast licenses and other intangibles: Total amortization of broadcast licenses and other intangibles decreased during the three and nine months ended September 30, 2017 compared to the same periods in 2016
primarily due to certain intangibles in Romania becoming fully amortized, partly offset by an increase in amortization of certain of our trademarks in the Czech Republic.
Selling, general and administrative expenses: Selling, general and administrative expenses increased for the three and nine months ended September 30, 2017 as compared to the same periods in 2016 primarily due to increased bad debt charges in Bulgaria.
Operating income: Operating income during the three and nine months ended September 30, 2017 increased compared to the same periods in 2016
due to increases in television advertising and carriage fee revenues, which outpaced the increases in content costs and selling, general and administrative expenses. Our operating margin, which is determined as operating income / loss divided by net revenues, was 13% and 19% for the three and nine months ended September 30, 2017 compared to 11% and 17% for the three and nine months ended September 30, 2016.
Other income / expense:
For
the Three Months Ended
September 30, (US$ 000's)
For the Nine Months Ended
September 30, (US$ 000's)
2017
2016
% Act
2017
2016
%
Act
Interest expense
$
(18,352
)
$
(22,424
)
18.2
%
$
(54,773
)
$
(90,640
)
39.6
%
Loss
on extinguishment of debt
(101
)
—
NM (1)
(101
)
(150,158
)
99.9
%
Non-operating
income / (expense):
Interest income
139
89
56.2
%
326
466
(30.0
)%
Foreign
currency exchange gain, net
4,609
602
NM (1)
14,085
13,099
7.5
%
Change
in fair value of derivatives
(1,150
)
(398
)
(188.9
)%
(1,882
)
(11,904
)
84.2
%
Other
income / (expense), net
45
57
(21.1
)%
254
(23
)
NM
(1)
Provision for income taxes
(3,157
)
(1,145
)
(175.7
)%
(12,770
)
(6,706
)
(90.4
)%
Loss
from discontinued operations, net of tax
(5,988
)
(8,054
)
25.7
%
(8,747
)
(15,971
)
45.2
%
Net
loss attributable to noncontrolling interests
188
196
(4.1
)%
534
387
38.0
%
(1)
Number
is not meaningful.
Interest expense: Interest expense during the three and nine months ended September 30, 2017 decreased compared to the three and nine months ended September 30, 2016 primarily due to lower amortization of debt discount and issuance costs following the extinguishment of the 2017 PIK Notes and 2017 Term Loan in April 2016 and due to a lower effective interest rate on the replacement facility. We also realized interest expense savings as a result of the repricing of our Guarantee Fees in March of 2017. See Item 1, Note 5, "Long-term Debt and Other Financing Arrangements".
Loss on extinguishment of debt: During the nine months ended September 30, 2017, we recognized a loss on extinguishment of debt related to our repayment of EUR 50 million (approximately US$ 59.1 million at August 1, 2017 rates) of the 2018 Euro Term Loan. During the nine months ended September 30, 2016, we recognized a loss on extinguishment of debt related to the redemption and discharge of the 2017 PIK Notes, repayment of the 2017 Term Loan and modifications of the 2018 Euro Term Loan and the 2019 Euro Term Loan, which were accounted for in a similar manner to a debt extinguishment.
Interest income:
Interest income primarily reflects earnings on cash balances and was not material.
Foreign currency exchange gain, net: We are exposed to fluctuations in foreign exchange rates on the revaluation of monetary assets and liabilities denominated in currencies other than the local functional currency of the relevant subsidiary. This includes third party receivables and payables, as well as certain of our intercompany loans which are not considered of a long-term investment nature. Our subsidiaries generally receive funding via loans that are denominated in currencies other than the dollar, and any change in the relevant exchange rate will require us to recognize a transaction gain or loss on revaluation. Certain of our intercompany loans are classified as long-term in nature, and therefore gains
or losses on revaluation are not recorded through the statement of operations and comprehensive income / loss. See the discussion under "Currency translation adjustment, net" below.
During the nine months ended September 30, 2017, we recognized a net gain of US$ 14.1 million comprised of transaction gains of US$ 7.7 million relating to the revaluation of intercompany loans, transaction gains of approximately US$ 2.4 million on our long-term debt and other financing arrangements and transaction gains of US$ 4.0 million relating to the revaluation of monetary assets and liabilities denominated
in currencies other than the local functional currency of the relevant subsidiary.
During the nine months ended September 30, 2016, we recognized a net gain of US$ 13.1 million comprised of transaction gains of US$ 38.1 million relating to the revaluation of intercompany loans, transaction losses of approximately US$ 25.3 million on our long-term debt and other financing arrangements and transaction gains of US$ 0.3 million relating to the revaluation of monetary assets and liabilities denominated in currencies other than the local functional currency of the relevant subsidiary.
Change
in fair value of derivatives: During the three and nine months ended September 30, 2017, we recognized losses as a result of the change in the fair value of our USD/EUR foreign currency forward contracts entered into on January 31, 2017, May 16, 2017 and July 21, 2017 and the interest rate swaps we use as hedging instruments for interest payments on the 2018 Euro Term Loan. During the three and nine months ended September 30, 2016,
we recognized losses as a result of the change in the fair value of certain USD/EUR foreign currency forward contracts which matured in 2016. See Item 1, Note 12, "Financial Instruments and Fair Value Measurements".
Other income / (expense), net: Our other income / expense, net during the three and nine months ended September 30, 2017 and 2016 was not material.
Provision for income taxes: The provision for income taxes for the three and nine
months ended September 30, 2017 and for the same periods in 2016 reflects losses on which no tax benefit has been received and an income tax charge on profits in the Czech Republic, Romania and the Slovak Republic.
Our subsidiaries are subject to income taxes at statutory rates ranging from 10.0% in Bulgaria to 21.0% in the Slovak Republic.
Loss
from discontinued operations, net of tax: Loss from discontinued operations, net of tax for the three and nine months ended September 30, 2017 and 2016 is comprised of the operational results of the Croatia and Slovenia segments including the allocation of interest expense and Guarantee Fees from the 2018 Euro Term Loan and transaction costs. See Item 1, Note 3, "Discontinued Operations and Assets Held for Sale" and Note 5, "Long-term Debt and Other Financing Arrangements".
Net loss attributable to noncontrolling interests: The
results attributable to noncontrolling interests for the three and nine months ended September 30, 2017 and 2016 relates to the noncontrolling interest share of our Bulgaria operations.
Other comprehensive income:
For
the Three Months Ended
September 30, (US$ 000's)
For the Nine Months Ended
September 30, (US$ 000's)
2017
2016
% Act
2017
2016
%
Act
Currency translation adjustment, net
$
9,227
$
7,262
27.1
%
$
42,203
$
15,264
176.5
%
(Loss)
/ gain on derivative instruments
(135
)
(1,360
)
90.1
%
1,083
(5,581
)
NM
(1)
(1)
Number is not meaningful.
Currency translation adjustment, net: The underlying equity value of our investments (which are denominated in the functional currency of the relevant entity) are converted into dollars at each balance sheet date, with any change in value of the underlying assets and liabilities being recorded as a currency translation adjustment to the balance sheet rather than net income / loss. Other comprehensive income / (loss) due to currency translation adjustment, net comprised the following
for the three and nine months ended September 30, 2017 and 2016:
For
the Three Months Ended
September 30, (US$ 000's)
For the Nine Months Ended
September 30, (US$ 000's)
2017
2016
% Act
2017
2016
%
Act
Foreign exchange gain on intercompany transactions
$
1,142
$
2,263
(49.5
)%
$
7,824
$
10,757
(27.3
)%
Foreign
exchange gain / (loss) on the Series B Preferred Shares
8,833
1,334
NM (1)
29,284
(4,919
)
NM
(1)
Currency translation adjustment
(748
)
3,665
NM (1)
5,095
9,426
(45.9
)%
Currency
translation adjustment, net
$
9,227
$
7,262
27.1
%
$
42,203
$
15,264
176.5
%
(1)
Number
is not meaningful.
Certain of our intercompany loans are denominated in currencies other than the functional currency of the lender and are considered to be of a long-term investment nature as the repayment of these loans is neither planned nor anticipated for the foreseeable future. The foreign exchange gains / (losses) on the remeasurement of these intercompany loans to the lender's functional currency are treated in the same manner as currency translation adjustments.
The following charts depict the movement of the dollar versus the functional currencies of our operations, based on monthly closing rates, during the nine months ended September 30, 2017 and September 30, 2016.
(Loss)
/ gain on derivative instruments: The (losses) / gains on derivatives classified as cash flow hedges of the Euro Term Loans, which are recognized in accumulated other comprehensive income / loss, for the three and nine months ended September 30, 2017 and 2016 are due to the effective portion of the changes in the fair value of our interest rate swap on the 2019 and 2021 Euro Term Loans. See Item 1, Note 12, "Financial Instruments and Fair Value Measurements".
Noncontrolling interests in consolidated subsidiaries
(58
)
1,272
NM
(1)
NM (1)
(1)
Number is not meaningful.
Note: The analysis below is intended to highlight the key factors at constant rates that led to the movements from December 31, 2016, excluding the impact of
foreign currency translation.
Current assets: Excluding the impact of assets held for sale, current assets at September 30, 2017 decreased from December 31, 2016 primarily due to lower trade receivables from increased collection and higher bad debt provisions. Further decreases are due to seasonality and lower prepayments for program rights.
Non-current assets: Excluding the impact of assets held for sale, non-current assets at September 30, 2017 increased from December 31, 2016
primarily due to higher program rights from foreign acquired and own-produced content partly offset by increased depreciation of property, plant and equipment and amortization of intangible assets.
Current liabilities: Excluding the impact of liabilities held for sale, current liabilities at September 30, 2017 increased from December 31, 2016. The increase is primarily due to higher deferred revenue from customer prepayments for the fall season and accrued interest and Guarantee Fees.
Non-current liabilities: Excluding the impact of liabilities held for sale, non-current liabilities at September 30, 2017
decreased from December 31, 2016 primarily due to our election to repay a portion of the 2018 Euro Term Loan in August 2017. See Item 1, Note 5, "Long-term Debt and Other Financing Arrangements".
Temporary equity: Temporary equity at September 30, 2017 increased from December 31, 2016 due to the accretion on the Series B Preferred Shares.
CME Ltd. shareholders’ deficit: CME Ltd. shareholders’ deficit decreased from December 31, 2016.
This primarily reflects a decrease in accumulated other comprehensive loss due to currency translation adjustments and the net income attributable to CME Ltd. during the nine months ended September 30, 2017, which was partly offset by accretion of the preferred dividend paid in kind on our Series B Preferred Shares.
Noncontrolling interests in consolidated subsidiaries: Noncontrolling interests in consolidated subsidiaries
at September 30, 2017 decreased from December 31, 2016 due to the net loss attributable to the noncontrolling interest in Bulgaria.
IV. Liquidity and Capital Resources
IV (a) Summary of Cash Flows
Cash and cash equivalents increased by US$ 26.4 million during the nine months ended September 30, 2017.
The change in cash and cash equivalents for the periods presented below is summarized as follows:
For the Nine Months Ended September 30, (US$ 000's)
2017
2016
Net
cash generated from continuing operating activities
$
90,638
$
56,972
Net cash used in continuing investing activities
(16,250
)
(14,762
)
Net
cash used in continuing financing activities
(57,782
)
(23,191
)
Net cash used in discontinued operations
(62
)
(22,278
)
Impact of exchange rate fluctuations
on cash and cash equivalents
9,884
2,005
Net increase / (decrease) in cash and cash equivalents
$
26,428
$
(1,254
)
Operating
Activities
The increase in cash generated from continuing operations during the nine months ended September 30, 2017 reflects a significant decrease in cash paid for interest and Guarantee Fees. In 2016, we paid accrued interest related to the 2017 PIK Notes and 2017 Term Loan when they were refinanced in April 2016 and we also repaid US$ 5.5 million of accrued Guarantee Fees in the first half of 2016 which were previously paid in kind. The increase also reflects higher cash collections from revenue growth which are partly offset by higher cash paid for programming and taxes in 2017. We paid cash interest (including mandatory cash-pay Guarantee Fees) of US$ 22.2 million during the nine months ended
September 30, 2017 compared to US$ 38.3 million during the nine months ended September 30, 2016.
Investing Activities
Our net cash used in continuing investing activities for the nine months ended September 30, 2017 and 2016 relates to capital expenditures for property, plant and equipment.
Financing Activities
Cash
used in continuing financing activities during the nine months ended September 30, 2017 primarily reflected principal repayments made on our 2018 Euro Term Loan. The cash used in continuing financing activities during the nine months ended September 30, 2016 primarily reflected the refinancing of the 2017 PIK Notes and the 2017 Term Loan, partly offset by proceeds from the exercise of stock warrants.
Discontinued Operations
The net cash used in discontinued operations during the nine months ended September 30, 2017
primarily reflected capital expenditures for property, plant and equipment. The net cash used in discontinued operations during the nine months ended September 30, 2016 primarily reflected the payment of Guarantee Fees related to the 2018 Euro Term Loan.
IV (b) Sources and Uses of Cash
Our ongoing source of cash is primarily the receipt of payments from advertisers, advertising agencies and distributors of our television channels. We also have available the 2021 Revolving Credit Facility (see Item 1, Note 5, "Long-term Debt and Other Financing Arrangements"). As at September 30, 2017,
the aggregate principal amount available under the 2021 Revolving Credit Facility was US$ 115.0 million and was undrawn. The available amount decreases to US$ 50.0 million with effect from January 1, 2018 or, if earlier, upon the repayment of the 2018 Euro Term Loan with the expected proceeds from the Divestment Transaction. Surplus cash, after funding ongoing operations, may be remitted to us, where appropriate, by our subsidiaries in the form of debt interest payments and capital repayments, dividends, and other distributions and loans from our subsidiaries.
Corporate law in the Central and Eastern European countries in which we operate stipulates generally that dividends may be declared by the
partners or shareholders out of yearly profits subject to the maintenance of registered capital, required reserves and after the recovery of accumulated losses. The reserve requirement restriction generally provides that before dividends may be distributed, a portion of annual net profits (typically 5.0%) be allocated to a reserve, which is capped at a proportion of the registered capital of a company (ranging from 5.0% to 20.0%). There are no third-party restrictions that limit our subsidiaries' ability to transfer amounts to us in the form of loans or advances.
IV (c) Contractual Obligations, Commitments and Off-Balance
Sheet Arrangements
Our future contractual obligations as at September 30, 2017 were as follows:
Payments due by period (US$ 000’s)
Total
Less
than 1 year
1-3 years
3-5 years
More than 5 years
Long-term debt – principal
$
1,068,366
$
—
$
514,901
$
553,465
$
—
Long-term
debt – interest
253,560
56,089
127,104
70,367
—
Unconditional
purchase obligations
140,986
54,344
62,223
20,509
3,910
Operating
leases
8,590
3,430
2,530
958
1,672
Capital
lease obligations
7,941
2,606
4,172
1,163
—
Other
long-term obligations
31,182
15,554
14,376
1,134
118
Total
contractual obligations
$
1,510,625
$
132,023
$
725,306
$
647,596
$
5,700
Long-Term
Debt
For more information on our long-term debt, see Item 1, Note 5, "Long-term Debt and Other Financing Arrangements". Interest payable on our long-term debt is calculated using exchange rates and interest rates in effect as at September 30, 2017. For the purposes of the above table, it is assumed that the Guarantee Fees eligible to be paid in kind will be paid in kind at each interest payment date through the maturity dates of the respective Euro Term Loan. However, we intend to allocate excess cash towards paying the Guarantee Fees related to the 2018 Euro Term Loan in cash rather than electing to pay any portion in kind.
Unconditional Purchase Obligations
Unconditional purchase obligations
primarily comprise future programming commitments. At September 30, 2017, we had commitments in respect of future programming of US$ $138.9 million. This includes contracts signed with license periods starting after September 30, 2017.
Operating Leases
For more information on our operating lease commitments see Item 1, Note 20, "Commitments and Contingencies".
Other Long-Term Obligations
Other long-term obligations are
primarily comprised of digital transmission commitments.
Other
Top Tone Holdings has exercised its right to acquire additional equity in CME Bulgaria. However, the closing of this transaction has not yet occurred because the purchaser financing is still pending. If consummated, we would own 90.0% of our Bulgaria broadcast operations. The option strike price is the fair value of the equity in CME Bulgaria, as determined by an independent valuation.
IV (d) Cash Outlook
Because cash flows from operating activities were negative from 2012 to 2014, we relied on equity and debt financings to ensure adequate funding for our operations. While cash flows from operating activities
were positive in 2015 and 2016, our average cost of borrowing was high and our election to pay certain interest and Guarantee Fees in kind increased our leverage. Our financing transactions in 2016 and 2017 significantly lowered our cost of borrowing.
Following the repricing of our Guarantee Fees completed in March 2017, we are now required to pay a portion of the Guarantee Fees related to all of the Euro Term Loans in cash. However, the total amount of cash paid for interest and Guarantee Fees will decrease significantly in 2017 due to the lower all-in rate following this repricing transaction and non-repeating payments that were made in 2016 when we elected to repay in cash accrued Guarantee Fees related to the 2018 Euro Term Loan that were previously paid in kind as well as when we paid accrued interest on the 2017 PIK Notes and 2017 Term Loan when they were refinanced.
As at September 30, 2017,
we have repaid in cash all previously accrued Guarantee Fees related to the 2018 Euro Term Loan and intend to continue to make payments of such Guarantee Fees in cash when due, rather than electing to pay in kind. However, we expect improvements in unlevered free cash flow to exceed the amount of these payments, and therefore expect free cash flow to increase in 2017 compared to 2016.
As at September 30, 2017, we had US$ 67.0 million in cash and cash equivalents. In August 2017, we paid down EUR 50.0 million (approximately US$ 59.1 million at August 1, 2017 rates) of the outstanding principal balance of the 2018 Euro Term Loan with cash on hand.
Following this repayment, we anticipate using excess cash, including free cash flow from the business, expected proceeds from the Divestment Transaction and expected proceeds from warrant exercises, to repay the remainder of the 2018 Euro Term Loan in full before it matures in November 2018. In the event that the Divestment Transaction does not close or we do not receive the expected warrant proceeds, we will need to secure other external sources of capital to repay the 2018 Euro Term Loan and fund our operations, including through public or private debt or equity financing transactions, which may not be available to us or may not be available on acceptable terms. If these actions are not successful, we will not have sufficient liquidity to repay the 2018 Euro Term Loan prior to its maturity on November 1, 2018.
Our corporate credit is rated B2 by Moody's Investors Service with a positive outlook and B+ by Standard & Poor's (currently on CreditWatch with developing implications due to the announced Divestment Transaction). Ratings agencies have indicated that retention of these ratings is dependent on maintaining an adequate liquidity profile, leverage ratios and cash flow profile as well as track record of strong financial support from Time Warner. Among other parameters, if we fail to meet adequate liquidity, it is likely that the rating agencies will downgrade us. The availability of additional liquidity is dependent upon our continued operating performance, improved financial performance and credit ratings. We are currently able to raise only a limited amount
of additional debt (other than refinancing indebtedness) or under the agreement governing the 2021 Revolving Credit Facility and the Reimbursement Agreement.
Credit risk of financial counterparties
We have entered into a number of significant contracts with financial counterparties as follows:
Interest Rate Swaps
We are party to interest rate swap agreements to mitigate our exposure to interest rate fluctuations on our Euro Term Loans. These interest rate swaps, certain of which are designated as cash flow hedges, provide the Company with variable-rate cash receipts in exchange for fixed-rate payments over the lives of the
agreements, with no exchange of the underlying notional amount.
Foreign Exchange Forwards
We are exposed to movements in the USD to EUR exchange rates related to contractual payments under dollar-denominated agreements. To reduce this exposure, from time to time we enter into pay-Euro receive-dollar forward foreign exchange contracts. As at September 30, 2017, two forward foreign exchange contract with an aggregate notional amount of approximately US$ 26.3 million related to contractual operating payments were outstanding.
Cash
Deposits
We may deposit cash in the global money markets with a range of bank counterparties and review the counterparties we choose weekly. The maximum period of deposit is three months but we have more recently held amounts on deposit for shorter periods, from overnight to one month. The credit rating of a bank is a critical factor in determining the size of cash deposits and we will only deposit cash with banks of investment grade rating. In addition, we also closely monitor the credit default swap spreads and other market information for each of the banks with which we consider depositing or have deposited funds.
IV (e) Off-Balance Sheet Arrangements
None.
V. Critical
Accounting Policies and Estimates
Our accounting policies that have a material effect on our financial condition and results of operations are more fully described in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission ("SEC") on February 9, 2017. The preparation of these financial statements requires us to make judgments in selecting appropriate assumptions for calculating financial estimates, which inherently contain some degree of uncertainty. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable. Using these estimates we make judgments about the carrying values of assets and liabilities
and the reported amounts of revenues and expenses that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe our critical accounting policies are as follows: program rights, goodwill and intangible assets, impairment or disposal of long-lived assets, revenue recognition, income taxes, foreign exchange, determination of the fair value of financial instruments, contingencies and discontinued operations. These critical accounting policies affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements. See Item 1, Note 2, "Basis of Presentation" for a discussion of accounting standards adopted in the period, and recently issued accounting standards not yet adopted.
Item
3. Quantitative and Qualitative Disclosures about Market Risk
We engage in activities that expose us to various market risks, including the effect of changes in foreign currency exchange rates and interest rates. We do not engage in speculative transactions, nor do we hold or issue financial instruments for trading purposes. The table below sets forth our market risk sensitive instruments as at the following dates:
As
discussed in Item 1, Note 5, "Long-term Debt and Other Financing Arrangements", as consideration for Time Warner's guarantee of the Euro Term Loans, we pay Guarantee Fees to Time Warner based on the amounts outstanding on the Euro Term Loans, each calculated such that the all-in borrowing rate on each of the Euro Term Loans will be 6.0% from the end of October 2017 due to the reduction of our net leverage ratio at September 30, 2017.
(2)
The interest rate swaps maturing in 2018 are forward starting to coincide with the maturity date of the interest rate swaps maturing in 2017.
See Item 1, Note 12, "Financial Instruments and Fair Value Measurements".
We
pay Guarantee Fees to Time Warner based on the amounts outstanding on the Euro Term Loans, each calculated such that the all-in borrowing rate on each the 2018 Euro Term Loan and the 2019 Euro Term Loan was 8.5% per annum and the all-in borrowing rate on the 2021 Euro Term Loan was 9.0% per annum.
(2)
The interest rate swaps maturing in 2018 are forward starting to coincide with the maturity date of the interest rate swaps maturing in 2017. See Item 1, Note 12, "Financial Instruments and Fair Value Measurements".
Foreign Currency Exchange Risk Management
We conduct
business in a number of currencies other than our functional currencies. As a result, we are subject to foreign currency exchange rate risk due to the effects that foreign exchange rate movements of these currencies have on our costs and on the cash flows we receive from our subsidiaries. In limited instances, including the transactions noted below, we enter into forward foreign exchange contracts to minimize foreign currency exchange rate risk.
We periodically enter into forward foreign exchange contracts to reduce our exposure to movements in the USD to EUR exchange rates related to contractual payments under dollar-denominated agreements. At September 30, 2017,
two forward foreign exchange contracts with an aggregate notional amount of approximately US$ 26.3 million were outstanding.
Interest Rate Risk Management
The Euro Term Loans each bear interest at a variable rate based on EURIBOR plus an applicable margin. We are party to a number of interest rate swap agreements intended to reduce our exposure to interest rate movements (see Item 1, Note 12, "Financial Instruments and Fair Value Measurements").
We have established disclosure controls and procedures designed to ensure that information required to be disclosed in our Quarterly Report on Form 10-Q is recorded, processed, summarized and reported within the specified time periods and is designed to ensure that information required to be disclosed is accumulated and communicated to management, including the co-Principal Executive Officers and the Principal Financial Officer, to allow timely decisions regarding required disclosure.
Our co-Principal Executive Officers and our Principal Financial Officer evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2017 and concluded that our disclosure controls and procedures were effective as of that
date. There has been no change in our internal control over financial reporting during the three months ended September 30, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
General
We are from time to time party to legal proceedings, arbitrations and regulatory proceedings arising in the normal course of our business operations, including the proceeding described below. We evaluate, on a quarterly basis, developments
in such matters and provide accruals for such matters, as appropriate. In making such decisions, we consider the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of a loss. An unfavorable outcome in any such proceedings, if material, could have an adverse effect on our business or consolidated financial statements.
In the fourth quarter of 2016, our Slovak subsidiary MARKIZA-SLOVAKIA, spol. s.r.o. (“Markiza”) was notified of claims that were filed in June 2016 in a court of first instance in Bratislava, the Slovak Republic to collect amounts allegedly owing under four promissory notes. These four promissory notes were purportedly issued in June 2000 by Pavol Rusko in his personal capacity and were purportedly guaranteed by Markiza under the signature of Mr. Rusko, who was an executive director of Markiza at that time as well as one of its shareholders. The notes
purport to be issued in favor of Marian Kocner, a controversial Slovak businessman, and to a former associate of Mr. Kocner, and were supposedly assigned several times, ultimately to Sprava a inkaso zmeniek, s.r.o., a company owned by Mr. Kocner that is the plaintiff in these proceedings. Two of the notes allegedly matured in 2015 and the other two in 2016. The four notes purport to be in the aggregate amount of approximately EUR 69 million.
Despite a random case assignment system in the Slovak Republic, claims in respect of three of the notes were initially assigned to the same judge. The judge who was assigned the claim in respect of the fourth promissory note (in the amount of approximately EUR 26 million) terminated proceedings in January 2017 because the plaintiff failed to pay court fees. The plaintiff refiled this claim in June 2017; the judge who was assigned the refiled claim terminated proceedings in September after
the plaintiff again failed to pay court fees. In responses to the claims in respect of the other three promissory notes that were filed in August 2017, Mr. Rusko asserted that he signed the three notes in June 2000. We do not believe that the notes were signed in June 2000 or that any of the notes are authentic. We are vigorously defending the claims.
Item 1A. Risk Factors
This report and the following discussion of risk factors contain forward-looking statements as discussed in Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations". Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks and uncertainties described below and elsewhere in this report. These
risks and uncertainties are not the only ones we may face. Additional risks and uncertainties of which we are not aware, or that we currently deem immaterial, may also become important factors that affect our financial condition, results of operations and cash flows.
Risks Relating to Our Financial Position
Changes in global or regional economic conditions may adversely affect our financial position and results of operations.
The results of our operations depend heavily on advertising revenue, and demand for advertising is affected by general economic conditions in the region and globally. Our markets have experienced overall growth in real GDP (as adjusted for inflation) and advertising spending since 2014; however, we cannot predict if the recovery that has begun will continue or how long it will last. Recessions or periods of low or
negative growth in the region or globally in the future may cause a deterioration of general economic conditions in one or more of our markets, which would have an adverse economic impact on our advertising revenues. Other factors that may affect general economic conditions in our markets include defaults by sovereigns or systemically important companies, austerity programs, natural disasters, acts of terrorism, civil or military conflicts or general political instability and responses to it, any of which may also reduce advertising spending. In addition, although we believe the advertising spend per capita of the countries in which we operate and advertising intensity (the ratio of total ad spend per capita to nominal GDP per capita) will converge with developed markets in Europe, such convergence may not occur in the time frame we expect, or at all. Any of these developments would have a significant negative effect on our financial position, results of operations and
cash flows.
Concerns regarding the Eurozone and the impact on the region of the United Kingdom’s exit from the European Union (“EU”) may adversely affect our financial position and results of operations.
Continued economic softness in the Eurozone, including a slowdown in the growth of consumer prices, prompted the European Central Bank to embark upon quantitative easing in 2015. Economic events related to the sovereign debt crisis in several EU countries have also highlighted issues relating to the strength of the banking sector in Europe and the Euro. Although the EU has created external funding and stability mechanisms to provide liquidity and financial assistance to Eurozone member states and financial institutions, there can be no assurance that the market disruptions in Europe related to sovereign debt and the banking sector or otherwise, including the increased cost
of funding for certain governments and financial institutions, will not continue and there can be no assurance that funding and stability packages utilized previously will be available or, if provided, will be sufficient to stabilize affected economies or institutions.
On March 29, 2017, the United Kingdom formally initiated the process to leave the EU, commonly referred to as "Brexit", triggering a two-year period to finalize the terms for its leaving the EU. It is expected that economic conditions in the EU will be impacted by Brexit. While the overall economic impact of Brexit on the EU and the Euro is difficult
to estimate at present, decisions to conserve cash and reduce spending by consumers and businesses in the United Kingdom would have a negative impact on economic growth rates in the United Kingdom and, to a lesser extent, in the EU, in particular those countries that are significant exporters to the United Kingdom. There is also significant uncertainty regarding the terms on which the United Kingdom will leave the EU, and it is expected that a more protracted process to set those terms would have a more prolonged economic impact. In addition, if other countries seek to leave the EU, that would increase uncertainty in the region, which may have a further negative impact on investment and economic growth rates. Furthermore, the departure of the United Kingdom from the EU may affect the budgetary contributions and allocations among the EU member states in the medium term, including the countries in which we operate, which are net recipients of EU funding. Economic uncertainty
caused by Brexit or other instability in the EU could cause significant volatility in EU markets and reduce economic growth rates in the countries in which we operate, which would negatively impact our business.
Our operating results will be adversely affected if we cannot generate strong advertising sales.
We generate the majority of our revenues from the sale of advertising airtime on our television channels. While we have implemented new pricing strategies to increase sales and television advertising spending, the success of these strategies has varied from market to market and continues to be challenged by pressure from advertisers and discounting by competitors. In addition to advertising pricing, other factors that may affect our advertising sales include general economic conditions (described above), competition from other broadcasters and operators of other distribution platforms,
changes in programming strategy, changes in distribution strategy, our ability to secure distribution on cable, satellite or IPTV operators, our channels’ technical reach, technological developments relating to media and broadcasting, seasonal trends in the advertising market, changing audience preferences and in how and when people view content and the accompanying advertising, increased competition for the leisure time of audiences and shifts in population and other demographics. Our advertising revenues also depend on our ability to maintain audience ratings and to generate GRPs. This requires us to have a distribution strategy that reaches a significant audience as well as to maintain investments in programming at a sufficient level to continue to attract audiences. Changes in the distribution of our channels, such as our decision to cease broadcasting on DTT in the Slovak Republic may reduce the number of people who can view our channels, which may negatively impact
our audience share and GRPs generated. Furthermore, significant or sustained reductions in investments in programming or other operating costs in response to reduced advertising revenues had and, if repeated, may have an adverse impact on our television viewing levels. Reductions in advertising spending in our markets and resistance to price increases as well as competition for ratings from broadcasters seeking to attract similar audiences may have an adverse impact on our ability to maintain our advertising sales. A failure to maintain and increase advertising sales could have a material adverse effect on our financial position, results of operations and cash flows.
Our liquidity constraints and debt service obligations may restrict our ability to fund our operations.
We have significant debt service obligations under the Euro Term Loans as well as the 2021 Revolving Credit Facility
(when drawn). Furthermore, we are paying Guarantee Fees to Time Warner as consideration for its guarantees of the Euro Term Loans (collectively, the "TW Guarantees"). Although a portion of the Guarantee Fees in respect of each of the Euro Term Loans can be non-cash pay at our option, accruing such fees will further increase the amounts to be repaid at the maturity of these facilities. Accordingly, the payment of Guarantee Fees in kind will increase our already significant leverage. In addition, if the Divestment Transaction does not close, the warrants are not exercised in full or cash flows from operations do not meet our forecasts, we would not be able to reduce our indebtedness as planned and would continue to bear higher average borrowing costs on our senior debt and pay more interest and Guarantee Fees. As a result of our debt service obligations and covenants contained in the related loan agreements, we are restricted under the Reimbursement Agreement and
the 2021 Revolving Credit Facility (when drawn) in the manner in which our business is conducted, including but not limited to our ability to obtain additional debt financing to refinance existing indebtedness or to fund future working capital, capital expenditures, business opportunities or other corporate requirements. We may have a proportionally higher level of debt and debt service obligations than our competitors, which may put us at a competitive disadvantage by limiting our flexibility in planning for, or reacting to, changes in our business, economic conditions or our industry. For additional information regarding the Reimbursement Agreement the 2021 Revolving Credit Facility and the TW Guarantees, see Part I, Item 1, Note 5, "Long-term Debt and Other Financing Arrangements".
We may be unable to refinance our existing indebtedness and may not be able to obtain favorable
refinancing terms.
We have a substantial amount of indebtedness. Under the Reimbursement Agreement and the 2021 Revolving Credit Facility (when drawn), we can incur only limited amounts of additional indebtedness, other than indebtedness incurred to refinance existing indebtedness. In addition, pursuant to the Reimbursement Agreement, the all-in rates on each of the Euro Term Loans increase to a maximum of 10.0% (or 3.5% above the then-current all-in rate, if lower), on the date that is 180 days following a change of control of CME Ltd. (as defined therein); and pursuant to the 2021 Revolving Credit Facility, all commitments terminate following a change of control (as defined therein) and the interest rate on amounts outstanding increases to 13% on the date that is 180 days following such change of control. We intend to repay the 2018 Euro Term Loan at or prior to maturity with cash flows from operations and the expected proceeds
from the Divestment Transaction or if the Divestment Transaction does not close, the expected proceeds from warrant exercises. In the event the Divestment Transaction does not close, the warrants are not exercised in full or cash flows from operations do not meet our forecasts, we would be required to refinance the 2018 Euro Term Loan in whole or in part. Pursuant to the Reimbursement Agreement, all commitments under the 2021 Revolving Credit Facility terminate on the refinancing of any Euro Term Loan. We face the risk that we will not be able to renew, repay or refinance our indebtedness when due, or that the terms of any renewal or refinancing will not be on better terms than those of such indebtedness being refinanced. In the event we are not able to refinance our indebtedness, we might be forced to dispose of assets on disadvantageous terms or reduce or suspend operations, any of which would materially and adversely affect our financial condition, results of operations
and cash flows.
We may be subject to changes in tax rates and exposure to additional tax liabilities.
We are subject to taxes in a number of foreign jurisdictions, including in respect of our operations as well as capital transactions undertaken by us. We are subject to regular review and audit by tax authorities, and in the ordinary course of our business there are transactions and calculations where the ultimate tax determination is unknown. Significant judgment is required in determining our provision for taxes. The final determination of our tax liabilities resulting from tax audits, related proceedings or otherwise could be materially different from our tax provisions. Economic and political pressures to increase receipts in various jurisdictions may make taxation and tax rates subject to significant change and the satisfactory resolution of any tax disputes more difficult.
The occurrence of any of these events could have a material adverse effect on our financial position, results of operations and cash flows.
A default by us in connection with our obligations under our outstanding indebtedness could result in our inability to continue to conduct our business.
Pursuant to the Reimbursement Agreement and the 2021 Revolving Credit Facility, we pledged all of the shares of CME NV and of CME BV, which together own substantially all of the interests in our operating subsidiaries, in favor of Time Warner as
security for this indebtedness. If we or these subsidiaries were to default under the terms of any of the relevant agreements, Time Warner would have the ability to sell all or a portion of the assets pledged to it in order to pay amounts outstanding under such debt instruments. This could result in our inability to conduct our business.
Fluctuations in exchange rates may continue to adversely affect our results of operations.
Our reporting currency is the dollar and CME Ltd.'s functional currency is the Euro. Our consolidated revenues and costs are divided across a range of European currencies. The strengthening of the dollar had a negative impact on reported revenues in 2016 when translated from the functional currencies of our operations. Continued strengthening of the dollar would have
a negative impact on our reported revenues. Furthermore, fluctuations in exchange rates may negatively impact programming costs. While local programming is generally purchased in local currencies, a significant portion of our content costs relates to foreign programming purchased pursuant to dollar-denominated agreements. If the dollar appreciates against the functional currencies of our operating segments, the cost of acquiring such content would be adversely affected, which could have a material adverse effect on our results of operations and cash flows.
Our strategies to enhance our carriage fees and diversify our revenues may not be successful.
We are focused on creating additional revenue streams from our broadcast operations as well as increasing revenues generated from broadcast advertising, which is how we generate most of our revenues. Our main efforts with respect to this
strategy are on increasing carriage fees from cable, satellite and IPTV operators for carriage of our channels as well as continuing to seek improvements in advertising pricing. Agreements with operators generally have a term of one or more years, at which time agreements must be renewed. There can be no assurance that we will be successful in renewing carriage fee agreements on similar or better terms. During negotiations to implement our carriage fees strategy in prior years, some cable and satellite operators suspended the broadcast of our channels, which negatively affected the reach and audience shares of those operations and, as a result, advertising revenues. There is a risk that operators may refuse to carry our channels while carriage fee negotiations are ongoing, which would temporarily reduce the reach of those channels and may result in clients withdrawing advertising from our channels. The occurrence of any of these events may have an adverse impact on our
financial position, results of operations and cash flows. If we are ineffective in negotiations with carriers or in achieving further carriage fee increases, our profitability will continue to be dependent primarily on television advertising revenues, which increases the importance placed on our ability to improve advertising pricing and generate advertising revenues. In addition to carriage fees, we are also working to build-out our offerings of advertising video-on-demand products and other opportunities for advertising online. There can be no assurances that our revenue diversification initiatives will ultimately be successful, and if unsuccessful, this may have an adverse impact on our financial position, results of operations and cash flows.
A downgrading of our ratings may adversely affect our ability to raise additional financing.
Moody’s Investors Service rates our corporate
credit as B2 with a positive outlook. Standard & Poor’s rates our corporate credit B+ (currently on CreditWatch with developing implications due to the announced Divestment Transaction). Our ratings show each agency's opinion of our financial strength, operating performance and ability to meet our debt obligations as they become due. These ratings take into account the particular emphasis the ratings agencies place on metrics such as leverage ratio and cash flow, which they use as measurements of a company's liquidity and financial strength. They also reflect an emphasis placed by the ratings agencies on a track record of strong financial support from Time Warner. We may be subject to downgrades if our operating performance deteriorates or we fail to maintain adequate levels of liquidity.
In addition, our ratings may be downgraded if the agencies form a view that material support from Time Warner is not as strong, or the strategic importance of CME Ltd. to Time Warner is not as significant as it has been in the past. In the event our corporate credit ratings are lowered by the rating agencies, it will be more difficult for us to refinance our existing indebtedness or raise new indebtedness that may be permitted under the Reimbursement Agreement and the 2021 Revolving Credit Facility (when drawn), and we will have to pay higher interest rates, which would have an adverse effect on our financial position, results of operations and cash flows.
If our goodwill, other intangible assets and long-lived assets become impaired, we may be required to record significant charges to earnings.
We review our long-lived assets for impairment when events or changes in circumstances
indicate the carrying amount may not be recoverable. Goodwill and indefinite-lived intangible assets are required to be assessed for impairment at least annually. Factors that may be considered a change in circumstances indicating that the carrying amount of our goodwill, indefinite-lived intangible assets or long-lived assets may not be recoverable include slower growth rates in our markets, reduced expected future cash flows, increased country risk premium as a result of political uncertainty and a decline in stock price and market capitalization. We consider available current information when calculating our impairment charge. If there are indicators of impairment, our long-term cash flow forecasts for our operations deteriorate or discount rates increase, we may be required to recognize additional impairment charges in later periods. See Part I, Item 1, Note 4, "Goodwill and Intangible Assets" for the carrying
amounts of goodwill in each of our reporting units.
Risks Relating to Our Operations
Content may become more expensive to produce or acquire or we may not be able to develop or acquire content that is attractive to our audiences.
Television programming is one of the most significant components of our operating costs. The ability of our programming to generate advertising revenues depends substantially on our ability to develop, produce or acquire programming that matches audience tastes and attracts high audience shares, which is difficult to predict. The commercial success of a program depends on several tangible and intangible factors, including the impact of competing programs, the availability of alternate forms of entertainment and leisure time activities, our ability to anticipate and adapt to changes in consumer tastes and behavior,
and general economic conditions. While we have been successful in reducing content costs compared to prior periods, the cost of acquiring content attractive to our viewers, such as feature films and popular television series and formats, may increase in the future. Our expenditures in respect of locally produced programming may also increase due to competition for talent and other resources, changes in audience tastes in our markets or from the implementation of any new laws and regulations mandating the broadcast of a greater number of locally produced programs. In addition, we typically acquire syndicated programming rights under multi-year commitments before knowing how such programming will perform in our markets. In the event any such programming does not attract adequate audience share, it may be necessary to increase our expenditures by investing in additional programming, subject to the availability of adequate financial resources, as well as to write down the
value of any underperforming programming. Any material increase in content costs could have a material adverse effect on our financial condition, results of operations or cash flows.
Our operations are vulnerable to significant changes in viewing habits and technology that could adversely affect us.
The television broadcasting industry is affected by rapid innovations in technology. The implementation of these new technologies and the introduction of non-traditional content distribution systems have increased competition for audiences and advertisers. Platforms such as direct-to-home cable and satellite distribution systems,
the internet, subscription and advertising video-on-demand, user-generated content sites and the availability of content on portable digital devices have changed consumer behavior by increasing the number of entertainment choices available to audiences and the methods for the distribution, storage and consumption of content. This development has fragmented television audiences in more developed markets and could adversely affect our ability to retain audience share and attract advertisers as such technologies penetrate our markets. As we adapt to changing viewing patterns, it may be necessary to expend substantial financial and managerial resources to ensure necessary access to new technologies or distribution systems. Such initiatives may not develop into profitable business models. Furthermore, technologies that enable viewers to choose when, how, where and what content to watch, as well as to fast-forward or skip advertisements, may cause changes in consumer behavior
that could have a negative impact on our advertising revenues. In addition, compression techniques and other technological developments allow for an increase in the number of channels that may be broadcast in our markets and expanded programming offerings that may be offered to highly targeted audiences. Reductions in the cost of launching new channels could lower entry barriers and encourage the development of increasingly targeted niche programming on various distribution platforms. This could increase the competitive demand for popular programming, resulting in an increase in content costs as we compete for audiences and advertising revenues. A failure to successfully adapt to changes in our industry as a result of technological advances may have an adverse effect on our financial position, results of operations and cash flows.
Our operating results are dependent on the importance of television as an advertising medium.
We
generate most of our revenues from the sale of our advertising airtime on television channels in our markets. Television competes with various other media, such as print, radio, the internet and outdoor advertising, for advertising spending. In all of the countries in which we operate, television constitutes the single largest component of all advertising spending. There can be no assurances that the television advertising market will maintain its current position among advertising media in our markets. Furthermore, there can be no assurances that changes in the regulatory environment or improvements in technology will not favor other advertising media or other television broadcasters. Increases in competition among advertising media arising from the development of new forms of advertising media and distribution could result in a decline in the appeal of television as an advertising medium generally or of our channels specifically. A decline in television advertising
spending as a component of total advertising spending in any period or in specific markets would have an adverse effect on our financial position, results of operations and cash flows.
We are subject to legal compliance risks and the risk of legal or regulatory proceedings being initiated against us.
We are required to comply with a wide variety of laws and other regulatory obligations in the jurisdictions in which we operate and compliance by our businesses is subject to scrutiny by regulators and other government authorities in these jurisdictions. Compliance with foreign as well as applicable U.S. laws and regulations related to our businesses, such as broadcasting content and advertising regulations, competition regulations, tax laws, employment laws, data protection requirements, and anti-corruption laws, increases the costs and risks of doing business in these jurisdictions.
We believe we have implemented appropriate risk management and compliance policies and procedures that are designed to ensure our employees, contractors and agents comply with these laws and regulations; however, a violation of such laws and regulations or the Company’s policies and procedures could occur. A failure or alleged failure to comply with applicable laws and regulations, whether inadvertent or otherwise, may result in legal or regulatory proceedings being initiated against us.
We have become aware of provisions in the tax regulations of one of our markets that shift the liability for taxes on gains resulting from certain capital transactions from the seller to the buyer. This provision may have been applicable to an acquisition made by us, although we do not believe we have any liability connected to this transaction. In addition,
in 2016 the prosecuting authorities in Romania requested information in respect of an investigation into certain transactions entered into by Pro TV in 2014 primarily with certain related parties. We believe that the transactions under review are fully supported and are cooperating with the authorities in responding to the information request. In Slovenia, the competition authorities have launched an investigation into whether our Slovenian subsidiary is dominant and abused its dominant position when concluding carriage fee agreements with platform operators in connection with its decision to cease broadcasting on DTT there. To date there has been no determination that a breach of competition law has occurred. If these or other contingencies result in legal or regulatory proceedings being initiated against us, or if developments occur in respect of our compliance with existing laws or regulations, or there are changes in the interpretation or application of such laws
or regulations, we may incur substantial costs, be required to change our business practices (including on what terms and conditions we offer our channels under carriage agreements), our reputation may be damaged or we may be exposed to unanticipated civil or criminal liability, including fines and other penalties that may be substantial. This could have a material adverse effect on our business, financial position, results of operations and cash flows.
Piracy of our content may decrease revenues we can earn from our content and adversely impact our business and profitability.
Piracy of our content poses significant challenges in our markets. Technological developments, including digital copying, file compressing, the use of international proxies and the growing penetration of high bandwidth internet connections, have made it easier to create, transmit and distribute high quality
unauthorized copies of content in unprotected digital formats. Furthermore, there are a growing number of video streaming sites, increasing the risk of online transmission of our content without consent. The proliferation of such sites broadcasting content pirated from us could result in a reduction of revenues that we receive from the legitimate distribution of our content, including through video-on-demand and other services. Protection of our intellectual property is in large part dependent on the manner in which applicable intellectual property laws in the countries in which we operate are construed and enforced. We seek to limit the threat of content piracy. However, detecting and policing the unauthorized use of our intellectual property is often difficult and remedies may be limited under applicable law. Steps we take may not prevent the infringement by third parties. There can be no assurance that our efforts to enforce our rights and protect our intellectual
property will be successful in preventing piracy, which limits our ability to generate revenues from our content.
Our operations are in developing markets where there are additional risks related to political and economic uncertainty, biased treatment and compliance with evolving legal and regulatory systems.
Our revenue-generating operations are located in Central and Eastern Europe and we may be significantly affected by risks that may be different to those posed by investments in more developed markets. These risks include, but are not limited to, social and political instability, changes in local regulatory requirements
including restrictions on foreign ownership, inconsistent regulatory or judicial practice, and increased taxes and other costs. The economic and political systems, legal and tax regimes, regulatory practices, standards of corporate governance and business practices of countries in this region continue to develop. Policies and practices may be subject to significant adjustments, including following changes in political leadership. This may result in social or political instability or disruptions and the potential for political influence on the media as well as inconsistent application of tax and legal regulations, arbitrary treatment before regulatory or judicial authorities and other general business risks. Other potential risks inherent in markets with evolving economic and political environments include exchange controls, higher taxes, tariffs and other levies as well as longer payment cycles. The relative level of development of our markets and the influence of local
politics also present a potential for biased treatment of us before regulators or courts in the event of disputes. If such a dispute occurs, those regulators or courts might favor local interests over our interests. Ultimately, this could have a material adverse impact on our business, financial position, results of operations and cash flows.
We rely on network and information systems and other technology that may be subject to disruption or misuse, which could harm our business or our reputation.
We make extensive use of network and information systems and other technologies, including those related to our internal network management as well as our broadcasting operations. These systems are central to many of our business activities. Network and information systems-related events, such as computer hackings, computer viruses, worms or other destructive or disruptive software, process
breakdowns, malicious activities or other security breaches could result in a disruption or degradation of our services, the loss of information or the improper disclosure of personal data. The occurrence of any of these events could negatively impact our business by requiring us to expend resources to remedy such a security breach or by harming our reputation. In addition, improper disclosure of personal data could subject us to liability under laws that protect personal data in the countries in which we operate. The development and maintenance of systems to prevent these events from occurring requires ongoing monitoring and updating as efforts to overcome security measures become more sophisticated. As technologies evolve, we will need to expend additional resources to protect our technology and information systems, which could have an adverse impact on our results of operations.
Our broadcasting licenses may not be renewed
and may be subject to revocation.
We require broadcasting and, in some cases, other operating licenses as well as other authorizations from national regulatory authorities in our markets in order to conduct our broadcasting business. While our broadcasting licenses for our operations in Slovenia and the Slovak Republic are valid for indefinite time periods, our other broadcasting licenses expire at various times through 2028. While we expect that our material licenses and authorizations will be renewed or extended as required to continue to operate our business, we cannot guarantee that this will occur or that they will not be subject to revocation, particularly in markets where there is relatively greater political risk as a result of less developed political and legal institutions. The failure to comply in all material respects with the terms of broadcasting licenses or other authorizations or with applications filed in respect
thereto may result in such licenses or other authorizations not being renewed or otherwise being terminated. Furthermore, no assurances can be given that renewals or extensions of existing licenses will be issued on the same terms as existing licenses or that further restrictions or conditions will not be imposed in the future. Any non-renewal or termination of any other broadcasting or operating licenses or other authorizations or material modification of the terms of any renewed licenses may have a material adverse effect on our financial position, results of operations and cash flows.
Our success depends on attracting and retaining key personnel.
Our success depends partly upon the efforts and abilities of our key personnel and our ability to attract and retain key personnel. Our management teams have significant experience in the media industry and have made important contributions
to our growth and success. Although we have been successful in attracting and retaining such people in the past, competition for highly skilled individuals is intense. There can be no assurance that we will continue to be successful in attracting and retaining such individuals in the future. The loss of the services of any of these individuals could have an adverse effect on our businesses, results of operations and cash flows.
Risks Relating to Enforcement Rights
We are a Bermuda company and enforcement of civil liabilities and judgments may be difficult.
We are a Bermuda company. Substantially all of our assets and all of our operations are located, and all of our revenues are derived, outside the United States. In addition, several of our directors and officers are non-residents of the United States, and all or a substantial portion
of the assets of such persons are or may be located outside the United States. As a result, investors may be unable to effect service of process within the United States upon such persons, or to enforce against them judgments obtained in the United States courts, including judgments predicated upon the civil liability provisions of the United States federal and state securities laws. There is uncertainty as to whether the courts of Bermuda and the countries in which we operate would enforce (a) judgments of United States courts obtained against us or such persons predicated upon the civil liability provisions of the United States federal and state securities laws or (b) in original actions brought in such countries, liabilities against us or such persons predicated upon the United States federal and state securities laws.
Our Bye-laws restrict shareholders from bringing legal action against our officers and directors.
Our
Bye-laws contain a broad waiver by our shareholders of any claim or right of action in Bermuda, both individually and on our behalf, against any of our officers or directors. The waiver applies to any action taken or concurred in by an officer or director, or the failure of an officer or director to take any action, in the performance of his or her duties, except with respect to any matter involving any fraud or dishonesty on the part of the officer or director. This waiver limits the right of shareholders to assert claims against our officers and directors unless the act or failure to act involves fraud or dishonesty.
Our
share price may be adversely affected by sales of unregistered shares or future issuances of our shares.
Time Warner is the largest holder of shares of our Class A common stock, holding 61,407,775 unregistered shares of Class A common stock, one share of Series A preferred stock ("Series A Preferred Share"), 200,000 shares of Series B preferred stock ("Series B Preferred Shares") and warrants to acquire 100,926,996 shares of our Class A common stock (the "TW Warrants"). The share of Series A Preferred Shares is convertible into 11,211,449 shares of Class A common stock and the Series B Preferred Shares are convertible into shares of Class A common stock at the option of Time Warner (subject to certain exceptions). As of September 30, 2017,
the 200,000 Series B Preferred Shares were convertible into approximately 108.1 million shares of Class A common stock. The TW Warrants are exercisable for shares of Class A common stock until May 2, 2018 at an exercise price of US$ 1.00 per share. Time Warner has registration rights with respect to all its shares of Class A common stock now held or hereafter acquired. Furthermore, there are additional unregistered shares of our Class A common stock outstanding that we may be obligated to register and shares of Class A common stock underlying other warrants that may enter into trading. For additional information on the Series A Preferred Shares, Series B Preferred Shares and TW Warrants, see Part I, Item I, Note 13, "Convertible Redeemable Preferred Shares" and Note 14, "Equity".
In October 2016, Time Warner announced it has entered into a definitive merger agreement with AT&T Inc. under which AT&T Inc. will acquire Time Warner. The merger is subject to regulatory approvals, including the U.S. Department of Justice. Following a successful completion of such merger, AT&T Inc. will become the beneficial owner of equity securities currently beneficially owned by Time Warner and the successor to rights related to such securities granted to Time Warner.
We cannot predict what effect, if any, the entry into trading of previously issued unregistered shares of Class A common stock will have on the market price of our shares. We may also issue additional shares of Class A common stock or securities convertible into our equity in the future. If more shares of our Class A common stock (or securities convertible into or exchangeable for shares of our Class A common stock) are issued to Time Warner,
the economic interests of current shareholders may be diluted and the price of our shares may be adversely affected.
The interests of Time Warner may conflict with the interests of other investors.
Time Warner is able to exercise voting power in us with respect to 46.5% of our outstanding shares of Class A common stock. As such, Time Warner is in a position to exercise significant influence over the outcome of corporate actions requiring shareholder approval, such as the election of directors or certain transactions. Following the issuance of the TW Warrants, the aggregate economic interest of Time Warner in us is approximately 76.0% (without giving effect to the accretion of the Series B Preferred Shares after September 30, 2017).
Furthermore, Time Warner has the right to appoint one less than the number required to constitute a majority of our board of directors, provided that Time Warner continues to own not less than 40% of the voting power of the Company.
We are also party to an amended investor rights agreement with Time Warner and the other parties thereto under which, among other things, Time Warner was granted a contractual preemptive right (subject to certain exclusions) with respect to issuances of the Company’s equity securities, which permits it to maintain its pro rata economic interest as well as a right to top any offer that would result in a change of control of the
Company. Under Bermuda law, there is no takeover code or similar legislation requiring an acquirer of a certain percentage of our Class A common stock to tender for the remaining publically held shares. In addition to being our largest shareholder, Time Warner is our largest secured creditor, as it guarantees 100% of our outstanding senior indebtedness and is the lender under the 2021 Revolving Credit Facility. The 2021 Revolving Credit Facility and the Reimbursement Agreement contain maintenance covenants in respect of interest cover, cash flow cover and total leverage ratios and include covenants in respect of the incurrence of indebtedness (including refinancing indebtedness), the provision of guarantees, the payment of dividends or making other distributions, acquisitions and disposals, and granting security. As such, Time Warner may be in a position to determine whether to permit transactions, waive defaults or accelerate such indebtedness or take other steps
in its capacity as a secured creditor in a manner that might not be consistent with the interests of the holders of our Class A common stock. Furthermore, in certain circumstances, the interests of Time Warner as our largest shareholder could be in conflict with the interests of minority shareholders.
The price of our Class A common stock has been volatile.
The market price of shares of our Class A common stock may be influenced by many factors, some of which are beyond our control, including but not limited to those described above under "Risks Relating to Our Operations","Risks Relating to Our Financial Position" as well as the following: variations in quarterly operating results, the condition of the media industry in our operating countries, the volume of trading in shares of our Class A common stock, future issuances of shares of our Class A common stock and investors’
and securities analysts’ perception of us and other companies that investors or securities analysts deem comparable in the television broadcasting industry. In addition, stock markets in general have experienced extreme price and volume fluctuations that have often been unrelated to and disproportionate to the operating performance of broadcasting companies. These broad market and industry factors may materially reduce the market price of shares of our Class A common stock, regardless of our operating performance.
Our business could be negatively impacted as a result of shareholder activism.
On January 17, 2017, TCS Capital Management, LLC ("TCS Capital"), a beneficial owner of 7.0% of our shares, filed an amendment to its Schedule 13D disclosing its opinion that the
Company should hire an investment bank to run a process to sell the Company as well as replace current members of the Company's Board of Directors with new directors recommended by TCS Capital. In recent years, shareholder activists, such as TCS Capital, have become involved in numerous public companies. Shareholder activists frequently propose to involve themselves in the governance, strategic direction and operations of the Company. Such proposals may disrupt our business and divert the attention of our management and employees, and any perceived uncertainties as to our future direction resulting from such a situation could result in the loss of potential business opportunities, be exploited by our competitors,
cause concern to our current or potential customers, and make it more difficult to attract and retain qualified personnel and business partners, all of which could adversely affect our business. In addition, actions of activist shareholders may cause significant fluctuations in our stock price based on temporary or speculative market perceptions or other factors that do not necessarily reflect the underlying fundamentals and prospects of our business.
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.