ROKU, INC (ROKU) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes included in Item 8 of this Annual Report. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, beliefs, and expectations, and involve risks and uncertainties. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report, particularly in the section titled Item 1A. Risk Factors and the Note Regarding Forward-Looking Statements.
This section of this Annual Report generally discusses fiscal years 2023 and 2022 and year-to-year comparisons between those years. Discussions of fiscal year 2021 and year-to-year comparisons between fiscal years 2022 and 2021 that are not included in this Annual Report can be found in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of our Annual Report for the fiscal year ended December 31, 2022 filed with the SEC on February 16, 2023.
Overview
Our two reportable segments are the platform segment and the devices segment. Platform revenue is generated from the sale of digital advertising (including direct and programmatic video advertising, media and entertainment promotional spending, and related services) and streaming services distribution (including subscription and transaction revenue shares, the sale of Premium Subscriptions, and the sale of branded app buttons on remote controls). Streaming services distribution was previously referred to as content distribution services.
Devices revenue is generated from the sale of streaming players, Roku-branded TVs (beginning in March 2023), smart home products and services, audio products, and related accessories as well as revenue from licensing arrangements with service operators. We expect to continue to manage the average selling prices of Roku streaming devices to increase our Active Accounts. We expect that the trade off from devices gross profit or loss to grow Active Accounts will result in increased platform revenue and platform gross profit.
During the fiscal year ended December 31, 2023, as part of our continuing evaluation of our operations, we determined to implement additional measures to continue to bring down our year-over-year operating expense growth rate by consolidating our office space utilization, performing a strategic review of our content portfolio, reducing outside services expenses, and slowing our year-over-year headcount expense growth rate through a series of workforce reductions and limiting new hires, among other measures. We recorded a total restructuring charge of $356.1 million during the fiscal year ended December 31, 2023 as a result of these actions. See Note 17 to the consolidated financial statements in Item 8 of this Annual Report for additional details.
Business Conditions and Macroeconomic Factors
Macroeconomic factors, such as increased inflation and interest rates, recessionary fears, financial and credit market fluctuations, changes in economic policy, global supply chain constraints, and geopolitical developments (such as the war in Ukraine and the unrest in the Middle East), have had, and we believe may continue to have, an impact on our business and results of operations. We believe that advertisers in a variety of industries reduce their overall advertising spend when they are impacted by these factors, which in turn adversely affects our platform revenue. Higher inflation and economic uncertainty also lead to a reduction in consumer discretionary spending, which impacts our devices revenue. We believe that the direct and indirect impacts of these business conditions and macroeconomic factors are difficult to isolate or quantify. See Item 1A, Risk Factors, and the Note Regarding Forward Looking Statements elsewhere in this Annual Report for additional details.
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Key Performance Metrics
The key performance metrics we use to evaluate our business, measure our performance, develop financial forecasts and make strategic decisions are gross profit, Active Accounts, Streaming Hours, and ARPU.
Gross Profit
We use gross profit as the primary metric to measure the performance of our business because we have two revenue segments that have different margin profiles, and we aim to maximize our higher margin platform revenue from our Active Accounts as they stream content on our platform. All of our gross profit is generated from our platform segment.
Our gross profit was $1,522.6 million and $1,441.1 million for the years ended December 31, 2023 and 2022, respectively, reflecting an increase of 6%.
Active Accounts
We believe that the number of Active Accounts is a relevant measure to gauge the size of our user base. We define Active Accounts as the number of distinct user accounts that have streamed content on our platform within the last 30 days of the period. Users who streamed content from The Roku Channel only on non-Roku platforms are not included in this metric. Additionally, users who only register an account for use of one of our smart home products are not included in our reported number of Active Accounts. The number of Active Accounts also does not correspond to the number of unique individuals who actively utilize our platform, or the number of devices associated with an account. For example, an Active Account may include more than one individual, such as a family, and one Active Account may include use of multiple Roku streaming devices.
We had 80.0 million and 70.0 million Active Accounts as of December 31, 2023 and 2022, respectively, reflecting an increase of 14%.
Streaming Hours
We believe the number of Streaming Hours on our platform is an effective measure of user engagement and that the growth in the number of hours of content streamed across our platform reflects our success in addressing the growing user demand for TV streaming. We define Streaming Hours as the aggregate amount of time Roku streaming devices stream content on our platform in a given period. Hours streamed from The Roku Channel on non-Roku platforms are not included in this metric. Additionally, smart home products do not contribute to our Streaming Hours. We report Streaming Hours on a calendar basis.
Additionally, we believe that over time, increasing user engagement on our streaming platform increases our platform monetization because we earn platform revenue from various forms of user engagement, including advertising, as well as revenue shares from subscriptions and transactional video on-demand. However, our revenue from content partners is not tied to the hours streamed on their streaming apps, and the number of Streaming Hours does not correlate to revenue earned from such content partners or ARPU on a period-by-period basis. Moreover, Streaming Hours on our platform are measured whenever a Roku streaming device is streaming content, whether a viewer is actively watching or not. For example, if a Roku player is connected to a TV, and the viewer turns off the TV, steps away, or falls asleep and does not stop or pause the player, then the particular streaming app may continue to play content for a period of time determined by the streaming app. We believe that this also occurs across a wide variety of non-Roku streaming devices and other set-top boxes.
Since the first quarter of 2020, all of our Roku streaming devices include a Roku OS feature that is designed to identify when content has been continuously streaming on an app for an extended period of time without user interaction. This feature, which we refer to as “Are you still watching,” periodically prompts the user to confirm that they are still watching the selected app and closes the app if the user does not respond affirmatively. We believe that the implementation of this feature across the Roku platform benefits us, our customers, content partners, and advertisers. Some of our leading content partners, including Netflix, also have implemented similar features within their apps. This Roku OS feature supplements these app features. This feature has not had and is not expected to have a material impact on our future financial performance.
We streamed 106.0 billion and 87.4 billion hours during the years ended December 31, 2023 and 2022, respectively, reflecting an increase of 21%.
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Average Revenue per User
We measure our platform monetization progress with ARPU, which we believe represents the inherent value of our business. We define ARPU as our platform revenue for the trailing four quarters divided by the average of the number of Active Accounts at the end of the current period and the end of the corresponding period in the prior year. ARPU measures the rate at which we are monetizing our Active Accounts base and the progress of our platform business.
ARPU was $39.92 as of December 31, 2023 as compared to $41.68 as of December 31, 2022, reflecting a decrease of 4%. The decrease in ARPU is due to an increasing share of Active Accounts in international markets where we are currently focused on growing scale and engagement, rather than monetization of our streaming platform.
Components of Results of Operations
Revenue
Platform Revenue
We generate platform revenue from the sale of digital advertising (including direct and programmatic video advertising, media and entertainment promotional spending, and related services) and streaming services distribution (including subscription and transaction revenue shares, the sale of Premium Subscriptions, and the sale of branded app buttons on remote controls). Our ad inventory includes video ad inventory from AVOD content in The Roku Channel, native display ads on our home screen and screen saver, as well as ad inventory we obtain through our streaming services distribution agreements with our content partners. To supplement supply, we purchase advertising inventory from our content partners, on an as needed basis. To date, we have generated most of our platform revenue in the United States.
Devices Revenue
We generate devices revenue from the sale of streaming players, Roku-branded TVs, smart home products and services, audio products, and related accessories. Our devices revenue also includes licensing arrangements with service operators. We generate most of our devices revenue in the United States. In our international markets, we primarily sell our devices through wholesale distributors which, in turn, sell to retailers.
Cost of Revenue
Cost of Revenue, Platform
Cost of revenue, platform primarily consists of costs associated with acquiring advertising inventory and amortization costs of content, both licensed and produced, and revenue share with content partners. Cost of revenue, platform also includes other costs such as payment processing fees, allocated expenses associated with the delivery of our services that primarily include costs of third-party cloud services and salaries, benefits, and stock-based compensation for our customer support and platform operations personnel, and amortization of acquired developed technology.
Cost of Revenue, Devices
Cost of revenue, devices is comprised mostly of manufacturing costs payable to third party manufacturers for devices we sell which include streaming players, Roku-branded TVs, audio products and smart home products. Cost of revenue, devices also includes technology licenses or royalty fees on devices we sell, inbound and outbound freight, duty and logistics costs, third-party packaging, inventory provisions, and allocated overhead costs related to facilities, third-party cloud services, customer support, and salaries, benefits, and stock-based compensation for operations personnel.
Operating and Other Expenses
Research and Development
Research and development expenses consist primarily of salaries, benefits, and stock-based compensation for our development teams as well as outsourced development expenses. In addition, research and development expenses include allocated facilities and overhead expenses.
Sales and Marketing
Sales and marketing expenses consist primarily of salaries, benefits, commissions, and stock-based compensation for our employees engaged in sales and sales support, marketing, communications, data science and analytics, business development, product management, and partner support functions. Sales and marketing expenses also include marketing, retail and merchandising expenses, and allocated facilities and overhead expenses.
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General and Administrative
General and administrative expenses consist primarily of salaries, benefits, and stock-based compensation for our finance, legal, information technology, human resources, and other administrative personnel. General and administrative expenses also include outside legal, accounting, and other professional service fees as well as allocated facility and overhead expenses.
Other Income, Net
For the years ended December 31, 2023 and 2022, other income, net consists of interest income on cash and cash equivalents, income recognized related to non-cash consideration associated with the delivery of services as part of a strategic commercial arrangement, interest expense that includes interest on our debt and amortization of deferred debt costs, foreign currency re-measurement, transaction gains and losses, and net change in the fair value of the Strategic Investment (as defined in Note 7 to the consolidated financial statements in Item 8 of this Annual Report).
Income Tax Expense
Our income tax expense consists primarily of income taxes in certain foreign jurisdictions where we conduct business and income taxes in the United States. We have a full valuation allowance for deferred tax assets, including net operating losses primarily for the U.S. and any jurisdiction where we do not expect to realize their benefits in the future. We expect to maintain this valuation allowance for the foreseeable future.
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Results of Operations
The following table sets forth selected consolidated statements of operations data as a percentage of total revenue for each of the periods indicated.
| Years Ended December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | 2021 | ||||||
| Net Revenue: | ||||||||
| Platform | 86 | % | 87 | % | 82 | % | ||
| Devices | 14 | % | 13 | % | 18 | % | ||
| Total net revenue | 100 | % | 100 | % | 100 | % | ||
| Cost of Revenue: | ||||||||
| Platform | 41 | % | 38 | % | 30 | % | ||
| Devices | 15 | % | 16 | % | 19 | % | ||
| Total cost of revenue | 56 | % | 54 | % | 49 | % | ||
| Gross Profit (Loss): | ||||||||
| Platform | 45 | % | 49 | % | 52 | % | ||
| Devices | (1) | % | (3) | % | (1) | % | ||
| Total gross profit | 44 | % | 46 | % | 51 | % | ||
| Operating Expenses: | ||||||||
| Research and development | 25 | % | 25 | % | 17 | % | ||
| Sales and marketing | 30 | % | 27 | % | 16 | % | ||
| General and administrative | 12 | % | 11 | % | 9 | % | ||
| Total operating expenses | 67 | % | 63 | % | 42 | % | ||
| Income (Loss) from Operations | (23) | % | (17) | % | 9 | % | ||
| Other Income, Net: | ||||||||
| Interest expense | — | % | — | % | — | % | ||
| Other income, net | 3 | % | 1 | % | — | % | ||
| Total other income, net | 3 | % | 1 | % | — | % | ||
| Income (Loss) Before Income Taxes | (20) | % | (16) | % | 9 | % | ||
| Income tax expense (benefit) | — | % | — | % | — | % | ||
| Net Income (Loss) | (20) | % | (16) | % | 9 | % |
Comparison of Years Ended December 31, 2023 and 2022
Net Revenue
| Years Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change $ | Change % | |||||||||||
| (in thousands, except percentages) | ||||||||||||||
| Platform | $ | 2,994,105 | $ | 2,711,441 | $ | 282,664 | 10 | % | ||||||
| Devices | 490,514 | 415,093 | 75,421 | 18 | % | |||||||||
| Total net revenue | $ | 3,484,619 | $ | 3,126,534 | $ | 358,085 | 11 | % |
Platform
Platform revenue increased by $282.7 million, or 10%, during the year ended December 31, 2023 as compared to the year ended December 31, 2022, primarily due to an increase in revenue from streaming services distribution, such as revenue share on content subscriptions and Premium Subscriptions through The Roku Channel, which was offset by slightly lower revenue from advertising driven primarily by weakness in media and entertainment promotional spending.
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Devices
Devices revenue increased by $75.4 million, or 18%, during the year ended December 31, 2023 as compared to the year ended December 31, 2022. $10.0 million of the increase was due to a change in estimated transaction price for a licensing arrangement with a service operator for which performance obligations were satisfied in prior periods and was recognized as revenue during the three months ended March 31, 2023. The remaining increase was driven primarily by the sales of Roku-branded TVs introduced in March 2023 and to a lesser extent by the sales of smart home products, partially offset by lower revenue from sales of streaming players. The volume of streaming players sold decreased by 8% and the average selling price of streaming players increased by 1% during the year ended December 31, 2023 as compared to the year ended December 31, 2022.
Cost of Revenue and Gross Profit
| Years Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change $ | Change % | |||||||||||
| (in thousands, except percentages) | ||||||||||||||
| Cost of Revenue: | ||||||||||||||
| Platform | $ | 1,427,546 | $ | 1,179,675 | $ | 247,871 | 21 | % | ||||||
| Devices | 534,458 | 505,737 | 28,721 | 6 | % | |||||||||
| Total cost of revenue | $ | 1,962,004 | $ | 1,685,412 | $ | 276,592 | 16 | % | ||||||
| Gross Profit (Loss): | ||||||||||||||
| Platform | $ | 1,566,559 | $ | 1,531,766 | $ | 34,793 | 2 | % | ||||||
| Devices | (43,944) | (90,644) | 46,700 | (52) | % | |||||||||
| Total gross profit | $ | 1,522,615 | $ | 1,441,122 | $ | 81,493 | 6 | % |
Platform
The cost of revenue, platform increased by $247.9 million, or 21%, during the year ended December 31, 2023 as compared to the year ended December 31, 2022. The increase of $182.4 million was primarily driven by higher costs of acquiring content, higher costs of Premium Subscriptions, and higher credit card processing fees, partially offset by lower content asset amortization and lower cost of advertising inventory. The cost of revenue, platform also includes restructuring charges of $67.0 million of which $65.5 million consisted of impairment charges related to removing selected content assets from The Roku Channel.
Gross profit for the platform segment increased by $34.8 million, or 2%, during the year ended December 31, 2023 as compared to the year ended December 31, 2022, primarily driven by the overall growth in our platform revenue.
Devices
The cost of revenue, devices increased by $28.7 million, or 6%, during the year ended December 31, 2023 as compared to the year ended December 31, 2022. The increase was primarily driven by higher manufacturing costs of $8.7 million, higher royalties of $8.6 million, higher inventory provision of $2.2 million, and higher other device related costs such as product warranties and overhead cost allocation of $9.3 million, offset by lower freight costs of $3.5 million. The increase in manufacturing costs was driven primarily by the cost of Roku-branded TVs that we began selling in March 2023 and the cost of smart home products. The cost of revenue, devices also includes restructuring charges of $3.3 million that consist of employee severance, facilities exit costs, and asset impairments.
Gross loss for the devices segment decreased by $46.7 million, or 52%, during the year ended December 31, 2023 as compared to the year ended December 31, 2022. The gross loss was driven by a higher cost of manufacturing of products in the devices segment as compared to the revenue generated from them. We manage the average selling prices of our products to increase our Active Accounts.
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Operating Expenses
| Years Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change $ | Change % | |||||||||||
| (in thousands, except percentages) | ||||||||||||||
| Research and development | $ | 878,474 | $ | 788,913 | $ | 89,561 | 11 | % | ||||||
| Sales and marketing | 1,033,359 | 838,419 | 194,940 | 23 | % | |||||||||
| General and administrative | 403,159 | 344,678 | 58,481 | 17 | % | |||||||||
| Total operating expenses | $ | 2,314,992 | $ | 1,972,010 | $ | 342,982 | 17 | % |
Research and development
Research and development expenses increased by $89.6 million, or 11%, during the year ended December 31, 2023 as compared to the year ended December 31, 2022. The increase was primarily driven by higher restructuring charges of $90.9 million comprised of asset impairments, facilities exit costs, and employee severance. In addition, the increase includes higher office facilities and IT infrastructure expenses of $7.9 million, offset by lower consulting expenses of $6.6 million and lower personnel-related expenses of $3.0 million.
Sales and marketing
Sales and marketing expenses increased by $194.9 million, or 23%, during the year ended December 31, 2023 as compared to the year ended December 31, 2022. The increase was primarily driven by higher restructuring charges of $102.8 million comprised of asset impairments, facilities exit costs, and employee severance. In addition, the increase includes higher marketing, retail, and merchandising expenses of $89.7 million, and higher office facilities and IT infrastructure expenses of $11.3 million, offset by lower consulting expenses of $4.8 million, lower other sales and marketing expenses of $2.7 million, and lower personnel-related expenses of $1.5 million.
General and administrative
General and administrative expenses increased by $58.5 million, or 17%, during the year ended December 31, 2023 as compared to the year ended December 31, 2022. The increase was primarily driven by higher restructuring charges of $53.9 million comprised of asset impairments, facilities exit costs, and employee severance. In addition, the increase includes higher personnel-related expenses of $5.5 million, and higher office facilities and IT infrastructure expenses of $2.3 million, offset by lower legal, consulting, and professional services expenses of $4.8 million.
Other Income, Net
| Years Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change $ | Change % | |||||||||||
| (in thousands, except percentages) | ||||||||||||||
| Interest expense | $ | (730) | $ | (5,161) | $ | 4,431 | (86) | % | ||||||
| Other income, net | 93,677 | 43,766 | 49,911 | 114 | % | |||||||||
| Total other income, net | $ | 92,947 | $ | 38,605 | $ | 54,342 | 141 | % |
Other income, net
Total other income, net, increased by $54.3 million, or 141%, during the year ended December 31, 2023 as compared to the year ended December 31, 2022. The increase was primarily driven by an increase in interest income of $51.0 million from higher interest rates on our cash balances, an increase in other income of $8.6 million that includes income recognized related to non-cash consideration associated with the delivery of services as part of a strategic commercial arrangement and an unrealized gain in the fair value of the Strategic Investment, and a reduction in interest expense of $4.4 million as the Credit Facility (as defined below) was fully repaid in February 2023, offset by an increase in foreign exchange losses of $9.7 million due to fluctuation in exchange rates.
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Income Tax Expense
| Years Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change $ | Change % | |||||||||||
| (in thousands, except percentages) | ||||||||||||||
| Income tax expense | $ | 10,131 | $ | 5,722 | $ | 4,409 | 77 | % |
Income tax expense
Income tax expense increased by $4.4 million, or 77%, for the year ended December 31, 2023 as compared to the year ended December 31, 2022. The increase was driven by the increases in foreign taxes primarily due to the increase of taxable earnings in our foreign operations.
Liquidity and Capital Resources
As of December 31, 2023, we had cash and cash equivalents of $2,025.9 million. Approximately 4% of our cash was held outside the United States in accounts held by our foreign subsidiaries, which are used to fund foreign operations.
Our primary sources of cash are receipts from platform and devices revenue. The primary uses of cash are costs of revenue including costs to acquire advertising inventory, costs to license and produce content, third-party manufacturing costs for our products, as well as operating expenses such as personnel-related expenses including employee termination payments, consulting and professional service expenses, facility expenses, and marketing expenses. Other uses of cash include purchases of property and equipment and mergers and acquisitions.
We have pursued merger and acquisition activities in the past, and we may pursue additional merger and acquisition activities in the future, including the acquisition of rights to programming and content assets. Though we do not expect to incur expenses for facilities and building related costs at the same level as the last few fiscal years, we will continue to incur expenses on the maintenance of our facilities and purchases of computer systems, and other property and equipment, in order to support future growth in our business. These activities may materially impact our liquidity and capital resources.
We believe our existing cash and cash equivalents balance will be sufficient to meet our working capital, capital expenditures, and material cash requirements from known contractual obligations for the next twelve months and beyond. Our future capital requirements, the adequacy of available funds, and cash flows from operations could be affected by various risks, uncertainties, including, but not limited to, those detailed in Item 1A, Risk Factors in this Annual Report and the effects of the current macroeconomic environment. While the current macroeconomic environment has not severely impacted our liquidity and capital resources to date, it has contributed to disruption and volatility in local economies and in capital and credit markets, which could adversely affect our liquidity and capital resources in the future.
We may attempt to raise additional capital through the sale of equity securities or other financing arrangements. If we raise additional funds by issuing equity, the ownership of our existing stockholders will be diluted. If we raise additional financing by the incurrence of indebtedness, we may be subject to fixed payment obligations and also to restrictive covenants. Additionally, due to the current macroeconomic environment, we may be unable to obtain debt or equity financing on terms that are acceptable to us.
Senior Secured Term Loan A and Revolving Credit Facilities
On February 19, 2019, we entered into a Credit Agreement with Morgan Stanley Senior Funding, Inc. (as amended on May 3, 2019, the “Credit Agreement”), which provided for (i) a four-year revolving credit facility in the aggregate principal amount of up to $100.0 million (the “Revolving Credit Facility”), (ii) a four-year delayed draw term loan A facility in the aggregate principal amount of up to $100.0 million (the “Term Loan A Facility”), and (iii) an uncommitted incremental facility subject to certain conditions (together with the Revolving Credit Facility and the Term Loan A Facility, collectively, the “Credit Facility”).
On November 18, 2019, we borrowed an aggregate principal amount of $100.0 million from the Term Loan A Facility. We elected an interest rate equal to the adjusted one-month LIBOR rate plus an applicable margin of 1.75% based on our secured leverage ratio. The Credit Facility matured on February 19, 2023 and the outstanding Term Loan A Facility was repaid in full.
As of December 31, 2022, we had outstanding letters of credit against the Revolving Credit Facility of $37.7 million. Upon maturity of the Credit Facility on February 19, 2023, the outstanding letters of credit were secured by our existing cash balance, a portion of which is restricted for that purpose. As of December 31, 2023, we had outstanding letters of credit of $37.5 million, which are secured by restricted cash of $40.7 million.
See Note 10 to the consolidated financial statements in Item 8 of this Annual Report for additional details.
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Cash Flows
The following table summarizes our cash flows for the periods presented (in thousands):
| Years Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||
| Consolidated Statements of Cash Flows Data: | ||||||
| Cash flows provided by operating activities | $ | 255,856 | $ | 11,795 | ||
| Cash flows used in investing activities | $ | (92,619) | $ | (201,696) | ||
| Cash flows (used in) provided by financing activities | $ | (61,243) | $ | 8,357 |
Cash Flows from Operating Activities
Our operating activities provided cash of $255.9 million for the year ended December 31, 2023. Our net loss of $709.6 million for the year ended December 31, 2023 was adjusted by non-cash charges of $972.7 million comprised mainly of stock-based compensation, amortization of content assets, depreciation and amortization of property and equipment and intangible assets, amortization of operating right-of-use assets, impairment of assets as part of restructuring charges, and change in fair value of the Strategic Investment.
The changes in our operating assets and liabilities used cash totaling $7.3 million mainly due to payments made to acquire content, payments made for operating leases liabilities, and an increase in the accounts receivable balance at the end of the year due to higher revenue, offset by an increase in accounts payable and accrued liabilities due to timing of payments, an increase in deferred revenue, a decrease in prepaid expenses, and a decrease in inventory balances at the end of fiscal 2023.
Cash Flows from Investing Activities
Our investing activities for the year ended December 31, 2023 included cash outflows of $92.6 million consisting of purchases of property and equipment and expenditures related to the expansion of our office facilities of $82.6 million and an additional investment in the Strategic Investment of $10.0 million.
Cash Flows from Financing Activities
Our financing activities used cash of $61.2 million for the year ended December 31, 2023. The cash outflow related primarily to the repayment of $80.0 million of our Credit Facility that became due in February 2023 offset by $18.8 million received from proceeds from the exercise of employee stock options.
Material Cash Requirements from Known Contractual Obligations
Our material cash requirements from known contractual obligations as of December 31, 2023 consisted of:
•Commitments to purchase finished goods from our contract manufacturers and other inventory related items. Consistent with industry practices, we enter into firm, non-cancelable, and unconditional purchase commitments with our contract manufacturers to acquire products through a combination of purchase orders, supplier contracts, and open orders based on projected demand information. Our contract manufacturers source components and build our products based on these demand forecasts. Changes to projected demand or in the subsequent sales mix of our products may result in us being committed to purchase excess inventory to satisfy these commitments. For additional information regarding manufacturing purchase commitments, see Note 12 to the consolidated financial statements in Item 8 of this Annual Report.
•Commitments to license content from content partners and produce content under contractual arrangements. For additional information regarding content commitments, see Note 12 to the consolidated financial statements in Item 8 of this Annual Report.
•Operating lease liabilities that are included in our consolidated balance sheets and liabilities related to the lease arrangements that have not yet commenced. For additional information regarding our lease liabilities, see Note 9 to the consolidated financial statements in Item 8 of this Annual Report. Our restructuring efforts to consolidate office space did not materially change our operating lease obligations.
The contractual commitments discussed above are associated with agreements that are enforceable and legally binding. Obligations under contracts that we can cancel without a significant penalty are not included above.
In addition, we have $6.2 million of uncertain tax positions as of December 31, 2023. We adjust these positions when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. We are unable to accurately predict when these amounts will be realized or released. Although we believe we have adequately provided for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be materially different.
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Critical Accounting Estimates
Our financial statements are prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. These estimates and assumptions are based on historical experience, current trends and other factors that we believe to be reasonable at the time our consolidated financial statements are prepared. We evaluate our estimates and assumptions on an ongoing basis. Our actual results could differ from these estimates.
The critical accounting policies requiring estimates, assumptions, and judgments that we believe have the most significant impact on our financial statements are described below.
Revenue Recognition
Our contracts with customers often include promises to transfer multiple products and services to a customer. Judgment may be required in determining whether products contain multiple distinct performance obligations and whether each should be accounted for separately or as one combined performance obligation.
For arrangements with multiple performance obligations, we allocate revenue to each distinct performance obligation based on its relative stand-alone selling price (“SSP”). Our process for determining SSP requires judgment. For performance obligations routinely sold separately, we consider multiple factors that may vary over time depending upon the unique facts and circumstances related to each performance obligation. We determine SSP based on prices charged to customers for individual products, taking into consideration other factors, which may include (i) historical and expected discounting practices, (ii) the size, and volume of transactions, (iii) the geographic areas in which our products are sold, and (iv) our overall go-to-market strategy. For those performance obligations that are not routinely sold separately, we determine SSP using information that may include market conditions and other observable inputs.
When arrangements have variable consideration, we utilize the expected value method to estimate the amount expected to be received. The amount of variable consideration that is included in the transaction price is constrained to the extent that it is probable a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period. The estimate of the variable consideration is based on the assessment of historical, current, and forecasted performance noted and expected from the performance obligation.
The transaction price in some of our arrangements include non-cash consideration. We determine the fair value of non-cash consideration at contract inception by using historical internal and observable third-party data.
For the sale of third-party goods and services, we evaluate whether we are the principal, and report revenue on a gross basis, or an agent, and report revenue on a net basis. In this assessment, we consider if we obtain control of the specified goods or services before they are transferred to the customer, as well as other indicators such as the party primarily responsible for fulfillment, inventory risk, and discretion in establishing price.
Our devices revenue includes allowances for returns and sales incentives in the estimated transaction price.
Amortization of Content Assets
The amortization expense for content assets (licensed and produced) is based on projected monetization of such content which results in accelerated or straight-lined patterns depending on the nature of the content. Judgment is required to determine the amortization patterns of our content assets which are monetized as a group. Critical judgments include: (i) the predominant monetization strategy of content, (ii) the grouping of content with similar characteristics, and (iii) the application of historical viewership model and projected decay. These judgments and underlying analysis are reviewed regularly and adjusted as needed on a prospective basis.
Impairment of Long-Lived Assets
We review long-lived assets, including property and equipment, right-of-use assets, and intangible assets with finite lives whenever events or changes in circumstances indicate the carrying amount of the asset or asset group to which it relates may not be recoverable. If such facts and circumstances indicate an asset or asset group’s carrying amount may not be recoverable, we assess its recoverability by comparing the projected undiscounted net cash flows directly associated with the use and eventual disposition of the asset or asset group against their respective carrying amounts. If the asset or asset group is not recoverable, an impairment loss is recognized based on the excess of the carrying amount over the fair value of the asset or asset group.
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During the year ended December 31, 2023, we recognized an impairment charge of $131.6 million for operating lease right-of-use assets and an impairment charge of $72.3 million for property and equipment related to a decision to sub-lease and cease the use of certain office facilities and related property and equipment. The impairment was a result of the restructuring efforts announced in the third quarter of fiscal year 2023. See Note 17 for additional details. There were no impairments of property and equipment, right-of-use assets, and intangible assets with finite lives during the years ended December 31, 2022 and December 31, 2021.
Significant judgments and estimates included in the determination of the fair value of the assets were identification of events or changes in circumstances necessitating an impairment assessment, the expected downtime prior to the commencement of future subleases, projected sublease income over the remaining lease periods, and discount rates that reflect the level of risk associated with the expected future cash flows.
Allowances for Sales Returns and Sales Incentives
Our accounts receivable is stated at invoice value less estimated allowances that include allowance for sales returns and sales incentives. We perform an ongoing analysis of various factors including our historical experience, promotional programs, claims to date, and other business factors to determine the allowances for sales returns and sales incentives. If our estimates regarding accounts receivable allowances differ from the actual results, the losses or gains could be material.
Provision for Income Taxes
We are subject to income taxes in the U.S. and foreign jurisdictions. We account for income taxes using the asset and liability method. Under this method, deferred income tax assets and liabilities are determined based upon the difference between the consolidated financial statement carrying amounts and the tax basis of assets and liabilities and are measured using the enacted tax rate expected to apply to taxable income in the years in which the differences are expected to be reversed.
In determining the need for a valuation allowance, we assess both positive and negative evidence in the various jurisdictions to determine whether it is more likely than not that our deferred tax assets are recoverable. We regularly assess all available evidence, including cumulative historic losses and forecasted earnings. A valuation allowance is established when it is more likely than not that the deferred tax assets will not be realized. We have established a full valuation allowance for our U.S. and Netherlands net deferred tax assets due to the uncertainty of realizing future tax benefits from our net operating loss carry-forwards and other deferred tax assets. A change in the assessment of the realizability of deferred tax assets may materially impact our tax provision in the period in which a change of assessment occurs. Release of the valuation allowance would result in the recognition of U.S. federal and state deferred tax assets and a corresponding decrease to income tax expense in the period the release is recorded.
Recent Accounting Pronouncements
The recent accounting pronouncements are discussed and included in Note 2 to the consolidated financial statements in Item 8 of this Annual Report. They are incorporated herein by reference.