ROKU, INC 10-K

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 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 Report on Form 10-K, particularly in the section titled Item 1A. Risk Factors and the Note Regarding Forward-Looking Statements. This section of this Form 10-K generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the Company's Report on Form 10-K for the fiscal year ended December 31, 2019 filed with the SEC on March 2, 2020. Overview We operate in two revenue segments: the platform segment and the player segment. Platform revenue is generated from the sale of digital advertising and related services, content distribution services, subscription and transaction revenue shares, Premium Subscriptions, billing services, sale of branded channel buttons on remote controls and licensing arrangements with service operators and TV brands. Player revenue is generated primarily from the sale of streaming players. We expect to continue to manage the average selling prices (“ASP”) of our streaming players to increase our active accounts. As a result, player revenues may not increase as they have historically. We expect that the tradeoff from player gross profit to grow active accounts will result in increased platform monetization and gross profit. COVID-19 Update The widespread global impact from the outbreak and spread of the novel strain of coronavirus referred to as COVID-19, which was declared a pandemic by the World Health Organization in March 2020, continued through the end of 2020. Precautionary measures to slow down the spread of the virus that were put in place by governmental authorities had eased in many locations but were re-instated in many geographies during the fourth quarter. We continue to have the majority of our workforce work from home to protect the health and safety of our employees and travel has been severely curtailed. The COVID-19 pandemic, and the resulting precautionary measures, have caused, and are expected to continue to cause, economic uncertainty both in the U.S. and globally as well as significant volatility in, and disruption to, financial markets. During the fourth quarter of 2020, the ongoing COVID-19 pandemic continued to accelerate the shift of TV viewing away from traditional pay TV to streaming TV resulting in a faster growth of our active accounts and an increase in streaming hours. Although the growth in streaming hours per account moderated during the third quarter, streaming hours per account accelerated again during the fourth quarter to 17.0 billion hours. Despite advertising slowdown during the second quarter that we experience as a result of the COVID-19 pandemic, during the fourth quarter we had strong platform revenue growth driven by advertising spend and the expansion of content distribution partnerships. We believe advertising budgets will continue to shift from traditional linear TV to streaming TV and that we will benefit from this shift due to our advanced advertising capabilities. Major content publishers continue to re-organize around streaming and as a result, our content distribution business has benefited as our rapid rate of active accounts growth was accompanied by strong consumer demand for ad-supported viewing, subscription services and premium movie rentals. While we have experienced an increase in TV streaming during the COVID-19 pandemic and our business generally has generally, there can be no assurance that these patterns will continue into 2021. Despite the adverse impact COVID-19 pandemic has had on global supply chains, we have largely been able to maintain inventory of our players, audio products and accessories in stock at retailers and online stores. During the fourth quarter, player sales moderated due to the impact of ongoing COVID-19 pandemic restrictions and ongoing economic uncertainty on holiday sales and consumer demand. While our player and Roku TV model sales have remained strong during the COVID-19 pandemic, there can be no assurance that these patterns will continue throughout the pandemic or beyond. 56 Although the COVID-19 pandemic’s impact on our future operations and financial performance remains uncertain, we are continuing to monitor our operating expenses and capital expenditures and are committed to investing in strategic areas to grow our business and extend our competitive advantages. 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. The majority of our gross profit is generated from our platform segment. Our gross profit was $808.2 million and $495.2 million for the years ended December 31, 2020 and 2019, respectively. 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. 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, a single account may be used by more than one individual, such as a family, and one account may be used on multiple streaming devices. We had 51.2 million and 36.9 million active accounts as of December 31, 2020 and 2019, respectively. During 2020, the fastest growing source of new accounts was licensing arrangements with our Roku TV brand partners and other service operators, which collectively accounted for 62% of new accounts, up from 56% in 2019. Hours Streamed 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 streaming devices stream content on our platform in a given period. Hours streamed on non-Roku platforms are not included in this metric. 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, revenue shares from subscriptions and transactional video on-demand. However, our revenue from content publishers is not tied to the hours streamed on their streaming channels, and the number of streaming hours does not correlate to revenue earned from such content publishers or ARPU on a period-by-period basis. Moreover, streaming hours on our platform are measured whenever a Roku player or a Roku TV 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 channel may auto-play subsequent content for a period of time determined by the streaming channel. We believe that this also occurs across a wide variety of non-Roku streaming devices and other set-top boxes. During the first quarter of 2020, we completed the deployment across all of our devices of a new Roku OS feature that is designed to identify when content has been continuously streaming on a channel 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 channel and closes the channel if the user does not respond affirmatively. We believe that the implementation of this feature across the Roku platform benefits us, our customers, channel partners and advertisers. Some of our leading channel partners, including Netflix, also have implemented similar features within 57 their channels. This Roku OS feature supplements these channel features. This feature has not had and is not expected to have a material impact on our future financial performance. We streamed 58.7 billion and 37.8 billion hours during the years ended December 31, 2020 and 2019, respectively. Note About Our Streaming Hours Adjustments To calculate and report our streaming hours, we utilize data from event logs generated by the firmware running on the Roku devices that are recorded in a central database. The event information (play, pause, stop, time counts, etc.) is generated by the firmware running on the Roku streaming devices, and event data is transmitted to our central database at regular intervals when a device is connected to the internet. Pause time is not intended to be included in streaming hours. During the second quarter of 2020 we discovered that some pause time was inadvertently included in the streaming hours information recorded in our central database. Upon discovering these errors in the log data, we promptly reviewed and analyzed the issue utilizing our firmware, data engineering and core analytics teams. We concluded that certain past Roku OS releases inadvertently caused the logging errors. The error rates varied over time and across different types of devices and firmware versions. As a result, we reported higher streaming hours and streaming hours growth rates for the affected periods than we would have if all pause time had been excluded from streaming hours as we had intended. Neither these logging errors, nor the resulting adjustments that we made to our streaming hours calculations, has had any impact on our financial results, and do not require us to revise any of our previously reported key operating metrics other than streaming hours. The affected log data was for the periods from February 2016 to August 2020. After adjusting for logging errors, we estimate that our streaming hours were, on average, approximately 0.5% lower than previously reported for the period January 2017 through September 2018, and approximately 5.8% lower for the period October 2018 through March 2020. By the end of August 2020, we fully deployed a software update that addressed the root cause of the pause time logging errors and prevented them from continuing. The roll out of the “Are you still watching” feature had no impact on the adjustments we made to our streaming hours calculations. While our revenue from content publishers is not based on the hours streamed on their streaming channels, and the number of streaming hours does not directly correlate to revenue earned from such content publishers or ARPU on a period-by-period basis; we believe 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. After adjusting our streaming hours as discussed above, our estimated year-over-year streaming hour growth rates for fiscal year 2018 versus fiscal year 2017, fiscal year 2019 versus fiscal year 2018 and the first quarter of 2020 versus the first quarter of 2019 were 60.5%, 59.3% and 46.8%, respectively. The estimated year-over-year streaming hour growth rate for the second quarter of 2020 versus the second quarter of 2019 was 65%. The following table presents the estimated impacts on streaming hours (in billions) for periods from January 1, 2017 through March 31, 2020 and streaming hours growth rates on a year-over-year (“YoY”) basis by quarter for periods from January 1, 2018 through March 31, 2020 and annually for fiscal year 2018 and 2019. Revised streaming hours for 2016 are not estimated and therefore revised 2017 YoY growth rates are not available. 58 Quarter Published SHs Revised SHs SHs % Delta Published YoY Revised YoY 2017 Q1 3.3B 3.2B -0.5% 63.4% NA 2017 Q2 3.5B 3.5B -0.4% 60.0% NA 2017 Q3 3.8B 3.8B -0.4% 57.8% NA 2017 Q4 4.3B 4.3B -0.2% 55.3% NA 2018 Q1 5.1B 5.1B -0.5% 56.0% 56.1% 2018 Q2 5.5B 5.4B -0.5% 57.2% 57.0% 2018 Q3 6.2B 6.1B -0.7% 62.7% 62.1% 2018 Q4 7.3B 7.1B -2.2% 68.6% 65.2% 2019 Q1 8.9B 8.4B -5.4% 74.1% 65.5% 2019 Q2 9.4B 8.8B -6.0% 72.1% 62.6% 2019 Q3 10.3B 9.6B -6.5% 67.6% 57.9% 2019 Q4 11.7B 10.9B -6.3% 60.2% 53.7% 2020 Q1 13.2B 12.3B -7.0% 49.3% 46.8% Year Published SHs Revised SHs SHs % Delta Published YoY Revised YoY 2017 14.8B 14.8B -0.4% 58.8% NA 2018 24.0B 23.7B -1.1% 61.7% 60.5% 2019 40.3B 37.8B -6.1% 67.8% 59.3% 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 account base and the progress of our platform business. ARPU was $28.76 as of December 31, 2020 as compared to $23.14 as of December 31, 2019. Factors Affecting Our Performance Rate of TV streaming and advertising shift to OTT Consumers have significantly shifted their TV viewing behavior, and we believe that someday all TV content will be streamed. We also believe this presents a large market opportunity for digital advertising. This shift in viewing behavior is a critical component of our business model because our platform revenue and player revenue, as well as our overall expense structure, is dependent on this shift. In addition, the number of hours streamed on our platform is a critical element of our business because user engagement with our platform generates our advertising inventory and determines our advertising sell through. User acquisition strategy We acquire users through three primary ways: our TV brand partners sell Roku TVs through our Roku TV licensing program, we sell streaming players, and we have licensing relationships with service operators. We monetize our user base through platform revenue. Player revenue and player gross profit have decreased, and may continue to decrease, over time as we strategically aim to acquire new users through the sale of lower priced streaming players. Ability to monetize users and streaming hours Our business model is to increase both active accounts and streaming hours while growing revenue and gross profit through the monetization of our streaming platform. We believe we have a significant opportunity to grow platform revenue as we further monetize our users’ engagement. Our platform makes it easy for content publishers to distribute and monetize their streaming content through three primary business models: transaction video on demand (“TVOD”) that includes channels that offer a la carte movie purchases or rentals, subscription video on demand (“SVOD”) that includes subscriptions to individual video on demand channels and so-called virtual multichannel video programming distribution services, and advertising supported video on demand (“AVOD”) that includes channels that do not charge a subscription 59 fee to users. We generate revenue from TVOD and SVOD channels from various forms of revenue sharing arrangements. Our revenue sharing arrangements generally apply to new subscriptions for accounts that sign up for new services and to movie rentals or purchases for TVOD. Through our platform we also are able to offer content partners with billing services which support in-channel purchases including movie purchases, rentals, and subscriptions. Revenue from the distribution of AVOD channels is generated through the sale of advertising within the channel. We are increasing the monetization of these streaming hours by expanding our advertising capabilities both on and off our platform. We intend to continue to leverage our data and analytics to deliver relevant advertising and improve the ability of our advertisers to optimize their campaigns and measure their results. We also plan to continue to expand our direct sales teams to increase the number of advertisers who use our services. The Roku Channel offers free, ad-supported access for users to a selection of films, television series and other content. The Roku Channel is a source of digital advertising inventory under our control and is another way that we connect content publishers with users. The Roku Channel provides customers with free access to over 50,000 titles, including hit Hollywood movies, TV episodes, news channels and more and is rapidly becoming one of our leading sources of advertising inventory. In January 2019, we launched Premium Subscriptions within The Roku Channel, through which we resell ad-free premium content subscription services from providers such as Showtime, Starz, and Epix. Continued investment in growth We believe that our future performance will depend on the success of the investments in our business that we have made, and will continue to make, to improve the value for users, content publishers and advertisers on our platform. We must regularly update and enrich our platform to meet evolving consumer behavior and deliver a superior experience for our users, content publishers and advertisers. Further, it is important that we remain a platform for content delivery and invest to provide content publishers with best-in-class publishing tools and actionable audience insights. We must continue to innovate and invest in our advertising capabilities and technology so that we attract and encourage incremental advertising spend on our platform. Accordingly, we plan to continue investing in our business to enhance our competitive differentiation and seed future growth. In particular, these investments will include: Research and Development initiatives to bring new features, technology, and content to our platform; Sales and Marketing efforts to drive increased scale and engagement of our user base; and building out our General and Administrative infrastructure to support a global scale business. Seasonality In the fourth quarter of each calendar year, we generally generate significantly higher levels of revenue and gross profit from platform segment revenue and significantly higher levels of player segment revenue. For the years ended December 31, 2020 and 2019, fourth quarter revenue comprised 37% and 36% of our total net revenue, respectively, and fourth quarter gross profit comprised 38% and 33% of our total gross profit, respectively. Components of Results of Operations Revenue Platform Revenue We generate platform revenue from advertising sales and related services, subscription and transaction revenue sharing arrangements with partners, the sale of Premium Subscription services, sales of branded channel buttons on remote controls and licensing arrangements with service operators. Our first-party video ad inventory includes The Roku Channel, native display ads on our home screen and screen saver as well as ad inventory we obtain through our content distribution agreements with publishers. To supplement supply, we re-sell video inventory that we purchase from content publishers and, to a lesser extent, directly sell third-party inventory on a revenue share basis. To date, we have generated most of our platform revenue in the United States. Player Revenue We generate player revenue primarily from the sale of streaming players through consumer retail distribution channels, including major brick and mortar retailers, such as Best Buy and Walmart, and online retailers, including Amazon. We generate most of our player revenue in the United States. In our international markets, we primarily sell our 60 players through wholesale distributors which, in turn, re-sell to retailers. We currently distribute our players in Canada, the United Kingdom, France, the Republic of Ireland, Mexico, Brazil and several other Latin American countries. Player revenue also includes the sale of our audio products, including wireless speakers, smart soundbars and wireless subwoofers. Cost of Revenue Cost of Platform Revenue Cost of platform revenue consists of costs associated with arrangements with content partners and publishers including advertising inventory and content or programming licensing fees. Cost of platform revenue also includes payment processing fees, allocated expenses associated with the delivery of our services including salaries, benefits and stock-based compensation for our operations and support teams, third-party cloud services and amortization of acquired technology. Cost of Player Revenue Cost of player revenue is comprised mostly of player manufacturing costs payable to our third-party contract manufacturer and technology licenses or royalty fees. Cost of player revenue also includes inbound and outbound freight, duty and logistics costs, third-party packaging and allocated overhead costs related to facilities and 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 personnel-related costs, including salaries, benefits and stock-based compensation for our development teams as well as outsourced development fees. In addition, research and development expenses include allocated facilities and overhead costs. We expect research and development expenses to increase in absolute dollars as we continue to invest in the development of our platform, player and TV products, advertising products and other platform services. Sales and Marketing Sales and marketing expenses consist primarily of personnel-related costs, including salaries, benefits, commissions and stock-based compensation expense for our employees engaged in sales and sales support, marketing, communications, data science and analytics, business development, product management and partner and customer support functions. Sales and marketing expenses also include marketing, retail and merchandising costs and allocated facilities and overhead expenses. We expect sales and marketing expenses to increase in absolute dollars in future periods as we focus on growing active accounts, platform and player revenues, and expanding our business internationally . General and Administrative General and administrative expenses consist primarily of salaries, benefits and stock-based compensation for our executive, 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 expenses. We expect our general and administrative expenses to increase due to the expansion of our business and related infrastructure. Other Income (Expense), Net For the year ended December 31, 2020, other income (expense), net consists of interest income on cash and cash equivalents, interest expense that primarily includes interest on our Credit Facility (as defined in ‘Liquidity and Capital Resources’ below) and amortization of deferred debt costs, foreign currency re-measurement and transaction gains and losses. For the years ended December 31, 2019 and 2018, other income (expense), net consists of interest income on short-term investments and cash balances, interest expense that primarily includes amortization of deferred debt costs, foreign currency re-measurement and transaction gains and losses. 61 Income Tax (Benefit) Expense Our income tax (benefit) expense consists primarily of income taxes in certain foreign jurisdictions where we conduct business and state income taxes in the United States. We have a valuation allowance for U.S. deferred tax assets, including net operating loss carryforwards and tax credits related primarily to research and development. We expect to maintain this valuation allowance for the foreseeable future. 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, 2020 2019 2018 Net Revenue: Platform 71 % 66 % 56 % Player 29 % 34 % 44 % Total net revenue 100 % 100 % 100 % Cost of Revenue: Platform 28 % 23 % 16 % Player 27 % 33 % 39 % Total cost of revenue 55 % 56 % 55 % Gross Profit: Platform 43 % 43 % 40 % Player 2 % 1 % 5 % Total gross profit 45 % 44 % 45 % Operating Expenses: Research and development 20 % 24 % 23 % Sales and marketing 17 % 16 % 14 % General and administrative 10 % 10 % 10 % Total operating expenses 47 % 50 % 47 % Loss from Operations (2 )% (6 )% (2 )% Other Income, Net: Other income, net — % 1 % 1 % Total other income, net — % 1 % 1 % Loss before income taxes (2 )% (5 )% (1 )% Income tax (benefit) expense — % — % — % Net loss attributable to common stockholders (2 )% (5 )% (1 )% Comparison of Years Ended December 31, 2020 and 2019 Net Revenue Years Ended December 31, 2020 2019 Change $ Change % (in thousands, except percentages) Platform $ 1,267,744 $ 740,776 $ 526,968 71 % Player 510,644 388,145 122,499 32 % Total Net Revenue $ 1,778,388 $ 1,128,921 $ 649,467 58 % Platform Platform revenue increased by $527.0 million, or 71%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The increase is mostly attributable to higher advertising revenues, including revenue from 62 our demand - side platform, which we acquired from dataxu in November 2019 . In 2020, we re-branded our demand - side platform as the OneView Ad Platform and integrated it with Roku-native identity, data and attribution tools. Platform revenues also increased due to higher content distribution and related transactional revenues, including from Premium Subscriptions. Player Player revenue increased by $122.5 million, or 32%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019, primarily due to an increase in the volume of streaming players sold in addition to increased revenues from the sale of audio products and accessories. During the year ended December 31, 2020, the volume of streaming players sold increased 28% as compared to the year ended December 31, 2019 offset by a 3% decrease in the average selling price of players. The increase in the volume of players sold was due to an increase in demand for lower priced models, namely the Roku Express player and the Roku Premiere player, and in part to consumers spending more time at home due to the COVID-19 pandemic. Cost of Revenue Years Ended December 31, 2020 2019 Change $ Change % (in thousands, except percentages) Cost of revenue: Platform $ 503,177 $ 262,655 $ 240,522 92 % Player 466,992 371,042 95,950 26 % Total Cost of Revenue $ 970,169 $ 633,697 $ 336,472 53 % Gross profit: Platform $ 764,567 $ 478,121 $ 286,446 60 % Player 43,652 17,103 26,549 155 % Total Gross Profit $ 808,219 $ 495,224 $ 312,995 63 % Platform The cost of platform revenue increased by $240.5 million, or 92%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. This increase is a result of higher advertising related costs including inventory acquisition costs, in addition to higher content licensing fees, programming fees and credit card processing fees totaling $215.3 million. Platform costs increased an additional $25.3 million due to increases in allocated personnel and operational overhead costs and amortization of acquired intangibles. Gross profit for platform revenue increased by $286.4 million, or 60%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019, primarily driven by the overall growth in our platform revenues. Player The cost of player revenue increased by $96.0 million, or 26%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The cost of player revenue increased approximately $73.1 million due to an increase in the volume of players sold. Freight expenses increased by $14.2 million as a result of an increase in the volume of units sold as well as an increase in the overall cost of transportation. Packaging and other overhead costs increased by $8.7 million. Gross profit for player revenue increased by $26.5 million, or 155%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019, driven by higher sales volumes of player products and accessories and lower direct manufacturing costs. 63 Operating Expenses Years Ended December 31, 2020 2019 Change $ Change % (in thousands, except percentages) Research and development $ 355,784 $ 265,011 $ 90,773 34 % Sales and marketing 299,457 178,855 120,602 67 % General and administrative 173,231 116,417 56,814 49 % Total Operating Expenses $ 828,472 $ 560,283 $ 268,189 48 % Research and development Research and development expenses increased by $90.8 million, or 34%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The increase was primarily due to increases in personnel-related costs of $65.5 million as a result of increased engineering headcount of 14% and related stock-based compensation, higher professional service and consulting fees of $27.8 million, and higher allocated facilities costs of $11.7 million offset by allocations of overheads to cost of platform and player revenue of $14.2 million. Sales and marketing Sales and marketing expenses increased by $120.6 million, or 67%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The increase was primarily due to increases in personnel-related costs of $61.9 million related to increased headcount of 15% and related stock-based compensation in sales and sales support, product management, marketing and business analytics to support efforts to grow our business. Other sales and marketing expenses include an increase of $42.2 million mainly due to increase in marketing, retail and merchandising costs, an increase of $10.6 million in higher facilities costs, an increase of $5.6 million in outside consulting expenses, and an increase of $3.7 million in other expenses primarily related to higher amortization of acquired intangible assets offset by a decrease of $3.4 million in travel expenses due to the COVID-19 pandemic. General and administrative General and administrative expenses increased by $56.8 million, or 49%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The increase was primarily due to increases in personnel-related costs of $29.2 million related to increased headcount of 27% and related stock-based compensation , an increase of $16.1 million related to higher legal, consulting and professional service fees, an increase of $5.1 million related to higher facilities costs, an increase of $3.1 million in allowance for doubtful accounts primarily from adoption of accounting standard for credit losses, and a net increase of $3.3 million that includes various corporate expenses and overheads partly offset by a decrease in travel expenses due to the COVID-19 pandemic. Other Income (Expenses), Net Years Ended December 31, 2020 2019 Change $ Change % (in thousands, except percentages) Interest expense $ (3,432 ) $ (2,366 ) $ (1,066 ) 45 % Other income (expense), net 5,233 6,506 (1,273 ) (20 )% Total Other Income (Expense), Net $ 1,801 $ 4,140 $ (2,339 ) (56 )% 64 Other income (expenses), net Total other income (expense), net, decreased by $2.3 million during the year ended December 31, 2020 as compared to the year ended December 31, 2019. Interest expense, including amortization of deferred debt costs, was higher for the year ended December 31, 2020 due to higher level of borrowings under our Credit Facility as compared to the prior year. Other income, net was $1.3 million lower in the year ended December 31, 2020. Interest income declined $2.7 million for the year ended December 31, 2020 due to a significant drop in interest rates early in the year in reaction to the COVID-19 pandemic, which impacted our investment yields. This was offset by favorable foreign exchange totaling $1.4 million primarily related to the British Pound. Income Tax (Benefit) Expenses Years Ended December 31, 2020 2019 Change $ Change % (in thousands, except percentages) Income tax (benefit) expense $ (945 ) $ (982 ) $ 37 (4 )% Income tax benefit Income tax benefit arises from foreign income taxes and state income taxes in the United States. Liquidity and Capital Resources As of December 31, 2020, we had cash and cash equivalents of $1,092.8 million. Approximately 1.2% 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 player revenue and proceeds from equity sales including equity issued pursuant to our employee stock option plans. The primary uses of cash are costs of revenue including third party manufacturing costs, costs to acquire advertising inventory, and content and programming license fees as well as operating expenses including payroll-related expenses, consulting and professional service fees, and facility and marketing expenses. Other uses of cash include purchases of property and equipment. We have multi-year lease agreements for office space and incurred material expenses in 2020. We expect to continue to incur material expenses for facility and building related costs for our campus headquarters in San Jose, California as well as at other office locations in the U.S. and internationally. As our business and workforce continue to expand, we further expect ongoing purchases of computer systems and other investments in property and equipment. In addition, w e may pursue merger and acquisition activities, including the acquisition of rights to programming and content assets that could materially impact our liquidity and capital resources. We believe our existing cash and cash equivalents, cash flow from operations, and our undrawn available balance under our Credit Facility will be sufficient to meet our working capital requirements for at least the next twelve months. Our future capital requirements, the adequacy of available funds, and cash flows from operations could be affected by various risks and uncertainties, including, but not limited to, those detailed in Part I, Item 1A, Risk Factors and the effects of the COVD-19 pandemic. While the pandemic 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. Our Credit Agreement expires in February 2023. If we raise additional financing by the incurrence of additional indebtedness, we may be subject to fixed payment obligations and also to restrictive covenants. 65 At-the-Market Offering On May 13, 2020, we entered into an Equity Distribution Agreement with Morgan Stanley & Co. LLC and Citigroup Global Markets Inc., as our sales agents, pursuant to which we sold an aggregate of 4.0 million shares of our Class A common stock and received gross proceeds of $504.0 million at an average selling price of $126.01 per share and incurred issuance costs of $6.8 million. Senior Secured Term Loan A and Revolving Credit Facilities On February 19, 2019 (the “Original Closing Date”), we entered into a Credit Agreement (the “Existing Credit Agreement”) with Morgan Stanley Senior Funding, Inc. On May 3, 2019, (the “Closing Date”), the Existing Credit Agreement was amended pursuant to an Incremental Assumption and Amendment No. 1 (the “Amendment” and the Existing Credit Agreement as amended by the Amendment, the “Credit Agreement”). The Credit Agreement provides 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 the satisfaction of certain financial and other conditions, in the amount of up to (v) $50.0 million, plus (w) 1.0x of our consolidated EBITDA for the most recently completed four fiscal quarter period, plus (x) an additional amount at our discretion, so long as, on a pro forma basis at the time of incurrence, our secured leverage ratio does not exceed 1.50 to 1.00, plus (y) voluntary prepayments of the Revolving Credit Facility and Term Loan A Facility to the extent accompanied by concurrent reductions to the applicable Credit Facility (together with the Revolving Credit Facility and the Term Loan A Facility, collectively, the “Credit Facility”). For our current borrowings, we have elected a Eurodollar borrowing with interest at a rate equal to the adjusted one-month LIBOR rate plus an applicable margin of 1.75% based on our secured leverage ratio. The borrowings under the facility mature or have to repaid in full by February 2023. Our obligations under the Credit Agreement are secured by substantially all of our assets. The Credit Agreement contains customary representations and warranties, customary affirmative and negative covenants, a financial covenant that is tested quarterly and requires us to maintain a certain adjusted quick ratio of at least 1.00 to 1.00, and cu stomary events of default. As of December 31, 2020, we were in compliance with all of the covenants of the Credit Agreement. See Note 10 to the consolidated financial statements in Item 8 of this Report, for additional details regarding the Credit Agreement. We had outstanding letters of credit of $30.8 million and $30.7 million as of December 31, 2020 and December 31, 2019, respectively, against the Revolving Credit Facility. Cash Flows The following table summarizes our cash flows for the periods presented (in thousands): Years Ended December 31, 2020 2019 Consolidated Statements of Cash Flows Data: Cash flows provided by operating activities $ 148,192 $ 13,707 Cash flows used in investing activities (81,324 ) (110,295 ) Cash flows provided by financing activities 509,048 458,328 Cash Flows from Operating Activities Our operating activities provided cash of $148.2 million for the year ended December 31, 2020. Our net loss of $17.5 million for the year ended December 31, 2020 was adjusted by non-cash charges of $225.7 million comprising mainly of $134.1 million of stock-based compensation, $36.2 million of depreciation and amortization primarily on property and equipment and acquired intangible assets, $28.7 million of amortization of operating lease right-of-use assets, $22.4 million of amortization of capitalized licensed content assets and $3.8 million of provision for doubtful accounts. The changes in our operating assets and liabilities used cash of $60.0 million comprised of outflows of $196.0 million from an increase in accounts receivable primarily driven by higher sales volume in the last quarter , $4.2 million from increased inventory levels 66 at the end of the year, $3.5 million from an increase in prepaid and other current assets due to an increase in contract assets, prepaid taxes and other general expenses , and $1.1 million from an increase in other long term assets. These outflows were offset by cash inflows by an increase of $103.2 million from an increase in accrued liabilities related to content publisher payables, marketing, retail and merchandising costs, advertising inventory costs and overall growth in the volume of business , $21.5 million from an increase in deferred revenue due to overall growth in the volume of business, $13.0 million from an increase in operating lease liabilities for new leases added during the year, $6.4 million from an increase in accounts payable, and $0.6 million from an increase in other long-term liabilities. Our operating activities provided cash of $13.7 million for the year ended December 31, 2019. Our net loss of $59.9 million for the year ended December 31, 2019 was adjusted by non-cash charges of $127.9 million comprising mainly of $85.2 million of stock-based compensation and $15.7 million of depreciation and amortization primarily on property and equipment and acquired intangible assets, $22.3 million of amortization of operating right-of-use assets and $2.9 million of amortization of capitalized licensed content assets. The changes in our operating assets and liabilities used cash of $54.2 million comprised of outflows of $110.2 million from an increase in accounts receivable due to increased seasonal revenues in the fourth quarter, $14.1 million from increasing inventory levels, $10.6 million from a decrease in deferred revenue, $9.9 million from an increase in prepaid and other current assets due to an increase in prepaid contracts, marketing expenses and prepaid capital expenditure for new facilities, $3.0 million from a decrease in other long-term liabilities, and $3.0 million from an increase in other long-term assets. These outflows were offset by cash inflows of $74.5 million from an increase in accrued liabilities due to timing of payments, increased content publishers payables, and overall growth in the volume of business , $11.7 million from an increase in operating lease liabilities, $9.4 million from an increase in accounts payable, and $1.1 million from a decrease in deferred cost of revenue. Cash Flow from Investing Activities Our investing activities used cash of $81.3 million for the year ended December 31, 2020. The cash used comprised of $82.4 million for the purchase of property and equipment, which primarily related to expenditures on leasehold improvements related to expanding our facilities and other capital investments, partially offset by $1.1 million of cash received from proceeds from the resolution of purchase acquisition contingencies. Our investing activities used cash of $110.3 million for the year ended December 31, 2019. The cash used comprised of $77.2 million for the purchase of property and equipment, which primarily related to expenditures on leasehold improvements related to expanding our facilities and other capital investments, $68.1 million related to the acquisition of dataxu, Inc., $12.4 million spent on the purchase of short-term investments, and $7.4 million related to the purchases of other intangible assets, partially offset by $54.8 million received from sales/maturities of short-term investments. Cash Flow from Financing Activities Our financing activities provided cash of $509.0 million for the year ended December 31, 2020. The cash was received mainly from net proceeds from the issuance of common stock through our at-the-market offering amounting to $497.2 million, net of offering costs and proceeds from the exercise of employee stock options of $16.8 million. We borrowed and repaid $69.3 million of our Revolving Credit Facility in addition to the repayments of $5.0 million on our Term Loan A during the year. Our financing activities provided cash of $458.3 million for the year ended December 31, 2019. The cash was received mainly from net proceeds from the issuance of Class A common stock through our at-the-market offerings amounting to $330.5 million, net of offering costs, proceeds from borrowings amounting to $99.6 million, net of issuance costs, and proceeds from the exercise of employee stock options of $28.2 million. Off-Balance Sheet Arrangements We did not have any off-balance sheet arrangements during the years ended December 31, 2020 and 2019, as defined by applicable SEC rules and regulations. 67 Contractual Obligations Our future minimum payments under our non-cancelable contractual obligations were as follows as of December 31, 2020 (in thousands): Payments Due by Period Total Less Than 1 Year 1 – 3 Years 3 – 5 Years More Than 5 Years Term Loan A Facility (1) $ 95,000 $ 5,000 $ 90,000 $ — $ — Purchase commitments (2) 185,945 185,945 — — — Operating lease obligations (3) 440,645 50,889 94,974 92,930 201,852 Other obligations (4) 70,990 42,574 26,376 2,040 — Total $ 792,580 $ 284,408 $ 211,350 $ 94,970 $ 201,852 (1) Represents the principal amount of Term Loan A Facility. For additional information regarding the terms of the debt and interest payable, see Note 10 to the consolidated financial statements in Item 8 of this Report. (2) Represents commitments to purchase finished goods from our contract manufacturer and other inventory related items. (3) Represents future minimum lease payments under operating leases. (4) Represents commitments included in other non- cancelable arrangements like licensed content assets, advertising inventory costs and other platform services. We rely on an outsourced supplier to manufacture, assemble and test our players and audio devices. Consistent with industry practices, we enter into firm, noncancelable, and unconditional purchase commitments to acquire products through a combination of purchase orders, supplier contracts, and open orders based on projected demand information. Our contract manufacturer sources components and builds 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. The contractual commitment amounts in the table 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 in the table above. As we are unable to reasonably predict the timing of settlement of liabilities related to unrecognized tax benefits, net, the table does not include $29.2 million of such non-current liabilities not included in our consolidated balance sheets as of December 31, 2020. Critical Accounting Policies and 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 affected by management’s application of accounting policies, as well as uncertainty in the current economic environment due to the ongoing COVID-19 pandemic. We evaluate our estimates and assumptions on an ongoing basis. 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. Determining whether products and services are considered distinct performance obligations may require significant judgment. Judgment is required to determine the stand-alone selling price (“SSP") for each distinct performance obligation. For performance obligations routinely sold separately, the SSP is determined by evaluating such stand-alone sales. For those 68 performance obligations that are not routinely sold separately, we determine SSP using information that may include market conditions and other observable inputs. To the extent platform services are part of multiple element arrangement, revenue recognition of each performance obligation in the estimated transaction price of a contract is based on the expected value for which a significant reversal of revenue is not expected to occur. The estimate of the variable consideration is based on the assessment of historical, current, and forecasted performance noted and expected from the performance obligation. For the sale of third-party goods and services, we evaluate whether we are the principal, and report revenues on a gross basis, or an agent, and report revenues 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 player revenue includes allowances for returns and sales incentives in the estimated transaction price. The estimates for returns and sales incentives are based on historical experience and anticipated performance. We provide unspecified upgrades and updates to our player end users. We record the allocated value of these as deferred revenue and recognize it ratably on a time elapsed basis over the estimated economic life of the associated players. Shipping charges billed to customers are included in revenue and the related shipping costs are included in cost of revenue. Business Combinations We recognize, separately from goodwill, identifiable assets and liabilities acquired in a business combination at fair value on the date of acquisition. We use our best estimates and assumptions to accurately assign fair value to the tangible and identifiable intangible assets acquired and liabilities assumed at the acquisition date as well as the useful lives of those acquired intangible assets. Examples of critical estimates in valuing certain of the intangible assets and goodwill we have acquired include, but are not limited to, future expected cash inflows and outflows, expected technology life cycle, attrition rates of customers, and discount rates. We estimate the useful lives of the intangible assets based on the expected period over which we anticipate generating economic benefit from the asset. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results. While we use our best estimates and assumptions as part of the purchase price allocation process to accurately value assets and liabilities acquired, these estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets and liabilities acquired, with the corresponding offset to goodwill to the extent we identify adjustments to the preliminary purchase price allocation. Upon the conclusion of the measurement period or final determination of the values of assets and liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the consolidated statements of operations. Goodwill and Intangible Assets We test goodwill for impairment on an annual basis during the fourth quarter of each fiscal year or when specific circumstances dictate, between annual tests. We measure recoverability of goodwill at the reporting unit level. The process of determining the fair value of a reporting unit is highly subjective and involves the use of significant estimates and assumptions. In performing our annual assessment, we can opt to perform a qualitative assessment to test a reporting unit’s goodwill for impairment or we can directly perform a quantitative assessment. Based on our qualitative assessment, if we determine that the fair value of our reporting unit is, more likely than not, less than its carrying amount, then the quantitative assessment is performed. Any excess of the reporting unit's carrying amount over its fair value will be recorded as an impairment loss. We identify intangible assets acquired in a business combination and determine their fair value. The determination involves certain judgments and estimates. These judgments include, but are not limited to, the cash flows that an asset is expected to generate in the future and the appropriate discount weighted-average cost of capital. We amortize purchased-intangible assets on a straight-line basis over the estimated useful life of the assets. We review purchased-intangible assets whenever events or changes in circumstances indicate that the useful life is shorter than we had originally estimated or that the carrying amount of assets may not be recoverable. If such facts and circumstances indicate an asset’s carrying amount may not be recoverable, we assess the recoverability of purchased-intangible assets by comparing the projected 69 undiscounted net cash flows associated with the asset group against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of these asset groups. If the useful life of the asset is shorter than originally estimated, we accelerate the rate of amortization and amortize the remaining carrying value over the new shorter useful life. Allowances for Sales Returns, Sales Incentives and Doubtful Accounts Accounts receivable are stated at invoice value less estimated allowances for sales returns, sales incentives and doubtful accounts which is our best estimate of the amount of probable credit losses in our existing accounts receivable. 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. We assess collectability by reviewing accounts receivable on a collective basis where similar characteristics exist and on an individual basis when we identify specific customers with collectability issues and determine the allowance for doubtful accounts. We regularly review the allowance by considering historical collectability based on past due status, credit quality, and make judgments about the creditworthiness of customers based on ongoing credit evaluations. We consider customer-specific information and current economic conditions that may affect a customer’s ability to pay. If our estimates regarding accounts receivable allowances differ from the actual results, the losses or gains, could be material. Stock-Based Compensation Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as an expense on a straight-line basis over the requisite service period, which is generally the vesting period of the respective award. Determining the fair value of stock-based awards at the grant date requires judgment. We account for the fair value of restricted stock units using the closing market price of our Class A common stock on the date of the grant. We use the Black-Scholes option-pricing model to determine the fair value of stock options. The determination of the grant date fair value of stock options using an option-pricing model is affected by our estimated common stock fair value as well as assumptions regarding a number of other complex and subjective variables. These variables include our expected stock price volatility over the expected term of the options, stock option exercise and cancellation behaviors, risk-free interest rates and expected dividends, which are estimated as follows: • Fair Value of Our Common Stock . We use the closing market price for our Class A common stock as reported on The Nasdaq Global Select Market on the date of grant. • Expected Term. The expected term of employee stock options represents the weighted-average period that the stock options are expected to remain outstanding. To determine the expected term, we generally apply the simplified approach in which the expected term of an award is presumed to be the mid-point between the vesting date and the expiration date of the award as we do not have sufficient historical exercise data to provide a reasonable basis for an estimate of expected term. • Volatility. As we do not have sufficient trading history for our Class A common stock, the expected volatility for our Class A common stock is estimated by taking the average historic price volatility for industry peers based on daily price observations over a period equivalent to the expected term of the stock option awards. Industry peers consist of several public companies in our industry which are either similar in size, stage of life cycle or financial leverage. We intend to consistently apply this process until a sufficient amount of historical information regarding the volatility of our own Class A common stock share price becomes available or unless circumstances change such that the identified peer companies are no longer similar to us, in which case, more suitable companies whose share prices are available would be utilized in the calculation. • Risk-free Rate. The risk-free interest rate is based on the yields of U.S. Treasury securities with maturities similar to the expected term for each of our stock options. 70 • Dividend Yield. We have never declared or paid any cash dividends and do not presently plan to pay cash dividends in the foreseeable future. Consequently, we use an expected dividend yield of zero. We account for forfeitures as they occur. If any of the assumptions used in the Black-Scholes model changes significantly, stock-based compensation for future awards may differ materially compared with the awards granted previously. We will continue to use judgement in evaluating assumptions related to our stock-based compensation cost. As we continue to accumulate additional data related to our Class A common stock and our business evolves, we may have refinements to our assumptions and estimates which could impact our future stock-based compensation cost. Provision for Income Taxes We account for income taxes in accordance with authoritative guidance, which requires the use of 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. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided when it is more likely than not that the deferred tax assets will not be realized. We have established a full valuation allowance to offset domestic 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. Our valuation allowance is attributable to the uncertainty of realizing future tax benefits from U.S. net operating losses and other deferred tax assets. Recent Accounting Pronouncements The recent accounting pronouncements adopted during the year ended December 31, 2020 and those not yet adopted are discussed and included in Note 2 to the consolidated financial statements in Item 8 of this Report. They are incorporated herein by reference.