Memoria episódica

9.3.1 Music Rights Expenses

The majority of Deezer’s expenses consist of royalties payable in respect of music rights and other content obtained from rights holders, including major record labels, independent record labels, publishers, collective societies and podcast producers. See Chapter 6.5.4, “Content Licensing”.

Music rights expenses are recorded under “Cost of revenues – music rights” in Deezer’s consolidated income statement. In 2014, they amounted to €112.5 million, or 79.3% of consolidated revenue.

The amount of Deezer’s music rights expenses depends primarily on the amount of subscription revenue earned and/or the number and categories of Deezer’s subscribers in the period, and on the terms of its contractual arrangements with rights holders. See Chapter 6.5.4, “Content Licensing”, for a description of these contractual arrangements. Payments to rights holders are generally based on how frequently their licensed content is streamed on Deezer’s platform and a percentage of all subscription or advertising revenues received. Payments vary depending on the service offering, the distribution channel (through partners or direct distribution) and geographic territory. Payments are typically lower for content streamed on Deezer’s free advertising-supported service and content streamed as part of a promotional free or reduced-price trial offer, and higher for its paid subscription services.

Music Rights expenses for Deezer’s standalone and bundle subscriptions represent the substantial majority of total Cost of revenues – music rights, but have decreased as a percentage of subscription revenues over time as Deezer has expanded its business and negotiated more favorable licensing agreements with the relevant rights holders. Deezer has experienced gross margin improvement largely due to the decreasing impact of music rights expenses on standalone and bundle subscription revenues. Content cost margin is equal to revenue from standalone and bundle subscription, less Cost of revenues – music rights for such subscriptions. The content cost margin does not reflect minimum guaranteed payments (the impact of which is described in Section 9.3.2, “Minimum Guaranteed Payments”, below), content costs associated with offering free advertising-supported services and promotional trial access to paid subscription services, the impact on revenue of reduced price trial offers and other amounts that do not relate directly to paid subscriber categories. In addition, the content cost margin does not include items included in Cost of revenues – other, which comprise payment processing, mobile application store billing commissions and technology costs (as described in Section 9.2.2, “Gross Margin”).

The following table sets forth the content cost margin for Deezer’s standalone and bundle subscriptions combined.

For the year ended December 31,

For the six months ended June 30,

2014 2013 2012 2015 2014

(millions of euros)

Total subscription revenue⁽¹⁾ ... 135,036 85,641 55,814 86,050 63,444 Cost of revenues – music rights for

subscriptions⁽²⁾ ... (104,301) (69,059) (44,790) (63,010) (49,240) Content cost margin ... 30,735 16,582 11,024 23,040 14,204

% of standalone and bundle

revenues ... 22.8% 19.4% 19.8% 26.8% 22.4%

_____________

(1) Calculated as the sum of revenues from direct and indirect standalone and bundle subscriptions.

(2) Comprises music rights expenses related to direct and indirect standalone and bundle subscriptions.

9.3.2 Minimum Guaranteed Payments

Pursuant to some of Deezer’s licensing arrangements, it has been required to pay record labels minimum guaranteed payments. The minimum guaranteed payments are generally paid in part in advance, and in part over the term of the license agreement. They are offset against total royalties paid for music rights under the agreements. Minimum guaranteed payments significantly impacted gross margin and operating loss in 2012 and 2013 (and to a lesser extent in 2014). Deezer’s gross margin was 15.6%, 2.4% and 8.7% of consolidated revenue in the years ended December 31, 2014, 2013 and 2012, respectively. Excluding the impact of minimum guaranteed payments, Deezer’s gross margin was 17.0%, 16.6% and 17.1% of consolidated revenue in the years ended December 31, 2014, 2013 and 2012, respectively.

Deezer has in the past agreed to minimum guaranteed payments primarily in connection with its entry into new geographical markets. The risk associated with the minimum guaranteed payment obligation is effectively the cost of entry into new markets, which Deezer anticipates recovering over time as its subscriber base grows. Certain expenses in respect of minimum guaranteed payments are nonetheless recorded in the consolidated income statement under “Cost of revenues – music rights” at the time they are recognized as expenses (as described below), as is the case for all royalties payable.

Deezer has entered into agreements providing for minimum guaranteed payments that exceed the anticipated amount of royalties that it expects to be payable based on expected usage (this is effectively the market entry cost). In such cases, the difference at the date of the signature of the contract is recorded in the consolidated balance sheet under “other liabilities” and as an intangible asset that is amortized over the life of the contract, typically on a straight-line basis. The amortization charge in each year is recorded under “Depreciation and Amortization.”

At each reporting date, Deezer estimates the amount of royalties it expects to be used for contracts and compares this with the amount of minimum guaranteed payments. If the anticipated royalties are lower than the minimum guaranteed payment obligations (after taking into account the amount of anticipated shortfall previously recorded as an intangible asset, if any), the difference is recorded as a write-down of advances against royalties to the extent the relevant amounts were previously paid and then any remaining difference as a provision. A corresponding charge in the same year is recorded in the income statement under “Depreciation and Amortization.” In each subsequent period covered by the contract a charge recorded under “Cost of revenues – music rights” equal to the portion of the minimum guaranteed payment allocable to the period less the amount of intangible assets for the same period and the actual royalties calculated for that period. The provision recorded at the end of the

prior year is reversed in the same amount with the reversal reflected in the income statement under

“Depreciation and Amortization”. A detailed presentation of the impact of the minimum guaranteed payments on Deezer’s consolidated statement of operations and consolidated operating profit as of and for the years ended December 31, 2014, 2013 and 2012 is set forth in note 6.8 to Deezer’s consolidated financial statements as of and for the years ended December 31, 2014, 2013 and 2012, included in in Annex I, “Group Consolidated Annual Financial Statements”.

Deezer signed licensing agreements at the end of 2012 with minimum guaranteed payment obligations as part of its strategy to expand into new markets. At the time, it estimated that it would have unused minimum guaranteed payments of €4.8 million in excess of the expected actual royalties and recognized an intangible asset for this amount, which it amortized over the two-year contractual period in 2013 and 2014. In connection with the preparation of Deezer’s 2012 consolidated financial statements, a new estimate of anticipated royalties was prepared, and Deezer determined that the expected shortfall would be greater than initially expected. After deducting the amount already being amortized, Deezer recorded a write-down of advance payments for music rights of €6.5 million, and an additional provision of €11.0 million as of December 31, 2012. In 2013, Deezer recorded, under

“Cost of revenues – music rights,” €13.2 million of minimum guaranteed payments in excess of the amount already being amortized plus actual calculated royalties, which was offset by a release of provisions recorded under “Depreciation and Amortization.” Deezer recorded additional residual minimum guaranteed payment charges of €2.0 million under “Cost of revenues – music rights” in 2014 (after deducting the amount already being amortized and actual calculated royalties).

The table below sets forth the impact of the minimum guarantee charges on Deezer’s gross margin:

For the year ended December 31,

For the six months ended June 30,

2014 2013 2012 2015 2014

(millions of euros)

Revenues 141.9 92.8 63.6 93.2 66.1

Cost of revenues – music rights (112.5) (87.4) (57.1) (71.2) (54.6) Of which:

Unused minimum

guarantees on rights (2.0) (13.2) (5.4) (0.5) (3.2)

Actual calculated cost of

revenues - music rights (110.4) (74.2) (51.7) (70.7) (51.3)

Cost of Revenues - other (7.3) (3.2) (0.9) (5.5) (2.3)

Gross margin 22.1 2.2 5.5 16.5 9.2

% of revenues 15.6% 2.4% 8.7% 17.7% 14.0%

Gross margin excluding impact of the unused minimum

guarantee charge 24.1 15.4 10.9 17.1 12.5

% of revenues 17.0% 16.6% 17.1% 18.3% 18.9%

As of December 31, 2014, Deezer’s provisions for minimum guaranteed payments are substantially lower than those recorded in respect of the 2012 contracts. The total provision at the end of 2014 was

€1.0 million, representing minimum guaranteed royalties payable by MIM, a company that Deezer acquired in 2014, which operates a music streaming service in Germany. See Section 9.6,

“Significant Acquisitions”.