Description
Sirius XM Radio Inc. 10% Owner Media Corp Liberty bought 89,970,000 shares on 8-14-2012 at $ 2.48
BUSINESS OVERVIEW
Programming
We offer a dynamic programming lineup of commercial-free music, sports, entertainment, talk, news, traffic and weather. The channel line-ups for our services vary in certain respects and are available at siriusxm.com.
Our subscription packages allow most listeners to enhance our standard programming lineup. Our “XM Premier” package offers subscribers the Howard Stern channels, Martha Stewart Living Radio, SiriusXM NFL Radio, SiriusXM NASCAR Radio, Playboy Radio, Spice Radio and play-by-play NFL games and college sports programming. Our “Sirius Premier” package offers subscribers Oprah Radio, Opie and Anthony, SiriusXM Public Radio, MLB Network Radio, NHL Home Ice, SiriusXM PGA Radio, Sirius XM Fantasy Sports Radio and select play-by-play of NBA and NHL games and college sports programming. Subscribers with a la carte-capable radios may customize the programming they receive through our a la carte subscription packages. We also offer family friendly, “mostly music” and “mostly sports, news and talk” packages.
In October 2011, we launched an expanded channel lineup, including new music, sports and comedy channels as well as SiriusXM Latino, a suite of Latin channels. These channels, available online and over certain new radios, are the first phase of SiriusXM 2.0, an upgrade and evolution of our satellite and Internet delivered service that will ultimately span hardware, software, audio, and data services.
We make changes to our programming lineup from time to time as we strive to attract new subscribers and offer content which appeals to a broad range of audiences and to our existing subscribers.
Music Programming
We offer an extensive selection of music genres, ranging from rock, pop and hip-hop to country, dance, jazz, Latin and classical. Within each genre we offer a range of formats, styles and recordings.
All of our original music channels are broadcast commercial free. Certain of our music channels are programmed by third parties and air commercials. Our channels are produced, programmed and hosted by a team of experts in their fields, and each channel is operated as an individual radio station, with a distinct format and branding. We also provide special features, such as our Artist Confidential series which provides interviews and performances from some of the biggest names in music, and an array of “pop up” channels featuring the music of particular artists.
Sports Programming
Live play-by-play sports is an important part of our programming strategy. We are the Official Satellite Radio Partner of the National Football League (“NFL”), Major League Baseball (“MLB”), NASCAR, National Basketball Association (“NBA”), National Hockey League (“NHL”) and PGA TOUR, and broadcast most major college sports, including NCAA Division I football and basketball games. Soccer coverage includes matches from the Barclays Premier League. We also air FIS Alpine Skiing, FIFA World Cup events and horse racing.
We offer many exclusive talk channels and programs such as MLB Network Radio, SiriusXM NASCAR Radio, SiriusXM NFL Radio and Chris “Mad Dog” Russo’s Mad Dog Unleashed on Mad Dog Radio, as well as two ESPN channels, ESPN Radio and ESPN Xtra. Simulcasts of select ESPN television shows, including SportsCenter , can be found on ESPN Xtra.
Talk and Entertainment Programming
We offer a multitude of talk and entertainment channels for a variety of audiences. Our diverse spectrum of talk programming is a significant differentiator from terrestrial radio and other audio entertainment providers.
Our talk radio offerings feature dozens of popular talk personalities, many creating radio shows that air exclusively on our services, including Howard Stern, Oprah Winfrey, Martha Stewart, Dr. Laura Schlessinger, Opie and Anthony, Bob Edwards, Senator Bill Bradley and doctors from the NYU Langone Medical Center.
Our comedy channels present a range of humor such as Jamie Foxx’s The Foxxhole, Laugh USA, Blue Collar Comedy and Raw Dog Comedy. Other talk and entertainment channels include SiriusXM Book Radio, Kids Place Live and Radio Disney, as well as OutQ, Road Dog Trucking and Playboy Radio.
Our religious programming includes The Catholic Channel, which is programmed with the Archdiocese of New York, EWTN, a Global Catholic Radio Network, and Family Talk.
News and Information Programming
We offer a wide range of national, international and financial news, including news from BBC World Service News, Bloomberg Radio, CNBC, CNN, FOX News, HLN, MSNBC, NPR and World Radio Network. We also air a range of political call-in talk shows on a variety of channels including our exclusive channel, POTUS.
We offer continuous, local traffic reports for 22 metropolitan markets throughout the United States.
Distribution of Radios
Automakers
Our primary means of distributing satellite radios is through the sale and lease of new vehicles. We have agreements with every major automaker to offer satellite radios in their vehicles and satellite radios are available as a factory or dealer-installed option in substantially all vehicle makes sold in the United States.
Many automakers include a subscription to our radio service in the sale or lease price of their vehicles. In many cases, we receive subscription payments from automakers in advance of the activation of our service. We share with certain automakers a portion of the revenues we derive from subscribers using vehicles equipped to receive our service. We also reimburse various automakers for certain costs associated with the satellite radios installed in their vehicles, including in certain cases hardware costs, tooling expenses and promotional and advertising expenses.
Previously Owned Vehicles
We expect to acquire an increasing number of subscribers through the sale and lease of previously owned vehicles with factory-installed satellite radios. We have entered into agreements with many automakers to market subscriptions to purchasers and lessees of vehicles which include satellite radios sold through their certified pre-owned programs. In addition, we work directly with many franchise and independent dealers on similar programs for non-certified vehicles.
We have developed systems and methods to identify purchasers and lessees of previously owned vehicles which include satellite radios and have established marketing plans to promote our services to these potential subscribers.
Retail
We sell satellite and Internet radios directly to consumers through our website. Satellite and Internet radios are also marketed and distributed through major national and regional retailers. We develop in-store merchandising materials and provide sales force training for several retailers.
Our Satellite Radio Systems
Our satellite radio systems are designed to provide clear reception in most areas despite variations in terrain, buildings and other obstructions. Subscribers can receive our transmissions in all outdoor locations in the continental U.S. where the satellite radio has an unobstructed line-of-sight with one of our satellites or is within range of one of our terrestrial repeaters. We continually monitor our infrastructure and regularly evaluate improvements in technology.
Satellites, Terrestrial Repeaters and Other Satellite Facilities
Satellites. We currently own a fleet of nine orbiting satellites. We have invested in more technologically advanced satellites and satellite deployment to provide for improved coverage, increased redundancy and more efficient use of our spectrum.
Space Systems/Loral has constructed another satellite, FM-6, for use in our system. We expect to launch this satellite on a Proton rocket in the first half of 2012.
We use four of our orbiting satellites in the Sirius system. These satellites, FM-1, FM-2, FM-3 and FM-5, are of the Loral FS-1300 model series. Our FM-1, FM-2 and FM-3 satellites travel in a geosynchronous orbit. Our FM-5 satellite is deployed in a geostationary orbit.
We own five orbiting satellites for use in the XM system which operate in a geostationary orbit. Four of these satellites were manufactured by Boeing Satellite Systems International and one was manufactured by Space Systems/Loral.
Satellite Insurance. We hold in-orbit insurance for our FM-5 and XM-5 satellites. These policies provide coverage for a total, constructive total or partial loss of the satellites that occurs during the first five in-orbit years. We also have negotiated launch and in-orbit insurance for our FM-6 satellite. This insurance provides coverage for a total, constructive total or partial loss of the FM-6 that occurs from launch through the end of the first annual in-orbit period. The insurance does not cover the full cost of constructing, launching and insuring new satellites, nor will it protect us from the adverse effect on business operations due to the loss of a satellite. The policies contain standard commercial satellite insurance provisions, including coverage exclusions. We use launch and in-orbit insurance to mitigate the potential financial impact of satellite fleet launch and in-orbit failures unless the premium costs are considered to be uneconomical relative to the risk of satellite failure.
Terrestrial Repeaters. In some areas with high concentrations of tall buildings, such as urban centers, signals from our satellites may be blocked and reception of satellite signals can be adversely affected. In many of these areas, we have deployed terrestrial repeaters to supplement satellite coverage. We operate over 140 terrestrial repeaters in the Sirius system and over 560 terrestrial repeaters in the XM system.
Other Satellite Facilities. We control and communicate with our satellites from facilities in North America and maintain earth stations in Panama and Ecuador to control and communicate with several of our Sirius satellites. Our satellites are monitored, tracked and controlled by a third party satellite operator.
Studios
Our programming originates principally from studios in New York City and Washington D.C., and, to a lesser extent, from smaller studio facilities in Cleveland, Los Angeles, Memphis, Nashville and Orlando. Our New York City offices house our corporate headquarters. Both our New York City and Washington D.C. offices house facilities for programming origination, programming personnel and facilities to transmit programming.
Radios
We design, establish specifications for, source or specify parts and components for, and manage various aspects of the logistics and production of satellite and Internet radios. We do not manufacture radios. We have authorized manufacturers and distributors to produce and distribute radios, and have licensed our technology to various electronics manufacturers to develop, manufacture and distribute radios under certain brands. We purchase radios from independent manufacturers, that are distributed through our website. To facilitate the sale of radios, we may subsidize a portion of the radio manufacturing costs to reduce the hardware price to consumers.
Internet Radio
We stream music channels and select non-music channels over the Internet. Our Internet service also includes channels and features that are not available on our satellite service. Access to certain Internet services is offered to subscribers for a fee. We have available products that provide access to our Internet services without the need for a personal computer. We also offer applications to allow consumers to access our Internet services on certain smartphones and tablet computers. Subscribers to our Internet services are not included in our subscriber count, unless the service is purchased separately and not as part of a satellite radio subscription.
Canada
We also have an equity interest in the satellite radio services offered in Canada through Sirius XM Canada. In June 2011, Canadian Satellite Radio Holdings Inc. (“CSR”), the parent company of XM Canada, and Sirius Canada completed a transaction to combine their operations. Following this merger, we own approximately 38.0% of the equity of CSR, which operates as Sirius XM Canada.
Other Services
Commercial Accounts. Our music services are also available for commercial establishments. Commercial accounts are available through providers of in-store entertainment solutions and directly from us. Certain commercial subscribers are included in our subscriber count.
Satellite Television Service. Certain of our music channels are offered as part of certain programming packages on the DISH Network satellite television service. Subscribers to the DISH Network satellite television service are not included in our subscriber count.
FCC Conditions
In order to demonstrate to the FCC that the Merger was in the public interest, we agreed to implement a number of voluntary commitments. These commitments include certain voluntary assurances regarding our programming and programming packages; the creation of public interest channels; and equipment manufacturing, all of which we have complied with.
Qualified Entity Channels
In April 2011, we entered into long-term leases or other agreements to provide rights to four percent of the full-time audio channels on our platforms to a Qualified Entity or Entities. A Qualified Entity is defined as an entity or entities that: (1) are not directly or indirectly owned, in whole or in part, by us or one of our affiliates; (2) do not share any common officers, directors or employees with us or any affiliate of us; and (3) did not have any existing relationships with us for the supply of programming during the two years prior to October 19, 2010.
As digital compression technology enables us to broadcast additional full-time audio channels, we will ensure that four percent of the full-time audio channels on our platforms are reserved for Qualified Entities. The Qualified Entities are not required to make any lease payments for such channels. We may not alter, censor, or otherwise exercise any control over the leased programming but we may remove programming that violates the law.
Subscription Rates
In connection with the Merger, we had agreed with the FCC not to raise the retail price for, or reduce the number of channels in, our basic $12.95 per month subscription package, our a la carte programming packages or certain other programming packages until July 28, 2011. In July 2011, the FCC issued an order confirming that the price cap was no longer necessary. On January 1, 2012, we increased the base price of our basic subscription packages from $12.95 to $14.49 per month.
Competition
We face significant competition for both listeners and advertisers. In addition to pre-recorded entertainment purchased or playing in cars, homes and using portable players, we compete with numerous other providers of radio or other audio services. Some of our new, digital competitors are making in-roads into automobiles, where we are currently the prominent alternative to traditional AM/FM radio. Our existing and emerging competition includes:
Traditional AM/FM Radio
Our services compete with traditional AM/FM radio. Many traditional radio companies are substantial entities owning large numbers of radio stations or other media properties. The radio broadcasting industry is highly competitive.
Traditional AM/FM radio has had a well-established demand for its services and offers free broadcasts paid for by commercial advertising rather than by a subscription fee like satellite radio. Many radio stations offer information programming of a local nature, such as local news and sports. Traditional free AM/FM radio reduces the likelihood that customers would be willing to pay for our subscription services and, by offering free broadcasts, it imposes limits on what we can charge for our services. Some AM/FM radio stations have reduced the number of commercials per hour, expanded the range of music played on the air and experimented with new formats in order to lure customers away from satellite radio.
HD Radio
Many radio stations now broadcast digital signals, which have clarity similar to our signals. These stations do not charge a subscription fee for their digital signals but do generally carry advertising. A group of major broadcast radio networks have created a coalition to jointly market digital radio services. According to this coalition, over 2,100 radio stations are currently broadcasting primary signals with HD Radio technology and broadcasting more than 1,300 additional FM multicast channels (HD2/HD3), and manufacturers are marketing and distributing digital receivers. To the extent that traditional AM/FM radio stations adopt digital transmission technology and listeners adopt digital receivers, any competitive advantage that we enjoy over traditional radio because of our clearer digital signal would be lessened. Traditional AM/FM broadcasters are also complementing their HD Radio efforts by aggressively pursuing Internet radio and wireless Internet-based distribution arrangements. Several automakers install or plan to install HD Radio equipment as factory standard equipment in select models, including Cadillac, Mazda, Lexus, Ford, Volkswagen, BMW, Mercedes-Benz, Scion, Kia and Hyundai.
Internet Radio and Internet-Enabled Smartphones
Internet radio broadcasts often have no geographic limitations and can provide listeners with radio programming from across the country and around the world. Major media companies and online-only providers, including Clear Channel, CBS and Pandora, make high fidelity digital streams available through the Internet for free or, in some cases, for a fraction of the cost of a satellite radio subscription. These services compete directly with our services, at home, in the automobile, and wherever audio entertainment is consumed.
Internet-enabled smartphones, most of which have the capability of interfacing with vehicles, have become popular. These smartphones can typically play recorded or cached content and access Internet radio via dedicated applications or browsers. These applications are often free to the user and offer music and talk content as long as the user is subscribed to a sufficiently large mobile data plan. Leading audio smartphone radio applications include Pandora, last.FM, Slacker, iheartradio and Stitcher. Certain of these applications also include advanced functionality, such as personalization and song skipping, and allow the user to access large libraries of content and podcasts on demand.
In 2011, Spotify launched its music streaming service in the United States, which allows its users unlimited, on-demand access to a large library of song tracks, allowing the sharing of playlists with other listeners through the Facebook platform. Other similar services have launched Facebook integration, including MOG and Rdio. These services, which usually require a monthly subscription fee, are currently available on smartphones but may become integrated into connected cars in the future.
Third and fourth generation mobile networks have enabled a steady increase in the audio quality and reliability of mobile Internet radio streaming, and this is expected to further increase as fourth generation networks become the standard. We expect that improvements from higher bandwidths, wider programming selection, and advancements in functionality are likely to continue making Internet radio and smartphone applications an increasingly significant competitor, particularly in vehicles.
Advanced In-Dash Infotainment Systems
Nearly all automakers have deployed or are planning to deploy integrated multimedia systems in dash boards, such as Ford’s SYNC, Toyota’s Entune, and BMW/Mini’s Connected. These systems can combine control of audio entertainment from a variety of sources, including AM/FM/HD radio broadcasts, satellite radio, Internet radio, smartphone applications and stored audio, with navigation and other advanced applications such as restaurant bookings, movie show times and financial information. Internet radio and other data is typically connected to the system via a bluetooth link to an Internet-enabled smartphone, and the entire system may be controlled by touchscreen or voice recognition. These systems enhance the attractiveness of our Internet-based competition by making such applications more prominent, easier to access, and safer to use in the car. Similar systems are also available in the aftermarket and sold through retailers.
Direct Broadcast Satellite and Cable Audio
A number of providers offer specialized audio services through either direct broadcast satellite or cable audio systems. These services are targeted to fixed locations, mostly in-home. The radio service offered by direct broadcast satellite and cable audio is often included as part of a package of digital services with video service, and video customers generally do not pay an additional monthly charge for the audio service.
Other Digital Media Services
The audio entertainment marketplace continues to evolve rapidly, with a steady emergence of new media platforms and portable devices that compete with our services now or that could compete with those services in the future.
Traffic News Services
A number of providers also compete with our traffic services. Clear Channel and Tele Atlas deliver nationwide traffic information for the top 50 markets to in-vehicle navigation systems using RDS/TMC, the radio broadcast standard technology for delivering traffic and travel information to drivers. The in-dash navigation market is also being threatened by increasingly capable smartphones that provide advanced navigation functionality, including live traffic. Android, Palm, Blackberry, and Apple iOS-based smartphones all include GPS mapping and navigation functionality, often with turn-by-turn navigation.
Government Regulation
As operators of a privately owned satellite system, we are regulated by the FCC under the Communications Act of 1934, principally with respect to:
• the licensing of our satellite systems;
• preventing interference with or to other users of radio frequencies; and
• compliance with FCC rules established specifically for U.S. satellites and satellite radio services.
Any assignment or transfer of control of our FCC licenses must be approved by the FCC. The FCC’s order approving the Merger requires us to comply with certain voluntary commitments we made as part of the FCC merger proceeding. We believe we comply with those commitments.
In 1997, we were the winning bidders for an FCC license to operate a satellite digital audio radio service and provide other ancillary services. Our FCC licenses for our Sirius satellites expire in 2017. Our FCC licenses for our XM satellites expire in 2013, 2014 and 2018. We anticipate that, absent significant misconduct on our part, the FCC will renew our licenses to permit operation of our satellites for their useful lives, and grant a license for any replacement satellites.
In some areas with high concentrations of tall buildings, such as urban centers, signals from our satellites may be blocked and reception can be adversely affected. In many of these areas, we have installed terrestrial repeaters to supplement our satellite signal coverage. In 2010, the FCC established rules governing terrestrial repeaters which are also intended to protect adjacent wireless services from interference. Under those rules, we filed an application in November 2011 for a single license to authorize operation of our repeater network.
CEO BACKGROUND
Joan L. Amble
58
Ms. Amble has been a director since July 2008. From December 2006 until the closing of our merger with XM Satellite Radio Holdings Inc. (“XM”) in July 2008, Ms. Amble served as a director of XM. From May 2011 to December 2011, Ms. Amble was the Executive Vice President, Finance for the American Express Company and also served as Executive Vice President and Corporate Comptroller from December 2003 until May 2011. Prior to joining American Express, Ms. Amble served as Chief Operating Officer and Chief Financial Officer of GE Capital Markets, a service business within GE Capital Services, Inc., overseeing securitizations, debt placement and syndication, as well as structured equity transactions. From 1994 to March 2003, Ms. Amble served as vice president and controller for GE Capital. Ms. Amble also serves as a member of the board of directors of Brown-Forman Corporation. Ms. Amble also served as a director at Broadcom during the last five years.
Key Attributes, Experience and Skills:
Ms. Amble has extensive experience in financial reporting, including experience with the rules of the Securities and Exchange Commission, based, in part, on her experience at the Financial Accounting Standards Board and General Electric Company. Ms. Amble also has significant experience in areas of: financial controls; Sarbanes-Oxley Act compliance; operations; risk management; six sigma quality; and consumer oriented subscription businesses.
Leon D. Black 60
Mr. Black has been a director since June 2001. Mr. Black is the Chairman of the Board, Chief Executive Officer and a Director of Apollo Global Management, LLC and a Managing Partner of Apollo Management, L.P. which he founded in 1990 to manage investment capital on behalf of a group of institutional investors, focusing on corporate restructuring, leveraged buyouts, and taking minority positions in growth oriented companies. From 1977 to 1990, Mr. Black worked at Drexel Burnham Lambert Incorporated, where he served as Managing Director, head of the Mergers & Acquisitions Group and co-head of the Corporate Finance Department. He serves on the boards of directors of Apollo Global Management, LLC and the general partner of AP Alternative Assets. Mr. Black is a trustee of The Museum of Modem Art, Mt. Sinai Hospital, The Metropolitan Museum of Art and The Asia Society. He is also a member of The Council on Foreign Relations and The Partnership for New York City. Mr. Black is also a member of the boards of FasterCures and the Port Authority Task Force. During the last five years, Mr. Black served as a director of United Rentals and was a member of the National Advisory Board of JPMorganChase.
Key Attributes, Experience and Skills:
Mr. Black’s experience in corporate finance is well renowned. He has extensive experience in arranging and structuring financings for enterprises worldwide, particularly enterprises with credit profiles similar to ours. In addition, Mr. Black’s experience in the private equity industry brings a long-term strategic perspective to the board’s deliberations.
Lawrence F. GilbertiEddy W. Hartenstein 61
Mr. Hartenstein has been a director since July 2008 and has served as the chairman of our board since November 2009. From May 2005 until the closing of the merger with XM in July 2008, Mr. Hartenstein served as a director of XM. Mr. Hartenstein is the Publisher and CEO of the Los Angeles Times and has served in that position since August 2008. He is also President and CEO of the Tribune Company, a position he has held since May 2011. Mr. Hartenstein was the Vice Chairman and a member of the board of directors of The DIRECTV Group, Inc. (formerly Hughes Electronics Corporation) from December 2003 until his retirement in December 2004. Mr. Hartenstein served as Chairman and CEO of DIRECTV, Inc. from late 2001 to 2004 and as President of DIRECTV, Inc. from its inception in 1990 to 2001. Prior to 1990, Mr. Hartenstein served in various capacities for Hughes Communications, Inc. and Equatorial Communications Services Company. Mr. Hartenstein also serves as a member of the board of directors of SanDisk Corporation, The City of Hope and Broadcom, Inc. Mr. Hartenstein also served as a director at Thomson Multimedia during the last five years.
Key Attributes, Experience and Skills:
As the former Chief Executive Officer of DIRECTV, Mr. Hartenstein has extensive experience in building, managing, marketing and operating a satellite service. He brings direct and highly relevant expertise to the board in such areas as: the construction and procurement of satellites, managing a large consumer subscriber base, consumer marketing, and the design and implementation of systems necessary to support a growing and dynamic consumer-oriented business. 61
Mr. Gilberti has been a director since September 1993. Since June 2000, Mr. Gilberti has been a partner in the law firm of Reed Smith LLP.
Key Attributes, Experience and Skills:
Mr. Gilberti has served on our board since 1993, shortly after our founding. He brings a range of institutional knowledge and experience to the board in evaluating business proposals, assessing risks and critiquing alternatives.
James P. Holden 59
Mr. Holden has been a director since August 2001. From October 1999 until November 2000, Mr. Holden was the President and Chief Executive Officer of DaimlerChrysler Corporation, one of the world’s largest automakers. Prior to being appointed President in 1999, Mr. Holden held numerous senior positions within Chrysler Corporation during his 19-year career at the company. Mr. Holden is a director of Speedway MotorSports, Inc., and the Lead Director of Snap-On Incorporated. Mr. Holden has also served as a director at Motors Liquidation Corporation, Meridian Automotive and SMobile Systems during the last five years.
Key Attributes, Experience and Skills:
Mr. Holden has spent his career in the automotive business which is a key market for our services. Mr. Holden’s perspective on and knowledge of the workings, business and product planning processes, and individuals in the automotive industry are significant assets to the board and its deliberations.
Mel Karmazin 68
Mr. Karmazin has served as our Chief Executive Officer and a member of our board of directors since November 2004. Prior to joining us, Mr. Karmazin was President and Chief Operating Officer and a member of the board of directors of Viacom Inc. from May 2000 until June 2004. Prior to joining Viacom, Mr. Karmazin was President and Chief Executive Officer of CBS Corporation from January 1999 and a director of CBS Corporation from 1997 until its merger with Viacom in May 2000. He was President and Chief Operating Officer of CBS Corporation from April 1998 through December 1998. Mr. Karmazin joined CBS Corporation in December 1996 as Chairman and Chief Executive Officer of CBS Radio and served as Chairman and Chief Executive Officer of the CBS Station Group (Radio and Television) from May 1997 to April 1998. Prior to joining CBS Corporation, Mr. Karmazin served as President and Chief Executive Officer of Infinity Broadcasting Corporation.
Key Attributes, Experience and Skills:
Mr. Karmazin has spent his career in the media and entertainment industry, with particularly relevant experience in radio. Mr. Karmazin’s expertise in general management, finance and strategic planning is extremely valuable; in particular, his radio experience and his skills in the areas of revenue maximization, cost control, music and talk programming as well as government, public and investor relations position him uniquely to serve as a director. As our Chief Executive Officer, Mr. Karmazin provides the board not only with knowledge of our daily workings, but also with the essential experience, insight and expertise that can be provided only by a person who is intimately involved in running our business.
James F. Mooney 57
Mr. Mooney has been a director since July 2003. Mr. Mooney is a director and chairman of the board of directors of Virgin Media Inc., a U.K. entertainment and communications business, and has served in that role since March 2003. From December 2004 to December 2007, Mr. Mooney was the chairman of the board of directors of RCN Corporation, a provider of bundled telephone, cable and high speed internet services. From April 2001 to September 2002, Mr. Mooney was the Executive Vice President and Chief Operating Officer of Nextel Communications Inc., a provider of wireless communications services. From January 2000 to January 2001, Mr. Mooney was the Chief Executive Officer and Chief Operating Officer of Tradeout Inc., an asset management firm owned jointly by General Electric Capital, Ebay Inc. and Benchmark Capital. From March 1999 to January 2000, Mr. Mooney was the Chief Financial Officer/Chief Operating Officer at Baan Company, a business management software provider. From 1980 until 1999, Mr. Mooney held a number of positions with IBM Corporation, including Chief Financial Officer of the Americas. Mr. Mooney is a member of the board of directors of Sidera Networks, LLC, a provider of high capacity communications services to carrier and enterprise customers.
Key Attributes, Experience and Skills:
Mr. Mooney has had a varied career in industries ranging from computer products to telecommunications. His diverse experience is very useful in our business and budget planning process, in analyzing subscriber growth and its trends and subscriber churn, assessing marketing opportunities, evaluating personnel and compensation, assessing financing alternatives, and assessing and evaluating our long-term business plans.
MANAGEMENT DISCUSSION FROM LATEST 10K
Executive Summary
We broadcast our music, sports, entertainment, comedy, talk, news, traffic and weather channels in the United States on a subscription fee basis through two proprietary satellite radio systems. Subscribers can also receive certain of our music and other channels over the Internet, including through applications for mobile devices.
We have agreements with every major automaker (“OEMs”) to offer satellite radios as factory- or dealer-installed equipment in their vehicles. We also distribute our satellite radios through retail locations nationwide and through our website. Satellite radio services are also offered to customers of certain daily rental car companies.
As of December 31, 2011, we had 21,892,824 subscribers. Our subscriber totals include subscribers under our regular pricing plans; discounted pricing plans; subscribers that have prepaid, including payments either made or due from automakers for subscriptions included in the sale or lease price of a vehicle; activated radios in daily rental fleet vehicles; certain subscribers to our Internet services; and certain subscribers to our weather, traffic, data and video services.
Our primary source of revenue is subscription fees, with most of our customers subscribing on an annual, semi-annual, quarterly or monthly basis. We offer discounts for prepaid and long-term subscription plans, as well as discounts for multiple subscriptions on each platform. We also derive revenue from activation and other subscription-related fees, the sale of advertising on select non-music channels, the direct sale of satellite radios, components and accessories, and other ancillary services, such as our Backseat TV, data and weather services.
In certain cases, automakers include a subscription to our radio services in the sale or lease price of new and pre-owned vehicles. The length of these prepaid subscriptions varies, but is typically three to twelve months. In many cases, we receive subscription payments from automakers in advance of the activation of our service. We also reimburse various automakers for certain costs associated with satellite radios installed in their vehicles.
We also have an equity interest in the satellite radio services offered in Canada. Subscribers to the Sirius XM Canada service are not included in our subscriber count. In June 2011, Canadian Satellite Radio Holdings Inc. (“CSR”), the parent company of XM Canada, and Sirius Canada completed a transaction to combine their operations (“the Canada Merger”).
Adjusted Results of Operations
In this section, we present certain financial performance measures that are not calculated and presented in accordance with generally accepted accounting principles in the United States of America (“Non-GAAP”). These Non-GAAP financial measures include: average monthly revenue per subscriber, or ARPU; subscriber acquisition cost, or SAC, per gross subscriber addition; customer service and billing expenses, per average subscriber; free cash flow; adjusted total revenue; and adjusted EBITDA. These measures exclude the impact of certain purchase price accounting adjustments. We use these Non-GAAP financial measures to manage our business, set operational goals and as a basis for determining performance-based compensation for our employees.
The purchase price accounting adjustments include the elimination of the earnings benefit of deferred revenue associated with our investment in Sirius XM Canada, the recognition of subscriber revenues not recognized in purchase price accounting and the elimination of the earnings benefit of deferred credits on executory contracts, which are primarily attributable to third party arrangements with an OEM and programming providers.
Our adjusted EBITDA also reallocates share-based payment expense from functional operating expense line items to a separate line within operating expenses. We believe the exclusion of share-based payment expense from functional operating expenses is useful given the significant variation in expense that can result from changes in the fair value as determined by the Black-Scholes-Merton model which varies based on assumptions used for the expected life, expected stock price volatility and risk-free interest rates; the effect of which is unrelated to the operational conditions that give rise to variations in the components of our operating costs.
Free cash flow is a metric that our management and Board of Directors use to evaluate the cash generated by our operations, net of capital expenditures and other investment activity. In a capital intensive business, with significant historical and current investments in satellites, we look at our operating cash flow, net of these investing cash outflows, to determine cash available for future subscriber acquisition and capital expenditures, to repurchase or retire debt, to acquire other companies and to evaluate our ability to return capital to stockholders. We believe free cash flow is an indicator of the long-term financial stability of our business. Free cash flow, which is reconciled to “Net cash provided by (used in) operating activities”, is a non-GAAP financial measure. This measure can be calculated by deducting amounts under the captions “Additions to property and equipment” and deducting or adding “Restricted and other investment activity” from “Net cash provided by (used in) operating activities” from the consolidated statements of cash flows. Free cash flow should be used in conjunction with other GAAP financial performance measures and may not be comparable to free cash flow measures presented by other companies. Free cash flow should be viewed as a supplemental measure rather than an alternative measure of cash flows from operating activities, as determined in accordance with GAAP. Free cash flow is limited and does not represent remaining cash flows available for discretionary expenditures due to the fact that the measure does not deduct the payments required for debt maturities. We believe free cash flow provides useful supplemental information to investors regarding our current and projected cash flow, along with other GAAP measures (such as cash flows from operating and investing activities), to determine our financial condition, and to compare our operating performance to other communications, entertainment and media companies.
We believe these Non-GAAP financial measures provide useful information to investors regarding our financial condition and results of operations. We believe investors find these Non-GAAP financial performance measures useful in evaluating our core trends because it provides a direct view of our underlying contractual costs. We believe investors use our current and projected adjusted EBITDA to estimate our current or prospective enterprise value and to make investment decisions. By providing these Non-GAAP financial measures, together with the reconciliations to the most directly comparable GAAP measure, we believe we are enhancing investors’ understanding of our business and our results of operations.
These Non-GAAP financial measures should be viewed in addition to, and not as an alternative for or superior to, our reported results prepared in accordance with GAAP. Please refer to the glossary (pages 45 through 51) for a further discussion of such Non-GAAP financial measures and reconciliations to the most directly comparable GAAP measure.
nt expense is expected to increase in future periods as we grant equity awards to our employees and directors. Compensation expense for share-based awards is recorded in the financial statements based on the fair value of the underlying equity awards. The fair value of stock option awards is determined using the Black-Scholes-Merton option-pricing model which is subject to various assumptions including the market price of our common stock, estimated forfeiture rates of awards and the volatility of our stock price. The fair value of restricted shares and restricted stock units is based on the market price of our common stock at date of grant.
Other non-cash purchase price adjustments include liabilities recorded as a result of the Merger related to executory contracts with an OEM and certain programming providers, as well as amortization resulting from changes in the value of deferred revenue as a result of the Merger.
Changes in operating assets and liabilities contributed $49,694, $112,097 and $220,966 to operating cash flows for the years ended December 31, 2011, 2010 and 2009, respectively. Significant changes in operating assets and liabilities include the timing of collections from our customers, the repayment of the XM Canada credit facility, and the timing of payments to vendors and related parties. As we continue to grow our subscriber and revenue base, we expect that deferred revenue and amounts due from customers and distributors will continue to increase. Amounts payable to vendors are also expected to increase as our business grows. The timing of payments to vendors and related parties are based on both contractual commitments and the terms and conditions of our vendors.
Cash Flows Used in Investing Activities
Cash used for investing activities consists primarily of capital expenditures for property and equipment. We will continue to incur significant costs to improve our terrestrial repeater network and broadcast and administrative infrastructure. In addition, we will continue to incur capital expenditures associated with our FM-6 satellite, which is scheduled for launch in the first half of 2012. After the launch of our FM-6 satellite, we anticipate no significant satellite capital expenditures for several years until it becomes necessary to replace satellites in our fleet.
Financings and Capital Requirements
We have historically financed our operations through the sale of debt and equity securities. The Certificate of Designations for our Series B Preferred Stock provides that, so long as Liberty Media beneficially owns at least half of its initial equity investment, Liberty Media’s consent is required for certain actions, including the grant or issuance of our equity securities and the incurrence of debt (other than, in general, debt incurred to refinance existing debt) in amounts greater than $10,000 in any calendar year.
Future Liquidity and Capital Resource Requirements
We have entered into various agreements to design, construct, and launch our satellites in the normal course of business. As disclosed in Note 17 in our consolidated financial statements in Item 8 of this Annual Report on Form 10-K, as of December 31, 2011, we expect to incur expenditures of approximately $60,517 and $5,526 in 2012 and 2013, respectively, and an additional $48,545 thereafter, the majority of which is attributable to the construction and launch of our FM-6 satellite and related launch vehicle.
Based upon our current plans, we believe that we have sufficient cash, cash equivalents and marketable securities to cover our estimated funding needs. We expect to fund operating expenses, capital expenditures, working capital requirements, interest payments, taxes and scheduled maturities of our debt with existing cash and cash flow from operations, and we believe that we will be able to generate sufficient revenues to meet our cash requirements.
Our ability to meet our debt and other obligations depends on our future operating performance and on economic, financial, competitive and other factors. We continually review our operations for opportunities to adjust the timing of expenditures to ensure that sufficient resources are maintained.
We regularly evaluate our business plans and strategy. These evaluations often result in changes to our business plans and strategy, some of which may be material and significantly change our cash requirements. These changes in our business plans or strategy may include: the acquisition of unique or compelling programming; the introduction of new features or services; significant new or enhanced distribution arrangements; investments in infrastructure, such as satellites, equipment or radio spectrum; and acquisitions, including acquisitions that are not directly related to our satellite radio business. In addition, our operations are affected by the FCC order approving the Merger, which imposed certain conditions upon, among other things, our program offerings.
Debt Covenants
The indentures governing our debt include restrictive covenants. As of December 31, 2011, we were in compliance with our debt covenants.
For a discussion of our “Debt Covenants”, refer to Note 13 to our consolidated financial statements in Item 8 of this Annual Report on Form 10-K.
Off-Balance Sheet Arrangements
We do not have any significant off-balance sheet financing arrangements other than those disclosed in Note 17 to our consolidated financial statements in Item 8 of this Annual Report on Form 10-K that are reasonably likely to have a material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
Contractual Cash Commitments
For a discussion of our “Contractual Cash Commitments,” refer to Note 17 to our consolidated financial statements in Item 8 of this Annual Report on Form 10-K.
Related Party Transactions
For a discussion of “Related Party Transactions,” refer to Note 11 to our consolidated financial statements in Item 8 of this Annual Report on Form 10-K.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with U.S. GAAP, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods. Accounting estimates require the use of significant management assumptions and judgments as to future events, and the effect of those events cannot be predicted with certainty. The accounting estimates will change as new events occur, more experience is acquired and more information is obtained. We evaluate and update our assumptions and estimates on an ongoing basis and use outside experts to assist in that evaluation when we deem necessary. We have disclosed all significant accounting policies in Note 2 to our consolidated financial statements in Item 8 of this Annual Report on Form 10-K.
Goodwill . Goodwill represents the excess of the purchase price over the estimated fair value of net tangible and identifiable intangible assets acquired in business combinations. Our annual impairment assessment of our single reporting unit is performed as of October 1 st of each year. Assessments are performed at other times if events or circumstances indicate it is more likely than not that the asset is impaired. Step one of the impairment assessment compares the fair value of the entity to its carrying value and if the fair value exceeds its carrying value, goodwill is not impaired. If the carrying value exceeds the fair value, the implied fair value of goodwill is compared to the carrying value of goodwill; an impairment loss will be recorded for the amount the carrying value exceeds the implied fair value. At October 1, 2011, the fair value of our single reporting unit substantially exceeded its carrying value and therefore was not at risk of failing step one of ASC 350-20, Goodwill (“ASC 350-20”). Subsequent to our annual evaluation of the carrying value of goodwill, there were no events or circumstances that triggered the need for an interim evaluation for impairment. As a result, there were no changes in the carrying value of our goodwill during the years ended December 31, 2011 and 2010.
Long-Lived and Indefinite-Lived Assets . We carry our long-lived assets at cost less accumulated amortization and depreciation. We review our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset is not recoverable. At the time an impairment in the value of a long-lived asset is identified, the impairment is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value.
Our annual impairment assessment of indefinite-lived assets, our FCC licenses and trademark, is performed as of October 1st of each year and an assessment is made at other times if events or changes in circumstances indicate that it is more likely than not that the asset is impaired. To determine fair value, we employ an expected present value technique, which utilizes multiple cash flow scenarios for the FCC licenses and trademark that reflect the range of possible outcomes and an appropriate discount rate.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Executive Summary
We broadcast our music, sports, news, talk, entertainment, traffic and weather channels, as well as infotainment services in the United States on a subscription fee basis through two proprietary satellite radio systems. Subscribers can also receive certain of our music and other channels over the Internet, including through applications for mobile devices.
We have agreements with every major automaker (“OEMs”) to offer satellite radios as factory- or dealer-installed equipment in their vehicles. We also acquire subscribers through the sale or lease of previously owned vehicles with factory-installed satellite radios. We distribute our satellite radios through retail locations nationwide and through our website. Satellite radio services are also offered to customers of certain daily rental car companies.
As of June 30, 2012 , we had 22,919,462 subscribers of which 18,670,966 were self-pay subscribers and 4,248,496 were paid promotional subscribers. Our subscriber totals include subscribers under our regular pricing plans; discounted pricing plans; subscribers that have prepaid, including payments either made or due from automakers for subscriptions included in the sale or lease price of a vehicle; activated radios in daily rental fleet vehicles; certain subscribers to our Internet services; and certain subscribers to our Backseat TV, data, traffic, and weather services.
Our primary source of revenue is subscription fees, with most of our customers subscribing on an annual, semi-annual, quarterly or monthly basis. We offer discounts for prepaid and long-term subscription plans, as well as discounts for multiple subscriptions on each platform. We also derive revenue from activation and other subscription-related fees, the sale of advertising on select non-music channels, the direct sale of satellite radios, components and accessories, and other ancillary services, such as our Internet radio, Backseat TV, data, traffic, and weather services.
In certain cases, automakers include a subscription to our radio services in the sale or lease price of new and previously owned vehicles. The length of these prepaid subscriptions varies, but is typically three to twelve months. In many cases, we receive subscription payments from automakers in advance of the activation of our service. We also reimburse various automakers for certain costs associated with satellite radios installed in their vehicles.
We also have an equity interest in the satellite radio services offered in Canada. Subscribers to the Sirius XM Canada service are not included in our subscriber count. As of May 31, 2012, Sirius XM Canada had 2,116,800 subscribers. In June 2011, Canadian Satellite Radio Holdings Inc. ("CSR"), the parent company of XM Canada, and Sirius Canada completed a transaction to combine their operations (the "Canada Merger").
Income Taxes
Income Tax Benefit (Expense) primarily represents the change in our deferred tax liability related to the difference in accounting for our FCC licenses, which are amortized over 15 years for tax purposes but not amortized for book purposes in accordance with GAAP, foreign withholding taxes on royalty income, the effect of changes in certain state laws related to the utilization of net operating losses ("NOLs") and the reversal of substantially all of our deferred income tax valuation allowance.
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For the three months ended June 30, 2012 and 2011 , income tax benefit (expense) was $2,996,549 and $(2,620) , respectively, a decrease of $2,999,169 . For the six months ended June 30, 2012 and 2011 , income tax benefit (expense) was $2,993,747 and $(4,192) , respectively. The income tax provision includes a discrete benefit of approximately $2,989,000 related to a reversal of substantially all of our deferred income tax valuation allowance and a discrete benefit of approximately $9,000 related to changes in the effective tax rate on certain deferred taxes.
T he remaining deferred tax asset valuation allowance as of June 30, 2012 of approximately $119,300 relates to deferred tax assets we expect to realize as a result of pre-tax income during the third and fourth quarters of 2012 of $111,800 and deferred tax assets of $7,500 that are not likely to be realized due to certain state NOL limitations.
Prior to the three months ended June 30, 2012 , we maintained a full valuation allowance against our net deferred tax assets due to our history of pre-tax losses as measured by trailing three year performance and uncertainty about the timing of and our ability to generate taxable income in the future.
The evaluation of the recoverability of our deferred tax asset and the need for a valuation allowance requires management to weigh evidence to reach a conclusion that it is more likely than not that all or some of the deferred tax asset will be realized. The weight given to the potential effects of positive and negative evidence is based on the extent to which it can be objectively verified. Our conclusion with regard to maintaining or releasing the valuation allowance gives consideration to a variety of factors including but not limited to a three-year cumulative pre-tax income; the extent of current period taxable income and an expectation of sufficient and sustainable future taxable income; and our ability to utilize net operating losses within the carryforward period.
In 2010, we had our first year of pre-tax earnings for financial statement reporting purposes, but continued to generate losses for tax purposes. For the year ended December 31, 2011, we had pre-tax earnings and generated taxable income for the first time. In 2012, we experienced three year cumulative pre-tax income and for the six months ended June 30, 2012 , we continued to report pre-tax earnings, validating our projections of pre-tax earnings and taxable income for the full year 2012. This, together with projections of sufficient future taxable income, represents significant positive evidence. As of June 30, 2012 , the cumulative positive evidence outweighed the historical negative evidence regarding the likelihood that our deferred tax asset will be realized. As a result, we concluded that $2,989,000 of the valuation allowance established against deferred tax assets should be released at June 30, 2012 .
Adjusted Results of Operations
In this section, we present certain financial performance measures that are not calculated and presented in accordance with generally accepted accounting principles in the United States of America (“Non-GAAP”). These Non-GAAP financial measures include: average monthly revenue per subscriber, or ARPU; subscriber acquisition cost, or SAC, per gross subscriber addition; free cash flow; and adjusted EBITDA. These measures exclude the impact of certain purchase price accounting adjustments. We use these Non-GAAP financial measures to manage our business, to set operational goals and as a basis for determining performance-based compensation for our employees.
The purchase price accounting adjustments include the elimination of the earnings benefit of deferred revenue associated with our investment in Sirius XM Canada, the recognition of subscriber revenues not recognized in purchase price accounting and the elimination of the earnings benefit of deferred credits on executory contracts, which are primarily attributable to third party arrangements with an OEM and certain programming providers.
Our adjusted EBITDA also reallocates share-based payment expense from functional operating expense line items to a separate line within operating expenses. We believe the exclusion of share-based payment expense from functional operating expenses is useful given the significant variation in expense that can result from changes in the fair value as determined by the Black-Scholes-Merton model, which varies based on assumptions used for the expected life, expected stock price volatility and risk-free interest rates, the effect of which is unrelated to the operational conditions that give rise to variations in the components of our operating costs.
Free cash flow is a metric that our management and board of directors use to evaluate the cash generated by our operations, net of capital expenditures and other investment activity. In a capital intensive business, with significant historical and current investments in satellites, we look at our operating cash flow, net of these investing cash outflows, to determine cash available for future subscriber acquisition and capital expenditures, to repurchase or retire debt, to acquire other companies and to evaluate our ability to return capital to stockholders. We believe free cash flow is an indicator of the long-term financial stability of our business. Free cash flow, which is reconciled to “Net cash provided by (used in) operating activities”, is a non-GAAP financial measure. This measure can be calculated by deducting amounts under the captions "Additions to property and equipment" and deducting or adding “Restricted and other investment activity” from "Net cash provided by (used in) operating activities" from the consolidated statements of cash flows. Free cash flow should be used in conjunction with other GAAP financial performance measures and may not be comparable to free cash flow measures presented by other companies. Free cash flow should be viewed as a supplemental measure rather than an alternative measure of cash flows from operating activities, as determined in accordance with GAAP. Free cash flow is limited and does not represent remaining cash flows available for discretionary expenditures due to the fact that the measure does not deduct the payments required for debt maturities. We believe free cash flow provides useful supplemental information to investors regarding our current and projected cash flow, along with other GAAP measures (such as cash flows from operating and investing activities), to determine our financial condition, and to compare our operating performance to other communications, entertainment and media companies.
We believe these Non-GAAP financial measures provide useful information to investors regarding our financial condition and results of operations. We believe investors find these Non-GAAP financial performance measures useful in evaluating our core trends because it provides a direct view of our underlying contractual costs. We believe investors use our current and projected adjusted EBITDA to estimate our current or prospective enterprise value and to make investment decisions. By providing these Non-GAAP financial measures, together with the reconciliations to the most directly comparable GAAP measure, we believe we are enhancing investors' understanding of our business and our results of operations.
These Non-GAAP financial measures should be viewed in addition to, and not as an alternative for or superior to, our reported results prepared in accordance with GAAP. Please refer to the glossary (pages 38 through 45 ) for a further discussion of such Non-GAAP financial measures and reconciliations to the most directly comparable GAAP measure.
Financings and Capital Requirements
We have historically financed our operations through the sale of debt and equity securities. The Certificate of Designations for our Series B-1 Preferred Stock provides that, so long as Liberty Media beneficially owns at least half of its initial equity investment, Liberty Media’s consent is required for certain actions, including the grant or issuance of our equity securities and the incurrence of debt (other than, in general, debt incurred to refinance existing debt) in amounts greater than $10,000 in any calendar year.
Future Liquidity and Capital Resource Requirements
We have entered into various agreements to design, construct and launch our satellites in the normal course of business. As disclosed in Note 15 to our unaudited consolidated financial statements, as of June 30, 2012 , we expect to incur satellite and transmission related expenditures of approximately $3,782 and $52,257 in 2012 and 2013, respectively, the majority of which is attributable to the construction and expected launch of our FM-6 satellite and related launch vehicle in 2013 and an additional $48,758 thereafter.
Based upon our current business plans, we believe that we have sufficient cash, cash equivalents and marketable securities to cover our estimated short-term and long-term funding needs. We expect to fund operating expenses, capital expenditures, working capital requirements, interest payments, taxes and scheduled maturities of our debt with existing cash and cash flow from operations, and we believe that we will be able to generate sufficient revenues to meet our cash requirements.
Our ability to meet our debt and other obligations depends on our future operating performance and on economic, financial, competitive and other factors. We continually review our operations for opportunities to adjust the timing of expenditures to ensure that sufficient resources are maintained.
We regularly evaluate our business plans and strategy. These evaluations often result in changes to our business plans and strategy, some of which may be material and significantly change our cash requirements. These changes in our business plans or strategy may include: the acquisition of unique or compelling programming; the introduction of new features or services; significant new or enhanced distribution arrangements; investments in infrastructure, such as satellites, equipment or radio spectrum; and acquisitions, including acquisitions that are not directly related to our satellite radio business. In addition, our operations are affected by the FCC order approving the Merger, which imposed certain conditions upon, among other things, our program offerings.
Debt Covenants
The indentures governing our debt include restrictive covenants. As of June 30, 2012 , we were in compliance with our debt covenants. For a discussion of our “Debt Covenants”, refer to Note 12 to our unaudited consolidated financial statements in Item 1 of this Quarterly Report on Form 10-Q.
Off-Balance Sheet Arrangements
We do not have any significant off-balance sheet arrangements other than those disclosed in Note 15 to our unaudited consolidated financial statements in Item 1 of this Quarterly Report on Form 10-Q that are reasonably likely to have a material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
Contractual Cash Commitments
For a discussion of our “Contractual Cash Commitments,” refer to Note 15 to our unaudited consolidated financial statements in Item 1 of this Quarterly Report on Form 10-Q.
Related Party Transactions
For a discussion of “Related Party Transactions,” refer to Note 10 to our unaudited consolidated financial statements in Item 1 of this Quarterly Report on Form 10-Q.
We have been engaged in discussion with Liberty Media to explore possible transactions with respect to its ownership interest in us, although we have not reached agreement with respect to a specific transaction that would be mutually beneficial to both our common and preferred stockholders. There is no assurance that these discussions will result in any specific action or transaction. We do not expect to disclose developments with respect to these discussions.
Critical Accounting Policies and Estimates
For a discussion of our “Critical Accounting Policies and Estimates,” refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2011 and Note 2 to our unaudited consolidated financial statements in Item 1 of this Quarterly Report on Form 10-Q.
Income Taxes. As of June 30, 2012 , the cumulative positive evidence outweighed the historical negative evidence regarding the likelihood that our deferred tax asset will be realized. As a result, we concluded that $2,989,000 of the valuation allowance established against deferred tax assets should be released at June 30, 2012 .
Glossary
Adjusted EBITDA - EBITDA is defined as net income before interest and investment loss; interest expense, net of amounts capitalized; income tax expense and depreciation and amortization. We adjust EBITDA to remove the impact of other income and expense, loss on extinguishment of debt as well as certain other charges discussed below. This measure is one of the primary Non-GAAP financial measures on which we (i) evaluate the performance of our businesses, (ii) base our internal budgets and (iii) compensate management. Adjusted EBITDA is a Non-GAAP financial performance measure that excludes (if applicable): (i) certain adjustments as a result of the purchase price accounting for the Merger, (ii) goodwill impairment, (iii) restructuring, impairments, and related costs, (iv) depreciation and amortization and (v) share-based payment expense. The purchase price accounting adjustments include: (i) the elimination of deferred revenue associated with the investment in XM Canada, (ii) recognition of deferred subscriber revenues not recognized in purchase price accounting, and (iii) elimination of the benefit of deferred credits on executory contracts, which are primarily attributable to third party arrangements with an OEM and programming providers. We believe adjusted EBITDA is a useful measure of the underlying trend of our operating performance, which provides useful information about our business apart from the costs associated with our physical plant, capital structure and purchase price accounting. We believe investors find this Non-GAAP financial measure useful when analyzing our results and comparing our operating performance to the performance of other communications, entertainment and media companies. We believe investors use current and projected adjusted EBITDA to estimate our current and prospective enterprise value and to make investment decisions. Because we fund and build-out our satellite radio system through the periodic raising and expenditure of large amounts of capital, our results of operations reflect significant charges for depreciation expense. The exclusion of depreciation and amortization expense is useful given significant variation in depreciation and amortization expense that can result from the potential variations in estimated useful lives, all of which can vary widely across different industries or among companies within the same industry. We believe the exclusion of restructuring, impairments and related costs is useful given the nature of these expenses. We also believe the exclusion of share-based payment expense is useful given the significant variation in expense that can result from changes in the fair value as determined using the Black-Scholes-Merton model which varies based on assumptions used for the expected life, expected stock price volatility and risk-free interest rates.
CONF CALL
Hooper Stevens
Thank you, Jim, and good morning, everyone. Welcome to Sirius XM Radio’s earnings conference call. Today, Mel Karmazin, our Chief Executive Officer will be joined by David Frear, our Executive Vice President and Chief Financial Officer. At the conclusion of our prepared remarks management will be glad to take your questions. Jim Meyer, President, Operations and Sales, and Scott Greenstein, President and Chief Content Officer, will also be available for the Q&A portion of the call.
First, I would like to remind everyone that certain statements made during the call might be forward-looking statements as the term is defined in the Private Securities Litigation Reform Act of 1995. These and all forward-looking statements are based on management’s current beliefs and expectations and necessarily depends upon assumptions, data or methods that may be incorrect or imprecise. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. For more information about those risks and uncertainties, please view Sirius XM’s SEC filings. We advise listeners not to rely unduly on forward-looking statements and disclaim any intent or obligation to update them.
As we begin, I would like to advise our listeners that today’s results will include discussions about both actual results and adjusted results. All discussions of adjusted operating results exclude the effects of stock-based compensation and certain purchase price accounting adjustments. With that I will now hand the call over to Mel Karmazin.
Mel Karmazin
Thanks for joining us this morning. Our Q2 results were outstanding across the board and we are particularly pleased that we have increased our guidance for subscribers, revenue, and EBITDA since Q2 ended. Q2 2012 was in some ways a microcosm of the company we said we would create by merging Sirius and XM. Our strategy is working and we are consistently delivering on the execution of our business plan that we articulated to you.
The audio entertainment business is more competitive than ever but we are delivering across all metrics. We have a unique and powerful business that we believe is very scalable and very sustainable. Our subscription revenue business model is unequaled. We derive almost 95% of our revenue from subscriptions with consumers paying us in advance for our service. We know that historically subscription business outperforms the more cyclical advertising business. We are also pleased that although small, our advertising business is growing and outperforming most radio companies.
Uniquely, Sirius XM has long-term agreements with all of the OEMs that manufacture and sell vehicles in the United States. As a result, today approximately two-thirds of all new vehicles sold come with a satellite radio and a trial to our service, which by the way consumers love. Since an estimated 145 million people spend over 50 minutes a day in the car with almost 75% of these people being alone, our integration into the car with an easy user interface also contributes significantly to our success.
We’re proud to say that since the merger we have consistently delivered excellent operating results quarter after quarter as reflected in all of our important metrics. Revenue is not only growing; it is actually accelerating. Operating expenses have been increasing less than revenue and principally only related to our growth. This has resulted in accelerating adjusted EBITDA growth along with margin expansion. Share in and conversion have been consistent for many quarters, and RPU is also growing as our January price increase rolls out to more and more of our subscribers.
We grew net subscribers by 622,000 in Q2, the strongest quarter of subscriber growth since the merger of Sirius and XM. This was a 38% increase from the subscriber growth we saw in last year’s Q2. Self-pay net adds, arguably the most important component of our subscriber growth, were 463,000, up 28% from Q2 2011. Year-to-date, total [net] additions through the first half have exceeded 1 million, up 24% from the first half of 2011.
This strong Q2 performance was built around very solid execution across the board, including stable conversion and stable churn despite more people paying higher prices from the January 1 price increase, and improving results from win back and subsequent owner vehicle sales. We continue to benefit from increases in auto sales and our churn and conversion performance is steady versus last year. We view both the churn and conversion statistics as significant wins viewed in light of a difficult economy and our January price increase.
We have a conservative expectation around auto sales and churn for the second half of the year, particularly as the economy continues to show signs of tepid growth. While it is still early, after two strong quarters we are positive that this year’s price change was the right step for the company. Consumers recognize our strong value proposition despite the intense competition from existing terrestrial and IP radio and the new audio services that are making their way into the market.
Revenue of $838 million, the highest quarterly revenue figure in the history of the company, was up 13% over Q2 2011. This acceleration from Q1’s 11% growth rate and the price change affected a higher proportion of the base. Following our Q2 subscriber pre-announcement in July we increased our full-year revenue estimate to approaching $3.4 billion. Total cash operating expenses were up just 7.1% with all of this growth attributed to revenue-based and growth-related expenses.
Fixed costs excluding revenue share and royalties, customer care, and billing and SAP were actually down year-over-year. We continue to find efficiencies in programming and other areas within the organization. The combination of accelerating revenue growth and strong expense management drove an expansion in our adjusted EBITDA of 28% to a record $237 million. Never before has the company produced so much EBITDA in one quarter and this figure clearly puts us on track to exceed the previous guidance we gave you.
Incidentally, the adjusted EBITDA margin in Q2 was also a record 28.2%, up significantly from 24.8% in Q2 last year. We are now confident in beating our previous adjusted EBITDA guidance so we are raising our full-year guidance to approximately $900 million.
Free cash flow in Q2 grew 39% to a record $230 million, the result of higher cash flow from operations combined with lower capital expenditures. This very strong cash flow performance beat all other quarters in the history of Sirius XM or its standalone predecessor companies. We even outperformed last year’s Q4 which is typically the strongest quarter seasonally for cash flows. Year-to-date free cash flow reached $245 million, up 65%. We are still very much on track to generate approximately $700 million of free cash flow this year.
As I mentioned on the Q1 call, revenue, adjusted EBITDA, and free cash flow are expected to continue to increase throughout the year as the price increase rolls out through the subscriber base and additional subscribers join the service. The consensus expectation for auto sales has flattened but remains up from last year’s numbers. The current expectation for full-year 2012 is 14.3 million and this is in line with where auto sales were at the time we did our Q1 earnings call in early May.
Despite this flattening in auto sales expectations, our strong execution has enabled us to raise our full-year guidance for the second time this year and we now believe our net subscriber additions will approach 1.6 million. This means our paid subscriber base should approach 23.5 million by the end of this year which would obviously be a record high level.
Challenges still abound in reaching our targets, but we’re confident that our subscriber growth estimates are achievable. I’m particularly pleased with the growth we are seeing in the used car channel, and we continue to target 1 million or more self-pay additions from our efforts with previously-owned cars. While we are coming up with programs to further improve our performance in used cars, we are benefiting from what is largely a numbers game. Cars turning over today in the second-owner market are increasingly likely to have a satellite radio as our new car penetration rate began to increase materially five to six years ago. These trends will continue accelerating over the years to come.
We continue to focus on the subscriber experience. This means we want to deliver the best content, the best customer service and the best technology that we possibly can to make sure our subscribers remain loyal members of the Sirius XM family. Our very strong lineup of non-music programming including Howard Stern, best-in-class curation of comedy, the NFL, Major League Baseball, National Basketball Association, the NHL, NASCAR, all types of collegiate sports, news and business offerings position us very well against our terrestrial and IP competitors. Added to this advantage is that we provide our music to subscribers commercial-free which is how listeners would prefer to receive their music content. Though some investors may be disappointed that we have chosen to keep our subscription costs low, we believe that this too adds to our competitive advantage.
Today, we are announcing the launch of Sirius XM On Demand. Sirius XM subscribers listening via our online media player on Apple iPhone, iPad or iTouch with Android soon to follow will be able to choose their favorite episodes from a catalog of more than 200 shows and over 2000 hours of content to listen to whenever they want. This is a very cool feature that enables our internet subscribers to listen to some of Sirius XM’s best content when and how they want it, pulling up recent shows, searching for archived content, and navigating through that content at will.
The company’s Personalized Radio Project is also on track for rollout by the end of this year. This is a feature that will let our internet subscribers tailor expertly-curated music channels to their taste. We continue to be excited about the additional Sirius XM 2.0 channels in English and Spanish that we’re offering in select radios and on the internet, and we’re getting good initial reaction from the expansion of our sports content online. Sirius XM is absolutely the best place to listen online to all of the major sports out there and no other competitor online comes close to matching the variety of non-music programming we offer.
We continue to look for ways to efficiently invest in more content including more exclusive new content online. All of this content and new features online will help drive adoption of our premium, all-access, and internet add-on packages which will benefit RPU. Once again, these investments in new content and new features are possible because of our strong business model.
We collect revenue from our subscribers and on a variable basis we keep the vast majority of our incremental revenue. By combining our great revenue model with tightly controlled fixed expenses and low variable costs we are able to produce tremendous operating leverage as we grow, and we can offer consumers the kind of expensive, hard-to-build content offerings that can’t be found elsewhere – content like Howard Stern, our great collection of sports and news, and even the simple yet powerful idea of commercial-free music. Free and premium competitors will always have a tough time replicating this winning lineup.
I do not believe that there is any question about how well we are performing today, but I also want to assure you that in addition to focusing on the current business our newest initiatives will be significant drivers of our long-term growth. These include our focus and investments in the second owner of each vehicle and our IP delivery platform. We also believe that while our satellite architecture will remain a very powerful advantage, the ultimate combination of satellite and IP will give us even stronger long-term competitive advantages. We are working with all of our automakers to roll out the next generation of radios and user interfaces that combine the best aspects of satellite and IP to enhance the driving experience. Our business continues to be very scalable and we continue to invest in our backend infrastructure to handle a subscriber-enabled vehicle base that will serve 35 million paying subscribers as well as 65 million inactive but potential subscribers.
Our earnings results are not being adversely affected by the slowdown in China, the troubles in Europe, or currency fluctuations. As our results demonstrate, there is nothing wrong with operating a company that is currently exclusively focused on the US that still can deliver the growth that our shareholders expect. In summary, we’re very pleased with the company’s performance particularly compared to other subscription media services and other radio companies.
We see no reason today why Sirius XM will not have many years of continued growth. Our greatest concerns are not company-related but more macro issues, such as the economy, fiscal cliff, budget deficit and gridlock in Washington. We can’t do much about those but I can assure you we will do everything possible to continue to grow our company no matter the environment.
The model and plan are quite simple: we grow subscribers, revenue and adjusted EBITDA grow; interest expense go down; capital expenditures remain low as there is no need to invest significantly in satellites for many years; NOLs are used to keep cash taxes minimal for many years. Free cash flow grows and is substantial. Management will then use that free cash flow in the most advantageous way for investors – real simple as long as we execute, and I am confident that Sirius XM will continue to execute.
With that I’ll turn the call over to Dave for some additional comments.
David Frear
Thanks, Mel. Q2 saw another extraordinary performance by Sirius XM. In the face of weakening global growth continuing through concerns about the stability of the Euro and a weak US economy, Sirius XM chalked up its best quarter for subscriber growth in the four years since the merger, adding 622,000 subscribers bringing total subs to over 22.9 million.
We continue to be pleased by consumer response to the $1.50 basic price increase initiated on January 1 of this year. Self-pay churn at 1.9% and new vehicle conversion rates at 45% remain consistent with our historical experience. The 1 million net additions in the first half of the year, a 24% increase over 2011’s first half, have prompted us to raise guidance for the second time this year to approaching 1.6 million net additions from 1.5 million last quarter and 1.3 million when we started the year.
[SAR] grew 16% over the prior year in Q2 to 14.1 million, though SAR actually declined modestly from 14.2 million in Q1. July SAR came in at just about 14 million, up 14% from July in 2011, however keep in mind that last summer’s numbers were adversely impacted by the tragedy in Japan. Analysts thought our outlooks for 2012 had been softening in the past couple of months although the average remains at 14.3 million for the year.
We entered the year with nearly 5.5 million trials in the conversion funnel. Growth in new and used car sales has led to consistent growth in the inventory of trial subscriptions which for the first time now top 6 million. As of today, over 6000 franchised and independent auto dealers have signed on to our used car program. We continue to convert new car trial opportunities at 45% even though vehicle mix continues to shift to smaller, less expensive cars.
With new vehicle conversion rates steady at 45% the increasing volume from new and used car conversions as well as reactivated radio increases resulted in nearly 15% growth in our self-pay gross additions in Q2. With self-pay churn steady at 1.9%, self-pay net additions grew by 58% over the first half of 2011 to 762,000 from 484,000 in the prior year.
The price increase has been rolled out to approximately 50% of the self-pay subscriber base. We continue to be pleased by subscriber reactions to the price increase and the success in selling our All-Access Plan which offers subscribers our premier channels and smartphone access for a 16% savings.
RPU was up 3.8% over the prior year to $11.97 for the quarter. Combined with the 9% growth in subscribers, subscriber revenue grew 14% to $730 million. Advertising revenue increased 14% over the prior year, continuing to grow faster than the national radio advertising market. Equipment and other revenue were largely unchanged. Total revenues increased by 13% to a record $838 million for the quarter.
Cash operating expenses increased by only 7.1% or $40 million to $602 million. $29 million of the increase was related to increases in variable costs, $16 million of the increase is related to increased subscriber acquisition costs, and fixed costs actually declined by $5 million. Adjusted EBITDA was a record $237 million up 28% over the prior year and a record 28.2% margin was up 2.4 points on revenue over Q1. Adjusted EBITDA for the first half of 2012 increased 22% from a year ago to $445 million. We are increasing adjusted EBITDA guidance from $875 million to $900 million as a result of this strong performance.
Our long track record of cost-effective growth continued in the quarter. Contribution margin was down slightly at 70.6% from the prior year’s 70.9%, reflecting the statutory increase in music royalty rates and an increasing mix of OEM vehicles with revenue share. Subscriber acquisition costs increased 13% as installs and gross additions increased by 22% and 14% respectively; while [SAC] per growth add was flat at $54.
Fixed costs declined in the quarter on continuing reductions in programming costs, lower satellite and transmission costs related to reductions in in-orbit insurance, and lower engineering, design, and development costs resulting from the reversal of an accrual for nonrecurring engineering costs. Sales and marketing costs increased 10% in the quarter due to increased marketing efforts associated with increased funnel conversion opportunities and increased marketing opportunities to reactivate subscriptions.
We also reversed our deferred tax allowance in the quarter resulting in a tax benefit to earnings of approximately $3 billion. Another $112 million of tax benefit will be recognized in the second half of the year. The reversal of the deferred tax allowance was triggered by achieving three years of cumulative pre-tax income in management’s expectation of sufficient and sustainable future taxable income to utilize our NOL.
Free cash flow increased 39% over the prior year to $230 million in the quarter. We are on pace to beat our guidance of $700 million in free cash flow for the year and we currently expect to launch Sirius 6 as early as late December. We ended the quarter with $868 million in cash and $2.9 billion in debt. On July 25 we called the remaining 186 million of 9.75% notes at 104 7/8. We will redeem the notes on September 1. Following the repayment of those notes our gross debt will stand at $2.7 billion and gross debt to 2012 EBITDA guidance will be at our 3.0x target leverage, a significant improvement from 4.4x one year ago.
Our rapidly growing EBITDA has also improved interest coverage which increased to 3.3x in the quarter from 2.4x in the prior year. The retirement of the 9.75% notes will be followed in the next several months by the refinancing or retirement of our 13% notes due August 1, 2013. These two debt issues have accounted for $125 million of annual interest payments representing a significant opportunity for continuing improvements in interest coverage and free cash flow.
With that, Operator, let’s open it up for questions.
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