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XM Satellite Radio Holdings 10-K 2009 Documents found in this filing:Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Fiscal Year Ended December 31, 2008
DELAWARE (State or other jurisdiction of incorporation or organization of both registrants) 1500 ECKINGTON PLACE, NE WASHINGTON, DC 20002-2194 (Address of principal executive offices) (Zip code) 202-380-4000 (Registrants’ telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: Not Applicable Securities registered pursuant to Section 12(g) of the Act: Not Applicable (Title of Classes)
Indicate by check mark if each registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act Yes ¨ No x Indicate by check mark if each registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x Indicate by check mark whether each registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of each registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x Indicate by check mark whether each registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).
Indicate by check mark whether each registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes ¨ No x The aggregate market value of common stock held by non-affiliates of XM Satellite Radio Holdings Inc., based upon the closing price of its Class A common stock as of June 30, 2008, is $2,505,566,799. Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
DOCUMENTS INCORPORATED BY REFERENCE THE REGISTRANTS MEET THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS I(1)(a) AND (b) OF FORM 10-K AND ARE THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT.
Table of ContentsEXPLANATORY NOTE This Annual Report on Form 10-K is a combined report being filed by two separate registrants: XM Satellite Radio Holdings Inc. and XM Satellite Radio Inc. XM Satellite Radio Holdings Inc.’s principal wholly owned subsidiary is XM Satellite Radio Inc. XM Satellite Radio Holdings Inc. also fully and unconditionally guarantees certain of XM Satellite Radio Inc.’s debt securities. The two companies’ information presented in this report has been combined. The combined report includes XM Satellite Radio Holdings Inc.’s consolidated financial statements as the only set of financial statements. An explanation of the differences between the companies is set forth in the Note 1 to the consolidated financial statements in Item 8 of this Annual Report on Form 10-K. Condensed consolidating financial information regarding XM Satellite Radio Inc. is set forth in Note 18 to the consolidated financial statements in Item 8 of this Annual Report on Form 10-K. On July 28, 2008, Vernon Merger Corporation, a wholly owned subsidiary of Sirius XM Radio Inc. merged with and into XM Satellite Radio Holdings Inc. and as a result XM Holdings became a wholly owned subsidiary of SIRIUS (the “Merger”). Unless otherwise indicated,
The SIRIUS satellite radio business is conducted by SIRIUS; and the XM satellite radio business is conducted principally by us. XM Holdings is primarily a holding company, although XM Holdings owns the headquarters and data center of XM and leases these buildings to XM; owns portions of the XM-3 and XM-4 satellites; holds the investment in XM Canada; and holds certain cash accounts. XM Holdings, together with its subsidiaries, is operated as an unrestricted subsidiary under the agreements governing SIRIUS’ existing indebtedness. As an unrestricted subsidiary, transactions between SIRIUS and XM Holdings are required to comply with various covenants in each company’s respective debt instruments. Special Note Regarding Forward-Looking Statements The following cautionary statements identify important factors that could cause our actual results to differ materially from those projected in forward-looking statements made in this Annual Report on Form 10-K and in other reports and documents published by us from time to time. Any statements about our beliefs, plans, objectives, expectations, assumptions, future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimated,” “intend,” “plan,” “projection” and “outlook.” Any forward-looking statements are qualified in their entirety by reference to the factors discussed throughout this Annual Report on Form 10-K and in other reports and documents published by us from time to time, particularly the risk factors described in Item 1A of this Annual Report on Form 10-K. Among the significant factors that could cause our actual results to differ materially from those expressed in the forward-looking statements are:
Because the risk factors referred to above could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any of these forward-looking statements. In addition, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which the statement is made, to reflect the occurrence of unanticipated events or otherwise. New factors emerge from time to time, and it is not possible for us to predict which will arise or to assess with any precision the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES INDEX TO FORM 10-K
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Table of ContentsPART I
We broadcast in the United States our music, sports, news, talk, entertainment, traffic and weather channels for a subscription fee through our proprietary satellite radio system. On July 28, 2008, SIRIUS’ wholly owned subsidiary, Vernon Merger Corporation, merged (the “Merger”) with and into us and, as a result, we are now a wholly owned subsidiary of SIRIUS. Our satellite radio system consists of four in-orbit satellites, over 700 terrestrial repeaters that receive and retransmit signals, satellite uplink facilities and studios. Subscribers can also receive certain of our music and other channels over the Internet. Our satellite radios are primarily distributed through automakers (“OEMs”); retail locations; and through our website. We have agreements with major automakers to offer XM satellite radios as factory or dealer-installed equipment in their vehicles. XM radios are also offered to customers of rental car companies, including Avis. As of December 31, 2008, we had 9,850,741 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 prepaid subscriptions included in the sale or lease price of a new vehicle; active radios under our agreement with Avis; subscribers to XM Online, our Internet service; and certain subscribers to our weather, traffic and data 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 subscriptions as well as discounts for multiple subscriptions on each platform. In 2009, we increased the discounted price for additional subscriptions from $6.99 per month to $8.99 per month. We also derive revenue from activation fees, the sale of advertising on select channels, the direct sale of satellite radios and accessories, and other ancillary services, such as our data and weather services. Since October 1, 2008, we and SIRIUS have both entered into a series of transactions to improve our liquidity and strengthen our balance sheet, including:
See Note 19 to the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for additional information on certain of these transactions. XM Satellite Radio Inc. was incorporated on December 15, 1992 in the State of Delaware. XM Satellite Radio Holdings Inc. was formed as a holding company for XM on May 16, 1997. Programming We offer a dynamic programming lineup of approximately 135 channels on the XM platform: 117 channels are available to subscribers on both the SIRIUS and XM platforms — 63 channels of commercial-free music and 54 channels of sports, news, talk, entertainment, and traffic and weather. The channel line-up for our service can be found at xmradio.com. Our subscription packages allow most listeners to customize and enhance our standard programming lineup. The “Best of SIRIUS” package offers to XM subscribers the Howard Stern channels, Martha Stewart Living Radio, SIRIUS NFL Radio, SIRIUS NASCAR Radio, Playboy Radio and play-by-play college sports programming. We also offer family friendly, “mostly music” and “mostly sports, news and talk” packages.
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Table of ContentsWe also generate revenue by offering our “Best of XM” package to SIRIUS subscribers, including Oprah Radio, The Virus, XM Public Radio, MLB Home Plate, NHL Home Ice, The PGA Tour Network, and select play-by-play of NBA and NHL games and college sports programming. Our programming lineup changes from time to time as we strive to attract new subscribers and create content that appeals to a broad range of audiences and to our existing subscribers. Music Programming Our music channels 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 from time to time provide special features, such as our Artist Confidential series which provides interviews and performances from some of the biggest names in music, and “pop up” channels hosted by and/or featuring the music of a diverse array of artists. Sports Programming Live play-by-play sports are an important part of our programming strategy. We are the Official Satellite Radio Partner of Major League Baseball (“MLB”), NBA, NHL, and the PGA Tour, and broadcast most major college sports, including NCAA Division I football and basketball games. Through the “Best of SIRIUS” package, our subscribers can also receive SIRIUS NFL Radio, SIRIUS NASCAR Radio and play-by-play college sports programming. Soccer coverage includes matches from the Barclays English Premier League and UEFA Champions League. We also air FIS Alpine Skiing and World Cup events, National Lacrosse League and horse racing. We offer many exclusive talk programs such as MLB’s “Home Plate” and Chris “Mad Dog” Russo’s Mad Dog Unleashed on Mad Dog Radio, as well as simulcasts of select ESPN television shows and a radio version of SportsCenter. 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 also feature dozens of popular talk personalities, most creating radio shows that air exclusively on XM, including POTUS and Oprah Winfrey. News and Information Programming We offer a wide range of national, international and financial news programming. We also offer continuous, local traffic reports for numerous metropolitan markets throughout the United States. We broadcast these reports, together with local weather reports from The Weather Channel. Distribution of Radios Automakers Our primary means of distributing satellite radios is through the sale and lease of new vehicles. We have agreements with several major automakers, including Acura/Honda, Ferrari, General Motors, Hyundai, Infiniti/Nissan, Lexus/Toyota/Scion, and Porsche, to offer our satellite radios as factory or dealer-installed equipment in their vehicles. 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.
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Table of ContentsRetail We sell satellite radios directly to consumers through our website. Satellite 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. Satellite radios are also sold nationwide at various truck stops. Our Satellite Radio System Our satellite radio system is 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 where the satellite radio receiver 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. The FCC has allocated the portion of the S-band located between 2320 MHz and 2345 MHz exclusively for satellite radio. XM uses 12.5 MHz of this bandwidth to transmit its signal. Uplink transmissions (from the ground to our satellites) use 12.5 MHz of bandwidth in the 7060-7072.5 MHz band. Our satellite radio system has three principal components:
Satellites, Terrestrial Repeaters and Other Satellite Facilities Satellites. We own four orbiting satellites; two of which, XM-3 and XM-4, currently transmit the XM signal and two of which, XM-1 and XM-2, serve as in-orbit spares. Each of these satellites was manufactured by Boeing Satellite Systems International. The XM satellites were launched in March 2001, May 2001, February 2005 and October 2006, respectively. The XM satellites are deployed in geostationary orbits at 85° West Longitude and 115° West Longitude. We expect to expand or replace our satellite constellation to meet our business needs. Space Systems/Loral is constructing a fifth satellite, XM-5, for use in our system. XM-5 is a Loral FS-1300 model satellite. We have entered into an agreement with Sea Launch to secure a launch for XM-5. We expect to launch XM-5 during late 2009 or early 2010. We currently have in-orbit insurance on XM-3 and XM-4, our primary operating satellites, but do not carry insurance coverage for XM-1 and XM-2, our in-orbit spare satellites. These policies provide coverage for a total, constructive total or partial loss of the satellites that occurs during annual (or multi-year) in-orbit periods. 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 our business operations due to the loss of a satellite. The policies contain standard commercial satellite insurance provisions, including coverage exclusions. 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 currently operate over 700 terrestrial repeaters. Other Satellite Facilities. Our satellites are monitored by telemetry, and tracked and controlled by Telesat Canada, a satellite operator. In addition, we operate backup stations in the United States. Studios The programming on our system originates from studios in New York City, Washington D.C., Nashville and Chicago. The New York City broadcast studio houses SIRIUS’ corporate headquarters and, together with our Washington D.C. studio, houses facilities for programming origination, programming personnel and facilities to transmit programming.
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Table of ContentsSatellite Radios We design, establish specifications for, source or specify parts and components for, and manage various aspects of the logistics and production of XM radios. We generally do not manufacture, import or distribute radios, except for products distributed through our website. We have authorized manufacturers to produce and distribute XM radios, and have licensed our technology to various electronics manufacturers to develop, manufacture and distribute radios under various consumer brands. To facilitate the sale of XM radios, we may subsidize a portion of the radio manufacturing costs to reduce the hardware price to consumers. XM radios are manufactured in three principal configurations — as in-dash radios, dock & play radios and portable or wearable radios.
Our home units that provide our satellite services to home and commercial audio systems are also available. Products that provide access to our internet radio service in the home without the need for a personal computer are also available to consumers. We have introduced an interoperable radio, called MiRGE, containing both SIRIUS and XM chip sets. This radio has a unified control interface allowing for easy switching between the two satellite radio networks. Canada We have an interest in a satellite radio service offered in Canada through our 23.33%-owned affiliate, Canadian Satellite Radio Inc. (“XM Canada”). XM Canada offers 130 channels of music and news, sports talk and entertainment programming. Subscribers to the XM Canada service are not included in our subscriber count. Other Services Commercial Accounts. Our music service is also available for commercial establishments. Commercial accounts are available through providers of in-store entertainment solutions. Commercial subscribers are included in our subscriber count. DirecTV Satellite Television Service. We offer music channels as part of certain programming packages on the DirecTV satellite television service. Subscribers to this network are not included in our subscriber count. XM Content Through Mobile Phone Carriers. We offer music and comedy channels to mobile phone users through relationships with certain mobile phone carriers. Subscribers to these services are not included in our subscriber count. Subscribers to the following services are not included in our subscriber count, unless the applicable service is purchased by the subscriber separately and not as part of a subscription to the XM satellite radio service: Internet Radio. We simulcast music channels and select non-music channels over the Internet. We are transitioning XM Online from a service offered for no additional charge as part of our base subscription price to a service that is offered to subscribers for a fee.
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Table of ContentsReal-Time Traffic Services. We offer services that provide graphic information as to road closings, traffic flow and incident data to consumers with compatible in-vehicle navigation systems. Real-Time Weather Services. We offer several real-time weather services. FCC Conditions In order to demonstrate to the FCC that the Merger was in the public interest, SIRIUS and XM agreed to implement a number of voluntary commitments. These programming, public interest and qualified entity channels, equipment, subscription rates, and other service commitments are summarized as follows: Programming A La Carte Programming: We and SIRIUS committed to offer the a la carte programming options described below to consumers with eligible radios:
SIRIUS’ a la carte packages allow subscribers to pick, through interactive menus available on the Internet, the specific channels they would like to receive. SIRIUS has introduced these packages, including channels from both services, and a radio capable of receiving them. “Best of Both” Programming: SIRIUS and XM offer customers the ability to receive the best of both SIRIUS and XM programming at a monthly cost of $16.99. Mostly Music or News, Sports and Talk Programming: SIRIUS and XM offer customers an option of “mostly music” programming or “mostly news, sports and talk” programming at a cost of $9.99 per month. Discounted Family-Friendly Programming: SIRIUS and XM offer consumers a “family-friendly” version of existing SIRIUS or XM programming at a cost of $11.95 a month, representing a discount of $1.00 per month. SIRIUS and XM also offer customers a family-friendly version of the “best of both” programming. This programming costs $14.99 per month, representing a discount of $2.00 per month from the cost of the “best of” programming. Public Interest and Qualified Entity Channels SIRIUS and XM have agreed to set aside four percent of the full-time audio channels on the SIRIUS platform and on the XM platform for non-commercial, educational and informational programming within the meaning of the FCC rules that govern similar obligations of direct broadcast satellite providers. SIRIUS and XM have agreed not to select a programmer to fill more than one non-commercial, educational or informational channel on each of the SIRIUS and XM platforms as long as demand by programming providers for such channels exceeds available supply. In addition, SIRIUS and XM have agreed to enter into long-term leases or other agreements to provide to a Qualified Entity or Entities, defined as an entity or entities that are majority-owned by persons who are African American, not of Hispanic origin; Asian or Pacific Islanders; American Indians or Alaskan Natives; or Hispanics, rights to four percent of the full-time audio channels on the SIRIUS platform and on the XM platform. As digital compression technology enables us to broadcast additional full-time audio channels, we will ensure that four percent of full-time audio channels on our platform are reserved for a Qualified Entity or Entities. The Qualified Entity or Entities will not be required to make any lease payments for such channels. We will have no editorial control over these channels. We expect the FCC to inform it how it plans to select these Qualified Entities in the future. In February 2009, the FCC commenced a proceeding to determine the method to select these Qualified Entities.
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Table of ContentsEquipment We are required to provide, on commercially reasonable terms, our intellectual property necessary to permit any device manufacturer to develop equipment that can deliver our satellite radio service. Chip sets for satellite radios, which include the encryption, conditional access and security technology necessary to access our satellite radio service, may be purchased by licensees from manufacturers in negotiated transactions with such manufacturers. We will not enter into any agreement that grants, or that would have the effect of granting, a device manufacturer an exclusive right to manufacture, market and sell equipment that can deliver our satellite radio services. We will also not execute any agreement or take any other action that would bar, or have the effect of barring, a car manufacturer or other third party from including non-interfering HD radio chips, iPod compatibility, or other audio technology in an automobile or audio device. Subscription Rates We have agreed not to raise the retail price for, or reduce the number of channels in, our basic $12.95 per month subscription package, the a la carte programming packages or the new programming packages described above until July 28, 2011. After July 29, 2009, we may pass through cost increases incurred since the filing of our FCC merger application as a result of statutorily or contractually required payments to the music, recording and publishing industries for the performance of musical works and sound recordings or for device recording fees. We will provide customers, either on individual bills or on our website, a summary of the costs passed through to consumers pursuant to the preceding sentence. Interoperable Radios We have agreed to offer for sale an interoperable receiver, and recently began offering such receiver. Local Programming and Advertising We have committed not to originate local programming or advertising through our repeater network. Transactions between SIRIUS, XM Holdings and XM SIRIUS and XM have begun to integrate their operations, and have agreed to share the costs of certain day-to-day functions. For example, we transferred our employees to SIRIUS, and SIRIUS, in turn, has agreed to provide various services to both companies necessary to support their business, such as product development, sales, marketing, finance, accounting, information technology, programming, human resources, public relations, investor relations, legal and other general management services. XM and SIRIUS will share equally the costs of these employees. SIRIUS and XM have also agreed to share programming and rationalize their channel line-ups, and to share equally the costs of certain programming that appears on both platforms. In addition, SIRIUS and XM have agreed to jointly market radios and coordinate rebate, warranty and customer support programs to subscribers who purchase radios at retail or via their websites. In general, SIRIUS and XM share equally the costs of this marketing and sales coordination. SIRIUS and XM have also begun to seek opportunities to jointly increase revenues. SIRIUS and XM have agreed to offer their respective subscribers programming packages that include “best of” programming from the other service. Each of SIRIUS and XM retain all the respective revenue generated from their respective “best of” programming packages. XM Holdings and XM are operated as unrestricted subsidiaries under the agreements governing SIRIUS’ existing debt. As unrestricted subsidiaries, transactions among the companies are required to comply with various contractual provisions in each company’s respective debt instruments. The agreements between XM and SIRIUS are intended to permit both companies to share in the benefits of the inter-company arrangements in approximately equal proportion. The terms of the agreements between XM and SIRIUS are intended to be no more favorable to one company or the other than those that could be obtained at the time in an arm’s-length dealing with a firm or person that was not affiliated. Certain operations, such as our call centers, have not yet been integrated in any significant respect. SIRIUS and XM expect to enter into additional arrangements as they continue to integrate their operations and pursue opportunities to realize cost savings and increase revenues.
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Table of ContentsCompetition 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, the companies compete with the following providers of radio or other audio services: Traditional AM/FM Radio We 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. Unlike satellite radio, traditional AM/FM radio has had a well established demand for its services and generally offers free broadcasts paid for by commercial advertising rather than by a subscription fee. Many radio stations offer information programming of a local nature, such as local news and sports. By attracting listeners to their stations, traditional AM/FM radio reduces the likelihood that customers would be willing to pay for our subscription services and by offering free broadcasts they impose 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 have begun broadcasting digital signals, which have a clarity similar to our signals. A group of major broadcast radio networks have created a coalition to jointly market digital radio services. According to this coalition, more than 1,750 radio stations are currently broadcasting primary signals with HD Radio technology, and manufacturers are marketing and distributing digital receivers. To the extent that traditional AM/FM radio stations adopt digital transmission technology, any competitive advantage that we enjoy over traditional radio because of our clearer digital signal would be lessened. Traditional AM/FM broadcasters are also aggressively entering Internet radio and wireless internet-based distribution arrangements. Internet Radio Internet radio broadcasts have no geographic limitations and can provide listeners with radio programming from around the country and the world. Major media companies including Clear Channel, CBS, America Online and Yahoo! make near CD-quality digital streams available through the Internet for free or, in some cases, for a fraction of the cost of a satellite radio subscription. In addition, an Internet based radio product was recently announced for vehicles. The past few years have seen a steady increase in the audio quality of Internet radio streams and in the amount of audio content available via the Web, resulting in a steady increase in Internet radio audience metrics. We expect that improvements from higher bandwidths, faster modems and wider programming selection are likely to continue making Internet radio an increasingly significant competitor in the near future. These services already compete directly with our Internet offerings and, through the use of home stereo media adapters or media-centric PCs, with our home line of products. Downloading Devices The Apple iPod® is a portable digital music player that allows users to download and purchase music through Apple’s iTunes® Music Store, as well as convert music on compact disc to digital files. Apple has sold over 170 million iPods®. iPods® are compatible with certain car stereos and various home speaker systems, and certain automakers have entered into arrangements with manufacturers of portable media players that are expected to enhance this compatibility. Availability of music in the public MP3 audio standard has been growing in recent years with sound files available on the websites of online music retailers, artists and record labels and through numerous file sharing software programs. These MP3 files can be played instantly, burned to a compact disc or stored in various portable players available to consumers. Internet-based audio formats are becoming increasingly competitive as quality improves and costs are reduced. Direct Broadcast Satellite and Cable Audio A number of companies provide 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.
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Table of ContentsDigital Media Services We face increased competition from businesses that deliver or plan to deliver media content through mobile phones and other wireless devices. The audio entertainment marketplace continues to evolve rapidly, with a steady emergence of new media platforms and portable devices that compete with our service now or that could compete 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. There are also services that provide real-time traffic information to Internet-enabled cell phones or other hand held devices, but these are available only in limited markets and the associated data plan costs in addition to normal cell phone rates may make the offering undesirable to many users. Government Regulation As an operator of a privately owned satellite system, we are regulated by the FCC under the Communications Act of 1934, principally with respect to:
Any assignment or transfer of control of our FCC license must be approved by the FCC. In 1997, XM and SIRIUS were each a winning bidder for an FCC license to operate a satellite digital audio radio service and provide other ancillary services. Our FCC licenses for our satellites expire on various dates from 2009 to 2014. Prior to these expirations, we will be required to apply for a renewal of our FCC licenses. We currently have two such applications on file for licenses expiring on March 31, 2009 and May 31, 2009. 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. The FCC has not yet established rules governing terrestrial repeaters. Rulemaking on the subject has been initiated by the FCC and is still pending. Many comments have been filed as part of these rulemakings. The comments cover many topics relating to the operation of our terrestrial repeaters, but principally seek to protect adjoining wireless services from interference. We cannot predict the outcome or timing of these FCC proceedings and the final rules adopted by the FCC may limit our ability to deploy additional terrestrial repeaters, require us to reduce the power of our existing terrestrial repeaters or fail to protect us from interference by adjoining spectrum holders. In the interim, the FCC has granted us special temporary authority (“STA”) to operate our terrestrial repeaters and offer service on a non-harmful interference basis to other wireless services. Following the FCC’s review of whether certain repeaters had been operating at variance to the specifications in their STAs, both SIRIUS and XM entered into consent decrees requiring both remedial action and a voluntary contribution to the federal government. We believe the repeaters operated by XM comply with the consent decrees, the STAs and applicable FCC rules. We design, establish specifications for, source or specify parts and components for, manage various aspects of the logistics and production of, and, in many cases, obtain FCC certifications for, satellite radios, including satellite radios that include FM modulators. Part 15 of the FCC’s rules establish a number of requirements relating to FM modulators, including emissions and frequency rules. Following the FCC’s review of whether the FM transmitters in certain XM radios comply with the Commission’s emissions and frequency rules, we entered into a consent decree requiring both remedial action and a voluntary contribution to the federal government. We believe our radios that are currently in production comply with the consent decree and applicable FCC rules.
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Table of ContentsWe are required to obtain export licenses from the United States government to deliver components of our satellite radio systems and technical data related thereto. In addition, the delivery of satellites and the supply of related ground control equipment, technical data, and satellite communication/control services to destinations outside the United States and to foreign persons is subject to strict export control and prior approval requirements from the United States government (including prohibitions on the sharing of certain satellite-related goods and services with China). Changes in law or regulations relating to communications policy or to matters affecting our services could adversely affect our ability to retain our FCC license or the manner in which we operate. Copyrights to Programming In connection with our music programming, we must negotiate and enter into royalty arrangements with two sets of rights holders: holders of copyrights in musical works, or songs, and holders of copyrights in sound recordings — records, cassettes, compact discs and audio files. Musical works rights holders, generally songwriters and music publishers, are represented by performing rights organizations such as the American Society of Composers, Authors and Publishers (“ASCAP”), Broadcast Music, Inc (“BMI”), and SESAC, Inc (“SESAC”). These organizations negotiate fees with copyright users, collect royalties and distribute them to the rights holders. We have arrangements with all of these organizations. Under the Digital Performance Right in Sound Recordings Act of 1995 and the Digital Millennium Copyright Act of 1998, we also have to negotiate royalty arrangements with the copyright owners of the sound recordings, or if negotiation is unsuccessful, the royalty rate is established by the Copyright Royalty Board (the “CRB”) of the Library of Congress. Sound recording rights holders, typically large record companies, are primarily represented by SoundExchange, an organization which negotiates licenses, and collects and distributes royalties on behalf of record companies and performing artists. In January 2008, the CRB issued a decision regarding the royalty rate payable by XM under the statutory license covering the performance of sound recordings over their satellite radio services for the six-year period starting January 1, 2007 and ending December 31, 2012. Under the terms of the CRB’s decision, XM paid a royalty of 6.0% of gross revenues, subject to certain exclusions, for 2007 and 2008, and will pay a royalty of 6.5% of gross revenues, subject to certain exclusions, for 2009, 7.0% for 2010, 7.5% for 2011 and 8.0% for 2012. SoundExchange has appealed the decision of the CRB to the United States Court of Appeals for the District of Columbia Circuit. Final briefs in this matter were submitted to the court in February 2009 and oral argument is scheduled for March 2009. In August 2006, we were sued in the United States District Court for the Southern District of New York in three separate lawsuits by various record labels and music publishers in actions seeking monetary damages and equitable relief alleging that certain XM radios that have advanced recording functionality infringe upon plaintiffs’ copyrighted sound recordings. We believe these allegations are without merit and these products comply with applicable copyright law, including the Audio Home Recording Act. We are vigorously defending these matters. Trademarks We have registered, and intend to maintain, the trademark “XM” with the United States Patent and Trademark Office in connection with the transmission services offered by us. We are not aware of any material claims of infringement or other challenges to our right to use the “XM” trademark in the United States. We also have registered, and intend to maintain, trademarks for the names of certain of our channels. We have also registered the trademark, “XM”, and the logo, in Canada. We have granted a license to use our trademark in Canada to XM Canada. Personnel As of January 1, 2009, we did not have any employees. We have transferred all our employees to SIRIUS, and SIRIUS has agreed to provide various services necessary to support our business, such as product development, sales, marketing, finance, accounting, information technology, programming, human resources, public relations, investor relations, legal and other general management services. We share equally with SIRIUS the costs of these employees.
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Table of ContentsCorporate Information Our executive offices are located at 1500 Eckington Place, NE, Washington, DC 20002 and our telephone number is (202) 380-4000. Our internet address is xmradio.com. Our annual, quarterly and current reports, and amendments to those reports, filed or furnished pursuant to Section 14(a) or 15(d) of the Securities Exchange Act of 1934 may be accessed free of charge through xmradio.com after we have electronically filed such material with, or furnished it to, the SEC. Xmradio.com is an inactive textual reference only, meaning that the information contained on the website is not part of this Annual Report on Form 10-K and is not incorporated in this report by reference. Executive Officers of the Registrant Certain information regarding our executive officers is provided below:
Mel Karmazin has served as our President since the Merger and has served as SIRIUS’ Chief Executive Officer and a member of its board of directors since November 2004. Prior to joining SIRIUS, 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 from 1981 until its acquisition by CBS Corporation in December 1996. Mr. Karmazin served as Chairman, President and Chief Executive Officer of Infinity from December 1998 until the merger of Infinity Broadcasting Corporation with Viacom in February 2001. Patrick L. Donnelly has served as our Secretary since the Merger and has served as the Executive Vice President, General Counsel and Secretary of SIRIUS since May 1998. From June 1997 to May 1998, he was Vice President and deputy general counsel of ITT Corporation, a hotel, gaming and entertainment company that was acquired by Starwood Hotels & Resorts Worldwide, Inc. in February 1998. From October 1995 to June 1997, he was assistant general counsel of ITT Corporation. Prior to October 1995, Mr. Donnelly was an attorney at the law firm of Simpson Thacher & Bartlett LLP. David J. Frear has served as our Treasurer since the Merger and has served as the Executive Vice President and Chief Financial Officer of SIRIUS since June 2003. From July 1999 through February 2003, Mr. Frear was Executive Vice President and Chief Financial Officer of Savvis Communications Corporation, a global managed service provider, delivering internet protocol applications for business customers. From October 1999 through February 2003, Mr. Frear also served as a director of Savvis. Mr. Frear was an independent consultant in the telecommunications industry from August 1998 until June 1999. From October 1993 to July 1998, Mr. Frear was Senior Vice President and Chief Financial Officer of Orion Network Systems Inc., an international satellite communications company that was acquired by Loral Space & Communications Ltd. in March 1998. From 1990 to 1993, Mr. Frear was Chief Financial Officer of Millicom Incorporated, a cellular, paging and cable television company. Prior to joining Millicom, he was an investment banker at Bear, Stearns & Co., Inc. and Credit Suisse. Employment Agreements Mel Karmazin In November 2004, SIRIUS entered into a five-year agreement with Mel Karmazin to serve as its Chief Executive Officer. Mr. Karmazin receives an annual salary of $1,250,000, and annual bonuses in an amount determined each year by the Compensation Committee of SIRIUS’ board of directors.
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Table of ContentsPursuant to SIRIUS’ agreement with Mr. Karmazin, his stock options and shares of restricted stock will vest upon his termination of employment for good reason, upon his death or disability and in the event of a change in control. In the event Mr. Karmazin’s employment is terminated by SIRIUS without cause, his unvested stock options and shares of restricted stock will vest and become exercisable, and he will receive his current base salary for the remainder of the term and any earned but unpaid annual bonus. In the event that any payment SIRIUS makes, or benefit it provides, to Mr. Karmazin would require him to pay an excise tax under Section 280G of the Internal Revenue Code, SIRIUS has agreed to pay Mr. Karmazin the amount of such tax and such additional amount as may be necessary to place him in the exact same financial position that he would have been in if the excise tax was not imposed. Patrick L. Donnelly Mr. Donnelly has agreed to serve as SIRIUS’ Executive Vice President, General Counsel and Secretary, through April 2010. SIRIUS pays Mr. Donnelly an annual base salary of $525,000, and annual bonuses in an amount determined each year by the Compensation Committee of SIRIUS’ board of directors. If Mr. Donnelly’s employment is terminated without cause or he terminates his employment for good reason, SIRIUS is obligated to pay him a lump sum payment equal to the sum of his annual salary and the annual bonus last paid to him and to continue his medical and life insurance benefits for one year. In the event that any payment SIRIUS makes, or benefit SIRIUS provides, to Mr. Donnelly would require him to pay an excise tax under Section 280G of the Internal Revenue Code, SIRIUS has agreed to pay Mr. Donnelly the amount of such tax and such additional amount as may be necessary to place him in the exact same financial position that he would have been in if the excise tax was not imposed. David J. Frear Mr. Frear has agreed to serve as SIRIUS’ Executive Vice President and Chief Financial Officer through July 2011. SIRIUS pays Mr. Frear an annual salary of $750,000, and annual bonuses in an amount determined each year by the Compensation Committee of SIRIUS’ board of directors. If Mr. Frear’s employment is terminated without cause or he terminates his employment for good reason, SIRIUS is obligated to pay him a lump sum payment equal to the sum of his annual salary and the annual bonus last paid to him and to continue his medical and life insurance benefits for one year. In the event that any payment SIRIUS makes, or benefit SIRIUS provides, to Mr. Frear would require him to pay an excise tax under Section 280G of the Internal Revenue Code, SIRIUS has agreed to pay Mr. Frear the amount of such tax and such additional amount as may be necessary to place him in the exact same financial position that he would have been in if the excise tax was not imposed. Additional information regarding the compensation for Messrs. Karmazin, Donnelly and Frear will be included in SIRIUS’ definitive proxy statement for its 2009 annual meeting of stockholders scheduled to be held on Wednesday, May 27, 2009.
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Table of ContentsITEM 1A. RISK FACTORS In addition to the other information in this Annual Report on Form 10-K, including the information under the caption “Competition,” the following risk factors should be considered carefully in evaluating us and our business. This Annual Report on Form 10-K contains forward-looking statements within the meaning of the federal securities laws. Actual results and the timing of events could differ materially from those projected in forward-looking statements due to a number of factors, including those set forth below and elsewhere in this Annual Report on Form 10-K. See “Special Note Regarding Forward-Looking Statements.” Our business and our financial condition are being affected by general economic conditions. We believe that our business and our financial condition are being adversely affected by general economic conditions in a variety of ways. For example:
We need to refinance portions of our debt in the next two years, which refinancing may not be available. We have approximately $536 million of debt maturing in 2009 and 2010, including;
As a result of the May 2010 maturities, our existing cash balances and our cash flows from operating activities may not be sufficient to fund our projected cash needs at that time. We may not be able to access additional sources of refinancing on similar terms or pricing as those that are currently in place, or at all, or otherwise obtain other sources of funding. An inability to access replacement or additional sources of liquidity to fund our cash needs or to refinance or otherwise fund the repayment of our maturing debt could adversely affect our growth, our financial condition, our results of operations, and our ability to make payments on our debt, and could force us to seek the protection of the bankruptcy laws. It will be more difficult to obtain additional financing if prevailing instability in the credit and financial markets continues. SIRIUS is our sole stockholder and our business is operated as an unrestricted subsidiary under the agreements governing SIRIUS’ indebtedness. Under certain circumstances, SIRIUS may be unwilling or unable to contribute or loan us capital to support our operations. To the extent our funds are insufficient to support our business, we may be required to seek additional financing, which may not be available on favorable terms, or at all. If we are unable to secure additional financing, we could be forced to seek the protection of the bankruptcy laws. Our operations will also be affected by the FCC order approving the Merger. In addition, our future liquidity may be adversely affected by, among other things, changes in our operations or business plans, or by the nature and extent of the benefits, if any, achieved by operating as a wholly-owned subsidiary of SIRIUS.
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Table of ContentsOur substantial indebtedness is adversely affecting us. As of December 31, 2008, we had an aggregate principal amount of approximately $1.8 billion of indebtedness. Our substantial indebtedness has important consequences. For example, it:
Interest costs related to our debt are substantial and, as a result, the demands on our cash resources are significant. Our indebtedness contains covenants that, among other things, restrict our ability to incur more debt, pay dividends and make distributions, make certain investments, repurchase stock, create liens, enter into transactions with affiliates, enter into sale lease-back transactions, merge or consolidate, and transfer or sell assets. Failure to comply with the covenants contained in the indentures and agreements governing this debt could result in an event of default, which, if not cured or waived, could cause us to seek the protection of the bankruptcy laws, discontinue operations or seek a purchaser for our business or assets. XM is required to maintain a minimum cash balance of $75 million under its credit facilities. If XM’s cash balance falls below this amount, it would need to obtain a waiver from the lenders to avoid a default. No assurance can be given that XM would be able to obtain such a waiver or otherwise avoid a default under its credit facilities. Our business depends in large part upon automakers, a number of whom have experienced a sharp decline in sales, reduced production and are experiencing extreme financial difficulties. The sale and lease of vehicles with satellite radios is an important source of subscribers for our service. We have agreements with many major automakers to include satellite radios in new vehicles, although these agreements do not require automakers to install specific quantities of radios. Current economic conditions, particularly the dramatic slowdown in auto sales, negatively impacted subscriber growth for our service in 2008 and is expected to significantly impact subscriber growth in 2009. In addition, some of the major automakers are experiencing extreme financial difficulties and are seeking government assistance. Subscription growth is dependent, in large part, on sales and vehicle production by automakers. Automotive sales and production are dependent on many factors, including the availability of consumer credit, general economic conditions, consumer confidence and fuel costs. To the extent vehicle sales by automakers continue to decline, or the penetration of factory-installed satellite radios in those vehicles is reduced, and there is no offsetting growth in vehicle sales or increased penetration by other automakers, subscriber growth for our service will be adversely impacted. Failure of other third parties to perform could also adversely affect our business. Our business depends in part on the efforts of various other third parties, including:
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Table of ContentsIf one or more of these third parties does not perform in a sufficient or timely manner, our business will be adversely affected. In October 2005, Delphi Corporation and 38 of its domestic U.S. subsidiaries filed voluntary petitions for relief under Chapter 11 of the U.S. Bankruptcy Code. Delphi manufactures, in factories outside the United States, satellite radios for installation in various brands of vehicles. Delphi also distributes to retailers certain models of XM radios. It is unclear whether Delphi will ever emerge from bankruptcy or will be liquidated. In November 2008, Circuit City and its wholly-owned United States and Puerto Rican subsidiaries filed voluntary petitions for reorganization relief under Chapter 11 of the U.S. Bankruptcy Code. In January 2009, Circuit City liquidated all of its assets as part of its Chapter 11 proceeding and ceased doing business. In 2008, Circuit City marketed and sold a substantial number of satellite radios and promoted subscriptions to our service. The liquidation of Circuit City reduced our retail points-of-presence and contributed, in part, to the decline we experienced in sales through retailers in 2008. We do not manufacture satellite radios or accessories, and we depend on manufacturers and others for the production of radios and their component parts. If one or more manufacturers does not produce radios in a sufficient quantity to meet demand, or if such radios do not perform as advertised or are defective, sales of our services and our reputation could be adversely affected. We design, establish specifications for, source or specify parts and components for, and manage various aspects of the logistics and production of radios. As a result of these activities, we may be exposed to liabilities associated with the design, manufacture and distribution of radios that the providers of an entertainment service would not customarily be subject to, such as liabilities for design defects, patent infringement and compliance with applicable laws, as well as the costs of returned product. Failure of our satellites would significantly damage our business. We operate four in-orbit satellites. The useful lives of these satellites will vary and depend on a number of factors, including:
We placed our XM-3 and XM-4 satellites into service during the second quarter of 2005 and during the fourth quarter of 2006, respectively. Our XM-1 and XM-2 satellites experienced progressive degradation problems common to early Boeing 702 class satellites and now serve as in-orbit spares. We estimate that the XM-3 and XM-4 satellites will exceed their fifteen year predicted useful lives, and that XM-1 and XM-2 satellites’ useful lives will end in 2011. An operational failure or loss of XM-3 or XM-4 would, at least temporarily, affect the quality of our service, and could interrupt the continuation of our service and harm our business. We likely would not be able to complete and launch our XM-5 satellite before late 2009 or early 2010. In the event of any satellite failure prior to that time, we would need to rely on its back-up satellites, XM-1 and XM-2. There can be no assurance that restoring service through XM-1 and XM-2 would allow us to maintain adequate broadcast signal strength through the in-service date of XM-5, particularly if XM-1 or XM-2 were to suffer unanticipated additional performance degradation or experience an operational failure. In addition, our network of terrestrial repeaters communicates with one of our satellites. If the satellite communicating with our repeater network fails unexpectedly, the service would be disrupted for several hours or longer. In the ordinary course of operation, satellites experience failures of component parts and operational and performance anomalies. Components on our in-orbit satellites have failed and from time to time we have experienced anomalies in the operation and performance of these satellites. These failures and anomalies are expected to continue in the ordinary course, and it is impossible to predict if any of these future events will have a material adverse effect on our operations or the useful life of our existing in-orbit satellites.
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Table of ContentsPotential satellite losses may not be covered by insurance. We maintain in-orbit insurance covering our primary satellites broadcasting the XM service, but not on our back-up satellites. Any insurance proceeds will not fully cover our losses. For example, the insurance covering our satellites does not cover the full cost of constructing, launching and insuring new satellites or our in-orbit spare satellites, nor will it cover and we do not have protection against business interruption, loss of business or similar losses. Our insurance contains customary exclusions, material change and other conditions that could limit recovery under those policies. Further, any insurance proceeds may not be received on a timely basis in order to launch a spare satellite or construct and launch a replacement satellite or take other remedial measures. In addition, our policies are subject to limitations involving uninsured losses, large satellite performance deductibles and policy limits that may not be sufficient to cover losses. If we experience a loss that is uninsured or that exceeds policy limits, this may impair its ability to make timely payments on its outstanding debt and other financial obligations. Failure to comply with FCC requirements could damage our business. We hold an FCC license and authorizations to operate a commercial satellite radio service in the United States, including authorizations for satellites and terrestrial repeaters, and related authorizations. The FCC generally grants licenses and authorizations for a fixed term. Although we expect our license and authorizations to be renewed in the ordinary course upon their expiration, there can be no assurance that this will be the case. Any assignment or transfer of control of any of our FCC license or authorizations must be approved in advance by the FCC. The operation of our satellite radio system is subject to significant regulation by the FCC under authority granted through the Communications Act and related federal law. We are required, among other things, to operate only within specified frequencies; to meet certain conditions regarding the interoperability of our satellite radios with those of other licensed satellite radio systems; to coordinate our satellite radio service with radio systems operating in the same range of frequencies in neighboring countries; and to coordinate our communications links to our satellites with other systems that operate in the same frequency band. Non-compliance by us with these requirements or other conditions or with other applicable FCC rules and regulations could result in fines, additional license conditions, license revocation or other detrimental FCC actions. There is no guarantee that the FCC will not modify its rules and regulations in a manner that would have a material impact on our operations. The terms of our license, the order of the FCC approving the Merger, and the consent decree we entered into with the FCC require us to meet certain conditions. We have agreed to implement a number of voluntary commitments, including programming, minority and public interest, equipment, subscription rates, and other service commitments. Non-compliance with these conditions could result in fines, additional license conditions, license revocation or other detrimental FCC actions. The FCC has not yet issued final rules permitting us to operate and deploy terrestrial repeaters to fill gaps in our satellite coverage. We are operating our terrestrial repeaters on a “non-interference” basis pursuant to grants of special temporary authority from the FCC. The FCC’s final terrestrial repeater rules may require us to reduce the power of our terrestrial repeaters or limit our ability to deploy additional repeaters. If the FCC requires us to reduce significantly the number or power of our terrestrial repeaters, this would have an adverse effect on the quality of our service in certain markets and/or cause us to alter our terrestrial repeater infrastructure at a substantial cost. If the FCC limits our ability to deploy additional terrestrial repeaters, our ability to improve any deficiencies in our service quality that may be identified in the future would be adversely affected. The anticipated benefits of the Merger may not be realized fully or may take longer to realize than expected. The Merger involved the integration of two companies that have previously operated independently with principal offices in two distinct locations and technologically different satellite radio platforms. We are devoting significant management attention and resources to integrating the companies. Delays in this process could adversely affect our business, financial results and financial condition. Even if we are able to integrate our business operations with SIRIUS successfully, there can be no assurance that this integration will result in the realization of the full benefits of synergies, cost savings, innovation and operational efficiencies that may be possible from this integration. In addition, the indentures and credit agreements governing SIRIUS’ indebtedness and our indebtedness contain covenants that restrict the integration of these two operating companies, which may in certain instances impede the realization of cost savings.
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Table of ContentsWe may from time to time modify our business plan, and these changes could adversely affect us and our financial condition. We regularly evaluate our plans and strategy. These evaluations often result in changes to our plans and strategy, some of which may be material and significantly change our cash requirements. These changes in our 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 of third parties that own programming, distribution, infrastructure, assets, or any combination of the foregoing. Our business might never become profitable. As of December 31, 2008, we had an accumulated deficit of approximately $6.4 billion. We expect our cumulative net losses to grow as we make payments under various contracts, incur marketing and subscriber acquisition costs and make interest payments on existing debt. If we are unable ultimately to generate sufficient revenues to become profitable and generate positive cash flow, we could default on our commitments and there is a risk that we would be unable to make the required payments on our indebtedness. Demand for our service may be insufficient for it to become profitable. We cannot estimate with any certainty whether consumer demand for our service will be sufficient for us to continue to increase the number of subscribers to our service. Our satellite radio service has experienced a significant decrease in new subscriptions from retail subscribers and most new subscription growth has come from automakers, many of which have experienced recent and dramatic decreases in sales. Among other things, continuing and increased consumer acceptance of our service will depend upon:
If demand for our products and service does not continue to increase, we may not be able to generate enough revenues to generate positive cash flow or to become profitable. Programming is an important part of our service, and the costs to renew our programming arrangements may be more than anticipated. Third-party content is an important part of our satellite radio service, and we compete with many entities for content. We have entered into a number of important content arrangements, including an agreement with Major League Baseball, which require us to pay substantial sums. Our agreement with MLB expires at the end of the 2012 baseball season. As these agreements expire, we may not be able to negotiate renewals of one or more of these agreements, or renew such agreements at costs we believe are attractive. In addition, we may not be able to obtain additional third-party content within the costs contemplated by our business plan. We must maintain and pay license fees for music rights. We must maintain music programming royalty arrangements with, and pay license fees to, BMI, ASCAP and SESAC. These organizations negotiate with copyright users, collect royalties and distribute them to songwriters and music publishers. We have agreements with ASCAP and SESAC through December 2011. We do not have a definitive agreement with BMI, and we continue to operate under an interim agreement with BMI. There can be no assurance that the BMI royalty fee will remain at the current level when the pending agreement is finalized. Under the Digital Performance Right in Sound Recordings Act of 1995 and the Digital Millennium Copyright Act of 1998, we pay royalties to copyright owners of sound recordings. Those royalty rates may be established through negotiation
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Table of Contentsor, if negotiation is unsuccessful, by the CRB. We participated in a CRB proceeding in order to set the royalty rate payable by our satellite radio service under the statutory license covering the performance of sound recordings for the six-year period starting in January 2007. Higher than expected costs of attracting new subscribers, higher subscriber turnover or weaker than expected advertising revenue could each adversely affect our financial performance and operating results. We are spending substantial funds on advertising and marketing and in transactions with automakers, radio manufacturers, retailers and others to obtain and attract subscribers. If the costs of attracting new subscribers are greater than expected, our financial performance and operating results could be adversely affected. We are experiencing, and expect to continue to experience, subscriber turnover, or churn. If we are unable to retain our current subscribers, or the costs of retaining subscribers are higher than we expect, our financial performance and operating results could be adversely affected. We cannot predict how successful we will be at retaining customers who purchase or lease vehicles that include a subscription to their satellite radio services. Over the past several quarters, we have retained approximately 47% to 50% of the customers who received a promotional subscription as part of the purchase or lease of a new vehicle. We cannot predict the amount of churn we will experience over the longer term. Our inability to retain customers who either purchase or lease new vehicles with its service beyond the promotional period, or who purchase or lease a new vehicle that includes a prepaid subscription to its service, and subscriber churn could adversely affect our financial performance and results of operations. Our ability to generate advertising revenues is directly affected by general economic conditions, the number of subscribers to our service and the amount of time subscribers spend listening to the talk and entertainment channels or the traffic and weather services. General economic conditions are affecting our ad revenues. Our ability to generate advertising revenues also depends on several factors, including the level and type of penetration of our service, competition for advertising dollars from other media, and changes in the advertising industry and the economy generally. We directly compete for audiences and advertising revenues with traditional AM/FM radio stations and other media, some of which maintain longstanding relationships with advertisers and possess greater resources. Rapid technological and industry changes could make our services obsolete. The audio entertainment industry is characterized by rapid technological change, frequent new product innovations, changes in customer requirements and expectations, and evolving standards. If we are unable to keep pace with these changes, our business may be unsuccessful. Products using new technologies, or emerging industry standards, could make our technologies obsolete or less competitive in the marketplace. Our broadcast studios, terrestrial repeater network, satellite uplink facilities or other ground facilities could be damaged by natural catastrophes or terrorist activities. An earthquake, tornado, flood, terrorist attack or other catastrophic event could damage our broadcast studios, terrestrial repeater networks or satellite uplink facilities, interrupt our service and harm our business. We do not have replacement or redundant facilities that can be used to assume the functions of our terrestrial repeater network. We do have redundant facilities that can be used to assume immediately many of the functions of our broadcast studios and satellite uplink facilities in the event of a catastrophic event. Any damage to the satellite that transmits to our terrestrial repeater network would likely result in degradation of our service for some subscribers and could result in complete loss of service in certain or all areas. Damage to our satellite uplink facilities could result in a complete loss of our service until we could transfer our operations to our back-up facilities. Consumers could pirate our services. Individuals who engage in piracy may be able to obtain or rebroadcast our satellite radio service or access our Internet transmission without paying the subscription fee. Although we use encryption technologies to mitigate the risk of signal theft, such technologies may not be adequate to prevent theft of the signals. If signal theft becomes widespread, it could harm our business.
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Table of ContentsThe unfavorable outcome of pending or future litigation could have a material adverse effect. We are parties to several legal proceedings arising out of various aspects of our business. We are defending all claims against us. There can be no assurance regarding a favorable outcome of any of these proceedings, or that an unfavorable outcome would not have a material adverse effect on our business or financial results. Our business may be impaired by third-party intellectual property rights. Development of our system has depended largely upon the intellectual property that we have developed, as well as intellectual property licensed from third parties. If the intellectual property that we have developed or use is not adequately protected, others will be permitted to and may duplicate portions of our satellite radio systems or services without liability. In addition, others may challenge, invalidate, render unenforceable or circumvent our intellectual property rights, patents or existing sublicenses or we may face significant legal costs in connection with defending and enforcing those intellectual property rights. Some of the know-how and technology we have developed, and plan to develop, is not now, nor will be, covered by U.S. patents or trade secret protections. Trade secret protection and contractual agreements may not provide adequate protection if there is any unauthorized use or disclosure. The loss of necessary technologies could require us to obtain substitute technology of lower quality performance standards, at greater cost or on a delayed basis, which could harm our business. Other parties may have patents or pending patent applications, which will later mature into patents or inventions that may block our ability to operate our system or license technologies. We may have to resort to litigation to enforce our rights under license agreements or to determine the scope and validity of other parties’ proprietary rights in the subject matter of those licenses. This may be expensive. Also, we may not succeed in any such litigation. Third parties may assert claims or bring suit against us for patent, trademark, or copyright infringement, or for other infringement or misappropriation of intellectual property rights. Any such litigation could result in substantial cost, and diversion of effort and adverse findings in any proceeding could subject us to significant liabilities to third parties; require us to seek licenses from third parties; block our ability to operate our system or license our technology; or otherwise adversely affect our ability to successfully develop and market our satellite radio system. Electromagnetic interference from others could damage our business. Our satellite radio service may be subject to interference caused by other users of radio frequencies, such as RF lighting and ultra-wideband (“UWB”) technology and Wireless Communications Service (“WCS”) users. The FCC is seeking comment on proposals by certain WCS licensees for modification of rules regarding their operations in spectrum adjacent to satellite radio, including rule changes to facilitate mobile broadband services in the WCS frequencies. We are participating actively in this proceeding and have opposed the changes requested by WCS licensees out of a concern for their impact on the reception of satellite radio service. We cannot predict the outcome of the FCC proceeding, or the impact on satellite radio reception. Liberty Media Corporation has significant influence over our business and affairs and its interests may differ from ours. Liberty Media Corporation holds preferred stock that is convertible into 40% of the issued and outstanding shares of SIRIUS’ common stock. Pursuant to the terms of the preferred stock held by Liberty Media SIRIUS cannot take certain actions, such as issue equity or debt securities, without the consent of Liberty Media. Additionally, upon expiration of the waiting period under Hart-Scott-Rodino Act, Liberty Media has the right to designate six members of SIRIUS’ fifteen-member Board of Directors. SIRIUS expects Liberty Media to designate these directors shortly. As a result, Liberty Media has significant influence over business and affairs. The interests of Liberty Media may differ from the interests of other holders of SIRIUS’ common stock. The extent of Liberty Media’s stock ownership in SIRIUS also may have the effect of discouraging offers to acquire control of SIRIUS and may preclude holders of SIRIUS’ common stock from receiving any premium above market price for their shares that may be offered in connection with any attempt to acquire control of SIRIUS. We depend on certain on-air talent with special skills. If we cannot retain these people, our business could suffer. We employ, or independently contract with, on-air talent who maintain significant loyal audiences in or across various demographic groups. There can be no assurance that this on-air talent will remain with us or that we will be able to retain their respective audiences. If we lose the services of one or more of them, or fail to attract qualified replacement personnel, it could harm our business and future prospects. ITEM 1B. UNRESOLVED STAFF COMMENTS None.
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Table of ContentsITEM 2. PROPERTIES Below is a list of the principal properties that we own or lease:
We also own or lease other small facilities that we use as offices for our advertising sales personnel, studios and warehouse space. These facilities are not material to our business or operations. In addition, we lease space for use in connection with the terrestrial repeater network that supports our service. In general, these leases are for space on building rooftops and communications towers. None of these individual leases is material to our business or operations. ITEM 3. LEGAL PROCEEDINGS FCC Merger Order. On July 25, 2008, the FCC adopted an order approving the Merger. The order became effective immediately upon adoption. This order was published in the Federal Register on September 8, 2008. On September 4, 2008, Mt. Wilson FM Broadcasters, Inc. filed a Petition for Reconsideration of the FCC’s merger order. This Petition for Reconsideration remains pending. Appellate Review of FCC Merger and Consent Decree Orders. Two different parties, U.S. Electronics and Michael Hartleib, sought appellate review of the FCC’s decision regarding the Merger. Each party also challenged the FCC’s decision to enter into the consent decrees resolving the investigations by the FCC’s Enforcement Bureau regarding certain non-compliant terrestrial repeaters and FM modulators contained in certain satellite radios. These matters were both filed in the United States Court of Appeals for the D.C. Circuit, and have been consolidated by the court. Subsequent to filing its initial request for appellate review, U.S. Electronics moved to both amend its original filing and submit an additional notice of appeal in order to comply with the statutory requirements for review of agency decisions. The FCC moved to dismiss both the Hartleib and the U.S. Electronics requests for review on the grounds that neither party has standing to challenge the merger order or the consent decrees, and further argued that the agency’s decision to enter into a consent decree is not reviewable by the court in these circumstances. Separately, the court issued a show cause order on its own motion that requires U.S. Electronics to demonstrate why its additional notice of appeal should not be dismissed as untimely. In January 2009, the court dismissed the appeals of both U.S. Electronics and Michael Hartleib. Copyright Royalty Board Proceeding. In January 2008, the Copyright Royalty Board, or CRB, of the Library of Congress issued its decision regarding the royalty rate payable under the statutory license covering the performance of sound recordings over our satellite digital audio radio service for the six-year period starting January 1, 2007 and ending December 31, 2012. Under the terms of the CRB’s decision, we paid a royalty of 6.0% of gross revenues, subject to certain exclusions, for 2007 and 2008, will pay 6.5% for 2009, 7.0% for 2010, 7.5% for 2011 and 8.0% for 2012. SoundExchange has appealed the decision of the CRB to the United States Court of Appeals for the District of Columbia Circuit. Final briefs in this matter were submitted to the United States Court of Appeals for the District of Columbia Circuit in February 2009 and oral argument is scheduled for March 2009. Atlantic Recording Corporation, BMG Music, Capital Records, Inc., Elektra Entertainment Group Inc., Interscope Records, Motown Record Company, L.P., Sony BMG Music Entertainment, UMG Recordings, Inc., Virgin Records, Inc. and Warner Bros. Records Inc. v. XM Satellite Radio Inc. In May 2006, the plaintiffs filed this action in the United States District Court for the Southern District of New York. The complaint seeks monetary damages and equitable relief, and alleges that our radios that include advanced recording functionality infringe upon plaintiffs’ copyrighted sound recordings. We filed a motion to dismiss this matter, and that motion was denied in January 2007. We have resolved the lawsuit with respect to Universal Music Group, Warner Music Group, Sony BMG Music Entertainment and EMI Group, and each of these parties has withdrawn as a party to the lawsuit and this lawsuit has been dismissed, with respect to such parties.
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Table of ContentsMusic publishing companies and certain other record companies also have filed lawsuits, purportedly on a class basis, with similar allegations. We believe these allegations are without merit and that our products comply with applicable copyright law, including the Audio Home Recording Act. We intend to vigorously defend these matters. There can be no assurance regarding the ultimate outcome of these matters, or the significance, if any, to our business, consolidated results of operations or financial position. Matthew Enderlin v. XM Satellite Radio Holdings Inc. and XM Satellite Radio Inc. In January 2006, the plaintiff filed this action in the United States District Court for the Eastern District of Arkansas on behalf of a purported nationwide class of all XM subscribers. The complaint alleges that we engaged in a deceptive trade practices under Arkansas and other state laws by representing that our music channels are commercial-free. The court stayed the litigation and directed the parties to arbitration. We instituted arbitration with the American Arbitration Association pursuant to the compulsory arbitration clause in its customer service agreement. The plaintiff has filed a counterclaim in the arbitration on behalf of the class that he seeks to represent. We believe this matter is without merit and intend to vigorously defend the ongoing arbitration. There can be no assurance regarding the ultimate outcome of this matter, or the significance, if any, to our business, consolidated results of operations or financial position. Other Matters. In the ordinary course of business, we are a defendant in various lawsuits and arbitration proceedings, including actions filed by former employees, parties to contracts or leases and owners of patents, trademarks, copyrights or other intellectual property. None of these actions are, in our opinion, likely to have a material adverse effect on our cash flows, financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Omitted pursuant to General Instructions I(2)(c) of Form 10-K.
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Table of ContentsPART II
Prior to the completion of the Merger, our common stock was traded on the Nasdaq Global Select Market under the symbol “XMSR.” ITEM 6. SELECTED FINANCIAL DATA Our selected financial data set forth below with respect to the consolidated statements of operations for the periods from August 1, 2008 through December 31, 2008 (the Successor Period), from January 1, 2008 through July 31, 2008 (the Predecessor Period) and for the years ended December 31, 2007 and 2006 (Predecessor Periods) and with respect to the consolidated balance sheets at December 31, 2008 and 2007, are derived from our audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K. Our selected financial data set forth below with respect to the consolidated statements of operations for the years ended December 31, 2005 and 2004, and with respect to the consolidated balance sheets at December 31, 2006, 2005 and 2004 are derived from our predecessor audited consolidated financial statements which are not included in this Annual Report. This selected financial data should be read in conjunction with the Consolidated Financial Statements and related notes thereto included in Item 7 of this Annual Report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
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This Annual Report on Form 10-K contains forward-looking statements within the meaning of the federal securities laws. Actual results and the timing of events could differ materially from those projected in forward-looking statements due to a number of factors, including those described under “Item 1A — Risk Factors” and elsewhere in this Annual Report. See “Explanatory Note” and “Special Note Regarding Forward-Looking Statements.” (All dollar amounts referenced in this Item 7 are in thousands, unless otherwise stated.) Executive Summary We broadcast in the United States our music, sports, news, talk, entertainment, traffic and weather channels for a subscription fee through our proprietary satellite radio system. On July 28, 2008, XM Satellite Radio Holdings Inc. merged with and into Vernon Merger Corporation, a wholly-owned subsidiary of SIRIUS; and as a result, XM Satellite Radio Holdings Inc. is now a wholly-owned subsidiary of SIRIUS. Our system consists of four in-orbit satellites, over 700 terrestrial repeaters that receive and retransmit signals, satellite uplink facilities and studios. Subscribers can also receive certain of our music and other channels over the Internet. Our satellite radios are primarily distributed through automakers (“OEMs”); through retail locations; and through our website. We have agreements with major automakers to offer satellite radios as factory or dealer-installed equipment in their vehicles. Our radios are also offered to customers of rental car companies including Avis. As of December 31, 2008, we had 9,850,741 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 prepaid subscriptions included in the sale or lease price of a new vehicle; active radios under our agreement with Avis; subscribers to XM Online, our Internet service; and certain subscribers to our weather, traffic and data 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 subscriptions as well as discounts for multiple subscriptions. In 2009, we increased the discounted price for additional subscriptions from $6.99 per month to $8.99 per month. We also derive revenue from activation fees, the sale of advertising on select channels, the direct sale of satellite radios and accessories, and other ancillary services. In certain cases, automakers include a subscription to our radio services in the sale or lease price of vehicles. The length of these prepaid subscriptions varies, but is typically three to twelve months. We reimburse various automakers for certain costs associated with satellite radios installed in their vehicles. We also have an interest in a satellite radio service offered in Canada. Subscribers to the Canadian Satellite Radio Inc. (“XM Canada”) service are not included in our subscriber count. XM Satellite Radio Holdings Inc., together with its subsidiaries, now operates as an unrestricted subsidiary under the agreements governing SIRIUS’ existing indebtedness. As an unrestricted subsidiary, transactions between the companies are required to comply with various contractual provisions in our respective debt instruments.
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Table of ContentsResults of Operations As a result of the consummation of the Merger, the financial results have been presented separately for the “Predecessor Entity” period, January 1, 2008 through July 31, 2008, and for the “Successor Entity” period, August 1, 2008 through December 31, 2008. To facilitate a comparison of our results, we combined the period from January 1, 2008 through December 31, 2008 in our discussions below, as we believe this combination is useful to provide the reader a more accurate comparison. However, due to certain adjustments to our assets and liabilities in connection with accounting for the Merger, results for the Successor Entity and Predecessor Entity combined may not be indicative of our future results. This combination is not a U.S. GAAP measure and it is provided to enhance the reader’s understanding of the results of operations for the periods presented.
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Table of ContentsOur discussion of our results of operations, along with the selected financial information in the tables that follow, includes the following non-GAAP financial measures: average monthly self-pay churn; conversion rate; average monthly revenue per subscriber, or ARPU; SAC, as adjusted, per gross subscriber addition; customer service and billing expenses, as adjusted, per average subscriber; free cash flow; and adjusted loss from operations. We believe these non-GAAP financial measures provide meaningful supplemental information regarding our operating performance and are used for internal management purposes, when publicly providing the business outlook, and as a means to evaluate period-to-period comparisons. Please refer to the footnotes following our discussion of results of operations (see pages 30 to 32) for the definitions and further discussion of usefulness of such non-GAAP financial measures. Subscribers and Key Operating Metrics: The following tables contain a breakdown of our subscribers and key operating metrics for the years ended December 31, 2008, 2007 and 2006:
Subscribers. We ended 2008 with 9,850,741 subscribers, an increase of 9% since 2007. Since December 31, 2007, 278,374 net retail subscribers deactivated and 1,075,088 net OEM subscribers activated, resulting in a decrease of 6% and an increase of 25% in retail and OEM subscribers, respectively. Gross additions in our OEM channel continued to grow as automakers continued to increase the portion of their vehicles which incorporates satellite radio.
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Table of ContentsARPU. Total ARPU for the year ended December 31, 2008 was $10.14, compared to $10.74 for the year ended December 31, 2007. The decrease was driven by an increase in the mix of discounted OEM promotional trials, subscriber winback programs, second subscribers, the effects of purchase price accounting adjustments and subscriber growth exceeding the growth in advertising revenues. We expect ARPU to fluctuate based on the growth of our subscriber base, promotions, rebates offered to subscribers and corresponding take-rates, plan mix, subscription prices, advertising sales and the identification of additional revenue from subscribers. SAC, As Adjusted, Per Gross Subscriber Addition. SAC, as adjusted, per gross subscriber addition was $60 and $73 for the years ended December 31, 2008 and 2007, respectively. The decrease was primarily driven by the effect of purchase price accounting adjustments and improved equipment margin. We expect SAC, as adjusted, per gross subscriber addition to decline as the costs of subsidized components of XM radios decrease in the future. Our SAC, as adjusted, per gross subscriber addition will continue to be impacted by changes in our mix of OEM and retail additions. Customer Service and Billing Expenses, As Adjusted, Per Average Subscriber. Customer service and billing expenses, as adjusted, per average subscriber decreased from $1.25 to $1.22 for the years ended December 31, 2008 and 2007, respectively. The decline was primarily due to efficiencies across a larger subscriber base. We expect customer service and billing expenses, as adjusted, per average subscriber to decrease on an annual basis as our subscriber base grows due to scale efficiencies in our call centers and other customer care and billing operations. Adjusted Loss from Operations. For the years ended December 31, 2008 and 2007, adjusted loss from operations was $18,727 and $238,042, respectively, a decrease of $219,315. The decrease was primarily driven by an increase in subscriber revenue of $107,506 as a result of a 9% increase in our subscriber base, a net benefit from the effect of purchase price accounting adjustments of $60,096 and improvements in subscriber acquisition costs and general and administrative expenses of $20,195 and $24,808, respectively. Year Ended December 31, 2008 Compared with Year Ended December 31, 2007 and Year Ended December 31, 2007 Compared with Year Ended December 31, 2006 Total Revenue Subscriber Revenue. Subscriber revenue includes subscription fees, activation fees and the effects of rebates.
The following table contains a breakdown of our subscriber revenue for the periods presented:
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Table of ContentsFuture subscriber revenue will be dependent upon, among other things, the growth of our subscriber base, promotions, rebates offered to subscribers and corresponding take-rates, plan mix, subscription prices and the identification of additional revenue streams from subscribers. Advertising Revenue. Advertising revenue includes the sale of advertising on our non-music channels, net of agency fees. Agency fees are based on a contractual rate applied to gross billing revenue.
We expect advertising revenue to grow as our subscribers increase, as we continue to improve brand awareness and content, and as we increase the size and effectiveness of our advertising sales force. Advertising revenue is subject to fluctuation based on the national advertising environment. Equipment Revenue. Equipment revenue includes revenue and royalties from the sale of radios, components and accessories.
We expect equipment revenue to increase as we introduce new products, integrate with SIRIUS products and as sales grow through our direct to consumer distribution channel. Operating Expenses Satellite and Transmission. Satellite and transmission expenses consist of costs associated with the operation and maintenance of our satellites; satellite telemetry, tracking and control system; terrestrial repeater network; satellite uplink facility; and broadcast studios.
We expect satellite and transmission expenses to decrease as we consolidate terrestrial repeater sites and other satellite and transmission activities as well as realize other cost savings as a result of the Merger. Programming and Content. Programming and content expenses include costs to acquire, create and produce content and on-air talent costs. We have entered into various agreements with third parties for music and non-music programming that require us to pay license fees, share advertising revenue, purchase advertising on media properties owned or controlled
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Table of Contentsby the licensor and pay other guaranteed amounts. Purchased advertising is recorded as a sales and marketing expense, and the cost of sharing advertising revenue is recorded as Revenue share and royalties in the period the advertising is broadcast.
Our programming and content expenses, excluding share-based payment expenses, is expected to decrease as a result of the Merger, as we reduce duplicate programming and content cost. Revenue Share and Royalties. Revenue share and royalties include distribution and content provider revenue share, residuals and broadcast and web streaming royalties. Residuals are monthly fees paid based upon the number of subscribers using radios purchased from retailers. Advertising revenue share is recorded to revenue share and royalties in the period the advertising is broadcast.
We expect these costs to increase as we continue to experience revenue growth and expand our distribution of radios through automakers and retailers, and as a result of increases in the royalty for sound recording performances. Customer Service and Billing. Customer service and billing expenses include costs associated with the operation of our customer service centers and subscriber management system as well as bad debt expense.
We expect our customer care and billing expenses to decrease on a per subscriber basis, but increase overall as our subscriber base grows due to increased call center operating costs, transaction fees and bad debt expense. Cost of Equipment. Cost of equipment includes costs from the sale of our radios, components and accessories.
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Table of ContentsWe expect cost of equipment to vary in the future with changes in sales through our direct to consumer distribution channel. Sales and Marketing. Sales and marketing expenses include costs for advertising, media and production, including promotional events and sponsorships; cooperative marketing; customer retention and compensation. Cooperative marketing costs include fixed and variable payments to reimburse retailers and automakers for the cost of advertising and other product awareness activities.
We expect sales and marketing expenses, excluding share-based payment expense, to decrease as we consolidate our advertising and promotional activities with SIRIUS, gain efficiencies in marketing management and eliminate overlapping distribution support costs. Subscriber Acquisition Costs. Subscriber acquisition costs include hardware subsidies paid to radio manufacturers, distributors and automakers, including subsidies paid to automakers who include our radio and a prepaid subscription to our service in the sale or lease price of a new vehicle; subsidies paid for chip sets and certain other components used in manufacturing radios; commissions paid to retailers and automakers as incentives to purchase, install and activate our radios; product warranty obligations; and compensation costs associated with stock-based awards granted in connection with certain distribution agreements. The majority of subscriber acquisition costs are incurred and expensed in advance or concurrent with acquiring a subscriber. Subscriber acquisition costs do not include advertising, loyalty payments to distributors and dealers of our radios and revenue share payments to automakers and retailers of our radios.
We expect total subscriber acquisition costs, to fluctuate as increases or decreases in our gross subscriber additions are accompanied by continuing declines in the costs of subsidized components of our radios. We intend to continue to offer subsidies, commissions and other incentives to acquire subscribers. General and Administrative. General and administrative expenses include rent and occupancy, finance, legal, human resources, information technology and investor relations costs.
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We expect our general and administrative expenses, excluding share-based payment expense, to decrease in future periods as we realize cost savings as a result of the Merger. General and administrative expenses may fluctuate in certain periods as a result of litigation costs. Engineering, Design and Development. Engineering, design and development expenses include costs to develop our future generation of chip sets and new products, research and development for broadcast information, and costs associated with the incorporation of radios into vehicles manufactured by automakers.
We expect engineering, design and development expenses, excluding share-based payment expense, to decrease in future periods as we realize cost savings as a result of the Merger and gain efficiencies in engineering, design and development activities. Other Income (Expense) Interest and Investment Income. Interest and investment income includes realized gains and losses, dividends and interest income, including amortization of the premium and discount arising at purchase.
Interest Expense. Interest expense includes interest on outstanding debt, reduced by interest capitalized in connection with the construction of our new satellite and launch vehicle.
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Table of ContentsGain on change in value of embedded derivative. We are required to bifurcate the conversion feature of each of our exchangeable debt instruments, which are exchangeable into SIRIUS common stock, and recognize the changes in the fair value of these embedded derivatives in earnings. The fair value of these derivatives are impacted by the value of the underlying SIRIUS common shares.
Income Taxes Income Tax Expense. Income tax expense primarily represents the recognition of a deferred tax liability related to the difference in accounting for our FCC license and trade name, which is amortized over 15 years for tax purposes but not amortized for book purposes in accordance with U.S. generally accepted accounting principles.
Footnotes to Results of Operations
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Adjusted loss from operations is calculated as follows:
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Table of ContentsLiquidity and Capital Resources Cash Flows for the Year Ended December 31, 2008 Compared with the Year Ended December 31, 2007 and for the Year Ended December 31, 2006 As of December 31, 2008, we had $206,740 in cash and cash equivalents compared with $156,686 as of December 31, 2007. We are required to maintain a minimum cash balance of $75 million under our debt covenants. The following table presents a summary of our cash flow activity for the periods set forth below (in thousands, except percentages):
Net Cash Used in Operating Activities
Net Cash Used in Investing Activities
We will incur significant capital expenditures to construct and launch our new satellites and to improve our terrestrial repeater network and broadcast and administrative infrastructure. These capital expenditures will support our growth and the resiliency of our operations, and will also support the delivery of future new revenue streams.
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Table of ContentsNet Cash Provided by Financing Activities
Financings and Capital Requirements We have historically financed our operations through the sale of debt and equity securities. It will be difficult to obtain additional financing if prevailing instability in the credit and financial market continues. Future Liquidity and Capital Resource Requirements Debt Maturing in 2009 and 2010. We have approximately $536,000 of debt maturing in 2009 and 2010, including:
As a result of the May 2010 maturities, our existing cash balances and our cash flows from operating activities may not be sufficient to fund our projected cash needs at that time. We may not be able to access additional sources of refinancing on similar terms or pricing as those that are currently in place, or at all, or otherwise obtain other sources of funding. An inability to access replacement or additional sources of liquidity to fund our cash needs or to refinance or otherwise fund the repayment of our maturing debt could adversely affect our growth, our financial condition, or results of operations, and our ability to make payments on our debt, and could force us to seek the protection of the bankruptcy laws. It will be more difficult to obtain additional financing if prevailing instability in credit and financial markets continues. Since October 1, 2008, we and SIRIUS have both entered into a series of transactions to improve our liquidity and strengthen our balance sheet, including:
See Note 19 to our consolidated financial statements in Item 8 of this Annual Report on Form 10-K for additional information on certain of these transactions. Operating Liquidity. Based upon our current plans, and other than our need to refinance our debt maturing in 2010, we believe we have sufficient cash, cash equivalents and marketable securities to cover the estimated funding needs through cash flow breakeven, the point at which revenues are sufficient to fund expected operating expenses, capital expenditures, working capital requirements, interest payments and taxes. The ability to meet our debt and other obligations depends on our
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Table of Contentsfuture 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 have the ability and intend to manage the timing and related expenditures of certain activities, including the launch of satellites, the deferral or payment of bonuses with equity, the deferral of capital projects, as well as the deferral of other discretionary expenses. Our financial projections are based on assumptions, which we believe are reasonable but contain significant uncertainties. There can be no assurance that our plan will be successful. We operate as unrestricted subsidiaries under the agreements governing SIRIUS’ existing debt. Under certain circumstances, SIRIUS may be unwilling or unable to contribute or loan us capital to support our operations. To the extent our funds are insufficient to support our business, we may be required to seek additional financing, which may not be available on favorable terms, or at all. If we are unable to secure additional financing, its business and results of operations may be adversely affected. Tightening credit policies could also adversely impact our operational liquidity by making it more difficult or costly for our subscribers to access credit, and could have an adverse impact on our operational liquidity as a result of possible changes to our payment arrangements that credit card companies and other credit providers could unilaterally make. We regularly evaluate our plans and strategy. These evaluations often result in changes to our plans and strategy, some of which may be material and significantly change our cash requirements or cause us to achieve cash flow breakeven at a later date. These changes in our 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 of third parties that own programming, distribution, infrastructure, assets, or any combination of the foregoing. In addition, our operations will also be affected by the FCC order approving the Merger which imposed certain conditions upon, among other things, our program offerings and our ability to increase prices. Our future liquidity also may be adversely affected by, among other things, the nature and extent of the benefits we achieve as a wholly-owned unrestricted subsidiary of SIRIUS. Off-Balance Sheet Arrangements We are required under the terms of certain agreements to deposit monies in escrow, which place restrictions on cash and cash equivalents. As of December 31, 2008, $120,000 was classified as restricted investments as a result of obligations under escrow deposits. In 2009, we released to Major League Baseball, $120,000 held in escrow in satisfaction of future obligations under our agreement with them. We have not entered into any other material off-balance sheet arrangements or transactions. 2007 Stock Incentive Plan We maintain a 2007 Stock Incentive Plan (the “2007 Plan”) under which our officers, other employees and other key individuals may be granted various types of equity awards, including restricted stock, stock units, stock options, stock appreciation rights, dividend equivalent rights and other stock awards. Stock option awards under the 2007 Plan generally vest ratably over three years based on continuous service; while restricted stock generally vests ratably over one or three years based on continuous service. Stock option awards are granted with an exercise price equal to the market price of our common stock at the date of grant and expire no later than ten years from the date of grant. Grants of equity awards other than stock options or stock appreciation rights reduce the number of shares available for future grant by 1.5 times the number of shares granted under such equity awards. In connection with the Merger, the shares available for future grant under the 2007 Plan were adjusted using a conversion factor of 4.6 SIRIUS shares for 1 XM Holdings share. Since the Merger, there have been no grants of awards from the 2007 Plan. As of December 31, 2008, there were 62,102,063 shares available for future grant under the 2007 Plan. 1998 Shares Award Plan We maintain the 1998 Shares Award Plan (the “1998 Plan”) under which our employees, consultants and non-employee directors were granted stock options and restricted stock awards. Stock option awards and restricted stock awards under the 1998 Plan generally vest ratably over three years based on continuous service. Stock option awards are generally granted with an exercise price equal to the market price of our common stock at the date of grant and expire no later than ten years from the date of grant. The 1998 Plan terminated in June 2008 and shares are no longer available for future grant.
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Table of ContentsXM Talent Option Plan We maintain a Talent Option Plan (the “Talent Plan”) under which our non-employee programming consultants may be granted stock options awards. Stock option awards under the Talent Plan generally vest ratably over three years based on continuous service. Stock option awards are generally granted with an exercise price equal to the market price of our common stock at the date of grant and expire no later than ten years from the date of grant. In connection with the Merger, the shares available for future grant under the Talent Plan were adjusted using a conversion factor of 4.6 SIRIUS shares for 1 XM Holdings share. Since the Merger, there have been no grants of awards from the Talent Plan. As of December 31, 2008, there were 1,564,000 options available under the Talent Plan for future grant. Contractual Cash Commitments For a discussion of our “Contractual Cash Commitments” refer to Note 16 of the Notes to the consolidated financial statements in Item 8 of this Form 10-K. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles, 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. We have disclosed all significant accounting policies in Note 2 to the consolidated financial statements included in this report. We have identified the following policies, which were discussed with the audit committee of our board of directors, as critical to our business and understanding our results of operations. Fair Value of Assets Acquired and Liabilities Assumed. On July 28, 2008, Vernon Merger Corporation, a wholly-owned subsidiary of SIRIUS, merged with and into XM Satellite Radio Holdings Inc. (the “Merger”), with XM Holdings becoming a wholly-owned subsidiary of SIRIUS. The application of purchase accounting under SFAS No. 141, Business Combinations, resulted in the transaction being valued at $5,836,363 and our recording of pushed down goodwill totaling $6,601,046. Long-Lived Assets. We carry our long-lived assets at cost less accumulated depreciation. In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, 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 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. To determine fair value, we employ an expected present value technique, which utilizes multiple cash flow scenarios that reflect the range of possible outcomes and an appropriate discount rate. We evaluate our indefinite life intangible assets for impairment on an annual basis in accordance with FASB Statement No. 142, Goodwill and Other Intangible Assets. During the year ended December 31, 2008, we recorded $6,601,046 of goodwill impairment. At December 31, 2008, our intangible assets with indefinite lives total $2,250,000, and remaining unamortized total basis of our intangible assets with definite lives was $438,671. Useful Life of Satellite System. Our satellite system includes the costs of our satellite construction, launch vehicles, launch insurance, capitalized interest, spare satellite, terrestrial repeater network and satellite uplink facility. In accordance with SFAS No. 144, we monitor our satellites for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset is not recoverable. We operate four in-orbit satellites, two of which function as in-orbit spares. The two in-orbit spare satellites were launched in 2001, while the other two satellites were launched one in each of 2005 and 2006. We estimate that the XM-3 and XM-4 satellites will meet their fifteen year predicted useful lives, and that XM-1 and XM-2 satellites’ useful lives will end in 2010. Under an agreement with Space Systems/Loral, we are constructing an additional satellite for use in our system. Our in-orbit satellites have experienced circuit failures on their solar arrays. We continue to monitor the operating condition of our in-orbit satellites. If events or circumstances indicate that the useful lives of our in-orbit satellites have changed, we will modify the depreciable life accordingly. If we were to revise our estimates, for example, a 10% decrease in the expected useful lives of satellites and spacecraft control facilities during 2008 would result in approximately $2,384 of additional depreciation expense.
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Table of ContentsRevenue Recognition. Revenue from subscribers consists of subscription fees; revenue derived from our agreement with Avis; non-refundable activation fees; and the effects of rebates. We recognize subscription fees as our service is provided to a subscriber. We record deferred revenue for prepaid subscription fees and amortize these prepayments to revenue ratably over the term of the respective subscription plan. At the time of sale, vehicle owners purchasing or leasing a vehicle typically receive a three month to twelve month prepaid subscription. We receive payment from certain automakers for these subscriptions in advance of our service being activated. Such prepayments are recorded to deferred revenue and amortized ratably over the service period upon activation and sale to a customer. We also reimburse certain automakers for certain costs associated with the installation of certain satellite radios at the time the vehicle is manufactured. The associated payments to the automakers are included in subscriber acquisition costs. We believe this is the appropriate characterization of our relationship since we are responsible for providing service to our customers including being obligated to the customer if there was interruption of service. Activation fees are recognized ratably over the estimated term of a subscriber relationship, currently estimated to be 3.5 years. The estimated term of a subscriber relationship is based on market research and management’s judgment and, if necessary, will be refined in the future. If we were to revise our estimate, for example, a 10% decrease to the estimated term of a subscriber relationship during 2008 would result in approximately $106 of additional activation fees. As required by Emerging Issues Task Force (“EITF”) No. 01-09, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products), an estimate of rebates that are paid to subscribers is recorded as a reduction to revenue in the period the subscriber activates our service. For certain rebate promotions, a subscriber must remain active for a specified period of time to be considered eligible. In those instances, such estimate is recorded as a reduction to revenue over the required activation period. We estimate the effects of rebates based on actual take-rates for rebate incentives offered in prior periods, adjusted as deemed necessary based on currently available take-rate data. In subsequent periods, estimates are adjusted when necessary. For certain instant rebate promotions, we have recorded the consideration paid by us to the consumer as a reduction to revenue in the period the customer participated in the promotion. In September 2006, the FASB issued EITF No. 06-01, Accounting for Consideration Given by a Service Provider to Manufacturers or Resellers of Equipment Necessary for an End-Customer to Receive Service from the Service Provider. The Task Force concluded that if consideration given by a service provider to a third-party manufacturer or reseller that is not the service provider’s customer can be linked contractually to the benefit received by the service provider’s customer, a service provider should account for the consideration in accordance with EITF No. 01-09, Accounting for Consideration Given by a Vendor to a Customer. EITF No. 06-01 is effective for annual reporting periods beginning after June 15, 2007. We adopted EITF No. 06-01 for the year ended December 31, 2007. The adoption of EITF No. 06-01 did not have a material impact on our consolidated results of operations or financial position. We recognize revenues from the sale of advertising on some of our non-music channels as the advertising is broadcast. Agency fees are calculated based on a contractual rate applied to gross billing revenue for our advertising inventory and are reported as a reduction of advertising revenue. We pay certain third parties a percentage of advertising revenue. Advertising revenue is recorded gross of such revenue share payments in accordance with EITF No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, as we are the primary obligor in the transaction. Advertising revenue share payments are recorded to programming and content expense during the period in which the advertising is broadcast. Equipment revenue from the direct sale of our radios and accessories is recognized upon shipment, net of discounts and rebates. Shipping and handling costs billed to customers are recorded as revenue. Shipping and handling costs associated with shipping goods to customers are recorded to cost of equipment. EITF No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables, provides guidance on how and when to recognize revenues for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets. Revenue arrangements with multiple deliverables are required to be divided into separate units of accounting if the deliverables in the arrangement meet certain criteria. Arrangement consideration must be allocated among the separate units of accounting based on their relative fair values. We determined that the sale of our service through our direct to consumer channel with accompanying equipment constitutes a revenue arrangement with multiple deliverables. In these types of arrangements, amounts received for equipment are recognized as equipment revenue; amounts received for service are recognized as subscription revenue; and
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Table of Contentsamounts received for the non-refundable, up-front activation fee that are not contingent on the delivery of the service are allocated to equipment revenue. Activation fees are recorded to equipment revenue only to the extent that the aggregate equipment and activation fee proceeds do not exceed the fair value of the equipment. Any activation fees not allocated to the equipment are deferred upon activation and recognized as subscriber revenue on a straight-line basis over the estimated term of a subscriber relationship. Income Taxes. We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes and FIN No. 48, Accounting for Uncertainty in Income Taxes. Deferred income taxes are recognized for the tax consequences related to temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for tax purposes at each year-end, based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. A valuation allowance is established when necessary based on the weight of available evidence, if it is considered more likely than not that all or some portion of the deferred tax assets will not be realized. Income tax expense is the sum of current income tax plus the change in deferred tax assets and liabilities. FIN No. 48 requires a company to first determine whether it is more-likely-than-not (defined as a likelihood of more than fifty percent) that a tax position will be sustained based on its technical merits as of the reporting date, assuming that taxing authorities will examine the position and have full knowledge of all relevant information. A tax position that meets this more-likely-than-not threshold is then measured and recognized at the largest amount of benefit that is greater than fifty percent likely to be realized upon effective settlement with a taxing authority.
As of December 31, 2008, we did not hold or issue any free-standing derivatives. Upon completion of the Merger, the convertible and exchangeable features in the 10% Senior Secured Discount Convertible Notes due 2009, the 10% Convertible Senior Notes due 2009 and the 7% Exchangeable Senior Subordinated Notes due 2014 became settleable in SIRIUS common stock and subsequently were accounted for as embedded derivatives. In the event the debt holders exercise their conversion or exchange option, SIRIUS intends to issue common stock to fulfill the obligation. We hold investments in marketable securities, which consist of United States government notes and certificates of deposit. We classify our marketable securities as available-for-sale. These securities are consistent with the investment objectives contained within our investment policy. The basic objectives of our investment policy are the preservation of capital, maintaining sufficient liquidity to meet operating requirements and maximizing yield. Our debt includes fixed interest rates and the fair market value of the debt is sensitive to changes in interest rates. Under our current policies, we do not use interest rate derivative instruments to manage our exposure to interest rate fluctuations.
See Index to Consolidated Financial Statements contained in Item 15 herein.
None.
Controls and Procedures As of December 31, 2008, an evaluation was performed under the supervision and with the participation of our management, including Mel Karmazin, our President, and David J. Frear, our Treasurer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our management, including our President and our Treasurer, concluded that our disclosure controls and procedures were effective as of December 31, 2008. There has been no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting during the quarter ended December 31, 2008.
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Table of ContentsManagement’s Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. We have performed an evaluation under the supervision and with the participation of our management, including our President and our Treasurer, of the effectiveness of our internal control over financial reporting. Our management used the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations to perform this evaluation. Based on that evaluation, our management, including our President and Treasurer, concluded that our internal control over financial reporting was effective as of December 31, 2008. Audit Report of the Independent Registered Public Accounting Firm The effectiveness of our internal control over financial reporting as of December 31, 2008 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their audit report appearing on page F-3 of this Annual Report on Form 10-K.
None.
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Table of ContentsPART III
Omitted pursuant to General Instructions I(2)(c) of Form 10-K.
Omitted pursuant to General Instructions I(2)(c) of Form 10-K.
Omitted pursuant to General Instructions I(2)(c) of Form 10-K.
Omitted pursuant to General Instructions I(2)(c) of Form 10-K.
Independent Registered Public Accounting Firm During the fiscal years ended December 31, 2008 and 2007, the Company’s independent registered public accounting firm, KPMG LLP, billed the Company the following fees:
All Audit-Related Fees were approved by the Audit Committee. None of the hours expended on KPMG’s engagement to audit the Company’s financial statements for the fiscal years ended December 31, 2008 and December 31, 2007 were attributed to work performed by persons other than KPMG’s full-time, permanent employees.
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Table of ContentsPART IV
Schedule II — Valuation and Qualifying Accounts. All other schedules for which provision is made in the applicable accounting regulations of the Commission have been included in the Consolidated Financial Statements of Sirius XM Radio Inc. or the notes thereto, are not required under the related instructions or are inapplicable, and therefore have been omitted. See Exhibit Index appearing on pages E-1 through E-8 for a list of exhibits filed or incorporated by reference as part of this Annual Report on Form 10-K.
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Table of ContentsSIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 13th day of March 2009.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
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Table of ContentsSIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 13th day of March 2009.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
F-1
Table of ContentsReport of Independent Registered Public Accounting Firm The Board of Directors and Stockholder of XM Satellite Radio Holdings Inc. and Subsidiaries: We have audited the accompanying consolidated balance sheets of XM Satellite Radio Holdings Inc. and subsidiaries (Successor) as of December 31, 2008, and of XM Satellite Radio Holdings Inc. and subsidiaries (Predecessor) as of December 31, 2007, and the related consolidated statements of operations, stockholder’s deficit and comprehensive loss, and cash flows for the period from August 1, 2008 to December 31, 2008 (Successor period), and from January 1, 2008 to July 31, 2008 and for each of the years in the two-year period ended December 31, 2007 (Predecessor periods). Our audits also included the financial statement schedule listed in the Index at Item 15(a). These consolidated financial statements and financial statement schedule are the responsibility of the Companies’ management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the aforementioned Successor consolidated financial statements present fairly, in all material respects, the financial position of XM Satellite Radio Holdings Inc. and subsidiaries as of December 31, 2008, and the results of their operations and their cash flows for the Successor period, in conformity with U.S. generally accepted accounting principles. Further, in our opinion, the aforementioned Predecessor consolidated financial statements present fairly, in all material respects, the financial position of XM Satellite Radio Holdings Inc. and subsidiaries as of December 31, 2007, and the results of their operations and their cash flows for the Predecessor periods, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. As discussed in note 1 to the consolidated financial statements, effective July 28, 2008, Vernon Merger Corporation, a wholly owned subsidiary of Sirius XM Radio Inc., acquired all of the outstanding stock of, and merged into, XM Satellite Radio Holdings, Inc. in a business combination accounted for as a purchase. As a result of the acquisition, the consolidated financial information for the periods after the acquisition is presented on a different cost basis than that for the periods before the acquisition and, therefore, is not comparable. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Successor’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 13, 2009 expressed an unqualified opinion on the effectiveness of the Successor’s internal control over financial reporting. /s/ KPMG LLP McLean, VA March 13, 2009
F-2
Table of ContentsReport of Independent Registered Public Accounting Firm The Board of Directors and Stockholder of XM Satellite Radio Holdings Inc.: We have audited XM Satellite Radio Holdings Inc and subsidiaries internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). XM Satellite Radio Holdings Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Item 9A. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, XM Satellite Radio Holdings Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of XM Satellite Radio Holdings Inc. and subsidiaries (Successor) as of December 31, 2008, and of XM Satellite Radio Holdings Inc. and subsidiaries (Predecessor) as of December 31, 2007, and the related consolidated statements of operations, stockholder’s deficit and comprehensive loss, and cash flows for the periods from August 1, 2008 to December 31, 2008 (Successor period), and from January 1, 2008 to July 31, 2008 and for each of the years in the two-year period ended December 31, 2007 (Predecessor period), and our report dated March 13, 2009 expressed an unqualified opinion on those consolidated financial statements. /s/ KPMG LLP McLean, VA March 13, 2009
F-3
Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying Notes to the consolidated financial statements.
F-4
Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
See accompanying Notes to the consolidated financial statements.
F-5
Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES STATEMENT OF STOCKHOLDER’S DEFICIT AND COMPREHENSIVE LOSS
F-6
Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES STATEMENT OF STOCKHOLDER’S DEFICIT AND COMPREHENSIVE LOSS — (Continued)
F-7
Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES STATEMENT OF STOCKHOLDER’S DEFICIT AND COMPREHENSIVE LOSS — (Continued)
F-8
Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES STATEMENT OF STOCKHOLDER’S DEFICIT AND COMPREHENSIVE LOSS — (Continued)
See accompanying Notes to the consolidated financial statements.
F-9
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