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XM Satellite Radio Holdings 10-Q 2008 Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 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)
Indicate by check mark whether the 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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES INDEX TO FORM 10-Q
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Table of ContentsEXPLANATORY NOTE This quarterly report on Form 10-Q is a combined report being filed by two separate registrants: XM Satellite Radio Holdings Inc. (the “Company”, “Holdings”, or “XM”) and XM Satellite Radio Inc. (“Inc.”). Holdings’ principal wholly owned subsidiary is Inc., and as such, the information presented in this report regarding Inc. also applies to Holdings. Unless the context requires otherwise, the terms “we,” “our” and “us,” refer to Holdings. Holdings fully and unconditionally guarantees Inc.’s registered debt securities. The combined report includes Holdings’ unaudited Condensed Consolidated Financial Statements as the only set of financial statements; an explanation of the differences between the companies is in the Notes to the unaudited Condensed Consolidated Financial Statements; and condensed consolidating financial information regarding Inc. The management’s discussion and analysis section has also been combined, focusing on the financial condition and results of operations of Holdings, which is consistent with the inclusion in the combined report of one set of financial statements. We make available certain reports filed with the Securities and Exchange Commission (“SEC”) that can be accessed, free of charge, through our website at http://www.xmradio.com, as soon as reasonably practicable after they are electronically filed with the SEC.
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Table of Contents
XM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS—(Continued)
See accompanying Notes to the unaudited Condensed Consolidated Financial Statements.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS—(Continued)
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS—(Continued)
See accompanying Notes to the unaudited Condensed Consolidated Financial Statements.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS—(Continued)
See accompanying Notes to the unaudited Condensed Consolidated Financial Statements.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS—(Continued)
See accompanying Notes to the unaudited Condensed Consolidated Financial Statements.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in thousands, unless otherwise stated) (1) Business XM Satellite Radio Inc. (“Inc.”) was incorporated on December 15, 1992 in the State of Delaware for the purpose of operating a digital audio radio service (“DARS”) under a license from the Federal Communications Commission (“FCC”). XM Satellite Radio Holdings Inc. (the “Company”, “Holdings”, or “XM”) was formed as a holding company for Inc. on May 16, 1997. The Company commenced commercial operations in two markets on September 25, 2001 and completed its national rollout on November 12, 2001. On July 28, 2008, Vernon Merger Corporation, a wholly owned subsidiary of Sirius Satellite Radio Inc. (“SIRIUS”), merged with and into Holdings (the “Merger”), and as a result Holdings is now a wholly owned subsidiary of SIRIUS. The Merger was effected pursuant to an Agreement and Plan of Merger (the “Merger Agreement”), dated as of February 19, 2007, entered into by and among SIRIUS, XM and Vernon Merger Corporation. On August 5, 2008, SIRIUS changed its name from Sirius Satellite Radio Inc. to Sirius XM Radio Inc. The accounting for the Merger has been “pushed-down” to the accompanying condensed consolidated financial statements. We are a satellite radio provider in the United States. We broadcast music, sports, news, talk, entertainment, traffic and weather for a monthly subscription fee. We broadcast through a proprietary satellite radio system, which currently consist of four satellites, over 800 terrestrial repeaters that receive and retransmit signals, satellite uplink facilities and studios. Subscribers receive XM service through radios, which are sold by automakers, consumer electronics retailers, mobile audio dealers and through our website. Subscribers can also receive music channels and certain other channels over the internet. As of September 30, 2008, we had 9,896,072 subscribers. As of September 30, 2008 (except as noted), the principal differences between the financial conditions of Holdings and Inc. were:
Accordingly, the results of operations for Inc. and its subsidiaries are substantially the same as the results of operations for Holdings and its subsidiaries except that Inc. has:
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
(2) Principles of Consolidation and Basis of Presentation Principles of Consolidation The accompanying unaudited condensed consolidated financial statements of XM Satellite Radio Holdings Inc. and subsidiaries have been prepared in accordance with U.S. generally accepted accounting principles, the instructions to Form 10-Q and Article 10 of Regulation S-X of the United States Securities and Exchange Commission (“SEC”) for interim financial reporting. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. We consolidate relationships with variable interest entities, as defined by Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 46(R), Consolidation of Variable Interest Entities, An Interpretation of ARB No. 51, in which we are the primary beneficiary. All significant intercompany transactions have been eliminated in consolidation. Basis of Presentation In presenting unaudited condensed consolidated financial statements, management makes estimates and assumptions that affect the amounts reported and related disclosures. Estimates, by their nature, are based on judgment and available information. Actual results could differ from those estimates. In the opinion of management, all normal recurring adjustments necessary for a fair presentation of the condensed consolidated financial statements as of September 30, 2008, the successor period of August 1, 2008 through September 30, 2008 and the predecessor periods of July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008 and three and nine months ended September 30, 2007 have been recorded. XM Satellite Radio Holdings Inc., and its subsidiaries and its businesses operate as an unrestricted subsidiary to SIRIUS under its existing indebtedness. As an unrestricted subsidiary, transactions between the companies are required to comply with various contractual restrictions in our existing debt instruments. As a result of the Merger, certain of our accounting policies were changed to conform with SIRIUS’ current accounting policies. These changes have not had, and are not expected to have, a significant impact on our consolidated financial statements. See Note 4, “Acquisition”. Although the effective date of the Merger was July 28, 2008, due to the immateriality of the results of operations for the period between July 28 and July 31, 2008, we have accounted for the Merger as if it had occurred on July 31, 2008 and “pushed-down” the recorded accounting adjustments to reflect the acquisition of XM at fair value of its assets acquired and liabilities assumed. Accordingly, our financial position and results of operations may not be comparable between the accompanying Successor and Predecessor periods. Interim results are not necessarily indicative of the results that may be expected for a full year. This Quarterly Report on Form 10-Q should be read together with our Annual Report on Form 10-K for the year ended December 31, 2007, filed with the SEC on February 28, 2008, as amended by Amendment No. 1 on Form 10-K/A, filed with the SEC on April 29, 2008, SIRIUS’ Annual Report on Form 10-K for the year ended December 31, 2007 and SIRIUS’ Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2008. (3) Summary of Significant Accounting Policies Revenue Recognition We derive revenue primarily from subscribers, advertising, direct sales of merchandise and royalties. Revenue from subscribers consists of subscription fees; non-refundable activation fees; and the effects of rebates. Revenue is recognized as it is realized or realizable and earned. We recognize subscription fees as service is provided to the subscriber. Prepaid subscription fees are recorded as deferred revenue and amortized to revenue ratably over the term of the applicable subscription plan. At the time of sale, vehicle owners purchasing or leasing a vehicle with a subscription to our service typically receive between a three-month and one-year prepaid subscription. Prepaid subscription fees received from automakers are recorded as deferred revenue and
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
amortized to revenue ratably over the service period, upon activation and sale to a customer. We reimburse automakers for certain costs associated with the satellite radio installed in the applicable vehicle at the time the vehicle is manufactured. The associated payments to the automakers are included in subscriber acquisition costs. Although we receive payments from the automakers, they do not resell our service; rather, automakers facilitate the sale of the service to our customers, acting similar to an agent. In the opinion of management, this is the appropriate characterization of our relationship since we are responsible for providing the service to the customers including being obligated to the customer in the case of an interruption of service. Activation fees are recognized ratably over the estimated term of a subscriber relationship, currently estimated to be approximately 3.5 years. The estimated term of a subscriber relationship is based on market research and management’s judgment and, if necessary, will be revised in the future. 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 by us to subscribers is recorded as a reduction to revenue. For certain rebate promotions, a subscriber must remain active for a specified period of time to be considered eligible, the estimate is recorded as a reduction to revenue over the required activation period. We recognize revenue from the sale of advertising as the advertising is broadcast. Agency fees are calculated based on a stated percentage 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 Revenue share and royalties during the period in which the advertising is broadcast. Equipment revenue from the direct sale of satellite 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. For bundled product and service promotions we allocate the revenue to subscription and equipment revenue based on their relative fair values. Stock-Based Compensation We account for equity instruments granted to employees in accordance with SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”). SFAS No. 123R requires all share-based compensation payments to be recognized in the financial statements based on their fair value. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates. We use the Black-Scholes option-pricing model to value stock option awards and have elected to treat awards with graded vesting as a single award. Fair value determined using Black-Scholes varies based on assumptions used for the expected life, expected stock price volatility and risk-free interest rates. We estimate the fair value of awards granted using the implied volatility of actively traded options on SIRIUS common stock (Successor periods) and on XM’s common stock (Predecessor periods). The expected life assumption represents the weighted-average period stock-based awards are expected to remain outstanding. These expected life assumptions are established through a review of historical exercise behavior of stock-based award grants with similar vesting periods. Where historical patterns do not exist contractual terms are used. The risk-free interest rate represents the daily treasury yield curve rate at the reporting date based on the closing market bid yields on actively traded U.S. treasury securities in the over-the-counter market for the expected term. Our assumptions may change in future periods.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
The fair value of equity instruments granted to non-employees is measured in accordance with EITF Issue No. 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. The final measurement date of equity instruments with performance criteria is the date that each performance commitment for such equity instrument is satisfied or there is a significant disincentive for non-performance. Stock-based awards granted to employees, non-employees and members of our Predecessor board of directors generally include warrants, stock options, restricted stock and restricted stock units. The stock-based compensation cost recognized includes compensation cost for all stock-based awards granted to employees and members of our Predecessor board of directors (i) prior to, but not vested as of, January 1, 2006, based on the grant date fair value originally estimated in accordance with the provisions of SFAS No. 123, Accounting for Stock-Based Compensation, and (ii) subsequent to December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. Upon completion of the Merger, all outstanding vested and unvested options and warrants to purchase XM common stock outstanding under XM Benefit Plans were converted into options and warrants to purchase shares of SIRIUS common stock at the same ratio of exchange of XM for SIRIUS common stock in the Merger. Additionally, unvested restricted stock awards outstanding under XM Benefit Plans at the time of the Merger were converted into unvested restricted stock awards of SIRIUS common stock at the same exchange ratio. SIRIUS will satisfy awards and options granted under these plans through the issuance of new shares; see Note 11, “Benefit Plans.” Subscriber Acquisition Costs Subscriber acquisition costs include hardware subsidies paid to radio manufacturers, distributors and automakers, including subsidies paid to automakers who include a satellite 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; device royalties for certain radios; commissions paid to retailers and automakers as incentives to purchase, install and activate radios; product warranty obligations; and provisions for inventory allowance. Subscriber acquisition costs do not include advertising, loyalty payments to distributors and dealers of radios and revenue share payments to automakers and retailers of radios. Subsidies paid to radio manufacturers and automakers are expensed upon shipment or installation. Commissions paid to retailers and automakers are expensed either upon activation or sale of radios. Research & Development Costs Research and development costs are expensed as incurred and primarily include the cost of new product development, chip set design, software development and engineering. For the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and the three and nine months ended September 30, 2007, we recorded research and development costs of $2,611, $23,045, $5,191, $8,343 and $23,812, respectively. These costs are reflected in Engineering, design and development expense in our unaudited condensed consolidated statements of operations. 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. Subsequent to the Merger, XM files its income tax returns as a part of the SIRIUS consolidated group; however, provisions for income taxes are recorded by XM as if we file separately.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
Inventory Inventory consists of finished goods, refurbished goods and other raw material components used in manufacturing radios. Inventory is stated at the lower of cost, determined on a first-in, first-out basis, or market. We record an estimated allowance for inventory that is considered slow moving and obsolete or whose carrying value is in excess of net realizable value. Investments Marketable Securities—We account for investments in marketable securities in accordance with the provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Marketable securities consist of certificates of deposit, auction rate certificates and investments in debt and equity securities of other entities. The basic objectives of our investment policy are the preservation of capital, maintaining sufficient liquidity to meet operating requirements and maximizing yield. Marketable securities are classified as available-for-sale securities. Available-for-sale securities are carried at fair market value. Unrealized gains and losses are included in Accumulated other comprehensive (loss) income, net of tax, as a separate component of Stockholders’ equity (deficit). Realized gains and losses, dividends and interest income, including amortization of the premium and discount arising at purchase, are included in Interest and investment income. The specific-identification method is used to determine the cost of all securities and the basis by which amounts are reclassified from Accumulated other comprehensive (loss) income into earnings. Restricted Investments—We have certificates of deposit, money market funds and interest bearing accounts which are restricted as to their withdrawal. See Note 9, “Investments”. Equity Method Investments—Investments in which we have the ability to exercise significant influence but not control are accounted for using the equity method. We recognize our share of net earnings or losses of the affiliate in Other income (expense) in our unaudited condensed consolidated statements of operations. We evaluate our equity method investments for impairment whenever events or changes in circumstances indicate that the carrying amounts of such investments may not be recoverable. The difference between the carrying value of the equity method investments and their estimated fair values is recognized as an impairment when the loss in value is deemed other than temporary. Cost Method Investments—Investments in equity securities that do not have readily determinable fair values and in which we do not have a controlling interest or are unable to exert significant influence are recorded at cost. We adopted the provisions of SFAS No. 157, Fair Value Measurements, on January 1, 2008 as it applies to financial assets and liabilities. SFAS No. 157 establishes a fair value hierarchy for input into valuation techniques as follows: i) Level 1 input—quoted prices in active markets for identical instrument; ii) Level 2 input—observable market data for same or similar instrument but not Level 1; and iii) Level 3 input—unobservable inputs developed using the best information available. We use Level 3 inputs to fair value our investments in auction rate certificates issued by student loan trusts and 8% convertible unsecured subordinated debentures issued by XM Canada. See Note 9, Investments. Investments are periodically reviewed for impairment and a write down is recorded whenever declines in fair value below carrying value are determined to be other than temporary. In making this determination, we consider, among other factors, the severity and duration of the decrease as well as the likelihood of a recovery within a reasonable timeframe.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
Property and Equipment Property and equipment is stated at cost less accumulated depreciation and amortization. Equipment under capital leases is stated at the present value of minimum lease payments. Depreciation and amortization are calculated using the straight-line method over the following estimated useful lives:
We operate four in-orbit satellites in our XM system, 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 have an agreement with Space Systems/Loral to construct one additional satellite. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, long-lived assets, such as property and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset. Goodwill and Other Intangible Assets Goodwill represents the purchase price in excess of the net amount assigned to assets acquired and liabilities assumed in the Merger. We will perform an impairment test at least annually or more frequently if indicators of impairment exist. We are required to perform a two-step impairment test of goodwill under the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. The fair value of the entity is compared to its carrying value and if the fair value exceeds its carrying value then goodwill is not impaired. If the carrying value exceeds the fair value then we will compare the implied fair value of goodwill to the carrying value of goodwill. If the implied fair value exceeds the carrying value then goodwill is not impaired; otherwise, an impairment loss will be recorded by the amount the carrying value exceeds the implied fair value. Other intangible assets with indefinite lives are tested for impairment at least annually or more frequently if indicators of impairment exist under the provisions of SFAS No. 142. Other intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment under the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Reclassifications Certain amounts in our Predecessor unaudited condensed consolidated financial statements have been reclassified to conform to the Successor presentation.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
Allocations SIRIUS XM allocates its overhead to the Company based on the estimated costs incurred by SIRIUS XM that pertain to the Company. The impact of cost allocation from SIRIUS XM during the period August 1 through September 30, 2008 has been determined to be immaterial. Recent Accounting Pronouncements In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position (“FSP”) 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13 and FSP 157-2, Effective Date of FASB Statement No. 157. FSP 157-1 amends SFAS No. 157 to remove certain leasing transactions from its scope. FSP 157-2, delays the effective date of SFAS No. 157 for all nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on at least an annual basis, until January 1, 2009 for calendar year end entities. We adopted the provisions of SFAS No. 157 on January 1, 2008, except as it applies to nonfinancial assets and liabilities as noted in FSP 157-2. The partial adoption had no significant impact on our consolidated results of operations or financial position. We have not determined the impact, if any, that the adoption of SFAS No. 157, as it relates to nonfinancial assets and liabilities, will have on our consolidated results of operations or financial position. In November 2007, the FASB issued SFAS No. 141R, Business Combinations, which continues to require that all business combinations be accounted for by applying the acquisition method. Under the acquisition method, the acquirer recognizes and measures the identifiable assets acquired, the liabilities assumed, and any contingent consideration and contractual contingencies, as a whole, at their face value as of the acquisition date. Under SFAS No. 141R, all transaction costs are expensed as incurred. SFAS No. 141R rescinds EITF No. 93-07, Uncertainties Related to Income Taxes in a Purchase Business Combination. Under EITF No. 93-07 the effect of any subsequent adjustments to uncertain tax positions were generally applied to goodwill, except for post-acquisition interest on uncertain tax provisions, which was recognized as an adjustment to income tax expense. Under SFAS No. 141R all subsequent adjustments to these uncertain tax positions that otherwise would have impacted goodwill will be recognized in the income statement. The guidance in SFAS No. 141R will be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning after December 15, 2008. SFAS No. 141R does not impact the accounting for the Merger. In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—An amendment of FASB Statement No. 133, which requires enhanced qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2008, with early adoption permitted. We will adopt this Statement effective January 1, 2009. We do not expect the adoption of SFAS No. 161 to have any impact on our consolidated results of operations or financial position. In December 2007, the FASB ratified EITF No. 07-1, Accounting for Collaborative Agreements, which provides guidance on how the parties to a collaborative agreement should account for costs incurred and revenue generated on sales to third parties, how sharing payments pursuant to a collaboration agreement should be presented in the income statement and certain related disclosure requirements. This EITF is effective for the first annual or interim reporting period beginning after December 15, 2008, and should be applied retrospectively to all prior periods presented for all collaborative arrangements existing as of the effective date. We will adopt EITF No. 07-1 effective January 1, 2009. We are currently evaluating the impact, if any, that the adoption of EITF No. 07-1 will have on our consolidated results of operations and financial position. In April 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 142-3, Determination of the Useful Life of Intangible Assets. FSP No. FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
useful life of a recognized intangible asset under SFAS 142, Goodwill and Other Intangible Assets. We will adopt FSP No. FAS 142-3 effective January 1, 2009. We are currently evaluating the impact, if any, that the adoption of FSP No. FAS 142-3 will have on our consolidated results of operations and financial position. (4) Acquisition On July 28, 2008, Vernon Merger Corporation, a wholly-owned subsidiary of SIRIUS, merged with and into XM Satellite Radio Holdings Inc. As a result, we became a wholly-owned subsidiary of SIRIUS. The Merger was effected pursuant to an Agreement and Plan of Merger (the “Merger Agreement”), dated as of February 19, 2007, entered into by SIRIUS, XM and Vernon Merger Corporation. The effective date of the Merger was July 28, 2008; however, due to the immateriality of the results of operations for the period July 28, 2008 through July 31, 2008, we have accounted for the Merger as if it had occurred on July 31, 2008. The Merger has been accounted for under the purchase method of accounting pursuant to the provisions of SFAS No. 141, Business Combinations. The application of purchase accounting under SFAS No. 141 resulted in the transaction being valued at $5,836,363, due predominantly to the average closing price of $3.79 of SIRIUS common stock on The NASDAQ Global Select Market for the two days prior to, including, and two days subsequent to the public announcement of the Merger on February 19, 2007. On that basis, the table below shows the value of the consideration paid in connection with the Merger:
SFAS No. 141 requires that the total purchase price be allocated to the fair value of assets acquired and liabilities assumed based on their fair values at the acquisition date, with any excess recorded as goodwill. We have preliminarily allocated the purchase price based on current estimates of the fair values of assets acquired and liabilities assumed in connection with the Merger.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
The table below summarizes the preliminary estimates of fair value of the XM assets acquired, liabilities assumed and related deferred income taxes as of the acquisition date. These preliminary estimates will be revised in future periods and the revisions may materially affect the presentation of our consolidated financial results. Any changes to the initial estimates of the fair value of the assets and liabilities will be recorded as adjustments to those assets and liabilities and residual amounts will be allocated to goodwill. You should not place undue reliance on the preliminary analysis of XM’s tangible and intangible assets and liabilities set forth below.
In connection with the Merger, we recorded a preliminary estimate of goodwill in the amount of $6,626,504. During the three and nine months ended September 30, 2008, we recorded a $5,026,838 impairment loss related to this goodwill; see Note 5 “Goodwill Impairment”. In connection with the Merger, $2,250,000 of the purchase price was allocated to certain indefinite lived intangible assets of XM, including $2,000,000 associated with XM’s FCC license and $250,000 associated with trade names. During the three and nine months ended September 30, 2008, no impairment loss was recorded for intangible assets with indefinite lives. In connection with the Merger, $453,444 of the purchase price was allocated to certain intangible assets of XM which are subject to amortization on a straight line basis. Acquired definite lived intangible assets include $360,000 associated with subscriber relationships (9-year useful life), $16,444 associated with proprietary software (6-year weighted average useful life), and $2,000 associated with developed technology (10-year useful life). During the three and nine months ended September 30, 2008, we recorded amortization expense of $9,232.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
As of September 30, 2008, we recorded $61,513 of costs recognized under EITF No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination, as liabilities assumed in the Merger. These costs are primarily associated with XM employee bonuses earned and severance benefits for involuntary separations. Future amortization expense for intangible assets as of September 30, 2008 is as follows:
(5) Goodwill Impairment We recorded a preliminary estimate of goodwill in the amount of $6,626,504 in connection with the Merger. Pursuant to the provisions of SFAS No. 141, we have made allocations of fair value to acquired assets and assumed liabilities. These allocations are preliminary and we may update them prior to July 28, 2009, the first anniversary of the Merger. SFAS No. 142 requires that we assess goodwill for impairment at least annually or more frequently if indicators of impairment exist. Subsequent to the Merger, the price of SIRIUS common stock has declined significantly from February 19, 2007, the measurement date for valuation of the Merger, indicating a potential impairment . Under SFAS No. 142, the fair value of the entity is compared to its carrying value and, if the fair value exceeds its carrying value, goodwill is not impaired. If the carrying value exceeds the fair value then the implied fair value of goodwill is compared to the carrying value of goodwill. If the implied fair value exceeds the carrying value then goodwill is not impaired; otherwise, an impairment loss is recorded reflecting the amount by which the carrying value exceeds the implied fair value. Our impairment analysis indicated that the carrying value of goodwill exceeded the implied fair value of goodwill, resulting in an impairment charge of $5,026,838. To the extent there are significant changes in the recorded amount of goodwill as a result of the final allocations of fair value to the acquired assets and assumed liabilities, there may be significant adjustments to this estimate of impairment loss. (6) Subscriber Revenue Subscriber revenue consists of subscription fees, non-refundable activation fees and the effects of rebates. Revenues received from automakers for prepaid subscriptions included in the sale or lease price of a new vehicle are also included in subscriber revenue over the service period upon activation and sale to the customer.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
Subscriber revenue consists of the following:
(7) Interest Costs We capitalize a portion of the interest on funds borrowed to finance the construction and launch of our satellites. The following is a summary of our interest costs:
(8) Related Party Transactions In 2005, we entered into a number of agreements with XM Canada that provide XM Canada with the right to offer XM satellite radio service in Canada in return for XM receiving consideration described below, and a 23.33% equity ownership in shares of XM Canada. The agreements have an initial term of ten years and XM Canada has the unilateral option to extend the term of the agreements for an additional five years at no additional cost beyond the current financial arrangements. XM Canada has expressed its intent to exercise this option at the end of the initial term of the agreements. We have the right to receive a 15% royalty fee for all subscriber fees earned by XM Canada each month for its basic service and a nominal activation fee for each gross activation of an XM Canada subscriber on our system. XM Canada is obligated to pay us a total of $71,800 for the rights to broadcast and market National Hockey League (“NHL”) games for the 10-year term of the Company’s contract with the NHL, as amended. In accordance with EITF No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, we recognize these payments on a gross basis as a principal. The amount of the Merger purchase price allocated to the value of our rights in XM Canada is $35,000 and is recorded as Deferred income on our condensed consolidated balance sheets and will be amortized on a straight-line basis over the remaining expected term of the agreements. The remaining carrying value of Deferred income related to XM Canada was $34,524 as of September 30, 2008. We have provided XM Canada with a C$45,000 standby credit facility which can only be utilized to finance purchases of terrestrial repeaters or for the payment of subscription fees. The facility matures on December 31, 2012; borrowings under the facility made prior to August 31, 2008 bear interest at a rate of 9% per annum; borrowings subsequent to August 31, 2008 bear interest at a rate of 17.75%. We have the right to convert unpaid principal amounts into Class A subordinate voting shares of XM Canada at the price of C$16.00 per share. As of September 30, 2008, XM Canada had drawn $7,831 on this facility in lieu of payment of subscription fees.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
In conjunction with the deferred income related to XM Canada, we recorded amortization of $833, $5,829, $1,665, $2,498 and $7,495 for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007, respectively. The royalty fees which we earn related to subscriber and activation fees are recorded as Other revenue in our unaudited condensed consolidated statements of operations. We recorded royalty fees of $76, $523, $146, $88 and $214 for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007, respectively. Related to the NHL agreement, XM Canada pays us a licensing fee and reimburses us for advertising, both of which are recorded to Other revenue in our unaudited condensed consolidated statements of operations. We recorded licensing fees of $500, $3,500, $1,000, $1,125 and $3,375 for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007, respectively. We recorded reimbursements for advertising of $0, $833, $0, $0 and $667 for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007. The amounts due from XM Canada at September 30, 2008 and December 31, 2007 were $12,815 and $9,752, respectively, and are included in Related party current assets in our unaudited condensed consolidated balance sheet. We have agreements with General Motors (“GM”) and American Honda Motor Co., Inc. (“American Honda”), both of which hold shares of SIRIUS common stock and have a director on the SIRIUS Board of Directors. GM and American Honda install XM radios, and jointly promote XM radio service, and XM will make available use of its bandwidth. Subscriber revenues received from GM and American Honda for these programs are recorded as Related party revenue. We recorded total revenue from GM, primarily consisting of subscriber revenue, of $4,041, $25,394, $6,733, $9,917 and $24,798 for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007, respectively. We recorded total revenue from American Honda, primarily consisting of subscriber revenue, of $1,738, $10,599, $3,321, $4,798 and $13,759 for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007, respectively. We rely on GM and American Honda for marketing and we are responsible for certain revenue share payments to these related parties. We recognized Sales and marketing expense with GM of $15,911, $116,677, $38,069, $52,299 and $133,122 for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007, respectively. We recognized Sales and marketing expense with American Honda of $1,046, $5,330, $1,848, $2,542 and $4,897 for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007, respectively. We recognized Revenue share and royalty expense with GM of $12,172, $79,869, $26,021, $28,514 and $79,369 for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007, respectively. We recognized Revenue share and royalty expense with American Honda of $376, $1,901, $747, $268 and $340 for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007, respectively. As of September 30, 2008, we recorded, within Related party assets, $10,955 and $213,703 of amounts due from GM and prepaid expenses with GM, respectively. As of December 31, 2007, we recorded, within Related party current assets, $8,505 and $218,196 of amounts due from GM and prepaid expenses with GM, respectively. As of September 30, 2008 and December 31, 2007, we recorded, within Related party current assets, $1,612 and $3,325 of amounts due from American Honda, respectively. As of September 30, 2008 and December 31, 2007, we recorded, within Related party current liabilities, $70,640 and $62,233 of amounts due to GM, respectively. As of September 30, 2008 and December 31, 2007, we recorded, within Related party current liabilities, $4,978 and $3,513 of amounts due to American Honda, respectively.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
(9) Investments Investments as of September 30, 2008 consist of marketable securities of $11,521, which are included in the Other assets in the condensed consolidated balance sheet; restricted investments of $120,250, which are included in the Restricted investments in the condensed consolidated balance sheet; embedded derivative accounted for separately from host contract of $420, which is included in the Other long-term assets in the condensed consolidated balance sheet; and equity method investments of $37,337, which are included in the Other long-term assets in the condensed consolidated balance sheet. XM Canada In 2005, XM Canada issued to us 11,077,500 Class A subordinate voting shares representing a 23.33% economic interest in XM Canada. In connection with the Merger, $41,188 of the purchase price was allocated to the value of our investment in XM Canada. The Company’s investment in XM Canada is recorded using the equity method since we have significant influence, but less than a controlling voting interest in XM Canada. Under this method, the investment in XM Canada is quarterly adjusted to recognize our share of net earnings or losses as they occur, rather than at the time dividends or other distributions are received, limited to the extent of the Company’s investment in, advances to, and commitments to fund XM Canada. Our share of net earnings or losses of XM Canada is recorded to Equity in net loss of equity method investment in our unaudited condensed consolidated statements of operations. We recorded $1,835, $10,385, $3,089, $4,546 and $12,723 for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and for each of three and nine months periods ended September 30, 2007 for our share of XM Canada’s net loss. In September 2007, we purchased C$4,000 face value 8% convertible unsecured subordinated debentures issued by XM Canada for which the embedded conversion feature is required under SFAS No. 133 to be bifurcated from the host contract. The host contract is accounted for as an available-for-sale security at fair value with changes in fair value recorded as Accumulated other comprehensive income, net of tax. The embedded conversion feature is accounted for as a derivative at fair value with changes in fair value recorded in earnings as Interest income. As of September 30, 2008, the carrying value of our equity method investment was $37,337, while the carrying value of the host contract and embedded derivative related to our investment in the debentures was $2,804 and $420, respectively. WorldSpace In 2005, we acquired 1,562,500 shares of Class A common stock of WorldSpace, Inc. (“WSI”). During July 2008, we wrote off the remaining carrying value of our investment in WSI’s shares due to decreases in fair value that were considered to be other than temporary and recorded $2,625 as a Loss from impairment of investments in the unaudited condensed consolidated statements of operations for the period July 1, 2008 through July 31, 2008. On October 16, WSI filed for reorganization under Chapter 11 bankruptcy codes. Auction Rate Certificates In October 2007, we purchased $9,450 of auction rate certificates issued by student loan trusts. Auction rate certificates are long-term securities structured to reset their coupon by means of an auction. We account for our investment in ARCs as available-for-sale securities. As of September 30, 2008, the carrying value of these securities was $8,718. Restricted Investments Restricted investments relate to deposits placed into escrow for the benefit of third parties pursuant to programming agreements. In May 2008, we deposited $120,000 into an escrow account pursuant to an agreement with Major League Baseball® (“MLB”) for general credit support. As of September 30, 2008 and December 31, 2007, the carrying value of our long-term restricted investments was $120,000 and zero, respectively, and included certificates of deposit and money market funds deposited in escrow for the benefit of MLB.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
The following table summarizes the fair value of our financial instruments at September 30, 2008:
The following tables present the changes in the Level 3 fair-value category for the Successor Entity period, August 1, 2008 through September 30, 2008 and the Predecessor Entity period, January 1, 2008 through July 31, 2008. The Company classifies financial instruments in Level 3 of the fair-value hierarchy when there is reliance on at least one significant unobservable input to the valuation model. In addition to these unobservable inputs, the valuation models for Level 3 financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Thus, the gains and losses presented below include changes in the fair value related to both observable and unobservable inputs.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
(10) Debt Debt and accrued interest consists of the following:
As a part of the Merger, XM’s pre-acquisition debt was revalued based on the fair value at the time of Merger. The resulting discount or premium is being amortized to interest expense over the remaining term of the debt. Refinancing transactions In connection with the Merger, we refinanced a substantial portion of our existing indebtedness:
We used the proceeds from the transactions described above to:
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
In July 2008, we amended the terms of its $400,000 aggregate principal amount of 1.75% Convertible Senior Notes due 2009 to increase the interest rate from 1.75% to 10% per annum effective July 2, 2008 as part of an agreement whereby holders of the notes waived any right to seek a change of control put in connection with the Merger. Senior Secured Term Loan We are party to a credit agreement relating to a $100,000 Senior Secured Term Loan (the “XM Term Loan”) with UBS AG. The XM Term Loan matures on May 5, 2009. Interest is payable quarterly on September 26, December 26 and March 26 at a rate currently set at 5.5625%. The interest rate is reset quarterly to 225 basis points over the 9-month LIBOR. The XM Term Loan is secured on a pari passu basis with the Revolving Credit Facility (as defined below) by substantially all of Inc.’s assets. 7% Exchangeable Senior Subordinated Notes due 2014 In August 2008, Inc. issued $550,000 aggregate principal amount of 7% Exchangeable Senior Subordinated Notes due 2014 (the “Exchangeable Notes”). The Exchangeable Notes are senior subordinated obligations of Inc. and rank junior in right of payment to its existing and future senior debt and equally in right of payment with its existing and future senior subordinated debt. XM, XM Equipment LLC and XM Radio Inc. have guaranteed the Exchangeable Notes on a senior subordinated basis. Interest is payable semi-annually in arrears on June 1 and December 1 of each year at a rate of 7% per annum. The Exchangeable Notes mature on December 1, 2014 and are exchangeable at any time at the option of the holder into shares of SIRIUS’ common stock, par value $0.001 per share, at an initial exchange rate of 533.3333 shares of SIRIUS common stock per $1,000 principal amount of Exchangeable Notes, which is equivalent to an approximate exchange price of $1.875 per share of SIRIUS common stock. 9.75% Senior Notes due 2014 Inc. has outstanding $5,260 aggregate principal amount of 9.75% Senior Notes due 2014 (the “9.75% Notes”). Interest on the 9.75% Notes is payable semi-annually on May 1 and November 1 at a rate of 9.75% per annum. The 9.75% Notes are unsecured and will mature on May 1, 2014. Inc., at its option, may redeem the 9.75% Notes at declining redemption prices at any time on or after May 1, 2010, subject to certain restrictions. Prior to May 1, 2010, Inc. may redeem the 9.75% Notes, in whole or in part, at a price equal to 100% of the principal amount thereof, plus a make-whole premium and accrued and unpaid interest to the date of redemption. Senior Floating Rate Notes due 2013 The aggregate principal amount of Inc.’s unsecured Senior Floating Rate Notes due 2013 (the “Floating Rate Notes”) outstanding as of December 31, 2007 was $200,000. Interest was payable quarterly on May 1, August 1, November 1 and February 1. Inc. repurchased all of the Floating Rate Notes in connection with the Merger. Debt of Consolidated Variable Interest Entity On February 13, 2007, we entered into a sale-leaseback transaction with respect to the transponders on our XM-4 satellite. We sold the XM-4 transponders to Satellite Leasing (702-4) LLT (“Trust”), a third-party trust formed solely for the purpose of facilitating the sale-leaseback transaction. The Trust pooled the funds used to purchase the transponders from a $57,700 investment by an equity investor and the $230,800 in proceeds from the issuance of its 10% senior secured notes due 2013 (“Debt of consolidated variable interest entity”). We accounted for the sale and leaseback of the transponders under sale-leaseback accounting with a capital lease, pursuant to SFAS No. 13, Accounting for Leases, as amended. We also determined that the Trust was a variable interest entity, as that term is defined under FIN No. 46(R), and that we were the primary beneficiary of the Trust. Pursuant to FIN No. 46(R), we consolidated the Trust into our consolidated financial statements.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
We sold the XM-4 transponders to the Trust owned by Satellite Leasing (702-4) LLC (“Owner Participant”) for $288,500. We leased the transponders for a term of nine years. These lease payment obligations, which were unconditional and guaranteed by XM Satellite Radio Holdings Inc., were senior unsecured obligations and ranked equally in right of payment with existing and future senior unsecured obligations. Under the terms of the lease, we were obligated to make payments that total $437,400, of which $126,600 was interest, over the nine-year base lease term. We were obligated to provide credit support to the Owner Participant. To provide this credit support, we retired the existing mortgages on our headquarters and data center properties in Washington, D.C. and put into place new mortgages on those properties in favor of the Owner Participant. We repurchased the transponders on our XM-4 satellite in connection with the Merger and terminated this sale leaseback arrangement. 13% Senior Notes due 2014 In July 2008, XM Escrow LLC (“Escrow LLC”), a Delaware limited liability company and wholly-owned subsidiary of us, issued $778,500 aggregate principal amount of 13% Senior Notes due 2014 (the “13% Notes”). Interest is payable semi-annually in arrears on February 1 and August 1 of each year at a rate of 13% per annum. The 13% Notes are unsecured and mature in 2014, with such maturity to occur earlier in 2013, in certain circumstances. Escrow LLC deposited the proceeds of the offering of the 13% Notes into escrow. Upon consummation of certain refinancing transactions and the Merger, the funds were released to Escrow LLC and Escrow LLC merged with and into Inc., with Inc. being the surviving corporation. Upon the Merger, the 13% Notes became our obligation and became guaranteed by us, XM Equipment Leasing LLC and XM Radio Inc. 10% Convertible Senior Notes due 2009 We have outstanding $400,000 aggregate principal amount of 10% Convertible Senior Notes due 2009 (the “10% Convertible Notes”). Interest is payable semi-annually at a rate of 10% per annum. The 10% Convertible Notes mature on December 1, 2009. The 10% Convertible Notes may be converted by the holder, at its option, into shares of SIRIUS’ common stock at a conversion rate of 92.0 shares of SIRIUS common stock per $1,000 principal amount, which is equivalent to a conversion price of $10.87 per share of SIRIUS common stock (subject to adjustment in certain events), at any time until December 1, 2009. 10% Senior Secured Discount Convertible Notes due 2009 We (with Inc. as co-obligor) have outstanding $33,249 aggregate principal amount of 10% Senior Secured Discount Convertible Notes due 2009 (the “10% Discount Convertible Notes”). Interest accreted through December 31, 2005 and was thereafter payable semi-annually at a rate of 10% per annum. The 10% Discount Convertible Notes mature on December 31, 2009. At any time, a holder of the notes may convert all or part of the accreted value of its notes at a conversion price of $0.69 per share of SIRIUS common stock. The 10% Discount Convertible Notes, rank equally in right of payment with all of our other existing and future senior indebtedness, and are senior in right of payment to all of our existing and future subordinated indebtedness. Senior Secured Revolving Credit Facility We are party to a $250,000 Senior Secured Revolving Credit Facility (“Revolving Credit Facility”), which has been fully drawn. The Revolving Credit Facility matures on May 5, 2009. Borrowings under the Revolving Credit Facility bear interest at a rate of LIBOR plus 150 to 225 basis points or an alternate base rate, to be the higher of the JPMorgan Chase prime rate and the Federal Funds rate plus 50 basis points, in each case plus 50 to 125 basis points. For $187,500 of the drawn amount, interest as of September 30, 2008 was 4.75%; and for $62,500 of the drawn amount, interest as of September 30, 2008 was 5.25%. The Revolving Credit Facility is secured by substantially all of Inc.’s assets, other than certain specified property.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
Embedded Derivatives We issued convertible debt securities, including the 10% Convertible Senior Notes and the 10% Senior Secured Convertible Notes, containing non-detachable conversion or exchange features. Upon completion of the Merger, these debt agreements were amended such that the settlement of conversion features is into shares of SIRIUS stock. The convertible and exchangeable features are embedded derivatives, and subsequent to the Merger are required to be separated from the host contract for accounting purposes in accordance with SFAS No. 133, Accounting for Hedging and Derivative Instruments. The embedded derivatives are recorded as derivative liabilities in accrued liabilities and the change in fair value is reported as a realized investment gain or loss during the period of change. As a result of the Merger, we recognized $65,679 in derivative liabilities related to the 10% Convertible Senior Notes and the 10% Senior Secured Convertible Notes. As a result of the issuance of Exchangeable Notes on August 1, 2008, we recognized an additional $279,326 in derivative liabilities. Due to the change in fair value of these embedded derivatives, we recognized $242,223 of a Gain on derivatives during the three and nine months ended September 30, 2008. The balance of derivative liabilities was $102,782 as of September 30, 2008. Covenants and Restrictions The XM Term Loan, 13% Notes and Revolving Credit Facility require compliance with certain covenants that restrict our ability to, among other things, (i) incur additional indebtedness, (ii) incur liens, (iii) pay dividends or make certain other restricted payments, investments or acquisitions, (iv) enter into certain transactions with affiliates, (v) merge or consolidate with another person, (vi) sell, assign, lease or otherwise dispose of all or substantially all of our assets, and (vii) make voluntary prepayments of certain debt, in each case subject to exceptions as provided in the applicable indenture or credit agreement. The XM Term Loan and Revolving Credit Agreement also require XM to maintain a level of cash and cash equivalents of at least $75,000. If we fail to comply with these covenants, the XM Term Loan, 13% Notes and the Revolving Credit Facility could become immediately payable. At September 30, 2008, we were in compliance with all such covenants. (11) Benefit Plans We maintain three share-based benefit plans. Upon completion of the Merger, all outstanding vested and unvested options and warrants to purchase XM common stock outstanding under XM Benefit Plans were converted into options and warrants to purchase shares of SIRIUS common stock at the same exchange ratio of XM common stock for SIRIUS common stock in the Merger. Additionally, unvested restricted stock awards outstanding under XM Benefit Plans at the time of the Merger were converted into unvested restricted stock awards of SIRIUS common stock. The rate used for this conversion was 4.6 SIRIUS options for 1 XM option. The same 4.6 conversion rate was also applied to the original grant date exercise price. There was no acceleration of vesting solely as a result of the exchange and the original expiration dates of the options remain in effect. The fair value of these options was estimated using the Black-Scholes option pricing model. SIRIUS will satisfy awards and options granted under these plans through the issuance of new shares. For the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007, we recognized share-based payment expense of $4,033, $34,485, $5,611, $19,987 and $48,198, respectively. Compensation expense was recorded in our unaudited condensed consolidated statements of operations related to these plans. For a summarized schedule of share-based payment expense, see the appended footnote to our unaudited condensed consolidated statements of operations. We did not capitalize any share-based payment cost during any of the periods described above. We did not realize any income tax benefits from share-based benefit plans during any of the periods described above, as a result of a full valuation allowance that is maintained for substantially all net deferred tax assets.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
2007 Stock Incentive Plan XM maintains a 2007 Stock Incentive Plan (“the 2007 Plan”) under which officers, other employees and other key individuals of XM 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. Following the Merger, SIRIUS assumed maintenance over the 2007 Plan and any future grants from the plan will be denominated in SIRIUS shares. Stock option awards are granted with an exercise price equal to the market price of SIRIUS’ 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. Since the Merger, there have been no grants of awards from the 2007 Plan. As of September 30, 2008, there were 60,084,705 shares available under the 2007 Plan for future grant. 1998 Shares Award Plan XM maintains a 1998 Shares Award Plan (“the 1998 Plan”) under which, 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 were 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. XM Talent Option Plan XM maintains a Talent Option Plan (“the Talent Plan”) under which non-employee programming consultants to XM may be granted stock options awards. Stock option awards under the Talent Plan generally vest ratably over three years based on continuous service. Since the Merger, SIRIUS assumed maintenance over the Talent Plan and any future grants from the plan will be denominated in SIRIUS shares. Stock option awards are generally granted with an exercise price equal to the market price of SIRIUS’ stock at the date of grant and expire no later than ten years from the date of grant. Since the Merger, there have been no grants of awards from the Talent Plan. As of September 30, 2008, there were 1,564,000 options available under the Talent Plan for future grant. The following table summarizes the weighted-average assumptions used to compute reported share-based payment expense to employees and members of our board of directors for the periods set forth below:
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
The following table summarizes stock option activity under our share-based payment plans for the nine months ended September 30, 2008 (shares in thousands) (all Predecessor amounts have been adjusted to reflect the application of the exchange ratio in the Merger):
The weighted average grant date fair value of options granted during the periods August 1, 2008 through September 30, 2008, January 1, 2008 through July 31, 2008 and nine months ended September 30, 2007 was $0, $5.47 and $6.30, respectively. The total intrinsic value of stock options exercised during the periods August 1, 2008 through September 30, 2008, January 1, 2008 through July 31, 2008 and nine months ended September 30, 2007 was $0, $817 and $3,471, respectively. We recognized share-based payment expense associated with stock options of $699, $6,119, $1,942, $5,166 and $19,193 for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007, respectively.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
The following table summarizes the non-vested restricted stock activity under our share-based payment plans for the nine months ended September 30, 2008 (shares in thousands) (all Predecessor amounts have been adjusted to reflect the application of the exchange ratio in the Merger):
The weighted average grant date fair value of restricted stock units granted during the periods August 1, 2008 through September 30, 2008, January 1, 2008 through July 31, 2008 and nine months ended September 30, 2007 was $0, $2.78 and $2.57, respectively. The total intrinsic value of restricted stock units that vested during the periods August 1, 2008 through September 30, 2008, January 1, 2008 through July 31, 2008 and nine months ended September 30, 2007 was $11,227, $30,863 and $10,428, respectively. We recognized share-based payment expense associated with restricted stock units and shares of restricted stock of $3,335, $28,366, $3,669, $14,822 and $28,952 for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007 respectively. Total unrecognized compensation costs related to unvested share-based payment awards granted to employees and the former members of the board of directors at September 30, 2008 and December 31, 2007, net of estimated forfeitures, was $40,105 and $69,239, respectively. The weighted-average period over which the compensation expense for these awards is expected to be recognized is three years as of September 30, 2008. No income tax benefits have been realized from stock option exercises during the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007 because a valuation allowance was maintained for all net deferred tax assets. 401(k) Savings Plans We sponsor the XM Satellite Radio 401(k) Savings Plan (the “XM Plan”) for eligible employees. The XM Plan allows eligible employees to defer the maximum percentage of their compensation allowable under law on a pre-tax basis through contributions to the savings plan. Under the XM Plan, we match 50% of employee voluntary contributions, up to 6% of an employee’s pre-tax salary. Matching contributions under the XM Plan vest immediately. Expense resulting from matching contribution to the plans was $202, $2,132, $327, $445 and $1,445 for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007, respectively.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
(12) Income Taxes We recorded income tax expense (benefit) of $508, $1,512, $672, $105 and ($1,070) for the periods July 1, 2008 through July 31, 2008, January 1, 2008 through July 31, 2008, August 1, 2008 through September 30, 2008 and three and nine months ended September 30, 2007, respectively. Such expense primarily represents the recognition of a deferred tax liability related to the difference in accounting for the FCC license intangible asset, which is amortized over 15 years for tax purposes but are not amortized for book purposes. (13) Commitments and Contingencies The following table summarizes our expected contractual cash commitments as of September 30, 2008:
Debt Obligations. Long-term debt obligations include principal payments on outstanding debt. Cash Interest Payments. Cash interest payments include interest due on outstanding debt through maturity. Lease Obligations. We have entered into operating leases related to certain studios, office space, terrestrial repeaters and equipment. Satellite and Transmission. We have entered into agreements with third parties to operate and maintain the off-site satellite telemetry, tracking and control facilities and certain components of the terrestrial repeater network. We have also entered into various agreements to design and construct satellites for use in our systems and to those launch satellites. XM has also entered into an agreement with Space Systems/Loral to construct its fifth satellite, XM-5. On July 15, 2003, Space Systems/Loral, Loral Space & Communications Ltd. and certain other affiliated entities commenced voluntary Chapter 11 bankruptcy cases under the Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York. The Bankruptcy Court approved XM’s agreement with Space Systems/Loral, pursuant to which XM may make construction payments on XM-5 into an escrow account until the occurrence of an “Emergence Date,” as defined in the agreement. In August 2007, XM’s agreement with Space Systems/Loral was amended to defer payments on the remaining construction costs until the earlier of post-launch or January 2010. Boeing Satellite Systems International, Inc., the manufacturer of XM’s four in-orbit satellites, may be entitled to future in-orbit performance payments with respect to two of XM’s four satellites. Boeing may be entitled to in-orbit performance payments of up to $25,900, plus interest, for XM-3 depending on the satellite’s performance over its fifteen year design life. As of September 30, 2008, we paid Boeing $6,436 on account of such in-orbit performance payments for XM-3. Boeing may also be entitled to in-orbit performance payments for XM-4 of:
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
As of September 30, 2008, we have paid Boeing $2,355 on account of such in-orbit performance payments for XM-4. Programming and Content. We have entered into various programming agreements. Under the terms of these agreements, the Company is obligated to provide payments to other entities that may include fixed payments, advertising commitments and revenue sharing arrangements. Marketing and Distribution. We have entered into various marketing, sponsorship and distribution agreements to promote our brand and are obligated to make payments to sponsors, retailers, automakers and radio manufacturers under these agreements. Certain programming and content agreements also require us to purchase advertising on properties owned or controlled by the licensors. We also reimburse automakers for certain engineering and development costs associated with the incorporation of satellite radios into vehicles they manufacture. In addition, in the event that certain new products are not shipped by a distributor to its customers within 90 days of the distributor’s receipt of goods, we have agreed to purchase and take title to the product. Chip Set Development and Production. We have entered into agreements with third parties to develop, produce and supply chip sets; to develop product; and in certain instances, to license intellectual property related to chip sets. Other. We have entered into various agreements with third parties for general operating purposes. In addition to the contractual cash commitments described above, the Company has entered into agreements with automakers, radio manufacturers, distributors and others that include per-radio, per-subscriber, per-show and other variable cost arrangements. These future costs are dependent upon many factors, including subscriber growth, and are difficult to anticipate; however, these costs may be substantial. We may enter into additional programming, distribution, marketing and other agreements that contain similar provisions. We are not entered into any off-balance sheet arrangements or transactions. Legal Proceedings FCC Matters. In August 2008, we entered into two Consent Decrees to settle with the Enforcement Bureau of the Federal Communications Commission outstanding enforcement matters pending against SIRIUS and XM. In 2006, the FCC commenced investigations regarding the compliance of certain radios that include FM transmitters with the Commission’s rules, and the compliance of certain terrestrial repeaters with the special temporary authority granted by the Commission. The Consent Decrees terminated these inquiries. As part of the Consent Decrees, we agreed, among other things, to:
We have taken all of these actions, and are in compliance with the terms of the Consent Decrees. 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.
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Table of ContentsXM SATELLITE RADIO HOLDINGS INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued) (Dollar amounts in thousands, unless otherwise stated)
Appellate Review of FCC Merger and Consent Decree Orders. Two different parties, U.S. Electronics and Michael Hartleib, have 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 mentioned above. These matters were both filed in the United States Court of Appeals for the D.C. Circuit, and have been consolidated by the court. We have moved to intervene, and that motion has been granted. 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 has 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 has 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. 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 by us under the statutory license covering the performance of sound recordings over our satellite digital audio radio services for the six-year period starting January 1, 2007 and ending December 31, 2012. Under the terms of the CRB’s decision, we will pay a royalty of 6.0% of gross revenues, subject to certain exclusions, for 2007 and 2008, 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 are scheduled to be submitted to the United States Court of Appeals for the District of Columbia Circuit by the end of February 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 XM radios that include advanced recording functionality infringe upon plaintiffs’ copyrighted sound recordings. XM 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 have withdrawn as a party to the lawsuit and this lawsuit has been dismissed. Music 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 these products comply with applicable copyright law, including the Audio Home Recording Act, and we intend to vigorously defend this matter. 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 XM engaged in deceptive trade practices under Arkansas and other state laws by representing that its music channels are commercial-free. The court stayed the litigation and directed the parties to arbitration. XM 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 the 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 business or financial results. (14) Condensed Consolidating Financial Information We have certain series of debt securities outstanding that are guaranteed by Holdings and two of the Company’s subsidiaries, XM Equipment Leasing LLC, which owns certain terrestrial repeaters, and XM Radio Inc. These guarantees are full and unconditional and joint and several. Inc. is owned 100% by Holdings, while XM Equipment Leasing LLC and XM Radio Inc. are owned 100% by Inc. Accordingly, we provide the following condensed consolidating financial information.
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Table of ContentsXM SATELLITE RADIO INC., SUBSIDIARIES AND AFFILIATES UNAUDITED CONDENSED CONSOLIDATING BALANCE SHEETS AS OF SEPTEMBER 30, 2008 (SUCCESSOR ENTITY)
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Table of ContentsXM SATELLITE RADIO INC., SUBSIDIARIES AND AFFILIATES UNAUDITED CONDENSED CONSOLIDATING BALANCE SHEETS—(Continued) AS OF SEPTEMBER 30, 2008 (SUCCESSOR ENTITY)
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Table of ContentsXM SATELLITE RADIO INC., SUBSIDIARIES AND AFFILIATES UNAUDITED CONDENSED CONSOLIDATING BALANCE SHEETS AS OF DECEMBER 31, 2007 (PREDECESSOR ENTITY)
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Table of ContentsXM SATELLITE RADIO INC., SUBSIDIARIES AND AFFILIATES UNAUDITED CONDENSED CONSOLIDATING BALANCE SHEETS—(Continued) AS OF DECEMBER 31, 2007 (PREDECESSOR ENTITY)
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Table of ContentsXM SATELLITE RADIO INC., SUBSIDIARIES AND AFFILIATES UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS FOR THE PERIOD JANUARY 1, 2008 THROUGH JULY 31, 2008 (PREDECESSOR ENTITY)
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